Key Features

Anthony Housego
Economics Section

Introduction

The Budget delivered on 8 May 2007 by the Hon. Peter Costello MP is the twelfth under the Howard Government and the twelfth brought down by the current Treasurer. All but two of these have been surplus budgets (as measured by the underlying cash balance).[1]

In cash terms, the latest Budget has an underlying surplus of $10.6 billion, produced by revenues of $245.6 billion and outlays of $231.9 billion.[2]

This exceeds mid-year estimates by $0.9 billion. Continued cash surpluses are forecast into the future at slightly higher levels: $12.7 billion in 2008–09, $13.8 billion in 2009–10 and $12.4 billion in 2010–11. In accrual terms, the Budget is in surplus by $10.0 billion for 2007–08, $0.1 billion above mid-year expectations, and this is produced by an accrual revenue of $246.8 billion and outlays of $235.6 billion. The present Budget comes at a time of continued economic prosperity, with unemployment at a 32 year low[3] and an ongoing mineral resources boom which, at the time of writing, shows few signs of abating. In the lead-up to the Budget, considerable commentary had therefore been apparent on the challenges inherent in managing an economy running at or near full employment.[4]

In describing the Budget prior to his presentation, the Treasurer said:

… the Budget which will be held tonight is the culmination of months of work, of carefully assessing the investment needs of the Australian nation, making sure that we properly use our resources and pitching our sail to the future to make sure that we are ready for the future challenges which are going to come upon us in the decades which lie ahead.  It will be responsible economic management.  It will have measures which will help families.  But most of all it will be preparing for the great challenges of the future, challenges which we are going to face in relation to the ageing of the population, challenges on the environment and making sure that we so strengthen our economy that we can meet those challenges from a position a strength.[5]  

These sentiments also reflect earlier discussion in the 2007 Intergenerational Report and elsewhere of the need for fiscal policy to improve outcomes in relation to the so-called ‘three Ps’: productivity, population and participation.[6]

A good deal of the Budget detail had already been informally revealed in the media prior to the Treasurer’s presentation. This included the changes to arrangements for claiming the childcare rebate, increased defence funding, land transport and industry spending initiatives, the indigenous housing package, increased dental funding and the changes to solar panel rebates.[7]

Tax cuts were also widely expected and, for the fifth Budget in a row, were delivered. The surprise for many observers on Budget night was some larger, previously unannounced spending and policy measures, particularly the additional expenditures on education and the introduction of the Higher Education Endowment Fund.

In the immediate aftermath of the Budget, the main focus of much of the media was on the tax cuts and education spending.[8]

For example, on the morning of 9 May the headlines said:

  • ‘Tax Cuts Target Voters’ in The Australian Financial Review
  • Costello Masterclass — Treasurer trumps Labor with billions for education’ in The Australian
  • ‘Blown Away — $70b on education, tax cuts’ in The Sydney Morning Herald, and
  • ‘Costello’s Clever Carrots’ in The Age.

This brief attempts to cover some of the main features of the Budget. First, it discusses the main revenue and spending aspects of the Budget.[9]

Second, the economic growth forecasts contained in the Budget are discussed, as well as the outlook for other macroeconomic aggregates, including inflation, unemployment, the current account and interest rates. Third, a brief consideration of the main Budget measures in relation to the ‘three Ps’ is provided.  

Spending and taxing priorities

Receipts

There was considerable discussion around the revenue side of the Budget this year, focussing on two main themes. First, the size and distribution of the personal tax changes garnered a good deal of attention. (These are discussed in greater detail in a separate paper [10] below). Second, the overall size of the revenue receipts also received large coverage. Many reports leading up to the Budget observed that the Government was ‘awash with cash’ due to increased corporate tax receipts connected to the mining boom. Access Economics, for example, referred to ‘a brimful war chest’ and to the Treasurer ‘pulling revenue rabbits out of his hat’. [11]

Revenue underestimates and continued ‘fiscal surprises’ 

Treasury continues its record of underestimating revenues, with forecast revenues continuing to be well out of line with actuals. As with other recent Budgets, these ‘fiscal surprises’ are in large part because of higher corporate receipts, up 10.8 per cent on the previous year. Superannuation receipts have also shown a marked increase over previous years. 

This year’s revenues are indeed considerable. Since December’s Mid Year Economic and Fiscal Outlook (MYEFO), estimated total revenue for 2006–07 have been revised upwards by $3.7 billion to $235 billion, while for 2007–08 estimates have been revised up by $4.0 billion to $246 billion. This latter revision is the net result from the negative contribution of the tax cuts announced in the Budget (expected to reduce receipts by $5.6 billion in 2007–08 and by $31.1 billion over the forward estimates) and $9.6 billion of ‘parameter and other variations’.

