The three key takeaways from this budget are that the economy is on a much stronger footing than what many had thought, that federal government finances are in better shape than many thought, and that the government has a much better chance at winning the next election than the polls indicate.
This is in the context of rising consumer and business confidence and a robust global economy. For those concerned about interest rates this all suggests that the RBA Board is quite right to maintain a soft tightening bias.
The political economy of Budget 2018
The government’s political strategy is based on two economic considerations. Australians will reward a government that keeps its house in order; that is, they want a balanced Budget. Also, that many Australians are struggling with low wage growth.
As a political judgement, the Labor party seems to be putting more emphasis on the latter of these two considerations, identifying the concerns about low wage growth with the type of disaffected voters who supported Brexit in the UK or who voted for Trump in the last US presidential election.
The government’s judgement appears to be that these socio-economic strains are less acute here in Australia than in the US or Europe and is placing more emphasis good budget management. The government is using more than half of the extra revenues it has received for budget repair with less than half going to income tax cuts and other new spending measures.
The economic foundations
There are two economic foundations of this budget – the sudden revenue windfall in the current financial year and the economic forecasts.
Central to the government’s ability to provide tax cuts both now and into the future has been a sudden surge in revenues over the last six months. This is a truly remarkable turn of events for a government that is behind in the polls and represents the first substantial upside surprise on government finances since the financial crisis.
We now know that the government will receive about $8 billion of revenues this year that it did not forecast at the mid-year update last December. Thanks very much. That $8 billion becomes an extra $10 billion of revenues in 2018/19 and $8 billion in 2019/2020.
Over the four years to 2020/21 the government has about $32 billion of extra revenues. Some of this is offset by higher government expenses and some has been used to fund new measures but importantly, the government has resisted any temptation to up the short-term handouts or increase the tax cuts ahead of the election and earmarked at least half of the new money for budget repair.
An optimistic but conservative set of economic forecasts underpin the budget projections. This set of forecasts are the right numbers albeit with a little more risk of missing on the downside than the upside.
The expectations for wage growth is drawing attention as it did last year. The government still expects wage growth to rise to 3.5% over the next two years from around 2% currently even though employment growth is only strong enough to push the unemployment rate down to 5.25% over this period.
If a week is a long time in politics, then two years is a long time in economic forecasting. Sure, the risk on wages is skewed to the downside but not by as much as many would have you believe. It won’t take much to get wage growth up to 3% and I don’t think the economy needs to be operating through full employment to get wages rising.
The demand for labour in the economy looks solid and inflation expectations are well anchored to the RBA’s 2-3% target.
What is potentially controversial is that most of the extra revenues over the next four years comes from personal income tax receipts even after factoring in tax cuts. This means that the government’s better financial position is dependent on the performance of the labour market and is therefore heavily impacted by the assumptions on employment and wages.
This is a clear vulnerability for the government as it sells its budget to the broader community, but it is unlikely that the credibility of the wage numbers will be tested before the next election.
The other leg of the economic forecasts that can be critical are those around the global economy. On this front the Treasury has given the government a set of numbers broadly in line with the consensus thinking and the forecasts of the major international institutions. The strong global growth we have seen in the last year is expected to moderate over the next two years.
Nothing too ambitious in those projections.
How will this Budget impact the economy?
Despite the headlines about new infrastructure measures, the reality is they are small and are not going to significantly alter the outlook for engineering construction or jobs in this sector. Some will see this as disappointing, but the infrastructure sector is growing strongly and this should not be seen as a major problem for economic activity over the next few years.
More importantly, the stronger budget result will give households more confidence in the government’s financial position which is likely to result in more spending and less saving. There is a strong negative correlation between government saving and household saving in this country. If the government is saving more, then households feel confident to save less, expecting a lower tax burden in the future.
The long term nature of the personal income tax cuts announced in the budget should reinforce this perception amongst Australian households.
Targeted income support for low and middle income households will reduce the vulnerability of some households to low wage growth and higher interest rates. This should, at the margin, reduce concerns within the RBA that higher interest rates could topple indebted households.
Overall, this budget will be mildly stimulatory to the economy, which might be enough to convince the RBA that interest rate normalisation can get under way before too long.
The RBA has interest rates too low for the state of nominal growth in the economy but is reluctant to begin the process of taking monetary policy back to a neutral setting because of concerns about the impact on indebted households.
Everything the government has done to address the pressures on low and middle income earners will also ease some of the RBA’s concerns about the effects of higher rates on consumer spending.
Both the government and RBA’s economic forecasts are projecting an economy that will continue to expand and absorb spare capacity well into the future. In my assessment, these projections are consistent with a RBA cash rate moving up to around 2.5% over the next year or two.
The good news for the government is that those rate hikes are unlikely to start before the next election, which looks increasingly likely to be called at about the same time Steve Smith is recalled into the Australian cricket team.
Warren Hogan is a Sydney-based economist and consultant. He has previously held roles as a senior official in the federal Treasury and as chief economist at ANZ Bank.
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