Putting the budget forecast to the test

If the MYEFO falls in line with historic averages, its forecasting error will be around $10 billion. How these predictions play into reality, and the next election, will be anyone's guess.

The 2012-13 budget outcome will be nowhere near the $1.077 billion surplus that was forecast by the government last month when it released its Mid Year Economic and Fiscal Outlook.

History shows the multitude of moving parts in the estimates of government spending and revenue and the inevitable uncertainty about the performance of the economy. This simply means that there is always a difference between the MYEFO estimates for the budget bottom line and the final budget outcome that is delivered around nine months later.

Over the last 12 years, the average error in the budget balance between the MYEFO and the final budget outcome is 0.63 per cent of GDP. In 2012-13 dollar terms, that is an average error of around $10 billion.

If the error for 2012-13 from the MYEFO to the final budget outcome is the same as the average of the past 12 years, the government will deliver either a budget surplus of $11 billion or a deficit of $9 billion. This is the extent of the unknowns that influence government spending and revenue measures. It’s obviously a very wide range.

What if Treasury has a corker of a year with its forecasts and the error between MYEFO and the final outcome equals the smallest error of the past 12 years?

In this circumstance, there would be a 0.2 per cent of GDP variance from MYEFO which in 2012-13 dollar terms is an error a little over $3 billion. This suggests that the budget outcome, on a best estimate, will come in between a surplus around $4 billion and a deficit around $2 billion.

These facts might highlight some of the recent caution in the budget rhetoric from Prime Minister Julia Gillard, Treasurer Wayne Swan and Finance Minister Penny Wong when embracing the "commitment” or "intention” to deliver a surplus, rather than a promise.

Since the MYEFO was released in October, there has not been a huge amount of fresh economic news to suggest the size and more importantly the direction of the inevitable budget error in 2012-13. No one can be sure whether the surplus is at risk or not.

There has of course been some economic news. Commodity prices are a little higher than assumed in MYEFO with iron ore and coal prices above the early October lows. This is good news for mining tax revenue and other company tax receipts. In terms of the biggest item of government revenue, individual’s income tax, employment growth is probably a touch below what Treasury was forecasting, while the moderate growth in wages in the September quarter is broadly consistent with the MYEFO forecasts.

Of the other economic parameters, it is too early to have a strong view about which way the errors are unfolding, so it is simply too early to have a definitive view about the risks to the surplus.

In the next two weeks, there is a bucket full of economic news that will add a lot more substance to the budget outlook. The September quarter GDP data are released next week and there will be the next round of monthly news on employment, retail sales, building approvals, inflation and job advertisements, to name a few. The business investment outlook will be updated with the capital expenditure survey and business confidence and consumer sentiment indicators will also be published.

Importantly, the Reserve Bank board meets on 4 December. It is widely expected that the Reserve Bank will deliver a confidence and cash flow boosting interest rate cut, factors that at the margin for 2012-13 will help support tax revenue. The data flow on the global economy continues and policy developments in the US in relation to the fiscal cliff, in the eurozone in relation to Greek and other sovereign debt concerns and news from China will continue to unfold.

All of which means that by the middle of December, Treasury and the government will be able to have an internal reassessment and an update of the fiscal position. Helping out that process, the Department of Finance will have additional hard information on tax, other revenue and spending which will be put into the fiscal spreadsheet.

For those privy to the information, it will be fascinating to see what the results show. The government is obviously hoping to see a surplus. But even if they do, the results will only be a rough guide to the final budget outcome. There are just so many risks in the process of estimating each segment of tax and other revenue and each element of every government spending program.

The 2012-13 budget outcome will be known in September 2013. In all probability, it will be released as the election campaigning is hotting up. It will be a vital element in the debate about economic management.

Whatever the result, Australia can rest assured its fiscal house is in order. In a budget of around $365 billion in revenue and $365 billion in spending, the economic impact of a delivering a surplus of $1 billion or a deficit of $1 billion is largely irrelevant. Politically, it matters given the importance of economic management in every election outcome. Which is why the government will keep a firm hand on spending and is already hoping the revenue side gets a boost from some upside surprises to the economy.