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May 22, 2013

The mystery of Treasury’s disappearing revenue: Parkinson explains

The Treasury Secretary's discussion of what has gone wrong with revenue forecasting in recent years provides a context for the coming challenges on fiscal policy. Bernard Keane and Glenn Dyer report.

The funniest aspect of the Coalition’s renewed claim that Treasury’s independence has been compromised — a claim that has been trundled out ever since Labor came to power by both opposition and their media apologists — is if you take the claim seriously, Labor must be pretty rubbish at politicising the public service.

After all, for the years leading up to the financial crisis, Treasury regularly underestimated tax revenue, making John Howard and Peter Costello look like stellar fiscal managers and setting the scene for them to turn the federal government into a giant cash machine blasting money at voters. As soon as Labor got into office, however, that came to an end. There was no more underestimating revenue. Indeed, Treasury promptly began overestimating it, and not by a few billion here or there, but by double-figure billions, leaving Treasurer Wayne Swan to explain why deficits were persisting when he’d promised surpluses, and up until December, repeatedly slashing spending to try to post a surplus.

If Treasury had been politicised by Labor, it sure had a funny way of showing it.

Yesterday, Treasury head Martin Parkinson discussed in detail exactly what had gone wrong with Treasury’s revenue forecasting in recent years. The guts of it, according to an independent review of the problem, was that:

“Treasury has tended to underestimate growth in nominal GDP and taxation revenues during upswings and overestimate growth during downturns.”

But that doesn’t tell us anything we don’t already know, so Parkinson went on to explain why. Before the financial crisis, during the first phase of the mining boom, “we consistently underestimated the strength of growth in emerging Asia and consistently overestimated the pace at which new global supply would be brought on-line. The result was that the terms of trade and nominal GDP growth continually surprised on the upside.” That is, Treasury was too gloomy about the strength of Asian growth and too optimistic about the capacity of the world’s miners to respond to it.

And since 2010, Treasury has been too optimistic about nominal GDP. “In 2012-13,” Parkinson said, “nominal GDP will be around $53¬†billion below our projection at the 2010 PEFO [Pre-Election Economic and Fiscal Outlook].” Why? Because export prices have fallen more than expected — but the dollar didn’t fall in response. Parkinson calls this a “break down in the relationship between the terms of trade and our exchange rate”.

Part of the problem, Parkinson admits, was that Treasury was using a one-size-fits-all forecasting model for company tax revenue, which didn’t take into account, for example, the lower rate of tax that mining companies pay because of their much higher deductions. It is now moving to use a three-part model, covering mining, finance and everything else.

But what Treasury also didn’t consider was the way our AAA (stable) credit rating turned out to be a millstone, as well as an asset. The asset part is clear — it is politically helpful. The millstone? If you had to pick one factor out of many why the dollar didn’t start falling last year as commodity prices fell (especially from July-August onwards when iron ore prices tanked) and our terms of trade fell, it was the siren-like attraction of the AAA to central banks, big insurers (such as Warren Buffett’s US insurers) and others as a home for yield-hungry investments, or a new addition to foreign reserves holdings of countries like Switzerland, China and Russia.

That kept the dollar higher for longer than expected, especially by Treasury, and contributed to the department missing the growing weakness in inflation, which in turn has cut growth in nominal GDP and tax revenues. Parkinson admits as much: “we have been genuinely surprised by the weakness in prices over the past year,” he said. That weakness helped the RBA produce the surprise rate cut earlier this month, and could allow for another cut if demand continues to soften in the economy. And yet low inflation is a major part of the health of the economy.

Parkinson’s discussion comes when Treasury is again being accused of being too optimistic. Alternatively, opposition Treasury spokesman Joe Hockey has claimed that Swan had cherrypicked from Treasury’s range of estimates. Hockey, who has been a junior minister in the Treasury portfolio, knows that’s a lie — Treasury does not serve up a range of budget forecasts for the Treasurer.

The “optimistic” accusations (from the likes of wannabe celebrity economist Stephen Anthony in The AFR) don’t centre on real GDP — Treasury believes we’ll grow at below-trend next year, despite a 1% of GDP deficit and record low interest rates — but on nominal GDP and terms of trade.

In fact, Treasury’s forecasts for nominal GDP growth of¬†5% in 2013-14 and 5% in 2014-15 are consistent with those of private economists. Citi predicts 5.5% in 2013-14; Bank of America Merrill Lynch predicts 4.0% in 2013-14 and 5.1% the year after; Goldman Sachs 3.5% next financial year and 5.1% the next year.

