MYEFO 2015 – government adopts 'more realistic' economic outlook: experts react

The government has revised down its forecast for economic growth to 2.5% in what Federal Treasurer Scott Morrison says is a “more realistic outlook” for Australia’s transitioning economy.

Morrison’s first mid-year economic update forecasts the deficit will blow out to A$37.4 billion in 2015-16, before being bought back to A$14.2 billion in 2018-19. The government now says it is committed to returning the budget to surplus “as soon as possible”, with a surplus not projected until 2020-21, and cumulative deficits of $108 billion over the next four years.

Net government debt is expected to grow to a peak of 18.5% of GDP in 2017-18, with gross debt rising to A$647 billion by 2025.

Facing a revenue write-down of almost A$34 billion caused by falling commodity prices, the government has also revised down its iron ore price assumption from US$48 per tone to US$39 per tonne. The tumbling iron ore price is expected to wipe A$7 billion off the government’s tax receipts in the years to 2017.

The government has revised down its expectation for unemployment to rise, pegging it at 6% for 2016-17. “Recent jobs data suggests even these estimates may be too conservative,” Morrison said in a statement.

Health, welfare and aged care have been selectively targeted in a bid to make the savings necessary to reduce the deficit. The government will target welfare payments with better income data matching, reduce bulk billing incentives for pathology services and cut back the size of Tony Abbott’s Green Army.

Morrison said the 180 measures in the update would mean the overall impact of policy decisions since the budget would be an improvement of A$400 million.

Our experts respond below.

On the path back to surplus

Professor Remy Davison, Jean Monnet Chair in Politics and Economics, Monash University

“Are we there yet?” Treasurer Scott Morrison asked in his media conference launching the MYEFO.

No. Not even close. No surplus in sight. $37.4 billion in deficit. Growth revised down.

Prime Minister Malcolm Turnbull and Treasurer Scott Morrison’s problem is they need to deliver innovation incentives, fiscal responsibility and generous election-year handouts simultaneously: an impossible trinity.

Deficits as far as the eye can see. Postpone any hint of surplus until 2020/21. Put simply, there is no clear path to surplus (or even minor deficits) in this MYEFO.

Driving the revenue shortfall is the dramatic fall in the terms of trade, driven by collapsing iron ore prices, which remain at less than $40 per tonne. The May 2015/16 Budget was built around price assumptions of $48. MYEFO revises this to a much-more-realistic $39 per tonne.

Around $7 billion in savings remain in the 2015/16 Budget that the government hopes will get through the Senate. So the numbers will be far worse if some, or all, of these savings are rejected.

The government is bullish on jobs, but has no reason to be, given flawed ABS data and a foundering mining sector, compounded by unimpressive demand from China.

The government’s Plan B is “innovation”. But leaving taxation system distortions entirely untouched (such as superannuation; trusts and negative gearing) means the cuts fall on the elderly, the health sector and welfare recipients). And not on those who are more likely to re-elect the government.

What they are not addressing is stark reality: the failure to transition from the automotive industry shutdown to smart, advanced manufacturing and investment in green jobs. The free trade agreements (FTAs) with Japan, China, South Korea, together with the TPP, will deliver variegated, minor, supply-side shocks to the economy, but will ultimately drive a further deterioration of the terms of trade, rather than addressing the fundamental imbalance. FTA effects are measured over years, not between Christmas and the May 2016 Budget.

The Turnbull government should pray that Janet Yellen and the US Federal Reserve board don’t abandon zero interest-rate policy on 17 December. If US interest rates rise, all bets are off. If Yellen tightens monetary policy, you can bin all these MYEFO assumptions.

Ben Phillips, Principal Research Fellow, NATSEM

The Federal Budget is set to produce a deficit in 2015-16 of $37.4 billion which will be the eighth straight deficit following a long stream of surpluses in the late nineties and last decade.

The deficit can be explained largely by the economic cycle and a number of important policy decisions. Prior to the GFC in 2008 the Australian economy grew in nominal GDP at an astounding 7% to 10% per annum. Wages growth, business income were all pushed along by a very strong domestic and international economy (particularly China) and a terms of trade bonanza.

With the exception of some pump priming by the Rudd Government in the years just after the GFC nominal GDP slipped well below those rates to around 2% per annum. In real, per capita terms Australia’s net income has not increased since 2008.

Australia has experienced an income recession but since this has not translated across to a major recession in terms of job losses or the volume of economic activity (real GDP) this recession has been less painful than past recessions. Income recessions lead to budget deficits via lower tax receipts (as company profits and wages slow or fall) and spending increases through welfare payments.

