- This budget is a political document with optimistic growth assumptions;
- We examine the changes made to the superannuation system;
- Balancing the budget by 2020 with require strong growth in exports and a lower $A;
- We question why there was no incentive created in invest in Australian Government Bonds, and regret the lack of a major infrastructure plan;
- Regrettably, Australia remains highly vulnerable to any disruption to China’s economic growth.
The features and stated intentions of the 2016/17 budget have been well covered by the mainstream press. In our view it is a budget that projects optimistic long term outcomes but has a short term focus – the July election.
Whilst there are some welcome policy initiatives – the youth internship strategy being noteworthy – it is the haphazard adjustments to superannuation that exemplify the chaos in the management of our national retirement policy. The sweeping changes that cap pension assets and restrict contributions rewrite years of policy. The contribution caps are backdated and disturbingly suggest a new found propensity for both the Government and the Parliament to retrospectively change the law. If the public and in particular the younger adult generation were sceptical of the long term integrity of the superannuation system, then this budget confirms their worst suspicions. While today’s tax incentives still support long term retirement savings, there is no certainty that future Governments will not change the rules again and again for political or fiscal reasons. Given the superannuation changes announced in the budget and seemingly supported by the Opposition, why would any person under the age of thirty seriously believe that superannuation is designed or will be maintained for their benefit?
In making the above observations, we do not suggest that the superannuation changes are wrong in principle. Rather, we suggest that it was the original policy design that was flawed. It is our view that the scrapping of the Costello “transitioning to retirement” tax minimisation rules rectifies a policy that should never have passed Parliament. It is indeed perplexing that for six years the Labour Government presided over this tax minimisation policy, accessed by the wealthy, even though it was clearly against their declared view of fairness. It is remarkable that it takes a Liberal Treasurer, moved by notions of fairness, to rectify the flawed policy of a former Liberal Treasurer.
In retrospect, it seems that the creation of the “transition rules” in 2006/07 was a short term bi-partisan political construct to circumvent criticism at that time of the creation of the Future Fund. This Fund was created to secure the unfunded defined benefit pensions for past public servants, while mainstream Australians were left to secure their own retirement benefits. Nine years later, it is fairness that dictates that a contrived tax loophole is closed while the Future Fund remains under-funded by at least $50 billion based on actuarial estimates out to 2020.
The Budget’s Key Charts
Unsurprisingly, the Government claims that this budget sets Australia on the road to fiscal surpluses shortly after 2020. The fiscal crisis that was presented to us by Joe Hockey in his 2014 budget has suddenly disappeared. Supposedly minor adjustments to superannuation taxation policy were all that was needed.
While the first chart paints a rosy outlook for budget outcomes; it is based on optimistic assumptions which we will outline below.
Figure 1. Payments v Receipts (%GDP)
The key assumption that drives the near balancing of the budget in 2020 is the projected jump in nominal growth to 5% of GDP from 2017 to 2020. Even in 2016/17, nominal growth is forecast to be 2% above each of the previous two years. The explanation for this dramatic lift in Australia’s growth is unclear but it is fortuitous because it creates the desired econometric result – a declining deficit!
Figure 2. Budget aggregates and major economic parameters
Source. ABS; Treasury
The forecast budget outcomes are reliant on accelerating growth in the Australian economy that could only occur from a sharply weaker $A, significantly higher export prices, or a massive fiscal stimulation. However none of these are forecast in the budget, with the iron ore price projected at $55 per tonne and with Government infrastructure investment unchanged from previous targets.
Figure 3. Mining and non-mining wages
The next table shows that taxation income over the next four years is projected to grow at twice the rate of expenditure. This will be a remarkable achievement given slowing wages growth (see chart above) and Australia’s demographics (propelling aged care and pensions higher). You may notice that the Future Fund’s earnings are booked as a credit to the budget even though it remains under-funded with no draw down required until 2020 to pay pensions. In the meantime, Commonwealth pensions are drawn from consolidated revenue.
Figure 4. Australian Government Budget aggregates
Source. ABS; Australian Office of Financial Management
Even with optimistic growth forecasts, it is still expected that the Commonwealth will increase its net debt by about $70 billion over the next 4 years. The following projected balance sheets do not disclose the shortfall in Commonwealth pension liabilities even though the budget claims the investment earnings (as revenue) from the Future Fund. Thankfully for Treasury, the Australian Securities and Investment Commission will not be reviewing the integrity of these accounts even though an election is akin to an IPO.
Figure 5. Liabilities and assets included in net debt from 2015-16 to 2019-20
Source. ABS; Australian Office of Financial Management
New infrastructure commitments announced in the budget are shown in the next graph. It is worth noting that there is $1.6 billion of “unallocated” expenditure in the budget, which will allow the Government to announce major pork barrel initiatives – all fully funded by the deficit!
Figure 6. New infrastructure commitments
The following extract from the budget papers outlines the ongoing infrastructure investments by the Commonwealth. While $50 billion over seven years sounds impressive, it reflects an investment of less than 0.5% of GDP per annum and does not offset the dramatic decline in private investment flowing from the end of the resources boom.
The Government is investing a record $50 billion in infrastructure from 2013‑14 to 2019‑20. There are currently around 100 major projects under construction and approximately another 80 in the pre‑construction stage involving detailed design and planning works, procurement, geotechnical assessments, environmental assessments and land clearing.
