‘Good and Bad debt’: Spending on Infrastructure
While the 2017/18 Budget addresses the political imperatives of social equality, it fails to add up in any national accounting sense. Most obviously, the headline result remains deep in deficit at $29.4 billion (1.6% of GDP); whilst the structural deficit (i.e. "adjusted for the economic cycle") is of the same order of magnitude.
A theme, which had been widely promoted in the lead-up to the Budget, is the introduction of "good and bad debt" terminology. The Budget announced the funding of both the Western Sydney Airport ($5.3 billion) and the Inland Rail Project ($8.4 billion) that will run from Melbourne to Brisbane. This incremental "good debt" and associated infrastructure spend ($25 bn in total, off-Budget) will in our view be marginally net positive for economic growth on a one to two-year view. Longer term, the benefits are more debatable.
Economic and Fiscal Outlook
The Budget has adopted a fairly conservative and realistic view on the Australian economy, anticipating that GDP growth will pick up from 1.75% in 2016/7 to 2.75% in 2017/8 (and 3% in 2018/19).
This growth will be driven by exports (underpinned by liquefied natural gas in particular), and investment. The onus will be on publicly funded investment to lead the way, with the private sector still seemingly hesitant to commit (despite strong self-reported business conditions and reasonable confidence).
The NSW Government is in the process of a large round of infrastructure spending, off the back of the sale of major public assets (with the Land and Property Information unit the most recent). This, together with improving economic conditions globally, gives some measure of credibility to the Budget's economic projections.
This backdrop of stronger economic growth will see a decline in the unemployment rate, on the Government's reckoning, from 5.9% currently to 5.75% by June 2018. This is somewhat consistent with the Reserve Bank of Australia's forecast of a temporary slowdown in the second half of 2017.
In terms of government finance, the Australian government has seen expenditure outpacing revenue since 2007. As of 2016, expenditure was at 25.9% of GDP, while revenues were at 23.4%. The budget anticipates that spending growth will be gradually reined in over the next five years, while revenues see steady growth. This combination is projected to deliver a small budget surplus of $7.4 billion by 2020/21.
Implications for Investors
Yet another year of deficit will offer short-term fiscal support for the Australian economy. It also diminishes the risks of recession should housing and commodity prices cool. Further, we believe that the Reserve Bank of Australia will applaud the higher-debt/higher-infrastructure combination, and after many long years of "emergency" cash rate settings, welcome the opportunity to hand over the task of stimulating the economy to fiscal policy.
This suggests that there will be no further cuts to official interest rates for this cycle, and raises the possibility of a hike in 2018 or even, should the economic news-flow remain firm, in late 2017.
With economic growth continuing and with a return to surplus still forecast, we believe that Australia will stave off any downgrade to its AAA credit rating for 2017 at least.
The budget confirmed rumours of the establishment of a savings arrangement for first home buyers. However, rather than separate accounts the saving arrangements will be managed through the superannuation system.
The arrangement will allow future voluntary contributions to superannuation, made by first home buyers from 1 July 2017, to be withdrawn for a first home deposit, along with an amount for deemed earnings on those contributions.
The announcement provides no indication of how voluntary contributions will be separated from other contributions. For employers that offer a total remuneration package and allow employees to select their level of superannuation contributions, changes to systems and processes may be required to report these voluntary contributions to superannuation funds so that they can be identified accordingly.
The contributions are limited to $15,000 per annum and $30,000 in total, within existing contribution caps. Contributions can be made from 1 July 2017.
These concessional contributions and the deemed earnings, will be taxed at marginal rates less a 30% offset on withdrawal. With the 15% tax on concessional contributions that provides an overall tax concession of 15% (not the 30% quoted in the Treasurer’s speech). Withdrawals will be allowed from 1 July 2018 onwards.
Both members of a couple can take advantage of this measure to buy their first home together.
The former Labor Government’s first home saver accounts (announced in 2007 and later abolished on 1 July 2015) offered an 18% Government co-contribution up to an annual contribution of $6,000.
The stated reason for the abolishment of those original accounts was lower than forecast take up rates. It’s not clear that this new arrangement will lead to a significantly different outcome now or that it is any more than a political response to the housing affordability issues.
There is of course a legitimate argument that initiatives like these which increase demand aren’t likely to reduce the growth in house prices nor do little more than increase the wealth of existing home owners.
People over 65 who downsize will be able to invest up to $300,000 of the proceeds of the sale in superannuation. That contribution will be treated separately to the $100,000 annual non-concessional contribution cap and the prohibition on non-concessional contributions for members who have reached a $1.6 million balance. These amounts cannot be transferred into an account-based pension if the $1.6 million transfer cap has already been reached.
There is no exemption associated for the sale proceeds from the age pension assets or income means tests. Those most interested in this measure are likely to already have large balances in superannuation and be well above the age pension means test thresholds.
The ability to place a part of the downsizing proceeds in a superannuation account, where the investment income will be taxed at a nominal rate of 15%, or a pension account if they haven’t reached the transfer cap, where investment income is tax-free, will be attractive to individuals with other assets outside superannuation. Previously these people would have had to pay tax on the investment income earned on the proceeds from downsizing.
However, with tax-free thresholds and the seniors and pensioners tax-offset (SAPTO), many people with more limited assets outside super don’t pay tax on the investment income on their assets.
