The last budget update was released before Melbourne’s Stage 4 lockdowns and included spending AU$15.6 billion more via easier eligibility for JobKeeper, as well as another $2 billion to extend telehealth. So you could be forgiven for thinking the worst…
Yet, according to Chris Richardson, Partner, Deloitte Access Economics, it’s not all bad news: Treasury assumed iron-ore prices would immediately nosedive, almost halving to US$55/tonne. But they’ve actually gone up, trading at double those rates. And Treasury was very conservative in its other forecasts, including of jobs and inflation.
The upshot is that we see better news than Treasury does on personal taxes, partly as we’re less pessimistic on both wages and jobs, while profit taxes may also outperform the low bar set for them in the official forecasts. The biggest difference lies in iron-ore.
Yet while the tax-take looks set to help the budget this year, the spending story goes the other way. It’s dominated by the extra costs driven by lockdowns in Victoria. The new policies announced in the past two months are set to add $19.0 billion to expenses in 2020-21.
The bottom line? We forecast this year’s underlying cash deficit at $198.5 billion, ‘just’ $14.0 billion worse than Treasury forecast back on 23 July. All-in-all, that’s a pretty good outcome.
Future deficits are less scary than many are expecting
The 23 July update forecast just 10 months out. What of later years? Relative to official forecasts released late 2019, we see massive ongoing shortfalls in personal taxes. There’ll be fewer jobs, and wages will be lower too, with that latter factor also limiting the usual tailwind for taxes of pushing people into higher tax-brackets. Small-business profits will also be down, as will income from rents, dividends and interest.
Profits take a bigger hit than wages in recessions, and losses being racked up now can be offset against tax bills in later years. So, despite lower investment deductions, we forecast profit taxes to stay well below the official numbers.
Yet today’s emergency spending is designed to phase-out in later years, while lower wages, lower prices, and lower interest rates all generate savings. So too will reduced State grants given GST weakness, although ongoing joblessness raises spending.
Add that together, and we forecast cash underlying deficits of $45 billion in 2021-22 and $26 billion in 2022-23. That’s worse than the pre-COVID official forecast in 2021-22 by a hefty $53 billion, followed by a narrowing of the gap versus official forecasts to $30 billion in 2022-23.
Is the damage permanent?
The budget has taken enormous damage – but it probably isn’t permanent. That’s a vital distinction. The budget is badly bent, but not broken. Today’s emergency policy measures are temporary. When they’re gone, the budget will still be running big deficits, because the economy is still weak. So we need to remain laser-focussed on economic repair. If our economy gets better, then the budget will too.
Bracket-creep just stopped being creepy
Looking for a silver-lining amid the zombie apocalypse? PAYG collections this year are very close to where they’d be if the 2014-15 tax thresholds had simply been indexed. And the arrival of the second phase of the tax cuts in 2022-23 will leave families paying $7.7 billion less in taxes than if the 2014-15 tax system had been indexed. In other words, tax cuts designed to combat bracket-creep look like over-achieving, as the collapse in wage growth has slowed bracket-creep.
The budget is stepping up to protect us
The budget guards the nation’s prosperity (size of pie) and fairness (how pie is sliced up). But both are taking heavy blows from COVID-19:
- There’s never before been a hit to the Australian economy that’s this big and this fast; and
- Relatively more jobs have been lost where unemployment was already the highest: the pain to our livelihoods isn’t evenly spread.
But we’ve acted fast and well. Our prosperity is being beautifully held together by lots of sticky-tape. JobKeeper and JobSeeker are standouts, but a range of policies have swung into action to cushion our living standards. Fairness was foremost: we rushed to offer extra support to the most needy. To our absolute credit as a nation, we doubled the unemployment benefit as the crisis arrived, meaning poverty went down in Australia at a time when it surged in the rest of the world.
