Budget day in Australia: here comes a tax hike

Ciobo: Shifting towards an 'investment budget'

Australia's government on Tuesday delivers its first budget since coming to power eight months ago and it's tipped to be one of the harshest in years, with a temporary tax hike for high-income earners on the agenda.

Striking a balance between measures that return Australia to a budget surplus while not derailing an economic recovery or fragile consumer sentiment could be the greatest challenge.

"We are mindful about the potential impact from fiscal consolidation and we don't want the outcome to be an [economic] slowdown," Steven Ciobo, parliamentary secretary to the Treasurer, told CNBC.

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A temporary income-tax hike, cuts on social services spending and a rise in the retirement age to 70 are all expected to feature in Tuesday's budget. The previous government had already unveiled plans to lift the retirement age to 67 by 2023 from 65 today.

Joe Hockey, Australia's treasurer, poses for photographs while holding a copy of his budget speech.
Mark Graham | Bloomberg | Getty Images

Australia's Prime Minister Tony Abbott and Treasurer Joe Hockey argue that tough action is needed to prevent the country's budget deficit from ballooning to A$123 billion ($115 billion) over the next four years. The government is expected to announce a A$30 billion deficit for the current fiscal year later in the day.

"We recognize that the government has a tough job to get the deficit down. They can't go too hard, too quick otherwise they will contract the economy and that is a great concern to us," said Innes Willox, CEO of the Australian Industry Group.

According to media reports, Australians earning over A$80,000 per year may have to pay an additional 1 percent in income tax. Those earning over A$180,000 could pay an extra 2 percent tax for a temporary period.

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Abbott confirmed on Australian radio Tuesday that an introduction of a deficit-reduction levy would be in the budget.

"There is a lot of speculation in relation to a temporary deficit levy on Australia's highest income earners," Ciobo said. "Ideally we wouldn't do this, but the reality is that we have to fight a very strong headwind and that's former government spending."

Ai Group: Australia's budget is about growth

Australia Industry Group's Willox said he was concerned about the impact a tax increase would have on the economy.

"We think that's quite problematic and all it will do is contract the economy, and will lead to great stagnation and get people to put their hands in their pockets," he said.

"The government is taking a political risk as well as an economic risk," Willox added.

Australia's retails sales inched up just 0.1 percent in March from a month earlier compared with a 0.3 percent increase in February, latest data show. Analysts say consumer confidence has already taken a hit from the prospect of higher taxes in the budget.

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While Australia runs a budget deficit, its finances are in relatively better shape than most of its developed world peers.

The budget deficit is forecast at 2.5 percent of gross domestic product (GDP) in 2014 by the Organization for Economic Cooperation and Development (OECD). That compares with a budget deficit forecast for OECD peers Japan and the U.S. at 8.5 percent and 5.8 percent respectively.

"In the medium term, what we have is no chance of returning the budget to a surplus unless we rein in spending," said Tony Shepherd, Chair at the Commission of Audit.

"What we are saying is the economic indicators in Australia are not in bad shape. If we act now, act incrementally, we can rein in the expenditure without an adverse effects on the economy," he said.