Australia s Budget Federal Budget 2016/17

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1 Economic Insights Economics May Australia s Budget Federal Budget 2016/17 Craig James Chief Economist (Author) Savanth Sebastian Economist (Author) Produced by Commonwealth Research based on information available at the time of publishing. We believe that the information in this report is correct and any opinions, conclusions or recommendations are reasonably held or made as at the time of its compilation, but no warranty is made as to accuracy, reliability or completeness. To the extent permitted by law, neither Commonwealth Bank of Australia ABN nor any of its subsidiaries accept liability to any person for loss or damage arising from the use of this report. The report has been prepared without taking account of the objectives, financial situation or needs of any particular individual. For this reason, any individual should, before acting on the information in this report, consider the appropriateness of the information, having regard to the individual s objectives, financial situation and needs and, if necessary, seek appropriate professional advice. In the case of certain securities Commonwealth Bank of Australia is or may be the only market maker. This report is approved and distributed in Australia by Commonwealth Securities Limited ABN a wholly owned but not guaranteed subsidiary of Commonwealth Bank of Australia. This report is approved and distributed in the UK by Commonwealth Bank of Australia incorporated in Australia with limited liability. Registered in England No. BR250 and regulated in the UK by the Financial Conduct Authority (FCA). This report does not purport to be a complete statement or summary. For the purpose of the FCA rules, this report and related services are not intended for private customers and are not available to them. Commonwealth Bank of Australia and its subsidiaries have effected or may effect transactions for their own account in any investments or related investments referred to in this report.

2 Federal Budget 2016/17: An economic plan focussed on jobs & growth Making Sense of it The Federal Budget is hardly the most riveting document you are ever likely to read. Sure you know it s important, but the problem is that it s a huge document with countless facts, figures and tables. And when it comes to analysis, economists seem to be writing for other economists; and accountants writing for other accountants. It s always important to remember that it is just a budget, the same that any household or company would prepare. Assumptions are made; forecasts are taken; and events can change. When the 2015/16 budget was first conceived in May 2012, a surplus of $7.5 billion was projected. Today, a deficit of $39.9 billion is tipped for the current year ending in June. And then there is the small matter of politics. The Government outlines the measures that it believes are important for the short and medium-term health of the economy. But given the absence of a majority in the Senate this means that it may need to seek agreement with other parties for the measures to become law. And this Budget is not your typical budget it is a pre-election budget so it is different again. At the end of the day most people want to know whether it s a good budget and what s in it for them. It doesn t matter whether you are a student, pensioner or CEO of a major company. So this analysis is different. Sure, there are the usual tables, graphs, facts and figures. But we reckon that there are only two questions most people want answered and that s where we will be concentrating: Did the Government get it right? Who are the winners and losers? 1. The Analysis 2. Taxing & spending 3. The Economy 4. Global backdrop 5. Future fund and GST 6. Selected Charts 7. Impact - Rates, $A, Shares Pages 3-4 Pages 5-7 Page 8 Page 9 Page 10 Page 11 Page 12 May

3 1. The Analysis Did the Government get it right? The short answer is yes. Could it have done more? Sure, but that is always the case. But the economic plan approach taken in the Budget is a positive step. To determine whether it got it right, you need to consider the landscape. Governments across the globe are struggling to lift economic growth. Australia is doing well with annual growth at 3 per cent, but the difficult transition from mining to housing is still occurring. Inflation is low. Ratings agencies are carefully watching our progress on reducing deficits and debts. Then there is the longer-term imperative of the ageing of the workforce and the challenge that this confers in higher spending and lower revenue. And then there is the small matter of an upcoming election. Budgets are economic as well as political documents. We are realists we know that governments have to weigh up good economics with good politics. Each budget has it s catch-cry or theme. In 2014 it was all about Budget emergency and End of the age of entitlement. In 2015 the catch-phrase was more positive with the budget seeking to help Australians to have a go. This year the theme is jobs and growth which is entirely approporiate. The government is focused on measures that will support both economic growth and employment, and thus provide assistance to the Reserve Bank which has shouldered the heavy lifting role with monetary policy. So the government has elected to spend more on infrastructure. Taxes have been cut to small and medium-sized enterprises (SME) ( the hope of the team ). The definition of small business has been widened. The assets writeoff for SME has been extended. And the government has lifted the 38 per cent income tax threshhold from $80,000 to $87,000. The proposed infrastructure projects are spread across Australia and support a raft of individuals and industries. So the spending like that on schools in the global financial crisis has potential to lift a lot of boats at once. As the Treasurer says, SME are the lifeblood of the economy. Over 97 per cent of SME employ fewer than 20 people so the sector is crucial for job creation. And the measures to address bracket creep will affect over 2.5 million workers and prevent almost 500,000 people from moving into the second highest tax bracket each year. The measure is important in efforts to keep people in the workforce and encourage more people to find jobs. The tax change complements the other measures designed to attract and retain more women in paid work. In many ways the budget is a transitional document. An election has to be held this year if not July, later in the year and the incoming Government has to secure agreement from Parliament on a new tax structure. Hopefully the Senate voting reforms can result in structure more amenable on making decisions for the good of all Australians. The aim of the economic plan to address short and longer-term challenges. It is important that there are additional measures to sustain economic momentum, confidence and employment. The longer-term goal of the Government is the same as it has been for some time pushing ahead with the PPP policy to combat the challenges of an ageing population. PPP is increased labour market participation, increased productivity, and increased population growth. It is an under-stated policy, but has characterised budget policy for a decade. May

