Editor’s Note: Tomorrow is a watershed moment in our publishing business.
It is the day we release to you a definitive plan for dealing with ‘what comes next’ in the Australian economy.
We’re calling it ‘Day Zero’. Really, though, it’s just an arbitrary line in the sand that we’re drawing. There was the last 12 years. And there’s the next 12 years. We’re going to focus, for a time at least, on what those next 12 years have in store for you. The potential dangers. And the potential opportunities.
Of course, we don’t possess a crystal ball.
But we can guess the next 12 years for Australia will be vastly different than the last 12. You just need to look back at when the last Long Boom ended in the mid-1970s for an indication of what might be in store…
It wasn’t pretty…
Aussie house prices crashed, unemployment doubled, there were riots and industrial disputes, inflation went up 16% — and that was just in 1974!
Australian profits imploded; government spending ballooned 46% in a single year; we plunged into a current account deficit and never ever got back into surplus. Just a year prior, the economy had been sailing along nicely at 6% annual growth! Maybe you were there and you remember. Ordinary Aussies were shell-shocked with how quickly it all happened.
Do we have a similar fall to Earth in our near future?
Maybe not. Maybe we’ll keep on chuggin’.
We defied all odds in the last decade. Who’s to say we won’t again?
But if the above scenario IS going play out again…at some point soon…wouldn’t it be good to have some kind of contingency plan? A safety net in place so you don’t lose as much as everyone else? And even pick up a few wealth-building opportunities along the way?
That plan is coming on Tuesday. It’s a contingency plan for ‘Peak Australia’.
Budget night is only seven weeks away.
On 9 May, we find out how Treasurer Scott Morrison intends to deliver on last year’s promise of ‘living within our means’.
‘Like any Australian family or business, the Government is focused on keeping expenses down to balance the Budget and pay down debt.
‘A stronger Budget supports jobs and growth and instils confidence as the economy transitions. Strengthening the nation’s finances is key to the Government’s economic plan. Working to balance the Budget will restore the buffers that protect Australia against the economic shocks and uncertainties that might otherwise threaten our future success. Importantly, the Government remains committed to balancing the Budget.
2016–17 Budget Papers
To achieve this noble and lofty objective, which expenses are going to be kept down, and which revenue sources are going to be raised?
Equally as important, which senators will support or block the initiatives to allow us to live within our means?
The government thinks it has time to ‘restore the buffers that protect Australia against the economic shocks and uncertainties that might otherwise threaten our future success.’
The current market conditions are like an aneurysm…a bulging, weak area in the wall of an artery that can rupture without notice, with deadly consequences.
The pressures from the greatest asset bubble in history could result in markets rupturing at any time.
Indebted and overcommitted governments may not be given time to restore their budgets to good health.
But, on a positive note, let’s assume Morrison and Prime Minister Turnbull have a little time up their sleeves to narrow the deficit gap.
What’s a probable course of action?
The path to a balanced budget is not easy
First, identify the problem.
We are deep in red ink due to overpromising on benefits and under-delivering on revenues.
A slow-growth economy — with stagnating wages and an increasing level of underemployment — is not generating the tax revenues needed to pay for burgeoning welfare and health costs.
So, do we raise taxes or lower expenditures (welfare, healthcare and education), or a combination of both?
My guess is that it’ll be the latter, with tax increases doing most of the heavy lifting.
Whenever any change to the status quo is flagged, the political message has been, is, and will always be: No disadvantage to less well-off Australians.
At all costs, we must not spook the electorate.
‘Tax the rich’ always plays out well to the crowd. The masses are told ‘don’t you worry, someone else (richer than you) will pay.’
The crowd is being played for mugs. They’ll pay; they just don’t realise it.
The government can make all the promises it likes about ‘compensation packages’ and ‘a fairer tax system’ to calm the nerves in voter land, but the reality is that the government needs more dollars…and lots of them.
We will all pay (either a lot or a little) in some way, shape or form. Believing the message that someone else will pay is either naivety or stupidity.
The 2015/16 budget papers included access to a nifty calculator that showed how much tax you pay on your income and where those tax dollars go.
For some reason, this tool was deleted from the 2016/17 papers… ‘Mushroom’ treatment, or an oversight?
Anyway, here’s the snapshot from the 2015/16 tax calculator for someone earning $70,000.
Source: 2016–17 Budget Papers
[Click to enlarge]
A person earning $70,000 pays income tax of $15,697.
Welfare consumes nearly 40% ($6,118) of the tax paid.
Add in the amount allocated to health, and you have a massive 57% of the tax take going to these two items alone. This percentage is destined to go higher when boomers are in full retirement mode.
This is just the allocation of the income-tax take. It does not include the tax revenues derived from levies, excises, sin taxes, duties, GST, superannuation tax, luxury car tax, a multitude of state government charges (vehicle registration, stamp duty, land taxes, etc.) and local government rates.
There are 125 ways the government can pick your pocket
According to the Federal Treasury Department, Australians pay at least 125 different taxes each year. Governments at every level (local, state and federal) have multiple pipelines into our hip pockets…to fund their overpromises, waste, bureaucracies, indebtedness and incompetence.
According to Treasury figures, the total taxes paid in Australia are nearly $500 billion.
How much waste is in that $500 billion?
10% or more?
That’s a lot of money.
