Economic Update – Oct 2020 – “Fiscal Policy Has Arrived”

Extraordinary times lead to extraordinary outcomes. This year is certainly extraordinary and marks the long-awaited return of fiscal policy as evidenced by the sheer size of the budget deficit and increase in government debt outlined in the 2020-21 Commonwealth Budget. Most notably it marks a shift away from years of budget repair to a ‘pro-growth’ agenda. Investors should take confidence from what is a clear plan to materially reduce unemployment from current levels, bolster the recovery via a suite of business incentives and ultimately lift the economy out of recession.

Before we talk about the Commonwealth Budget, we should look at what has been happening in the lead up. In most economies during September we saw signs of a bounce in economic activity from the depths of the COVID-19 recession. This occurred despite rising infection rates globally and increasing social restrictions to suppress outbreaks.  In Australia most economic readings were repeatedly stronger than consensus forecasts despite Victoria (25% of the economy) returning to tough lockdowns. Tempering our enthusiasm is the deteriorating political and trading relations between China and the US, Europe and Australia….not to mention the rising tension within the US in the fractious presidential election.

In the US and Europe, economic readings have continued to improve. In the US, reading of housing activity has been surprisingly strong which is why we have seen both JHX and REH perform strongly of late. Very low long-term fixed mortgage interest rates and the Federal Reserve’s (Fed’s) buying support promising to keep mortgage rates very low for a long-time ahead are adding fuel to already booming US housing activity. Employment in the US has also surprised with its faster than expected recovery. In Europe, the economy has shown signs of its recovery however this is being tempered by the second wave of COVID-19 and increasing social restrictions.

China has bounced off the bottom of the COVID-19 downturn. GDP rose 3.2% y-o-y in Q2 after falling 6.8% in Q1. July and August monthly readings point to the recovery continuing but at modest pace. The best of China’s recovery remains in exports, up 9.5% y-o-y in August from +7.2% y-o-y in July but that improvement is likely to be tempered over coming months on growing trade tensions with the US and Europe.

In Australia, Q2 GDP was released early in September and showed a bigger-than-expected fall of 7.0% q-o-q, -6.3% y-o-y compared with Q1 –0.3% q-o-q, +1.6% y-o-y. The GDP fall driven primarily by a collapse in household consumption spending occurred despite a huge lift in government transfer payments driving large increases in household disposable income and company profits. The July and August readings released in September mostly showed the springboard effect, although tempered by the late July shutdowns in Victoria. On the housing front, July housing finance commitments rose 10.7% m-o-m, the biggest monthly rise on record, and home building approvals rose 12.0% m-o-m. The August labour force report was surprisingly strong with employment up 111,000 (consensus forecast –50,000) and the unemployment rate fell to 6.8% (consensus forecast 7.7%) from 7.5% in July.

Moving forward this week and we have just had the delayed 2020/21 Federal budget delivered. It is likely the most significant in decades. The overriding thrust of the budget is about transitioning the economy off unsustainable welfare payments (JobKeeper) via a heavy emphasis on policies that support job creation (JobMaker).

There is a willingness of government to support the economy through this transition. In combination with emergency monetary policy settings, the combination of expansionary fiscal policy provides an unparalleled level of policy stimulus for the Australian economy.

Debt levels are set to increase significantly but this is unavoidable and a necessary response given the size of the economic hit and the ongoing headwinds that this has created. The extraordinary budget deficits will lead to a sharp rise in Commonwealth government debt from an estimated $491.2bn, 24.8% of GDP as at June 2020, to $703bn , 36.1% of GDP as June 2021 and then $966bn as June 2024, estimated to be a peak of 43.8% of GDP.

Significantly, the interest cost of the government debt will be very low. The Australian government can currently borrow money for 3 years under the 0.25%pa cash rate and 10 years at less than 1%pa. The government needs an economic return from its borrowings and it seems the return will far exceed the interest costs of the higher debt and by supporting the economy in this way should hasten the recovery, allowing the budget to eventually return to a more sustainable position.

The RBA this week kept the official cash rate on hold at 0.25%. Interestingly the RBA stated, “the Board continues to consider how additional monetary easing could support jobs as the economy opens up further”. This seems to leave the door open for a further rate cut to an unprecedented 0.10%. Whether this would be enough to have an impact on jobs or the economy remains to be seen but many economists are factoring in a November rate cut.

Economic forecasts in the Budget are an insight into the Government’s expectations for the path of the economy over the coming years. Everyone agrees that forecasts are fraught with danger, and this year’s forecasts are more uncertain than ever before. In saying that, there is not a lot to argue with until you get to the commodity forecast. These appear consistently conservative with prior year budgets. This also plays into the view for the AUD$.