Parameter variations include such things as greater than expected revenues from taxes, ‘slippage’ in the implementation of past policy decisions, and changes in the economic assumptions underlying spending or revenue projections. [12]   Over the forward estimates, the amount of these variations is expected to reach $53.6 billion. This is partly a result of the buoyant economy, and also partly the result of the increasingly prevalent Budget practice of what Australian journalist George Megalogenis has dubbed ‘regifting’ (where unspent moneys earmarked for certain policy purposes in past Budgets are recycled on new measures). [13]  

Sources of revenue in the Budget

The following table shows revenue receipts for the Budget year, and for purposes of comparison also looks at how these receipts have changed in a five year period since the 2002–03 Budget (see Table 1).

Table 1: Receipts: 2007–08 estimates (cash basis)

 

$m

Share of total receipts %

Change 2002–03 to 2007–08 %

Individuals

117 950

48.0

31.2

Companies

62 964

25.6

92.2

Superannuation funds

8 280

3.4

71.1

Petroleum resource rent tax

1 890

0.8

10.4

Fringe Benefits tax

4 050

1.6

17.1

Total income tax

195 134

79.4

47.1

Customs and Excise Duty

28 350

11.5

10.2

Other indirect taxation

3 373

1.4

11.6

Total Taxation

226 857

92.4

40.5

Interest

3 992

1.6

306.5

Dividends and other

14 762

6.0

24.3

Total Receipts

245 611

100.0

39.1

Source: Budget Strategy and Outlook 2007–08, Budget Paper No. 1.

In line with previous Budgets, taxation receipts make up over 90 per cent of total receipts. The rest are interest, dividends from bodies such as the Reserve Bank of Australia and the Future Fund, and other small amounts. These figures exclude GST receipts, which are expected to be worth some $43.1 billion, or around 3.8 per cent of GDP, in 2007–08. [14] The reasons for excluding the GST from reported revenues are discussed elsewhere, [15] but basically the Commonwealth’s argument is that the GST is a tax which it collects for, and appropriates to, the states.

Over the five years between the 2002–03 Budget and the current Budget, the most significant increases in taxation receipts have come from company and superannuation tax.  The latest available figures (2004–05) quoted in the Budget papers suggest that over three-quarters of company income tax is collected from two per cent of incorporated taxpayers, these being large companies with over $100 million in revenue annually. [16] Interest as a source of receipts has also grown considerably, and this includes interest earned on Australian Government cash balances and on Future Fund assets. The long term decline in indirect taxation as a revenue source also continues, in part because the base for such taxes does not grow as quickly as the income tax base, and in part because of the combined effect of previous policy changes, such as the abolition of wholesale sales tax and removal of indexation from petrol excise. [17]     

Expenses

Overall new spending initiatives (including capital measures) announced in this Budget amount to $36.7 billion over the forward estimates.

The Government announced a considerable number of spending initiatives in this Budget which, in total, contribute the bulk of the change in the Budget balance. These include:

  • $3.3 billion over five years towards increased Child Care Benefits and more timely provision of the Child Care Tax Rebate [18]
  • $3.5 billion over four years for universities under the Realising Our Potential initiative
  • $6.6 billion over thirteen years to acquire Super Hornet aircraft, and
  • $703 million over four years for Australia’s military contribution in Afghanistan.

The relative importance assigned to different expenditure functions in this Budget, as well as changes from the previous year’s Budgets, can be shown by separating expenses into functional areas and ranking them by order of magnitude (see Table 2). As in previous years, social security and welfare expenditure represents over 40 per cent of total expenditure. The next highest items are health at 18.2 per cent, defence at 8.4 per cent and education at 7.5 per cent. Between 2006–07 and 2007–08, expenses are estimated to increase on average by 6.3 per cent in real terms. A number of areas are expected to increase by significantly more than this, including transport and communications, defence, fuel and energy, recreation and culture, and public order and safety.

Looking out over the forward estimates, the approximate share of total spending taken up by each function remains constant or decreases slightly for most functions. This decrease is basically to make room for an increase in ‘other purposes’, including significant anticipated increases in notional spending on the ‘Contingency reserve’. [19] This Reserve reflects, in part, the tendency for agencies to underestimate their spending and for that bias to grow over time. It also consists of commercial-in-confidence and national security-in-confidence items which cannot be disclosed separately, as well as several other items. [20]

Table 2: Expenses: 2007–08 estimates

 

$m

 Share %

Change 2006–07 to 2007–08 %

Social security and welfare

96 450

40.9

3.5

Health

42 964

18.2

7.1

Defence

19 880

8.4

14.5

Education

17 752

7.5

7.3

General Public Services

15 768

6.7

8.4

Other economic affairs

5 617

2.4

5.5

Fuel and energy

5 360

2.3

13.8

Transport and communication

4 516

1.9

32.8

Public order and safety

3 670

1.5

10.7

Housing and community amenities

3 011

1.3

2

Recreation and culture

2 979

1.3

11.4

Agriculture, forestry and fishing

2 799

1.2

2.6

Mining, manufacturing and construction

2 029

.9

7.7

Other purposes

12 794

5.5

1.4

Total expenses

235 590

100.0

6.3

Source: Statement 6: Expenses and net capital investment  2007–08, Budget Paper No. 1, May 2007.