Ridding the system of this waste is not a politically-acceptable option. Powerful public sector unions and highly-organised and well-financed special interest groups (of which there are plenty) are committed to maintaining (and preferably increasing) their share of the tax pie.
Any politician with an eye on the opinion polls (especially one who has plummeting ratings) would never seriously consider poking these angry bears too much. Easier to pay the waste of $50 billion or more in hush money.
Accepting the expenditure side of government budgets is unlikely to be seriously addressed (unless a major economic event forces this outcome or a politician grows a pair); it’s only logical then to expect some of the 125 different taxes to be increased.
This is where it gets interesting.
An ageing population poses two big problems. Over the coming decade, the income-tax receipts from retiring boomers are going to contract as welfare and health expenditures expand.
With the tax receipts from boomers declining, where does the government get the money needed to fund ballooning welfare and healthcare commitments?
Increase the income tax burden on those left in the workforce? Unlikely.
The money will come from the other 124 taxes.
We will all pay, whether we know it or not.
GST and superannuation (contribution and pension tax rates) are the obvious tax targets, but you can bet there will be others.
Back to the future
We are fast approaching a point I wrote about over a decade ago.
On 6 August 2006, my weekly article in The Cairns Post was titled: ‘Plan for the Future Now’.
Here’s an extract:
‘As stated in previous columns water, fuel, food and healthcare costs in the future are going to absorb much more of your household budget.
‘The cost of these items will grow at a higher rate than inflation.
‘The other big impact on future budgets will be an increased rate of GST.
‘Over the next 20 years, the Government will gradually lose the income tax receipts from the retiring baby boomers.
‘Where will they source the much-needed revenue to pay age pensions and healthcare for an ageing population? Governments won’t be able to significantly increase income taxes on the next generation as it will be too much of a disincentive.
‘The only logical answer is to spread the cost across the whole community via an increase in GST.
‘The average retiree of tomorrow will enjoy a longer life but the cost of living will be much higher than expected.
‘Any government contribution, via the age pension, to their living expenses may not be as generous as the current pension system.
‘There simply may not be enough tax revenue to share around so a harsher means test would need to be introduced.
‘I cannot emphasise enough the need to organise your financial planning requirements. There are massive social, technological and economic changes that will occur in the next one to two decades.
‘Exactly what they will be and what the precise repercussions will be I cannot tell you.
‘But the one answer that keeps coming back to me is that we will need more money to live on if you wish to retain a reasonable standard of living, in this new and exciting world.’
The harsher means test was delivered on 1 January 2017…and it will only get tougher in the years to come.
Technological change is coming rapidly. The automation of jobs is possibly one of the greatest threats to income tax revenues.
The one important variable I didn’t foresee a decade ago was ultra-low interest rates.
When you add this into the mix with the other challenges — living longer, rising costs of living and crimping of age pension benefits — it means retirees will need much, much more money to live on.
Not hard to see retirements being postponed until people are well into their seventies. People will simply not have the money to fund a multi-decade-long retirement.
Low interest rates are a reflection of the low-growth (deflationary) world we now find ourselves in.
Gone are the days of boomers going deeper and deeper into debt to keep up with the Joneses.
Without these credit dollars flowing through the system to boost economic activity, the government cannot generate sufficient tax dollars to fund its promises.
The twin-edge sword of low interest rates
Everything is being done, via lower interest rates, to encourage another sustained debt binge by the next generation.
A severe market downturn may well make younger generations adopt the same frugal mindset as the generation who lived through the Great Depression.
A repudiation of debt by an entire generation would certainly throw a spanner into the Treasury’s works.
The flipside of low interest rates is that income-starved retirees are being forced to chase higher-yielding investment options. There is a capital risk attached to these investments, whether they know it or not.
What happens in the event that a major market meltdown actually takes place?
Those who reached for an extra few percent of income will see a good chunk of their capital vaporised.
Instead of having much, much more money to live on, they’ll have much less money…and fewer assets to be means tested.
This, in turn, puts more pressure on the welfare budget.
We are facing a real conundrum. The nuts and bolts of how this gets resolved are going to be interesting, but the big picture outcome is almost assured.
For workers, it will be a combination of working much longer, paying higher indirect taxes, and receiving lower levels of government benefits (welfare).
For retirees, it possibly means returning to the workforce (full or part-time), paying higher indirect taxes, subsiding their lower incomes with capital drawdowns (reverse mortgages will be in vogue in the coming decade) and paying higher healthcare costs.
The system we have today is a product of an economic model that encouraged far too much debt to create economic ‘growth’.
This artificial ‘growth’ provided the political class with an increasing stream of taxes to buy votes with…in the form of generous welfare promises.
The promises remain, but the income has proved to be transient.
No matter how well intentioned the Treasurer might be, balancing the budget is not going to happen voluntarily.
We’ve had it too good for too long to recognise the unsustainability of the situation we’ve created.
Therefore, budget discipline will be forced upon us by the markets at a time of their choosing.
Obviously, the government hopes the economic shocks and uncertainties that might otherwise threaten our future success are delayed long enough to build a buffer.
I’m not so sure we have that luxury.
The financial and economic model that’s been built on a bulging pile of debt is in danger of rupturing at any time.
Be prepared…make sure you are living within your means.
Editor, The Daily Reckoning