Analysis of its monthly financial statements since 2005 uncovers trends that commentaries about its annual budget downplay or overlook.
For more than 20 years, it’s been a basis of Leithner & Company’s operations: as a conservative-contrarian value investor, we think for ourselves – and thus always discount and often reject conventional opinion and behaviour. Warren Buffett epitomises this disposition. “Most people,” he told Newsweek in 1985, “get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.” In other words, you stack the odds against yourself when you credulously accept mainstream views or eagerly join the crowd.
The crucial problem is that if you rely upon the herd – and particularly “social media” – for information and opinions, you’ll unwittingly absorb its biases and affirm its outlook; as a result, you’ll become woefully misinformed.
This is hardly a novel insight. As an adult, and particularly after he became America’s third president in 1801, Thomas Jefferson’s youthful confidence in a free press foundered on the shoals of reality – and in his later years he increasingly distrusted journalism and despised journalists. Concluding that it’s far better to be ignorant than deluded, he advised one young man never to read the newspapers (see also Why investors should ignore most “news” and Investors beware: “News” impairs your mental and physical wellbeing).
For these reasons and more besides, I greatly discount and mostly disregard the annual commotion surrounding federal and state governments’ budgets. In my view, commentators’ opinions are often tedious and tendentious; and by my experience, mainstream analyses are at best selective and superficial – and at worst naive and simply wrong.
I also do what apparently nobody else does: examine Canberra’s monthly financial statements. At Leithner & Company, we analyse the Commonwealth’s finances in much the same way we assess ASX-listed companies’. This article summarises our results and their implications.
Budgets versus Financial Statements
Financial statements describe the actual past. Budgets, on the other hand, envisage a desired future. Today’s budget is at best a sober projection of, at worst a delusional wish regarding – and often simply a wild guess about – next year’s and subsequent years’ financial statements. Budgets, in short, express possible results of today’s choices.
Assumptions (such as rates of amortisation and depreciation, etc.) form a significant part of financial statements. Budgets, in contrast, are mostly collections of assumptions. How much company tax and royalty income will the Commonwealth collect each year during the next several years? That depends not just upon its policies, but also the economy’s future rate of growth, the quantities and prices of Australia’s exports, and who knows what else. How many billions will JobSeeker cost? That depends upon the future rate of unemployment, etc.
Even modest changes to a small number of these myriad assumptions can greatly affect a budget’ bottom line; they can and often do, in other words, convert a deficit into a surplus. Then reality intrudes and confirms that the assumptions were unrealistic. Remember what happened to Wayne Swan’s, Joe Hockey’s and Scott Morrison’s confident expectation of “surpluses”?
There’s a strong parallel between company analysts’ “forward earnings” and Commonwealth budgets’ “forward estimates.” Both reflect implausibly favourable assumptions: specifically, they overestimate income, underestimate outgoings and thus overegg the bottom line.
Like analysts’ “forward earnings,” politicians’ “forward estimates” tell us much about fond hopes – but bear little relation to subsequent reality (see also How experts’ earnings forecasts harm investors; Why you’re probably overconfident – and what you can do about it; and Experts can’t predict yet investors must plan: What, then, to do?).
In contrast, financial statements tell us much about the past and present – and from their trends we can make cautious inferences about the future.
The Commonwealth’s Monthly Income Statement
Revenues and Expenditures
Each month since July 2005, the Department of Finance has published the Commonwealth’s income and cash flow statements and balance sheet (state governments, by the way, aren’t nearly as transparent). From its monthly income statements, Figure 1 plots the Commonwealth’s total CPI-adjusted revenues and expenditures on an annualised (i.e., July 2005-July 2006, August 2005-August 2006, … and March 2022-March 2023) basis. Revenues increased from $352 billion in the year to July 2006 to $641 billion in the year to March 2023; that’s a compound annual growth rate (CAGR) of 3.7%. Spending rose from $320 billion to $619 billion (CAGR of 4.1%). Both CAGRs exceed GDP’s average rate of increase during these years: the federal government bulks ever larger.
Figure 1: Commonwealth Revenue and Expenditure, Billions of CPI-Adjusted $A, Annualised Monthly Observations, July 2006-March 2023
This disparity of CAGRs encapsulates the Commonwealth’s dilemma. Some people will contend that it’s spending too much; others will retort that it’s taxing too little. Yet overtly raising revenues, which are mostly taxes, isn’t easy; hence the resort to covert means such as “bracket creep.” Abating expenditures’ rate of growth is even harder, and cutting spending in absolute terms is usually insuperably difficult.
