March quarter 2002
11 May 2004
Budget Report
2004-05
ANZ Budget Report is produced by Economics@ANZ Contributors: Melanie Hay Senior Economist/Editor (03) 9273 5083 Saul Eslake Chief Economist (03) 9273 6251 Paul Braddick Senior Economist (03) 9273 9224 David de Garis Senior Treasury Economist (03) 9273 1995 Ian James Senior Economist (03) 9273 6252 Katie Dean Economist (03) 9273 6286 Shaz Eaqub Economist (03) 9273 6288
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Inside
Budget overview
• The 2004-05 Budget has been framed with the forthcoming Federal election in mind, with the ‘big -ticket’ items being directed at middle -income families with children. The Budget’s centrepiece is income tax cuts totalling nearly $15bn over fo ur years, through increases in the income thresholds at which marginal tax rates of 42% and 47% become payable. The Budget also provides for additional spending totalling nearly $30bn over the next four years, concentrated in the areas of payments to families with young children, health, aged care, education, defence, and infrastructure.
Budget outcome
• Strong economic growth in recent years has delivered the Government a revenue windfall, allowing plenty of scope to bring forward some of its new spending initiatives into this financial year. As a result the forecast for an underlying cash surplus of $4.6bn for 2003-04 remains the same as at December’s Mid Year Economic and Fiscal Outlook (MYEFO). The forecast for the underlying cash surplus in 2004-05 is $2.4bn or 0.3% of GDP, around $1.4bn less than forecast at MYEFO, with higher spending across a range of portfolios.
Economic forecasts
• On the domestic economy, the Government’s view is largely in line with ANZ’s. Economic growth is expected to ease from 3¾% in 2003-04 to 3½% in 2004-05, the same as ANZ’s forecasts. Like ANZ, the Government expects more balanced economic growth in the forecast period. The Government’s outlook for the international economy has brightened further from the time of the MYEFO and world economic growth for 2004 has been revised up to 4½% (from 3½%), right in line with ANZ’s forecast.
Financial market implications
• With the Federal Budget forecast to remain in surplus and an already low level of Commonwealth net debt, the implications of the Budget for the credit worthiness of the Commonwealth Government are very limited.
$ billion 2002-03(a) 2003-04(e) 2004-05(f) 2005-06(f) 2006-07(f)
Fiscal Balance(a) Underlying Cash(b) Headline Cash 6.0 7.5 7.3 3.0 4.6 4.0 0.7 2.4 1.0 0.7 1.6 0.0 2.3 3.4 12.8 (a) The fiscal balance is the accruals -based measure of the underlying ‘cash’ budget position
Budget overview
The 2004-05 Budget has been framed with the forthcoming Federal election in mind, with the ‘big-ticket’ items being directed at middle -income families with children. The Budget’s centrepiece is income tax cuts totalling nearly $15bn over four years, through increases in the income thresholds at which marginal tax rates of 42% and 47% become payable. These are to take effect in two stages (assuming their passage through Parliament) beginning on 1 July and then 12 months late r. They account for around one-third of the total budgetary impact of the policy decisions taken since last November’s Mid-Year Review.
The Budget also provides for additional spending totalling nearly $30bn over the next four years, concentrated in the areas of payments to families with young children, health, aged care, education, defence, and infrastructure.
The Budget envisages an ‘underlying’ cash surplus of $2.4bn (0.3% of GDP) in 2004-05, slightly above market expectations but down from an estimated $4.6bn for the 2003-04 financial year.
The Budget is framed on reasonably conservative economic assumptions. Economic growth is projected to average 3½% in 2004-05, representing a marginal slowing from 3¾% in 2003-04. However the mix of growth is expected to change significantly, with growth in domestic spending slowing from 6% in 2003-04 to 3¾% in 2004-05. Dwelling investment is forecast to fall by 3%, after a 6% increase in 2003-04. In addition, the expected ‘flattening in aggregate’ in house prices is anticipated to result in an easing in the growth rate of consumer spending from a robust 5½% in the current financial year to 4¼% in 2004-05. Business capital spending, which is expected to have grown by 11% in 2003-04, is forecast to slow to 7% in the coming financial year.
Stronger global growth and a recovery in farm production are forecast to produce growth in exports of 8% in 2004-05, after several years of relatively poor export performance, although the appreciation of the A$ over the past two years will dampen the growth of manufactured exports. However imports are also expected to rise by 9%, so that the current account deficit will remain sizeable, at more than $43bn, or 5% of GDP, compared with 5¾% of GDP in 2003-04.
