Date created: 28 November 1996
Last modified: 18 November 1997
Maintained by: John Quiggin
John QuigginAugust 20, 1996
The putative $8 billion 'black hole' has formed the basis of the Howard government's political strategy. However, on the basis of the information released so far, it is very hard to tell whether or not the black hole exists and how large it might be. The issue is clouded by the fact that, as I have previously observed (AFR ..), there are two 'black holes'. The Budget deficit for 1995-96, net of asset sales and loan repayments has now been estimated at $10.3 billion. This was $3.6 billion more than the $6.7 billion figure implicit in the Budget Statement for 1995-96, produced by Mr. Willis in April 1995, and about $1 million more than the figure estimated by Mr. Costello in his March statement announcing the 'black hole'. The gap arises primarily because revenue fell far short of the 1995-96 Budget estimates, which projected an increase in tax revenue of 13.3 per cent. It seems reasonable to surmise that this optimistic estimate reflected the Keating government's desire to announce a headline Budget surplus. Certainly it reflects a disastrously poor forecasting performance by Treasury and Finance. The only comparable error in revenue forecasts in recent years was in 1991, when Treasury assumed a rapid recovery from the recession we had to have. But this time, economic growth was almost exactly in line with projections, so there is no excuse for the poor performance.
Some members of the government have suggested that the fact that 1995-96 outcome was a deficit of more than $8 billion proves the existence of the black hole. But the fact that the underlying deficit for 1995-96 was around $8 billion was a matter of public record from April 1995 onward, and cannot be used to justify the government's abandonments of its electoral commitments.
The figure that really matters is the starting point deficit for 1996-97. An estimate of this figure can be obtained in several ways. The msot useful approach is to take the observed outcome for 1995-96, and estimate the likely change in the underlying deficit in the absence of new policy initiatives. In general, revenue can be expected to grow a little more rapidly than nominal GDP because of the effects of fiscal drag. By contrast, most outlays will remain constant or decline in real per capita terms in the absence of new initiatives or shocks such as increases in the proportion of people claiming benefits.
With nominal GDP growing at around 7 per cent per year, it is reasonable to expect revenue to grow by around 9 per cent per year, and outlays to grow by around 5 per cent per year, in the absence of policy initiatives. Since the government share of GDP is around one quarter, the gap of 4 percentage points is equivalent to an improvement in the Budget deficit of around 1 per cent of GDP or about $5 billion. That is, in the absence of any special factors, we would expect the starting point deficit for 1996-97 to be around $5 billion. A slight additional improvement could be expected from the phasing in of the increase in the company tax rate to 36 per cent. This should reduce the starting point deficit to around $4 billion
If the approach described here had been applied in assessing the 1995-96 Budget estimates, it would have rung some warning bells. Since the Budget contained few substantial revenue-enhancing measures, the estimated gain of 13 per cent in tax receipts appears highly optimistic. In fact, it appears that the increase in tax revenue was around 9 per cent, as might have been anticipated. For the less politically sensitive year 1996-97, the Budget projection was for a tax revenue increase of 8 per cent, almost exactly in line with the rule of thumb described above.
In order to derive the $8 billion dollar starting point deficit for 1996-97, Treasury must have bent in the opposite direction. Assuming that most of the change in projections is on the revenue side, Treasury must now be projecting a revenue gain of only around 5 per cent for 1996-97, far less than could reasonably be expected. This projected decline cannot be explained by the marginal variations in aggregate growth forecasts included in Mr. Costello's March statement.
Treasury will have to put a few more cards on the table when the Budget is brought down next week. But, there is still plenty of room for manoeuvre. In particular, some of the parameters used to derive the 'starting point' deficit forecast will be affected by decisions in the Budget itself. For example, a tight budget and cuts in training programs will push up the unemployment rate, and thereby increase the starting point deficit reported by Treasury.
A final assessment of the reality or otherwise of the $8 billion starting point deficit will have to wait until the end of the 1996-97 financial year. By then, of course, the 'black hole' will have served its political purpose, and the issue will be one of academic interest. This academic, at least, will still be taking an interest to see how it all turns out.
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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