Saturday, November 10, 2012

States are correcting earlier mismanagement

In most states around Australia, recent years have seen long-standing Labor governments tossed out and replaced by Coalition governments. In all cases, the new governments have immediately embarked on campaigns to cut government spending. Why?

Is it American-style anti-government ideology? Is it uniform Labor mismanagement across the nation? Could it be some changed feature of the national economy, or just the state governments' irrational pre-occupation with preserving or restoring their triple-A credit ratings?

Turns out to be a bit of most of those.

The Commonwealth Grants Commission, which is responsible for deciding how the proceeds of the goods and services tax are divided between the states, has published an information paper on the changes in state budgets over the 10 years to 2010-11 (which you can find on its website).

It found that, taking all the states and territories together, they ran small overall budget deficits (known as the "net borrowing position") in the first two years of the noughties. Then, for the next five years, from 2002-03 to 2006-07, they ran quite large overall budget surpluses ("net lending position"), meaning they could run down their level of government debt.

Great. But then, for the final four years, they switched back into ever-growing overall budget deficits, rising from $4.3 billion in 2007-08 to a mammoth and unsustainable $15.3 billion in 2010-11.

Can you think of some momentous event about that time that might help explain such a marked deterioration in the states' finances? How about the global financial crisis, which began in August 2007 and reached its climax in September 2008 with the collapse of Lehman Brothers investment bank?

But there was another factor, which got going a bit earlier: the states' rapidly increased spending on capital works. How much does this explain?

Before we go any further, note that these figures relate only to the states' "general government" sector. That is, they don't include the activities or the borrowing of government-owned businesses, such as water boards or electricity authorities.

Also, note that state budgets are heavily influenced by the receipt and spending of grants from the federal government. These receipts are the proceeds of the GST, plus "special purpose payments" - which include federal grants for spending on capital works. Much of the Rudd government's fiscal stimulus went on capital works spending by the states.

Total grants from the federal government account for about half the total revenue received by the states. Until 2007-08, the GST accounted for about 60 per cent of all federal money received; since then its share has fallen to half, a sign it's no longer the "growth tax" it was.

So far, however, this decline in the relative importance of GST money has been offset by increased special purpose payments - though whether this will remain true is different matter.

So next the Grants Commission's information paper strips out all federal payments (and the spending of them) so we can see what's been happening to the states' "own-account" revenue-raising and spending.

It turns out the states' own-account "expenses" - that is, their spending for recurrent purposes - have grown quite strongly relative to the growth in their economies, from 7.3 per cent of gross state product in 2005-06 to 8.1 per cent in 2010-11.

At the same time, however, the states' own-account revenue - composed of mainly of state taxes and receipts from public transport fares and public housing rents - has fallen relative to gross state product, from a peak of 7.8 per cent in 2006-07 to 7.4 per cent in 2010-11.

This explains the marked deterioration in the states' own-account "operating balance" from a surplus of $4 billion in 2006-07 to a deficit peaking at $12.1 billion in 2009-10, before falling to $9.7 billion in 2010-11.

All this suggests there was a degree of mismanagement by the mainly Labor governments in power at the time. While their own-account revenue raising was failing to keep pace with their economies, they were allowing their own-account expenses to grow very much faster than their economies.

I don't have a problem with a growing public sector, but I do have a problem with politicians allowing their day-to-day spending to grow rapidly without being willing to increase taxes to cover it. Particularly at the state level, that's not being "progressive", it's being irresponsible.

To be fair, much of the weakness on the revenue side of their budgets wouldn't have been the state premiers' fault. In particular, conveyancing duty - which accounts for 12 per cent of the states' own-account revenue - made a negative contribution to revenue growth after 2005-06.

This was due to the global financial crisis's effect on the housing market. At the same time the state governments were allowing their own-account operating budgets to deteriorate, they were also stepping up their own-account spending on capital works. This increased from a mere $32 million in 2004-05 to $5.6 billion in 2010-11. (If these figures seem low, it just shows how much of state capital works spending is financed by the feds - in the final year, about two-thirds.)

But if you look at it from the last overall budget surplus of $1.2 billion in 2006-07 to the overall deficit of $15.3 billion in 2010-11, the increase in own-account capital spending accounts for just $2.8 billion of the $16.5 billion deterioration.

So the popular impression that the states are in bother with the credit rating agencies simply because of their need to overcome the widely assumed (but rarely demonstrated) infrastructure backlog seems far from true.

The main problem is borrowing to finance recurrent operations - which, unless states are in the depths of recession, can't be defended.

I don't have much time for Standard & Poor's, Moody's and the other rating agencies. Their dereliction of duty contributed greatly to the global financial crisis, for which they've got away with far too little public censure.

Sometimes I suspect they run an especially hard line on government borrowers to distract attention from the way they disgraced themselves with their paying-customer private sector borrowers in the years before the crisis. They're walking proof that an independent opinion on your financial affairs is not something you can buy.

But in this case they're in the clear.

The main reason for all the belt-tightening by state governments is old-fashioned mismanagement.