Unemployment is expected to remain at around 5¾%, the lowest since the recession of the early 1980s. Treasury expects inflation to decline to 1¾% over the year to the June quarter 2005, largely reflecting the impact of the rise (up until February) in the Australian dollar.
While we do not have any major quarrel with Treasury’s growth forecast, we expect that inflation may be a little higher, given that the A$ is likely to be weaker than the ‘no change’ assumption on which the Budget forecasts are predicated.
The net effect of the income tax reductions and other measures in the Budget is estimated to add about ½ pc point to economic growth in 2004-05, compared with what may otherwise have been anticipated.
That said, however, the Budget is likely to have little significant impact on financial markets.
Although the Reserve Bank’s most recent Monetary Policy Statement, released at the end of last week, has been widely interpreted as implying that interest rates are likely to remain unchanged for the time being, we believe that another increase in the official cash rate is possible later this year or early next. This partly reflects our less sanguine view of the outlook for inflation, together with the prospect of higher global interest rates over the next twelve-eighteen months as the upturn in the world economy continues.
Nonetheless, there is more upside to US interest rates from present levels than to Australian rates, suggesting that the Australian dollar is likely to remain under US70c.
From a longer-term perspective it is perhaps disappointing that the Budget’s tax cuts do not entail more far-reaching reforms to the taxation system. The Budget’s tax measures postpone rather than solve the problems associated with ‘bracket creep’ (the way in which rising wages and salaries interact with progressive rate scales). This remains an issue for future Budgets.
The Budget is likely to gain a mixed reaction from voters. The absence of tax cuts for taxpayers earning less than $52,000 per annum will be a focus of the Opposition’s response to the Budget, and with opinion polls suggesting that the forthcoming election is likely to be a closely fought contest some uncertainty will persist as to the future structure of the taxation system.
The Budget arithmetic appears to leave the Government with only limited room to fund additional spending or tax reductions whilst maintaining the budget in underlying surplus. However an update of the budgetary position is required under the Government’s ‘Charter of Budget Honesty’ once an election is called, and it can be expected that further measures will be announced during this period.
Budget outcome
Strong economic growth in recent years has delivered the Government a revenue windfall, allowing plenty of scope to bring forward some of its new spending initiatives into this financial year. While ‘parameter’ variations are expected to boost the Budget bottom line by around $4.2bn in 2003-04 thanks to higher company and individual tax collections, ‘policy’ variations have led to a decrease in the budget balance by around $4.3bn due to the commencement of some of the Government’s family tax, aged care and infrastructure spending initiatives in 2003-04. As a result the forecast for an underlying cash surplus of $4.6bn for 2003-04 remains broadly the same as at December’s Mid Year Economic and Fiscal Outlook (MYEFO).
The forecast for the underlying cash surplus in 2004-05 is $2.4bn or 0.3% of GDP, around $1.4bn less than forecast at MYEFO. The strong economy continues to deliver benefits in 2004-05, with ‘parameter’ variations adding $6.8bn to the budget bottom line, partly reflecting the strength of company profits and superannuation fund contributions and earnings which boost taxation revenue. Another benefit from strong economic growth is lower unemployment benefits, by virtue of having the lowest unemployment rate in 23 years. Interestingly the Government is also expecting that fewer people will be eligible for the Family Tax benefits and Child Care benefits due to higher incomes and this is expected to reduce expenses by $0.5bn in 2004-05 and is included as a ‘parameter’ variation. Despite expectations that higher dividend payments from the RBA would boost non-taxation revenue, this did not eventuate, with lower dividends from the RBA expected in 2004-05 as a result of lower world interest rates and the re-building of RBA foreign exchange reserves.
The ‘policy’ variations sum to $8.3bn in 2004-05, largely reflecting higher spending across a broad range of portfolios. The biggest initiative was the Government’s More help for families package, which included an increase in the rate of Family Tax Benefit (A) by $600 per child along with a reduction in the income test taper rate which together was worth $2.5bn a year. Other new areas of spending (some of which were previously announced) included aged care, MedicarePlus, national security, assistance to the Solomon Islands Government and additional spending for defence forces in Iraq. On the revenue side the Government’s personal tax cuts, to commence from 1 July 2004 will cut around $1.9bn from revenue in 2004-05 while further reductions in the superannuation surcharge rate to a maximum rate of 7.5% by 2006-07 will also impact on revenue.
