New housing prices could be so much cheaper

The State Government levies a charge of $95,000 a hectare on land on the urban fringe that it rezones for housing.  That's about $10,000 a housing block.

The Government claims this charge is a contribution for infrastructure.

But in new housing estates the local infrastructure is provided by the developer, not the Government.

The developer levels and drains the land, installs pipes and wires and builds local roads.  Those costs are passed on to the buyer.

Government incurs infrastructure costs for dams, long distance water pipelines and main roads, but these costs are present wherever people choose to live and are paid by rates and general taxation.

Moreover, local infrastructure costs are considerably greater in built-up areas than for new developments on the city edge.  It is far less expensive to start afresh than it is to maintain or improve existing roads or to replace ageing water pipes in established areas.

So the $95,000 a hectare infrastructure charge is simply a revenue grab.

Naturally, landowners object to the charge.  But, contrary to some claims, the $95,000 does not of itself increase the cost of land for housing.

This is because the charge creams off some of the inflated profits on land already present because of the Government's land use restrictions and other planning policies.

There is no physical shortage of land suitable for housing around Melbourne.  It is the regulatory-induced shortage created by the Melbourne 2030 plan and its accompanying armada of other planning restraints, environmental overlays and heritage obstacles that drives up prices.

Farmland around Melbourne is worth about $20,000 a hectare.  But once the Government stops preventing that land being used for housing it becomes worth $300,000 to $600,000 a hectare.  And the Treasury takes $95,000 of that.

Higher prices from regulatory-induced shortages of housing land, together with regulatory delays in approval processes, mean higher costs of new houses.  In Melbourne this translates into about $70,000 a new house.  And there is a ripple effect on all house prices in the metropolitan area.

Premier John Brumby claims he has released enough land from its regulatory shackles for 10 or 15 years of housing supply.  This is simply untrue.  There are 30,000 houses a year built in Greater Melbourne and we certainly don't have 300,000 blocks ready to be built on.

The Government's 10-year supply simply means that 300,000 potential blocks have passed the first of many regulatory hurdles that prevent land being used for housing.

Genuine removal of regulatory restrictions making 300,000 potential new houses available would bring a welcome fall in costs to new house buyers, but existing policy makes this unlikely because the Government's $95,000 a hectare "infrastructure contribution" tax gives it a vested interest in maintaining a shortage of housing land.

The consequent higher prices provide a bonus to the Government as well as to the landowners lucky enough to win the lottery of having their land rezoned for housing.

The losers are the people who don't own their home, few of whom would be able to recognise that housing unaffordability stems from government land use regulations.

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Outsider Sol bucked system

Sol Trujillo is wrong.  We're far from perfect but we're not racist.  The cartoons of Trujillo under a sombrero riding a donkey are no more offensive than the treatment banks receive every day in the press.  And after all, in exchange for having to put up with some unkind caricatures, Trujillo was paid a lot of money.

The reason that Trujillo was disliked by politicians (on both sides), other business leaders, unions and the media wasn't because he was an American of Hispanic background.  Trujillo was disliked because he disturbed the comfortable and cozy culture that characterises much of corporate life in this country.  Australia has changed a great deal but many aspects of the old government/business/union corporatist mentality remain.

Chief executives of Australian public companies are reluctant to speak out on issues for fear not just of displeasing the government, but of showing up their fellow CEOs who don't have the same courage of their convictions.  This wasn't always the case, but it is now.  That's why it's easy to find any number of CEOs happy to recite motherhood statements about "the need to invest more in education".  And why it's next to impossible to find a CEO willing to reveal what they honestly think about the emissions trading scheme.

Trujillo was an outsider who had nothing to lose and who called it as he saw it.  And what he saw astounded him.

He saw how Telstra, which supposedly had been privatised, was treated by successive coalition and Labor governments as if it were still a public utility.  He saw how politicians demanded "universal service obligations" of Telstra that the politicians expected the company's shareholders to pay for.  He saw how politicians had (and still have) no compunction at telling Telstra how many pay phones it must operate in rural areas or how fast its broadband speeds must be.  The fact that it was taken for granted that Trujillo's replacement needed to "get along with" the federal government reveals how perverted government-business relations have become.

Trujillo saw how Telstra was expected to meekly accede to the whims of the multitude of regulators and regulatory agencies that made it their business to make life for Telstra as difficult as possible.  He then saw how, whenever Telstra had the temerity to fight back against what it regarded as the confiscation of its property, the company was accused of "not playing by the rules".

Executives who have been born and bred in this country understood what Trujillo did not.  Australia is not America.  Here the relationship between government and business is understood, accepted and managed in a way different from the US.  Ours is an economy about a twentieth the size of the US.  Government is hard to avoid at the best of times, but it is especially hard to avoid in Australia.

In Australia, unlike the US, there's no tradition of shareholder activism.  Trujillo was surprised at the equanimity with which Telstra shareholders accepted the regulatory depredations constantly being visited upon the company.  What he didn't appreciate was that most Telstra shareholders understand it has ever been thus.  If you expect to be mugged you won't be too upset when it actually happens.  If you're a Telstra shareholder you know the company's share price will be affected as much by the political preferences of ministers as by the performance of your executives.

One of the more amusing comments after the announcement of Trujillo's departure was from an analyst who said that Trujillo should have made Telstra "more like Google or Apple".  How Trujillo was actually going to do this wasn't explained.  Trujillo could have been a combination of Bill Gates, Jack Welch and Richard Branson and the task would still have been impossible.