Total Commonwealth payments excluding the GST payments to the states are estimated to be 21.5 per cent of GDP in 2006–07 and 2007–08, with this share rising to 21.6 per cent in 2008–09 and 21.8 per cent in 2009–10 and 2010–11. A rising share of GDP taken up by expenditures, together with relatively constant shares of expenditures by function, implies that most functional areas will see rises in spending in real terms over the forward estimates. The Budget anticipates that, in terms of functions, the most significant increases are likely in several areas, including social security and welfare and health (partly as a result of the ageing of the population); education (in part due to indexed Commonwealth payments and also as a result of initiatives announced in the Budget); and defence (due largely to acquisition, military personnel and recruitment and retention initiatives).  

State of the economy and economic outlook

A further important part of the Budget documentation is an assessment of the state of the economy. There is a comprehensive discussion of the state of the economy in Statement 3: Economic Outlook, Budget Paper No. 1. The Statement contains forecasts of the major economic variables that are summarised in an important table, headed ‘domestic economy forecasts’. [21] Some of the main items are presented below (Table 3).

Table 3: Major Economic Aggregates, Forecasts

 

Estimates 2006–07

Forecasts
2007–08

Household consumption (per cent change)

3.5

3.5

Business investment (per cent change)

4

7.5

Exports (per cent change)

3

5

Imports (per cent change)

8.5

6.5

Net exports (per cent contribution to GDP growth)

-1.25

-0.5

Current account balance ($billion)

58.25

65.75

GDP (per cent change)

2.5

3.75

Unemployment (per cent)

4.75

5

Consumer Price Index

2.75

2.5

Wage Price Index

4.25

4.25

Source: Statement 3: Economic Outlook 2007–08, Budget Paper No. 1, May 2007.

These forecasts show household consumption growing at a moderate rate of 3.5 per cent in 2007–08, which is slightly down on the higher levels of previous years, most notably 4.2 per cent in 2004–05. Business investment is forecast to improve over 2006–07 levels, underpinned by strong growth in mining and construction, albeit at levels lower than the highs experienced in the last five years. Exports are also expected to grow at a faster rate of 5 per cent in the coming year – this more moderate forecast is a departure from the over-forecasting of exports in previous Budgets. However, while exports (particularly non-agricultural exports) are expected to grow, so are imports, up by 6.5 per cent in 2007–08 on the back of a higher exchange rate and domestic demand. The forecast is therefore for net exports to decline, and to deduct approximately 0.5 per cent from GDP growth in the coming year. This is an improvement on the expected 1.25 per cent deduction in 2006–07, but still a source for concern given that a positive forecast of export performance in the coming year is prefaced partly on a moderate recovery in rural exports from the drought.

A slight rebound in unemployment is also expected, up from 4.75 per cent in 2006-07 to five per cent in 2007–08, in part due to changes in eligibility requirements for recipients of the Disability Support Pension and Parenting Payment. [22]

Forecast Australian growth

The Budget forecasts real GDP to grow by 3.75 per cent in 2007-08, up from growth of 2.5 per cent in 2006–07. This upwards revision on earlier forecasts was expected, and reflects in part the continued strong performance of the Australian economy in early 2007. If this forecast rate transpires it would mean that, in regional terms, the Australian economy is likely to be among the better performers for the next couple of years.

These forecasts are broadly in line with those put out by the IMF in their latest World Economic Outlook (WEO) in April. The IMF forecast growth in the Australian economy of 2.6 per cent in 2007, rising to 3.3 per cent in 2008, and forecast a slight slowing of world growth for the same period. [23] The WEO states:

In Australia and New Zealand, real GDP growth weakened slightly in 2006, reflecting slower domestic demand and the impact of a severe drought in Australia. Growth is expected to pick up during 2007–08. [24]

However, despite the general consensus that projected growth is likely to improve on 2006 levels in 2007 and 2008, there are some sources of uncertainty in relation to growth in the short term. These are described in the next section.

Some short term risks…

In discussing forecast growth of the Australian economy, the Budget Papers state:

The forecast for 2007–08 reflects an assumed return to average seasonal conditions and a partial recovery from the drought, which is expected to add ½ of a percentage point to GDP growth. Strong growth in 2007–08 also reflects solid growth in consumption and business investment, a modest increase in dwelling investment and accelerating export growth. [25]

The Budget Papers acknowledge that, despite these assumptions, the drought and its impact on agricultural performance (not to mention on exports and the wider economy) remains a considerable source of uncertainty. [26] In April, ABARE forecast a fall in farm output of around 20 per cent in 2006–07, with a decline in winter crops by 60 per cent (see Figure 1). [27] Estimates prior to the Budget suggested that, if such falls do occur, farm output will make a negative contribution to GDP growth of something in the order of 0.75 per cent in 2006–07. [28] Continued reductions in agricultural output would put a significant brake on growth in 2007–08. What remains uncertain is not just future rainfall, but the extent of such rainfall required for a significant recovery from drought conditions.

