Revealed: China's role in the upcoming Federal Budget

Next week’s budget will deliver income tax cuts, reiterate cuts to company tax, it will confirm the abandonment of the previously proposed hike in the Medicare levy and will still have a forecast for the budget returning to surplus in 2020-21.

How can there be such a cargo cult give-way of goodies, yet not change in the path of returning the budget to surplus?

The answer, it appears, is in a mix of China, upbeat economic forecasts and a pay back from the pea and thimble budget trickery that former Treasurer Joe Hockey engineered shortly after the 2013 election when he sneakily and quite unnecessarily gave a stunning $8.8 billion to the Reserve Bank of Australia, ostensibly to firm up its financial position.

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Each of those issues has fuelled a lift in revenue relative to forecast, that the government seems keen to give away as is strives to woo the electorate ahead of the upcoming Federal election.

Chinese demand for Australian goods and services has underscored a lift in export earnings through a combination of greater export volumes and higher commodity prices.

A US$5 increase in the iron ore price relative to the price assumed by Treasury at the time of the last budget is worth over $2 billion a year in extra government revenue. At the moment, the iron ore price is around US$10 a tonne higher than assumed so there is a large chunk of the extra cash – close to $50 billion in windfall cash over the next decade – that will help fund the pre-election give-aways.

Chinese tourism numbers are also expanding rapidly, boosting export incomes which is helping to shore up bottom line GDP, jobs and tax revenue for the government.

Thank you China.

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It also appears that in the budget, Treasury will present an upbeat view on the economy not just for the current year, but also into the next couple of years. While such a view on the economy is clearly open to question, any forecasts for stronger GDP growth, lower unemployment and a pick up in wages will feed straight through in a mechanical way into forecasts and estimates of tax revenue.

The budget is also set to benefit from a hefty dividend payment from the RBA to the government.

It sounds odd that the RBA would do such a thing but is appears to have made a significant profit from its foreign exchange and bond holdings which it maintains to cover open market operations and as a guard against instability in financial markets.

The bulk of the RBA dividend will merely be a cash transfer back of some of the $8.8 billion given to it when Joe Hockey tried to inflate the budget deficit he inherited from Labor, even though the RBA didn’t request or need the money. At the time, it appeared to be a cynical political move from Hockey and this is set to be confirmed on budget night. The RBA dividend is likely to be of the order of $2 to $3 billion.

It is open to serious debate whether the government should use this mix of good fortune and fiscal smoke and mirrors to splurge with pre-election tax cuts.

After all, the projected surplus by 2020-21 will be wafer thin and vulnerable to even a moderate undershooting on commodity prices, GDP, employment or wages.

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It will not look good if in, say, a year the budget is revised back to deficit because of a downturn in any of these parameters.

A US$10 a drop in iron ore prices and wages growth undershooting the budget forecasts would be enough to blow the projected surplus back into deficit.

The budget is also likely to confirm the level of net government debt at its highest level, as a percentage of GDP, in over 60 years, since the aftermath of World War Two.

A prudent economist could sensibly argue that the windfall revenue gains evidence over the past six months be used to start to edge government debt levels lower, just in case there is an unexpected slowdown in the years ahead.

But for next week, get set for headlines of ‘Santa’ Morrison, a fist full of dollars for income earners and a glowing outlook for the economy.

Time will tell if it was the right budget for the right time or whether is was a budget that gave away too much after a five seconds of economic sunshine.