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Caton: Federal Budget 2008

1. Budget Overview 2008-2009

In the first Budget of the Rudd era, Treasurer Wayne Swan had to balance several conflicting objectives. In the cause of responsible economic management, he needed to deliver (or at least forecast!) a relatively large surplus, of at least 1.5% of GDP. He also needed to commit to the cause of battling inflation. To help working families, he needed to deliver on the tax cuts promised during the election campaign. He also needed to show that "we're in charge now"-by clearly changing priorities, by blaming the Coalition government for years of fiscal looseness (or, at the least, for lazy, unimaginative use of the "river of gold" of revenue coming from the commodity price boom), and by demonstrating that there was a clear (and different?) vision of Australia's economic future.

The above paragraph was written before the Treasurer began his speech, but it corresponds very closely with the structure outlined in the Budget Overview. It was never going to be easy to accommodate all of these objectives. This fact may have been one of the reasons for the extensive leaking of Budget measures beforehand. We have become used, in recent years, to reading all about the Budget before it is actually delivered. This year, we may have reached a new record for leaking; we were even told in advance just how many spending measures (649) there were in the Budget. Though some of the measures were rather small, they had to count them all.

To no-one's surprise, the tax cuts will proceed as previously advertised, and there are extensive increases in several areas of spending, as detailed below in Table 2. The Key Budget parameters appear in Table 1. There is a "healthy" surplus in both the first year and the "outyears". It peaks at $21.7 billion (1.8% of GDP) in 2008-09.

Table 1: Key Budget Parameters

(a) The 2006-07 figures have been adjusted to reflect the recognition of GST as an Australian Government tax.
(b) Excludes expected Future Fund earnings.

The increase in spending in real terms in 2008-09 is 1.1%, the lowest gain in 9 years, but still an increase. The restraints in spending could hardly be described as swingeing.

Table 2 shows the major new initiatives in the Budget. Obviously, these have to be financed, and the Government has found $33.3 billion of savings over the four-year Budget horizon. This actually exceeds the $27.4 billion in new spending initiatives.

Table 2: Major Initiatives in the 2008-09 Budget

(a) Spending totals include some payments in 2007-08

One of the ways to change course is to "soak the rich", in part to pay for the tax cuts and for the surplus. After all, it could be argued that the well-off benefited mightily in the last years of the Howard government, both via the income tax cuts and the superannuation changes. The increased tax on luxury cars is more symbolic than anything else, while the means testing of the family tax benefit and the baby bonus seems quite reasonable. Did Tony Abbott really say that means testing these goodies would create two classes of kids? There is also a range of measures designed to reduce so-called "tax
expenditures", which tend disproportionately to benefit higher income earners. These reductions are, in total, far bigger than the increase in the luxury car tax.

The Government also (re)announced the establishment of three new (nation-building) Funds, to be financed by the current and future surpluses. These are the Building Australia Fund, the Education Investment Fund and the Health and Hospitals Fund.

All up, the Government has made a reasonable fist of moving towards its objectives. As outlined below, it has done this against the background of a very uncertain economy. One can't help but think that the Budget would have been somewhat tougher-with the tax cuts scaled back, for example-if the Government were more sure that economic growth was going to continue to be at least moderately strong.

2. The Economic Background

The economic environment is the most uncertain that it has been for several years; or perhaps it always seems that way at Budget time. The Australian economy grew unsustainably quickly over most of 2007, leading the RBA to raise interest rates four times since last August. Inflation is at a 17-year high. There are many signs ( eg housing lending, retail trade, business and consumer confidence) that growth has slowed this year. But has it slowed enough (to bring inflation down) or perhaps too much? It's very difficult to tell.

As usual, the economy is affected by overseas developments, and here there is bad news and good news. On the one hand, the continuing credit market problems emanating from the United States are having an effect, and the weakness of the US economy will likewise affect us. On the other hand, the continued growth in China and elsewhere is driving a huge gain in Australia's terms of trade (estimated in the Budget to rise by 16% in 2008-09), which will clearly be a positive for growth here. The strength of the developing world is also a factor in the rise in oil prices, which has contributed to our current inflation problem.

How these disparate influences resolve themselves can only be guessed at the moment. The Budget forecast assumes that growth in 2008-09 will slow to 2.75% from an estimated 3.5% in 2007-08, while inflation will remain stubbornly high, at 3.25% over the course of the year. Table 3 below shows the economic forecast/projection. Given the resources that Treasury devotes to the task, it would be arrogant to quibble with these forecasts. That said, the outlook appears, if anything, to be a touch optimistic for both growth and inflation. The Reserve Bank's forecasts published late last week, for example, suggest just 2.5% GDP growth in 2008-09 and 3.5% headline inflation over the course of the financial year.

Treasury has also assumed higher growth than the RBA over the following year, although this is in keeping with its standard practice of assuming something close to trend growth in the out years.
In the detail of its forecasts, Treasury shows the unemployment rate rising to just 4.75% by June 2009. This may turn out to be accurate, but it does drive home the point that the Australian economy is almost certain to pay for growing too quickly for too long by having to accept a year of rising unemployment; something we are no longer used to!

Table 3: Major Economic Parameters

(a) All parameters except the CPI are year average percentage changes. The CPI parameter is through the year growth.
(b) As in previous Budgets, the projections assume a two-year step-down in non-rural commodity prices.

3. Market Implications

Financial markets no longer care very much about the Budget, in part because there are bigger concerns elsewhere, and in part because so much is leaked beforehand. There is unlikely to be any significant reaction.