This year’s budget deficit is holding up better than expected.
The last official budget update was released before Melbourne’s Stage 4 lockdowns and the policy reactions to that, including spending $15.6 billion more via easier eligibility for JobKeeper, as well as another $2 billion to extend telehealth. So you could be forgiven for thinking the worst …
Yet it’s not all bad news: Treasury assumed iron ore prices would immediately nosedive, almost halving to US$55 a tonne ahead of Christmas. But they’ve actually gone up, trading at double those rates. And Treasury was very conservative in its other forecasts, including of jobs and inflation.
The upshot is that we see better news than Treasury does on personal taxes, partly as we’re a little less pessimistic on both wages and jobs, while profit taxes may also outperform the low bar set for them in the official forecasts. And yes, the biggest difference there lies in iron ore.
Yet while the tax take looks set to help the budget this year, the spending story goes the other way. It’s dominated by the extra costs driven by lockdowns in Melbourne and regional Victoria. The new policies announced in the past two months are set to add $19.0 billion to expenses in 2020-21.
The bottom line? We forecast this year’s underlying cash deficit at $198.5 billion, ‘just’ $14.0 billion worse than Treasury forecast back on 23 July. All in all, that’s a pretty good outcome.
But remember a key caveat: our forecasts assume no new policies are announced, even though policy should do more. (As discussed below, there are great reasons to keep supporting recovery, and lots of possible policies are being flagged, but our forecasts assume a clean slate to begin.)
And future deficits are less scary than many are expecting
The 23 July update forecast just ten months out. What of later years? Relative to official forecasts released in late 2019 (yes, they’re pre-COVID, but they’re also the latest available for these years), we see massive ongoing shortfalls in personal taxes. There’ll be fewer jobs, and wages will be lower too, with that latter factor also limiting the usual tailwind for taxes of pushing people into higher tax brackets. Small business profits will be down as well, as will income from rents, dividends and interest.
There’s a similar tale of woe in profit taxes. Profits take an even bigger hit than wages in recessions, and losses being racked up now can be offset against tax bills in later years. So, despite lower investment deductions, we forecast profit taxes to stay to well south of the official numbers.
Yet today’s emergency spending is designed to phase out in these later years, while lower wages, lower prices, and lower interest rates all generate savings. So too will reduced State grants given GST weakness, although ongoing joblessness raises spending.
Add that together, and we forecast cash underlying deficits of $45 billion in 2021-22 and $26 billion in 2022-23. That’s worse than the (pre-COVID) official forecast in 2021-22 by a hefty $53 billion, followed by a narrowing of the gap versus official forecasts to $30 billion in 2022-23.
Is the damage permanent?
The budget has therefore taken enormous damage – but it probably isn’t permanent damage. That’s a vital distinction. Yes, the budget is badly bent, but it’s not broken. Today’s emergency policy measures are temporary. When they’re gone, the budget will still be running big deficits: but that will be because the economy is still weak.
That says we need to remain laser focussed on economic repair. If our economy gets better, then the budget will too.
Bracket creep just stopped being creepy
Looking for a silver lining amid the zombie apocalypse? PAYG collections this year are very close to where they’d be if the 2014-15 tax thresholds had simply been indexed. And the arrival of the second phase of the tax cuts in 2022-23 will leave families paying a handy $7.7 billion less in taxes than if the 2014-15 tax system had been indexed. Or, in other words, tax cuts designed to combat bracket creep look like overachieving, as the collapse in wage growth has slowed bracket creep.
The budget is stepping up to protect us
The budget guards the nation’s prosperity (the size of the pie) and fairness (how that pie is sliced up). But both our prosperity and our fairness are taking heavy blows from the coronavirus crisis:
- there’s never before been a hit to the Australian economy that’s this big and this fast,
- and relatively more jobs have been lost where unemployment was already the highest: suburb by suburb in the cities, town by town in the bush, the pain to our livelihoods isn’t evenly spread.
But we’ve acted fast and well. Our prosperity is being beautifully held together by lots of sticky-tape. JobKeeper and JobSeeker are the standouts, but a whole range of policies have swung into action to cushion our living standards. And fairness was foremost: we rushed to offer extra support to the most needy. To our absolute credit as a nation, we doubled the unemployment benefit as the crisis arrived, meaning that poverty went down in Australia at a time when it surged in the rest of the world.
Australia’s ability to do that was made easier, economically and politically, by our strong position when the crisis hit: the federal budget was balanced, and debt was low. Even better still, we got the money into people’s pockets faster than we did during the global financial crisis, and our success against the virus has reduced the cost of our emergency measures – a virtuous cycle.
So Australia’s defence against the virus has been world class so far. But challenges are mounting: families and businesses are set for a big cash crunch between now and end-March 2021 as emergency responses run out: as JobKeeper and JobSeeker are dialled back, as money from early access to superannuation dries up, and as a range of mortgage and rent deferrals run out.
This means war
Will we keep up the good work? The global financial crisis was less damaging in Australia than in most nations. And so far, we look like going one better still on that degree of outperformance this time. But that will mostly mean avoiding the mistake too many nations made in the immediate aftermath of the GFC – they rested on their oars, generating a woulda-coulda-shoulda moment.
