Thursday, 25 May 2017

Budget 2017 - the big picture

What's the very, very first thing you should look for in any Budget? It's not the headline surplus or deficit, no, nor the spend-ups, nor the tax breaks, nor the gimmicks (does anyone ever track the effectiveness of this year's grant scheme or last year's incentive?).

It's whether the Budget boosts or brakes the economy. And how would you know? By digging out the 'fiscal impulse'. Which isn't the easiest thing to find: it's never in the big Budget bumph, but is relegated with the horoscopes and crossword to an 'additional information' document (this year's is here). And that's partly because Treasury are a bit embarrassed by it: the calculations involved can be on the arbitrary side, and you wouldn't want to bet anything valuable on the accuracy of the outcome.

But for all its flakiness, it's the only thing we've got. What it does, is strip out all the cyclical stuff from last year's Budget and this year's. It could be, for example, that last year's Budget showed a surplus solely because the economy was doing well and the GST take was pouring in, and this year's surplus is even bigger because the economy is doing even stronger still (not a million miles removed from what's actually happened). Both surpluses, and the increase from the first to the second, may have sweet eff all to do with careful stewardship of the nation's finances, and may not tell you anything about the overall impact of the Budget.

So what you do, is you strip out the fortuitous cyclical stuff from both Budgets, taking out (for example) the happenstance of higher GST in good times or lower GST in bad times. You might have to take out one-offs like earthquakes as well, to get a proper feel for the real 'normal times' state of the government's books. And when you've done that, then you compare the true, 'underlying', 'structural', 'cyclically adjusted', outcome - call it what you will - in the two Budgets. If, for example, last year's Budget had a true deficit of 1% of GDP, and this year's has a true surplus of 1%, that's a turnaround of 2% of GDP, which by fiscal standards would be a reasonably significant tightening of fiscal policy - a clear brake on the economy (last year injecting some money into the economy, this year taking some out). And conversely a larger true deficit, or a smaller true surplus, would be a boost.

We know, too, that Ministers of Finance ought to do the right counter-cyclical thing - in good times (like now), fiscal policy doesn't need to be, and shouldn't be, a stimulus to the economy. In bad times, it does, and should. So, how'd Joyce go? Here's the fiscal impulse.


The good news is that he didn't go for a pro-cyclical splurge in election year. Overall, the stance of fiscal policy won't be making much of a difference, either way, to our current business cycle. There is a mildly pro-cyclical fiscal stance for 2018 and 2019 (acknowledging, again, the ropiness of these kinds of calculations), and the heavy lifting of getting government debt down has been pushed out to 2020 and 2021 and beyond.

That said, I for one don't mind too much if we take a while to get net government debt below the target 20% (which on current forecasts will be in the June 2021 year) if instead we spend up large on our severely deficient infrastructure. The Budget speech said that "Through this new capital spend [$11 billion] and existing commitments the Government and its key infrastructure agencies will invest a total of $32.5 billion over the next four years in new infrastructure". It may sound odd to say that $32.5 billion is only a start, but that's the reality: the infrastructure deficit has been allowed to balloon to a level that is now difficult to grapple with, even in $32.5 billion chunks. And even these higher levels of spending will result in indefensibly slow improvement (30 year timeframes for rail to Auckland's North Shore come to mind).

What else?

The tax thresholds. Yes, of course they should have been adjusted upwards, good job they were. And it's good to see the bulk of the increase concentrated on raising the lowest threshold (where the 10.5% rate applies) from $14,000 to $22,000. Leaving them unadjusted had been an insidious and regressive way to raise the tax take: people barely into middle-class incomes, paying the top marginal tax rate, along with the millionaires? Give us a break.

Mr Joyce did not, however, take a principled approach and commit to keep on adjusting them every year. While (I guess) he thinks that's clever politics - keeping a lolly up his sleeve for future years' scrambles - it's not good, either as economics or politics. The economics is obvious: we'll soon have teachers and police constables back paying the millionaires' tax rate. Politically, it would have been smarter to commit to indexing the thresholds, gaining all the moral high ground, and watch the opposition parties squirm if they didn't match it. And if you really want to inherit the technocratic, managerial mantle of Bill English, a valuable political asset built up over many years, you do the fiscally right thing, even if it costs you the option of a cheap political stunt every year.

Lowering the target for net government debt to 10% to 15% of GDP by 2025 is fine by me. If there's anything we've learned over the past decade, it's that you need to leave a lot more 'fiscal space' or 'fiscal leeway' than you might have thought in pre-GFC days. You don't want to go into whatever the next unpleasant surprise may be carrying significant amounts of debt (as countries like France may discover) and even countries like Ireland, which appeared to be in a decent net debt starting point, found that, in fact, it wasn't enough to cope with the implosion of their banking system.

Finally, the economic forecasts. At first squizz they look reasonable enough - perhaps a tad on the optimistic side - but there's an interesting wrinkle in the details, where housing construction is expected to barely grow in the year to June '18 (+0.3%) and then perk up a lot (up 8.7% in the year to June '19, and another 8.8% in the following year). As the forecast document says, "There is considerable uncertainty associated with the judgement that this slow-down will be temporary", and that a building boom in the Auckland market is on the horizon. I really hope there is. But then I look at our capacity constraints, and our planning delays, and I wonder.

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