Commodity Price Booms and Fiscal Policy Options in Australia

From Australia: 2008 Article IV Consultation - Staff Report;

Fiscal policy, focused on medium-term sustainability, delivered a sequence of surpluses that eliminated Commonwealth net debt. This leaves Australia with an enviable fiscal position by international standards. The new Labor government aims to maintain a conservative fiscal strategy by focusing on three objectives:
• achieving budget surpluses, on average, over the medium term;
• keeping tax as a share of GDP, on average, below the 2007/08 level (currently estimated at 24.7 percent); and
• improving the government’s net financial worth over the medium term.

In the near term, the authorities stressed that the latest budget places priority on helping to fight inflation and reprioritizing spending to build capacity. The 2008/09 budget slows the pace of growth of Commonwealth government expenditure and forecasts an increase in the underlying cash surplus to 1.8 percent of GDP. This stance is slightly contractionary, with the staff’s estimate of the structural balance increasing by ¼ percent of GDP, broadly in line with the change in the underlying cash surplus (Figure 11). The budget saves about half of the revenue surprise from the jump in the terms of trade and higher nominal GDP.5 The remainder of the revenue surprise helps fund personal income tax cuts targeted at lower income earners. Some other tax increases and expenditure cuts finance new initiatives for health, education, climate change, and housing. Beyond 2008/09, spending is projected to pick up and the underlying cash surplus is expected to fall slightly over the next four years.

The surpluses for 2007/08 and 2008/09 will be saved in three new funds for infrastructure, health, and education to finance capital spending. About 3 percent of GDP will be contributed to the funds, depending on the final budget outcomes and spending from the funds is included in the budget. The funds are a means to constrain spending revenue from the commodity boom in the near term, by saving for infrastructure spending over the medium to long term.

The staff advised that further fiscal restraint may be needed. The staff encouraged the authorities to identify areas where additional spending cuts can be implemented and to save any positive revenue surprises to assist monetary policy, until it is clear that inflation will decline. Given the uncertainty about how much of the increase in commodity prices will be permanent, saving the additional revenue in the near term may avoid sharp changes in taxes and spending in the future. Moreover, state governments are expected to run deficits and increase infrastructure spending, offsetting restraint at the Commonwealth level.

The authorities stated that if inflation pressures persist they would take the necessary action to support monetary policy. They noted that the next budget would offer another chance to constrain spending and direct it toward areas that are more productive, such as education, health, and infrastructure. They also emphasized that they are committed
to saving any further positive revenue surprises in 2008/09. If there is a positive revenue surprise in the 2009/2010 Budget and inflation remains high, the authorities indicated that they would maintain tight controls on spending.

To the extent that the improvement in the budget balance is structural, associated with permanently higher commodity prices, there should be scope to reduce taxes or increase spending over the medium term. Staff analysis suggests that a combination of lower labor and capital income taxes, along with increased public investment, will generate the largest economic gains.6 The gains from other options such as lower consumption taxes or higher public consumption are not as large. Despite the expected structural improvement in the medium term, significant long-term fiscal challenges remain, particularly in the area of healthcare spending, and early adjustments will be key to preserving fiscal sustainability.

The authorities noted that there would be scope to reform taxation and increase spending in priority areas, if the recent gains in commodity export prices prove to be permanent. The budget projections assume some easing in commodity prices over the medium term from the record levels forecast for 2008/09. Nevertheless, in recent years the authorities have been surprised by revenue on the upside, and commodity prices may not ease as expected. The authorities made it clear that any changes in taxes and spending would be consistent with the new government’s medium-term fiscal objectives, thereby further strengthening the fiscal position.