Trujillo should be judged against the possible, not the miraculous.  Although he got some things wrong, he got some things right.  For example, Telstra delivered one of the world's best wireless broadband networks.  Perhaps his biggest contribution was the realisation he imposed on Telstra staff, customers and shareholders that the company had to change.

It wasn't race that brought Trujillo undone, it was that he was an outsider.

And when he bade Trujillo "adios", Kevin Rudd wasn't being racist, he was simply applying the double standard widespread in public life whereby it's acceptable to poke fun at some ethnic groups and some religions but not others.  If the departing boss of Telstra had been of Arabic origin it's unlikely Rudd would have said "maasalama".

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A True Maverick

If any one life story can tell the tale of social and economic change in Australia in the second half of the 20th century, it would be Gordon Barton's.

Yet when he died aged 75 in April 2005, it took a while for anyone to notice.  Proof of the obscurity into which Barton had faded is the fact that it was not until several months after his death that Melbourne writer Sam Everingham first heard of him.  Intrigued by what he heard, Everingham decided to write a biography of Barton, the recently published Gordon Barton:  Australia's Maverick Entrepreneur, thereby progressing from complete ignorance of a subject to published biographer in three years, which must surely be some sort of record.

I have something of an advantage here, because I first heard about Barton when I was four years old when the fledgling Australian Reform Movement (subsequently the Australia Party) put together a ticket to contest the half-Senate election in NSW.  Barton headed the ticket, supported by well-known figures Harry Seidler, Ken Thomas and Peter Mason.

The fact that a copy of one of the ARM campaign advertisements is reproduced in Everingham's book earned it a tick from me before I even started reading.  Fortunately, it deserves ticks on other grounds too, chiefly for weaving Barton's different simultaneous activities into a coherent narrative.

Barton was first and foremost a businessman.  For decades he fought to be allowed to deliver freight in a market-oriented way, both in Australia and Europe.  He acquired his first trucks while still a Sydney University student in his early twenties, in the era when state governments were attempting to stem losses on rail freight by imposing extortionate taxes on road freight, or even prohibiting it.

One of Barton's early trucking endeavours was to bring onions from South Australia, where they were cheap, to Sydney, where they were not.  However, NSW law prohibited onions being carried by truck, while in Victoria nothing at all could be carried by truck on Sundays.

It took the Privy Council's 1954 ruling in the Hughes and Vale case, that no government had the right to protect rail by prohibiting the interstate operation of trucks, to enable trucks to operate across state boundaries.  Of course, the intrastate restrictions still applied, forcing Barton into ruses such as routing all freight from Melbourne, bound for rural Victoria, across the Murray to Moama, so that it became interstate freight.

Barton expanded his business to the point where in 1962 he was able to purchase one of his two major competitors, Interstate Parcels Express Company (IPEC).  The company had only been founded in 1958, but by offering door-to-door delivery it had revolutionised the freight market.

As IPEC expanded its road business, it naturally also wanted to move into air freight.  But there it had to deal with the two-airline policy.  Remarkably, the amount of freight carried by air was actually falling in Australia at that time because the incumbents, TAA and Ansett, offered a spectacularly bad service.  Yet the Menzies government fought tooth and nail to prevent Barton being allowed to get import licences for aircraft with which he intended to operate air freight services.

After 15 years of trying, IPEC finally received permission to operate a national cargo service in 1979.  However, it was far from fair and open competition.  The Fraser government still reserved 80 per cent of the business for Ansett and TAA, and imposed restrictions on what sort of aircraft IPEC could use, precluding the most efficient option.  Finally, in 1981, freight was divorced from the passenger part of the two-airline policy and sanity prevailed:  business could transport freight by air in the most efficient manner.

So what were Gordon Barton's politics?  He had started out in the Sydney University Liberal Club, but as a vocal opponent of Menzies' Communist Party Dissolution Bill, that vehicle lost its appeal.  As with so many of his contemporaries, it was the Vietnam War that got him stirred up.  Never one to take small steps, Barton's intervention into the debate came by way of $1,782 and a full-page letter in the Sydney Morning Herald attacking US and Australian policy on the day in October 1966 that LBJ visited Sydney.

Within days, the outpourings of support for Barton's views led to the formation of support for what was originally called the Liberal Reform Movement, soon was renamed the Australian Reform Movement, and eventually became the Australia Party.  Everingham describes those who founded the party at Barton's Castle Cove home as "for the most part disillusioned Liberals -- hard-nosed businessmen, visionary academics and despairing clergymen".  Any consideration of the Australia Party's support base demonstrates that the concept of "doctors' wives" was not some completely new phenomenon of the Howard years.

The Australia Party was certainly a factor in delivering a middle-class alternative to Labor, and Everingham records that "commentator Malcolm Mackerras concluded that Whitlam owed Labor's victory to Barton's Australia Party".  In that 1972 election, the AP vote reached as high as 13 per cent in the ACT.  However, by 1974, Barton was disillusioned with the direction the party was taking, initially quitting as convenor and then withdrawing his financial support.  The Australia Party was eventually folded into the Australian Democrats.

If anyone thinks running a major freight transport business and founding a political party were enough excitement for one lifetime, they have not read the Barton biography.  Included in his curriculum vitae were building Australia's first legal casino, at Wrest Point in Hobart, running Angus & Robertson booksellers and publishers, publishing the influential Nation Review and starting Melbourne's first Sunday newspaper, the Sunday Observer.

