Estimates of the structural budget balance adjust for temporary factors that have a significant impact on the budget balance. For the Australian Government, these factors include cycles in the real economy, and deviations in the terms of trade and capital gains tax (CGT) receipts from their estimated long-run, or ‘structural’, levels. Considered alongside underlying cash balance estimates and balance sheet indicators, structural budget balance estimates can provide broad guidance on whether current fiscal policy settings are sustainable over the medium term.
While structural budget balance measures are conceptually appealing, they are sensitive to the assumptions and parameters underpinning the estimates. Following a decade in which Australia’s terms of trade has doubled, to reach the highest level in at least 150 years, identifying the structural or long-run level is conceptually challenging — using different assumptions for the terms of trade leads to substantial differences in structural balance estimates. In addition, the relationship between tax receipts and economic activity is a complex one that varies through time as the structure of the economy changes. Finally, international experience has demonstrated the difficulties in disentangling temporary from permanent economic factors, especially in real time.
For these reasons, it is best to consider a range of structural budget balance estimates based on plausible assumptions for the underlying parameters as one element of a broader assessment of fiscal sustainability. The budget balance, balance sheet indicators, projections of the fiscal costs of demographic change and assessments of contingent liabilities each provide a different perspective on fiscal sustainability over time. Budget Statement 4 2013-14 presents a range of such indicators for the Australian Government.
This Working Paper presents an overview of structural budget balance estimates and the adjustments most relevant for Australia. Three models (the OECD model, the IMF model and Treasury’s previously published model in the Australian Government’s 2009-10 Budget and McDonald et al (2010)) are explored. Updated estimates of the Australian Government’s structural budget balance are presented using the preferred approach in McDonald et al (2010) under a range of plausible assumptions for the terms of trade. Lastly, sensitivity analysis is conducted on key parameters, illustrating that parameter uncertainty has less impact on structural budget estimates than varying the assumption for the structural level of Australia’s terms of trade.