In this year’s budget, Chalmers has to keep a lid on spending – or risk stoking inflation
- Written by Stephen Bartos, Professor of Economics, University of Canberra
Crafting a federal budget is never easy. Tonight’s budget is harder than most.
The government faces irreconcilable pressures: spend more to meet community demands, spend less to keep inflation down.
The Reserve Bank is concerned about inflation. Governor Michele Bullock has signalled[1] a preparedness to drive Australia into recession rather than let inflation get out of control.
Treasurer Jim Chalmers and his advisers are well aware that increased government spending will push up inflation. It is not the main driver at present – that dubious honour goes to the impact of the Iran war on global prices – but it does contribute.
The government therefore has to keep a lid on spending, or increase taxes – or most likely do both – to reduce the likelihood of further interest rate increases.
Here’s a rundown of what to expect in tonight’s federal budget.
Tax changes are coming
Tax will be the centrepiece of the budget. The government has signalled[2] it intends to reduce:
There are two good reasons for this – to help the budget bottom line, and intergenerational equity.
The Parliamentary Budget Office has estimated[3] the combination of the CGT discount and negative gearing of residential property cost the budget A$13.4 billion in lost revenue this year.
Equity arguments apply especially to the CGT discount. Young people are being locked out of home ownership as house prices rise due to the favourable treatment of property investors[4].
The details of how this will be implemented, to be revealed on budget night, are crucial to whether the changes have any significant impact on the budget bottom line or on housing affordability.
“Grandfathering[5]” changes (not applying them to people’s current assets) could take many forms. Options include no grandfathering at all; having changes apply from budget night; or exempting any current assets until they are eventually sold.
The third option could tempt the government. It means the change will not take full effect for years, or in many cases decades.
But exempting current assets would deliver less revenue for the budget and is bad economics. It would create an incentive for people to hold on to assets that have a CGT discount attached. This means those assets are not used in the most productive manner.
However, budgets are always political as well as economic. An economically poor option for grandfathering is a distinct possibility.
Read more: Negative gearing tax breaks could finally be tightened in the May budget. What options are on the table?[6]
A long list of extra spending
At the same time, cost of living pressures are hurting voters. The government will be looking for ways to respond and assist without a spending blowout.
This means cost-of-living assistance should be tightly targeted to those in greatest need, while the government will have to make savings in other programs. There is speculation[7] assistance could be in the form of a one-off tax cut.
The government has also promised more spending, totalling more than $60 billion[8], including:
Savings to be made
Last week, in a warning to the government, RBA Governor Bullock said:
it doesn’t take much additional spending to make the job of returning inflation to target more challenging.
The treasurer now has even more reasons to find savings.
Most of this has been foreshadowed, with savings of $64 billion[9] announced. The government has predicted large savings[10] from sweeping reform[11] of the National Disability Insurance Scheme (NDIS).
The risk here is that savings – based on changes to eligibility criteria, assessments on evidence and cracking down on fraud – are uncertain[12]. They rely on assumptions about how people will respond, and whether the government can control fraud.
Unfortunately, history tells us that smart operators often find ways to exploit a government entitlement program, no matter how tight the guardrails.
There are other savings in the wind. For example, government departments are reportedly[13] expecting cuts in departmental expenses. Some are offering staff redundancy packages now (paid for out of this year’s budget, naturally) to lower costs next year. These will cause pain in the public service, but are small by comparison with NDIS savings.
A slowing economy
One variable that affects how much room the government has for spending is its economic forecasts.
Although some commentators predict higher global commodity prices will boost the budget bottom line, Chalmers is not so optimistic[14]. A small reduction[15] in deficits is expected.
A key determinant of the budget is economic growth. When the economy slows, the budget deficit increases for two main reasons: lower income and company tax receipts, and higher Jobseeker payments.
If the likely economic downturn is bad enough, this effect will outweigh gains from commodity prices. We are not in a recession yet, but could be if the RBA raises interest rates further.
Budgets never forecast a recession. That would be a self-fulfilling prophecy, causing a loss of confidence in the community and a slump in investment.
However, if the budget forecasts are too optimistic on growth, the likely result is that the mid-year review in December will show the budget bottom line in a much worse state.
This budget has to strike just the right balance: doing more to support Australians in a global crisis, without doing too much and triggering further interest rates hikes.
References
- ^ signalled (www.rba.gov.au)
- ^ signalled (www.abc.net.au)
- ^ has estimated (www.pbo.gov.au)
- ^ favourable treatment of property investors (theconversation.com)
- ^ Grandfathering (theconversation.com)
- ^ Negative gearing tax breaks could finally be tightened in the May budget. What options are on the table? (theconversation.com)
- ^ speculation (www.abc.net.au)
- ^ more than $60 billion (www.smh.com.au)
- ^ savings of $64 billion (www.afr.com)
- ^ savings (www.smh.com.au)
- ^ reform (www.health.gov.au)
- ^ are uncertain (theconversation.com)
- ^ reportedly (region.com.au)
- ^ is not so optimistic (www.abc.net.au)
- ^ small reduction (www.smh.com.au)
Authors: Stephen Bartos, Professor of Economics, University of Canberra
