9 May 2013

Australian Federal budget 2013: a preview

2012/13: a $14bn deficit Budget to remain in deficit on lower revenue
The Treasurer is likely to announce a budget deficit
(underlying cash basis) of $14.0bn for 2012/13 compared to a surplus of $1.1bn which was predicted in October's Mid Year Economic and Fiscal Outlook.

Table 1
Underlying cash balance, $bn '12/13 MYEFO Expenses, starting point Revenue slippage Weaker growth, 2013/14 Carbon permits Spectrum auction Sub-total Gonski, school funding NDIS Education cuts Medicare levy Family benefits, remove Carbon related spending Sub-total Budget night *
%GDP

'13/14 '14/15 2.2 0 11.8 2.0 +3.0 10.8 0.3 0.3 0.6 0.6 8.0
0.5

'15/16 6.4 0 6.7 5.0 3.0 14.7 0.8 1.3 0.9 3.4 0.6 1.5 4.3 4.0
0.2

Dominant contributors to the slippage will be

company tax ($6.3 bn), the mining tax ($1.2bn) and the petroleum tax ($2bn), as well as a one year delay in proceeds from selling digital spectrum ($4bn). The tax shortfall is mainly in the resource sector as a 22% average fall in bulk commodity prices in 2012 was not offset by a fall in the Australian dollar (up 0.4%), thereby reducing mining profits.

1.1 +1.0 12.1 4.0 15.1 0.0 14.0

0.9

3.3 0 9.5 5.0 14.5 0.7 0.8 0.8 3.3 0.6 3.2 8.0
0.5

The 2012/13 deficit

is likely to be the peak deficit to be announced in the 5 year forecasts and projections despite a marked downward revision to growth in 2013/14. We expect that a deficit of around $4bn will be forecast for 2015/16. Compensating factors in the out years will be proceeds from the spectrum sale; the early introduction (2014/15) of the increased Medicare levy before those funds are required for the National Disability Scheme; a reduction in Family Benefits payments which were planned to be funded by the mining tax; and, most importantly, a forecast that there will be a catch-up in the disparity between the AUD and commodity prices in the out years. and the National Disability Insurance Scheme are only introduced very gradually in the years for which this Budget will contain projections. Both schemes are not fully operational until 2018/19.

Major Budget initiatives around the Education reforms

* Westpac's expectation of Government forecasts to appear in 2013 Budget

There will be a downward revision of $3bn in revenue

resulting from a cut in the assumed carbon price in 2015/16 when a market determined price will be adopted. We are assuming only $1.5bn in savings will be adopted to offset that downgrade, mainly from the cancellation of $1.4bn in tax cuts in that year.

Table 2
Key forecasts Real GDP (% chg) Nominal GDP (% chg) Terms of trade (% chg) MYEFO Budget * MYEFO Budget * MYEFO Budget * '12/13 3.00 2.75 4.00 3.75 8.00 8.50 '13/14 3.00 2.75 5.50 4.75 2.75 2.75 '14/15 3.00 3.00 5.25 5.25 1.00 '15/16 3.00 3.00 5.25 5.25 1.00

There are likely to be other revenue initiatives,

particularly around business taxes (thin capitalisation; depreciation; tax offsets) but these are not expected to be substantial amounts and will be used to fund other social initiatives.

The stance of fiscal policy will be broadly neutral after

policy tightened in 2012/13 by around $30bn (2.1% of GDP). On our figuring, with the deficit narrowing from $14bn in 2012/13 to $4.0bn in 2015/16, the "tightening" of policy over 3 years will be a modest 0.7% of GDP.

* Westpac's expectation of Government forecasts to appear in 2013 Budget Sources: Budget papers, ABS, Westpac Economics

The impact of the Budget on economic growth will

be more significant for its effect on confidence, both business and consumer. We expect that revelations of the substantial move into deficit; the elimination of both tax cuts and some increases in Family Payments are likely to be met with a further down turn in confidence reversing any boost to confidence from the recent rate cut delivered by the RBA.

Australian Federal budget 2013: a preview Budget in deficit, as revenue disappoints

The government late last year abandoned their commitment to return the budget to surplus this financial year. Revenue collections have surprised to the low side in 2012/13 and, accordingly, revenue prospects have been downgraded. See Table 1 for a summary of our figuring on the revenue numbers. With a significant downgrading of revenue for 2012/13 and beyond, the budget is on current policy likely to remain in deficit across the forecast period. Taxation receipts in 2012/13 are up on last year, with collections for the initial eight months of the year up 7% on the corresponding period a year earlier. However the rate of growth is less than the government expected, with growth forecast to be 11% for the full year. The revenue shortfall in 2012/13 is judged by officials to be around $12bn. Company tax revenues ($6.3bn), the mining tax ($1.2bn) and the petroleum tax ($2bn) are the major sources of downside surprise. Company tax collections are likely to be broadly unchanged from 2011/12, whereas the government forecast a rise of 9.4%, +$6.3bn. The mining tax was to raise $2bn, whereas an outcome of $0.8bn is now more likely. A lower starting point for revenue will flow through to the out years. Although, the impact is likely to diminish somewhat from around 2014/15. By then, the AUD premium over the terms of trade may have declined and tax loss offsets against company tax are likely to have decreased. Weaker economic growth prospects for next year will also reduce revenue collections. We anticipate that forecast nominal GDP growth for 2013/14 will be lowered by 0.75% (see discussion below). Applying a rule of thumb estimates the budget impact will be $2bn in the initial year, rising to $5bn in 2014/15. Revenue numbers will also be impacted in 2015/16 and beyond by a downgrading of the projected price of carbon. Reportedly, officials will revise the price assumption for 2015/16 to $15 a tonne, down from $29. Proceeds from the sale of carbon permits are likely to be around half of the previously expected $6.7bn. Reportedly, taxation receipts across the four years to 2015/16 will be some $60bn to $80bn less than expected in the budget, or alternatively, some $40bn to $60bn less than projected in the Mid Year Economic & Fiscal Outlook (MYEFO.) On our figuring, revenue for the four years is $55bn lower than in MYEFO. There is also a delay in proceeds from the sale of digital spectrum. MYEFO anticipated a $4bn boost in 2012/13. Proceeds, which are now more likely to be around $3bn, will be received in 2013/14.

