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Statement 1: Fiscal Strategy andBudget Priorities

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Part II: Fiscal strategy

The 2001-02 Budget has been framed against the Government's medium-term fiscal strategy. The primary objective of the strategy is to achieve budget balance on average over the course of the economic cycle. The supplementary objectives of the fiscal strategy are:

The 2001-02 Budget continues to meet these objectives.

Benefits of the medium-term fiscal strategy

The Government's medium-term fiscal strategy provides a number of benefits to the Australian economy. These benefits were discussed in detail in Budget Statement 1 of the 2000-01 Budget. The benefits include:

Adherence to the medium-term fiscal objective of budget balance on average over the course of the economic cycle also ensures that, abstracting from asset sales, nominal net debt will remain constant over time (as GDP increases over time, the ratio of net debt to GDP would fall). Net debt as a per cent of GDP has fallen considerably since 1996, from its peak of around 19 per cent in 1995-96 to under 6 per cent projected for 2001-02.

Australia's total general government net debt level is much lower than in most other industrial countries (Chart 2). It is among the lowest in the OECD and compares well to the OECD average of around 40 per cent of GDP.

Chart 2: General government net debt levels in selected countries (a)

Chart 2:  General government net debt levels in selected countries (a)

(a) Data are for the total general government sector (that is, the aggregate of all levels of government including the social security sector but excluding the PTE sector).

(b) The above net debt data for Japan are inclusive of assets held by the social security system. Japan's net debt, calculated exclusive of these assets, was estimated by the IMF to be almost 100 per cent of GDP by March 2001.

Source: OECD Economic Outlook 68, Reserve Bank of New Zealand, Monetary Policy Statement March 2001, ABS Public Sector Financial Assets and Liabilities, 1998 (Cat. No. 5513.0), ABS 1999-2000 Government Financial Estimates (Cat. No. 5501.0), ABS 2000-01 Government Financial Estimates (Cat. No. 5501.0), State and Territory 1999-2000 budget outcomes, 2000-01 mid-year reports, 2001-02 Budgets where available and Treasury estimates.

Fiscal policy response to economic shocks and the medium-term fiscal strategy

Within its inflation targeting framework, monetary policy can be adjusted much more quickly to respond to short-term variation in economic activity than can fiscal policy.

That said, a key strength of the medium-term fiscal strategy is that it allows fiscal policy to respond to short-term fluctuations in economic activity while providing an anchor to ensure that fiscal discipline is maintained over time. In the present situation of a temporary slowdown in economic growth, an easing in the fiscal position is appropriate as it helps to support demand growth in the economy.

The Government has provided a moderate stimulus in the 2001-02 Budget through targeted tax reductions, discretionary spending and by allowing the Budget to respond to the temporary slowdown in economic growth (through the operation of the `automatic stabilisers' which reduce tax revenues and increase expenditure). This is an appropriate policy response to recent economic developments. It is consistent with the medium-term fiscal strategy.

The easing in the fiscal position in 2001-02 builds on the stimulus already provided in the 2000-01 Budget. Discretionary policy action in the form of significant personal income tax cuts associated with The New Tax System, the further reduction in the company tax rate, the abolition of the Financial Institutions Duty (FID) levied by the States and Territories and the bring forward of full input tax credits for motor vehicles acquired by GST registered businesses will support economic growth.

However, as noted in the Fiscal Strategy statement of the 2000-01 Budget, the scope to use fiscal policy to `fine-tune' demand should not be overstated. The impact of significant changes in fiscal policy are likely to lag underlying changes in economic activity, and be offset, to some extent, by changes in private saving, the `crowding out' effects of increased competition for funds, and changes in the exchange rate.

The significant fiscal consolidation of recent years has achieved an average budget surplus of around ½ per cent of GDP. This has provided sufficient scope for fiscal policy to be accommodative of slower economic growth without threatening the sustainability of public finances. Furthermore, consistent with the temporary nature of the current economic slowdown, the fiscal easing is moderate and, as indicated in projections for the forward years (2003-04), is expected to reverse in later years.

The sustainability of the current fiscal position is also demonstrated by the expected continued improvement in the Government's net worth and reduction in the ratio of net debt to GDP over the budget and forward estimates period.

Commonwealth general government net debt as a proportion of GDP is expected to further decline from 6.4 per cent of GDP in 2000-01 to 5.4 per cent of GDP in 2001-02 (Budget Statement 2, Chart 3). On current policy settings, debt could be eliminated in 2004-05.

Policy measures introduced in this and previous budgets, including reforms to the welfare and taxation systems, deliver longer-term structural benefits to the economy. Furthermore, the Government's medium-term fiscal strategy also contributes to a stable economic environment conducive to longer-term productive investment. Together, these benefits will help to sustain stronger economic growth over the medium-term and improve the economy's flexibility to adjust to economic shocks. This will yield significant dividends to the budget over time and assist with the future achievement of fiscal objectives.

Fiscal policy beyond 2001-02

The underlying cash balance will remain in surplus over the entire forward estimates period.

A small fiscal deficit is currently projected for 2002-03 before the fiscal position returns to surplus over the remainder of the forward estimates period, in line with projected economic growth.

The small deficit in 2002-03 occurs as a result of accounting treatment which treats tax accruing but unpaid as revenue in 2000-01 and consequently treats it as not accruing in the later years when it is actually paid.

As always, the size of the projected surpluses in the forward years need to be treated with some caution, given uncertainties associated with economic projections and the `no policy change' assumptions on which they are based.

The Government will continue to assess economic developments as they occur and will set fiscal policy each year according to the economic circumstances at that time and the requirements of sound economic and fiscal management established by the medium-term fiscal strategy.

1 Net worth is defined as general government assets less liabilities and discussed in more detail in Budget Statement 2 and Budget Statement 8.

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