With an election likely to be called before the next full federal budget, it’s not surprising to see this year’s budget papers brimming with optimism.
But that optimism comes with risks.
After a couple of lucky years, driven by a mini-commodities price boom and an infrastructure jobs boom, the government is spinning the barrel in the revolver and asking Australia to believe more of the same is on the way.
As Dirty Harry would say: “Do you feel lucky, punk? Well, do ya?”
The answer, in what investors call risk-adjusted terms, should be ‘no’.
This year’s beautiful set of numbers shows better-than-expected job creation, better-than-expected tax revenues, and a return to budget surplus a year earlier than previously forecast.
Six months ago at the mid-year budget update, Treasurer Scott Morrison thought the next three full-year deficits – starting with this financial year – would be -$23.6 billion, -$20.5 billion, -$2.6 billion, swinging to a surplus of $10.2 billion in 2020-21.
He is now expecting two deficits, -$18.2 billion this financial year and -$14.5 billion the next, followed by a surplus in 2019-20 of $2.2 billion.
A couple of factors helped reach this happy state. The strong jobs growth saved a fair bit of welfare spending and boosted income tax revenue, and strong company profits increased the overall tax receipts.
It’s a big turnaround, and we should all hope it continues.
On the other hand, if there’s one thing the fiscal rollercoaster of the past decade has taught us, it’s not to be too hasty in assuming the good times will continue.
But that’s what the Turnbull government is saying – that the “luck” wasn’t really luck after all.
It arrives at that position by considering upside and downside risks and concluding that they are pretty evenly balanced.
The iron ore price, for example, is assumed in this year’s budget to hold steady at the current free-on-board spot price of about $55 a tonne.
That could fall or rise depending on demand from China, but the odds are stacked in favour of a fall as China cuts down on polluting mills, its historic credit bubble threatens, again, to collapse, and its trade war with the US threatens to escalate.
The same risk hangs over the price of coking coal, which is required to turn all that lovely iron ore into steel.
Another downside risk is household consumption growth, which has been lagging for some time.
Households are being squeezed between increases to their borrowing costs, especially on mortgages, and flat wages, so the risk of household consumption growing less than forecast continues to be substantial.
On the upside, the budget models the impact of non-mining business investment growing 3 per cent more than expected in the next two financial years (it models a sudden slump, too, but nobody is expecting that at present).
If the accelerated business investment happens, the positive impacts of increased job creation and company tax receipts could be substantial.
Why might we expect business investment to take off in that way? Partly because of the government’s unshakeable belief that its phased company tax cuts are central to investment decisions.
The logic is simple, but the reality of that policy is far more complex.
Company tax cuts can improve returns to shareholders but they are not the only factor – returns can be boosted or squashed by the cost of debt funding, currency movements, land and property values, labor costs, government regulation compliance and so on.
So it is naive to say “we gave them a tax cut, so investment will take off”. It might, or it might not.
The middle way
If we were not headed for an election, a more prudent budget would use more of the fiscal headroom to get the budget closer to surplus sooner – just in case one of those downside risks becomes a reality.
Or, it would cut taxes in a way that was certain to stimulate the economy.
The company tax cuts don’t fit that bill, but the government’s tax cuts for middle- and low-income earners do, because the recipients have a high propensity to spend the money as it hits their bank accounts.
To a prudent investor, a couple of years of luck would be enough, and the need to return to a more conservative path would seem obvious given the current of risks.
That’s not what this budget does, however.
So the best we can do now is cross our fingers while the trigger is pulled. And who knows, we might be lucky after all.