Joe Hockey faces $60bn budget hole

Savings of more than $60 billion a year will have to be found by 2023-24 for the Abbott ­government to reach its surplus target, according to the Commission of Audit, which presented a bleaker outlook for tax revenue than was contained in the midyear budget update.

The commission’s pessimism is understood to be based both on a further downgrade in tax revenue growth and on its belief that it is not realistic to assume there will not be any personal income tax cuts over the next 10 years.

The size of the savings task is equivalent to total federal spending on education or defence and will demand the axing of complete government functions and reductions in spending on pensions and allowances. Tony Abbott and Joe Hockey have been stepping up their ­rhetoric on the budget shortfall over the past week, the Treasurer emphasising a blowout in 2017-18 as a result of new programs such as the National Disability Insu­rance Scheme and the Prime Minister telling his backbenchers they must be prepared to sell a tough budget message.

A briefing note distributed by Mr Hockey’s office at the weekend contained long-term projections showing that revenue would rise from this year’s 22.9 per cent of GDP to 26 per cent by 2023-24, mostly as a ­result of inflation pushing an ­increasing share of people’s ­incomes into higher tax brackets, known as bracket creep. The note, which reflected the presentation Mr Hockey made to state treasurers on Friday, was based on figures in the midyear budget update released in December.

It showed that, even with strong revenue growth, the budget would still have a deficit of 0.5 per cent of GDP by 2023-24 which, with the economy ­expected to reach $2.5 trillion by that time, would be equivalent  to ­$12.5bn.

The first of the commission’s two reports, which was handed to Mr Hockey on February 14, contains a “base case” for the budget outlook, which assumes revenue reaches no more than 25 per cent of GDP by 2023-24, a full percentage point lower than Mr Hockey’s projection.

The new revenue shortfall would increase the deficit in that year to more than $35bn. Achieving a surplus equivalent to 1 per cent of GDP in that year, as required under the commission’s terms of reference, raises the total savings needed above $60bn.

The Treasurer’s briefing note highlighted the extent to which the budget forecasts depended on “bracket creep”, saying the effect of inflation would be to push the average rate of tax for someone on the average wage up from 23 per cent to 28 per cent.

The second top marginal tax rate of 37 per cent would apply to people earning considerably less than the ­average wage.

“If tax cuts were provided in order to return fiscal drag, and prevent the tax-to-GDP ratio reaching historically high levels, the savings task would be even larger,” it said.

The Commission of Audit does not believe it is realistic to assume there would not be any tax cuts over the next 10 years. The political cost of imposing such a burden on lower-income households would be too great, while it would also lead to lower workforce participation. Its projections reduce the government’s revenue by an allowance for tax cuts, based on the historic trend. The report also contains a further markdown in the underlying trend for revenue growth.

Stephen Anthony, director of consultancy Macroeconomics, said yesterday the budget in the this financial year was broadly in line with the mid-year budget update, which had severely marked down the revenue projections in Treasury’s pre-election budget analysis.

“Our assessment is that the budget position has not worsened significantly in the current year, and, looking forward, things are about at the level in the mid-year budget update,” Dr Anthony said.

He said a revenue downgrade by the Commission of Audit may either reflect a more pessimistic view about Australia’s terms of trade (export prices compared with import prices) or new Treasury estimates of the losses outstanding from the global financial crisis, which have been depressing company and capital gains tax revenue.

Dr Anthony said Treasury was already taking a more conservative approach to the terms of trade than was the case in last year’s budget but iit was possible there were further downgrades.

Difficulty in estimating tax losses from the crisis has been one of the main reasons for Treasury’s difficulty in estimating company tax revenue over the past six years.

Dr Anthony said losses were normally equivalent to 8 per cent of GDP, but the latest available estimates from the tax office, which are for 2010-11, show they had reached 25 per cent of GDP.

There are other sources of potential revenue weakness. GST flows directly through to the state governments, but is still registered on the commonwealth’s revenue. It has been depressed both because of much higher savings rates among consumers, and because people are spending more on services like health, education and financial services, which are GST-free.

Mr Hockey’s office declined to comment on the Commission of Audit’s findings yesterday, with the report expected to be released publicly about three weeks before the May budget.