4 Changes to prevent more people moving into higher tax brackets ( bracket creep ) work to attract and retain people in the workforce. Measures focussed on improving infrastructure especially in cities are also seen as employment friendly. Who are the winners? (source: Budget Papers, AAP) Businesses: Company tax cut to 27.5 per cent for all small companies with annual turnover of up to $10 million from July 1, Over next decade lower tax rate extended to all companies and then progressively reduced for all to 25 per cent by July 1, Small business tax concessions extended including depreciation pooling provisions, simplified trading stock rules and pay as you go instalment payments options. Australian Taxation Office - Gets $679 million for a new task force to ensure multinationals, private companies and the super-rich pay the right amount of tax. Wage earners and families: Those earning more than $80,000 get a modest tax cut, through increasing second-highest tax bracket threshold of 32.5 per cent from $80,000 to $87,000. Prevents 500,000 taxpayers being pushed into the 37 per cent tax bracket. Working mums, low-income earners. Partners encouraged to top up low-income spouses' superannuation through extended eligibility to claim tax offset for contributions; allowing women and carers whose work has been interrupted to make catch-up super contributions. Young job seekers: Interns to get $200 a fortnight and their host employer to get $1000 per placement. Skills program to help young people under 25 get into the workforce. Wage subsidy gives employers $6,500 and $10,000 for taking on young job seekers. City Dwellers: $50 billion infrastructure spend on roads and rail, including Sydney and Melbourne metros and inland rail. Rural sector $2 billion water program to invest in new dams and pipelines across Australia. Teachers and students Additional $1.2 billion between for schools contingent on better education outcomes. Health $2.9 billion more for public hospital services plus new money for essential dental services for children and low income adults. Military 20-year defence plan, new high-tech jobs including 3,600 jobs in naval ship building. Who are the losers? (Source: Budget Papers, AAP) High end superannuation users and high income earners New $1.6 million cap on amount of super that can be transferred tax-free into retirement phase; 30 per cent tax on concessional super contributions extended to those earning over $250,000; annual concessional contribution caps cut to $25,000 for all; lifetime cap on $500,000 on all non-concessional contributions. Anyone earning less than $80,000: No tax cut for anyone earning less than $80,000. Multinational Corporations: New ATO taskforce to crackdown on tax avoidance and raise $3.7 billion by Smokers: Four annual 12.5 per cent increases in tobacco excise to lift price of packet of cigarettes to about $40 by Buying goods online: 10 per cent GST levy on low-value goods imported by consumers. Welfare recipients: Tightening of welfare safety net to get those at risk of long-term dependency into employment. May

