Federal Budget 2023-24 – A transitory surplus gives way to sticky deficits

Treasurer Chalmers delivered the Government’s second Federal Budget on 9 May 2023. For the current 2022-23 fiscal year, the budget ‘banks’ another $42 billion uplift from both elevated commodity prices and a better-than-expected economy to deliver a $4.2 billion surplus (0.2% of output), the first since 2007-08. However, the combination of modest net new stimulus (about 0.5% of output) and growing spending pressures across a range of budget areas, including health, disability, climate and defence, means the budget quickly returns to a small deficit in 2023-24 and deficits of a little over 1% in the out-years. This is a decent improvement from last year’s deficit trend closer to 2%. Yet, with deficits proving ‘sticky’, this again highlights the need to embrace further reforms to balance budgets in future years.

The 2023-24 budget, while maintaining a commitment to the Stage-3 tax reforms, continues the significant reprioritising of spending in line with the Government’s core constituency. Significant new funding is directed toward cost-of-living relief, the aged, the unemployed and Medicare, with additional spending for disability and single parenting support. Global challenges around the climate transition and defence also attract new funding. While tax increases (across superannuation, resources, and tobacco) fund a significant share of new spending, the net impact remains a stimulus of about 0.5% of output. While moderate and supportive for growth, it would be hard to argue this makes the task of lowering inflation easier, particularly given the potential for a significant mid-year minimum wage adjustment.

In this Special report, we provide an overview of the budget’s key take-away messages from the perspective of investors. We also provide a summary of key policy changes from a wealth planning perspective, and what the most recent budget announcement likely means for markets.

Elevated commodity prices and a resilient economy mask growing budget pressures

Higher commodity prices and lower unemployment have improved the current year fiscal position from a forecast $36.9 billion deficit last October to an expected surplus of $4.2 billion (0.2% of output). While the Government’s outlook for growth in 2023-24 is unchanged (at 1.5% after 3.25% in 2022-23), stronger jobs growth and lower unemployment, combined with a higher (still conservative) commodity price outlook, should deliver a further $42 billion uplift for 2023-24. Even with new spending of $12 billion, the fiscal position for 2023-24 improves from a forecast deficit of $44.0 billion to $13.9 billion.

As shown in the table on the following page, from a starting point of $199 billion of deficits (over four years), a $104 billion improvement in the macro outlook, of which $20 billion is spent on new policy support, lowers cumulative deficits to $114 billion. The decision to save 80% of the near-term revenue upgrade (together with higher commodity price and population forecasts for future years) delivers average out-year deficits of a little over 1%. This compares favourably to October’s almost 2% forecast outlook and contributes to a significantly lower debt trajectory for the economy.

After almost no fiscal stimulus in last year’s October budget, new spending of about $13 billion between now and mid next year—about 0.5% of output—represents a moderate fiscal stimulus. It will raise the question of whether the Government has struck the right balance between helping the economy’s most vulnerable and making the task of lowering inflation more difficult for the broader benefit (or embracing meaningful structural reforms to repair the longer-term fiscal outlook). Notwithstanding current cost-of-living pressures, unemployment remains near a 50-year low of 3.5% and inflation at 7.0%.

What are the budget’s key spending policies (expenses over four years)?

• Cost of living relief—The budget includes $14.6 billion of cost-of-living support, adding to the $4.7 billion for cheaper childcare announced in October’s budget. The measures include one-off energy bill discounts for low income households and small businesses, increased payments for jobseekers, single parents (where the cut-off age is being lifted from 8 to 14) and higher rent assistance.
• Aged care—A package worth $14.1 billion, focused on funding 15% wage increases for workers (on top of the $2.5 billion in October to fund 24/7 nurses).
• Health, NDIS and Medicare funding—A $5.7 billion package for Medicare includes funding for primary healthcare and tripling of bulk-billing incentives, $1.2 billion for cheaper prescription medication, while plans to slow the growth of the National Disability and Insurance Scheme (NDIS) from 14% to 8% per year will initially require $0.7 billion for staff increases and other reforms.
• Climate transition—A further $4 billion to renewable energy projects (including upgrading the electricity grid to allow the feed-in of more renewable energy), $2 billion to support hydrogen projects, and tax breaks for small business and loans to households to encourage energy efficiency.
• Defence—A $19 billion package (partly offset by $8 billion of re-prioritising) to fund the Defence Strategy Review, as well as incentives to encourage personnel re-enlistment.
• Other measures—$2.2 billion for social and affordable housing (and tax breaks to encourage build-to-rent), easier access to the first homeowner scheme (including for those who have not owned a home for more than 10 years), and $535 million to upgrade cultural institutions.