Beyond the major economic drivers there are a number of policy issues that are not helping the situation - particularly on the revenue side. During the boom of last decade significant personal income tax cuts removed $20 billion from revenue annually (even after taking into account bracket creep). Generous superannuation concessions, capital gains tax cuts, the removal of the carbon price (but continuation of the compensation), and the petrol excise freeze added to the revenue losses.

On the expenditure side we have an ageing population and this will become an increasing issue as the cost of pensions, aged care, disability, health and caring all increase. While there may be some room for cuts in these areas the vast majority of expenditure is unavoidable.

Tax revenue as a share of the economy has fallen away badly since the income recession and expenditure has increased. However, the budget pressures remain broadly consistent with the ups and downs of the economic cycle with current deficits similar to the early 1990s relative to GDP.

Australia’s fiscal challenges remain as much about the future as they do about today. An ageing population and a shrinking taxation base will collide over the coming decades and structural policy change will be required to balance the budget to overcome our already significant structural deficit.

Reducing spending in a significant way (tens of billions of dollars each year) or increasing tax via a higher GST or reducing various tax concessions and breaks will not be politically easy. The trick will be to find solutions that are both politically palatable and do the least harm to the economy and society more broadly.

Pathology and radiology take a hit

Stephen Duckett, Director of the Health Program, Grattan Institute

There are swings and roundabouts in the health portfolio in MYEFO.

Spending on the rollout of the National Disability Insurance Scheme and new listings on the Pharmaceutical Benefits Scheme are the big winners, pathology and diagnostic imaging providers – mostly big corporates – are losers.

Workforce programs, which help to position the health and aged care industries, including rural providers, have also been sliced.

Both changes are important.

Pathology and radiology:

The changes to pathology and diagnostic imaging will reduce government spending by more than $200 million per year from July 1, 2016. This will either reduce the revenue of the big corporate providers by a similar amount, or increase the cost to patients of those diagnostic services, or a mix of both.

The government spending reduction is achieved by:

• removing the current bulk-billing incentive of A$6 (A$9.10 in Tasmania and rural areas) for each pathology service;
• reducing the bulk-billing incentive for diagnostic imaging (including magnetic resonance imaging) services.

There is no word in the MYEFO papers about what the government plans to do to protect consumers from being adversely impacted by these changes. Consumers generally have no knowledge of whether a pathology test or an x-ray is necessary and so follow the advice of their general practitioner or specialist on what is needed. Consumers have little power to bargain or price-shop for these tests.

Given the corporatisation of pathology and diagnostic imaging services, it may now be time to move away from an open-ended fee-for-service reimbursement system that was developed for the old era of professional, rather than corporate, practice. A tender arrangement might generate more savings for government at the same time as protecting consumers.

Workforce changes:

Net savings of more than A$175 million this year, with smaller amounts in later years (declining to around A$130 million per year in 2017-18) are to be achieved by cutting some workforce programs and expanding others.

The MYEFO statement does not provide details but it appears aged care workforce programs may be particularly hit. This would be unfortunate, as the number of older people who need care (at home or in an aged care facility) is increasing.

The relatively low wages paid in this sector compared to those in acute hospitals means there are chronic workforce shortages in this area, which may be exacerbated by these cuts.

Debt and revenue

Ross Guest, Professor of Economics, Griffith University

MYEFO has confirmed that we’ll never, yes never, stop borrowing from our kids and grandkids unless we substantially raise taxes, cut spending or both, as a share of national income. Sitting back and relying on economic growth along with bracket creep will simply not do it - the deficit is too far gone.

The projected 2016-17 deficit has increased by 30% from $25.8bn to $33.7bn since the projection in May this year. Such a huge revision in the space of 7 months, due largely to errors in predicting commodity prices which flows through to the deficit bottom line, just shows how unpredictable is our federal budget deficit. Not only are we beholden to the internal business cycle that affects all economies, we are also at the mercy of volatile commodity prices.

Given this extreme uncertainty, it is reckless to adopt Keynesian debt-financed government spending in the face of a weak economy in the hope that the economic cycle will correct itself and allow the borrowing to be repaid. If there is any such thing as an economic cycle for Australia we have no idea how deep or how long it is. The Federal Treasury certainly has no idea.

Given such an unpredictably volatile budget outcome, it is prudent for the Australian to run a more conservative budget than larger more diversified economies such as the United States.

We all need to understand that the government budget is just an outsourced version of our own budgets. And we cannot outsource our problem of declining commodity prices and a debt hangover from the crisis - we must pay and pay we will, either today or tomorrow.