Did you catch the apparent contradiction in this week's mid-year budget
update? It left unchanged the forecast that the economy would grow by
2.5 per cent this financial year, but then blamed a weaker-than-expected
economy for most of the $10 billion blowout in the expected budget
deficit.
How on earth is that explained? By a widening gap between real gross domestic product and nominal GDP.
We
tend to focus on the growth in real GDP - GDP adjusted for inflation -
as the best guide to how many additional jobs are being created and, in
normal circumstances, what's likely to be happening to our material
standard of living.
Trouble is, as former treasurer Wayne Swan
kept saying, we live - and work, earn income and pay taxes - in the
nominal economy, not one that's already been adjusted for inflation.
At
budget-time Treasury was expecting nominal GDP to grow by 3 per cent
and real GDP by 2.5 per cent, implying that the prices of all goods and
services Australia produces would rise by 0.5 per cent.
Now,
however, it's expecting nominal GDP to grow by just 1.5 per cent,
implying it's expecting the overall price of the stuff we produce to
fall by 1 per cent.
So initially Treasury was expecting "producer"
prices to rise only a little overall and now it's actually expecting
them to fall. Why? Because of falls in the prices our producers of
commodity exports receive, particularly for iron ore.
The budget
in May assumed the price of iron ore would stay at $95 a tonne, but now
Treasury's assuming it will stay at its recent level of $60. Lower
export prices mean lower mining company profits which, in turn, mean
lower collections of company tax - by $2.3 billion this financial year,
and more in subsequent years.
But there's another major factor
contributing to the lower growth in nominal GDP: nominal wage rates are
now expected to grow by only 2.5 per cent, not 3 per cent. This (plus
lower growth in employment) is expected to reduce the growth in
collections of income tax by a further $2.3 billion.
Adding a few
other items, expected total tax receipts have been cut by $6.2 billion,
with all the delays and deals in the Senate explaining most of the
remainder of the $10 billion increase in the now-expected budget deficit
of $40 billion.
The mid-year document says that if nominal GDP
grows by only 1.5 per cent in 2014-15, this will be its weakest growth
in more than 50 years. But the truth is nominal GDP has been growing by
much less than its usual 5.5 per cent or so (real growth of 3 per cent
plus inflation of 2.5 per cent) ever since mining export prices peaked
in 2011.
The writedown in expected tax receipts of $6.2 billion
this financial year increases to $31.6 billion over the four years of
the "forward estimates". And that brings the total writedown in tax
receipts since the Abbott government was elected to more than $70
billion.
Wow. The prices we get for our mining exports have been
falling much further and faster than Treasury has expected. Of course,
the rot set in during Julia Gillard's term. It was the biggest reason
she failed to keep her promise to get the budget back to surplus in
2012-13.
Back then, Joe Hockey was having none of Swan's claim
that nominal GDP and tax collections had collapsed under him. No, there
was just a single explanation for the continuing budget deficit: Labor's
uncontrolled spending.
Different story now you're Treasurer, eh Joe. You've got it right now.
But
there's a lesson in this week's budget blowout for Labor, too. In last
year's mid-year update, Hockey produced an estimate for the 2013-14
budget deficit of $47 billion, up $17 billion on the $30 billion the
secretaries of Treasury and Finance signed off on during the election
campaign.
About $10 billion was creative accounting and other
dubious transactions Hockey claimed were Labor's fault. The remaining $7
billion was explained by Treasury revising down its forecasts for
employment and wage growth and, hence, tax collections.
Former
Labor ministers were convinced Hockey lent on Treasury to make its
revenue forecasts worse than they needed to be and so make Labor look
bad. My guess, however, is that Treasury had been over-forecasting
revenue for so long it seized the opportunity to try to get ahead of the
game and, if anything, start under-forecasting revenue.
Subsequent
events have confirmed the wisdom of Treasury's downward revisions at
that time. They proved pretty right. But as this week's further downward
revisions for the following financial year show, Treasury is yet to get
ahead of the game in accurately forecasting the extent of the slowdown
in the growth of tax receipts.
So, Labor, no conspiracy, just the
usual stuff-up. That's to say, the usual human frailty. Treasury is no
better at predicting what will happen to commodity prices than the rest
of us.
There remains one more puzzle to be explained. If Treasury
is now expecting slower growth in employment and wages this financial
year, how can this not have led it to revise down its forecast of real
GDP growth of 2.5 per cent?
Good question, but you'll be sorry you
asked. Part of the explanation is a change in the expected composition
of the growth - some components were revised up, some down.
But
longstanding convention requires official forecasts to be expressed in
fractions of a quarter, so as to avoid "spurious accuracy". Strictly,
the forecast is 2 1/2 per cent, not 2.5 per cent. Treasury's actual,
decimal-point forecast has been revised down, from a bit above 2 1/2 to a
bit below.
But not enough below to be closer to 2 1/4 than to 2 1/2.
Don't say I didn't tell you.