And that's before we start on Barton's complicated private life.  In a 1974 Woman's Day interview, he scandalised conservatives when he revealed that he had girlfriends in various parts of the world and compared sexual variety with eating out, saying, "You don't go to the same restaurant all the time."  He argued that "a man's first responsibility is to enjoy his own life", and certainly the reader of this work finds a catalogue of amusing and often bizarre anecdotes involving Barton in suits of armour, or Madame Lash coming to dinner, both in and out of character.

While this philosophy led to much enjoyment, it also caused significant pain to others at times (such as when he forced abortions on his lovers in the 1950s) and to himself, with his excessive drug use in later life.  Indeed, much of the last couple of decades of Barton's life makes for sad reading, as a series of poor judgments saw him lose businesses and almost all his wealth, and suffer poor health, including the loss of his hearing.

"Maverick" is an overused word, but its use in Everingham's title is certainly justified.  Barton was a restless personality, always full of ideas and always challenging authority.  The fact that he lived in Indonesia until the age of nine, and then lived most of his later life in Europe, may indicate a lack of deep Australian roots, an impression perhaps reinforced by his faded fame.  Yet, while he was here, he certainly stirred the place up which, on balance, was probably a good thing.

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New sheriff needed to ride shotgun on heritage suburbs

It's a bit of a rhetorical leap to compare Melbourne's gentrified suburbs with the Wild West.

But after a Port Melbourne man knocked down his own home in order to build a double townhouse, that was apparently what came to mind for the mayor of Port Phillip.

"Saddle up your horse and ride out of town now if you think you can get away with it," the mayor wrote in an official statement released last week, obviously confusing his role as the chief political representative of a wealthy inner-city suburb with a gun-slinging saloon manager in Deadwood.

When demolishing houses is outlawed, only outlaws will demolish their houses.  The property's owner, Hodo Zeqaj, was fined more than $52,000 for the demolition because his rather ordinary-looking brick duplex had been subject to a "heritage overlay" -- that is, it's located in an area of Port Melbourne the proud and self-satisfied local government has decided is historically significant.

A team of three men managed to demolish the house in less than 15 minutes using a couple of chainsaws, which, no matter what you think of heritage laws, sounds like it would have been a lot of fun.

Certainly, Mr Zeqaj shouldn't have demolished his house without getting a permit to do so.  (And he definitely should have consulted his neighbour, with whom he shared a wall.)  Even so, the council has publicly stated that had Mr Zeqaj applied for a demolition permit, it would have refused him one.

Once your home has been "heritaged", well, you don't really own it any more, no matter how much money you've paid off your mortgage.  The council effectively does.  Almost every petty little alteration has to be approved by local government functionaries.

Want to paint your door?  In Port Phillip, there are 27 approved colours.  But don't get too excited -- you can't choose from the whole range.  You will need to carefully maintain historic consistency.

Want to install an air-conditioner?  There are planning permits to fill out, of course, and you need to make sure the unit is as hidden from the street as possible.  After all, we wouldn't want to ruin the seductive milieu of a suburban road by revealing that people actually live in those houses.

But don't we as a society need to protect historically significant properties from the ravages of the marketplace?  Perhaps.  But what is historically significant?  For the past half century, social history -- the history of ordinary people, as opposed to the history of priests, politicians and warriors -- has dominated the way we look at the past.  That's all great.  But the rise of social history does make it a bit harder to assess what is uniquely important.

For a social historian, almost everything can be counted as "historically significant".  Everything reflects in some fashion the social circumstances of the past.  So we get a barely interesting piece of trivia -- the properties around Mr Zeqaj's house are apparently early examples of low-cost homes built by the Housing Commission after World War II -- transformed into a harsh legal edict.  It isn't quite Captain Cook's cottage we're talking about here.  Does an entire neighbourhood need to be frozen in time so we can display cheaply and quickly built government housing in its full glory?  For those people who care about the history of public housing, wouldn't, perhaps, a few photographs suffice?

Anyway, if councils really want to protect important buildings, they should just buy them -- or at minimum compensate the owners for their loss of control over their own property.  If councils had to pay for the rights they steal, then they would perhaps be a little more cautious about doing so.  Right now, it's far too easy for local government to casually brand whole suburbs as critically important heritage areas while bearing none of the substantial costs.

It might seem glib to point out that we can't stop all development.  But it appears some councils are trying to do so.  Vast swathes of Melbourne's suburbs are being locked up by heritage regulation.

Unless we want Melbourne and its suburbs to become nothing but museum pieces, we're going to have to accept that the flip-side of having a dynamic, modern city is having to occasionally watch that dynamism sweep aside physical remnants of the past.

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Aussie Jitters

In recent years, a wave of protectionism has stymied foreign investment deals all over the world.  We all remember the U.S. Congress's rejection of bids by China National Offshore Oil Corporation and the United Arab Emirates' Dubai Ports World to acquire American oil and port interests in 2005 and 2006.  The antiglobalisation hysteria has been so intense in parts of Western Europe that even food and music are "protected" from foreign influences as a matter of national survival.

