Abbott Plots Path to Surplus With Australia Budget Cuts

Australia will cut spending on foreign aid, welfare and the public service and impose a tax on the highest paid as Prime Minister Tony Abbott uses his first budget to downsize government and set a path to surplus.

Treasury forecast a A$29.8 billion ($27.9 billion) deficit for the 12 months through June 2015, down from A$49.9 billion this fiscal year, with shortfalls narrowing in the following three years, budget papers released late yesterday in Canberra show. It announced a A$11.6 billion infrastructure package to help a shift from mining-led growth, and will start a A$20 billion medical research fund.

Echoing the past coalition government, Abbott is cutting programs and imposing new levies, betting a firmer fiscal footing will help win over voters in time for elections due to be called by 2016. The looming consolidation, which will see 16,500 civil servants lose their jobs, was described as a “headwind” for the economy by the central bank last week.

“The days of borrow and spend must come to an end,” Treasurer Joe Hockey told lawmakers in Canberra. “The age of entitlement is over. It has to be replaced, not with an age of austerity, but with an age of opportunity.”

Net debt is forecast to rise to 13.9 percent of gross domestic product in the coming fiscal year, the highest since 1997-98, and is projected to peak at 14.6 percent in 2016-17, the budget shows.

‘Drag on GDP’

“Fiscal policy will be a drag on GDP,” said Stephen Walters, JPMorgan Chase & Co.’s chief economist in Australia, who said he’s still calculating the impact. “The RBA was aware of that. There’s been little market reaction.”

The Australian dollar bought 93.80 U.S. cents as of 11:45 a.m. today in Sydney. It was at 93.40 cents before the release of the budget last night. The benchmark 10-year bond yield was at 3.82 percent, down 3 basis points since yesterday. The benchmark S&P/ ASX 200 index of equities was 0.2 percent lower.

Gross debt as a proportion of GDP in 2013 was the smallest outside of Estonia among advanced economies, according to International Monetary Fund data. Opposition Labor lawmakers say the government is inflating a false budgetary crisis to justify politically motivated spending cuts.

‘Budget Emergency’

“It has been extraordinary for the new government to be claiming there is some sort of budget emergency,” Shadow Finance Minister Tony Burke said in an interview with Bloomberg Television in Canberra today. “We have one of the lowest debt-to-GDP ratios in the world. We have triple A credit ratings from all three major credit ratings agencies. What’s happened is the new government has tried to deliberately manufacture a sense of crisis.”

The budget will help the government build a “more resilient economy for Australia,” Finance Minister Mathias Cormann told Bloomberg TV today. “We have put a stop to the unsustainable spending growth trajectory.”

The A$49.9 billion deficit seen for the year to June 30 is higher than the A$46 billion median estimate in a Bloomberg survey of 10 economists and the Treasury’s December forecast.

Real GDP growth is projected to slow to 2.5 percent in 2014-15, from 2.75 percent in the year to June 30. Growth will pick up to 3 percent in 2015-16 and 3.5 percent in the following two years, according to the budget estimates.

A 2 percent levy will be applied to those earning over A$180,000 a year, risking a backlash for Abbott who vowed ahead of the September election he wouldn’t surprise voters with new taxes. Labor says the levy represents a broken promise.

Tax Rate

The impost on about 400,000 taxpayers will raise A$3.1 billion over the forward estimates. For an individual earning A$200,000, 2 percent is imposed on the last A$20,000, equating to A$400 a year and pushing the effective top income tax rate to 49 percent, among the highest in Organization for Economic Cooperation and Development countries.

“This is unsustainable if we want to be internationally competitive, and shows the desperate need for comprehensive tax reform rather than temporary fixes,” Grant Wardell-Johnson, a Sydney-based tax expert at KPMG, said ahead of the release.

The government plans an A$11.6 billion infrastructure growth package to help boost total federal, state and private sector investment to A$125 billion by 2020. It committed A$5 billion to provide incentives over five years to states and territories to sell assets and reinvest the proceeds in infrastructure.

Cormann told Bloomberg TV the investment in “productivity enhancing infrastructure” would permanently add 1 percent to Australia’s GDP.

Asset Sales

Hockey flagged the sale of Australian Hearing, which provides aural aid including more than 150,000 hearing devices a year; Defence Housing Australia, which provides housing services for military personnel; the Royal Australian Mint and the registry services of the nation’s securities regulator. The proceeds of privatizations will be reinvested into the asset recycling fund for new projects.

The Medical Research Future Fund will aim to boost one of the economy’s better-performing industries at a time of retrenchment in manufacturing and a slowdown in mining investment. Savings from health reforms and A$5 of each A$7 patient contribution for doctor visits will be reinvested in the fund until it reaches A$20 billion, the budget papers show.

The resources industry has “done much of the heavy lifting” to boost growth over the past decade, Hockey said in the speech. “Now we need to fire up the rest of the economy.”

Fuel Excise

The government will reintroduce indexation of fuel excise from Aug. 1, a move projected to raise A$2.2 billion over the forward estimates. It’s been locked at 38.14 cents a liter since 2001, when coalition Prime Minister John Howard halted automatic indexing of the rate to inflation as a pre-election sweetener.

The government reiterated its commitment to cut the company tax rate by 1.5 percentage point from July 1, 2015. It said public service cuts will total 16,500 over the four years to 2016-17 and said 230 programs have been abolished.

“A smaller, less interfering government won’t need as many public servants,” Hockey said.

The government’s plans to scrap a carbon price and mining profits tax introduced by Labor have been stalled by opposition lawmakers in the Senate. The make-up of the upper house will change from July 1 when the Palmer United Party -- led by Clive Palmer -- will hold the balance of power, meaning Abbott will have to negotiate with the mining magnate to pass laws.

The retirement age will rise to 70 by 2035, from 65 now, the government said. That would give Australia the highest age among OECD countries.

Welfare Payments

The budget also announced measures to tighten eligibility for unemployment and disability payments and family tax benefits and scrap some concessions for some pensioners. Growth in foreign aid will be cut to save A$7.9 billion over five years.

Abbott’s bid to return the budget to surplus mirrors Howard, who justified cuts to government services by saying some of his pre-election pledges were “non-core promises.” Voter dissatisfaction with some budget measures revealed by the government in the past month have been reflected in the polls, with Abbott’s coalition trailing on 47 percent to Labor’s 53 percent on a two-party preferred basis, according to a Newspoll published in The Australian newspaper May 6.

With Abbott’s attacks against the previous Labor government’s trustworthiness helping pave his path to power, there’s more at stake politically for the coalition than is usually the case for a government delivering its first budget, according to political analyst Zareh Ghazarian.

“This government has boxed itself into a corner by promising to cut the deficit, deliver no new taxes and above all to keep its word,” said Ghazarian, a Melbourne-based professor at the Monash University School of Political and Social Inquiry. “New governments usually use their first budget to get all the bad news out of the way early so they can throw sweeteners at voters closer to the election.”

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