The budget is not convincing enough to advance the treasurer’s ambitions, according to John Edwards
THE WONDER of Treasurer Peter Costello’s 2005-06 budget is a handsome run of higher than expected forecast revenue, not only for the current year but right through to 2008-09. That’s why Mr Costello is able to promise big tax cuts and a useful contribution to funding future public pensions liabilities, measures to encourage movement from welfare to work, more child care places and assorted spending increases, and still leave a considerable underlying surplus in each of the next four years. It is every treasurer’s dream budget. But the budget is also a missed opportunity. After fourteen years of continuous prosperity, the forecast stream of revenues offered Mr Costello the opportunity to entrench the expansion with a commitment to increase skills through more education and training, to increase supply through targeted infrastructure investment, to increase incentives by broadening the base of income tax and reducing the marginal rates, and to restrain consumer demand by budgeting an underlying surplus through next year at least as great as the expected outcome for the current year. On each of these opportunities, the treasurer passed.
Caught between the embarrassment of unexpectedly high revenues, a commitment to preserve the bond market by continuing to issue government debt, and a reluctance to undertake major infrastructure projects, Mr Costello decided to hand a good deal of the revenue back to the taxpayer. The $22 billion in tax cuts over four years are markedly more generous to the well off than the not so well off, with a sharp increase in the threshold for the top marginal rate of 47 cents and complete elimination of the superannuation contributions tax surcharge for high incomes. There will be no complaint from the winners, but it is another missed opportunity for a major tax reform. Mr Costello has spent $22bn in expected revenues over four years, and in doing so lost the means to pay for serious reform of the structure of personal income tax within the life of this parliament.
The only sensible measure of the government’s contribution to the change in overall demand next year is the change in its underlying budget surplus compared to this year. On Mr Costello’s forecast the underlying surplus this year will be $9.2bn and next year will be $8.9bn. It is fair to say this tiny fall in the budget surplus will not stimulate demand. But Mr Costello has passed up the opportunity to restrain demand - and avert another interest rate tightening - by budgeting a bigger surplus next year. The Reserve Bank will be unaffected by the budget, which is to say the likelihood of a tightening in the second half remains. Mr Costello thinks the economy is quite weak, and needs help. The Reserve Bank does not. As we saw in last week’s Statement on Monetary Policy the Bank thinks demand may have slowed a bit this year, but the strong terms of trade and high business investment will keep it going at a reasonable pace.
The creation of a Future Fund to amass financial assets against future pubic service pension liabilities was announced during the October 2004 election campaign. The budget puts clothes on the form, and assets in the fund. Importantly, Mr Costello has said the $30bn plus proceeds from the sale of the government share of Telstra will be put in the fund, a commitment which will put him in a serious conflict with the National Party, and also with those in the government who believe the federal government can be doing more to build infrastructure.
There are roughly 700,000 working age Australians on disability support pensions, and 400,000 on the supporting parents benefit. The budget includes measures intended to push a significant proportion of them into jobs. The tougher eligibility tests and lower effective marginal tax rates will be useful in slowing the growth of welfare dependence - but it is entirely implausible that single parents now minding children and older males on disability support pensions will make a big difference to the looming skills shortages in the Australian economy. It is a useful measure, but not for addressing labour supply constraints.
The economic forecasts offered by the budget are towards the lower end of consensus range, but well within it. I think a 2 per cent real growth outcome for 2004-05 is about right, and since we have half of the data for the year it is not a bold forecast. The economy may do a little better in 2005-06 than the 3 per cent forecast in the budget, but not much better. The forecast composition of growth shows Treasury’s firm belief that exports will pick up sufficiently through 2005 and 2006 to offset the continuing fall in residential construction, a view I share.
Behind the unexpectedly high forecast revenues is a high profit share of GDP, which reflects high commodity prices, productivity gains, and restrained growth in wages. Personal income tax has also been increased by rising incomes and employment, even allowing for the tax cuts announced during the last election. The swelling revenue stream was already strikingly apparent in last year’s Pre-Election Economic and Fiscal Outlook (PEFO), which lifted the underlying surplus by roughly $12 billion over the four year forecast period, compared to the budget forecast only five months earlier. The Mid-Year Economic and Fiscal Outlook came out only two months after the PEFO, modestly raised revenue projections but also the spending projections, for minimal net impact on the underlying surpluses. The 2005-06 budget lifts the underlying surplus projections in each of the forecast years compared to the December estimate, after providing for $22 billion in tax cuts and considerable additional spending.
THE POLITICS of this budget are as much between the treasurer and the prime minister as between the government and the opposition. In the past two weeks Mr Costello has challenged Mr Howard for the top job, and despite the temporary lift he will get from the budget publicity, he has already lost. This leadership challenge was conducted without a vote, a party room discussion, or any serious counting of numbers. It took the form of Mr Costello’s claim on the party leadership, advanced through the media and personally pressed in a meeting with the prime minister. Mr Howard called his bluff, and Mr Costello has discovered he has a poor hand. The public opinion polls suggest he could lose against opposition leader Kim Beazley, while Mr Howard would win. Party room opinion suggests the while Mr Costello would be elected leader virtually unanimously if Mr Howard chooses to leave, he would get very few votes in a contest against him. The budget is Mr Costello’s one chance to break through, but it is not big enough, fresh enough or convincing enough to change his standing. In the undeclared challenge, Mr Costello is the undeclared loser. •
John Edwards is Chief Economist with HSBC. A former advisor to Prime Minister Paul Keating, his latest book, Curtin’s Gift, was published recently by Allen and Unwin. Photo: iStockphoto.com.