Labor’s Treasury has routinely been accused of being too optimistic. Hockey made a dill of himself in 2009 when he claimed Treasury was being too optimistic in its growth forecasts and there was no way the economy could grow that quickly, only to reverse position and complain that Treasury had been too pessimistic (Laurie Oakes mauled him over that).

That was when the focus was on real GDP figures; now nominal GDP is the new black amongst forecasters and politicians. Still, Hockey can’t complain too much. It is likely Treasury will have overhauled and improved its revenue forecasting capabilities by the time he’s Treasurer, which should spare him the sort of blushes that Wayne Swan has had to endure. And he’ll need them. Parkinson said this yesterday:

“Some of the factors that have contributed to weaker-than-anticipated tax receipts are expected to persist, including the downward shift in the level of nominal GDP compared to what we had been anticipating. Combined with growing community expectations of the role of government and rising costs associated with healthcare and the ageing of the population, this creates a challenging environment for fiscal policy in the years ahead — not only for the Commonwealth government, but for state and local governments as well.”

There are only two long-term solutions: disappoint community expectations or lift taxes. Recently our politicians have decided the latter is more palatable.

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22 thoughts on “The mystery of Treasury’s disappearing revenue: Parkinson explains

  1. Jimmy

    Hang on this aritcle seesm to make out that Hockey has been inconsistent and has been making things up about the economy – that can’t be true because the media would flay anyone who does that!

    Oh wait he is a liberal.

  2. Mike Flanagan

    No, There are three solutions Bernard and Glen.
    The third solution is the imperative to keep economic illiterates and numerical dunces like Hockey, Robb and Abbott from the budget and finance departments that this nation, and all of us, depend on.

  3. Scott

    “Treasury does not serve up a range of budget forecasts for the Treasurer.”

    No, but I’m sure they produce a detailed sensitivity analysis based on movements of key economic indicators and assumptions, like every other forecaster worth their salt. These can be used to create optimistic and pessimistic scenerios and hence budget forecasts.

    Costello used to say he always allowed for some downside bias to combat the institutional optimistic bias of Treasury. He knew they were fallible. If Wayne Swan was a confident Treasurer with some real business experience, he might have done the same. Joe Hockey, take note!

    Sadly, this Government have mythologised Treasury (probably due to the influence of Saint Ken Henry, who saved their bacon during the GFC) and this is the end result.

  4. klewso

    Mike they had Cousin Jethro in there too (as “Fine Ants Minister”?) before Robb.

    In that “interview” on Lateline the night of the budget – I was almost surprised Robb wasn’t challenged and pursued by such a “learned journalist” as Alberici when he made that claim of his, about “that range of figures” he knows all about :-
    [“Yes, but also I know how it works. The Treasury provides a range of forecasts. I mean what we’ve just heard from Penny Wong that they’ve taken a hit to revenue, it’s a myth. It is an absolute myth….” That would have drawn some like a rat up a drain-pipe – and I reckon she would have been right in there to, if it was “Labor” that said it, rather than the insipid rejoinder she threw in.]

  5. Gavin Moodie

    The Coalition’s attack on the professionalism of Treasury officials is unwarranted and will make it harder to recruit and retain disinterested civil servants.

  6. Jimmy

    Gavin – It’s just the standard conservaitve attitude – climate change scientists don’t know anything, the Navy is wrong about the risks of turning back the boats, the GFC didn’t happen and the treasury doesn’t know what it talking about – no matter how credible the evidence against their policy they deride it, get take the friendly press front page headline and ignore the correction on page 23 in the knowledge the majority of the public will too.

  7. Gavin Moodie

    Thanx Jimmy; you do seem to have spotted a pattern.

  8. Jimmy

    It’s not hard to see, people just don’t want to look.

  9. Gavin Moodie

    Not that Costello had ‘real business experience’ before he became Treasurer. He was a junior lawyer before he entering politics.

  10. klewso

    Remember Bishop the Elder making a name for herself tearing strips off Hawke/Keating public servants in public – then defending “hers” in Howard’s government (kero baths etc)?
    The more things change …..?
    Hockey and Robb will protect their “workers” in their time.
    ‘Til then they’ll use them as whipping boys and girls, to pillory and score political points.