Looming Budgets likely to show up Australia’s comparative weakness.
The Australian Budget and the New Zealand Budget will be major highlights over the next two weeks.
Australian Treasurer Joe Hockey will deliver his Budget on Tuesday and Finance Minister Bill English will present his Budget on Thursday week.
English has a much easier task than his Australian counterpart.
Hockeyfaces a difficult Budget because the sharp fall in iron ore prices, and low wage growth, are having a negative impact on the Commonwealth's tax receipts.
In last year's Budget Hockey forecast a cash deficit of A$29.8 billion ($31.6 billion) for the June 2015 year but the Government's Mid-Year Economic and Fiscal Outlook (MYEFO), released in December, raised this forecast to A$40.4 billion.
Deloitte Access Economics recently predicted that the 2014/15 cash deficit will be A$5.5 billion higher at A$45.9 billion.
The December MYEFO had this to say about the Australian economy: "The changes to the economic outlook since the Budget [in May 2014] are driven by the sharper than expected fall in the terms of trade, including significant falls in prices of iron ore and coal, and weaker wage growth.
"While the forecasts for solid real GDP growth are unchanged, the prices we receive from our production have declined significantly.
"Accordingly, nominal GDP growth in 2014/15 is expected to be weaker than forecast at 1.5 per cent. This would be the weakest nominal GDP growth in a financial year in over 50 years."
The last sentence illustrates that low inflation, particularly low wage inflation, is having a major impact on government tax revenue.
This is a relatively recent phenomenon and indicates that Governments may be better off when real GDP growth is 2 per cent - achieved through nominal growth of 5 per cent minus 3 per cent inflation - rather than 2.5 per cent real growth achieved through nominal growth of 3 per cent less 0.5 per cent inflation.
The MYEFO said iron ore prices had fallen from US$95 ($127) a tonne in May 2014 to US$60 a tonne seven months later and "has led to company tax receipts being revised down by A$2.3 billion in 2014/15 and A$14.4 billion over the forward estimates".
Iron ore prices have rallied from US$47 to US$61 a tonne in recent weeks but investment bank UBS continues to forecast prices at US$45 a tonne in the second half of this year, rising slightly to US$48 per tonne in 2016.
According to the MYEFO: "At the same time weaker wage and employment growth are expected to lower individuals' income tax receipts by A$2.3 billion in 2014-15 and A$8.6 billion over the forward estimates.
"Weaker wage and employment growth will also increase payments for existing government programmes.
"Excluding policy changes, total taxation receipts have been revised down by A$6.2 billion in 2014/15 and A$31.6 billion over the forward estimates."
Hockey has been criticised because he hasn't made major inroads into the large Budget deficit and next week's Budget will be a big challenge for him.
The problem is that he made a half-hearted attempt to cut the deficit in the 2014 Budget but the response was negative. Consumer and business confidence slumped immediately afterwards because Australians were finding it difficult to accept subdued economic activity after more than two decades of sustained growth.
There have been a number of Budget leaks to the media including:
• The introduction of measures to reduce the number of wealthy Australians who are entitled to the government pension. • A $7 billion cut in health spending. • Tax cuts for small businesses. • The introduction of GST on downloaded books, music and software. • The Australian Financial Review reports there will be a new bank deposit tax which will be targeted to purchase insurance against bank failures. • Measures could be introduced to stop multinational companies from moving income from Australia to low-tax countries.
The leaks don't point to any major measures that would reduce the size of the deficit and ANZ Research is forecasting a Budget deficit of A$39 billion, or 2.3 per cent of GDP, for the June 2016 year.
This compares with a A$17.1 billion deficit forecast in last year's Budget for the same period and A$31.2 billion in December's MYEFO.
The Australian Government hasn't had a Budget surplus since 2007/08 as illustrated in the accompanying table.
The Abbott Government blames the previous Labour Government, which was in power from 2007 until 2013, but the pressure is now on Hockey and Abbott to correct the situation.
New Zealand Finance Minister Bill English is in a more enviable position because his deficit has fallen from $18.4 billion, or 9 per cent of GDP, in 2010/11 to a forecast deficit of .6 billion, or 0.2 per cent of GDP in the current year.
The June 2011 year deficit was mainly due to the global financial crisis and the Christchurch earthquakes.
Joe Hockey faces a tough task on Tuesday. Picture / Bloomberg
One of the more interesting points is that the NZ Government plays a relatively smaller role in our economy than the combined Commonwealth and state governments in Australia.
New Zealand government expenditure represents 30.5 per cent of GDP whereas government expenditure accounts for 33.7 per cent of Australian GDP with the Commonwealth Government accounting for 25.9 per cent and state governments 7.8 per cent.
New Zealand's latest Half Year Economic and Fiscal Update (HYEFU), which was released in December 2014, was relatively upbeat.
It stated: "The Government operating balance before gains and losses (OBEGAL) is expected to increase through time but at a slower pace than forecast in the pre-election update. Forecasts of tax revenue have been revised lower [and] a small deficit is forecast for the current 2014/15 fiscal year followed by a small surplus next year."
The HYEFU revealed that tax revenue will be below budget for a number of reasons including:
• Income tax receipts will be lower than expected because of low wage growth and reduced dairy farmer income. • Residential withholding tax on interest income will be below earlier predictions because of depressed interest rates. • GST forecasts have been reduced because of lower than expected price inflation.
These comments are fairly consistent with statements made in Australia's MYEFO.
There have been almost no Budget leaks in New Zealand and Finance Minister Bill English had this to say at a pre-Budget speech in Wellington last week: "As the Prime Minister has said, you wouldn't open your Christmas presents before Christmas so I'm going to leave the details of the Budget for Budget day."
He went on to say "we support a broad-base, low-rate tax system" and the top personal tax rate has fallen from 39 per cent to 33 per cent since the Key Government came to power.
English reiterated that "we remain committed to further reductions in income tax rates and thresholds, when fiscal and economic conditions permit".
However, in the current low-inflation environment nominal GDP growth will be $15 billion lower than expected over the next four years and this will mean that the Crown's income tax, GST and company tax receipts will be lower than expected.
As a consequence the Crown will collect $4.5 billion less tax over the next four years than forecast in the 2014 Budget.
The Finance Minister's only real giveaway in his pre-Budget speech was that the 2014/15 deficit would be slightly bigger than the .6 billion deficit forecast in the December HYEFU and the 2015/16 surplus forecast would be slightly under the .6 billion previously indicated.
The good news is that English is in a much stronger position to deal with the low inflation/deflation issue on Thursday week than the Australian Treasurer when he delivers his 2015 Budget on Tuesday.
• Brian Gaynor is an executive director of Milford Asset Management.
