Mid-year Fiscal and Economic Outlook - Australia - Case Study Example

Mid-year fiscal and economic outlook (MYEFO) case study Student: Institutional Affiliation: Date: Mid-year fiscal and economic outlook (MYEFO) case study Fiscal policy is the combination of government spending and taxation decisions aimed at influencing aggregate demand and growth in an economy [Bau15]. According to Hansen (2014), fiscal policies are heavily influenced by Keynesian economics theories. Keynesian economics advocate for extended government involvement in the economy through use of taxation and spending to control inflation and demand. This is a radical departure from the laissez faire advocated for total government non-interference in economic affairs. Government spends its money through such means as payment of wages, funding infrastructure projects, giving subsidies and unemployment benefits. Governments also rely on taxes to raise funds for running their national budgets (Kopcke et al., 2006). There are two types of fiscal policies: contractionary and expansionary. The choice of either type is influenced by prevailing economic conditions and to a large extent the political considerations of the government of the day [Ben14]. A contractionary fiscal policy is normally used by governments to slow economic growth and reduce liquidity in the domestic market [Bau15]. This is achieved by reducing government spending and increasing taxes for individuals and businesses. Contractionary fiscal policies reduce the level of inflation in an economy by reducing the circulation of money. Government constitutes the single largest consumer of goods and services ion most economies. If the government cuts its spending, there is a high likelihood that the circulation of money will reduce as well. This lowers inflation to acceptable levels. As argued by Kuester et al., (2012), imposing higher Taxes on businesses and individuals reduces their spending power and thus lowers aggregate demand for goods and services. This is an indirect form of contractionary fiscal policy. Its effect is a slower economic growth. During contractionary fiscal policies, the government budget may be in surplus or moving towards it [Bau15]. An expansionary fiscal policy is mostly favoured by a government when there is a need to spur economic growth, increase money circulations and aggregate demand. Increased demand for goods and services helps reduce unemployment in the economy [Bau15]. A government can implement an expansionary fiscal policy directly by increasing its spending on subsidies, wages, infrastructure, unemployment benefits and other social support initiatives. The government can also achieve its expansionary policy objectives by lowering taxes for individuals and businesses. This means that businesses and individuals have more money to spend thus increasing the aggregate demand and circulation of money in the economy. An expansionary fiscal policy usually forces a government to run a budget deficit as it spends more than it generates through revenue and other sources. This has been a major concern in countries such as Australia and UAE where huge budget deficits have lead to increased government borrowing (Botman et al., 2006). An expansionary fiscal policy may be used to remove a deflationary gap in an economy [Bau15]. A deflationary gap occurs when the equilibrium level of income is below the employment level of income. This results in a situation where the aggregate demand is less than a country’s total potential output. This means that there is reduced spending in the economy despite high output occasioned by full employment of the production factors. A deflationary gap indicates the extent of recession in the economy. In the diagram below, the economy is operating at equilibrium income level at $200 billion. This is below the potential income level of $350 billion. The deflationary gap is the deficiency of $150 billion in the aggregate expenditures marked by E1 and E2. If left unchecked, a huge deflationary gap may result in deep recession in an economy. A government may use fiscal policy tools to stimulate demand and consumption in the economy. Such tools include increased spending, reduction in taxes imposed on individuals and businesses. Monetary tools such as reduced interest rates may be used alongside expansionary fiscal policies to stimulate demand in an economy [Ben14]. According to the Mid-Year Economic and Fiscal Outlook 2015-2016, Australia had a budget deficit of $37.4b in the 2015-16 fiscal year. The MYEFO also projected a deficit of $33.7b in the 2016-17 fiscal year. The government has pushed its projections for returning the budget to surplus to 2020-21. This is one year later than the government’s previous projections. The government has, however, reiterated its commitment to returning the budget to surplus through fiscal and monetary policies. The government’s strategy is underpinned by the following three policy components: Government spending in quality investments to boost productivity and workforce participation; Control of government expenditure through strict fiscal discipline; Improving the government net financial worth over the long-term. The Australian government in 2015-16 committed $50 billion to infrastructure development through the Asset Recycling Initiative. This initiative involves the federal government partnering with states and territories to direct capital to finance productive infrastructure that will enhance overall growth of the economy. State governments are expected to privatise assets and reinvest the money in infrastructure development. By spending $50b in infrastructure development, the federal government is advancing an expansionary fiscal policy that aims at injecting money into the economy. This will enhance the aggregate demand in the economy given the fact that improved income by contractors and suppliers will lead to stronger ability to pay for goods and services. Moreover, infrastructure development will partly reduce the level of unemployment in the economy by having more people working directly and indirectly to facilitate the projects’ completion. This will also