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Why Low Wages Growth Will Threaten A Return to Surplus

The Federal Government’s Mid-Year Economic Forward Outlook (MYEFO) was released this week, promising that ‘after a decade of deficits, the Budget is on track to return to surplus’ by 2019-20.

We should welcome good news about the state of the Budget – but a closer look at some the assumptions in MYEFO are cause for concern.

Once again, heroic estimates about future wage growth are central to achieving the Government’s predicted surplus. That leaves it to a future Treasurer Frydenberg or Bowen to write down income tax revenues and potentially push the Budget back in deficit.

Growing wages essential to achieving surplus

The Federal Budget’s projected surplus for 2019-20 will be reduced to a wafer-thin $0.8 billion if low wage growth persists, and the assumptions the Government has made about future wage growth do not eventuate.

If wage growth remains as low as it has since 2013-14, the projected surpluses for the later years in the MYEFO will be almost cut in half to $6.4 billion in 2020-21 and $9.8 billion 2021-22.

In contrast, if Australia’s wages and bargaining system had been functioning properly over the last six years – and the level of wage growth assumed in successive budgets achieved rather than continually downgraded – the Budget would have been back in the black in 2017-18. Had previously assumed wage growth rises eventuated, the Budget would likely be on track for a surplus of $23.7 billion in 2019-20 instead of the $4.1 billion recently forecast.

We’ve seen this before

Budget statements since 2013-14 have continually over-estimated future wage growth.

The 2018-19 Budget was initially built on the most optimistic assumptions for wage growth since 2013-14, and with the recent downgrades they are still the most optimistic of any MYEFO in the same period.

This latest statement does not provide a substantial explanation for why wage growth is expected to defy recent trends and not be subject to further downgrades.  The forecast return to surplus relies on a wage growth higher than any of the last five MYEFOs and 0.7% above what was recorded in the September quarter – which suggests a large part of the projected surpluses are built on very shaky ground.

The budget impact compounds over time

As the saying goes, a pay rise you miss out on is a pay rise you can never get back.

This is because of the compounding effect that pay rises have as they build up on top of one another over time.  The same is true for the Federal Budget.

Had the predicted wages growth actually occurred over the past few years, not only would the budget have been back in surplus earlier, but government debt would also have been substantially lower as the cumulative impact builds up over the 9-year period.

Our detailed analysis breaks down changes to personal income tax receipts from past budget papers that can be attributable to either revised assumptions to the Wage Price Index (WPI) or the level of work activity (which is an aggregate of changes to unemployment, population growth, workforce participation etc.)  It shows that if original WPI assumptions from 2013-14 were achieved rather than constantly downgraded, that government debt would be as much as $104 billion lower by 2021-22.  And if low wage growth continues for the next four years that number would increase to $119 billion, more than a third of level of net government debt projected for the same year.

All other budget assumptions and outcomes are held constant so we isolate the impacts of changing WPI on personal income tax receipts.

Fixing wage growth key to our fiscal health

This highlights the Budget’s sting in the tail for whomever forms government after the next election, made sharper by the move to bring forward Budget Night to April 2.  With the March quarter WPI not yet available, it might be easier to justify retaining the current assumptions and leave it to the Treasurer overseeing next year’s MYEFO to have to perform any write downs and be the one that puts the surplus at risk.

There is of course an alternative, and that is to develop a plan to fix Australia’s broken bargaining system and get wage growth back on track to historical norms.