What are the budget’s key savings policies (savings over four years)?

• Superannuation—Additional tax on superannuation accounts with balances of over $3 million is expected to raise $3.2 billion (refer below for more detail).
• NDIS—Targeted reductions of $10 billion, focused on reducing fraud and targeting waste.
• Other tax increases—Additional taxes on the LNG sector (refer to the next page ‘What it means for markets’) to raise $2.4 billion, and higher tobacco excises worth $3.3 billion.
• Infrastructure reprioritisation—A review of Australia’s $120 billion 10-year infrastructure pipeline is expected to generate savings for the budget outlook.

Source: Australian Government, LGT Crestone

Around $80 billion of higher commodities and a resilient economy have improved the debt outlook

The strength in near-term commodity prices and the resilient economy have delivered a significant improvement in the debt outlook, albeit interest servicing costs remain elevated at a bit below 1% of output in the years to 2026-27. Whether inflation falls from 7.0% in early 2023 to 2.75% in 2024-25, as forecast, will impact the path for interest rates, the budget position and debt levels.

The Government forecasts gross debt on issue to rise from $895 billion (38.8% of output) in 2021-22 to a record high $1,067 billion (36.5% of output) in 2026-27 (below the 43.2% peak forecast in October), before drifting down to 32.3% by 2033-34. Net debt increases from a lower 21.6% in 2202-23, to peak at a record in 2026-27 of 24.1%. With a better-than-expected budget position, the Government’s gross issuance of debt over the next few years is expected to be noticeably lower than expected.

The Australian dollar was little changed post the budget. Australia’s S&P AAA credit rating is also unlikely to be affected by the 2023-24 budget, given Australia’s strong fiscal position compared to other developed economies, where much larger fiscal deficits persist post the pandemic stimulus.

What are the key policy changes from a wealth planning perspective?

Superannuation

As previously announced in February 2023, as part of its ‘Better Targeted Superannuation Concessions’, the Government has proceeded with the introduction of an additional earnings tax of 15% for members with total superannuation balances above $3 million. Key items from this policy are summarised below:

• The policy will commence from 1 July 2025 and is not indexed.
• The additional tax of 15% will be applied to ‘earnings’ on a member’s balance that exceeds the $3 million threshold.
• ‘Earnings’ are defined as the growth that is applied to a member’s total superannuation balance at each 30 June. This captures all unrealised gains and losses (market movements) of investments over the financial year, with adjustments made for withdrawals and contributions over the year.
• It is a per-person limit, not per-fund or per-couple limit. For example, a self-managed super fund (SMSF) with two members could have up to $6 million (up to $3 million per member) and not be impacted by these new rules.
• The fund will continue to pay 15% tax on income and 10% on capital gains (assume one third discount) on all its taxable income earned during the financial year.
• Franking credits and capital gains tax (CGT) discounts will not factor into the additional tax equation. However, they will continue to be part of the fund’s ordinary tax position.
• Account-based pensions that are in place (under the relevant cap at the time of commencement of either $1.6 million, $1.7 million or $1.9 million for new pensions 1 July 2023 onwards) will remain tax-free within the fund.
• The additional tax will be calculated by the Australian Taxation Office (ATO) and is applied directly to the member (not to the fund). This is similar to the way high income earners pay additional concessional contributions tax of 15% as part of the Division 293 tax provisions. The member can choose how to pay the additional tax, either personally or from their super fund account.
• Defined benefit schemes will be appropriately valued and will have earnings taxed under this measure to ensure commensurate treatment.