Economic growth: downgraded

The government will lower forecast real GDP growth for this year and next by 0.25% to 2.75%, for both years. See Table 2 for a summary of the economic growth forecasts. Similarly, forecast nominal GDP growth for 2012/13 is likely to be trimmed by 0.25%, to 3.75%. For the 2013/14 year, forecast nominal GDP growth may be trimmed by a more substantial 0.75%, to 4.75%. This would allow for prospects of lower inflation across the broader economy than currently assumed. The terms of trade view is unlikely to differ greatly from the current forecasts for a 8.0% decline in 2012/13 and a 2.75% fall in 2013/14. Current projections for 2014/15 and 2015/16 are real GDP growth of 3.0% and nominal GDP growth of 5.25%, in both years. These numbers are unlikely to change. Such a set of forecasts is credible, as a central case. Risks surrounding forecasts over a four year period are understandably considerable, particularly given the fragile nature of conditions across Europe.

Policy measures: spending, savings, tax reform

The Government has committed to matching any additional expenditure associated with new policy with offsetting savings. Education funding (Gonski) and the National Disability Insurance Scheme (NDIS) are the two key areas of new spending priority. Both of these are multi-billion policies, which are to be phased in over a number of years. See Table 1 for a summary of expenditure and saving measures. (Note, fiscal projections in the budget papers will extend to 2016/17, and not beyond, if standard practice is adopted.) The medicare levy is to be increased by 0.5% to 2.0%, raising around $3.5bn a year. This revenue is to be directed to funding the NDIS. The medicare levy increases on 1 July 2014 but major new funding for NDIS is not required until 2017/18, after the end of the three year trial period. Hence, the levy generates net savings in 2014/15 and 2015/16, potentially around $2bn to $2.5bn a year. Reports suggest the government will shelve some measures that were tied to the mining tax and to the carbon price scheme, both of which are now expected to generate less revenue than anticipated. Family assistance linked to the mining tax is unlikely to proceed, valued at $0.6bn a year from 2013/14. Tax cuts of $1.4bn scheduled for 2015, as compensation for a higher carbon price, are likely to be jettisoned. The budget will provide more detail surrounding the cost of the NDIS. Available information suggests that the NDIS when fully operational in 2018/19 will require annual funding of $22bn. Of this, some $10.5bn in new funding is required, above existing programs. The Federal government would be required to meet around $8bn of this, given a 75:25 funding split with the states. Of this $8bn, a new medicare levy would raise around $3.5bn a year. Current funding allows for limited trials in 5 states and territories, at a cost to the Federal budget of around $1bn over four years. Some shifting of responsibilities between the states and the Commonwealth is likely to come at a cost to the Federal budget over the forecast period.

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

Australian Federal budget 2013: a preview

Funding of schools is to be reformed, as the government responds to the Gonski report. School funding over the six years from 2014 to 2019 is to be increased by $14.5bn. Of this, $9.4bn will be Federally funded and $5.1bn by the states. The scheme will be fully implemented in 2018/19, with a total annual cost of $6.5bn, of which $4.2bn is Federally funded. Funding details for the transition period will be unveiled in the budget. It may well be that additional spending is backloaded during this transition period. If so, and given that the government has announced cuts to higher education, it may be that the net impact of education spending over the four years to 2015/16 is minimal. Offsetting the cost of increased spending on any other new measures unveiled in the budget, ahead of a Federal Election scheduled for 14 September, will require that there are a number of savings measures. These savings measures will take the form of increased taxation and a reduction in expenditures. Modest reforms to superannuation taxation arrangements will generate some small savings. Some changes to business taxation arrangements is likely, with a focus on the scaling back of some deductions. In respect of revenue downgrades due to a lower starting point in the 2012/13 year and due to a weaker economic outlook, the impact of these is likely to be allowed to flow through to the budget bottom line.

Net debt
Australian Federal government net debt increased by $63bn to $147bn (10.0% of GDP) at the end of 2011/12. MYEFO forecast that net debt would decline to $144bn (9.4% of GDP) in 2012/13 and would moderate as a share of GDP across the forward years to 7.7% at the end of 2015/16. On our figuring, the budget position deteriorates by $15bn in 2012/13 and by $47bn across the four years. This weaker budget position will see net debt increase to around $159bn in 2012/13, $170bn the year after, $180bn in 2014/15, and to $185bn at the end of 2015/16. As a share of GDP, net debt represents about 10.5% in 2012/13 and holds broadly steady at this level across the forecast period.

Bill Evans, Chief Economist, Westpac ph (61-2) 8254 8531 Andrew Hanlan, Senior Economist ph (61-2) 8254 9337

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

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