improve the aggregate demand in the economy, as households will have more disposable income to spend on goods and service [Ben14]. The Australian government is also committed $1.1 billion to National Innovation and Science Agenda. This initiative is aimed at supporting innovation and entrepreneurship in Australia by improving access to equity capital, removing restrictive tax barriers and revising insolvency laws that limit business’s ability to restructure during financial stress. The National Innovation and Science Agenda also includes a $200 million innovation fund to be finance operations in new spin-off companies and existing start-ups. Investing in science and technology projects that can be scaled into profitable businesses in the short-term will significantly boost economic growth by increasing demand and employment in Australia. The Australian government targets to reduce government payments to 25.3% as a share of GDP. In 2015, this ratio was at 25.9%. This will be in line with government’s efforts to maintain a strict fiscal disciple that will free up resources for private investment leading to creation of jobs and stimulation of growth in the economy. The government also aims at reducing its debt to 9.6% to GDP by 2025-26 from the 15% in 2015. Fiscal discipline will improve the government’s ability to control its expenditure thus eliminating the need to seek expensive funding and running a budget deficit. Compared to five other leading OECD economies, Australia had a fairly manageable budgetary deficit for fiscal year 2015-16. Australia’s deficit during the period was $37.4 billion (2.3% of the country’s GDP). The United States budget deficit in 2015 was at 2.5% of the GDP [Sah15]. Japan’s budgetary deficit stood at 6% of the GDP [Smi15]. UK’s budget deficit in 2015 was at 4.4% to GDP [All151]. France also posted a 3.5% deficit to its GDP. This is outside the 3% limit recommended by the European Union [Mel15]. Countries such as Luxembourg maintained a much healthier balance between receipts and expenditure. Luxembourg had a budget surplus of 1.2% of its GDP [Tra151]. While budgetary deficits may not be a positive indicator of the soundness of an economy, they are sometimes necessary to restore growth in the economy through increased government spending and tax cuts [Ben14]. For instance, the government in Japan has in the recent past had to increase its spending on stimulus programs aimed at restoring economic growth in a country where demand and consumption for goods and services has been critically low thus affecting the growth of the economy [Smi15]. Similarly, the Australian government has to balance between cutting its expenditure in crucial areas to reduce the deficit and spending in high value economic drivers. In the Mid-Year Economic and Fiscal Outlook 2015-2016, the Australian government attributes the budget deficit for the fiscal year to several that have impacted on its total receipts and expenses. The government expected total receipts to be revised downward by $33.8 billion over the four years to 2018-19. The fall in price of iron ore affected the income generated from taxes paid by mining companies. In 2015, the price of iron ore was revised downward from US $48 per tonne to US $39 per tonne. The demand for iron in china, the single largest producer of steel in the world, has fallen significantly in 2015. Such factors have affected the demand for iron ore from Australia. Thermal and metallurgical coal prices also fell by around 15% in 2015. The mining sector also recorded negative growth in employment in 2014-15. This contributed to weaker wages growth that resulted in downward revision of tax income expected from individuals. The Mid-Year Economic and Fiscal Outlook 2015-2016 document also cites weaker equity markets as major contributor of downward revision of capital gains tax revenue for the Australian government in 2015. Government inability to generate its target receipts from its tax sources automatically triggers an expansionary fiscal planning situation if the expenses outweigh the available funds [Bot06]. As part of Australia’s its effort to reduce the budget deficit, the Australian government intends to exercise increased fiscal discipline. This means the government will consider cutting payments to some projects and schemes. For instance, the government intends to cut contributions to the National Disability Insurance Scheme. If the payments to this scheme by states and territories is scrapped, the payments-to-GDP ratio will decline by 25% by 2018-19. The government also intends to reduce its payments significantly through a range of policy measures outlined in the MYEFO document. These include: Removing bulk-billing incentives for pathology and MRI services. This is estimated to save the government $639 million over four years to 2018-19; Restricting health workforce programs payments to save $595 million over ours years; Reviewing the aged care funding instrument to reduce unjustified cash payment amounting to $472 million over three years through to 2018-19; Changes to Child Care Subsidy for families will also cut cash payments over the four years to 2018-19 saving the government $441 million. The above mentioned changes are likely to impact heavily on the social support and health subsidy programs affected by the payments cut. The government will be able to reduce its budget deficit by the projected margins but will be subjected to political pressure from the affected segments of the population. The changes will also have a negative impact on the spending power of the affected people thus reducing their ability to consume goods and services. Overall, the changes may lower aggregate demand in the economy as families will allocate money to only necessary expenses. The political dilemma for the government highlights the difficulty in relying on fiscal policy to maintain economic stability particularly in developed economies. Moreover, such measures may face persistent legislation setbacks in federated states such as Australia [Imb04]. According to Australia’s Mid-Year Economic and Fiscal Outlook for 2016-17, the cash deficit reduced to $36.5 