7.1 Methodology of Budget aggregate projections

The Budget aggregate projections within the Phase One Report are based on projections from the 2013‑14 MYEFO. Where the Commission has made its own assumptions (for instance about future tax revenue), these are noted in the Report.

The Commission used Treasury’s fiscal aggregate projection model (FAPmod) to produce the aggregate projections.

FAPmod combines projections of receipts, payments and balance sheet components to produce an internally consistent cash and accrual framework, with interconnected operating and cash flow statements and balance sheet. From these statements, aggregate Budget projections are produced.

This differs to the approach used for Budget aggregates across the forward estimates period, where estimates are based on detailed programme level information.

The projections of receipts, payments (both of which are cash) and balance sheet components come from separate but methodologically consistent models. The models are underpinned by the ‘three Ps’ (population, participation, productivity), the same framework which underlies the intergenerational report. The models assume the continuation of current policy.

Further information about Treasury’s FAPmod can be found in Treasury (2009).

Receipt projections

Medium-term tax receipts are projected by head of revenue using parameters for wages, profits and consumption linked to nominal GDP growth — similar to the revenue projections for the last two years of the forward estimates period.

Consistent with current presentation in the Budget papers, the underlying cash balance does not include earnings from the Future Fund. For simplicity and consistency, the charts displaying projections of total receipts do not include Future Fund earnings.

Payment projections

Payments are projected using a suite of models, including models that project spending on health, income support payments, education and training, aged care, major superannuation defined benefit schemes, and defence. Whilst the details of the various spending models differ, they are mainly driven by expected changes in demand (in most cases driven by demographic change) and prices.

A number of programme estimates are included in the aggregate projections where programmes are expected to have a substantial financial impact beyond the forward estimates period, for example the National Disability Insurance Scheme.

The underlying cash balance does not include the operating costs of the Future Fund. For simplicity and consistency, the charts displaying projections of total payments do not include the operating expenses of the Future Fund.

Economic and demographic projections

The fiscal aggregate and programme projections are based on economic and demographic parameters.

These parameters are based on medium-term assumptions of growth consistent with historical experience adjusted, where appropriate, for long-term factors such as demographic change.

The same set of economic and demographic parameters is used for the medium-term aggregate projections and the medium-term programme projections. These parameters are also consistent with those from the 2013-14 MYEFO.

Further detail on the significant parameters is below.

Real Gross Domestic Product

Real GDP is assumed to grow by 2½ per cent in 2013-14 and 2014‑15, and 3 per cent per year in 2015‑16 and 2016-17.

Beyond the forward estimates, real GDP is assumed to grow at its trend rate of around 3 per cent a year. Trend growth in real GDP is projected to slow early next decade as the participation rate declines with Australia’s ageing population.

Inflation

Consumer price inflation is projected to be around 2½ per cent per year from 2015-16 consistent with the Reserve Bank’s medium-term target band.

Nominal Gross Domestic Product

Nominal GDP is assumed to grow at 3½ per cent per year in 2013-14 and 2014-15, increasing to 4¾ per cent per year in 2015-16 and 2016-17.

Nominal GDP growth is determined by the combination of real GDP growth and economy wide prices, and is projected to be around 5½ per cent per year, beyond the forward estimates period.

Unemployment rate

An unemployment rate of 6 per cent in 2013-14 and 6¼ per cent in 2014-15 has been assumed. The unemployment rate is projected to remain at around 6 per cent beyond 2014‑15.

Participation

A participation rate of around 65 per cent in 2013-14 is assumed. This rate falls over time, primarily due to the impact of the ageing of the population.

Productivity

Labour productivity is assumed to grow at a rate of 1.6 per cent per year, reflecting historical annual rates.

Wages growth

Growth in wages is assumed to be around 2.75 per cent per year in 2013-14 and 2014-15. From 2015-16 growth in wages is projected to be around 4 per cent per year. This reflects growth in the CPI and labour productivity.

Terms of trade

It has been assumed that the terms of trade decline until 2019-20, when they reach a long‑run level similar to the level in 2006-07. They then remain at this level.

Budget aggregate scenarios

The Commission has produced medium-term fiscal outlook scenarios under different assumptions than those presented in the 2013-14 MYEFO. These scenarios help explain the fiscal outlook and implications of possible government decisions. They are purely indicative to demonstrate what the projected outlook could look like under different assumptions.

‘Business as Usual’ scenario

In the ‘Business as Usual’ scenario, estimates and projections of spending and revenue out to 2023-24 are based on the forecasts and projections presented in the 2013‑14 MYEFO.

However, tax collections are limited to 24 per cent of GDP. Implicit in this assumption is that bracket creep is returned through the personal income tax system.

Payments increase in line with published MYEFO numbers, with the only difference occurring through higher public debt interest payments, due to weaker Budget projections than at MYEFO.

‘Reform’ scenario

The ‘Reform’ scenario makes the assumption that tax receipts do not exceed 24 per cent of GDP, (the same assumption as the ‘Business as Usual’ scenario) and that growth in payments is constrained such that the Budget improves to a 1 per cent of GDP surplus in 2023-24.

The constraint on payments begins in 2014-15 and continues until 2023-24.

Under this scenario, payments would decline from their current level of around 26 per cent of GDP to around 24 per cent of GDP by 2023-24.