Bill Shorten, Meet John Hewson

Josh Frydenberg handed down his pre-election budget last night. It was a return to Liberal ideals. That is, tax cuts and budget surpluses…albeit thin ones.

Clearly, the aim is to challenge Labor on economic credentials. Given Bill Shorten’s high spending and high taxing agenda, it’s a challenge the Coalition should easily win…if the electorate cares enough.

But Labor are much stronger in the climate change debate. While the sands will shift over the next six weeks, this election is shaping up as one between climate change action and economic management. It should be fascinating…if that’s your thing.

What’s really interesting is that these issues appeal to the opposite of each party’s natural constituency.

Frydenberg’s budget gives immediate tax relief to low and middle class income earners. Shorten’s climate change policies appeal to the more financially secure, city voter.

Three Aussie gold Stocks to watch in 2019.

The best reform in the budget

The best reform in the budget is one that may never come to fruition. I’m talking about the tax cuts that come into play in 2022-23 and the following year. After that time, Australian taxpayers will have a simple, three tier tax system, with marginal rates of 19%, 30% and 45%.

This means 94% of taxpayers will have a marginal rate of no more than 30%. It also aligns personal tax rates closer to the company tax rate.

It’s a much more sensible and efficient tax system than we’ve had for many years. Let’s hope this simplified system becomes reality.

One thing I find pretty funny when reading commentary about the tax cuts is how they’re referred to as a ‘gift’ or a ‘tax splash’ for consumers.

Umm…it’s our money. The government is just graciously taking less of it. It’s not a gift, its just less theft. So let’s cut the crap that the government is doing us a favour and being generous.

They are simply allowing us to keep more of what we rightfully earned.

And the tax cuts won’t result in more overall spending. This is not a boost to the economy. It’s simply returning the dividend of increased economic growth to the people who helped create it, rather than the government taking the money and spending it as they see fit.

So, in that respect, its more efficient spending. Money in the hands of those who earned it, rather than those who taxed it, is always spent more efficiently.

The other centrepiece of the budget is the return to surplus next financial year —2019-20. The budget is expected to be in surplus to the tune of $7.1 billion, or 0.4% of GDP. Then, in the following years, the surplus is expected to be 0.5%, 0.8% and 0.4% of GDP.

In other words, there is not much room for error. If the economy, or China, slows more than expected, the government can kiss those numbers goodbye.

The most important number for determining government receipts (and therefore the budget balance) is nominal GDP. This is in turn influenced by our ‘terms of trade’, which is the ratio of export prices to import prices.

Terms of trade boost nominal GDP

Thanks to the boom in iron ore and coal prices, our terms of trade boosted nominal GDP in recent years (to June 30). Take a look:

2016/17: 6.3%
2017/18: 5.5%
2018/19: 5% (govt. forecast)

The budget papers rightly expect nominal GDP to slow in the years ahead, as commodity prices decline from near historic highs. But the expected fall is pretty tame. Here’s how the government sees it:

2019/20: 3.25%
2020/21: 3.75%
2021/22: 4.5%
2022/23: 4.5%

But during the last major China slowdown from around 2012 to 2016, in which Australia experienced a commodity price bear market, here’s how the nominal GDP figures looked in each financial year:

2012/13: 3%
2013/14: 3.3%
2014/15: 1.6%
2015/16: 3.4%

Let’s just say that any greater than expected slowdown in China will blow the forecast surpluses out of the water.

Also, keep in mind that while China was going through that managed slowdown from 2012-16, interest rates in Australia fell from 4.75% down to 1.5%. This inflated the housing bubble and created a residential construction boom, which helped soften the blow from China’s slowdown.

Now, Australia has very little interest rate ammunition to fight a sharp terms of trade fall.

That’s the problem with the government’s nominal growth forecasts. They factor in a comfortable pullback, and then an increase. But the real world doesn’t work like that. Commodities, especially, don’t work like that.

China’s huge run up in debt levels over the past decade makes its economy difficult to manage. If the communists want continued growth, it means debt will continue to grow strongly. But that creates long-term stability issues, which the leaders want to try and avoid.

At some point in the next few years, you’d expect China to have another crack at managing its debt bubble. When that happens, it won’t be good for Australia.

That’s a worry for another time though — at least until after the election. Putting aside the inherent uncertainty about the longer-term budget projections, the next six weeks on the campaign trail should be very interesting indeed.

The government is at long odds to win. But a well argued and aggressive campaign could just see Labor losing the unlosable election.

Perhaps Bill Shorten should chat with John Hewson…

Regards,

Greg Canavan,
Editor, The Rum Rebellion

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