Poor recent productivity performance, and the limit it may place on growth, also remains an area of risk in relation to forecasts of improved growth in the coming year. [29] Problems with extrapolating trends from short periods of data exist, as do problems with international comparisons of productivity performance. [30] Nevertheless, aggregate figures are suggestive of a pronounced slowdown in Australian productivity, both in international and historical terms (see Figure 2). This was emphasised recently by the Reserve Bank Governor, Glenn Stevens, who stated in February:

There are figures here that I think are probably worth recording… in the part of the economy for which you can do a good measurement—the market sector— for about 13 or 14 years up to 2004 the rate of (productivity) growth was 2.6 per cent a year on average. It was quite volatile year to year, but that was the average. Since then—and it has only been a two- or three-year period since then, and even that is a shortish period to be drawing a trend from—the trend rate of growth has been 0.9 per cent. That is quite a slowdown. [31]

Figure 1 Projected winter and summer crop production

Figure 1 Projected winter and summer crop production

Source: Australian Bureau of Agricultural and Resource Economics (April 2007)[32]

While there is no explicit forecast for average labour productivity growth in the Budget Papers, some experimental estimates can be obtained by comparing GDP and employment growth forecasts. This is shown below (Table 4), together with estimates derived using a similar experimental methodology applied to figures from the 2006–07 Budget Papers and the December 2006 MYEFO.

Figure 2 Australian productivity, per cent of US level

Figure 2 Australian productivity, per cent of US level

Source: Productivity Commission (2007, p. 25)[33]

Table 4: Budget and MYEFO experimental estimates of productivity growth

 

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

Budget 2006-07

           

   GDP growth

2.5

3.25

3.5

3.25

3.25

 

   Employment growth

2.0

1.0

1.5

1.25

1.25

 

   Implied productivity growth

0.5

2.25

2.0

2.0

2.0

 

MYEFO

           

   GDP growth

 

2.5

3.75

3.0

3.0

 

   Employment growth

 

2.25

1.25

1.25

1.25

 

   Implied productivity growth

 

0.25

2.5

1.75

1.75

 

Budget 2007-08

           

   GDP growth

 

2.5

3.75

3

3

3

   Employment growth

 

2.5

1.5

1.25

1.25

1.25

   Implied productivity growth

 

0.0

2.25

1.75

1.75

1.75


Sources: Budget Paper No. 1, 2006–07, MYEFO, December 2006, Budget Paper No 1, 2007–08. Library estimates.

Elsewhere, Treasury have stated that their long run forecast is for labour productivity growth of around 1.8 per cent per annum over the next 40 years.

The causes of poor recent productivity growth remain the subject of considerable debate. However, what appears certain is that the extent to which productivity levels can improve in the short to medium term will be a fundamental determinant of further sustained and non-inflationary growth across time.

A further related source of risk to the Budget forecasts is emerging capacity constraints. This risk is discussed in Budget Paper No. 1. The potential for such constraints to put a brake on further growth continues to garner wider attention and debate in the media.[34] Certainly, given the strong economy a range of capacity indicators show that the economy is running at full throttle (see Figure 3). The Reserve Bank therefore continues to monitor such constraints with interest — on this issue it is worth again quoting RBA Governor Glenn Steven’s comments on 21 February 2007:

In the broad, after a long period of fairly solid economic growth, we have approached what for practical purposes can be called full capacity, at least for the moment. The evidence for that proposition is quite widespread... It may well be possible for these trends to go further yet, but a wide array of business enterprises the bank talks to in our regular liaison have been saying for some time that it is harder and more costly to find appropriate staff, and that the factor most constraining further expansion is not insufficient demand but insufficient capacity, either of labour or capital or both.[35]

Figure 3 Indicators of capacity constraints

Figure 3 Indicators of capacity constraints

Source: ANZ Economics (based on statistics from Australian Bureau of Statistics; National Australia Bank; Property Council of Australia).

World economic outlook

The world economy has continued to post very strong growth figures in the past year, with world GDP growing at 5.4 per cent in 2006.[36] The role of developing countries in this continued strong performance is particularly noteworthy (see Figure 4). In the past three years over 70 per cent of world growth has come from developing countries, despite them comprising only 47 per cent of world production.[37] China and India remain the standout contributors in this regard, with growth rates of 10.75 per cent and 9.25 per cent in 2006 respectively.

