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Economics

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

Outcomes
Overview
Content
Review exercises
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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

Please note - this tutorial is based on 2002 figures and this needs to be kept in mind as you read the information. 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 reduce government debt, increasing national savings and lowering domestic interest rates. Higher levels of domestic savings lessen the need to borrow funds from overseas with the effect of reducing interest payments and lowering the current account deficit.

Changes in the methods of revenue collection and expenditure can also effect the distribution of income and the patterns 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

1. 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).

   1. Government revenue

      Graph 1

      

      Graph 1 indicates the main components of government revenue for 2002–03. Total revenue collection is estimated to be $169.65 billion (22.6% of GDP), a 4% increase on the previous fiscal period.

      Individual or Pay as You Go (PAYG) income tax collection is the largest source of revenue, totalling $93 billion. Pay as You Go collections from employees are expected to grow during this next period due to lower unemployment levels and wage increases.

      Company taxation is expected to be $28 billion and revenue from indirect taxation $25 billion. Some examples of indirect taxation are excise duty on petrol ($13 billion) and customs duty ($5 billion).

      The Goods and Services Tax (GST), which is expected to net $30 billion in 2002–03, is not included as part of revenue. This is because the revenue is passed onto the states as part of an income sharing arrangement.

   2. Government expenditure

      Graph 2

      

      Total outlays for 2002–03 are estimated to be $170.2 billion (22.7% of GDP), an increase of 2% on 2001–02.

      The main components of expenditure are:

      • social security and welfare $72.9 billion, with $25 billion assistance to the aged, $21 billion to families with children, $10 billion assistance to people with disabilities and $6 billion to the unemployed
        
      • health $29.1 billion, including $8.3 billion allocated to medical benefits subsidies for doctors
        
      • defence expenditure of $13.1 billion
        
      • education expenditure of 12.3 billion.

2. The budget outcome

   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).

3. 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 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, Mr Costello, refers to this measure of determining the budget outcome in his budget speech.

      An underlying cash surplus is available to the government to purchase assets or pay off debts. For example in, 2000–01 the underlying cash surplus of $5.6 billion was used to reduce government debt. Underlying cash surpluses are also projected for 2002–03, 2003–04, 2004–05 and 2005–06.

      Alternatively, 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 2001–02 was approximately $1.2 billion.

   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, affecting the balance of payments and the current account.

4. 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 in methods of revenue collection and expenditure levels by the government. For example, in the 2002–03 budget, the government increased defence spending to support the war against terrorism and protect Australia’s borders. These 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 and increases the deficit.

        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 and reduces the deficit. For example, in the September quarter 2002, unemployment rates decreased to 6.0%, the lowest level for a number of years.

      • 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 stabilsers in the budget therefore play a counter-cycle 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.

5. 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 leakages or G>T. The government borrows money to inject funds into the economy so as to increase the level of aggregate demand and economic activity.
      
   • Contractionary fiscal policy is associated with surplus budgets, where injections are less than leakages 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 effects 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 and Table 1, Commonwealth budget aggregates to answer the following question.

Analyse the reasons for the change in fiscal stance in the 2001–02 budget.

Answer

Exercise 3

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

What is the difference between the cyclical and discretionary components of the 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, Mr Peter Costello.