Federal Budget October 2022: Difficult decisions deferred

After four Budgets in two years, we’re accustomed to a steady stream of ‘decisions taken but not yet announced.’ Tonight, the Treasurer delivered a Budget full of decisions announced, but not yet taken.

The Treasurer said he is prepared to make difficult decisions in difficult times, but instead we saw that he’d prefer to defer them.

These deferred decisions are only going to become harder as Australians spend their pandemic savings buffers, inflation accelerates and the Reserve Bank slows the economy.

The ferocity of the inflation problem – which has been confirmed in the Budget by upgraded inflation forecasts – meant the Government could not risk increasing price pressure through additional spending.

The Budget has been carefully curated to ensure new policy spending did not fall into the current financial year when the inflation risk is (at least on current forecasts) most acute. Only $1.6 billion was added to the net policy spend in 2022-23 and $130 million to direct capital spend. Stimulatory policy flows again from 2024-25, when the forecasts safely park inflation in the 2-3 per cent target band.

The public sector (including Commonwealth, state and local government spending) pushed up to over 27 per cent of GDP mid-year, and the program of spending outlined in the Budget suggests the Commonwealth component of that will increase further from 2024-25.

That ratio is high when compared to the long-term average of 23 per cent of GDP. It was appropriate when the COVID-19 shutdowns were strangling the economy – but not this year. The economy is hitting capacity constraints and employers of every size are suffering from acute skills shortages.

The Reserve Bank has been quickly reversing the stimulatory policy it put in place during the COVID-19 lockdown years, and this Budget was the Government’s opportunity to do the same with fiscal policy.

The Government hasn’t risked additional inflationary pressure with fiscal policy, but neither has it delivered what the economy needs, which is tighter policy that removes some inflationary pressure.

Policy savings should have more than offset new policy

Some of the new proposals in the Budget were significant and a welcome start to the Albanese Government’s reform agenda. We applaud the measures that encourage workforce participation by making childcare cheaper and allowing older Australians to keep more of their pension when they work.

Extending the Paid Parental Leave scheme and including a use it or lose it provision for dads is a helpful way to lift workforce participation and level the playing field for men and women at work and home. Devoting $1 billion for 180,000 free TAFE positions in skills shortage areas will help boost productivity in Australia’s service-based economy. The $770 million for schools and $485 million for 20,000 new university places for disadvantaged students will also help improve the skills base of the workforce.

There were a number of savings to offset new policy spends. Over the four years to 2025-26, these include $6.5 billion from altering the timing of planned infrastructure builds, $3.7 billion from better resourcing the Australian Tax Office, $953 million from reducing the amount of interest and royalty expenses that can be deducted by multinationals and $3.6 billion from cutting public service use of external labour, advertising, travel and legal services.

The Budget projections show, however, a loosening of fiscal policy from 2024-25. New payments exceeded new receipts by $2 billion in 2024-25 and in 2025-26 new payments exceed receipts by $7.4 billion. Payments push higher in these two years reaching 27.1 per cent of GDP, the highest ratio since the mid-1980s. Cuts to these projections would have shown that the Treasurer is serious about addressing the structural deficit.
 

The deficit projections are smaller, but not small enough

The underlying cash balance improved significantly from the March Budget. The $78.0 billion deficit projection for 2022-23 has been revised down $36.9 billion, and a $56.5 billion deficit in 2023-24 was revised down to $44 billion. That was mainly because revenue was revised up by $59.6 billion in 2022-23 and $36.2 billion in 2023-24. The strength of this upward revision was expected given commodity prices have been well above the Treasury’s forecast prices, while the labour market has been stronger than expected.

The position of the Budget is expected to worsen after 2024-25 because commodity prices and labour market conditions are forecast to normalise, while payments rise substantially faster than receipts as new policy measures take effect.

Despite the talk of the need for restraint, in the current financial year, there was no cost cutting as $1.4 billion in additional receipts since the last Budget update were more than offset by $2.5 billion in additional payments.

Debt down, but rising interest rates lift the cost of servicing it

The improved underlying cash balance has been accompanied by a significant downward revision to net debt. But because of COVID-19 support delivered in 2020 and 2021, net debt remains at record levels. As the Reserve Bank hikes interest rates to tame inflation, this drives up interest costs for the Government.

In the short term, lower net debt levels are expected to reduce net interest payments, however, from 2024-25 net interest payments are expected to rise, reaching 1 per cent of GDP by the end of the forward estimates. The assumed yield on 10-year government bonds has been revised up from 2.3 per cent at Pre-election Economic and Fiscal Outlook (PEFO) to 3.8 per cent over the forward estimates.

Tougher times ahead

After a 3.25 per cent GDP growth rate in the current financial year, Treasury is forecasting a significant slowdown to 1.5 per cent for 2023-24 due to downward revisions to commodities and employment. That’s a 1 percentage point downward revision since the March Budget forecast.

Despite the current unemployment rate being near a record low 3.5 per cent, unemployment is expected to remain largely unchanged in 2022-23 at 3.75 per cent. A rise to 4.5 per cent is expected in 2023-24, before unemployment returns to Treasury’s estimate of the Non-accelerating Inflation Rate of Unemployment (NAIRU) of 4.25 per cent.

Inflation is expected to accelerate, as both domestic and international inflationary pressures continue to mount. Inflation was revised up significantly from 3.0 per cent in 2022-23 at the time of the March Budget (through the year to the June quarter) to 5.75 per cent in this Budget. Inflation is expected to slow to 3.5 per cent in 2023-24, before returning to the Reserve Bank’s target band by 2024-25.

Wages are expected to finally pick up, albeit slower than the tightness of the labour market would indicate, with the wage price index (WPI) now expected to grow by 3.75 per cent in 2022-23, which is 0.5 percentage point faster than forecast in the March Budget. However, given inflation levels will remain elevated, real wages are expected to continue to fall.

Productivity growth has been downgraded to 1.2 per cent, from the 30-year average growth rate of 1.5 per cent, acknowledging structurally weaker productivity growth over time.

On a positive note, Treasury has increased its forecast for population growth which is expected to reach 1.1 per cent in 2021-22 (from 0.7 per cent in the March Budget), rising to 1.4 per cent in 2022-23 and 2023-24. Driven by an increase in overseas migration, this will provide some relief to a very tight labour market which is constraining activity in many sectors across the economy.

Structural budget problems underpin need for difficult decisions

The reality facing the Government is a structural deficit that is worse than in the March Budget by the end of the forecast period. The cost of significant programs, particularly the National Disability Insurance Scheme, have been revised substantially higher in recent years. The cost of many of these programs are forecast to rise faster than GDP over the foreseeable future.

So inflation aside, if spending is running faster than revenue, budget realities will jar with community expectations of high-quality aged and disability care and further defence and infrastructure spending.

There were some baby steps taken to start down the productivity reform path, following the long list of worthy recommendations from the Jobs and Skills Summit. The Government must now take seriously the suggestions that will be made by Treasury in the upcoming White Paper. It should also embrace the reforms that the Productivity Commission is updating following its 2017 Shifting the Dial report.

The last decade of inaction means that the concepts and ideas put forward by the Henry Tax Review remain worthy in the tax reform process.

The Government’s discussion of wellbeing and “measuring what matters” within the Budget, was very welcome and in future will assist in decision making to determine effectiveness of spending and value for money.