IMF projections in April 2007 suggest a slight slowing in world GDP growth over the next two years, to (still very robust) annual rates of 4.9 per cent in 2007 and 2008. In part this slowing is due to a levelling off of growth in the US and some European economies going forward. For the US, the IMF has projected growth to be relatively low at 2.2 per cent and 2.8 per cent in 2007 and 2008. This relative pessimism appears well founded in part: in the March 2007 quarter, for example, GDP growth in the US was at a 1.3 per cent annual pace, the lowest rate since the first quarter of 2003. A major contributor to this poor performance has been a sluggish housing sector, with residential investment declining by 17 per cent in the March 2007 quarter. In its most recent WEO, the IMF has argued that the extent to which the world economy can continue its high growth trajectory may, in part, be determined by its ability to ‘decouple’ from the adverse effects of slow growth in the US economy.

Figure 4 Advanced and developing economy shares of global GDP (a)

Figure 4 Advanced and developing economy shares of global GDP

(a) Note. ‘Advanced’ economies comprise the US, Western Europe, Japan, Canada, Australia, New Zealand, Korea, Taiwan, Hong Kong, Singapore and Israel.
Source: ANZ Economics (based on IMF WEO).

Treasury projections are broadly in line with this assessment. The international growth forecasts in the Budget Papers are shown below (Table 5).

Table 5: International GDP growth forecasts

 

Actual

Estimate

Forecasts

 

2005

2006

2007

2008

United States

3.2

3.3

2.25

3

Euro area

1.5

2.8

2.25

2.25

Japan

1.9

2.2

2

2

China

10.4

10.7

10.5

10.25

India

8.7

9.1

8.25

7.75

Other East Asia

5.0

5.6

5

5

Major trading partners

4.4

4.8

4.5

4.5

Total OECD

2.6

3.2

2.5

2.75

World

4.9

5.4

5

5

Source: Statement 3: Economic Outlook, 2007–08 Budget Paper No. 1.

As with domestic growth forecasts, some sources of risk remain in regard to world growth in the short term. These include not only the indifferent recent performance of the US economy, but also supply-side inflationary pressures (particularly in the US and UK), the oil market, and global external account imbalances (discussed in the next section). [38] A slowing in global productivity growth also remains a medium term concern for international observers such as the IMF.  

Continued global external imbalances

Despite the healthy outlook for the international economy, some major imbalances persist (see Figure 5), especially the large and persistent current account deficit (CAD) in the US. It is now a number of years since the IMF warned of the US CAD. [39] Since then there have been no major economic upheavals yet but the US CAD remains very high at around 6.5 per cent

Figure 5 Major current account balances $US billions

Figure 5 Major current account balances $US billions

Source: US Treasury (2006) [40]

of GDP. Past predictions have ranged from ‘business as usual’ to something dramatic and harmful is on the horizon. In the meantime China continues to loom larger on the world economy to the extent that almost every economy has been affected. Most economies have been affected by the competition coming from China—jobs have been lost or threatened while there have been benefits such as access to cheaper consumer goods. China has been producing major surpluses on the current account of its balance of payments, surpluses that are to a large extent the counter-part of the US deficits.

The latest IMF WEO report appears more optimistic on prospects for resolving the problem of global imbalances than in previous years, suggesting that a smaller than assumed depreciation in the US dollar may go some way towards improving this problem. However, it also pointed to the need for more fundamental reform in deficit countries, stating:

A consistent theme that emerges… is that a market-led real depreciation of the U.S. dollar and a real appreciation of the currencies of surplus countries could potentially play a helpful role in narrowing global imbalances. At the same time, the adjustment process will involve a rebalancing of domestic demand toward surplus economies, including a rising private saving rate and further fiscal consolidation in the United States. Policies that remove obstacles to the reallocation of resources and to international trade would help lower the dislocation in economic activity that might accompany this adjustment process. [41]

The continuing dichotomy in the world between CAD and current account surplus nations, with this dichotomy splitting very much the US/UK/European/Australian economies from the Established Asian/Emerging Asian economies, is likely to remain an area of concern for some time.

Inflation outlook and possible impact of the Budget

A large amount of commentary leading up to the Budget cautioned the Government against large spending and/or tax cuts, suggesting that the effect of this would be to put upwards pressure on interest rates in an already fully stretched economy. [42] In regard to spending, several commentators (and the Treasurer) placed emphasis on the crowding out argument, whereby high government spending places upwards pressure on interest rates as the public sector competes for resources with the private sector. 

Despite the buoyancy of the economy described elsewhere in this paper, the inflation outlook has moderated recently. Latest CPI figures for March showed a sharp drop in headline inflation to 2.4 per cent. This was due to a combination of factors, including an easing in the prices for petrol, food (in particular bananas) and imports. After earlier comments by Reserve Bank Assistant Governor, Malcolm Edey, in March this year that were widely interpreted as signalling a tightening bias by the Bank, many analysts had been predicting a further rate rise in April or May, but this did not transpire. [43] The last cash rate rises occurred in May, August and November of 2006.

