Document Index Budget Paper 1 Budget Statement 1

Part III: Fiscal Outlook and Strategy

• Fiscal Outlook
• Fiscal Strategy
• Budget Surplus, National Saving and the Current Account
• Net Debt and Net Assets
• Expenses Restraint and Investment
• Taxation Reform and Revenue

FISCAL OUTLOOK

The Budget maintains a sound fiscal outlook with surpluses in 1999-2000 and over the period of the forward projections. The fiscal balance for 1999-2000 is expected to be in surplus by $5.4 billion, an increase from the $3.1 billion surplus expected in 1998-99. The underlying cash surplus for 1999-2000 is expected to be $5.2 billion, a substantial increase from the expected outcome of $2.9 billion in 1998-99 (these estimates allow for a reduction of around $1¼ billion per year from Commonwealth payments for PTE superannuation provisions).

Chart 1 shows the recent outcomes, current estimates and projections for revenues, expenses and the fiscal balance for the Commonwealth general government sector. Chart 2 shows the underlying cash balance, again for the Commonwealth general government sector, over a longer period.

Chart 1: Budget Balances^(a)
Panel A: General Government Revenue and Expenses

Panel B: Fiscal Balance

1. Accrual data prior to 1998-99 are taken from the annual Consolidated Financial Statements. From 1998-99, the accounting treatment of certain revenue items, in particular taxation revenue and some dividends, has changed. See Statement 4 for further information.

Chart 2: Underlying Cash Balance^(a)

1. From 1998-99 onwards the underlying cash balance estimates include payments by the Commonwealth in respect of accumulated PTE superannuation liabilities. This detracts around $1¼ billion from the surplus in 1998-99 and following years.

Over the forward estimates period, both revenue and expenses as a proportion of GDP are expected to fall significantly. These reductions are largely driven by the abolition of Financial Assistance Grants to the States and Territories, the abolition of Wholesale Sales Tax and the personal income tax cuts arising from the introduction of A New Tax System.

The major economic parameters underpinning the budget estimates are summarised in Table 3. The economic forecasts are discussed in detail in Statement 2.

The economic parameters are based on forecasts for 1998-99 and 1999-2000 and medium-term projections for the following three financial years. The projections for economic growth in the outyears are based on an analysis of underlying trends, while the projections for inflation are consistent with the mid-point of the medium-term inflation target band. The impact on prices of the tax reforms under A New Tax System is not included in the projections. However, this impact has been taken into account separately in projecting the revenues and expenses affected by the tax reforms.

Table 3: Major Economic Parameters (percentage change from previous year)

1. Labour Force Survey basis.
2. Average earnings (national accounts basis).

Table 4 provides a reconciliation between the underlying cash estimates released at the time of the 1998-99 Budget and the 1998-99 MYEFO; and fiscal balance estimates at the time of the 1998-99 MYEFO and 1999-2000 Budget.

Table 4: Reconciliation of 1998-99 Budget, MYEFO and 1999-2000 Budget General Government Estimates^(a)

1. A positive sign indicates an improvement in the fiscal balance and a negative sign indicates a deterioration in the fiscal balance.
2. Includes total budgetary costs of A New Tax System (including the public debt interest effects). For all other policy decisions the public debt interest effects are included in parameter and other variations.
3. Estimates of the fiscal balance at the 1998-99 MYEFO are based on accrual data collected for the 1999-2000 Budget.
4. Derived from movements in physical and intangible assets in the balance sheet.
5. Includes variations in depreciation and economic revaluations.

Parameter and other variations since the 1998-99 MYEFO reduce expenses in 1999-2000 and in 2000-01. This mainly reflects draw-downs in the conservative bias allowance[3], lower unemployment forecasts, reduced pension and benefit payments due to lower CPI forecasts, and lower than expected growth in beneficiary numbers. These are partially offset by increased expenses mainly associated with higher estimates of schools funding, residential aged care and higher education operating grants.

On the revenue side, parameter and other variations since the 1998-99 MYEFO have a net positive impact on revenue in 1999-2000 driven by higher individual and other income taxes, outweighing lower indirect tax revenue. Higher than expected dividend payments also substantially increase revenue in 1999-2000. In the outyears, parameter and other variations have a negative impact on revenue. This is mainly due to lower forecasts of customs and excise duty, as well as lower public debt interest revenues.