Australia’s ability to do that was made easier, economically and politically, by our strong position when the crisis hit: the federal budget was balanced, and debt was low. Better still, we got the money into people’s pockets faster than we did during the global financial crisis (GFC), and our success against COVID-19 reduced the cost of our emergency measures – a virtuous cycle.
So Australia’s defence against COVID-19 has been world-class so far. But challenges are mounting: families and businesses are set for a big cash-crunch between now and March 2021 as JobKeeper and JobSeeker are dialled back; as money from early access to superannuation dries up; and as a range of mortgage and rent-deferrals run out.
This means war
Will we keep up the good work? The GFC was less damaging in Australia than in most nations. And so far, we look like going one-better still on that degree of outperformance this time. But that will mostly mean avoiding the mistake too many nations made in the immediate aftermath of the GFC –resting on their oars.
2020 has been a war to protect our health – mostly older Australians. But the next war is now looming – the war for jobs, which in many ways is to help younger Australians. Whereas the war for our health was a sprint, the war for our jobs will be a marathon. Both history and economics tell us that unemployment goes up fast, but comes down slow.
Getting unemployment down again is going to be hard. In every other recession and recovery we’ve seen, the Reserve Bank could always do more if needed. But not this time. That says Australia’s recovery is very reliant on governments going hard and going smart:
- Going smart means reform – letting our economy grow faster. More growth = more jobs.
- Going hard means federal and state governments need to keep spending.
That combination gives us the best chance to recover as fast as possible. It underscores a key point: let growth in the economy shrink debt, rather than letting attempts to shrink debt hold back the economy.
But haven’t we mortgaged the future?
Defending our lives and livelihoods doesn’t come cheap. Taxpayer money is doing a more effective job today than it’s ever done before. In ordinary times, we’d worry about debt. Yet these aren’t ordinary times. Although the increases in debt are very large, the falls in interest rates are even larger. That’s a game-changer.
So, when Treasury updated its budget forecasts on 23 July, it forecast government interest payments were dropping to the smallest share of national income seen in a decade. But its forecasts only covered 2020-21. Our forecasts indicate that, in June 2023, federal debt will be $401 billion higher than Treasury’s pre-COVID forecasts. But we also forecast that the cash-cost of interest paid by government will be $2.4 billion lower in 2022-23 than it was in 2018-19.
Yep, you read that right. It will have fallen. A lot. Never in the 2000 years of recorded history of interest rates has it been cheaper for governments to borrow. Never!
Although interest costs won’t have fallen as much as had been hoped pre-COVID, that gap ($1.6 billion in 2022-23) is the equivalent of an ongoing cost to the average taxpayer of just $2.66 a week. That may be the biggest bargain you’ll ever score. These costs are far from scary. The defence of our lives and livelihoods has been cheaper than people realise.
Focus on creating new jobs
This story hasn’t finished. Australians should see the October budget as continuing the defence of our livelihoods, but to gradually change gear from protecting old jobs towards creating new jobs.
However, stimulus is effective only if that money is spent. That’s why infrastructure ranks highly in economists’ thinking on stimulus, because that money gets spent rather than saved. Ditto the construction of social housing, or unemployment benefits.
The October budget provides new support to defend our livelihoods (e.g. time-limited money for the states for infrastructure, or further help for age pensioners). We especially like the wage subsidies swinging away from protecting old jobs towards creating new jobs.
Other possibilities are in play too. Our assessment of two of the mooted options is:
- Adopting a business-investment allowance: Keep as much as it can of the incentive effects of a company tax-cut, but to deliver that rather more cheaply (because the incentive applies to new investments rather than existing ones).
- Delaying or dropping the lift in the SG: If the key to getting jobs back as fast as possible is seeing more spending in the economy, is this the best time to promote a policy that boosts saving at the expense of spending?
Bringing forward tax cuts
We’ve always said that personal tax-cuts weren’t unfair, but that they are too big. And now COVID is here, raising the question of how good the tax-cuts would be as stimulus.
