Budgets are driven by the government of the day delivering changes to economic policy – taxing and spending in other words.
Those policies feed into the other important part of budget – the bottom line surpluses or deficits which are driven by maths of how much tax and other revenue it raises and how much money it spends.
Budget surpluses and deficits are calculated by Treasury when they bring together forecasts for GDP, wages, inflation, company profits, unemployment, commodity prices and a myriad of other parts of the economy.
If the economy is forecast to be strong, for example, tax revenue is likely to flow into the government as employment and wages growth picks up, company tax increases and spending on some welfare measures is lower. This is the pre-condition for Treasurer Josh Frydenberg’s forecast for the budget surplus in 2019-20.
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And if the Treasury budget forecasts come to pass, then the budget surplus would seem assured.
If, for whatever reason, the economy is weaker than forecast by Treasury the surplus will not materialise.
These are the problems with the surplus forecast
Fydenberg revealed a budget surplus forecast of $7.1 billion in financial year 2019-20. As everyone knows, that financial year does not start until 1 July 2019 and will finish on 30 June 2020.
The Treasury forecasts are very optimistic. For 2019-20, it reckons GDP growth will be 2.75 per cent which is well above the sub 2 per cent growth rate likely to be revealed when the March quarter data are released in June.
It is also forecasting wages growth to lift to 2.75 per cent and for the unemployment rate to hold at 5 per cent by June 2020, both extremely optimistic forecasts if the recent job advertisement data and information from the various business surveys is to be believed.
Any downside to the economy relative to what are upbeat Treasury forecasts will undermine actual revenue flows to the government and risk turning the surplus back to a deficit.
Recall that as recently as 2015, when Scott Morrison was Treasurer, he was forecasting the 2017-18 budget deficit to come in at $25.8 billion. Alas, a sharply weaker economy, a slide in commodity prices and a blow out in government spending saw the deficit come in at $33.2 billion.
This was a $7.4 billion error or blow out in the budget bottom line.
Coincidently, this is a little more than the $7.1 billion surplus forecast.
A small change in economic conditions from those projected by Treasury and last night’s surplus will be gone.
All of which points to Frydenberg’s “budget surplus” rhetoric to be a wish; a forecast; a hope that the economy remains strong enough to deliver the surplus when the new financial year finishes.
And perhaps most importantly, the outcome of the 2019-20 budget will not be known until September 2020, some 17 months from now.
A lot can happen in 17 months
A lot can and will happen in the economy over those 17 month.
Housing, the global economy, interest rates are some of the many things that will change and will impact the budget bottom line. Wages growth could – and probably will – be weaker.
It is fair to say that the $7.1 billion surplus is based on everything going right.
Let’s hope the budget does in fact record a surplus because it will mean the economy has grown solidly. But with housing weak, retail spending sluggish, the global economy turning down, it is probably an even money bet whether the budget ends up being is surplus or yet another deficit.
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