The AUD$ was not impacted by the Federal government Budget 2020. Many policies were leaked prior to the release leaving little to surprise.  The AUD$ is predominantly being driven by the USD$ direction and the US political uncertainty.  Commodity prices should continue to be the main driver of the AUD$ over the medium term.

This is a very positive budget which should be greeted with enthusiasm despite the depth of the problems it seeks to address, it is the return of Fiscal Policy that has been missing for a decade or so. This is the right approach and treads a line between balancing short versus long term objectives. Investors should welcome this pro-growth budget which addresses ‘fiscal cliff’ concerns, pulls forward tax-cuts and looks to turbo-charge the recovery via job creation. In combination with record low borrowing rates and forward guidance provided by the RBA, policy makers have shown their willingness for the level of policy support to get the economy back to a self-sustaining level as quickly as possible. The US Presidential election is next, and we anticipate heightened volatility for investment markets until a clear victory is achieve for either candidate, anything else could destabilise investment markets.

Highlights from the budget are on the following pages.

Federal Budget 2020

On Tuesday 6 October, the Federal Government handed down its Budget for the 2020–21 financial year. With the economic impacts of Coronavirus pushing Australia into recession for the first time in nearly three decades, the Federal Government have announced significant stimulus measures to promote economic growth and recovery.

According to the Treasurer, this year’s Budget measures aim to create job opportunities and help Australians get back on track. The Treasurer claims that these measures will get the economy growing again by 2021. Here are some of the announced Budget changes that could affect you. However, it’s important to remember that these are only proposals at this stage, and each proposal will only become law once it’s passed by Parliament.

Personal Tax Changes

Personal tax cuts

The Government has announced that it will bring forward stage two of the previously legislated tax cuts that were due to take effect from 1 July 2022 by two years. As a result, from 1 July 2020:

• the Low Income Tax Offset (LITO) will increase from $445 to $700. The increased LITO will be reduced at a rate of 5 cents per dollar between taxable incomes of $37,500 and $45,000. The LITO will then be reduced at a rate of 1.5 cents per dollar between taxable incomes of $45,000 and $66,667.
• the top threshold of the 19% tax rate will increase from $37,000 to $45,000, and
• the top threshold of the 32.5% tax rate will increase from $90,000 to $120,000.

 Low and Middle Income

Tax Offset The Low and Middle Income Tax Offset (LMITO) was introduced in the 2018 Budget, to complement the existing Low Income Tax Offset (LITO). In 2019, the base rate for the LMITO increased from $200 to $255 and the maximum payment increased from $530 to $1,080. The Government had planned to discontinue the LMITO when the stage two cuts were to be introduced in mid-2022. However, even though the stage two cuts have been moved forward to the current financial year, the LMITO will also remain in place for the 2020–21 financial year.

Business tax incentives

The Government will support businesses to invest, grow and create more jobs through targeted tax incentives.

Temporary full expensing Effective 6 October 2020

Businesses with aggregated annual turnover below the relevant threshold will be able to deduct the full cost of eligible capital assets acquired from 7:30pm AEDT on 6 October 2020 (Budget night) and first used or installed by 30 June 2022.

• Full expensing in the year of first use will apply to new depreciable assets and the cost of improvements to existing eligible assets for businesses with aggregated annual turnover of less than $5 billion.
• Full expensing also applies to second-hand assets for small and medium-sized businesses with aggregated annual turnover of less than $50 million.

Full expensing does not apply to second-hand assets for businesses with aggregated annual turnover of $50 million or more.

Enhanced instant asset writing-off

Business with aggregated annual turnover between $50 million and $500 million can still deduct the full cost of eligible second-hand assets costing less than $150,000 that are purchased by 31 December 2020 under the existing expanded instant asset write-off measure.

The existing enhanced instant asset write-off measure requires an eligible asset to be first used or installed by 31 December 2020 to qualify. The Government announced that businesses that hold assets eligible for the enhanced $150,000 instant asset write-off will have an extra six months (until 30 June 2021) to first use or install those assets.

Temporary loss carry-back Effective from 2019-20

Under the existing rules, companies are required to carry losses forward to offset profits in future years. The Government has announced that it will allow companies with aggregated annual turnover of less than $5 billion to carry back tax losses from 2019-20, 2020-21 or 2021-22 income years to offset previously taxed profits in the 2018-19 or later income years. Eligible corporate tax entities can elect to apply tax losses against taxed profit in a previous year, generating a refundable tax off set in the year in which the loss is made. The tax refund is limited by 6 requiring that the amount carried back is not more than the earlier taxed profit and cannot result in a franking account deficit. The tax refund will be available on election by eligible companies when they lodge their 2020-21 and 2021-22 tax returns. Companies that do not elect to carry back losses under this measure can still carry losses forward as normal.