5 2. Taxing & Spending Jobs and growth Small Business What is included in the budget? (Quotes taken largely in full from Budget papers) From 1 July this year, the small business tax rate will be lowered to 27.5 per cent and the turnover threshold for small businesses able to access it will be increased from $2 million to $10 million. This means businesses with a turnover of less than $10 million will also be able to access other tax incentives, including the small business depreciation pooling provisions, simplified trading stock rules, and Pay-As-You-Go Instalments payments option. This will mean 870,000 businesses, employing 3.4 million Australians, will have their tax rate reduced, including a 2.5 percentage point cut in the tax rate for up to 60,000 businesses with a turnover between $2 million and $10 million, employing around 1.5 million Australians. Increase the unincorporated small business tax discount to 8 per cent and extend the threshold from a turnover of $2 million to less than $5 million. Jobs and growth Infrastructure Roll out our $50 billion national infrastructure plan to support economic growth including $857 million for the Melbourne Metro rail project, $1.7 billion for the Sydney metro project and a new infrastructure body to encourage private sector infrastructure investment. Providing $594 million in additional equity to the Australian Rail Track Corporation for land acquisition and the continuation of pre-construction works and due diligence activities. The Government will also establish a $2 billion Water Infrastructure Loan Facility which will catalyse new investment in dams and pipelines across Australia, building on the existing National Water Infrastructure Development Fund and the Northern Australia Infrastructure Facility. The Government has finalised or committed to agreements with four states and territories under the Government's Asset Recycling Initiative, worth $3.3 billion, which will catalyse $23 billion in additional infrastructure investment in projects including the Sydney and Melbourne Metro projects, light rail in Parramatta, regional road and rail freight corridors across NSW and Victoria, and flood mitigation works in the Northern Territory. Increase the upper limit for the middle income tax bracket From 1 July this year, an increase in the upper limit for the middle income tax bracket from $80,000 to $87,000 per year. Those earning average wages full-time or otherwise should stay in the middle income tax bracket. This will stop around 500,000 taxpayers from facing the 37 per cent second top marginal tax rate in each and every year. No removal or limit on negative gearing. Those earning less than $80,000 a year in taxable income make up two thirds of those who use negative gearing. May

6 Healthcare Providing additional funding to the State and Territory Governments for public hospitals by retaining key features of Activity Based Funding, including the National Efficient Price, which is expected to increase payments by up to $2.9 billion over the three years to Growth in the Government s contribution will be capped at 6.5 per cent a year over this period. Schools Funding support for government and non-government schools for the 2018 to 2020 school years, which is expected to increase payments by $928 million over the three years to Total school funding will be indexed by an education sector specific index of 3.56 per cent, with an allowance for changes in enrolments. Multinational & tax Establishing a new Tax Avoidance Taskforce as part of the ten year enterprise tax plan, which is expected to increase cash payments by $49 million in and $679 million over the four years to This measure will enhance the Australian Taxation Office s audit and compliance activities targeting multinationals, large corporations and high wealth individuals. These changes are expected to increase receipts by $2.2 billion over the forward estimates period. Defence Continuing Australia s military contribution to the international effort to disrupt and degrade Daesh (or ISIL) in Iraq and Syria, which is expected to increase payments by $345 million in and $373 million over the three years to Higher education and Youth Delaying the implementation of the higher education reforms announced in the Budget and the MYEFO by an additional year to undertake further consultation, which is expected to increase payments by $327 million in and $573 million over five years to Improving youth employment outcomes through the establishment of a Youth Jobs PaTH program for young job seekers aged under 25 years, which is expected to increase payments by $12 million in and $249 million over the five years to Superannuation tax concessions Reduction in access to superannuation tax concessions for the most wealthy effective from July Introducing a transfer balance cap of $1.6 million on amounts moving into the tax-free retirement phase, with balances able to increase above this cap, on account of tax free earnings, once transferred; extending the 30 per cent tax on concessional contributions to those earning over $250,000; reducing the annual cap on concessional superannuation contributions to $25,000; and from tonight, establishing a lifetime nonconcessional contributions cap of $500,000. A balance of $1.6 million can support an income stream in retirement around four times the level of the single Age Pension. The transfer balance cap will be applied to both current retirees and to individuals yet to enter their retirement phase. The transfer balance cap, lifetime non-concessional cap and the 30 per cent contributions tax for those on high incomes will each affect less than one per cent of superannuation fund members. A concessional contributions cap of $25,000 per annum will affect just three per cent of superannuation fund members, particularly those who pay the top rate of income tax. Commensurate measures will also be applied to high income earners with defined benefit arrangements, including current and former politicians and public servants. Identified Savings All new spending measures have been offset by savings in payments, not by policy increases to tax revenue. The overall impact of new policy decisions on payments in this Budget is an improvement to the bottom line of $2.4 billion over the five years to , with all increases in expenditure offset by savings in payments. Since the MYEFO, total payments for have decreased by $233 million. May