The 1999-2000 Budget provides for targeted new policy spending largely associated with meeting the Government's election commitments. Major policy decisions taken since the 1998-99 MYEFO include:

• improved funding arrangements for non-government schools ($338 million over four years to 2002-03; for the 2001-04 school quadrennium this will amount to $561 million);
• improving literacy and numeracy in schools ($131 million over four years);
• additional funding for the National Illicit Drug Strategy (over $80 million for existing strategies and $221 million over four years for new intervention and diversion strategies);
• increased funding for health and medical research funded through the National Health and Medical Research Council ($274 million over four years; amounting to $614 million over the next six years);
• a primary health care package for older Australians and those with chronic conditions ($228 million over four years);
• funding for hearing services ($210 million over four years);
• increased funding for national highways and roads of national importance ($195 million over four years);
• additional funding for an expansion of Work for the Dole for Year 12 school leavers ($99 million over four years) and a further expansion of the principle of Mutual Obligation to long-term unemployed people aged between 25 and 34; and
• taxation changes to encourage philanthropy ($189 million over four years).

A full description of all policy decisions taken since the 1998-99 MYEFO can be found in Budget Paper No. 2.

Appendix C in Statement 4 contains a Statement of Risks which details potential factors which could materially affect the fiscal outlook. One important factor will be variations in the economic parameters. A discussion of the estimated sensitivity of the expenses and revenue estimates to changes in economic parameters is provided in Appendix B of Statement 4.

FISCAL STRATEGY

The 1999-2000 Budget has been framed against the Government's medium-term fiscal strategy, consistent with the requirements of the Charter of Budget Honesty Act 1998. The Charter requires the Government to set out its medium-term strategy in each budget, along with its shorter-term objectives and targets. The Government is also required to determine its fiscal objectives with regard to the Charter's principles of sound fiscal management and report regularly on its progress in achieving them.

The primary objective of the Government's medium-term fiscal strategy is to achieve fiscal balance, on average, over the course of the economic cycle. This will ensure that, over time, the Commonwealth general government sector makes no net call on private sector saving and therefore does not directly contribute to the national saving-investment imbalance (ie the current account deficit). Sustainable fiscal settings help promote longer-term growth prospects by reducing Australia's vulnerability to external shocks and allowing greater flexibility to adjust to changing economic conditions.

This objective, which previously applied to the underlying balance in the cash budgeting framework, has not changed but has been redefined under the new accrual budget framework to apply to its accrual counterpart, the fiscal balance. The fiscal balance closely approximates the contribution of the Commonwealth to national net lending -- the difference between national saving and investment. Differences between the fiscal balance and the underlying cash balance, which are discussed in more detail in Appendix A to this Statement, largely reflect the timing of bringing transactions to account.

The Government's supplementary fiscal targets will also be maintained under accruals, albeit slightly reconfigured. In addition, the move to accruals provides scope to consider an additional measure -- net assets. With the move to accruals and the budget now returned to surplus, the medium-term fiscal objective has five supplementary fiscal targets:

• maintaining fiscal surpluses over the forward estimates period while economic growth prospects remain sound;
• halving the ratio of Commonwealth general government net debt to GDP from almost 20 per cent in 1995-96 to 10 per cent by 2000-01;
• directing sufficient resources to high priority areas, while significantly reducing the ratio of expenses to GDP through to the turn of the century;
• no increase in the overall tax burden; and
• improving the Commonwealth's net assets position over the medium to long term (see Box 2).

Substantial progress has already been achieved on the second and third of these targets, while tax revenue as a percentage of GDP has remained below the 1996-97 ratio.

The Government will run fiscal surpluses during periods of sound economic growth, so that deficits emerging during periods of low growth (if such occur) are manageable. Accordingly, a surplus is again forecast for 1999-2000 and current policy settings are projected to deliver fiscal surpluses over the forward estimates period (Chart 1).

The budget will remain in surplus over the forward estimates period under both the accrual fiscal balance and the cash underlying balance measures. Nevertheless, the two fiscal indicators will diverge in the short term. The fiscal balance will detect non-monetary effects, such as increases in accruing superannuation entitlements that would be ignored by the underlying cash balance. Conversely, the underlying cash balance will detect cash transactions such as superannuation payouts (outlays) on previously accrued liabilities that do not affect the fiscal balance.

The fiscal balance will generally provide a better indication of the ongoing impact of current policy on the fiscal position because transactions are recognised when economic value changes. The underlying cash balance has advantages in helping to identify the short-term impact of the budget on demand.

