Paul Davidson
As part of the Budget process, Treasury provides future
estimates of a whole host of macroeconomic variables.[1]
The major economic parameters are Gross Domestic Product (GDP) (both nominal
and real), the labour force (employment and unemployment), inflation (change in
the Consumer Price Index), and wages (the wage price index).[2]
Estimates of these key parameters are important for creating
future revenue and expense estimates in the federal budget. For example,
estimates of nominal GDP have important implications for tax receipts in the
budget. Nominal GDP is a measure of total economic activity at current prices.
Generally, if economic activity increases and/or if the prices received for
various economic activities increases then nominal GDP rises. The link to tax
receipts is through two potential avenues:
-
if economic activity increases then revenues would generally rise
in proportion to the growth in the economy
- if the prices received for economic activity increased, business
profitability would generally be expected to increase and, as such, additional
tax would be paid as a result of the additional profitability.
An important variable in determining nominal GDP in
Australia is commodity prices, particularly the prices of coal and iron ore. An
increase in key commodity prices can result in substantially higher nominal GDP,
and vice versa. Treasury has estimated that if metallurgical coal[3]
prices were to remain at USD$200 per tonne (excluding transport costs) for just
six months longer than is currently forecast, nominal GDP would increase by AUD$4.4
billion. Similarly, if iron ore prices remained at the current price of USD$66
per tonne (excluding transport costs) for six months longer than is currently
forecast, nominal GDP would increase by AUD$3.2 billion.[4]
A main driver of the estimates of the major economic
parameters is an assumption about the presence and closure of an ‘output gap’.
The output gap is the difference between the economy’s potential output (based
on what the economy can produce when all its resources—such as land, labour,
and capital—are fully utilised) and its actual output (as measured by
GDP). In order to close the output gap, actual GDP must grow faster than
potential GDP. Treasury adopts a baseline assumption that the output gap will
be closed over a five-year adjustment period,[5] and that once the gap is
closed, GDP grows at the potential output rate.
Among many others, one important consequence of the output
gap closure is in relation to the labour market. By closing the output gap, the
unemployment rate falls to its ‘natural rate’.[6] At the same time,
employment increases as economic activity increases. The employment growth has
implications for wages growth. As the labour market tightens, this has a
positive effect on wages.
These labour market effects have important impacts on
revenue and expense estimates. For example, expenses are expected to reduce as
unemployment benefit payments are provided to fewer people due to the fall in
the unemployment rate. Income tax receipts are expected to increase as there
are more people in the labour force (through both employment growth and a lower
unemployment rate), and wages are higher.
Views on the estimates
There have been a range of views expressed about the
confidence and reliability of Treasury’s estimates of key macroeconomic
variables and their implications for future expected revenues and expenses.
Views on economic growth estimates
With regard to economic growth, PwC expressed some concerns:
Economic growth will be modest this year, but pick up
strongly next year and thereafter track at a healthy 3 per cent. This
growth will then underwrite strong nominal growth in Commonwealth tax receipts.
The only problem? We’ve heard this before. In virtually all recent budgets the
forecast profile has been the same – a pick-up in economic growth 2-3 years out
doing the budget heavy-lifting. The risk is that a slower-growth global economy
will act as a drag on our economy, and with it, the lift in Commonwealth
revenues expected to restore the fiscal balance.[7]
On the major economic parameters, KPMG concluded:
Given the underlying economic forecasts contained within the
Budget do not indicate ‘boom times ahead’, and that current excess capacity
within the Australian economy will take some time to be taken up, KPMG
considers this forecast path to Budget repair proposed by Treasury may be at
the optimistic end of the spectrum of outcomes.[8]
CommSec, an arm of the Commonwealth Bank, attributed consistent
delays to return the budget to surplus to a ‘lack of solid revenue growth’ as
opposed to excessive growth in expenses.[9] It considered that a path
to surplus ‘while growing the economy, funding infrastructure and the NDIS is
an impressive balancing act’. The economic estimates were considered to be
‘basically conservative and therefore eminently achievable’. However, CommSec
analysis highlighted the expected increase in wages growth as an area for future
debate.
Views on wages growth estimates
The National Australia Bank (NAB) stated that there was very
little difference between Treasury’s and NAB’s forecasts for 2017–18. However,
the bank’s economic growth forecasts ‘are notably more pessimistic’ from
2018–19, albeit with similar expectations for the unemployment rate. NAB
forecasts nominal GDP growth of 3.3 per cent in 2018–19, whereas Treasury has
estimated 4 per cent:
The Government’s nominal GDP numbers then accelerate further
– heightening our scepticism. The Government’s wages growth forecasts in
particular, of 3% in 2018–19 and up to 3.75% by 2020–21, appear very
optimistic.[10]
In an opinion piece written by Deloitte Access Economics,
Chris Richardson stated that the ‘baked-in optimism’ of the Treasury numbers
were nothing new.[11] However he did consider
that the projected doubling in wages growth over the next four years was a
defensible projection. Instead, Richardson’s main concern was with the
long-held Treasury view that the tax system ‘will start generating much more
revenue from a growing economy’. He pointed out that current economic
conditions are the best they have been in years, yet the tax take has not
followed. As such, Richardson considered that there is ‘little reason to
believe it will magically start to do so in the years ahead’.
[1].
Australian Government, Budget strategy
and outlook: budget paper no. 1: 2017–18, Statement 1, p 1-9.
[2].
The major economic parameter estimates incorporate ‘assumptions and
judgements based on information at the time of preparation’: Australian
Government, Budget strategy
and outlook: budget paper no. 1: 2017–18, Statement 8, p. 8-3.
Statement 8 provides sensitivity analysis.
[3].
Metallurgical coal is primarily used in steel making.
[4].
Australian Government, Budget strategy
and outlook: budget paper no. 1: 2017–18, p. 2-26. The forecast commodity
price assumptions in the Budget are the same as those at MYEFO: Australian
Government, Mid-year
economic and fiscal outlook 2016–17, December 2016, pp. 19–20.
[5].
Australian Government, Budget strategy
and outlook: budget paper no. 1: 2017–18, p. 8-18. Treasury conducted
scenario analysis of the closing speeds of the output gap over two and eight
years, respectively: Australian Government, Budget strategy
and outlook: budget paper no. 1: 2017–18, Statement 8, pp. 8-19 to
8-21.
[6].
The natural rate of unemployment is the rate of unemployment which
would prevail in an economy with a constant rate of inflation: J Black, N
Hashimzade, G Myles, Oxford dictionary of economics, 5th edn, Oxford University
Press, United Kingdom, 2017, p. 353.
[7].
PricewaterhouseCoopers (PwC), Prosperity
or peril: federal budget 2017–18, 1997, p. 3.
[8].
KPMG, Federal
Budget 2017: a review of the Budget’s major business implications, May
2017, p. 2.
[9].
CommSec, Economic
insights: Australia’s 2017–18 Budget, 9 May 2017, pp. 4, 10.
[10].
National Australia Bank, Federal
Budget 2017, p. 2.
[11].
C Richardson, ‘Plan
B: the “tax and spend” budget we had to have’, The Australian Financial
Review, 11 May 2017, p. 63.
All online articles accessed May 2017.
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