7 Outcome, Payments & Revenues 2. Taxing & Spending BUDGET BOTTOM LINE 2014/ /16e 2016/17f 2017/18f 2018/19f 2019/20f Underlying Cash Balance - $B % of GDP -$ $ $ $ $ $ Net Debt - $B % of GDP -$ $ $ $ $ $ Source: Budget Papers. May

8 3. The Economy Economic Assumptions Last year 2014/15 This year 2015/16 Economic growth (% change) Inflation (% change to June quarter) Wages (% change, year to June quarter) Unemployment (%, June quarter) Source: Budget papers, CommSec Next year 2016/ And 2017/ Are the economic assumptions reasonable? Last year we thought Federal Treasury s economic forecasts were reasonable, if not rather conservative. That conservatism worked for Treasury in 2014/15. On current figuring it looks like the economy has done better than the Government expected this year. But Treasury is persisting with conservative forecasts for the next few years which makes the projected deficit outcomes more achievable. The economy was projected to grow by around 2.75 per cent this year (2015/16) with wages and prices around 2.50 per cent and unemployment at 6.5 per cent in the June quarter Inflation and wages are much lower and the jobless rate is also lower. In 2016/17, the economy is expected to continue to grow around 2.50 per cent. Inflation is tipped to lift from low levels and further modest improvement is expected in the job market. The Reserve Bank currently expects economic growth of 2-3 per cent in 2015/16, 2-3 per cent in 2016 and between per cent in 2016/17. Underlying inflation is expected to be between 2-3 per cent through to June The CBA Group expects a budget deficit of $33 billion in 2016/17 (Bloomberg survey average $35 billion; range $ billion). Economic growth is tipped at 2.6 per cent in 2016/17 after 2.8 per cent in 2015/16. One forecast worth focussing on is the estimate of nominal GDP the assumption that is important for projected tax receipts. Over the past five years nominal GDP has grown on average by around 4.4 per cent a year after growing 6.1 per cent on average over both the last 15 and 20 years. In 2014/15 nominal GDP grew by just 1.6 per cent the slowest growth in 53 years highlighting the challenging conditions for the budget. In 2016/17, Federal Treasury expects nominal GDP to grow by 4.25 per cent and then grow by 5.0 per cent in 2017/18. May

9 4. Global backdrop Disappointing growth of the global economy In April 2016, the International Monetary Fund (IMF) forecast the global economy to expand by 3.2 per cent in 2016, after growing by 3.1 per cent in 2015 and by 3.4 per cent in Growth of 3.2 per cent is below the average growth rate of 3.5 per cent recorded over the past 35 years. In 2017, the IMF tips growth of 3.5 per cent before lifting 3.6 per cent in 2018, 3.7 per cent in 2019, 3.8 per cent in 2020 and almost 3.9 per cent in The modest growth of the global economy in the past five years (3.3 per cent average growth since 2012) has to be viewed as disappointing. This is especially the case when viewed against the context of expansionary monetary and fiscal policies, particularly the former. China is tipped to grow by 6.5 per cent in 2016 and 6.2 per cent in 2017 after 6.9 per cent growth in The Euro area is expected to exhibit stable growth, with GDP tipped to lift by 1.5 per cent in 2016 and by 1.6 per cent in 2017 after 1.6 per cent growth in Similar stability is expected in the US. The IMF tips growth of 2.4 per cent in 2016 and 2.5 per cent in 2017 after expanding 2.4 per cent in The Federal Reserve started lifting interest rates in December 2015 but has intimated that it will take its time with further rate hikes over Economists tip two rate hikes at most in 2016 but certainly the timing and frequency of rate changes will have key implications for financial markets. Federal Treasury influences the IMF and OECD forecasts for Australia. But looking at The Economist April 2016 poll of forecasters, the Australian economy is tipped to grow by 2.5 per cent in 2016 and 2.9 per cent in If realised, Australian economic growth will be close to the fastest of major developed economies in May

