Australia has a budget policy credibility deficit

The December quarter national accounts show Australia's been in an income recession throughout 2012. This further exposes the Government's structural Budget weakness. It makes restoring even a 'headline' Budget surplus harder.

In trend terms, real net national disposable income per capita fell by 1.7% in the year to the December quarter 2012. The decline accelerated through each quarter of last year. Even total real net national disposable income declined slightly (by 0.1%) over the same period and fell in the September and December quarters of 2012. Why?

In trend terms, real GDP grew by 2.9% in the year to the December quarter of 2012, but growth decelerated in every quarter of last year. This slowing made a small contribution to the fall in Australian income.

The main influence was Australia's terms of trade. In trend terms, they fell by 13.9% in the year to the December quarter of 2012, and declined substantially in every quarter last year. They have declined over 17.2% since their mid-2011 peak.

As a result, nominal GDP (ie, including price changes as well as real growth) increased by less than 1.9% in the year to the December quarter of 2012 – a full percentage point less than real GDP growth.

The long economic upswing for Australia began turning down in mid-2011, especially prices for our exports, and our terms of trade. Falling terms of trade are driving Australia's real per capita income down. Nominal income is slowing. Income/profits taxes are hit. For example, company tax, the carbon tax and the oxymoronic MRRT are raising much less revenue than expected.

Is this structural or cyclical? It's largely cyclical, including most or all of the recent decline in our terms of trade. There's been strong investment in mining production capacity in Australia and many competitor suppliers. Mining output is increasing globally. Commodity prices should move down even closer to long-term averages, even if there is a global demand recovery. Our terms of trade, and incomes, could fall further.

These cyclical forces will drive further increases in Australia's Budget deficit.

But what should Australia's Budget balance have been when our terms of trade peaked over eighteen months ago?

Successive governments' Budget policy is for an underlying cash surplus, or at least balance, over the course of the economic cycle. Eighteen months ago, on this policy, we should have been running sizeable surpluses. We weren't.

Is the Budget response to the global financial crisis (GFC) a good excuse? Whatever its intrinsic merits, no.

If the Government's response to the GFC had been more limited, and devoted entirely to 'go early, go hard, go households', as reportedly advised by Treasury, the resulting 'cash splash' would now be out of the current Budget numbers, aside from a lasting effect on public debt and public debt interest payments. The Budget would be much closer to, if not in, surplus.