Superannuation contributions: From 1 July 2026, all employers will be required to pay their employees’ superannuation entitlements on the same day that they pay salary and wages. The change is designed to help employees have greater visibility over their superannuation entitlements and to help the ATO recover unpaid superannuation. The change is also expected to support better retirement outcomes. The delayed commencement date is designed to allow the ATO, payroll providers, and superannuation funds time to make system changes and for employers to adjust their cashflow practices.

Other superannuation amendments from prior federal budgets: Amendments to the treatment of Non-Arm’s Length Income (NALI) applies to expenditure incurred by an SMSF or Australian Prudential Regulation Authority (APRA)-regulated fund. Income for NALI purposes is limited to twice the level of a fund’s general expenses. Additionally, fund income taxable as NALI will exclude contributions.

Small business support

Energy bill relief: From 1 July 2023, eligible small businesses with annual turnover of less than $10 million will receive $650 towards their electricity bill as part of the Government’s Energy Price Relief Plan. It is expected that 1 million small businesses will directly benefit.

Small business energy incentive: Between 1 July 2023 and 30 June 2024, small and medium businesses, with annual turnover of less than $50 million will be able to deduct an additional 20% of the cost of eligible depreciating assets that support electrification and more efficient use of energy, such as electrifying cooling and heating systems, installation of batteries and heat pumps.

Up to $100,000 of total expenditure will be eligible for the Small Business Energy Incentive, with the maximum bonus deduction being $20,000. Certain exclusions will apply, such as electric vehicles, renewable electricity generation assets, capital works, and assets that are not connected to the electricity grid and use fossil fuels.

$20,000 instant asset write-off: The Government will increase the instant asset write-off threshold to $20,000 from 1 July 2023 to 30 June 2024. This is to reduce compliance costs and improve cashflows for small businesses. Small businesses, with aggregated annual turnover of less than $10 million will be eligible to immediately deduct the full cost of eligible assets costing less than $20,000 when first installed or ready to use. Importantly, this measure is based on a per-asset basis, so businesses can instantly write off multiple assets.

Managing tax instalments: The Government will amend the tax law to set the growth adjustment factor for pay as you go (PAYG) and Goods and Services Tax (GST) instalments at 6 per cent for the 2023–24 income year, a reduction from 12 per cent under the statutory formula. The reduced factor is designed to provide cash flow support to small businesses and other PAYG instalment taxpayers.

Personal income tax

Increasing the Medicare levy low-income thresholds: The Government will increase the Medicare levy low-income thresholds for singles, families and seniors and pensioners from 1 July 2022. The increase in thresholds aims to provide cost-of-living relief by taking account of recent inflation outcomes so that low income individuals continue to be exempt from paying the Medicare levy. The threshold for singles will be increased from $23,365 to $24,276 and the family threshold will rise from $39,402 to $40,939.

Exempting lump sum payments from the Medicare Levy: The Government will exempt eligible lump sum payments in arrears from the Medicare levy from 1 July 2024. This measure will ensure low income taxpayers do not pay higher amounts of the Medicare levy as a result of receiving an eligible lump sum payment, for example as compensation for underpaid wages.

Tax integrity

Additional funding for ATO: Additional funding will be provided to the ATO over the next four years to engage businesses with growing tax and superannuation liabilities. The measure will target businesses with high-value debts over $100,000 and aged debts over two years where those taxpayers are either a public or multi-national group with turnover greater than $10 million. Privately-owned groups or individuals controlling over $5 million of net wealth will also be targeted. A lodgement penalty amnesty program will be provided to small businesses with turnover less than $10 million.

Personal income tax compliance: The Government will provide $89.6 million to enable the ATO to conduct key activities in areas of non-compliance and expand the scope of the program from 1 July 2023. This aims to address emerging areas of risk, such as deductions relating to short-term rental properties to ensure they are genuinely available to rent.

Global and domestic minimum tax: From 1 January 2024, a 15% minimum tax rate will be applied to large multi-national and domestic enterprises with annual global turnover of $1.2 billion. The minimum tax is based on the OECD Global Anti-Base Erosion Model Rules, which are designed to ensure large multi-nationals pay an effective minimum level of tax on the income arising in each jurisdiction where they operate.