In its most recent (May 2) Statement on Monetary Policy, the RBA have also revised downwards their inflation forecasts (see Table 6). While the Bank mentions some possible risks, including exchange rate appreciation, recent wage growth, oil prices and drought, the Bank’s view appears to be that these will exert modest pressure on prices in coming quarters. 

Table 6: RBA Inflation Forecasts

Percentage change over year to quarter shown

 

June 2006

Dec
2006

June 2007

Dec
2007

June
2008

Dec
2008

June
2009

CPI

4.0

3.3

1.75

2.25

2.5 - 3

2.5 - 3

2.5 - 3

Underlying inflation

2.9

3.0

2.5

2.5

2.5 - 3

2.5 -3

2.5 -3

Source: RBA Statement on Monetary Policy, May 2007, p. 58.

For its part, the Government now forecasts inflation at 2.5 per cent for 2007–08. [44] Further into the future the Government projects inflation at the same rate for each of the forward years. However, not much credence should be given to ‘projections’ as distinct from forecasts. Projections for inflation assume it remains at the centre of the Government’s target range of 2 to 3 per cent. However, projections are used as the basis for calculating forward estimates of outlays and revenues and should not be taken as forecasts.

Some risks to this otherwise favourable outlook clearly persist. Again, the ‘productivity problem’ mentioned above is relevant here. [45] The value of Australian production decomposes into wages and profits with wages making up 54 per cent of Australia’s total factor income. [46] For that reason the major long run influence on inflation is going to be wages. Nominal wages are expected to increase by 4.25 per cent in 2007–08 and 4 per cent in 2008–09. [47] Productivity growth ensures that labour costs per unit of output will increase by something less than the 4 to 4.25 per cent increase in wages. Productivity growth of around 1.75, equivalent to the long term average, will mean that wage increases are consistent with inflation remaining around the middle of the target range.

As discussed above, the implied forecast in the Budget is for the productivity growth rates to return to around 2 per cent in 2007–08. Given the recent poor productivity performance in Australia, these growth rates are likely to be more of a challenge than they might once have been. By implication, difficulties may therefore persist in keeping inflation within the target band over the medium term. Recent cautionary statements by the Treasurer that the inflation ‘genie’ is contained but never truly goes away therefore appear apt. [48] The latest post-Budget figures, showing unemployment falling to 4.4 per cent in April and strong retail and housing sectors, add further weight to such statements.

Budget impacts and ‘fiscal stance’

This year’s Budget continues in the tradition of surpluses of around 1 per cent of GDP in cash terms. In fact, if one were to adopt a ‘fiscal target’ approach to surpluses of between 0.5 percent and 1.5 per cent of GDP, the present Government has delivered underlying cash balances within that band in 7 of its 12 budgets.

However, the bottom line as expressed in the Budget Papers says very little about the actual impact of fiscal settings on the macroeconomy, and a range of alternative measures exists which attempt to net out the effects of the business cycle and other factors (such as terms of trade fluctuations) [49] to come up with a ‘structural’ measure of the fiscal balance. [50] The RBA, for example, measures fiscal stance by looking at the change in the Budget bottom line (cash balance) between years — $2.2 billion in 2006–07 and $3 billion in 2007–08. This would suggest a small stimulus to growth for 2007–08 from the Budget of around 0.3 per cent of GDP. Further factoring in of recently announced spending measures affecting the 2006–07 and 2007–08 balances would give a 2006–07 surplus of around $16.4 billion and a 2007–08 surplus of $8 billion, which would suggest a more significant stimulus of around 0.8 per cent of GDP. [51]

While structural measures of fiscal stance are useful, they are only one part of a broader set of parameters which the Bank factors in to its decision making. [52] The relatively moderate stimulus suggested by calculations of current fiscal stance, together with measures within the Budget aimed at improving labour supply, suggest that the Budget measures are unlikely to force the Bank’s hand in the short term.

Budget measures and the ‘three Ps’

Some parts of the Budget have a microeconomic, supply side focus, and this is unsurprising given the strength of the economy and the fact that we are likely to be approaching or are at full employment. The constraints this imposes on macroeconomic policy (or, at least, effective macroeconomic policy) were described by Ken Henry in his widely publicised address to Treasury officials in March:

As a rather crude, but nevertheless instructive generalisation, there is no policy intervention available to government, in these circumstances, that can generate higher national income without first expanding the nation’s supply capacity. Policy actions that expand the nation’s supply capacity target at least one of the 3Ps — population, participation or productivity – that we have been talking so much about in recent years. [53]

