The sleight of hand in the Gillard/Swan budget

It's a surplus only in a technical sense. A lot of the announced "goodies" come out of this year's budget, not out of the budget just announced. And the big NBN expenditure is left out!

Swan has had to move a lot of things around between years to make it possible to keep the Prime Minister, Julia Gillard's, election promise to get the budget back to surplus in 2012-13. When he's taken spending and pulled it forward into the last few weeks of the old financial year, that's not genuine for our purposes. For the government's accountants, whether something happens on June 30 or on July 1 makes all the difference in the world. You've got to draw the line somewhere, and that's where we draw it.

From the perspective of the budget's effect on the economy, however, a difference of a few days or a few weeks is a difference that doesn't make any difference.

And it turns out a big part of the $46 billion turnaround is explained by Swan's decision to draw spending forward into the last few weeks of the old year. There's compensation for the carbon tax (which doesn't start until July 1) of $2.7 billion, advance payment of natural disaster relief funds to Queensland of $2.3 billion, a bring-forward of infrastructure spending of $1.4 billion, the new "schoolkids bonus" cash splash of $1.3 billion, and financial assistance grants to local government of $1.1 billion.

That long list adds up to $8.8 billion. But here's the trick: when you take money out of one year and put it into the year before, you have twice the effect on the difference between the two years. So Swan's bring-forward of that spending explains $17.6 billion of the $46 billion turnaround.

Another thing to take account of is that the new year's budget is expected to benefit from increased revenue from resource rent taxes of $5.7 billion (that's from the existing petroleum rent tax as well as the new minerals rent tax). The point is that these taxes are explicitly designed to tax "economic rent", so they have no effect on the incentive to exploit petroleum or mineral deposits and thus have no effect on economic activity. A further factor is that, thanks to a quirk of public accounting, Swan's underlying cash surplus of $1.5 billion takes no account of the government's spending on the continuing rollout of the national broadband network.

The budget item "net cash flows from investment in financial assets for policy purposes" is expected to involve increased spending of about $6 billion in 2012-13. Not all of that would be the broadband network rollout. But to the extent it involves the government funding economic activity, it has the effect of reducing the budget's adverse effect on economic activity.

Put these three arguments together and you conclude the budget's drag on demand would be less than half the 3 percentage points of GDP we started with.

Even so, it's still a big effect. There's no denying the stance of fiscal policy is contractionary.

But the budget is only one of the factors affecting aggregate demand. It's also only one of the instruments available to the macro-economic managers to influence demand.

So if fiscal policy proves to be too tight, the obvious remedy will be to further loosen monetary policy - to cut the official interest rate, in plain English. The stance of monetary policy is already mildly expansionary and, if necessary, it can be made more so.


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