The fiscal consolidation implemented by the Government has been a key ingredient in Australia's recent strong economic performance. The Government's fiscal strategy and the outlook for continuing surpluses have been important in sustaining financial market confidence during the economic downturn in the East Asian region. These developments underscore the continuing need to operate prudent fiscal policy and maintain a strong fiscal position. This is discussed in more detail in Statement 3.

BUDGET SURPLUS, NATIONAL SAVING AND THE CURRENT ACCOUNT

Improvements in the fiscal balance as a result of the Government's programme of fiscal consolidation have been associated with increases in Commonwealth general government saving and public sector saving (Chart 3). These increases have helped maintain overall national saving during a period of declining private saving.

With the budget now in surplus, the Commonwealth is no longer drawing on the available pool of private saving; instead, it has become a net lender -- adding to the pool of saving available to fund private investment. Moreover, its contribution to national net lending is expected to increase over the forward estimates period. With the State/local general government sector and the PTE sector also expected to be in surplus over the forward estimates period, both the Commonwealth and the public sector as a whole should contribute to reducing the current account deficit (CAD) over time. Projected developments in the State/local general government and PTE sectors are discussed in detail in Statement 9.

Chart 3: Ratios of Gross Saving and Investment to GDP

Source: ABS Cat. No. 5204.0 and Treasury estimates.

International evidence suggests that higher public saving tends to raise national saving. While some private saving response to fiscal consolidation might be expected, experience indicates that this only partly offsets the improvement in public saving. Chart 3 shows that national saving in Australia has normally improved when public saving has improved, and fallen when public saving has fallen. Abstracting from the long-term decline in private saving, which does not appear to be related to public saving trends, movements in national saving have clearly  been strongly influenced by movements in Commonwealth general government saving.

To the extent that past Commonwealth borrowing may have `crowded out' private investment by raising interest rates, a sound fiscal policy may encourage private investment. Private investment should generally produce benefits in terms of higher future incomes that justify the costs of servicing external borrowing.

The fiscal strategy means that the CAD is now essentially a product of private saving and investment decisions that reflect market disciplines and incentives. Much has been done to reduce distortions to private saving and investment that have existed in the past, through the achievement of low inflation and structural and financial market reform (see Statement 3). In this environment, the fiscal strategy provides assurance to financial markets that the CAD reflects soundly based private sector decisions.

NET DEBT AND NET ASSETS

Improvements in the Commonwealth's net assets and net debt positions help to reduce Australia's vulnerability to economic shocks by reducing the risk of adverse swings in financial market confidence. Improving the Commonwealth's balance sheet will also help to ensure that the Government is better placed to cope with any emerging fiscal pressures (such as those caused by the ageing of the population) and is able to meet its future obligations without requiring sharp changes in policy settings at later -- and possibly less opportune -- times.

Chart 4: Commonwealth General Government Net Debt^(a)

1. Includes the impact of the sale of the Government's remaining share in Telstra.

As shown in Chart 4, the Government's fiscal strategy has been successful in reducing the level of Commonwealth general government net debt over recent years. The Government has not borrowed, in net terms since its election in 1996. From a peak of 18.8 per cent of GDP in 1995-96, net debt levels are expected to fall as a share of GDP to 8.2 per cent in 1999-2000. This compares with average net debt levels of around 43 per cent of GDP for OECD countries since the mid-1990s (see Chart 5).

The fiscal surpluses in prospect in each of the forward estimates years, along with expected proceeds from Commonwealth asset sales, provide for further substantial reductions in net debt. As shown in Chart 4, the Government's target of halving the ratio of Commonwealth general government net debt to GDP over the five years to 2000-01 is expected to be exceeded by a substantial margin. Indeed, with the further sale of Telstra, by the end of the forward estimates period in 2002-03 Commonwealth general government net debt could be completely eliminated.

Chart 5: Total General Government Net Debt Levels
in Selected Countries 1992 to 2000^(a)(b)

1. All data are for the total general government sector (ie the aggregate of all levels of government, including the social security sector but excluding the PTE sector). The OECD is the Organisation for Economic Co-operation and Development. Its membership consists of the industrial countries of Europe and North America, Mexico, Japan, Korea, Australia and New Zealand. The OECD average data relate to only the 18 countries included in the OECD Economic Outlook 64. The EU average data relate to only the 11 member countries of the European Union included in the OECD Economic Outlook 64.
2. Data up to 1997 are outcomes, except for Japan where 1997 data is an estimate. The OECD data for the period 1998 to 2000, and the data for Australia and New Zealand for 1999 and 2000, are estimates. For Australia and New Zealand, data refer to the year ending 30 June (eg 1996 data are for the year ended 30 June 1996).