Judged by this metric, the Budget contains a mix of measures that are likely to have a positive effect on labour force participation and productivity across time, as well as other measures that stand up less well to such scrutiny (a subset of which could be termed ‘dead giveaways’ in relation to the ‘three Ps’). In the former category are changes such as those to child care arrangements and income tax that may affect female workforce participation, and measures in higher education, schools and vocational education and training designed to improve human capital outcomes. In the latter category, the direct benefits of measures such as one-off payments to seniors are potentially more ambiguous. [54]    

The likelihood of variable lags in effect of the measures announced in the Budget should also be noted. Some measures, such as those announced in relation to skilled migration, are likely to have relatively rapid effects on labour supply. Others, such as educational reform, may take longer to yield improvements in capacity and productivity. It remains to be seen if the balance of measures provided by the Budget will be ‘too little too late’ in easing the capacity constraints and productivity problems described above. A further assessment issue, also yet to be fully determined, is how well the Budget measures complement a broader framework of ongoing microeconomic reform, such as that set out in COAG’s recent National Reform Agenda. [55]   

Endnotes



 

[1] .     Essentially the ‘cash balance’ records the difference between the cash receipts and expenditures. If receipts exceed expenditures then the budget balance is a surplus, if receipts are less than expenditures the budget is in deficit. Instead of ‘receipts’ and ‘expenditure’ the Budget Papers now refer to ‘revenue’ while expenditures include both ‘expenses’ and ‘net capital investment’. The Budget Papers now also refer to the ‘underlying cash balance’ which excludes asset sales and the so-called ‘headline cash balance’ that includes asset sales. Further detail on the budget reporting framework and processes can be found in R.Webb, ‘The Commonwealth Budget: Process and Presentation”, Research Brief, no. 7, Parliamentary Library, 2007.        

[2] .     The underlying cash balance as now defined in the Budget is equal to receipts less payments less expected Future Fund earnings. See Budget Paper No. 1, 2007-08, Statement 13, Table 1. 

[3] .     Based on the most recent ABS Labour Force statistics, 10 May 2007.

[4] .     See, for example, the much-publicised speech given on 14 March by the Head of Treasury, Mr Ken Henry: http://www.treasury.gov.au/documents/1249/PDF/speech_14_march_2007.pdf and the Treasurer’s more recent comments on the Lateline program on 12 April : http://www.treasurer.gov.au/tsr/content/transcripts/2007/035.asp   

[5] .     http://www.treasurer.gov.au/tsr/content/transcripts/2007/042.asp

[6] .     http://www.treasury.gov.au/documents/1239/PDF/IGR_2007_final_report.pdf

[7] .     See, for example, F Anderson and D Crowe, “Budget delivers tax break to big business”, The Australian Financial Review, 8 May 2007. http://parlinfoweb.aph.gov.au/piweb/TranslateWIPILink.aspx?Folder=pressclp&Criteria=CITATION_ID:2CZM6%3B

[8] .     For a detailed listing of post-Budget media coverage, see: http://libauth1/library%5Fservices/budget%5Flibrary/

[9] .     Sections of this brief draw on discussion from previous Library Budget Briefs, in particular D. Richardson, Budget 2006–07: Background Note and D. Richardson, 2005–06 Budget — Main Features.

[10] .    L. Nielson, Personal income tax and superannuation.

[11] .    Access Economics, Commonwealth Budget Monitor, Issue #71, May 2007.

[12] .    Saul Eslake, The 2007 Budget: context, construction and consequences, presentation to the Economics Society of Australia, Canberra, 14 May 2007. 

[13] .    George Megalogenis, Budget 2007: Opinion: ‘Just give or take a few billion’, Weekend Australian, May 12 2007. http://parlinfoweb.aph.gov.au/piweb/TranslateWIPILink.aspx?Folder=pressclp&Criteria=CITATION_ID:UK1N6%3B

[14] .    Budget Paper No. 3, pp. 7–9.

[15] .    This issue is discussed in R.Webb, ‘The Commonwealth Budget: Process and Presentation”, Research Brief, no. 7, Parliamentary Library, 2007.   

[16] .    Budget Paper No. 1, 2007-08, Statement 5, p. 5-55.

[17] .    Budget Paper No. 1, 2007-08, Statement 5, p. 5-57.

[18] .    Includes $452 million in 2006–07.

[19] .    Budget Paper No. 1, 2007–08, pp. 6-25 to 6-26.

[20] .    A fuller description of the main elements of the contingency reserve can be found in R.Webb, ‘The Commonwealth Budget: Process and Presentation”, Research Brief, no. 7, Parliamentary Library, 2007.        

[21] .    Budget Paper No. 1, 2007-08, pp. 3-1 to 3-13.

[22] .    These eligibility changes are likely to increase the size of the labour force, with a corresponding increasing effect on the measured unemployment rate.

[23] .    IMF forecasts are based on calendar years.

[24] .    IMF World Economic Outlook 2007, p. 60.