This provision applies only to sales of a principal place of residence that has been owned for more than 10 years.
Given the limitations on this change, it seems to benefit a limited segment of investors with significant assets inside and outside super. While there may be some trickledown effect it’s not clear that they will be selling houses that are within the reach of first home buyers.
The CGT and tax loss rollover relief scheduled to expire 30 June 2017 has been extended to 30 June 2020 to coincide with the completion of the Productivity Commission review of the efficiency of the superannuation system.
The rollover relief allows superannuation funds to merge without losing the value of accumulated tax losses known as deferred tax assets (which ordinarily can’t be transferred between superannuation funds) or triggering the realisation of capital gains.
Rollover relief was originally offered following the GFC when superannuation funds had significant capital losses and stood to lose the value of the deferred tax assets if they merged. It was reintroduced with stronger super to allow for mergers as part of the transition to the MySuper regime.
With the Government and Regulators keen to see a reduction in the number of superannuation funds, retaining this provision is sensible. The retention of this provision, of course applies to those funds merging and the benefit depends on the extent to which those funds carry tax losses or capital gains.
Following the review by Prof Ian Ramsay on the various existing dispute resolution frameworks (the Superannuation Complaints Tribunal (SCT), and the two ombudsman services), the Government will establish a new single one-stop shop service from 1 July 2018 called the Australian Financial Complaints Authority (AFCA) who will have the power to resolve complaints regarding banks, super funds and other financial institutions.
Decisions by the AFCA will be binding on both consumers/members as well as financial services providers.
ASIC will be provided with stronger powers to oversee the new body, and to require providers to report on their dispute resolution activity.
Existing complaints as at 30 June 2018 will need to be resolved by the SCT before it is wound down from 1 July 2020.
It remains to be seen whether this will be a more efficient and fair external dispute resolution process.
From 1 July 2017, the Australian Securities & Investments Commission (ASIC) will introduce a new levy and the existing Australian Prudential Regulation Authority (APRA) levies will be further increased.
Entities regulated by ASIC will be required to pay a levy which ASIC will use to fund its operations. The Government expects to raise $112.6 million over the next 3 years. The levy will be used to cover ASIC operations including:
- promoting financial literacy;
- the administration of unclaimed moneys;
- the operation of the North Queensland Insurance Aggregator; and
- the activities by ASIC’s Enforcement Special Account.
The existing APRA levies on superannuation funds and other APRA regulated organisations will be increased to provide APRA with additional funding to meet the evolving regulation needs of new products.
In addition, Authorised Deposit-taking Institutions (ADIs) with licensed entity liabilities of at least $100 billion, i.e. the big banks, will be required to pay a new levy. The levy is 6 basis points per annum of an ADI’s licensed entity liabilities. Liabilities subject to the levy will include corporate bonds. The Government says that the levy will raise $6.2 billion over the next 4 years. The levy does not apply to superannuation funds and insurance companies.
The Government will invest $10.2m over 10 years from 2017-18 to trial the use of Social Impact Investments (SII). The investments are to be aimed at improving housing and welfare outcomes for young people at risk of homelessness.
The first investment for youth homelessness is anticipated for implementation in 2018-19.
This project complements the broader SII funding the government is currently providing ($20.2bn over 10 years from 2017-18). The current funding is targeting areas other than homelessness.
The funding is aimed to increase the infrastructure around SII opportunities as well as partnering in investments with States and Territories.
The additional funding for SII is no doubt a positive and represents a 50% increase on the current level of funding in operation. The increase can only help to alleviate some of the capacity issues in what remains a nascent market. However, the scale of funding will not be a game changer. Perhaps the investment in the SII Readiness Fund, which aims to build skills and capabilities to develop projects and business plans for SII opportunities is the area that will have a longer-term benefit. It is an area we are seeing increased interest in from our clients, particularly in the for-purpose segment. Increasing the size of the market and the infrastructure to support it, can only be beneficial for both investors and those it is seeking to aid.
Limited Recourse Borrowing Arrangements
The Government has indicated concern that limited recourse borrowing arrangements (LRBA) used by SMSFs to invest in property can be used to circumvent contribution caps, effectively transferring growth in assets from the accumulation phase to the retirement phase, that is not captured by the transfer balance cap. From 1 July 2017, the outstanding balance of a LRBA will now be included in a member’s annual total superannuation balance and the repayment of the principal and interest of a LRBA, from a member’s accumulation account, will be a credit in the member’s transfer balance account.
Non-arm’s length arrangements
From 1 July 2018, the Government will amend restrictions on related party transactions to prevent transactions on non-commercial terms being used to increase superannuation savings. The non-arm’s length income provisions will be amended to ensure expenses, that would normally apply in a commercial transaction, are included when considering whether the transaction is on a commercial basis.
The Future Fund was established in 2006 to meet the future superannuation liabilities of public servants. The Government has indicated that drawdowns from the Future Fund will not commence in 2020-21 as allowed (but not required) by the Future Fund Act 2006. The Government will review whether drawdowns will commence in 2021-22 prior to the 2018-19 budget.
Similar to a worker delaying retirement and not drawing a retirement income from their superannuation savings, delaying the commencement of drawdowns from the Future Fund is expected to improve the likelihood of the Future Fund assets being sufficient to cover the future superannuation liabilities of public servants.