Reconciliation of 2003-04 MYEFO and 2004-05 Budget underlying cash balance estimates
2003-04 $mn
2004-05 $mn
2003-04 MYEFO 4,635 3,829
Changes between MYEFO and 2004-05 budget
Total policy decisions -4,255 -8271 Parameter and other variations 4,206 6,832
2004-05 Budget 4,586 2,391
(per cent of GDP) 0.6 0.3 Over the projection period, the increases in the tax thresholds again from 1 July 2005 will help to address the problem of bracket creep and along with the cost of the Government’s family tax package contributes to the shrinking surplus over the forecast period. An underlying cash surplus of $1.6bn and $3.4bn is forecast for 2005-06 and 2006-07 respectively, compared with the MYEFO surpluses of $4.6bn and $7.7bn. The headline cash surplus is also pretty slim with a balanced budget forecast in 2005-06 but is expected to fatten up in 2006-07 to $12.8bn on the back of the (again) deferred sale of Telstra. This also means that net debt estimates are a little higher than anticipated at MYEFO but at 2.9% of GDP in 2004-05, as the Government points out, remains very low compared with the OECD average.
Underlying cash surplus
4.5 3.4 1.6 4.6 2.4 0 1 2 3 4 5 6 7 8 9 2003-04 2004-05 2005-06 2006-07 2007-08 2003-04 Mid-Year Review 2004-05 Budget $ billion
The ‘underlying’ cash surplus is the cash surplus net of sales of financial assets and net advances to State and Territory governments.
While the fiscal balance has fallen out of favour as the Government’s preferred measure of the budget position, it should be mentioned, not the least because most of the Budget documentation is on an accruals basis. The fiscal surplus is expected to be around 0.1% of GDP or $0.7bn in both 2004-05 and 2005-06, expanding slightly to $2.3bn in 2006-07.
Key policy measures
Family and child care
The centrepiece of the 2004-05 Commonwealth Budget is the provision of an additional $19.2bn in assistance to families over the next 5 years. The existing Family Tax Benefit (FTB) arrangements have been extended and include a further $600 p.a. payment per child plus a relaxation of the income test for these benefits. Families currently eligible for FTB(A) will receive an immediate lump-sum payment of $600 per child paid before 30 June 2004 at a cost to the Budget of over $2bn. In addition, from July 1 the Government has introduced a new (non-income tested) maternity payment of $3000 (rising to $5000 by 1 July 2008) on the birth of a child. Changes to the Family Tax benefit also provide increased incentives for women re-entering the workforce and the number of child care places will be extended (40,000 outside school hours places and 4,000 family day care places).
Income tax cuts
The Budget has further increased the income thresholds for the top 2 marginal rates of personal income tax at a cost of $14.7bn over 4 years. The thresholds will be adjusted in 2 stages. From July 1 2004, the threshold for the 42% marginal income tax rate will be increased from $52,000 p.a. to $58,000 p.a., while the threshold for the 47% marginal income tax rate will be increased from $62,000 p.a. to $70,000 p.a. From 1 July 2005 the thresholds will be lifted further to $63,000 p.a. for the 42% bracket and to $80,000 p.a. for the 47% rate. This ensures that 80% of taxpayers in 2005-06 will face a top marginal tax rate of 30% or less. However, the non-indexation of the income tax thresholds ensures that these benefits will be steadily eroded over time by further ‘bracket creep’ and taxpayers earning less than $52,000 p.a. will gain nothing from these measures. Superannuation
Changes to the superannuation co -contribution scheme for low-income earners will lift the government’s co-payment from 100% to 150% of member contributions up to a maximum of $1,500, costing $2.1bn over 4 years. Plus, the superannuation surcharge rate for high income -earners will be reduced further, from 14.5% at present to 7.5% by 2006-07, costing $610mn over the forward estimates. These measures are welcome but do not go far enough given insufficient retirement savings and the rapid ageing of Australia’s population. Aged, disability and veteran care
The Treasurer announced additional funding of $2.2bn over 5 years to expand the number of aged care places (by 27,000) and improve the quality of aged care. This includes extra funding of $878mn for the introduction of a Conditional Adjustment payment and a further $101mn for training specialised aged care nurses. $513mn will be allocated in 2003-04 to improve safety and building standards for aged care homes and a one-off payment of $3,500 will be made to providers for each resident in an aged care facility before June 30 this year. Moreover, disability carers will receive new funding of $461mn over 5 years including $255mn for a one-off carer bonus to be paid by 30 June 2004. The Budget also contains $443mn new funding for veterans over the next 5 years.
National security
In response to the heightened terrorist threat facing Australia, the Government has budgeted for additional spending of $755mn over 5 years, including $270mn for Australia’s intelligence agencies and $207mn to upgrade protective security capabilities. Other areas to receive extra funding include incident response, border security and security capacity and cooperation in the region.
