The Budget is heading in the right direction

Business Council's James Baulderstone's speaking notes from the panel session at the CFO Forum event 'Budget Considerations: Outcomes and Priorities from the 2016 Federal Budget' in Sydney on 17 May 2016. 

Check against delivery. 

There were two core tasks for this year’s budget:

  • First, to stay on course to achieve a credible structural surplus
  • Second, to equip the economy with the means for faster economic growth to support jobs and prosperity.

On these two measures the budget headed in the right direction.

It laid down a solid framework for future fiscal consolidation.  It was not a big spending and big taxing budget (the last thing we needed in the current economic climate), recognising the imperative to live within our means.  

  • Tax measures haven’t underwritten extra spending. Revenues from tightening of super concessions and tax integrity measures have been reinvested into fixing the tax system by giving tax relief to families who are going to be hit by bracket creep first and by reducing business taxes.
  • The budget held the line on spending growth at the same time as committing to some sensible and fair investments in health and education.
  • Importantly it began the redesign of these programs – as well as an innovative youth employment program - to achieve better outcomes.
  • But make no mistake, there is still a lot of work to be done to contain spending growth and to reduce a reliance on higher revenues to reduce the deficit which persists at around 2% of GDP next year. The realisation of a small surplus in 2020-21 will depend on stronger economic growth along with considerable spending restraint beyond the forward estimates.

Importantly, the budget showed that the government understands the growth challenge and that we have to grow the economic pie to continue to deliver the services people want.  Ultimately the only way of providing opportunity, jobs and higher living standards for all Australians is a strong economy.

This will require getting our businesses investing and our people working.

  • The budget made a very substantial investment in infrastructure, which is crucial for improving the capabilities of businesses, our productivity and our living standards.
  • The enterprise tax package in particular will make a solid contribution to improving the investment environment for enterprises - which contribute 80% of the economy and 88% of all jobs. This will be vital for entrepreneurship and jobs.

Lower business taxes will significantly increase economic prosperity and living standards

The proposed cuts in business taxes over the next 10 years to 25 per cent will significantly boost output, real wages and job opportunities as well as increase government revenues over time. In short, lower business taxes will permanently increase the size of the economic pie.

Recently-released Treasury modelling estimates a 1 percentage point increase in GDP once the full tax cuts flow through to investment. In today’s dollars, this translates to an additional $16 billion in economic activity and about $4 billion additional government revenue.

This additional revenue can be used to fund spending, tax cuts or to reduce the deficit. Real wages increase by 1.2 per cent (or the equivalent of $8.5 billion or the equivalent of more than 100,000 full-time jobs paying average wages).

The benefits of tax cuts start early and will build over the medium term 

The benefits of cutting business taxes will build over time as the tax rate is further reduced and lower rates are extended to more and more businesses and investments. In particular, businesses will bring forward investments ahead of actual tax cuts if they are confident that the lower rates will apply once investments come on stream. Credible future tax cuts will bring forward the economic benefits for the whole community.

Analysis by KMPG and others (including UK Treasury) indicates that gains accrue reasonably quickly.  We could see around half of the full uplift in GDP being captured by the end of the 10-year plan, with further gains over the following few years. Importantly, this means that we will not have to wait 15-20 years to see a significant economic pay-off.

The benefits are permanent and add up over time

The increase in GDP, income and revenue is permanent. That is, once the full benefits flow through, year in year out, GDP will be 1 per cent higher and real wages will be 1.2% higher than otherwise. Commonwealth revenues will be higher and payments lower because of lower transfer payments. 

Benefits that accrue in each and every year add up. For example, over a decade 1% higher GDP adds up to an additional $160 billion (in today’s terms).   

Australian workers gain the most

Lower business taxes primarily benefit Australian workers. This is because additional capital investment makes labour more productive and thus more valuable enabling real wages to increase.  Higher labour productivity is the main driver of higher real wages.

While raising skill levels is also an important ingredient of labour productivity, higher skills and capital investment go hand in hand.  There is not much point having higher skills without the capital equipment and new technology to work with.  New investment also usually brings new technology which increases innovation and productivity.  Business expansion also increases job opportunities.

Small, medium and large businesses alike will respond to company tax cuts by expanding their businesses including investing in a new machine, improved  technology and equipment (such as IT systems), new or expanded production facilities (such as a manufacturing plant)  and new projects such as mines. 

There will be significant additional productivity benefits not captured in the modelling 

New investment and new technology and innovation typically go hand in hand.  New technology will bring additional productivity benefits that will increase GDP and real wages.  Unfortunately the models cannot capture these important benefits, but the OECD believes this effect is significant and provides yet another reason why competitive business taxes are crucial for stronger growth.