Did you catch the apparent contradiction in this week's mid-year budget update? It left unchanged the forecast that the economy would grow by 2.5 per cent this financial year, but then blamed a weaker-than-expected economy for most of the $10 billion blowout in the expected budget deficit.
How on earth is that explained? By a widening gap between real gross domestic product and nominal GDP.
We tend to focus on the growth in real GDP – GDP adjusted for inflation – as the best guide to how many additional jobs are being created and, in normal circumstances, what's likely to be happening to our material standard of living.
Trouble is, as former treasurer Wayne Swan kept saying, we live – and work, earn income and pay taxes – in the nominal economy, not one that's already been adjusted for inflation.
At budget-time Treasury was expecting nominal GDP to grow by 3 per cent and real GDP by 2.5 per cent, implying that the prices of all goods and services Australia produces would rise by 0.5 per cent.
Now, however, it's expecting nominal GDP to grow by just 1.5 per cent, implying it's expecting the overall price of the stuff we produce to fall by 1 per cent.
So initially Treasury was expecting "producer" prices to rise only a little overall and now it's actually expecting them to fall. Why? Because of falls in the prices our producers of commodity exports receive, particularly for iron ore.
The budget in May assumed the price of iron ore would stay at $95 a tonne, but now Treasury's assuming it will stay at its recent price of $60. Lower export prices mean lower mining company profits which, in turn, mean lower collections of company tax – by $2.3 billion this financial year, and more in subsequent years.
But there's another major factor contributing to the lower growth in nominal GDP: nominal wage rates are now expected to grow by only 2.5 per cent, not 3 per cent. This (plus lower growth in employment) is expected to reduce the growth in collections of income tax by a further $2.3 billion.
Adding a few other items, expected total tax receipts have been cut by $6.2 billion, with all the delays and deals in the Senate explaining most of the remainder of the $10 billion increase in the now-expected budget deficit of $40 billion.
The mid-year document says that if nominal GDP grows by only 1.5 per cent in 2014-15, this will be its weakest growth in more than 50 years. But the truth is nominal GDP has been growing by much less than its usual 5.5 per cent or so (real growth of 3 per cent plus inflation of 2.5 per cent) ever since mining export prices peaked in 2011.
The writedown in expected tax receipts of $6.2 billion this financial year increases to $31.6 billion over the four years of the "forward estimates". And that brings the total writedown in tax receipts since the Abbott government was elected to more than $70 billion.
Wow. The prices we get for our mining exports have been falling much further and faster than Treasury has expected. Of course, the rot set in during Julia Gillard's term. It was the biggest reason she failed to keep her promise to get the budget back to surplus in 2012-13.
Back then, Joe Hockey was having none of Swan's claim that nominal GDP and tax collections had collapsed under him. No, there was just a single explanation for the continuing budget deficit: Labor's uncontrolled spending.
Different story now you're Treasurer, eh Joe. You've got it right now.
But there's a lesson in this week's budget blowout for Labor, too. In last year's mid-year update, Hockey produced an estimate for the 2013-14 budget deficit of $47 billion, up $17 billion on the $30 billion the secretaries of Treasury and Finance signed off on during the election campaign.
About $10 billion was creative accounting and other dubious transactions Hockey claimed were Labor's fault. The remaining $7 billion was explained by Treasury revising down its forecasts for employment and wage growth and, hence, tax collections.
Former Labor ministers were convinced Hockey lent on Treasury to make its revenue forecasts much worse than they needed to be and so make Labor look bad. My guess, however, is that Treasury had been over-forecasting revenue for so long it seized the opportunity to try to get ahead of the game and, if anything, start under-forecasting revenue.
Subsequent events have confirmed the wisdom of Treasury's downward revisions at that time. They proved pretty right. But as this week's further downward revisions for the following financial year show, Treasury is yet to get ahead of the game in accurately forecasting the extent of the slowdown in the growth of tax receipts.
So, Labor, no conspiracy, just the usual stuff-up. That's to say, the usual human frailty. Treasury is no better at predicting what will happen to commodity prices than the rest of us.
There remains one more puzzle to be explained. If Treasury is now expecting slower growth in employment and wages this financial year, how can this not have led it to revise down its forecast of real GDP growth of 2.5 per cent?
Good question, but you'll be sorry you asked. Part of the explanation is a change in the expected composition of the growth – some components were revised up, some down.
But longstanding convention requires official forecasts to be expressed in fractions of a quarter, so as to avoid "spurious accuracy". Strictly, the forecast is 2½ per cent, not 2.5 per cent. Treasury's actual, decimal-point forecast has been revised down, from a bit above 2½ to a bit below. But not enough below to be closer to 2¼ than to 2½.
Don't say l didn't tell you.
Ross Gittins is the economics editor.