If Canberra raises taxes, it incurs the displeasure of taxpayers; but if it decelerates the growth of expenditures, it triggers the wrath of tax-consumers. Tax-consumers outnumber tax-producers, and in a democracy the majority rules. The “solution” since the GFC, as we’ll see, has debt-financed deficit spending – and thus, increasingly, macro-economic stagnation.
It’s true that in the year to March 2023 expenses have fallen considerably (to $619 billion) from the all-time high they attained in the 12 months to February 2021 ($797 billion). However, this latter amount remains considerably greater – that is, well above the long-term trend – than the $562 billion in the year to January 2020.
During the GFC and COVID-19 panic, revenues sagged but expenditures rose. Moreover, after the GFC revenues took years to rescale their pre-GFC high whilst spending mounted relentlessly.
Figure 2 expresses revenues and expenditures as annualised (rolling 12-month) percentage changes. Since 2007, expenditures have grown more quickly (average of 4.7% per 12-month period) than revenues (3.8%).
Figure 2: the Commonwealth’s Revenue and Expenditure, Annualised Percentage Changes, July 2007-March 2023
Expenditures’ growth has been virtually continuous – only in COVID-19’s aftermath has it fallen – but revenues have been more elastic: they ebb as well as flow, largely as a consequence of the business cycle.
Components of Revenue
Taxes provide virtually all (average of more than 90%) of the Commonwealth’s revenues. Since 2007 the Department of Finance has reported its major components in a comparable manner; Figure 3 plots them. “Company/PRRT” includes receipts from company taxes, the petroleum resource rent tax (PRRT) and superannuation taxes. “Other/Indirect” revenue comprises customs and excise duties, interest and dividends and proceeds from fees and sales of goods and services.
Figure 3: Commonwealth Tax Revenues, Major Categories, Billions of CPI-Adjusted $A, Rolling 12-Month Periods, July 2008-March 2023
Revenues from personal income tax fell slightly during the GFC and stagnated during the COVID-19 crisis; otherwise, they’ve risen virtually without interruption. Company tax, PRRT, etc., on the other hand, took more than ten years – until the 12 months to June 2021 – to regain the level (CPI-adjusted $130 billion) they scaled shortly before the GFC. Moreover, for most of this time the Commonwealth collected less from company and related taxes than from indirect taxes and other revenues. From 2020 to 2022, on the other hand, the receipt of company taxes boomed.
Figure 4 expresses the quantities in Figure 3 as percentages of the Commonwealth’s total revenues from taxation. Personal income tax’s share of total tax rose steadily from 43% in 2008 to 51% in 2006. It then remained stable until 2020, sagged somewhat during the COVID-19 crisis and rebounded strongly (to 50% in the year to March 2022). The company/PRRT share, on the other hand, dropped steadily from 30% in 2008 to 20% in 2016, and since then has fluctuated between 20% and 30%. As a result, its current share (26%) is lower than in 2008. The other/indirect share has varied between 25% and 30%.
Figure 4: Commonwealth Tax Revenues, Major Categories as Percentages of Total, Rolling 12-Month Periods, July 2008-March 2023
Components of Expenditure
Figure 5 plots the Commonwealth’s major categories of expenditure. Operating expenses comprise wages and salaries (including superannuation) of bureaucrats and military personnel; goods and services (such as the consultants, office space, etc.); and depreciation and amortisation. Current transfers encompass non-capital grants (to businesses, charitable organisations, state governments, universities, etc.), subsidies (of aged care, private sector wages, etc.) and “personal benefits” such as aged, disability and military pensions, JobKeeper and JobSeeker payments, etc. Capital transfers include capital and infrastructure funding to businesses, private schools, state governments, universities, etc.
Figure 5: Commonwealth Expenditures, Major Categories, Billions of CPI-Adjusted $A, Rolling 12-Month Periods, July 2008-March 2023
Current transfers are by far the biggest component of expenditure – and the only one which COVID-19 affected. Interest on the debt is and capital transfers are relatively minor categories. Operating expenditure is the second-largest component, and has risen glacially but steadily over the years.
