Reflections on the 2010-11 Budget

The Rudd Government’s third budget is built on the Australian economy’s better than expected performance over the past year (for which the government can claim some credit) and the return of the minerals boom (for which, of course, the government can claim no credit at all). Together these have generated a revenue windfall reminiscent of those that the Howard government enjoyed in its last two terms, which has allowed Wayne Swan to return the Budget to surplus three years ahead of the schedule laid out in last year’s budget, while still leaving room to fund a number of (mostly worthwhile) measures that seek to boost infrastructure investment, skills and saving, and without having to make politically difficult spending cuts less than six months out from an election.

Thanks to upward revisions to forecasts of economic growth (of half a percentage point for each of 2009-10 and 2010-11) and, especially, of export commodity prices (so that Australia’s “terms of trade” are now expected to be more than 20 per cent stronger in 2010-11 than had been assumed six months ago), the value of goods and services produced by the Australian economy over the four years from 2009-10 to 2012-13 will be almost $450 billion more than had been reckoned six months ago.

These and other changes to the assumptions underpinning the budget arithmetic (what are referred to in the Budget Papers as “parameter variations”) put an additional $49 billion at the government’s disposal over the four years to 2012-13. Of this amount, the government has used a net $7.5 billion to fund the various taxation and spending “policy decisions” announced before, or in, last night’s budget; while the remaining $41.5 billion has been applied to improving the “bottom line”, resulting in the budget returning to a modest surplus in 2012-13, rather than in 2015-16 as envisaged six months ago.

Alternatively, over the four years to 2012-13, revenues are now expected to be almost $66 billion higher than projected six months ago (including $28 billion more in personal income tax and $19 billion more in company tax); of which, a little over $24 billion will be absorbed by higher spending than projected six months ago while (as before) just under $42 billion goes to improving the “bottom line”.

The government has thus delivered on its commitment to hold real growth in spending to less than 2 per cent per annum until the budget returns to surplus. But it has done that without really making any significant net savings. The Treasurer’s claim that “every dollar of new policy in this budget has been offset across the forward estimates” holds true only as a result of a $5.9 billion net saving forecast for 2013-14, the last year of the forward estimates period: in all but one of the years 2009-10 through 2012-13, the “spends” in the budget exceed the “saves”. Moreover, some 60 per cent of the “saves” are the result of tax increases or new taxes, rather than spending cuts.

For all its (justified) criticism of the Howard government’s profligate spending during its last two terms, Labor in government has done very little to unwind it. That said, judged by the standards of the Howard government’s pre-election budgets of 2004 and 2007 (which featured net give-aways over the ensuing four years of $36 billion and $50 billion respectively), this is a remarkably restrained effort.

The specific initiatives in the budget are for the most part modest and well targeted to addressing the challenges facing the Australian economy as it moves back, more quickly than previously expected, to “full capacity”. However, they will take time to come to fruition.

In the meantime, Treasury now expects that growth will accelerate to an above trend pace of 4 per cent in 2011-12. This is slightly above the Reserve Bank’s forecast, issued last Friday, of 3.75 per cent growth in 2011-12. However, whereas the Reserve Bank sees inflation reaching the top of its 2-3 per cent target band during 2012, reflecting “a gradual increase in capacity utilisation and demand pressures in the economy and some pick-up in wage growth as the labour market tightens”, Treasury simply notes these as “upside risks” to a rather sanguine forecast that inflation will remain at 2.5 per cent per annum throughout the forecast period. Both forecasts are premised on the “technical assumption” that interest rates will move “broadly in line with market expectations”, which imply a rise of about one percentage point over the next 12 months.

The budget does nothing to lessen that prospect. The “bottom line” is returning to surplus more quickly than previously expected because the economic outlook is much brighter than it appeared previously, not because the government has consciously and deliberately tightened the stance of fiscal policy. Fiscal and monetary policy aren’t pushing in opposite directions, as they were during the years leading up to the financial crisis. But monetary policy still seems likely to have to shoulder most of the burden of keeping inflation within acceptable bounds. And it may well be that 4 per cent growth and 2.5 per cent inflation turn out to be mutually inconsistent.

Treasury’s discussion of the challenges involved in managing the mining boom suggests that it sees the increased superannuation savings funded in part out of the proposed resource rent tax as a more desirable way of providing “an enduring benefit” from the exploitation of Australia’s mineral resources than the establishment of a sovereign wealth fund. However, if the boom continues (and that may now be a bigger “if”), this is unlikely to be an “either/or” question, but one which will be a recurring issue for future budgets.