This may happen, of course, and no one is seriously forecasting a major slump in economic activity. Even so it was interesting that hours before Mr Morrison handed down the budget, there was news of yet another month of weak retail spending and further falls in house prices. There is also clear evidence that housing finance for both owner-occupiers and investors is in sharp retreat and this is before the latest round of credit restrictions take effect. Even a small undershoot in economic conditions, including perhaps GDP growth 0.5 per cent lower than forecast, wages undershooting expectations or commodity prices being below the Treasury assumptions will blow many billions of dollars away from the budget bottom line.
In this instance, the forecasts for a near elimination of net government debt by 2030 will be unobtainable and will require a new strategy if that objective is ever to be reached.
The minor parties in the Senate need to be convinced
One other risk is the Senate. With a diverse mix of minor parties in the Senate, there is a material risk that the tax cut legislation will be blocked or that the government will need to offer some potentially expensive trade offs to get the tax legislation passed. At the moment, the next tranche of the company tax cut legislation for medium and large businesses is being held up in the Senate and it’s unclear whether these cuts will become law before the election is called.
If the Senate remains a road block to the government’s tax plans, Mr Morrison and his colleagues will need to rethink their policy strategy, especially with the next election rapidly coming into focus.
Speaking of the election…
The budget is being described as a pre election budget largely because of the income tax cuts and promises of infrastructure spending. The government is hoping the electorate responds positively to these initiatives. But beware, the election looks likely to turn into a bidding war for our votes. Not to be outdone, the Labor Opposition is ramping up tax policy as a key aspect of its attempts to appeal to the electorate.
It is proposing bigger income tax cuts than the Coalition for low and middle income earners and has committed to extra funding for health and education. It is paying for these commitments by opposing the company tax cuts to medium and large business and looking to raise revenue from a range of tax reforms that will coincidently have a material impact on investment strategies.
The election could impact how and where you invest
It’s been well documented that Labor plans to change negative gearing rules by limiting tax deductions for investment properties to newly built properties. At the same time, its proposal to change income tax refunds to individuals from fully franked dividends will likely discourage investment in the high yielding, fully franked ASX-listed companies. It is also planning to change the rules surrounding capital gains tax concessions, a policy that will deliver more revenue to the budget.
As a result of these changes, a Labor win at the election will no doubt see investors adjusting their asset allocation in their investments, with negatively geared established dwellings and high yielding stocks less attractive.
Open the door for fixed income?
One asset class has been gaining greater attention in recent years is higher yielding fixed income. At a time when the economic cycle is moving against property and the stock market is fragile, relatively low risk, high yielding investments are a sound part of any portfolio. With corporate borrowing set to increase in line with the probable lift in non mining business investment, corporate debt issuance is likely to rise at a time when the asset allocation shift will be unfolding.
Tax Plan A versus Tax Plan B
The budget sounded the starting gun for the election. Both sides of the political fence will be offering income tax cuts, albeit targeted to different income scales and different constituents in the electorate. Labor will be collecting more revenue from tax changes in areas where the Coalition is strongly opposed.
One thing both sides can agree on (and it is actually a welcome big picture policy issue) is a pledge to deliver budget surpluses and lower government debt. Both sides will however, be banking on future solid economy growth in order to implement planned policies.
Investment strategies for individual investors may need to be revised depending on which side wins, with traditional negative gearing of property and investing in high yielding stocks moving out of fashion if Labor wins. Either way, the good news is that there are income tax cuts, budget surpluses and lower government debt, which most people would agree is a good policy prognosis.