Now that protectionist wave is set to hit Australia, a medium-sized, commodity-exporting nation that has greatly benefited from exposure to the global economy.  The spur is the proposed 26 billion Australian dollar (US$20.1 billion) investment by the state-owned Aluminum Corporation of China (Chinalco) in Rio Tinto, Australia's second-largest resource company.  Next month, Treasurer Wayne Swan will decide whether to support the Foreign Investment Review Board's presumptive approval of the deal.  The aluminum company hopes to lift its stake in the Aussie mining giant to 18% from 9%.  But with current shareholders restive over the terms of the deal and political pressure mounting in opposition, the signs are not looking good that the deal will go forward.

Never mind that China is one of the few sources of investment cash;  and given that Rio's options to improve its balance sheet are confined to slashing jobs and selling off assets, it needs vital capital to reduce part of its enormous debt load.  A new wave of protectionism, moreover, would raise a red flag to markets about Australia's openness to foreign capital.  As former prime minister John Howard said last week, "we have to be very careful not to reject investment unless we have good reason".

The problem is that public opinion is a double-edged sword.  Polls here consistently show that foreign investment taps deep feelings of identity and violation in the community.  They also reveal that Australians know that investment has been crucial to the nation's prosperity.

We have witnessed the emotive force of foreign investment in the reaction to Royal Dutch Shell's takeover bid of Woodside Petroleum in 2001 as well as the Japanese investment in the resources industry in the 1970s.  Whether it has been Kraft's decision to move jobs to low-cost India or businessman Dick Smith's warnings about food icons falling into foreign hands, the message is consistent:  Aussies are very uneasy whenever a well-known local brand, or a large stake of that local company, is sold to foreigners.

In the Sydney-based Lowy Institute's annual foreign policy survey in October, 90% of respondents said the federal government has "a responsibility to ensure major Australian companies are kept in majority Australian control" and "a majority of Australians oppose major foreign investments by companies, banks or investment funds controlled by governments".  Yet more than 75% of Australians recognise that foreign investment leads to job growth and wealth creation.  In other words, we sneer at the very foreign investment we know has been crucial to our prosperity.

Australians are especially two-faced about Chinese foreign investment.  We're very uneasy about Chinese state-run companies that are increasingly investing in our raw materials;  78% are opposed to a state-run company, bank or investment fund that bids for a controlling stake in a major local company.  Yet 62% also think China's economic growth is a good thing, because it has helped underpin the nation's 17-year growth cycle and may enable Australia to weather the worst effects of the global financial storm.

In recent months, several high-profile conservative political figures -- such as Liberal leader and former investment banker Malcolm Turnbull and former treasurer Peter Costello -- have opposed the Chinalco deal.  They insist Canberra should be vigilant about monitoring Chinese state-run investment bids, especially where issues of energy and resource security emerge.  Fair enough.  After all, China remains a communist one-party state and state-owned companies may still be subject to direction from Beijing bureaucrats.

But firms -- regardless of the source of ownership -- still need to obey the laws of the nations in which they are investing.  Australia should recognise that Beijing is in the process of making a transition from communism to capitalism, that its state-run companies are becoming more independent and that foreign investment helps build a Chinese middle class that will demand more political freedom.

Public unease about globalisation is hardly an Australian peculiarity.  Nonetheless, the onus falls on political leaders and policy makers to try to bridge the divide between elite and public opinion by explaining more clearly the benefits of capital flows.  Ultimately, Australia is deeply integrated into the global economy.  We have more to gain from relaxing barriers to foreign investment than from searching for hidden perils.

Henry's upside-down economics

The Treasury chief simply doesn't understand how the economy works.

Treasury secretary Ken Henry says very large fiscal packages have been designed by governments across the world, suggesting they "have learned something from history".  That would be the governments that have taken the advice of their treasury departments, which totally failed to foresee the present debacle.

Henry reveals how the Treasury's modelling of the economy is largely uninformed by economic theory.  Essentially, Treasury's model is a series of mechanistic forecasts about growth rates that are assumed to be inevitable, and simply delayed or accelerated as a result of world conditions.  Last year Treasury pointed to an ageing of infrastructure in Australia, but such matters seem to have no bearing on future levels of growth and income.

Treasury's models naively add growth in employment and population and make an assumption about productivity.  Thus, if Australia were to accept an extra half a million immigrants of mainly working age, this would, on Treasury modelling, bring an increase in gross domestic product of 2 per cent for population plus another 3 per cent for employment.  Hey presto!  We have just lifted growth by 5 per cent!

In reality, such a rise in immigration could have a negative effect on GDP, as hands and mouths create wealth only when combined with skills, infrastructure and capital investment.

Treasury's modelling can project broad aggregates a year ahead in a stable domestic and world economy, but it's hopeless at forecasting in times of rapid change.  Thus, last year business investment was estimated to "remain flat" in 2009-10.  Now it is forecast to fall 18 per cent.

This inability to predict investment drivers is the basic flaw in the Treasury models' medium and long-term forecasts.  Contrary to Henry's view, growth is not some preordained upward trajectory that might be interrupted, but subsequently simply catches up on its trend.  Still less is it a revenue stream that can be raided without undermining its fecundity.

Economic growth depends upon government resisting its natural inclination to tax and spend.  Its basis is accumulating savings and ensuring that nothing impedes these savings being allocated to productive investment.  That's why economic growth took off in the industrial revolution leading to the modern era.  It's why Japan embarked on an explosive industrialisation in the 1950s and 1960s, increasing its per capita income levels from a quarter of Australia's levels to surpass those of this country.  It's the reason Hong Kong, Singapore, Taiwan and Korea followed suit in the 1970s and 1980s, and why China and then India have embarked on the same path.