Expanding Part IVA anti-avoidance rules: The Government will expand the scope of the general anti-avoidance rules for income tax to ensure it can apply to:

• Schemes that reduce tax paid in Australia by accessing a lower withholding tax rate on income paid to foreign residents.
• Schemes that achieve an Australian income tax benefit, even where the dominant purpose was to reduce foreign income tax.

This measure will apply to income years commencing on or after 1 July 2024.

GST compliance: The Government will provide $588.8 million to the ATO over four years from 1 July 2023 to continue a range of activities that promote GST compliance. These activities will ensure businesses meet their tax obligations, including accurately accounting for and remitting GST, and correctly claiming GST refunds.

What does it mean for markets?

For domestic equity markets, the botched UK budget last year, and Treasurer Chalmers’ response at the time, has served to make this year’s Federal Budget a comparatively benign one. In his pre-budget interview in October 2022, Chalmers went as far as to comment that:

“Inflation is at its most threatening over the course of the next couple of years. And that puts an onus on us to be even more responsible”.

Not much has changed, and while it would be hard to argue this budget helps the Reserve Bank of Australia, it probably doesn’t make its task of lowering inflation sufficiently difficult to engender a market backlash (as was the case in the UK). Domestically, a near-term surplus and an improvement in the budget outlook to deficits of around 1%, from 2% previously, has at least initially led to little bond yield and currency movement overnight.

Consequently, the broad equity market impacts from the 2023-24 budget appear limited, and we are reluctant to draw too much sensitivity from announcements at a sector or stock level. We believe a 15% global and domestic minimum tax for large multi-national companies will have little to no direct implications for the domestic equity market.

How will sectors be impacted?

Energy: The Government’s proposal was the least impactful for earnings and valuations. The most significant change is to limit annual tax deductions for expenditure at 90% of a project’s income each financial year, not 100%. Analysts forecast limited impact on earnings pre-2025 but Woodside (WDS) is the most exposed. As onshore is excluded, Santos (STO) has more limited exposure. The ultimate tax paid will be highly dependent on the short-term and long-term global oil price, which is notoriously volatile and unpredictable.

Renewable energy: The Government’s total investment in this area is more than $40 billion and includes $2 billion for a hydrogen program called Hydrogen Headstart, $4 billion to “realising our future as a renewable energy superpower”, and a Capacity Investment Scheme designed to unlock more than $10 billion of investment in firmed-up renewable energy projects along the east coast.

Retail: There had been speculation about whether the proposed Stage-3 tax cuts might be unwound or postponed. Ahead of the budget’s formal release, the Government talked down this prospect – thus, the tax cuts remain. This was already factored into the sector and the implications are minimal. The proposed ‘cost-of-living’ package (estimated to cost around $14.6 billion) is largely focused on a boost to JobSeeker and financial assistance for households and small businesses, in an effort to tackle higher energy costs. Tax incentives for electrification and energy-efficiency upgrades also fall under the total $14.6 billion worth of spending. There is likely insufficient stimulus, or direct spending flow-through, to meaningfully boost the listed retail sector (particularly given the expected slowing consumer outlook).

Small businesses will have access to a $20,000 instant asset write-off, a small business energy investment, and help to ‘adopt and adapt’ to digital technology. Although relief is targeted at energy efficiency, ‘adopting and adapting to digital technology’ may mean some shorter replacement cycles (i.e. a greater intent to purchase), which may benefit some retailers like JB Hi-Fi and Harvey Norman.

Housing: Siblings and friends will be able to use the Government’s first home buyer programs together. People who have not owned a house in the past 10 years will also be able to access the scheme. This is positive for housing and sentiment but does little to alter supply-side dynamics, nor will it materially change demand. There are approximately 50,000 places available (10,000 of which are in regional areas). While this is not a new policy, the eligibility criteria has been widened (which in itself suggests that the original incarnation of the proposal had little impact on the overall housing market). Another $2 billion has been allocated for more social and affordable housing through the National Housing Finance and Investment Corporation. No significant listed exposure in this space as it stands.