two of the best?

As seemed likely, Treasurer Swan is selling this as a inflation-busting budget.

Well, I can’t blame him… that’s what do if I were caught in his jam.

The truth is that this is not an inflation busting budget. Spending rises relative to the 2010/11 MYEFO  — IN EVERY YEAR.

And while it falls as a proportion of GDP, it’s higher relative to the 10/11 MYEFO baseline — IN EVERY YEAR

fiscal policy has been more stimulatory than expected when the 2010/11 budget was framed — as Treasury underestimated depreciation and capital loss allowances. As a result, they overestimated the average economy wide tax rate in 2010/11. Think of it as an accidental tax cut.

Of the approx 9.5bn drop in revenue in 2010/11, I estimate that around 2.5bn was due to a weaker economy, and the other 7bn was due to getting their tax allowance assumptions wrong.

Sure, there has been fiscal drag – as you’d hope after such a large expansion – but it’s not been as large as had been factored into everyone’s forecasts (I assume the Treasury gets these things right when I forecast – and I think that’s the norm).

For 2011/12, Treasury forecasts imply 10bps of extra fiscal drag over and above the 2010/11 MYEFO (-2.2ppts of GDP v. -2.1ppts). That’s appropriate, but not statistically or economically significant – it shouldn’t move anyone’s inflation forecast.

Because they have anchored the fiscal balance in 2012/13 at +0.2ppt of GDP, 2010/11 was worse, and 11/12 is about the same improvement as in 10/11, the catch-up is in 2012/13 — as such, the fiscal drag is materially larger at that time (-70bps to -1.8% of GDP … it just looks like -80bps due to rounding).

This is large enough to make a difference, however it’s far enough away (and anyone’s forecasting is weak that far out) that I doubt this will sway the RBA at all in 2011. In any case, if you believed the 2012/13 surplus promise, you would have already figured this out to within ~20bps (my forecast error after 2hrs fiddling last night) when you’d written the Q2 SOMP.

It looks like we have a slow start, and a determined finish — less tight fiscal policy in 2010/11, an insignificant change to 11/12, and a bit more work done in 12/13.  However, that’s not so.

What we have is an assumption that receipts growth really picks up in 2012/13.

Revenue growth exceeds the MYEFO forecast in 2012-13 – thanks to nominal GDP being higher than in the 2010/11 MYEFO – but payments are higher than the MYEFO. Thus the surplus is exactly the same fraction of GDP — it’s 377m larger is cash terms, but that’s still 20bps of GDP.

What’s going on here? Treasury assumed the two best every years of revenue growth since the RBA beat inflation in the 1990s (I’ve included prior to the 1991 recession to give perspective).

They might get there if they get their taxes up (MRRT + CPRS) else they are a good chance of missing. Which means the fiscal contraction in 2012/13 won’t occur – which is another reason you’d be nuts to put too much stock in the planned 2012/13 fiscal contraction.

Payments grow more slowly than GDP, and as such expenditure to GDP declines – but it is not yet back down to the pre-GFC binge level. It ought to be back ~23% (where it was in 2007/08) given the terms of trade.

Despite higher nominal GDP and higher revenues than forecast in the MYEFO we do not get a better outcome. So much for banking any improvement!

We ought to be saving more of this bonanza, and not being timid about closing down wasteful GFC spending programmes (or the wasteful programmes we started up before the GFC). After all, this is a full employment economy.

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