Spendthrift countries have failed to grow, although some, like many in Africa, started off better placed than many of the success stories.

Henry fails to understand this and offers growth prescriptions that are the opposite of what is needed, as revealed in his defence of the various Rudd spendathons when he argues that employment would be much lower if there had been no government spending.  But the spendathons' injection of funds into the economy came from savings.  The government cannibalised savings and delivered them to parties with a high propensity to consume.  This policy of borrowing from the future for consumption now is the opposite of what is needed to create sustainable growth and jobs.  It diminishes the capability of the economy to sustain growth because the future has been raided -- funds that would go to investment have been siphoned off into consumption.

Henry's picture of the economy not only leads him into a cavalier approach to the nexus of investment and income levels, it also leaves him indifferent to measures that will reduce the economy's income-generating capacity.  He overlays what he calls a vast reform agenda onto the income-diminishing measures that have been budgeted.  This agenda includes a carbon tax designed to raise the price of energy and to thus reduce the competitiveness of our most efficient industries.  This blow on top of all the other damage is shrugged off as just another perturbation to be managed out of the cornucopia that is seen to be the natural state of the economy.

Without a reversal of the present policy approach, the best Australia can hope for is a long period of economic stagnation.

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Up, up and away goes deficit

When Wayne Swan says it will be seven years before the budget is back into balance you know he means he can never achieve this.  Still less can he build the surpluses to pay back the hundreds of billions of dollars of debt budget deficits will accumulate in the interim.  Restoring balance means taking tough decisions in terms of cutting spending.  This is difficult for the ALP, which is genetically programmed against reining in spending unless it is defence spending and there is little enough of that left to be whittled away.

The present level of deficits is a 35-year legacy of expenditure increases.  Having commenced a major spending spree and pressured business to increase wages in the teeth of a serious world recession, Gough Whitlam won an early re-election in 1974 claiming, with the baying support of the media, that the latest set of statistics proved "we have turned the corner".  Within days of his re-election, the corner we had turned was exposed as a blind alley and the economy tanked.  Whitlam then installed Bill Hayden as Treasurer but Hayden's razor gang was too little too late and an early election forced on Whitlam saw him thrown out in a landslide.  Runaway inflation and cascading spending deficits needed sterner remedies than Whitlam, even with reconstructed government, could offer.  Whitlam oversaw spending growth that raised the Commonwealth's share of GDP from 20 to 25 per cent.  Overall spending as a share of GDP is the quintessential budget figure against which the Rudd Government must be judged.  The Fraser Liberal government from 1975 allowed scope for the conservative Treasury department to apply corrective restraints on spending but still presided over a blow-out in the Commonwealth's share of expenditure to 28 per cent of GDP.  In the 1983 election, this allowed Hawke to portray the Fraser government as irresponsibly spendthrift.  The Hawke government and later the Keating government was in office for 13 years.  Its many reforms to competition and limited privatisations together with a benign international economy saw it presiding over relatively buoyant growth.  Even so, it failed to rein in the share of government in GDP which remained at close to the 28 per cent it inherited.

These comparisons suggest the achievements of the Howard government were creditable.  In the main the Howard government continued and accelerated the reforms to markets (including labour markets) that Hawke/Keating had commenced.  But Howard took a more disciplined approach to spending, which as a share of GDP was reduced to under 24 per cent.

This and continued global economic buoyancy resulted in relatively strong economic growth.  From the latter part of the Whitlam government until the past year, there was an understanding that government expenditure had a negative influence on the economy's performance.  The ALP, while dabbling in winner-picking industry policies, for the most part presided over a freeing up of markets.  This induced economic growth from which a portion could be taken to satisfy the party's natural support base.  The ALP lost office under Keating when this went too far in the context of a slower international economy.  The difficulty we now confront is that the bastion that promoted responsible fiscal policies, the Treasury, now encourages increased spending and has even been a leading promoter of introducing increased costs in pursuit of lower carbon dioxide emissions.  The Treasury Secretary, Ken Henry, has given full license to Rudd's exorbitant expenditure give-aways.

Henry even urged that these to be concentrated on the consumer rather than on infrastructure.  The latter at least has some payoff albeit likely to be inferior to leaving the funds with the private sector in terms of increased productivity.  There has never been a case in the past when the Treasury was anything other than a bulwark against the natural proclivity of politicians to spend.  This therefore is a particularly dangerous period for the Australian economy.  The present Prime Minister has clearly expressed his own view that increased expenditure is the means of sheltering Australia and allowing the economy to rapidly emerge from the world downturn.  He and Treasury in supporting this position both see the appropriate policy framework as being driven by an "accelerator" which is associated with the Keynesian economics approach.  Under the accelerator theory a demand deficiency is countered by an injection of government funding which causes demand to rise and eventually to become self propelling as firms respond to this with increased investment.  The problem is that the demand injection comes either from creating money or from borrowing.

In the first case it will end up with inflation, perhaps galloping inflation.

In the second case it will siphon off savings that would otherwise be used for investment and thereby cannibalise the available funds that would be available for investment as pockets of demand emerge and equipment might be replaced.  Hence fiscal deficits will undermine a recovery, perhaps, as was seen in Japan in the 1990s and US in the 1930s, totally prevent it occurring.