Defence and foreign affairs
The Budget will provide further funding of $132mn to the Australian Defence Force (ADF) operations in Iraq and $27mn for our efforts in East Timor. A further $610mn has been allocated in this budget to enhance ADF logistics capabilities including the F/A 18 fleet, the ANZAC frigates and the Collins class submarines programs. Rural
Drought assistance has been raised by $72mn over 3 years in this budget for primary producers in regions that have been declared eligible for Exceptional Circumstances assistance. The Budget also provides greater assistance to the Wine industry with a $290,000 rebate to every wine producer from 1 October 2004 to offset the wine equalisation tax (WET) on domestic sales up to $1mn p.a. These changes effectively exempt 90% of wine producers from the WET. Plus, funding for the Rural Health Strategy w ill be renewed at a cost of $830mn over 4 years to improve access to health services in rural and remote areas.
The impact on business
As expected there is little in this budget for business and few new industry specific measures. Industries involved in family services are clear winners such as the child care industry. The Government has announced the provision of an extra 30,000 outside school hours places and an additional 1,500 day care places.
However there are two stand out beneficiaries. Aged care providers are big winners in this Budget. This year, at a cost of $513mn the Government will provide a one-off grant of $3,500 per aged care resident. In future years, the Government will effectively raise the recurrent basic subsidy by introducing a Conditional Adjustment Payment that will rise over the four year period. The cost to the 2004-05 budget is $81mn rising to $373mn in 2007-08. Aged care providers will also benefit from a lift in the maximum rate they can charge non-concessional residents and a corresponding rise in the Government concessional resident subsidy, at a cost to the 2004-05 budget of $123m. Additional funding of $101mn will be provided over four years for educational training of direct care workers in the aged care industry. The wine industry (as leaked to the press pre- Budget) is another beneficiary with all producers eligible for a $290,000 wine equalization tax (WET) rebate. As a quid pro quo, the cellar door rebate will be abolished. The Government claims that 90% of wine producers will effectively no longer pay the WET and that tax on the wine industry will reduce by $338m.
There is some compliance relief for micro businesses who earn below the $50,000 income threshhold but have registered for GST voluntarily. They can now report annually.
Most of the other measures announced for business involve what we already knew or are extensions of existing programs in the out-years. Hence, for agriculture, drought assistance measures have been extended and funding provided for an extension of the popular FarmBis and FarmHelp programs as well as funding for the sugar industry package.
Monies have been allocated for the recently announced Backing Australia’s Ability – Mark 2 which aims to support research and development and innovation. Total government commitment to this package is $5.3bn over the 7 years from 2004-05.
Funds have been allocated for increased expenditure on transport infrastructure and a commitment to the Auslink project. Details of project allocation will
be released in a statement next month. This is in addition to funding commitments already announced for the National Highway System, Roads of National Importance and extension in the out-years to the Roads to Recovery Program. A one off allocation of $450m to the Australian Rail Track Corporation has been made for this year to upgrade rail infrastructure.
Economic forecasts
The Government’s outlook for the international economy has brightened further from the time of the MYEFO and world economic growth for 2004 has been revised up to 4½% (from 3½%), right in line with ANZ’s forecast. In 2005, the Government expects world growth to remain strong, albeit at a slightly more moderate pace of 4¼%, higher than ANZ’s view of 3¾% growth over that period. ANZ’s relatively more subdued view for world growth in 2005 reflects a slightly softer forecast for US growth prospects, following an expected rise in interest rates later this year (the Government forecasts on a ‘no policy change’ basis). ANZ also expects economic growth in China to slow by around 3ppts in 2005, which may be softer than the Government view (no forecasts for China were published).
International GDP growth forecasts(a)
(Budget versus ANZ)
2004 2005
% ch. on preceding
yr Budget ANZ Budget ANZ
World 4½ 4½ 4¼ 3¾
United States 4¾ 4½ 3¾ 3½
Japan 3 3½ 2 2¼
Euro Area 1¾ 1½ 2¼ 2¼ Major Trading Part. 4¾ 4½ 4 3½ East Asia ex Japan 6¾ 7½ 5½ 5½
(a) Growth rates for World and the European Union are calculated using GDP weights based on purchasing power parity, while growth rates for Major Trading Partners and Non-Japan East Asia are calculated using export trade weights.
On the domestic economy, the Government’s view is also largely in line with ANZ’s. Economic growth is expected to ease from 3¾% in 2003-04 to 3½% in 2004-05, the same as ANZ’s forecasts. Like ANZ, the Government expects more balanced economic growth in the forecast period. A turnaround in net exports, and in particular export growth (facilitated by the improved world economy and easing in drought conditions), is expected to offset slower growth in household consumption, falling dwelling investment and slower growth in business investment. Interestingly, the only component of domestic demand that is not expected to slow next year is public final investment, which is expected to accelerate to 3½% growth.
