Australian Government, 2013-14 Budget

Statement 5: Revenue (Continued)

Appendix D: Revenue forecasting methodology and performance

Review of Treasury Macroeconomic and Revenue Forecasting

The Government's receipts forecasts, like all forecasts, are subject to a margin of error. Tax receipts in 2012‑13 have been written down by around $17 billion since the 2012‑13 Budget. In light of concerns regarding the performance of economic and revenue forecasts, the Secretary to the Treasury commissioned an independently overseen Review of Treasury Macroeconomic and Revenue Forecasting (the Review).

The Review concluded that forecasts of taxation revenue exhibited little evidence of bias over the last twenty years. While taxation revenue forecast errors revealed sustained periods of under‑ and over‑forecasted revenue, these periods were offset over the full time period and, in part, reflected the patterns of forecast errors in the nominal economy. The Review also found that revenue forecast performance is comparable with, or better than, those of official agencies overseas over the past decade.

The Review made 11 recommendations on improving the forecasting methodology, of which four related specifically to revenue forecasting. All of these are currently being implemented.

As discussed in Box D1, a three sector company tax model has been developed and is being utilised in full for the first time this Budget. Other recommendations related to revenue forecasting include: investigating whether further information can be drawn from the Australian Taxation Office's liaison with large corporate taxpayers; examining the feasibility of constructing a micro‑simulation model for forecasting personal income tax; and giving further consideration to the appropriate balance between the top‑down versus bottom‑up approaches to forecasting revenue.

Box D1: Revising the company taxation forecasting methodology

The Review of Treasury Macroeconomic and Revenue Forecasting (December 2012) found that some of the largest revenue forecast errors in recent years have been in company tax. Company tax is a relatively large and volatile source of revenue and is difficult to forecast due to both timing and compositional factors. The Review identified two directions for methodological development — more detailed analysis by different sectors and better accounting for companies operating on non‑June accounting years.

The forecasting methodology has been revised in two ways. Firstly, the key sectors of mining and finance (including insurance) are now forecast separately from the rest of companies. Both of these sectors have unique characteristics, including the reliance on interest income in the financial sector, the varying impacts of the terms of trade on each sector and the high capital intensity of the mining sector. The latter is particularly important given the recent surge of mining investment in response to mining boom mark I.

These different characteristics contribute to significantly different historical growth rates for profitability in each sector, as shown in Chart A. As the mining sector's share of the economy increases, it becomes more important to fully account for its volatility when forecasting tax collections.

Chart A: Yearly growth in corporate GOS by sector

Chart A: Yearly growth in corporate GOS by sector

Source: ABS cat. no. 5206.0 and 5204.0.

The second methodological revision has been to better estimate the impact of companies who report on non‑June accounting years. These different payment patterns can affect both the interpretation of the corporate profit parameter as well as the estimation of the timing of company tax payments. Accurately accounting for both aspects is particularly important when understanding how an economic shock impacts on collections of company tax receipts.

Revenue forecasting methodology and performance

The Government's receipts estimates are generally prepared using a 'base plus growth' methodology. The last known outcome (2011‑12 for the 2013‑14 Budget) is used as the base to which estimated growth rates are applied, resulting in receipts estimates for the current and future years. The growth rates are determined from forecasts for a large range of economic data, many of which are described in Budget Statement 2.

The smaller and relatively simple heads of revenue, such as luxury car tax and many of the excises, are forecast by mapping the growth rate of an appropriate economic parameter directly to the tax growth rate in the relevant head of revenue. Most of the large and complex heads of revenue, such as personal and company income taxes, are forecast by mapping appropriate economic parameter growth rates to the various income, expense and deduction items on the relevant tax returns. An estimate of total tax payable is then calculated by applying the statutory rates to the estimated income base. Timing models based on past payment behaviour assist in determining whether this tax will be paid in the year the income is earned, such as for pay‑as‑you‑go withholding tax, or in future years, such as for individuals' refunds. Other information affecting receipts forecasts includes known tax collections for the current year, new policy, and calendar date timing (for example, more pay‑as‑you‑go withholding tax is paid on a Thursday than any other day of the week, so years with 53 Thursdays will result in more receipts than years with 52 Thursdays).