Australia’s national discussion of these measures has been pretty woeful. On one hand, some argue that the lift in government debt as a result of COVID-19 means that the further rounds of tax cuts should be junked completely. That’s ‘junk economics’. Australia has high unemployment, very low interest-rates, and families and businesses that aren’t likely to be spending at the pace needed to continue to see unemployment fall after the initial effect on joblessness of a re-opening economy.
Withdrawing government support by dropping proposed tax-cuts would be downright dumb. The key policy question lies around changing from government emergency support as a defence against COVID-19 to a fight against unemployment. The main near-term policy debate should be around what extra policy is needed – not what withdrawal of policy support is needed.
The third tranche of these tax-cuts has a bad rep that’s entirely undeserved. Our own modelling – like Treasury’s – shows that by the time legislated cuts to personal income taxes are fully implemented in 2024-25, they’ll have made little change to the share of income paid as personal taxes by different income quintiles – including at the top-end of the income scale. Yes, you read that right.
Treasury’s analysis indicates that, even once all three stages of the tax plan are in place, the shares of tax paid by the top 1% and 5% of taxpayers will go up a little, while the share paid by the top 10% and 20% will go down a little. Those results aren’t dramatic.
But those Treasury numbers assumed rising wage growth. That hasn’t (and won’t) happen. That’s important, as it’s wage-growth that pushes people into higher tax-brackets. So what happens when you redo those estimates?
Not surprisingly, the worsening in the shares of tax paid by the top-end becomes more evident in a COVID world. Each of the top 1%, 5%, 10% and 20% of taxpayers will pay a higher share of personal tax than if there’d been no tax-cuts, with that pain concentrated at the top-end.
We see the top 1% and 5% paying a higher share of personal taxes after all three tax-cut tranches, with the difference being that their increase in burden is greater in our modelling (picks up the effect of slower wage gains than Treasury had been assuming).
Unfortunately, our modelling and Treasury’s will remain ignored. But they shouldn’t be. These tax-cuts are the biggest dollars in the national discussion of the moment, and almost everything that Twitter has yelled about them is wrong.
Don’t forget that, compared with the rest of the OECD, Australia is more reliant on personal tax, and also has a high top-marginal-rate of tax that cuts in at relatively low levels of income. So yes, these tax-cuts are entirely fair. Their fairness is the most compelling thing about them.
Yet there are still good reasons to be wary of the tax-cuts. We’ve always been worried that they’re too big – that they promised too much too soon. Events have served to underscore that very point. Then again, that’s a battle we lost: these cuts are already legislated.
More relevant still is a new point: they’re not as effective as stimulus as some alternatives.
But Australia’s COVID-crunched economy definitely needs a boost, and bringing forward the already legislated cuts would pump a lot of gas into the economy. How much gas are we talking here?
If it’s just Phase 2 tax cuts being brought forward by a year, then the bigger stimulus would be to keep the existing low and middle income tax offsets in play. The cost of that combo would be $12.35 billion in 2021-22.
If it’s both Phases 2 and 3 being brought forward (and existing low and middle income-tax offsets removed a year early), that would cost $21.0 billion in 2021-22, $14.8 billion in 2022-23 and $15.4 billion in 2023-24.
The cost goes down over time as the 2021-22 figure includes bringing forward both Phases 2 and 3 (less the LMITO), whereas the 2022-23 and 2023-24 figures simply cover the cost of bringing forward Phase 3. And we’ve deliberately abstracted from a timing impact – the current tax-offset arrives via refunds the following year.
But stimulus is effective only if that money is then spent. So the fact that the top 1% of taxpayers pay 17% of all personal tax is a reason why personal-tax-cuts work less well as stimulus – as they’re more likely to be saved. That’s why we wouldn’t want any bring-forward of personal-tax-cuts to happen instead of other forms of stimulus.
The bottom line? Tax-cuts are not unfair. But they are too big. And they aren’t as effective at creating jobs as some other programs. But if they are in addition to other stimulus measures, then you should welcome them with open arms.