Budget 2024-25 Preview

Treasurer Jim Chalmers will deliver Budget 2024-25 on Tuesday 14 May 2024 at 7.30pm AEST. AICD Chief Economist Mark Thirlwell previews the Budget, which will be the current Treasurer’s third and potentially the final one before the next federal election – which must be held by mid-May next year.

With the latest numbers from the Department of Finance running ahead of  fiscal projections included in last December’s Mid-Year Economic and Fiscal Outlook (MYEFO), there is a good chance that the government will be able to deliver a second consecutive surplus on the underlying cash balance for 2023-24: in media interviews early this week, Chalmers said the government was ‘shooting for that second surplus’. If it does manage to hit this target, it will be the first time an Australian federal government has been able to deliver back-to-back surpluses since the period between 2002-03 and 2007-08.

The macroeconomic context for the budget is complex. On the one hand, inflation remains above target, requiring the RBA to run a contractionary monetary policy to achieve disinflation. It follows that any move by the budget to significantly increase demand in the economy risks triggering an offsetting tightening of monetary policy by Australia’s central bank. On the other hand, activity is weak, with the economy spending most of last year mired in a per capita recession. Political pressures on the government to offer voters some additional cost-of-living relief, and navigating the near-term fiscal trade-offs present a challenge similar to that of sticking to the RBA’s much-cited narrow path.

A further complication here is the government’s desire to move its fiscal and economic strategy beyond the twin objectives of inflation containment and fiscal repair that have overshadowed the past two budget offerings. It has ambitious plans around its Future made in Australia strategy, plus expensive recommendations to implement from the recent Defence Strategic Review. Alongside these are short-term cost pressures associated with the NDIS and longer-running fiscal challenges associated with an aging population. That mix of priorities and pressures is likely to weigh on the budget forward estimates and the medium-term fiscal outlook.

More detail below.

The Macroeconomic Context

As we’ve discussed in the last two weekly notes, the Treasurer is facing a complex macroeconomic environment that simultaneously limits his room for fiscal manoeuvre while also making a case for policy support.

Start with the constraints. The Australian economy continues to face a persistent inflation problem. Granted, disinflation is underway. Thus, the headline rate of inflation eased to 3.6 per cent in the March quarter of this year, recording its lowest reading since the December quarter 2021. Likewise, underlying inflation (as measured by the trimmed mean) edged down to four per cent in the same quarter, the lowest outcome for that measure since the March quarter 2022. But both results left the inflation rate above the top of the RBA’s target band of two-to-three per cent. Moreover, the March quarter inflation data came in hotter than market expectations while also running above the RBA’s (implicit) inflation forecasts.

The next monetary policy decision will be announced on 7 May and while the most likely outcome is for rates to remain on hold, the possibility of an upward revision to the central bank’s inflation forecasts means there now is at least some risk of an offsetting policy response over the coming months, even absent any material shift in the government’s fiscal stance.

Indeed, all else equal, the presence of above target inflation would argue for at least a modestly contractionary fiscal stance to help monetary policy in its task to return inflation target. At a bare minimum, fiscal policy would be expected to at least avoid adding additional demand to the economy, lest it force the RBA’s to deliver an offsetting monetary tightening.

Of course, all else is not equal.

While Australia is struggling with above target inflation, accompanying high interest rates, high living costs and low consumer confidence are creating significant headwinds for the real economy in general and for households in particular. Australia fell into a per capita recession last year, with quarterly growth in output per head stagnant in Q1:2023 and then falling over the next three consecutive quarters. Only rapid population growth due to record rates of net overseas migration kept overall GDP growth in positive territory. More recent data suggest that households remain under pressure. Sentiment readings remain at recession-like levels while the latest retail sales data showed spending went backwards over the month in March this year. Setting aside the pandemic and the volatility associated with the introduction of the GST, the past six months has now seen the weakest rate of annual growth in retail turnover on record.