Source: OECD Economic Outlook 64, Reserve Bank of New Zealand Monetary Policy Statement, March 1999, ABS Public Sector Financial Assets and Liabilities (Cat. No. 5513.0) and Treasury estimates.

The 1999-2000 Budget incorporates, for the first time, a statement of financial position, or balance sheet, showing the Commonwealth's overall assets and liabilities. In addition to the longer-standing objective of reducing net debt, which covers selected financial assets and liabilities of the Commonwealth, the introduction of the accrual framework provides the opportunity to introduce an objective for net assets, which covers all the physical and financial assets and liabilities of the Commonwealth.

There are important reasons for governments to track their net assets positions over time, reflecting the extent to which this provides insights into their intergenerational positions. For example, while negative net asset levels do not imply insolvency for governments, as they may do for private profit making enterprises, a significant negative net assets position, particularly if it is expected to deteriorate, may be considered unsustainable and indicate an inequality between current and future generations. This inequality reflects the extent to which high past and/or current period spending by governments may limit the fiscal options open to governments in future periods. Reflecting a desire to address this issue, the Government has set as an objective an improved Commonwealth net assets position over the medium to long term. This objective is consistent with the Government's broader fiscal responsibility objectives set out in the Charter of Budget Honesty Act 1998.

Chart 6: Commonwealth General Government Net Assets

Chart 6 illustrates recent trends, current estimates and projections in Commonwealth net asset levels as a share of GDP. The level of net assets as a percentage of GDP is currently estimated at -13.6 per cent. This level is projected to improve over the forward estimates period, consistent with the Government's objective to improve its net assets position over the medium to long term. This reflects the expected operating surpluses. An additional factor contributing to this improvement is the proposed sale of the remainder of the Government's share in Telstra. In line with accounting standards, Telstra is currently recorded in the Commonwealth's balance sheet at book value[4], which is significantly below its expected market value. That is, the estimate of the Government's current net asset position is, in fact, distorted by this valuation issue. As Telstra is sold, however, this undervaluation is undone, contributing to the significant improvement in the measure of net assets.

EXPENSES RESTRAINT AND INVESTMENT

The achievement of budget surpluses has largely relied on expenses restraint. While maintaining overall restraint on expenses, in this Budget the Government is carefully targeting high priority areas such as health, education, research and development, employment, rural and regional Australia, and families.

The Government's budget priorities are spelt out in greater detail in Part IV of this Statement.

A feature of the move to accrual budgeting is a greater emphasis on the reporting of capital expenditure by the Commonwealth. For the first time, Budget Paper No. 1 includes a separate capital funding statement -- Statement 7.

TAXATION REFORM AND REVENUE

The tax reform package outlined in A New Tax System is consistent with the Government's medium-term fiscal strategy. In particular, this fiscal strategy commits the Government to maintain fiscal surpluses while growth continues and to not increase the overall tax burden.

A New Tax System will be implemented progressively from 1999-2000 and will reduce the size of the Commonwealth surplus estimated for that year and projected for subsequent years. The package will bring substantial benefits to the operation of the economy and to the sustainability of Commonwealth government and State government finances.

Reflecting the considerable improvements in the Government's fiscal position in recent years, the tax package can be accommodated while retaining budget surpluses through the forward estimates period.

Footnotes

[3] The forward estimates are based on decisions already made and economic projections. They also include an allowance for the established tendency for spending on existing Government policy (particularly demand driven programmes) to be higher than estimated. This allowance, known as the conservative bias allowance, is included as part of the contingency reserve in the forward estimates at the beginning of each budget year. It is then gradually reduced as the year progresses so that the budget year conservative bias allowance is zero.

[4] Consistent with accounting standards, the Commonwealth balance sheet records two thirds of Telstra's `net assets' as a Commonwealth asset. This amount is significantly below the equivalent value of two thirds of Telstra's shares. In line with accounting standards, the Commonwealth is only able to value its Telstra investment according to its share price once the Commonwealth owns less than 50 per cent of Telstra.