The Government's Ballooning Deficit

The Charter of Budget Honesty Act 1998 requires the federal Treasurer to publicly release and table a mid-year economic and fiscal outlook (MYEFO) report by the end of January in each year, or within 6 months after the last budget, whichever is later.

Treasurer Hockey must be starting to sweat how the numbers will stack up, given the economic and political conditions in which he finds himself. His MYEFO report will continue in a long line of revisions showing a worsening situation for the budget.

Each budget presents six years worth of aggregate data. The budget presents the actual numbers (income, spending and balances) for the previous year, an estimate for the current and following year, and three more years of projections. Years are from July to June (financial years). So, for example, the 2008-09 budget includes actuals for the 2006-07 year, estimates for 2007-08 and 2008-09, and projections for the following three years.

Graphing all of the estimates and projections together, along with the known actuals, shows us just how accurate the Treasury boffins are in their guesses and how much they are revised from year to year.

The three graphs below show the five years of estimates and projections of each budget, with the actuals shown separately. The graphs all present the same information, but each has different budgets highlighted, as we will explain.

The first graph shows the 2008-09 budget (in blue), which was prepared before impact of the unfolding sub-prime mortgage crisis in the United States on the global economy was anticipated. It shows that the government expected continued surpluses of around $20 billion into the foreseeable future. As history records (in black on our graph), this was hopelessly optimistic. From 2007-08 to 2008-09, the budget balance dropped from a surplus of $19.7 billion to a deficit of $27.1 billion. That’s a change of $46.8 billion in only one year. The government reacted well in terms of guessing the impacts, and the budget of the following year (2009-10, in red) made big adjustments to the forward estimates, which anticipated, quite accurately, the future budget outcomes (see comparison of red and black dots).

Federal budgets, underlying cash balance 2007-08 to 2017-18

We then had some wildly optimistic budgets beginning in 2010-11 (green) and continuing through 2011-12 (purple) and 2012-13 (teal blue). The steepness of these lines show that the government expected a fast recovery in the budget’s bottom line. To the most recently published actual balance of 2012-13 (-$18.8 billion), these estimates proved to be far too optimistic. Interestingly, the 2009-10 (red) projections were more accurate, even underestimating the pace of recovery. Labor’s continued insistence of a return to surplus in 2012-13, despite persistent challenges and contrary evidence, ended in failure both in terms of realising that goal and in terms of political credibility. The opposition’s repeated claim that it would return to surplus even sooner proved to be just as indefensible.

We will look at some of the reasons for the continually worsening fiscal position in future posts, as we consider impacts on the revenue and expenditure sides of the budget.

Federal budgets, underlying cash balance 2007-08 to 2017-18

Recent budgets have shown a more cautious approach, with slower returns to a balanced budget expected. Even so, continued downward revisions have been required as global conditions have deteriorated and the domestic economy has failed to hit second gear.

In particular, the most recent budget (the first of the new Liberal-National Coalition Government) includes a massive deterioration in the budget balance over the forward estimates. In particular, the estimate for the 2013-14 year was downgraded from a deficit of $18 billion in the 2013-14 budget (under treasurer Wayne Swan) to a deficit of $49.9 billion in the most recent 2014-15 budget (under treasurer Joe Hockey). This downgrade in expectations is remarkable given the wide ranging spending cuts that the new government has been making. We have previously explained some of this here and here.

Federal budgets, underlying cash balance 2007-08 to 2017-18

In January the government will release its mid-year economic and fiscal outlook statement. In it, we can expect to see further downgraded estimates, for a number of reasons.

Firstly, since the current budget was announced, the government has faced resistance to many of its spending cuts in the senate. Without a majority in the upper house, the government has been forced to negotiate with different parties and independents on different issues. As the recent resignation of Jacqui Lambie from the Palmer United Party is added to the mix, the government’s task of negotiating unpopular cuts will be made more difficult.

The second issue is increasingly apparent global economic stagnation. While there are promising signs of hastened growth in the United States,¹ and continued economic expansion in China and India, Europe remains a drag on the world economy. As Germany orders the rest of the European Union to keep digging its way out of its austerity hole, the drain on demand continues to hurt economies across the globe.

Another key problem for the budget is declining commodity prices. Indeed, the plummeting price of iron ore alone could well take around $10 billion out of the government's income, exacerbating the deteriorating fiscal position.

Add to the mix the climbing unemployment rate and falling real wages, and the government faces both reduced tax receipts and increased expenditure on welfare. Negative and low wages growth, coupled with continuing low consumer sentiment (according to the The Westpac-Melbourne Institute of Consumer Sentiment) translate into reduced demand for goods and services. Despite the RBA holding interest rates at low levels, households continue to save rather than spend. All of this, of course, means declining revenue for the government's coffers.

How the government handles all of these circumstances in its MYEFO will be crucial both for the economy and for the Coalition's political fortunes. A set of fundamental changes to the budget approach at the start of 2015 could set a more positive course. We will be posting more on the government's fiscal position through to the end of the year and in the approach of teh MYEFO.

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¹Although, as we've pointed out, the declining unemployment rate in the US should be treated with caution.