Not only do those activity numbers argue for a degree of caution on the fiscal front if the government wants to avoid tipping the economy into outright recession. They are also a reminder of significant political pressure on the government to deliver cost-of-living relief to households. January’s decision to revise the Stage 3 tax cuts means the government has already made a significant move in that direction. Judged purely in terms of meeting conflicting macro and political pressures, the changes looked like a smart piece of business. The redesign will deliver greater benefits to squeezed budgets in low and middle income households. By keeping the changes broadly revenue neutral – Treasury estimated they would lift receipts in 2024-25 by about $1.3 billion while cumulatively lowering revenues by roughly the same amount across the forward estimates as a whole – there should be little additional inflationary impact to that already baked into the forward profile by the original policy.

That brings us to one critical macro-political question for Budget 2024-25: Will the reconfigured Stage 3 tax cuts be deemed to deliver a sufficient political and economic payoff? Or will the government be tempted to do more, and if so, will this be on a large enough scale to warrant an offsetting RBA response?

It’s also worth noting here that the same macro constraint also applies to the government’s ambitions to deliver a new industrial policy bolstered by improved investment incentives (discussed further the budget strategy section below).

Tracking the budget bottom line from the MYEFO to May

The 2023-24 MYEFO was published on 13 December 2023. Back then, the forecast for 2023-24 called for an underlying cash deficit of just $1.1 billion, roughly equivalent to a balanced budget when expressed as a share of GDP. That meant the expected fiscal shortfall had been trimmed by a sizeable $12.8 billion from Budget 2023-24’s forecast for a $13.9 billion (0.5 per cent of GDP) shortfall.

Source: MYEFO 2023-24

The improvement in the budget bottom line was expected to be sustained across the remaining years of the forward estimates. Over the three years to 2026-27, the MYEFO projected a sequence of modest budget deficits equivalent to a cumulative $73.4 billion. That represented a $26.8 billion improvement in the fiscal bottom line relative to the projections set out in Budget 2023-24.

Those smaller deficits also implied smaller financing needs, and a result the MYEFO also trimmed the government’s forecasts for gross debt as a share of GDP across each year of the forward estimates. As a result, by 2026-27 the gross debt to GDP ratio was projected to be 35.3 per cent, down 1.2 percentage points of GDP from the corresponding Budget 2023-24 estimate.

Most of this fiscal turnaround was driven by stronger-than-expected government receipts and especially by higher tax receipts. According to the MYEFO, company tax receipts were expected to be $9.2 billion higher than at the time of the Budget, mainly due to the boost to mining profits from much higher than forecast commodity prices. Expected personal income tax receipts were also revised up due to higher-than-expected employment and the impact of bracket creep.  Similarly, over the four years to 2026-27, tax receipts were revised up by a cumulative $66.6 billion. Again, this was split relatively evenly between about $34.5 billion of increases to forecast company tax receipts (with upgrades to non-mining profits in line with higher nominal GDP projections also adding to receipts) and $30 billion of upgrades for personal income tax receipts.

Latest numbers from the Department of Finance suggest the improvement in  fiscal outcome for the current financial year is likely to be even better than the one predicted by the MYEO. The March 2024 Monthly Financial Statements reported that the underlying cash balance for the 2023-24 financial year to 31 March was a deficit of $1.8 billion. That compares to a MYEFO profile which had projected a deficit of $5.9 billion. The ongoing deficit undershoot reflects payments over the year to date running behind their MYEFO profile ($490.2 billion actual vs $494.9 billion projected). Receipts over the financial year to March were slightly below their MYEFO profile ($488.4 billion vs $489 billion).

Those March 2024 numbers suggest that the Government should be able to announce a second consecutive annual budget surplus for 2023-24. If it does so, this will be the first time that Australia has been able to run a sequence of surpluses on the underlying cash balance since the period between 2002-03 and 2007-08. All else equal, that stronger starting position will have helpful implications for the trajectory of gross government debt.

How the budget strategy and budget projections have changed over time

Chalmers’s first budget came in October 2022, just months after Labor had secured victory in the May 2022 federal election. Then, the new government’s overarching Economic and Fiscal Strategy was to ‘make the economy more resilient and put the budget on a more sustainable footing over time’. The ‘immediate priority’ was to ‘ensure fiscal policy is not adding to inflationary pressures and to begin budget repair.’ After that, the focus would ‘shift to achieving measured improvements in budget position to stabilise and reduce gross debt as a share of the economy.’