An alliance of politicians with strong predilections in favour of spending to buy votes and influence, and the public service agency that was previously the Praetorian Guard of the public purse is particularly dangerous to the national wellbeing.

It leaves an incoming government adrift from the necessary advice in restoring economic health and with the need to replace much of the current public service leadership.

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Irresponsible spending taken to a new level

Kevin Rudd has delivered a Nike "swoosh" Budget.

The charts in the Budget papers illustrate the reality of the present economic downturn together with fantasy forecasts of future upticks stimulated by government splurging.

Governments don't actually have any money to splurge.  All they can do is shift money into different buckets by taxing and spending.

Spending on education, roads and other infrastructure is clearly valuable.  But most government expenditure is far less productive than leaving the money with the taxpayers who earn it.

Back in the early 1970s Commonwealth spending was less than 20 per cent of national income.  The Whitlam years saw this rise to 24 per cent and it continued to grow until the mid-1980s.  Concerns about excessive government spending causing loss of economic competitiveness saw spending reined back to below 24 per cent before the Rudd spendathon got into gear.

Now Commonwealth spending will hit a high of close to 29 per cent of national income.

And don't be fooled by the Government solemnly promising to keep future annual spending increases to 2 per cent.

Within a day of this pledge, Treasurer Wayne Swan announced further increased spending "if the recession deepens".

Governments subject to little restraint in their spending can easily bankrupt and destroy nations -- think Hitler or Napoleon.

Prior to the modern era, parliaments were bulwarks preventing excessive spending -- the American War of Independence was fought by colonists who rejected new taxes without parliamentary representation.

But now that the government and the major parliamentary party are one and the same they have a common interest in re-election.

This often involves giving money to Peter (who will gratefully re-elect the government) by taking it from Paul (who is kept unaware of losing it or who would not vote for the government anyway).

For the most part taxing and spending is restrained by fears about the consequent work and investment disincentives.

Even so, almost all politicians would rather see economic disaster than face being voted out of office.

And they can often retain office by spending -- if the damage doesn't show up until after the election.

This brings us back to the Rudd Budget.

In the past the Treasury Department was a moderating influence over politicians' spending excesses.  Treasury, aware of politicians' weaknesses in favour of spending, reminded them of the adverse economic consequences.

This has changed.  Treasury is now joining the politicians in stoking the fires of irresponsible spending.

Treasury Secretary Ken Henry has urged the Prime Minister to spend recklessly on taxpayer giveaways.

The Treasury Department has also been the lead player in advising the Government to introduce a comprehensive new tax on energy that would strike at the heart of the mining and energy-intensive industries that are the backbone of the Australian economy.

The 2009 Budget raised spending to a new plateau.  Considerable pruning will be necessary to restore economic health.  But as Treasury is now part of the problem, this will require replacement of the key officials.

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Kept on a short leash

If Prime Minister Kevin Rudd genuinely believes Treasury is conservative when it forecasts economic growth of 4 per cent within two years, then it would be interesting to know his definition of optimistic.

Treasury officials are not used to being laughed at on budget night but, as soon as their growth forecasts were revealed, no other reaction was possible.  Of course there is a chance that for once Treasury will have made a prediction that proves to be correct.  But there's at least as much chance of Treasury being wrong.

Treasury's forecasts are based on the notion that the Australian economy will recover from this recession in the same way it did from the recessions of the 1980s and 1990s.  This is a heroic assumption.

If there's one thing about the current crisis that can be agreed upon, it is that it is different from and worse than other post-war downturns.  Despite this, Treasury remains happy to assume growth will return at the same pace and same scale as it did in previous decades.

It's not just Treasury's forecasts that are a worry.  There's also the spectacle of Rudd continuing to insist that the forecasts are "conservative".  Treasurer Wayne Swan has gone one better, claiming they are "very conservative".  When Opposition Leader Malcolm Turnbull came closer to the truth by describing them as "highly optimistic" and "top of the range", Swan retorted by saying that anyone who doubted the wisdom of Treasury was "silly".

The Prime Minister has spent the days since the budget defending Treasury and labouring the point that Treasury is independent.  He has pretended to be offended that anyone would criticise the integrity of Treasury.

But Treasury is not independent.  It is a government department responsible to its minister;  the secretary of the department is a political appointee.

There might once have been a time when Treasury was regarded (and regarded itself) as independent of the political persuasion of the government of the day but that time has long since passed.  Based on its track record since Rudd's election, Treasury has proved itself anything but independent of the Labor government.

Whereas once it was the voice of fiscal prudence, Treasury has embraced record budget deficits and record levels of government debt.  Whereas once Treasury could have been relied upon to undertake rigorous assessments of the impact of policies such as the cash handouts, the abolition of Work Choices or the introduction of the emissions trading scheme -- and to make those assessments public -- now Treasury accedes to the government's measures in silence and in secret.

Last year, Treasury secretary Ken Henry said it was entirely appropriate that the policy development for the government's bank deposit guarantee be undertaken away from the prying eyes of public scrutiny.

As bad as Treasury has been on policy, it is on matters of principle that Treasury has proved singularly lacking in independence.

When Rudd embarked on his crusade against neo-liberalism in The Monthly, he was attacking the principles of economic liberalism to which Treasury had adhered to since the 1980s.  If Treasury really was independent, as the Prime Minister claims it is, then some sort of response to this assault could have been expected.  But no response was forthcoming.

