Budget 2006: Australian Government Passes Expansionary Package

Treasurer Lays Groundwork for Election Victory

Australian treasurer Peter Costello presented a budget that surprised many by the extent of its expansionary character. Supported by buoyant revenues, based on higher international commodity prices, he passed a 'boom budget', including a A$45 billion (US$ 34.7 billion) spending spree and A$47 billion in tax cuts, intended to compensate domestic consumers and producers for high oil prices and secure the conservative ruling alliance another electoral victory. For this fiscal year (ending June 2006), Costello forecasts an underlying record budget surplus of A$14.8 billion - A$3.3 billion above a Treasury forecast issued in December. The 2006/07 budget provides for an underlying cash surplus of A$10.8 billion. Although it incorporates important structural reforms and spending initiatives, the expansionary nature of the budget could well induce the central bank to raise policy rates again in the short term, to prevent increased domestic spending from exerting excessive upward pressure on prices. In addition, little has been done to tackle Australia's imminent capacity constraints, especially in the mining sector, which push prices higher and keep exports below their potential.

Outlook and Implications

Surplus Budget Allows Spending Spree and Broad-Based Tax Cuts

Soaring profits among Australian companies - especially in the mining sector, as international commodity prices remain high on strong demand from China and India - have bestowed Australia with record tax revenues and a fiscal surplus projected at A$14.8 billion - A$3.3 billion above the government's target. At the same time, the central bank's decision to raise its leading cash rate to 5.75% (see Australia: 3 May 2006: Reserve Bank of Australia Raises Interest Rates to Contain Inflationary Presssures) and sustained high international oil prices have hit important voters in the 'mortgage belt', who will be compensated by tax cuts and increased support programmes. Personal income tax allowances worth A$36.7 billion, an increase in the 30% and 40% thresholds and broad-based tax cuts are targeted to win 'middle Australia' in the next general election, scheduled to take place next year. Hundreds of millions of dollars in extra family benefits and support for older Australians and carers go in the same direction. To support the lower income group of the population, the low income tax offset was increased to A$600 per year, and its phase-out raised to A$25,000. However, the plan did not forget the conservatives' core voters, and the top tax rate was cut from 47% to 45%. To support the production side of the economy, the government's eleventh budget included a A$3.7 billion support package for the take-up of new technology, and tax cuts for small businesses worth A$435 million.

The government's strong revenue generation not only allowed Costello to engage in broad-based tax cuts, but also had an impact on the expenditure side. Among the major spending initiatives were a A$2.3 billion upgrade of the road and transport infrastructure, major investments in university research programmes and A$389 million to combat illegal fishing. In addition, A$16 billion will be spent to strengthen defence and national security, including funding to improve policing levels at airports, establish a bomb research centre in Thailand and boost staff levels at the Australian Security Intelligence Organisation (ASIO). An extra A$623 million was pledged to ongoing military operations in Iraq and Afghanistan, and A$10 billion was earmarked for future defence initiatives. In addition, increased spending was channelled into health and medical research efforts, including a major funding boost for the mental health system. Overseas aid, mainly to the Asia-Pacific region, was increased by 15% to just under A$3 billion, including increased funding to fight HIV/AIDS.

Costello's 2006/07 budget has surprised observers through its highly expansionary nature, with the government's fiscal policy having previously been characterised by its conservative nature. Recurrent fiscal surpluses were first aimed at paying down the government's public debt (Australia is now virtually debt-free), and then to stock up the government's superannuation programme, aimed at securing pensions for an aging society. In this sense, this eleventh fiscal plan is a pre-election budget in a non-election year, clearly aimed at securing another electoral win for the conservative ruling National/Liberal alliance. While it includes important structural reforms, such as increased spending on health and education, it bears the risk that the increased cash flow to domestic consumers will add to already crippling inflationary pressures, in an economy working at full employment and showing signs of capacity bottlenecks. In this sense, the budget could have short-term inflationary consequences, either prevented or combined with increased monetary tightening, as well as doing little to reduce these bottlenecks and improve long-term productive capacities. In addition, while high international commodity prices currently secure high tax revenues, the fiscal concessions could become unsustainable if high international prices start to ease again. However, the government can be expected to revert to its conservative fiscal stance if it secures another legislative period in power.