WEEKEND ECONOMIST: Slip, slipping away

This week's federal budget contained quite a few surprises. We had been 'primed' by selective leaks to expect that the tax receipts estimates were going to be significantly revised down from those in the Mid Year Economic and Fiscal Outlook, which printed in October 2012.

The revisions incorporated in the budget were a deterioration of the fiscal position of $20.6 billion in 2012-13 and $20 billion in 2013-14. For 2012-13 the slippage was explained by payments up by $4.0 billion and total revenue down by $16.6 billion. For 2013-14 the slippage was explained by payments up by $3.4 billion and revenue down by $16.6 billion. For 2012-13 the main revenue slippage was company tax ($5.2 billion), resource rent taxes ($3.7 billion) and individual income tax ($2.9 billion. For 2013-14, the main revenue slippage was company tax ($7.0 billion); resource rent tax ($3.3 billion) and individual income tax ($3.7 billion).

Key points to note from the breakdown:

– slippage was not entirely on the revenue side - payments also contributed significantly.

– within revenue, while the majority of slippage came in company and resource rent tax, there was also significant slippage of individual income tax.

– the slippage announced on budget night was reportedly more than the market had been lead to believe in the days before the budget announcement.

All of the additional slippage seemed to come in outlays, although there was no indication of this. In explaining the sharp deterioration in the revenue position of the budget since MYEFO the government noted, "weaker commodity prices and a persistently high Australian dollar which has put pressure on domestic prices, have hit company profits across most of the economy, including the resources sector".

Attributing the 'blame' for the slippage between MYEFO and the budget to commodity prices and the Australian dollar seems a little curious. Note that in MYEFO the government's forecasts for the terms of trade in 2012-13 were a fall of 8 per cent and in 2013-14 a fall of 2.75 per cent. In the 2013 budget the government amends the forecasts to a fall of 7.5 per cent and 0.75 per cent respectively.

Assumptions around the Australian dollar were U$S1.02 for MYEFO and $US1.03 for the budget. Therefore we are confronted by the curious situation where the government has revised up its forecast for the terms of trade; kept the Australian dollar assumption broadly the same; attributed the revenue slippage to the commodity price-Australian dollar interaction and revised down revenue by around $16 billion in both 2012-13 and 2013-14.

The government did not make a forecasting error with its terms of trade and Australian dollar forecast at MYEFO. The logical explanation for the significant slippage between MYEFO and the budget is that there was a misjudgment of the relationship between the terms of trade, Australian dollar and corporate profits-company tax collections. It places some doubt that the intuitive explanation for the slippage – Australian dollar held up despite a fall in commodity prices – is only part of a much broader story . It seems more likely that the slippage is telling us a broader story about the Australian economy. Disinflation and margin compression evident in the Australian economy at present are not necessarily related to the higher Australian dollar or commodity prices. It may be that these disinflationary forces have played a much larger role in revenue slippage than indicated by the government.

Certainly, one forecast change between MYEFO and budget supports this assertion. For MYEFO, the gross non-farm product deflator was forecast to increase by 1 per cent in 2012-13, compared to zero per cent in the budget, and to increase by 2.5 per cent in 2013-14, compared to 2 per cent in the budget. In effect the reduction in the forecast for nominal GDP growth from 4 per cent (MYEFO) to 3.25 per cent (budget) is explained by lower inflation in the domestic economy rather than the terms of trade-Australian dollar effect.

This observation has implications for the government's forecast in later years. The assumption in the forecast is that the commodity price-Australian dollar nexus will be restored to a more normal relationship (if only because the terms of trade forecasts are quite flat). Accordingly growth in nominal GDP is assumed to return to 5 per cent, after the "anomaly" of 2012-13. But what if the explanation for the weakness of nominal GDP growth is more around disinflationary pressures in the domestic economy? These pressures may persist for much longer than assumed in the government's forecasts.

A recent piece in the Reserve Bank's Statement on Monetary Policy highlighted these structural forces. In this analysis the Reserve Bank pointed out that consumer durable prices in Australia had fallen by much more over the last two years that would have been expected given observed moves in import prices. The Bank pointed out: "over the past two years the average rate of deflation in consumer prices (of a number of durable goods) has been greater than the average rate of import price deflation". (See chart for details). 

The Reserve Bank goes on to note that: "liaison with business suggests that competitive pressures have been particularly pronounced in the past few years, which may in turn be partly attributable to the emerging presence of online vendors, based in Australia and overseas".

The bank concludes that moves to increase efficiency through cutting overheads, negotiating lower rents, streamlining distribution may have explained these price falls.

We have considerable sympathy with these observations. Note that further support for this view can be found in the unexpected deterioration in personal taxes ($2.9 billion in 2012-13; $3.7 billion in 2013-14). Downward pressure on wages would be a potential source of this downgrade – consistent with businesses efforts to reduce costs.