During the Howard government, the Treasury secretary had no compunction about complaining that Treasury wasn't consulted on policy initiatives.  But when the Rudd government embarks on a repudiation of everything his department once stood for, the Treasury secretary remains mute.  This is ironic given that, not too long ago, Henry was an eloquent defender of neo-liberalism.

In a speech to the Sydney Institute in 2005, he listed the reforms of neo-liberalism such as floating the currency, eliminating tariffs, and significantly "deregulation of capital and financial markets".  He said:  "It is now widely accepted -- not only by commentators but also within the general community -- that these policies have been a great success.

"Australia's ranking in the Organisation for Economic Co-operation and Development by gross domestic product per capita has moved from 18th in the early 1990s to eighth today.

"Overall, the reforms of the 1980s and the 1990s have seen Australians experiencing much higher standards of living in 2005 than would have been the case had governments not had the determination and perseverance to pursue difficult, but necessary, policy changes".

When Henry repeats in 2009 what he said in 2005 we'll know that Treasury is truly independent.  Until he does, Treasury will be just another government department.

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Never mind the deficit, look at the spending

It must take a lot of confidence to blame the size of our new deficit on revenue loss due to the financial crisis just seconds after you have finished a mind-numbingly long list of new spending measures.

In fact, there's a weird -- almost creepy -- sense of confidence surrounding Wayne Swan's second budget.

Treasury's reputation should be very battered.  Just last year, the inflation genie was out of the bottle and we were looking at a beautiful vista of economic happiness stretching as far as our eyes could see.  But Treasury seems to be getting more sure in its ability to predict the future, not less.

Wayne Swan's conceit that this recession will be quickly followed by a burst of astonishing, face-saving growth relies on a predicted GDP growth of more than 4% in the next couple of years.  That's a pretty big call in the middle of a recession that took the Treasury itself by surprise.  And it's an even bigger call considering during the twentieth century, the average GDP growth was only 3.4%.  So if Treasury's forecasts are accurate, then the fire in which this budget was forged was not very hot.

The misplaced confidence of this budget is even clearer when we look at Wayne Swan's counterfactuals.  Without the property bailout, the Wellington Street bus station, the highways up (and down) the coast, the detailed design work for the Sydney West Metro, and the $900 recession hush-money, the Treasury believes that Australia would apparently be 2 ¾ per cent poorer next year.  And there'd be 210,000 fewer people in work.  Not 220,000, not 200,000 but 210,000.

Of course, these numbers are almost always invented out of thin air.  Treasury secretary Ken Henry admitted as much in February.

So without these impressively self-assured Treasury figures we are left with just a historically large deficit and a government piling its promises up behind the next election.  We have spending levels not seen since the Second World War, and not a whole lot to show for it.

Wayne Swan's budget is a chickie run between Treasury and the global economy.  Sure, both could get out of it safely, but you wouldn't want to bet on it.

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Debt spiral

When Wayne Swan says it will be seven years before the budget is back into balance you know he means he can never achieve this.  Still less can he build the surpluses to pay back the hundreds of billions of dollars of debt budget deficits will accumulate in the interim.

Restoring balance means taking tough decisions in terms of cutting spending.  This is difficult for any government, especially Labor, which is far more oriented to increased spending to win support than the Liberals.

The present level of deficits is a 35-year legacy of expenditure increases.  Overall spending as a share of GDP is the quintessential budget figure against which the Rudd Government must be judged.

Gough Whitlam, having embarked on major new programs and pressured business to increase wages in the teeth of a serious world recession, won an early re-election in 1974 claiming that the latest set of statistics proved "we have turned the corner".  Within days of his re-election, the corner we had turned was exposed as a blind ally and the economy tanked.

Whitlam oversaw spending growth that raised the Commonwealth's share of GDP from 19 to 24 per cent.

The Fraser Liberal Government from 1976 allowed scope for the conservative Treasury Department to apply corrective restraints on spending but still presided over a blow-out in the Commonwealth's share of expenditure to 27 per cent of GDP.  In the 1983 election, this allowed Hawke to portray the Fraser Government as irresponsibly spendthrift.

The Hawke/Keating Government was in office for 13 years.  Its many reforms to competition and limited privatisations together with a benign international economy saw it presiding over relatively buoyant growth.  Even so, the share of government in GDP was at 26 per cent when it was voted out of office.

The Howard Government continued and accelerated the reforms to markets (including labour markets) of Hawke/Keating but pared back spending, which as a share of GDP was reduced to under 24 per cent.  This and continued global economic buoyancy resulted in relatively strong economic growth.  The Rudd Government in the 2009 budget has now reversed that progress and set a new benchmark with Commonwealth spending at over 28 per cent of GDP.

From the latter part of the Whitlam Government until the past year, there was an understanding that government expenditure had a negative influence on the economy's performance.  The ALP, while dabbling in winner-picking industry policies, for the most part presided over a freeing up of markets.  This induced economic growth from which a portion could be taken to satisfy the party's natural support base.  The ALP lost office under Keating when this went too far in the context of a slower international economy.

The difficulty we now confront is that the bastion that promoted responsible fiscal policies, the Treasury, now encourages increased spending and has even been a leading promoter of introducing increased costs in pursuit of lower carbon dioxide emissions.  The Treasury Secretary, Ken Henry has given full license to Mr Rudd's exorbitant expenditure give-aways.  Dr Henry even urged that these to be concentrated on the consumer rather than on infrastructure.  The latter at least has some payoff -- albeit likely to be inferior to leaving the funds with the private sector -- in terms of increased productivity.