10 Government investments 5. Nation building funds and GST The value of all the nation building funds currently stands at $ billion, up from $127.7 billion a year ago. The Future Fund was set up to provide for the unfunded superannuation liabilities of Commonwealth public servants. As at March , the Future Fund stood at $ billion, up $418 million over the past year or 0.4 per cent. The Building Australia Fund was set aside for the creation or Medical Research $3.13 development of transport, communications, energy, and water DisabilityCare $5.18 infrastructure and in relation to eligible national broadband matters. As at March , the Building Australia Fund stood Source: futurefund at $3.672 billion, up from $3.59 billion over the year. The Education Investment Fund was set aside to make payments for education infrastructure. As at March the Education Investment Fund had assets of $3.70 billion, down from $3.73 billion over the year. The Medical Research Future Fund (MRFF) was set up on January with the aim to grow the fund to $20 billion. The first contribution to the MRFF was made on September in the form of a transfer of A$1.010bn from the Health and Hospitals Fund with a further transfer from government of A$2.139bn on December As at March the MRFF was valued at $3.126 billion. The DisabilityCare Australia Fund (DCAF) was established to provide support for Australians with significant and permanent disability. The DCAF received its first contribution on November As at March the DCAF had received contributions of $5.183 billion, up from $1.65 billion over the year. Goods and services tax (GST) Investing for the future Assets as at March $billion FutureFund Education Investment Building Australia $ $3.70 $3.67 To some extent this is the forgotten tax. Despite the fact that the GST is the third biggest revenue generator behind personal tax and company tax, it tends not to feature in budget analyses. All of the revenue goes to the states and territories so it certainly has a major influence on the ability of governments to spend across the community. Receipts from the Goods and Services Tax stood at $57.7 billion in the twelve months to March 2016, up 0.3 per cent on a year ago but affected by the one extra day in February and the early timing of Easter. The Government has forecast GST receipts of $59.79 billion for the entire 2015/16 year. Actual GST receipts for the nine months to March stood at $ billion, above the Budget profile of $ billion. GST Receipts are forecast to grow by 6.0 per cent in and 5.4 per cent in Since the MYEFO, receipts are expected to be around $190 million higher in and $1.1 billion higher over the four years to The estimate has been revised upward largely owing to stronger-than-expected collections. May

11 6. Selected Charts May

12 Interest rates 7. Impact Rates, $A, Shares The Federal Budget has few implications for interest rate settings. The government is aiming to lift economic growth and economic revenue and show discipline on spending as the key strategy to gradually trim the budget deficit over time. There would have been few surprises in the Budget for the Reserve Bank. If anything, stimulatory fiscal policy measures on tax and infrastructure spending complements monetary policy settings. If confidence and economic activity are boosted and economic growth exceeds predictions of 2.5 per cent growth in 2016/17 then the Reserve Bank may delay further rate cuts. Australian dollar We don t believe the federal budget has major implications for the Australian dollar. Still, that has been the case for probably over a decade now. Any assurances by ratings agencies on Australia s AAA credit rating would further mean that currency trading can continue on a business as usual basis. The more important influences on the Aussie dollar over the next six months are the Federal Election, Chinese economic growth and US monetary policy. The Federal Election is too close to call and much can change over the next two months. There are signs that Chinese authorities are adopting a new reflation strategy, worried about the slowdown in the industrial sector. Commodity prices have lifted over 2016, while commodity currencies like the Australian dollar have also been supported. And the US Federal Reserve is expected to tread cautiously on rate hikes. If rates lift just twice this year at most then this will keep downward pressure on the US dollar. CBA group currency strategists tip the Aussie dollar to be near US77 cents in September; US78 cents in December; US79 cents in March 2017 and US80 cents in June Sharemarket implications The government is focussed on jobs and growth. If solid, low inflationary growth is achieved, then this translates into higher spending, higher revenues, higher profits, and potentially higher share prices. Increased spending on infrastucture is positive for a raft of industry sectors including building materials, transport, industrials, developers & contractors and consumer discretionary sectors. Some infrastructure projects such as road and rail will have flow-on benefits in terms of home building in, or near the areas, where the projects are based. The transport sector is supported by workers travelling to where the key infrastructure projects are based. A lift in the second highest tax rate income threshold from $80,000 to $87,000 should assist retailing, consumer discretionary more generally, and consumer staples sectors. The small business tax cut and asset write-off measures should be supportive for the hardware chains, Officeworks, telecommunications providers and business-to-business operations. Retailers generally will benefit from measures to assist small business. May