Date created: 28 November 1996

Last modified: 18 November 1997

Maintained by: John Quiggin

John Quiggin

Rubbery figures shape black hole

Australian Financial Review,

June 27, 1996

The $8 billion 'black hole' in the Budget has become the core of the government's post-election rhetoric and the justification for dumping most of its election promises. As with the astrononomical variety , the discovery of the Budget black hole has been announced with confidence, but there is plenty of doubt over whether it actually exists. Again as with the astronomical variety, quite a bit of detective work is required.

The position is made more complicated by the fact that there are two $8 billion holes. The first, which is uncontroversial, is the 'underlying' Budget deficit, net of asset sales, debt repayments by the States and the like, for the current financial year 1995-96. The ABS measure of the underlying deficit came in at almost exactly $8 billion in the 1995 Budget. This underlying deficit was acknowledged in the 1995 Budget Papers, though it was right at the back, and the Treasurer did not choose to mention it in his speech. The Treasury uses a slightly different measure, not reported in the 1995 Budget Papers, which was estimated at $6.7 billion in May 1995.

Mr Costello's March 1996 statement contains a modest adjustment to this figure. Labor's policy decisions between the Budget and the election added a net $400 million to the deficit. Parameter revisions, that is changes in the projected levels of employment, prices, wages and other incomes, are projected to add another $2 billion, yielding an underlying deficit of $9 billion. Most analysts think this is a little too pessimistic and that the 1995-96 Budget will finally come in between $7 billion and $8 billion.

But the 1995-96 deficit is of little more than historical interest. The financial year is virtually over, the taxes have been raised and the money spent. What matters is the deficit for 1996-97 and beyond. Here there is a gaping hole between the projections offered by Willis and Beazley in 1995 and those offered by Howard and Costello in 1996. In the 1995 Budget statement, Mr. Willis predicted that the 1996-97 Budget would be in surplus without taking account of asset sales. When State debt repayments are also deducted, the 1995 projection was for an underlying Budget deficit of $0.5 billion, close enough to a perfectly balanced Budget.

Mr. Costello's 1996 statement presents a very different picture. It projects an underlying Budget deficit of $7.6 billion for 1996-97. It is this figure, and the claimed need to get the Budget into surplus that justifies proposals to cut $8 billion from public expenditure, breaking large numbers of clear election undertakings in the process. So this is the $8 billion hole that really matters.

As we have seen, only $0.4 bilion of the increased deficit can be traced to what Mr. Costello refers to as Labor's 'decisions and mismanagement'. The remainder of the difference, more than $6 billion, must be attributed to 'deceit' or, more prosaically to parameter revisions. Projected economic growth is revised from 3.75 to 3.25 per cent for 1996-97. The CPI is projected to rise by 4.75 rather than 4 per cent in 1995-96, after which projections are unchanged. Projected increases in average earnings are lower in 1995-96, but higher in 1996-97, leaving the outcome from 1996-97 onwards unchanged.

A little arithmetic shows that something is fishy here. By the end of 1996-97, Mr. Costello's estimate for Australia's GDP is about 1 per cent lower than that put forward by Mr. Willis. 1 per cent of GDP is about $5 billion. Yet, as a result of this change, the Budget deficit is expected to blow out by $6 billion. If Mr. Costello is to be believed, a decline in growth will leave the government worse off, but the rest of the economy will actually be better off to the tune of $1 billion.

Economists have a rule of thumb that a 1 per cent decline in GDP costs the government around $2 billion. This rule of thumb can be justified fairly easily. Tax revenue is about 25 per cent of GDP, so a 1 per cent (5 billion) decline in GDP will reduce revenue by around $1.25 billion. Employment will normally fall as well, and this implies an increase in benefit payments of around $0.75 billion.

A more formal approach to this kind of problem is called 'sensitivity analysis' and the basis for such an analysis is presented in the 1995 Budget papers, showing the impact of a 1 per cent change in prices, employment and other variables on revenue and outlays. This more elaborate exercise confirms the result that the parameter revisions presented in Mr. Costello's statement should not have changed the projected Budget outcome by any more than $2 billion.

Where then, does the $6 billion come from ? Digging into Mr. Costello's statement we find that in addition to lower growth, the deterioration is due to lower forecast growth in 'certain incomes and prices', not revealed in the aggregate parameters. Presumably the revised estimates must involve low growth in private sector incomes offset by high growth in the prices and wages paid by the government, while the original estimates must have had the opposite characteristics. Neither assumption has any obvious merit.

To put it more bluntly, the most likely explanation is that the parameters were juggled in the 1995 Budget to generate a projected surplus and have been juggled in the 1996 Statement to make the deficit as big as possible. A surplus suited both Labor and the Coalition before the election, while a large deficit suits the government today. Despite some improvement's over the past twenty years, Philip Lynch's description of Budget estimates as 'rubbery' is still valid. If projections showing a surplus were needed for the government's political purposes, they could be produced tomorrow.

In summary, we can safely attribute most of the $8 billion Budget 'black hole' to deceit, but the responsibility for this deceit is shared between Mr. Costello and his predecessors. The Budget 'crisis' has been manufactured by the government to justify the abandonment of its electoral commitments.

John Quiggin is Professor of Economics at James Cook University and author of Great Expectations: Microeconomic reform and Australia, published by Allen & Unwin.

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