The Government's receipts forecasts, like all forecasts, are subject to a margin of error. The discernible trend between 2002‑03 and 2007‑08 was for receipts forecasts to under‑predict outcomes (Chart D1). For example, the 2007‑08 Budget forecast taxation receipts to grow by 5.0 per cent in 2007‑08, compared to the outcome of 8.1 per cent, a forecast error of 3.1 percentage points. Since 2008‑09, the outcome for receipts has been lower than the Budget forecast, broadly reflecting the impacts of the GFC.

The receipts forecasting error may be split into three underlying sources: errors in economic forecasts that underpin the receipts forecasts; errors in translating the economy to receipts forecasts; and miscellaneous factors such as post‑Budget policy decisions, court decisions regarding tax law interpretation, changes in compliance activities of the ATO, and revisions to historical economic data. Note that there may also be secondary errors relating to the timing of payments of tax — even if the underlying forecasts were accurate, revenue may be recorded in the fiscal year before or after it was expected.

Chart D1: Budget forecast error on taxation receipts growth

Chart D1: Budget forecast error on taxation receipts growth

Source: Treasury.

Chart D2: Budget forecast errors on nominal non‑farm GDP growth and taxation receipts growth (excluding CGT)

Chart D2: Budget forecast errors on nominal non‑farm GDP growth and taxation receipts growth (excluding CGT)

Source: Treasury.

Chart D2 shows the relationship between forecast errors of the economy and tax receipts (excluding CGT) over recent years, including the current estimates for 2012‑13. The dotted lines depict a receipts forecasting error of plus or minus 0.5 per cent if there is zero error on the economic forecasts.

Nominal non‑farm GDP was chosen as a broad indicator of the economic forecasts. The relationship in Chart D2 is only approximate as some sources of error are independent of economic conditions and the forecasts for tax receipts rely on forecasts of a range of economic variables, not just nominal non‑farm GDP.

On average, economic forecasting errors will be magnified in receipts forecasting errors, due to the progressive nature of personal income tax. The lower and upper lines are based on aggregate elasticities (of receipts with respect to nominal non‑farm GDP) of 1.0 and 1.5 respectively, which are consistent with theoretical models of the tax system.

Broadly, points outside this range may represent forecasts of tax receipts growth that were either too high or too low given the economic growth forecasts. The points may also fall outside the range due to the timing of tax payments, where economic activity in one year affects tax paid in the following year. In addition, the points outside of the range in the lower left quadrant have been impacted by a larger elasticity between the economy and tax during a downturn, due to the varying impacts of the downturn on different components of GDP and the automatic stabilisers in the tax system.

Chart D3. Forecast error on capital gains tax (contribution to tax receipts growth)

Chart D3. Forecast error on capital gains tax (contribution to tax receipts growth)

Source: Treasury.

For example, in 2002‑03, nominal non‑farm GDP growth turned out to be around 1 percentage point higher than forecast, but growth in tax receipts (excluding CGT) were almost 4 percentage points higher than forecast. That is, the error in the revenue forecast was higher than the around 2 percentage points that the rule of thumb suggests should be theoretically associated with an economic forecasting error of that magnitude.

From 2008‑09, forecasting errors in tax receipts have been significantly affected by the economic downturn related to the GFC, particularly with regards to capital gains tax (Chart D3).

The forecast for 2012‑13 tax receipts (excluding CGT) in the 2012‑13 Budget is expected to be an over estimate of around 4½ percentage points, compared to an over estimate of around 2 percentage points for nominal non‑farm GDP growth. In 2012‑13, the forecasting error is partly attributed to the shortfall in resource rent taxes. The resource rent tax base is not expected to relate as closely to nominal GDP as taxes on wages or corporate profits. Abstracting from the resource rent tax forecasting error, the forecasting error for tax receipts growth in 2012‑13 (excluding CGT) is expected to be around 3 percentage points, consistent with an elasticity of tax to GDP of around 1.5.

Discussions of earlier years can be found in previous budgets.

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