Given that context, the Budget papers projected a series of deficits on the underlying cash balance, edging up from an actual deficit of around $32 billion (1.4 of GDP) in 2021-22 to an estimated deficit of $36.9 billion (1.5 per cent of GDP) in 2022-23 and followed by budgeted shortfalls of $44 billion (1.8 per cent of GDP) and $51.3 billion (two per cent of GDP) in 2024-25. The first projected fall in the deficit only arrived in 2025-26 in the form of a forecast $49.6 billion (1.8 per cent of GDP) deficit. That fiscal profile took gross debt as a share of GDP from 39 per cent in 2021-22 to a projected 43.1 per cent by the end of the budget estimates in 2025-26. In other words, the projections involved at best only modest progress against the stated fiscal strategy.

Source: Budget Paper No.1, Budget October 2022-23, and Budget 2023-24

By the time of Chalmers’s second budget, delivered on 9 May 2023, the overarching Economic and Fiscal Strategy remained unchanged, with the same objectives of making the economy more resilient and putting the budget on a more sustainable footing. The explicit reference to inflationary pressures and budget repair had retreated into the background somewhat, but the ‘overarching goal of reducing gross debt as a share of the economy over time’ remained.

Meanwhile, the accompanying budgetary projections had improved noticeably.  According to Budget 2023-24, after delivering a small budget surplus in 2022-23 of $4.2 billion (0.2 per cent of GDP), there would still be a sequence of deficits on the underlying cash balance over the forward estimates. But these would now be significantly smaller than the deficits anticipated in the previous budget. A similar story applied to the profile for general government debt, which was appreciably lower in the later Budget.

Source: Budget Paper No.1, Budget October 2022-23, and Budget 2023-24

As discussed above, the latest MYEFO – and more recent fiscal data – suggests that in the short term Budget 2024-25 should be well-positioned to deliver another improvement in the debt and deficit numbers relative to its predecessors, at least in the near-term. That will allow the government to continue to book progress on its strategy of debt stabilisation.

The more challenging questions relate to the future of the budget strategy and the budget’s out years. In the Treasurer’s 14 March 2024 Address to CEDA on Relief, repair and reform: a preview of the 2024 Budget he told his audience that the ‘three biggest drivers of our thinking about this third budget are global uncertainty, persistent cost of living pressures, and slowing growth’ and said that when it came to budget strategy ‘these pressures necessitate an approach to the third budget which is a little bit different, but not a lot different, to the first two.’ That meant ‘a primary focus, but not a sole focus, on inflation.’  According to the Treasurer, the Budget will likely include additional cost of living help ‘but it won’t be anywhere near the magnitude of the tax cuts.’

In terms of the budget bottom line, the Treasurer explained that this means that while the government expects Budget 2024-25 to benefit from revenue upgrades like its two predecessors did (each of which enjoyed more than $100 billion in revenue increases relative to previous estimates), the gains this time will be much smaller. Moreover, while the government banked most of those earlier upgrades in the previous two budgets (92 per cent and 82 per cent on the Treasurer’s calculations), he also anticipated that the share banked would be smaller this time.

In a second speech – this one delivered to the Lowy Institute on 1 May 2024 – on Economic security and the Australian opportunity in a world of churn and change, the Treasurer told his listeners that inflation ‘will still be the major near-term focus’. But he also promised that Budget 2024-25 would ‘have a big emphasis on attracting and deploying investment from the private sector’ and that this would include ‘financial incentives, regulatory changes, and other enablers.’  The government wants to boost investment in order to develop ‘domestic sovereign capability…to protect our national security interest or ensure our economy is sufficiently resilient to shocks’ and to ‘support  decarbonisation’ is central to the government’s A future made in Australia strategy. One recent example of this new emphasis was the announcement of almost $1 billion of combined public investment by the Federal and Queensland governments into the technology company PsiQuantum to build the world’s first fault tolerant quantum computer in Brisbane.

Separately, the government has also announced increases in defence spending in response to the Defence Strategic Review. The Treasurer has described this approach as ‘at the front end, an emphasis on inflation [and] a medium‑term emphasis on growth, and that does impact the way that we time and sequence and shape our investments in the Budget’.

How successfully the government can combine the promised near-term focus on inflation with the pledge to provide further cost of living relief and the ambitions around the future made in Australia strategy and the new defence commitments will be a significant test of this year’s economic and fiscal strategic framework.