The Underlying Cash Balance (Budget Outcome)

Understanding the Budget Outcome

• The budget outcome reflects the difference between the Australian Federal Government’s total receipts (revenue) and total outlays (expenditure) over a specific period (typically one financial year).

• A budget surplus occurs when total receipts exceed total outlays.

• A budget deficit occurs when total outlays exceed total receipts.

• A balanced budget occurs when total receipts equal total outlays.

Underlying Cash Balance

• The underlying cash balance is the most commonly used measure of the budget outcome. It provides a comprehensive view of the government’s financial position.

• It excludes certain one-off or volatile transactions that can distort the overall picture of the government’s fiscal performance. This provides a clearer indication of the ongoing sustainability of government finances.

• Excluded items typically include:

  • Net cash flows from investments in financial assets for policy purposes.
  • Assets sales.
  • Unrealised gains and losses due to currency fluctuations.

Components of the Budget

• Receipts (Revenue):

  • Tax revenue:
    • Direct taxes: Personal income tax, company tax, superannuation tax.
    • Indirect taxes: Goods and Services Tax (GST), excise duties, customs duties.
  • Non-tax revenue: Profits from government business enterprises (GBEs), interest income, dividends.

• Outlays (Expenditure):

  • Government consumption (G1): Day-to-day spending on goods and services (e.g., healthcare, education, defence).
  • Government investment (G2): Spending on infrastructure (e.g., roads, schools, hospitals).
  • Transfer payments: Welfare payments (e.g., unemployment benefits, pensions), subsidies.

KEY TAKEAWAY: The underlying cash balance is the primary indicator of the government’s fiscal health, reflecting the difference between total receipts and outlays, excluding specific volatile items.

Budget Outcome as a Proportion of GDP

• Expressing the budget outcome as a percentage of Gross Domestic Product (GDP) provides a more meaningful context for assessing the size and impact of the budget surplus or deficit.
• It allows for comparison of budget outcomes across different years and countries, adjusting for the size of the economy.

• Formula:

  $$
  \text{Budget Outcome as % of GDP} = \frac{\text{Underlying Cash Balance}}{\text{Nominal GDP}} \times 100
  $$

• A larger economy (higher GDP) can more easily absorb a budget deficit than a smaller economy.

Significance of the Ratio

• Sustainability: A large deficit as a percentage of GDP may indicate unsustainable fiscal policy, leading to increased government debt.

• Economic Impact: The budget outcome as a percentage of GDP can influence aggregate demand and economic growth.

  • A large deficit may stimulate economic activity but could also lead to inflation and higher interest rates.
  • A large surplus may dampen economic activity but could also reduce government debt and inflationary pressures.

• International Comparisons: Allows for comparison of fiscal performance between countries, taking into account their relative economic sizes.

Interpreting the Budget Outcome as a % of GDP

• A negative percentage indicates a budget deficit.
• A positive percentage indicates a budget surplus.
• The larger the absolute value of the percentage, the greater the relative size of the deficit or surplus compared to the economy.
• Small changes may seem insignificant in dollar terms, but when expressed as a percentage of GDP, they can represent a substantial shift in fiscal policy.

EXAM TIP: When analyzing budget data, always consider the budget outcome as a percentage of GDP to provide context and assess its significance relative to the size of the economy.

Factors Influencing the Budget Outcome

• Economic Growth: Higher economic growth generally leads to increased tax revenue (e.g., higher company profits, more employment) and reduced welfare payments, improving the budget outcome.
• Unemployment Rate: A lower unemployment rate increases tax revenue (more people earning income) and reduces unemployment benefit payments, improving the budget outcome.
• Inflation: Higher inflation can increase tax revenue (e.g., through bracket creep) but may also increase government spending (e.g., indexation of welfare payments), with the net effect being ambiguous.
• Government Policy Decisions: Changes in tax rates, government spending programs, and welfare policies directly impact the budget outcome.
• Global Economic Conditions: A global recession can reduce demand for Australian exports, lowering company profits and tax revenue, worsening the budget outcome.
• Terms of Trade: An improvement in the terms of trade (higher export prices relative to import prices) increases national income and tax revenue, improving the budget outcome.

Impact of Fiscal Policy Stance

• Expansionary Fiscal Policy: Involves increasing government spending or reducing taxes to stimulate economic activity. This typically leads to a larger budget deficit (or a smaller surplus).
• Contractionary Fiscal Policy: Involves decreasing government spending or increasing taxes to reduce inflationary pressures or decrease government debt. This typically leads to a smaller budget deficit (or a larger surplus).
• Neutral Fiscal Policy: Involves maintaining government spending and tax levels to have a minimal impact on economic activity.

COMMON MISTAKE: Students often confuse the dollar value of the budget outcome with its significance. Remember to consider the budget outcome as a percentage of GDP to understand its impact on the economy.

Using Budgetary Policy to Achieve Macroeconomic Goals

• Budgetary policy can be used to influence aggregate demand (AD) and achieve the government’s macroeconomic goals:
  • Strong and Sustainable Economic Growth: Expansionary fiscal policy can stimulate AD during periods of slow growth.
  • Full Employment: Increased government spending on job creation programs can reduce unemployment.
  • Low Inflation: Contractionary fiscal policy can reduce AD and inflationary pressures.
  • External Stability: Fiscal policy can influence the current account deficit by affecting national savings and investment.

Automatic Stabilizers

• Automatic stabilizers are elements of the budget that automatically adjust to changes in the level of economic activity, without requiring deliberate policy changes by the government.
• Examples:
  • Progressive income tax system: As incomes rise during an economic expansion, tax revenue automatically increases, dampening AD.
  • Unemployment benefits: During a recession, unemployment benefit payments automatically increase, supporting AD.

Discretionary Fiscal Policy

• Discretionary fiscal policy involves deliberate changes to government spending and tax policies to influence AD.
• Examples:
  • Increasing infrastructure spending during a recession.
  • Cutting taxes to stimulate consumer spending.

STUDY HINT: Create a table summarizing the different types of government receipts and outlays, along with examples of each, to improve your understanding of the budget components.

Strengths and Weaknesses of Budgetary Policy

Strengths

• Direct Impact on AD: Government spending directly influences AD.
• Targeted Spending: Spending can be directed to specific sectors or regions of the economy.
• Automatic Stabilizers: Provide a built-in mechanism to cushion economic fluctuations.
• Political Feasibility: Can be popular with voters if it involves increased spending on desired programs.

Weaknesses

• Implementation Lag: It can take time to implement budgetary policy changes and for them to have an effect on the economy.
• Political Constraints: Policy decisions can be influenced by political considerations rather than economic needs.
• Crowding Out: Increased government borrowing can lead to higher interest rates, crowding out private investment.
• Ricardian Equivalence: Consumers may save rather than spend if they anticipate future tax increases to pay for current government spending.

APPLICATION: Consider recent government budgets and analyze how specific policy decisions have influenced the budget outcome and the achievement of macroeconomic goals.

Recent Trends in the Australian Budget

• Analyze recent budget outcomes, including the underlying cash balance and its percentage of GDP.
• Identify the key factors that have influenced these outcomes, such as economic growth, commodity prices, and government policy decisions.
• Discuss the implications of these outcomes for the Australian economy.

VCAA FOCUS: Be prepared to analyze and interpret budget data, including the underlying cash balance and its percentage of GDP, and to discuss the factors that influence the budget outcome and its implications for the economy.