The Government is slightly more upbeat than ANZ on employment prospects, with growth expected to average 1¾% in 2003-04 and 2004-05, keeping the
unemployment rate at around current 23-year-lows of 5¾%. ANZ expects employment growth in 2004-05 to be slightly slower at 1½% and expects the unemployment rate to rise slightly to 6% by June 2005.
Economic forecasts (Budget versus ANZ)
2003-04 2004-05
% ch. on preceding yr
unless otherwise stated Budget ANZ Budget ANZ Economic activity
Private consumption 5½ 5¼ 4¼ 3¾ Private investment
- dwelling 6 6½ -3 -3¾ - non-dwelling (a) 16 16 6 7 - plant & equip (a) 10 13 8 8 Private demand (a) 6½ 6½ 4 4 Public demand (a) 2¾ 3½ 3½ 4 Ch. in Inventories (b)
- private non-farm -¼ ¼ 0 -¼ - farm & public auth. ½ ¼ -¼ 0
GNE 6 6¼ 3¾ 3½ Exports 2 2 8 9 Imports 12 15 9 9 - Net exports (b) -2¼ -3 -½ -½ GDP 3¾ 3¾ 3½ 3½ Other indicators
Consumer price index 2¼ 2¼ 2 2½ Employment 1¾ 1¾ 1¾ 1½ Unemp. rate (%) 5¾ 5¾ 5¾ 6 Wage cost index 3¾ 4 3¾ 4 Current account $bn -46 -49 -43½ -46 - % GDP -5¾ -6 -5 -5¼
(a) excluding transfers of second-hand asset sales from the public sector to the private sector
(b) % point contribution to growth in GDP
Given the upbeat international outlook, the Government expects Australia’s terms of trade to improve in both 2003-04 and 2004-05, driven largely by continued appreciation of Australia’s non-rural commodity export prices and falling import prices. This is driving the Government’s forecast for the current account deficit (CAD) to improve from 5¾% of GDP in 2003-04 to 5% in 2004-05. ANZ’s forecasts are slightly less optimistic owing to a more moderate outlook for net exports (our forecasts are slightly stronger for import growth). Nevertheless, ANZ expects the CAD to narrow by a similar margin from 6% of GDP in 2003-04 to 5¼% in 2004-05. The Government’s outlook for inflation is benign and interestingly, very similar to the outlook presented by the RBA at the 7 May Monetary Policy Statement. The Budget forecasts are for the CPI to rise by 2¼% in 2003-04, in line with ANZ’s outlook. But in 2004-05 the Government is forecasting the CPI to rise by 2%, lower than ANZ’s outlook for an increase of 2½%. The difference between the Government’s and ANZ’s inflation forecasts probably
reflect different views on the exchange rate. ANZ’s outlook for inflation is underpinned by a forecast for the A$TWI to fall to 56.3 by June 2005. In contrast, the Government’s inflation forecasts are based on the assumption that the A$TWI remains around 63. Given that the A$TWI is currently trading 5% below that level at around 60, there is clearly significant upside risk to the Government’s inflation forecasts. The economic outlook is not without risks and the Government has singled out the housing market (and related to this, household debt) as the most important threat to the economy in the near term, particularly the future path of house prices and their flow on effects on private consumption and the economy more generally. The risk of another drought is also of concern and the threat to the local and world economy from high and volatile oil prices remains.
Financial market implications
With the Federal Budget forecast to remain in surplus and an already low level of Commonwealth net debt, the implications of the Budget for the credit worthiness of the Commonwealth Government are very limited.
The Budget forecasts an underlying cash surplus of A$4.6bn for 2003-04 and A$2.4bn for 2004-05, estimates that are little different from consensus expectations of A$5.6bn and A$1.5bn. The economic growth forecasts upon which the Budget estimates are formed were also right on market expectations of 3¾% and 3½%. In that sense, little to no reaction from financial markets was not surprising.
O n the outlook for short term interest rates, the Treasury makes no forecast. However, with the RBA seeking to restrain consumer spending and household credit growth, the Budget’s net stimulus leaves the door open to rates rising later this year or early next year with fiscal policy supporting growth in aggregate demand. ANZ expects the next movement in the cash rate to be up and that this could still come before a likely Federal election later this year. The Treasury notes that the major uncertainties to the outlook going forward - mainly downward - are housing investment and borrowing. Prospects for housing markets over the next six months or so will continue to be a key determinants of whether and how soon the RBA might need to lift rates.
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