Every year, the Parliamentary Budget Office (PBO) prepares a large number of policy costings for parliamentarians. These provide estimates of the impact of the proposed policies on the Australian Government Budget over the next decade.
Individual policies can affect the Budget through a number of different channels. The most significant is generally the impact that the policy has on the individuals, businesses or organisations that are directly affected by the policy. These impacts are referred to as direct or first round effects and are routinely included in PBO costing estimates.
In any economic system, however, there are often flow-on effects from a given policy change to other prices and markets which, in turn, can affect budget outcomes. These impacts are referred to as broader economic effects, second round effects, or indirect effects. While there is no question that these broader economic effects do arise, there is generally considerable uncertainty about the magnitude, direction and timing of those effects and their subsequent impact on the Budget.
The approach taken by the PBO to estimate the broader economic effects of policy proposals on the Budget is consistent with the Charter of Budget Honesty Policy Costing Guidelines. That is, in the majority of circumstances budget costings only capture the direct impacts of the policy change, including the behavioural changes of groups who are directly affected by the policy. This is consistent with the approach to most costings undertaken in the United States of America, United Kingdom, Canada and New Zealand.
Every now and then, however, broader economic effects are incorporated in budget projections. Over recent decades there have been seven examples of major reform proposals put forward by Australian governments where broader economic effects have been incorporated.
Consistent with its current approach, the PBO will continue to highlight in its costing responses a qualitative statement when a policy proposal could have material broader economic effects that may affect budget outcomes and cannot be estimated. We will consider incorporating quantitative estimates of broader economic effects into policy costings in limited circumstances where there is compelling evidence of the direction, size and timing of a material economy‑wide impact, where the way the proposal would be funded has been made clear and where the broader economic impact can be estimated in a cost‑effective manner.
The purpose of this paper is to expand upon the PBO’s general approach to costings as set out in Information paper no. 02/2017 What is a Parliamentary Budget Office costing? and, in particular, to explain our treatment of potential broader economic effects in costings.