2020 has been a war to protect our health. But the next war is now looming – the war for jobs:
- The war for our health has in many ways been a war to help protect older Australians.
- The war to get our jobs back will in many ways be a war to help younger Australians.
Yet whereas the war for our health has been a sprint, the war for our jobs will be a marathon. Both history and economics tell us that unemployment goes up fast, but it comes down slow.
Getting unemployment back down again is going to be hard. In every other recession and recovery you’ve seen, the Reserve Bank could always do more if it needed to. But not this time. That says
Australia’s recovery is very reliant on governments going hard and going smart:
- Going smart means reforming. That let’s our economy grow faster, and more growth = more jobs.
- Going hard means that the federal and state governments need to keep up their spending.
That combination gives us the best chance to get back to the Australia of February as fast as we can. And it underscores a key point: the need to let growth in the economy shrink the debt, rather than letting attempts to shrink the debt hold back the economy.
But haven’t we mortgaged the future?
Defending our lives and our livelihoods doesn’t come cheap. And in other circumstances Deloitte Access Economics would be up in arms about that: taxpayers’ money is always precious.
But taxpayer’s money is also doing a more effective job today than it’s ever done before.
In ordinary times we would worry about the debt. Yet these aren’t ordinary times. And although the increases in debt are very large, the falls in interest rates are even larger. That’s a game changer.
So, when Treasury updated its budget forecasts on 23 July, it forecast government interest payments were dropping to the smallest share of national income seen in the better part of a decade.
But its forecasts only covered 2020-21, so we’ve looked further forward. Our forecasts indicate that, in June 2023, federal debt will be $401 billion higher than Treasury’s pre-COVID forecasts for it. But you really shouldn’t be surprised to hear that we also forecast that the cash cost of interest paid by the government will be $2.4 billion lower in 2022-23 than it was in 2018-19.
Yep, you read that right. It will have fallen. A lot. Never in the two thousand years of recorded history of interest rates has it been cheaper for governments to borrow. Never.
And although interest costs won’t have fallen as much as had been hoped pre-COVID, that gap (of $1.6 billion in 2022-23) is the equivalent of an ongoing cost to the average taxpayer of just $2.66 a week. For not much more than the cost of a sausage sandwich at Bunnings, that may be the biggest bargain you’ll ever score.
These costs are far from scary. The defence of our lives and our livelihoods has been heaps cheaper than people have yet realised.
What to focus on next? -Creating new jobs
This story hasn’t finished. Australians should look to the budget on 6 October to continue the defence of our livelihoods, but to gradually change gear from protecting old jobs towards creating new jobs.
However, there’s a challenge: stimulus is effective only if that money is then spent. That’s why infrastructure ranks highly in economists’ thinking on stimulus, because by definition that money gets spent rather than saved. Ditto the construction of social housing. Or unemployment benefits.
Various leaks suggest that there’ll be elements of that agenda announced on budget night, with new support getting added to the defence of our livelihoods (such as time limited money for the states for infrastructure, or further help for age pensioners). And we especially like the possibility that wage subsidies will start to swing away from protecting old jobs towards creating new jobs.
Other possibilities are in play too. Our assessment of two of the mooted options is that:
- Adopting a business investment allowance: This approach tries to keep as much as it can of the incentive effects of a company tax cut, but to deliver that rather more cheaply (because the incentive, by definition, applies to new investments rather than existing ones).
- And delaying or dropping the lift in the SG: There’s a debate worth having on this one: if the key to getting jobs back as fast as we can is seeing more spending in the economy, is this the best time to promote a policy that boosts saving at the expense of spending?
Bringing forward the tax cuts let’s get a better debate
One particular policy looks likely to be announced on budget night: bringing forward the personal tax cuts. Is that smart?
We’ve always said that the personal tax cuts weren’t unfair, but that they are too big. And now COVID is here, raising the question of how good the tax cuts would be as stimulus.
Australia’s national discussion of these measures has been pretty woeful. And it remains woeful. On the one hand some have argued that the lift in government debt as a result of the coronavirus crisis means that the further rounds of tax cuts should be junked completely.
That is, of course, junk economics. Australia has high unemployment, interest rates that are as low as they can go, and families and businesses that aren’t likely to be spending at the pace needed to continue to see unemployment fall after the initial effect on joblessness of a re-opening economy.
Withdrawing government support by dropping proposed tax cuts would be downright dumb. The key policy question lies around changing from government emergency support as a defence against the virus to a fight against unemployment. That says the main near term policy debate should be around what extra policy is needed – not what withdrawal of policy support is needed.
There’s an extra point. The third tranche of these tax cuts has a very bad rep. That’s entirely undeserved. For what it’s worth, our own modelling – as does Treasury’s – shows that by the time when the legislated cuts to personal income taxes are fully implemented in 2024-25, they will have made little change to the share of wage and salary income paid as personal taxes by different income quintiles – including at the top end of the income scale. Yes, you read that right.
Table i: Treasury estimates of shares of personal income tax paid