Super Changes

Default super accounts

Currently, if you start a new job and you don’t let your employer know where you want them to pay your super contributions, they will open a super account for you. The account will be in your employer’s default super fund. This may result in you having multiple super accounts. By 1 July 2021, your employer will be able to obtain information about your existing super account from the ATO. They will then pay your super contributions into this account, unless you instruct them to pay it to a different account. For people who don’t yet have a super account, their employer will be able to open an account for them in their default super fund.

Performance testing for MySuper products

MySuper products follow a strict set of government guidelines. They tend to offer their members lower fees, simple features and limited investment options. The Government feels there are too many underperforming super funds in the market, and this is impacting members’ retirement savings. From 1 July 2021, MySuper products will be subject to an annual benchmarking test. If the fund is found to be underperforming, it will need to inform its members by 1 October 2021. Further, if a fund is found to underperform for two consecutive years, they won’t be permitted to accept new members until their performance improves. By 1 July 2022, all super funds will need to do the annual benchmarking test – not just MySuper products.

YourSuper online comparison tool

To help members easily compare super funds, the Government will release an interactive online comparison tool called YourSuper by 1 July 2021 which will:

• rank MySuper products by fees and investment returns
• provide links to super fund websites
• show if you have more than one super account so you can consider consolidating them.

Health, welfare and jobs

Additional support payments for welfare recipients

Government support recipients will receive two separate economic support payments of $250, to be paid progressively from December 2020 and March 2021. This follows two previous payments of $750 to eligible recipients, with the new payments estimated to cost a total of $2.6 billion.

Health services

Coronavirus has taken its toll on the mental health of many Australians. Therefore, the number of psychological services funded by Medicare will be doubled from 10 to 20, effective immediately. The NDIS will also receive additional funding of almost $4 billion, to provide essential support to Australians living with a disability. Women facing ovarian cancer will now be able to access the drug Lynparza through the PBS. Rather than costing $140,000 per course, general patients will now pay around $41 for a script while concession card holders will be charged $6.60.

New jobs in key industries

The Government is committing $1.5 billion over five years from 2020–21 to support the building of competitiveness, scale and resilience in the Australian manufacturing sector. It will focus on six key industries of strategic interest:

• defence
• space
• medicine and medical products
• food and beverages
• resources technology
• recycling and clean energy.

Rural communities will benefit from $2 billion in funding over 10 years to improve water infrastructure, while regional businesses will benefit from an expansion of the instant asset write-off scheme. Regions that rely on international tourism will benefit from their share of $51 million in funding over two years to diversify their markets. While the Budget doesn’t offer much financial relief to female workers currently impacted by Coronavirus, the government is committing $240 million over four years towards a range of employment initiatives for women. These include increasing female workforce participation in male-dominated industries such as construction.

Other measures

SMSF and small APRA funds – deferring the increase in the maximum number of allowable members from four to six

In the 2018-19 Federal Budget, the government proposed to increase the maximum number of allowable members in self -managed super funds and small APRA funds from four to six commencing from 1 July 2019. This measure is now proposed to commence from the date the enabling legislation receives Royal Assent.

Managed Investment Trusts – deferring the removal of the capital gains discount

In the 2018-19 Federal Budget, the government proposed to remove the capital gains discount at the trust level for Managed Investment Trusts (MITs) and Attribution Managed Investment Trusts (AMITs). This was designed to prevent beneficiaries who are not entitled to the CGT discount in their own right from getting a benefit from the CGT discount applied at the trust level. The start date has now been revised from 1 July 2020 to the income year commencing on or after three months from the date of Royal Assent of the enabling legislation.

Tax Integrity – deferring the start date of proposed Division 7A amendments

The Government will defer the start date of the 2018-19 Budget measure, Tax Integrity — clarifying the operation of the Division 7A integrity rule, from 1 July 2020 to the income year commencing on or after the date of Royal Assent of the enabling legislation.

The Government issued a consultation paper in October 2018 seeking stakeholder views on the proposed implementation approach for the amendments to Division 7A of the Income Tax Assessment Act 1936. The Government indicated that it has received valuable feedback from stakeholders which highlighted that this is a complex area of the tax law and raised implementation issues that warrant further consideration.

Delaying the start date will allow additional time to further consult with stakeholders on these issues and to refine the Government’s implementation approach, including to ensure appropriate transitional arrangements so taxpayers are not unfairly prejudiced.

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Sources:  Colonial First State, Commbank Global Markets Research, RBA, Morningstar, Macquarie Bank, Alexander Funds Management.