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Home > Economics > Economic policies and management > Fiscal Policy and Budget Outcomes

Fiscal Policy and Budget Outcomes

This tutorial was written by
Ken Edge
Head Teacher Social Science
Cardiff High School

Outcomes
Overview
Content
Review exercises
More

Outcomes

HSC Topic Four: Economic Polices and Management is described in the Board of Studies NSW Stage 6 Economics Syllabus (1999) on pages 40 to 42. The specific outcomes from the syllabus for this tutorial are listed below.

A student:

H1	demonstrates understanding of economic terms, concepts and relationships
H2	analyses the economic role of individuals, firms, institutions and governments
H5	discusses alternative policy options for dealing with problems and issues in contemporary and hypothetical contexts
H6	analyses the impact of economic polices in theoretical and contemporary Australian contexts
H7	evaluates the consequences of contemporary economic problems and issues on individuals, firms and governments.

Being up to date and aware of contemporary issues

Students of Economics need to be aware of what is happening in the Australian Economy today and should, for instance, have looked at the most recent Federal Budget. There is an excellent web link to notes on the most recent budget at the bottom of this page in the section 'MORE'.

Overview

Fiscal policy involves the Commonwealth Government changing expenditure and revenue patterns to achieve a range of economic objectives. The estimated revenue and expenditure for the next year and future years of the government is known as the Commonwealth Budget and is the main instrument of fiscal policy.

Deliberate or discretionary changes to the structure of revenue and expenditure components of the Budget can be used to alter the level of economic growth, inflation, unemployment and external stability. For example, a budget surplus can be used to slow down an overheated economy and reduce inflation, whilst a budget deficit can be used to stimulate economic recovery from recession.

Changes in the methods of revenue collection and expenditure can also affect the distribution of income and the pattern of resource allocation in the economy.

The major objective of the federal government is to achieve a fiscal balance over the length of the business cycle.

Content

The Commonwealth Government’s budget

The Budget is delivered in May of each year and is a statement of the government’s estimated expenditure (G) and revenue (T) for the next fiscal year. However, economic conditions can change and alter the budget estimates. Revisions of the budget estimates occur in December or January, when the government issues an assessment of economic conditions. This is referred to as the Mid-Year Economic and Fiscal Outlook (MYEFO).

There are three possible budget outcomes:

• a balanced budget where government expenditure equals revenue (G="T)
• a deficit budget where government expenditure is more than revenue (G>T)
• a surplus budget where government expenditure is less than revenue (G<T).

Measuring the budget outcome

Table 1 Commonwealth budget aggregates

The main methods used by the government to calculate the budget outcome are:

1. The headline cash balance includes all sources of government revenue and expenditure.

   headline cash balance = total outlays less total revenue

   This method of calculating the budget outcome uses the cash accounting system where the government records transactions when payments are made and income is received.

2. The underlying cash balance removes "one-off" effects such as the partial privatisation of Telstra in 1997–98, 1998–99 and the sale of Sydney Airport Corporation Limited in 2001–02 from the headline budget outcome.

   underlying cash balance = headline cash balance less net advances

   (net advances include the purchase and sale of assets, and debt transfers between the state and federal governments)

   This method of calculating the budget outcome gives a good indication of the overall impact of the budget on the economy. The Treasurer refers to this measure of determining the budget outcome in his or her Budget speech.

   An underlying cash surplus is available to the government to purchase assets or pay off debts. Successive surpluses were used by the Australian Government up until the 2008/9 Budget which reduced debt to virtually zero and allowed the accumulation of savings to be used in the future for investment and economic downturns.

   An underlying cash deficit needs to be financed by the sale of government financial assets or by drawing on cash reserves from other sectors of the economy. The underlying cash deficit for 2009-2010 of $3.6 billion was incurred because of a shortfall in tax collections due to low economic growth, and to pay for cash and infrastructure stimulus spending. The projected budget deficits and cash deficits are expected to be very large for the foreseeable future as the Government is intending to spend more in the community to offset the impact of the GFC and associated downturn.

3. The fiscal balance is similar to the underlying cash balance but is calculated using an accrual accounting system. Using this system, transactions are recorded as they occur, not as they are received or paid (cash accounting system). The Treasury first introduced the fiscal balance in the 1999–2000 budget.

   fiscal balance = net operating balance minus net capital investment

   The fiscal balance is also adjusted for “one-off” purchases and sales of non- financial assets by the government (net capital investment).

   The fiscal balance is important because it measures the balance between government savings and investment. For example, a fiscal surplus enables the government to increase national savings and reduce debt. A fiscal deficit means that the government has to borrow funds from other sectors of the economy, potentially affecting the balance of payments and the current account.

Changes in the budget outcome

One important observation from Table 1 is that, the amount of revenues, expenditures as well as budget outcomes change each year. There are two main reasons for these variations:

1. Discretionary changes in fiscal policy

   Discretionary changes are deliberate changes inrevenue and expenditure levels by the government. For example, in the 2009–10 Budget, the government anounced a $22billion infrastructure investment. Such deliberate changes in fiscal stance alter the structural component of the budget, and are used to stabilise the economy in the medium-term.

