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The Budget: getting the big calls right?

By Geoff Carmody - posted Thursday, 23 May 2013


Maintaining Budget balance on average over the economic cycle gets bipartisan lip-service. Budget surpluses in boom times should (at least) offset deficits in slumps. Otherwise public debt increases.

To navigate this Budget policy course, governments need to know where they are in the economic cycle.

The 2013-14 Budget provides insufficient information on this.

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Based on optimistic assumptions, including those for our terms of trade, underlying cash deficits of $18 billion in 2013-14, $11 billion in 2014-15, and balance or small surplus later, are forecast.

These numbers are not split into their cyclical and 'structural' components. Economic cycles push the Budget balance around a lot. These forces are often overseas sourced, beyond our control. They drive the cyclical Budget balance. Government spending and revenue decisions affect the remaining component; the 'structural' Budget balance.

The split of the reported Budget balance into cyclical and structural components is a key tool for fiscal policy analysis and Budget transparency. It should be up-front in all the Budget papers (especially the Budget Speech and Paper No. 1). It isn't.

The Budget papers do not estimate the structural Budget balance, or emphasise it as a fiscal policy guide.

Private businesses (Macroeconomics, Access Economics) and official agencies (IMF, OECD) produce 'structural' Budget balance estimates. The Parliamentary Budget Office (PBO) has indicated it will produce estimates too (hopefully soon).

Pre-Budget private sector estimates had the economic cycle still producing a cyclical Budget surplus (the difference between the reported deficit and the larger 'structural' deficit) of around $10 - $25 billion averaged over 2012-13 and 2013-14. The estimated 'structural' deficit – a better guide to fiscal policy – was around $20 - $35 billion or more. Excluding revenue from 'tax bracket creep' would increase some private sector 'structural' Budget deficit estimates.

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The claimed net effect of discretionary measures reported in the 2013-14 Budget papers (mainly tax increases) is almost nothing in 2013-14, a deficit reduction of $6.5 billion in 2014-15, and a little over $12 billion in each of the next two years.

A 'structural' deficit is likely to remain over the Forward Estimates. 'Cyclical' factors may continue driving a surplus, reducing the reported Budget deficit, and possibly driving it towards a surplus some time. That prospect rests on the Budget's optimistic economic assumptions being realised.

For example, an additional 4 per cent decline in the terms of trade – quite possible – reduces nominal GDP by 1%. The underlying Budget deficit would increase by $3.1 billion in 2013-14, and $5.7 billion in 2014-15.

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This article was first published in the Australian Financial Review.



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About the Author

Geoff Carmody is Director, Geoff Carmody & Associates, a former co-founder of Access Economics, and before that was a senior officer in the Commonwealth Treasury. He favours a national consumption-based climate policy, preferably using a carbon tax to put a price on carbon. He has prepared papers entitled Effective climate change policy: the seven Cs. Paper #1: Some design principles for evaluating greenhouse gas abatement policies. Paper #2: Implementing design principles for effective climate change policy. Paper #3: ETS or carbon tax?

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