The government's explanation for the slippage in the revenue numbers may be putting too much emphasis on commodities/Australian dollar and not enough on the more pervasive and sustainable disinflation forces that may now be part of Australia's economic landscape.

Bill Evans is Westpac's chief economist.

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Superbly written Bill. A brilliant expose' on why Julia Gillard, Wayne Swan and the Labor Party have become such appalling frauds, trying to argue it's all just commodity price falls beyond their control. It deserves a wider audience.

Agree John,

Communists always try to take from 'rich and give to poor, stealing huge part between !!!

But, problem is that exists in all western countries, maybe except Germany, maybe.

Money printing confirms that communistic play.

I am sure huge banks and hedge funds play brilliantly to take gold from all corners !!!
They know money printing have to accelerate, that's the only way !!!

Read this site: http://www.kingworldnews.com/kingworldnews/King_World_News.html

Agreed Alexei. The interference in markets we are currently seeing is socialism not capitalism. If the banks take a gamble and win good, if they don't the govts got their back - win win.

A few years ago Australia was unique. To have a govt in power with a clean balance sheet. Now since Rudd/Gillard and Co - we now have spent 5 years spending on rubbish which is now starting to show up as useless and now the RBA is having to compensate for the waste of time policies of the last 5 years - which it won't be able to do without causing further bubbles that may explode and require tax payer rescues.

We have governments all around the world trying to achieve that position we had 5 years ago only for our govt to pursue policies which sent other countries into the doldrums. 3 years ago a number of us saw what was going to happen to the budget. 3 to 5 years from now - the problems will start to show in gdp and unemployment. This is inevitable - it will occur on Abbots watch but very few people actually understand that benefits/problems that occur in an election term were probably created in the previous 2 election terms. The only solution to it now will be on the monetary policy side. Because thats a 2 sided trade you have to evaluate whether the prospects of it here are worse than overseas.

One things for sure - the actions of Rudd/Gillard and Co will make the elderly and the poor poorer - which is absolute irony when you consider what their so called mandates are. It happened during the GFC and its happening after the GFC. These guys are not like Keating who was an absolute visionary.

Mr Tozer

don't be so one eyed. Abbot and Co will have to fight these same disinflationary forces, and considering the slowing of the economy those forces could become quite a bit stronger. Will be interesting to see how the Libs will fare when confronted with falling revenues and little to no Govt assets left to sell of. If my memory serves me correctly the Libs only produced one budget with reduced Govt spending, then bequeathed us with wasteful programs like the baby bonus and family tax benefits etc.

From nearly $200B in windfall resource boom revenue, what does Australia have to show for it. Between 2 inept Govts pandering to the battling $150K middle class (depending on the number of children they have can be in the top 30% of households) we've got crumbling infrastructure, congested roads, toll roads out of the wazoo and still a half trillion $ backlog in infrastructure spending.

Tozer doesn't explain why but I think he is correct. If the govt had of cut company tax a few years ago and increased gst (which was the right thing to do) - businesses would have had a lot more capital to work with to maintain full employment longer and to compete better with online.
This was the strategy the govt should've been focusing on instead of constant cash distributions and tax rises. Unfortuantely I don't think this is Abbotts policy either - perhaps now because they are in a tighter fiscal position because of the govt - not the GFC. Although many, including myself, can't fathom why Abbot is pushing for paid parental leave.
At the end of the day, the govt should've been on watch for the problems business will have over the next 5 years and they weren't. In addition we will also be saddled with more debt spent on items that do not provide an ROI.

Perhaps the carbon tax, did work Bill?

Disinflation, is falling down a hole and not trying to get out and no you cant, do it with monetary policy. That is what got us into the hole, Carbon tax and resource costs, are a bit like exported products and the AUD. They are both anti profit.

Take away profit and one could presume (on a simplistic level), that employers would not be throwing around huge wage rises.

So, will the carbon tax change economic outlook? absolutely, it will give an impression of confidence and that will dissipate quickly. When numbers cannot be rationalised, then we can only rationalise human behaviour. That's right, dont you think Bill? We all understand herd mentality, its what makes the market work, its what makes FOREX move, its what makes business profitable and its what elects government.

Show people a positive outlook and the response will be immediate, show people, negative scenarios and they will become bears and we all know that bears bight.

Amendment: "So, will the carbon tax change economic outlook" should read, Will removing the carbon tax, change economic outlook.

Interesting article Bill, amazing figures from the RBA, look almost like someone using a desktop pressed the flip diagram left to right button accidentally!

Expect more disinflation!

This country and citizens have been paying way over the top for tens of thousands of household items. Pharmaceuticals; electrical; gift wear; clothing; hard wear; furniture.

Our Public Sector with double the overall numbers plus probably on higher wages that say Germany as a benchmark costs us more. Price times quantity.

The world is awash with finished goods. Prices can be negotiated down.

So expect "disinflation" ................. ! So it might be the end of the world for an economist. But business will still continue to operate.

It is only figures Bill. And some of them are not all that bad!