2. Cyclical or non-discretionary changes in fiscal policy

   Adjustments in levels of revenue and expenditure can result from changes in the level of economic activity (booms and recessions). These adjustments are beyond the control of the government and are known as automatic stabilisers. There are two main automatic stabilizers:
   
   Unemployment benefits
   
   In a recession, the level of economic activity falls and the unemployment rate increases. As a result, government expenditures on unemployment benefits and Job Search allowances automatically increase. This increase in government expenditure reduces the budget surplus or increases the deficit. As unemployment increases in the recession then spending on unemployment will rise, increasing the spending of unemployed people. This acts to offset the recession and increase spending in the community.
   
   The opposite occurs during an upturn in economic activity. In this situation, jobs are created and the government spends less on unemployment benefits, which increases the budget surplus or reduces the deficit.
   
   The PAYG income tax system
   
   During times of economic growth, employment levels and incomes rise. Workers move into higher income brackets automatically increasing government taxation revenue. This process is known as fiscal drag or bracket creep. During a downswing in economic activity or recession, taxation revenue is reduced, increasing the deficit or reducing the surplus.
   
   The automatic stabilisers in the budget therefore play a counter-cyclical role, in that they tend to smooth out the effects of booms and recessions on the economy. In booms, demand is automatically checked through higher tax revenue and reduced government expenditure. In a recession, increases in government expenditure (unemployment benefits) help stimulate the economy and raise aggregate demand.
   
   Between 2002 and 2008 the mining boom and increased consumption of raw materials by China is estimated to have added $334 billion to corporate taxes paid by business to the Australian Government. This large increase in revenues allowed the government to deliver budget surpluses, tax cuts and save funds in national infrastructure funds – all at the same time.

Fiscal stance

The fiscal stance refers to the intended overall impact of the Budget on the level of economic activity in the coming and future years. There are three possible fiscal stances:

• A neutral stance is where G="T," with little or no impact on the level of economic activity.
   
• Expansionary fiscal policy is associated with budget deficits, where injections are greater than withdrawals or G>T. The government borrows money to inject
   
• Contractionary fiscal policy is associated with surplus budgets, where injections are less than withdrawals or G<T. In this situation, government expenditure is less than revenue, thereby reducing the level of aggregate demand and economic activity.

In determining fiscal stance the government must also consider the impact of changes in spending and revenue on:

1. resource reallocation and production in the economy
    
2. the redistribution of income that could occur.

Review exercises

Exercise 1     Flash version     HTML version

Exercise 2

Use the information from the tutorial including Table 1, Commonwealth budget aggregates to answer the following question.

Analyse the reasons for the change in fiscal stance in the 2009–10 Budget

Answer

Exercise 3

This statement outlines the fiscal outlook and how the Government has delivered on its fiscal strategy. Temporary deficits are necessary to support growth while the economy is weak. In this Budget, the Government has fully offset all new spending in 2012-13. This approach is consistent with the Government's medium-term fiscal strategy of achieving budget surpluses, on average, over the medium term.

An underlying cash deficit of $57.6 billion (4.9 per cent of GDP) is expected in 2009-10, compared with the February 2009 Updated Economic and Fiscal Outlook (UEFO) estimate of $35.5 billion (2.9 per cent of GDP). The budget deficit is a direct consequence of the global recession, which has had a substantial impact on tax revenues. Since the 2008-09 Budget, tax receipts have been revised down by around an estimated $210 billion over the forward estimates to 2012-13. Consistent with the fiscal strategy, the 'automatic stabilisers' have been allowed to flow through to the budget position, supporting economic growth.

The Government has met its commitment to fund new expenditure through a reprioritisation of existing expenditure. New spending has been offset by the final year of the forward estimates. The budget deficit is expected to halve as a share of GDP by the end of the forward estimates, and in the medium term, the underlying cash balance is projected to return to surplus by 2015-16. This will be achieved through expenditure restraint (holding real spending growth to 2 per cent when the economy recovers and grows above trend) and by allowing receipts to recover naturally with the recovery in the economy. This will ensure that the economic recovery is not jeopardised while at the same time providing a clear path back to surplus.

Australia's budget position remains sound and sustainable. Australia's deficit in 2009-10 is less than half that of the major advanced economies' collective deficit of 10.4 per cent of GDP and considerably smaller than the 8.8 per cent of GDP collective deficit for advanced economies as a whole.

Net debt will remain low by international standards and is projected to decline to 3.7 per cent of GDP by the end of the next decade.

Source 2009-2010 Budget Fiscal Outlook

Use the information from the tutorial and the extract to answer the following question.

Explain the difference between the cyclical and discretionary components of the budget with reference to the 2009/10 Australian Government Budget.

Answer

More

Need to know more about the Commonwealth Budget?

• The Commonwealth Budget web-site has excellent information on past and present budgets and a list of all press releases made by the Treasurer. The “Fiscal Strategy and Outlook” is worth reading and taking notes from in order to understand and explain the government’s current fiscal policy stance.