As has been evident in recent times, wages growth is weak, struggling to break above 2 per cent in annual terms and it is being held back by an underutilised workforce, technological change and globalisation.
The forecasts for a pick up in tax revenue need not only employment growth to drive PAYG tax receipts for the government, but wages growth to exceed 3 per cent for several years. This may occur and the government is banking on it, but at the moment the risks appear to the downside. Even a relatively small undershoot in wages growth costs the budget many billions of dollars which can quickly erode the surplus currently penciled in for 2020-21.
On the upside, Treasury has taken a cautious approach to forecasting the ever-volatile iron ore price. It is assuming the iron ore trades at US$55 a tonne, which is around $US10 a tonne below the current market price. This is an important driver for the budget bottom line. In the budget in May, Treasury estimated that for each US$1 a tonne change in the iron ore price, the budget bottom line is impacted by $430 million in each year. This means that a US$10 upside surprise in the iron ore price would add around $4.3 billion to government revenue in a single year and lock in larger surplus in 2020-21.
If the iron ore price remains firm, at around current levels, a large upgrade to the return to surplus may occur when the annual budget is handed down in May 2018. It would be the sort of news that would see the government move to reduce income taxes as the election draws near.
As is clear, the factors that influence the budget bottom line are many and they are usually unrelated. The key issues for the budget into 2018 will be wages, employment, iron ore and company profits. The government is banking on these being strong so that it can collect the tax revenue it needs to hand back in the form of pre-election tax cuts.