billion from $37.5 billion in 2015. This represents 2.1% of GDP compared with 2.3% to GDP in 2015. This is consistent with the government’s commitment to reducing the budget deficit and eventually returning it to surplus by 2010-21. However, Australia projected a GDP growth of 2% compared to 2.7% in 2015-16. Unemployment rate in 2016-17 fell to 5.5% from 5.7% in 2015-16. The consumer price index rose to 1.3% through the year compared to 1.0% in 2015. From these economic indicators, it is clear that though the government has remained true to its promise of improving the economy, there has not been a significant change from the situation in 2015. However, it is important to note that spending changes made by the government in 2015-16 have reduced its total payments substantially. According to the MYEFO 2016-17, the government payment reduced from 25.8 per cent of GDP to 25.2 per cent of GDP in 2016-17. Since the 2016 PEFO, estimated cash payments by the government have decreased by $4 billion. Costs related to government payment such as Child Care support are expected to decrease by $724 million in 2016-17. Evidently, strict fiscal discipline has been effective at reducing the budget deficit in 2016-17. However, the net debt for the government has increased and is now 18.1% of GDP compared to 16.9% in 2015-16. This means that the government has certainly had to borrow more to finance its payments. In fact, the government has halted the asset recycling infrastructure development program to save $10 billion 2020. Improvement in tax receipts and revenues also contributed significantly to reducing the budget deficit in 2016-17. For instance, the price of iron ore increased to $65 per tonne compared to $39 in 2015. This has improved tax revenue from corporate sources. Reduction in unemployment may have also increased the individual tax revenue that the government collected in 2016-17. Governments all over the world use fiscal policies to stabilise their domestic economies. Most of the time, fiscal policies are often combined with complementary monetary policies to achieve a greater impact within the shortest time possible [Imb04]. According to Kuester et al., (2012), fiscal policies have their merits as well as demerits as far as their impact in the economy and society at large is concerned. However, through careful consideration and monitoring, it is possible to achieve the intended economic goals with either an expansionary or a contractionary fiscal policy. One of the main strengths of using fiscal policy to stabilise the economy is the fact that government spending can be directed to particular projects or initiatives (Botman et al., 2006). This gives the government an opportunity to invest in initiatives that will have a significant short-term or long-term impact on the economy. For instance, increased spending on infrastructure as part of an expansionary fiscal policy is likely to improve the economic growth in a country over the long-term. However, Kopcke et al., (2006) caution that it is important to align the spending with the long-term goals and economic projections of a country. It is also common for government to spend in welfare initiatives such as healthcare insurance, disability and childcare support. Such initiatives usually have the public’s support as they impact directly on them [Imb04]. Fiscal policies may also be used a tool to lower unemployment by reducing corporate tax, spending more on labour intensive projects and offering unemployment support. This enhances the aggregate demand and consumption in the economy as people have improved income to spend on goods and services. In the long-run, the government will benefit from increased tax revenue from a robust economy (Beetsma et al., 2007). The use of fiscal policy to stabilise the economy is subject to political influence due to the direct effects of the adopted policies [Imb04]. For instance, a government may opt for increased taxes to fund an expansionary fiscal policy. This will likely cause the government to lose support among the working population. Similarly, withdrawal of spending in some programs such as healthcare and aged care may face stiff political opposition. Such political challenges make it difficult to rely entirely on fiscal policies as economy stabilisers. Botman et al., (2006) also note that fiscal policies may as well achieve undesirable economic consequences. For example, increased spending on infrastructure and other economic stimulus programs may increase the national debt owed by a government. This has been a major issue for countries such as USA, Australia and the UK. Unsustainable national debt may plunge a country into an economic crisis if it is unable to access funding in future due to poor credit ratings (Kuester et al., 2012). From a different perspective, increased government spending may out-crowd private sector investments thus limiting the long-term economic growth potential. The effectiveness of Fiscal policies is also dependent on accurate forecasting to determine the choice of adjustments to me made [Flo09]. Accurate forecasting of economic situations is becoming increasingly difficult particularly due to the interconnected nature of the global economy. The recent Eurozone crisis and slow economic growth in China have proved that challenges in one region may have far-reaching effects in the rest of the world as noted by MYEFO 2015-16. Fiscal policies may also face administrative challenges particularly if decisions require legislative approvals. This causes a lag in implementation resulting in fiscal policies that fail to achieve their intended goals within the expected time. However, despite such challenges, governments cannot eliminate the use of fiscal policy in economic stabilisation due to its aforementioned strengths. References Bau15: , (Baumol & Blinder, 2015), Ben14: , (Hansen, 2014), Sah15: , (Sahadi, 2015), Smi15: , (Smith, 2015), All151: , (Allen, 2015), Mel15: , (Melander & Guernigou, 2015), Tra151: , (Trading Economics, 2015), Bot06: , (Botman, Muir, Romanov, & Laxton, 2006), Imb04: , (Imbeau & Petry, 2004), Flo09: , (Flores, Leigh, & Clements, 2009), Read More