The Budget: getting the big calls right?

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.

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.

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.

Why is an official 'structural'/cyclical split excluded? The Budget Papers argument that 'it's too hard to measure' is a cop-out answer, really. Besides, an IMF structural Budget estimate is used for international comparison purposes (Budget Paper No. 1, pages 4.29-4.31, and Chart 11).

Cynics will conclude its exclusion suits governments. Boom-time Budget surpluses can be claimed as 'proof' of good Budget management, or used for tax cuts and increasing other entitlements even though these might be unsustainable over the full economic cycle.

The current Government's label for such profligacy is 'sharing the benefits of the mining boom'. Nonsense. Booms are temporary. Their Budget benefits should be used for temporary purposes, especially delivering surpluses to offset Budget deficits when the bust follows. Creating expectations of permanent increases in entitlements financed by forecast revenue increases is even more irresponsible.

Without estimates of the cyclical/'structural' split, governments can have it both ways on the downside too.

The current Government says slowing growth in revenue is structural when much of it is cyclical. To add to the confusion, some Ministers call this a revenue 'contraction'. Then it's argued taxes need to increase. Some Ministers call these increases 'structural saves'. Claiming the tax/GDP ratio is lower than the boom-inflated ratio under the Howard Government is also used to 'justify' tax increases.

By also saying revenues will recover, the Government implies (i) the revenue slump is cyclical, and (ii) boom-time revenues are cyclically average! The structural credibility deficit rises.

The current Government also claims revenue shortfalls were unexpected. Really? Australia's terms of trade have been falling for nearly two years now. This is likely to continue, and more than the Budget forecasts. Globally, the mining industry shows the classic demand-price-supply responses of the 'hog cycle' studied by economics 101 students for well over half a century. As a commodity exporter, Australia has weathered commodity price cycles for centuries.

Besides, basic risk management dictates preserving boom time surpluses to cover busts, even if the timing of the latter cannot precisely be foreseen. Spending the boom's present and expected proceeds – and more – on supposedly permanent entitlement increases is the antithesis of responsible fiscal housekeeping.

The Budget papers should give priority and prominence to the structural Budget balance. That way, we get a fix on the cyclical Budget position over time as well.

The Treasurer says his job is 'to get the big policy calls' right. Quite so. For this, having the right navigation tools is essential.

The 'structural' Budget balance is both policy guide and public justification for fiscal discipline. It's the Budget's GPS.

Without it, the big policy calls can be wrong, and governments can go off course, in one year – or ten.

The 'pathway to surplus' can become a 'runway to ruin'.