[25] .    Budget Paper No. 1 2007-08, Statement 3, p. 3-3.

[26] .    See Budget Paper No. 1, p. 3-5.

[27] .    RBA Statement (p. 32).

[28] .    RBA Statement (p. 2).

[29] .    See, for example, AFR, Thursday 12 April 2007, p. 5, ‘Costello puts productivity on COAG’s critical list’ (http://parlinfoweb.parl.net/parlinfo/Repository1/Media/npaper_5/WYQM60.pdf), and AFR, Friday 13 April, pp. 72-73, ‘The problem is all talk and no output’ (http://parlinfoweb.parl.net/parlinfo/Repository1/Media/npaper_3/NGRM60.pdf ).  

[30] .    See, for example, Dolman, B., Parham, D. and Zheng, S. 2007, Can Australia Match US Productivity Performance?, Productivity Commission Staff Working Paper, Canberra http://www.pc.gov.au/research/swp/productivityperformance/productivityperformance.pdf

[31] .    http://www.aph.gov.au/hansard/reps/commttee/R9961.pdf , p. EFPA 16  

[32] . ABARE (2007, p. 4): http://www.daff.gov.au/corporate_docs/publications/pdf/industry_dev/abare-feedgrains-report.pdf

[33] . Dolman, B., Parham, D. and Zheng, S. 2007, Can Australia Match US Productivity Performance?, Productivity Commission Staff Working Paper, Canberra http://www.pc.gov.au/research/swp/productivityperformance/productivityperformance.pdf

[34] . At: http://parlinfoweb.aph.gov.au/piweb/TranslateWIPILink.aspx?Folder=pressclp&Criteria=CITATION_ID:ZNWM6%3B

[35] . http://www.aph.gov.au/hansard/reps/commttee/R9961.pdf , p. EFPA2

[36] . IMF World Economic Outlook 2007, p. 2.

[37] . Kennedy and Garton (2007, p. 1): http://www.treasury.gov.au/documents/1238/PDF/Steven_Kennedy_AIG_Speech.pdf

[38] .     IMF World Economic Outlook, 2007, p.6. http://www.imf.org/external/pubs/ft/weo/2007/01/index.htm

[39] .     This discussion is based partly on that provided in D. Richardson, Budget 2006-07: Background Note, pp. 13-14.  

[40] .     See: http://www.ustreas.gov/offices/international-affairs/economic-exchange-rates/pdf/2006_FXReport.pdf

[41] .     IMF World Economic Outlook 2007, (chapter 3).

[42] . See, for example: http://parlinfoweb.aph.gov.au/piweb/TranslateWIPILink.aspx?Folder=pressclp&Criteria=CITATION_ID:JIWM6%3B    

[43] .     At: http://www.rba.gov.au/Speeches/2007/sp_ag_160307.html

[44] .     Figures taken from Budget Paper No 1, p. 3-7.

[45] .     This discussion draws on earlier material provided in D. Richardson, Budget 2006-07: Background Note, pp. 18-19. 

[46] .     Latest figure for 2005–06 from ABS, Australian System of National Accounts, 2005–06, Cat. No. 5204.0, 1 November 2006.

[47] .    Budget Paper no. 1, pp. 1-5.

[48] . http://parlinfoweb.aph.gov.au/piweb/TranslateWIPILink.aspx?Folder=pressclp&Criteria=CITATION_ID:XRXM6%3B

[49] .    For a discussion of the possible implications of including terms of trade adjustments in measures of fiscal stance in Australia, see OECD (2006).

[50] .    Treasury do not publish such measures ‘because significant assumptions about the economy’s potential output level and the cyclical sensitivity of revenues are required.’ See http://www.treasury.gov.au/documents/987/PDF/06_structural_fiscal.pdf

[51] .    http://parlinfoweb.aph.gov.au/piweb/TranslateWIPILink.aspx?Folder=pressclp&Criteria=CITATION_ID:XN1N6%3B

[52] .    See, for example, the statements by current RBA Governor Glenn Stevens on 21 Febraury 2007: http://www.aph.gov.au/hansard/reps/commttee/R9961.pdf , pp. 10-11.

[53] .    14 March, 2007: http://www.treasury.gov.au/documents/1249/PDF/speech_14_march_2007.pdf

[54] .    In relation to increases in the 40 and 45 per cent tax thresholds, Treasury do suggest that recent post-Budget modelling points to positive benefits for labour supply, but that these benefits are smaller than those resulting from adjustment of the 30 per cent threshold. The latter threshold increase accounts for ‘most of the positive impact on labour supply’.  http://www.treasury.gov.au/documents/1260/PDF/speech_15_may_2007.pdf 

[55] .    For an assessment of the possible benefits from the National Reform Agenda, see: http://www.pc.gov.au/research/crp/nationalreformagenda/nationalreformagenda.pdf

 

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