Figure 6 expresses these major components of total expenditure as percentages of total expenditure. Shortly after the GFC, current transfers’ share fell somewhat. It remained largely stable until the COVID-19 crisis and has fallen markedly since 2021. During the year to March 2023, its share (57%) was the lowest on record. Operating expenditures’ share, on the other hand, has risen slowly but steadily, from 28% in 2008 to 36% – an all-time high – in the 12 months to March 2023. Finally, interest and capital transfers have comprised a constant but minor (approximately 5% each) share of total expenditure.
Figure 6: Commonwealth Expenditure, Major Categories as Percentages of Total, Rolling 12-Month Periods, July 2008-March 2023
The Commonwealth is bloated and self-serving. Should it really be devoting more than one-third of its income to itself – on bureaucrats’ salaries, superannuation and other operating costs – and just two-thirds to everybody else?
Unlike private businesses, the Commonwealth’s primary purpose isn’t the generation of profit. Like any business, however, it can’t indefinitely sustain losses. And like ASX-listed entities, its income statement contains several “bottom line” measures.
Net operating balance (NOB) equals total revenue minus total expenses including accrued capital expenditure. As an accrual measure, it records revenues and expenses when they’re incurred rather than received or paid; in general, it indicates whether the government must sell assets or borrow in order to finance its operating activities. If NOB is positive (negative), the government’s revenue is (isn’t) sufficient to finance its operations including the net investments in non-financial assets it must undertake. NOB thus measures the sustainability (relative to the tax base) of the existing level of goods and services that the government supplies.
A second measure of net income, fiscal balance (FB), equals NOB net of capital investment. It’s always greater than the NOB unless net capital investment is negative (i.e., the government sells rather than acquires assets). Also an accrual measure, if FB is less than $0 then the government must borrow in order to cover its day-to-day operations (not including the net investments in non-financial assets it requires in order to provide goods and services). A third measure of net income is simply the difference between the annualised revenues and expenditures plotted in Figure 1.
Figure 7: Three Estimates of the Commonwealth’s Net Income, Billions of CPI-Adjusted $A, Annualised Monthly Observations, July 2006-March 2023
Figure 7 plots these three measures. During all rolling 12-month periods, NOB has averaged -$3.3 billion, FB $8.7 billion and net income -$24.4 billion; from July 2006 to April 2020, which excludes the enormous swings attributable to the COVID-19 panic and lockdowns, etc., NOB averaged -$0.3 billion, FB $6.1 billion and net income -$10.8 billion. Except during the GFC, from July 2006 to April 2020 these 12-month periods varied within the range ±$50 billion. During the periods since October 2022, NOB has exceeded $20 billion, FB $40 billion and net income $15 billion.
Canberra’s income statements since 2005 demonstrate that its current income has (a) generally been able to finance its current non-capital spending, but (b) usually fallen short of the amount required to finance both its current operations and the capital expenditure required to maintain these operations into the future.
The Commonwealth’s Monthly Cash Flow Statement
Operating Cash Flows
In Creating Shareholder Value: A Guide for Managers and Investors (The Free Press, 1997), Alfred Rappaport stated: “Cash is a fact, profit is an opinion.” He contended that profit relies upon accounting conventions and assumptions that are prone to adjustment – and, potentially, exploitation. Cash, in contrast, is harder to manipulate. Consequently, major discrepancies between reported profit and cash flow can occur.
Rappaport has a point, but we mustn’t overstate it. In The End of Accounting: The Path Forward for Investors and Managers (Wiley Finance, 2016), Baruch Lev countered: “although the ending balance in cash and the change in cash from one period to the next are not readily subject to manipulation, the components of total cash flow, the operating, investing, and financing amounts, are more susceptible to (manipulation) …”
The general point, however, is indisputable: in the long run it’s essential that a company earns a profit (and that a government’s NOB remains above $0). But having enough cash to operate day-to-day – that is, a positive operating cash flow – is the more pressing concern.
Using monthly income statements produced by the Department of Finance, Figure 8 plots the federal government’s operating cash received, operating cash used and net operating cash flow (OCF) for each 12-month period since July 2006. Operating cash received mostly comprises taxes and secondarily proceeds from the sale of goods and services. Operating cash used is mostly “personal benefits” (e.g., pensions, JobSeeker allowances, Medicare rebates, etc.) and payments to employees, and incidentally payments to suppliers of goods and services and recipients of grants and subsidies.
Figure 8: The Commonwealth’s Operating Cash Flow, Billions of CPI-Adjusted $A, Annualised Monthly Observations, July 2006-March 2023