Economic winds help Coalition’s budget bottom line

The global upturn will boost the budget but much more work is needed to rein in the deficit.

Early this year, Treasury secretary John Fraser told Scott Morrison that the world economy was turning up and that it would do so more forcefully than anyone expected, dragging both the Australian economy and the federal government’s budget along with it. This week’s final report for the 2016-17 budget contains the first sign that Fraser’s advice was correct.

The final figures for any financial year are nearly always a bit better than expected six weeks from the finish line, when the May budget is unveiled, but the margin is usually only $500 million to $1 billion. Government departments get into more trouble for overspending their budget than they do for underspending, so they give themselves a margin for safety that comes to light when the books are ruled off.

The $4.4bn gain in the 2016-17 budget bottom line between the delivery of the budget and the end of the financial year was the biggest since 2004-05, when the resources boom was building a head of steam.

It is only 1 per cent of total annual government spending, so it is not a moment for hats in the air — the deficit is still three times greater than was predicted in Joe Hockey’s 2014-15 budget. But there was an improvement over a period of just six weeks.

There were several one-off gains that will not be repeated. A change in the pricing of pharmaceuticals raised revenue by $1.1bn. The ramp-up of the National Disability Insurance Scheme is slower than expected.

But there were many telltale signs of an improving economy. GST revenue is a good indicator of spending, and it was $600 million better than expected. Company profits had been at a standstill since 2011, but have surged in the first six months of this year. Soaring coal and iron ore prices have doubled resource sector profits, but earnings are now showing good growth across most of the economy. The best measure of company tax revenue is up 12.7 per cent from a year ago.

In both the May budget and in last December’s budget update, Treasury expected stronger commodity prices to bring a lift in tax payments from resource companies, but it did not see the broader recovery coming. Moreover, it expected gains in company tax would be cancelled out by weaker personal income tax because wage growth has been so weak. However the final budget statement suggests that employment growth is offsetting weak wages — PAYG tax payments were higher than Treasury predicted.

The dollars involved in these upgrades are too small to make a difference to the overall budget, but they are straws in a wind that is blowing in the right direction for the first time in a decade.

Tax revenue remains about 22 per cent of GDP, which is where it has been stuck since 2012-13. It is a full 2 percentage points below the level averaged over the last eight glorious budget years of the Howard government. In the absence of spending cuts, revenue needs to return to Howard-era levels if the budget is to return to surplus.

Morrison’s approach to the politics of the budget is to take revenue as a given, declaring his focus is on controlling costs. “We have had to deal with changes to what has happened on revenue, but all along the line we have been holding firm to keeping expenditure under control,” he said this week.

The budget result for 2016-17 provides some evidence for the Coalition’s success. Over the first three full years of Coalition government, total spending rose 8 per cent, slightly less than the 10 per cent growth in the nominal economy. Over the previous three years of Labor’s government, spending rose by 17 per cent.

The Coalition is still dealing with three landmines sown by the Gillard government, with huge and largely unfunded policy commitments to hospitals, schools and disabilities. The Abbott government’s efforts to axe the gains for schools and hospitals were partially unwound by the Turnbull government.

Over the past three years, spending on schools is up 27 per cent, hospitals 35 per cent and disabilities 19 per cent. The Abbott government added its own unfunded commitment to lift defence spending to 2 per cent of GDP, which has added 23 per cent to defence costs.

Dealing with blowouts in these four large commitments, which between them account for a fifth of budget spending, has meant cuts elsewhere. Family benefits have been frozen. Growth in social welfare spending overall has been kept to 9 per cent — about the same as economic growth — despite absorbing the new NDIS and rising pension payments.

Spending on higher education has risen only 4 per cent while immigration spending has fallen 13 per cent. Finance Minister Mathias Cormann has found cuts in many of the smaller areas of government spending, like employment, the public service, culture and the arts, and the parliament.

Is it enough? Even a burst of sustained economic growth would not take company tax revenue back to the glory days of the resources boom when the Howard government collected a greater share of its revenue from the corporate sector than any other nation. Treasury’s forecast that wage growth will lift from 1.9 per cent to 3.75 per cent over the next two years, taking PAYG revenue with it, is also in doubt. A theme of this year’s IMF October meeting is why wage growth has fallen everywhere, despite the return to economic growth. So the government needs to do more.

But growth improves the budget on both the revenue and the spending sides by more than anyone expects and the signs from the 2016-17 budget are good. The Coalition is contesting the economic space, arguing the cause of growth, while Labor tackles inequality. The economy is moving in the Coalition’s direction.