The Government is committing to the Melbourne to Brisbane Inland Rail and, in this Budget, is providing $594 million in additional equity funding to the Australian Rail Track Corporation to acquire land for the Inland Rail corridor and continue pre‑construction and due diligence activities.
The Government is also committing $115 million for further preparatory activities to support the development of a Western Sydney airport at Badgerys Creek. Construction of the airport would contribute to economic development in Western Sydney.
In Western Australia, $490 million is being provided for the Forrestfield‑Airport Link and $261 million for Section 2 of the Perth Freight Link.
The $1.5 billion in funding that was previously paid to Victoria for construction of the East West Link road project will be reallocated to essential Victorian infrastructure, including:
- $500 million to upgrade the Monash Freeway;
- a further $350 million to upgrade the M80 Ring Road;
- $220 million to upgrade the Murray Basin Freight Rail network;
- 345 million to upgrade rural and regional roads; and
These measures build on the Government’s existing investments in major infrastructure projects, including $5.6 billion for a Pacific Highway upgrade in NSW; $6.7 billion for a Bruce Highway upgrade in Queensland; $1.7 billion for the Adelaide North South Road Corridor; $925 million for Section 1 of the Perth Freight Link; and $400 million for a Midland Highway upgrade in Tasmania.
Balancing the Budget
The next tables outline the key credits and debits over the four year forecast period that are designed to help balance the budget by 2020. There is about $16 billion in new increased expenditure identified. The offsets are credits from a massive increase in tobacco taxes ($4.7 billion), collection of multinational taxes ($3 billion), and curtailing superannuation concessions ($4.4 billion).
Figure 7. Budget Initiatives
Source. ABS; Australian Office of Financial Management
Australia has followed the UK example with the so-called Google Tax, but as yet there is limited evidence that such policies will capture significant tax. More consequential could be the collection of GST on internet ordered goods and services under $1,000. From 1 July, on-line importers must be registered with the Australian Taxation Office to engage in importation, and they must collect the tax from Australian consumers. Notable targets will be Amazon and eBay.
Transitioning the Australian economy
There is no doubt that Australia is transitioning its employment at a solid clip. The creation of a net 300,000 jobs in 2015/16 is indicative of this with the growth skewed to services rather than production of goods. The manufacturing sector is in steady decline and Australia’s skill base is becoming very focused on retail, health, tourism and financial services. However, these sectors have limited capacity to substantially grow export income. The following chart gives an insight into why the Government is moving to aggressively promote manufacturing in South Australia through the submarine program. Without that focus, the Australian manufacturing base is in terminal decline.
Figure 8. Job creation in 2015
Source. ABS; budget.gov.au
The transitioning of the Australian economy is inextricably linked to the powerful trade connection with China. In 2015/16, China will take over 30% of Australia’s exports amounting to over $100 billion in purchases. This figure has declined in recent years with the falls in iron ore and coal prices.
The next chart shows the growth in services exports to China. While the growth is impressive, it is off a very low base. In 2015/16, services exports will amount to less than 10% of our exports to China. Service exports to China are still too small to balance the dominance of commodity exports.
Figure 9. Australian service exports to China
The budget forecasts benefit from the assumption that iron ore prices will stabilise at about $55 per tonne for the next four years. However, the bigger impact on the forecasts is the developing LNG exports and this is where Australia’s short term fortunes lie.
The next chart outlines the forecast growth in commodity and energy exports and it swamps the growth potential of services by a ratio of 3 to 1. While Australia’s employment is transitioning towards services, the trade account will increasingly be dominated by commodities and energy exports. Therefore Australia remains very vulnerable to any economic shocks emanating from China; any major disruptions in China’s growth will wipe out the base assumptions in the budget.
Figure 10. Mining volumes
Source. ABS; Treasury
While the trade deficit may have peaked in the March quarter (annualised $40 billion deficit), the budget forecasts that Australia will grow imports of consumption and services at 3% compound. To quote …
“Imports continue to reflect the transition of the economy to broader‑based growth. Total capital imports are falling as investment in the mining sector winds down, while other imports are rising in line with growth in the broader economy and the appreciation in the Australian dollar since the 2015‑16 MYEFO. Total imports are expected to grow by 2½ per cent in 2016‑17 and 3 per cent in 2017‑18.”
If Australia’s trade deficit has peaked at 2.5% of GDP, then to balance it in the face of 3% compounding growth in imports will require compounding export growth in the vicinity of 5% over the next four years. To achieve this, the massive rollout of LNG must be a success. Success will depend on achieving volume, sustaining export prices and a weak $A.
The final table allows readers to observe the budget dynamics over the last thirty years. While the projections are optimistic, the table discloses the distrurbing decline in Australia’s net worth emanating from a succession of poorly crafted budgets. The last ten years have seen the resources growth boom squandered by poor budget structuring.
Given recent history and the changes occurring in the Australian economy, we doubt that this budget has set Australia on a path to a balanced budget in five years. Rather we predict that whoever forms the next Government will quickly adjust the budget settings and overhaul the tax system. This budget was framed with an election in mind and investors should expect that the next budget (or perhaps a mini budget) will be more significant.
Figure 11. Historical Budget and Net Financial Worth
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