There has never been a case in the past when the Treasury was anything other than a bulwark against the natural proclivity of politicians to spend.  This therefore is a particularly dangerous period for the Australian economy.  The present Prime Minister has clearly expressed his own view that increased expenditure is the means of sheltering Australia and allowing the economy to rapidly emerge from the world downturn.

He and Treasury in supporting this position both see the appropriate policy framework as being driven by an "accelerator" which is associated with the Keynesian economics approach.  Under the accelerator theory a demand deficiency is countered by an injection of government funding which causes demand to rise and eventually to become self propelling as firms respond to this with increased investment.

The problem is that the demand injection comes either from creating money or from borrowing.  In the first case it will end up with inflation, perhaps galloping inflation.  In the second case it will siphon off savings that would otherwise be used for investment and thereby cannibalise the available funds that would be available for investment as pockets of demand emerge and equipment might be replaced.

Hence fiscal deficits will undermine a recovery perhaps, as was seen in Japan in the 1990s and US in the 1930s, totally prevent it occurring.

A combination of politicians with strong predilections in favour of spending to buy votes and influence, and the leading public service agency also counselling increased expenditure is particularly dangerous to the national wellbeing.  The Treasury, previously the Praetorian Guard of the public purse, is no longer providing government with the advice necessary to restore economic health and to restrain spending.

Restoring economic stability will therefore require the replacement of much of the current public service leadership.

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The road to hell is not paved with poker machines

Is there any form of entertainment more reviled than the pokies?  Perhaps cockfighting, or rabbit hunting.  Or Russian roulette.  But then again, nursing homes aren't sending the elderly in groups to watch blood sports.

Obviously, when problem gambling manifests itself as a serious mental illness, there should be, and is, professional help available.  But levels of problem gambling are actually quite low.  According to the most recent study in Victoria, less than 2 per cent of pokies players are problem gamblers, and that's with a pretty fuzzy and expansive definition of what constitutes a "problem".

Ninety-eight per cent of people who play the slots suffer no negative consequences.  Why then is there such extraordinary venom directed at the industry?  The average Victorian spends just $50 on poker machines a month -- the cost of dinner and a movie.

So there's something a bit distasteful about the passion with which the great and good declare their anti-pokies views.

Not even cigarettes cop as much flak as the pokies.  Anti-tobacco activists appear to believe smoking is the equivalent of being stabbed in the face by a cigarette company -- every cigarette is doing you damage -- but few community leaders go so far as proposing the complete elimination of smoking, as they do with the pokies.

Perhaps it's like that old anecdote about the academics who have never met anyone who voted for John Howard -- pretty much everybody has tried a cigarette, and most people have friends who regularly smoke, but who could be so tasteless as to enjoy gambling with a machine?  Certainly not anyone I know.

Still, it makes sense that poker machines would cop the brunt of anti-gambling sentiment.  The pokies have none of the romance of other types of gaming.  Playing high-stakes poker around a table while wearing a tuxedo could be very romantic.  One-cent pokies?  Very rarely romantic.  In his 22 adventures so far, James Bond has never once seduced a leggy European femme fatale while grasping a cup full of change and hoping three strawberries will appear in a row, as delightful as that would be to watch.

Sure, it doesn't always look like pokies players are having a whole lot of fun.  But while it's easy to disdain those who spend Saturday night pulling a lever in a suburban pub -- their vacant look, their robotically repetitive movements, their apparent joylessness -- have you ever looked at somebody else while they watched a movie?

I don't want to sound all "neo-liberal" here -- respecting individual choice and economic liberty is so 2007 -- but for the most part, people do things because they want to.

As a consequence, saying that Victorians "lost" $2.4 billion at the pokies last financial year makes about as much sense as saying Victorians lost $2.4 billion at the cinemas.  Perhaps the critics of poker machines could grant that people who go out of their way to play the pokies derive at least some small benefit from doing so?  As much as it enjoys the revenue from taxes on poker machines, the State Government doesn't force anybody to play.

Indeed, a very weird concern of the anti-pokies movement is that state governments are addicted to the revenue they receive from heavily taxing poker machines.  Admittedly, in the Victorian budget last week, the Government expects to receive slightly over $1.6 billion from its assorted gaming taxes -- most of which comes from the pokies.  But this is a tiny 4 per cent of total state revenue.

Anyway, if the Government needs "to wean itself off gambling revenue", as the head of the Interchurch Gaming Taskforce said last week, then the quickest way would be to dramatically reduce taxes on gambling.  This may not, however, be the solution anti-pokies activists are looking for.

Traditionally, governments have banned the lower classes from card games and betting.  And those same cash-hungry governments kindly offered the middle classes official revenue-raising lotteries.  The upper classes have had free rein to indulge in whatever stupid games of chance they can devise.  In fact, in the history of Europe, a surprising number of territorial acquisitions have been made not through war but as a result of bets between over-confident monarchs.

After centuries of paternalism, anti-gambling activists perhaps need a change of attitude.  Even if you don't enjoy the pokies, others do.

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Bring Back the Thatcher Revolution

Thirty years ago this week, Margaret Thatcher led her Conservative Party to victory and set the scene for a wave of privatisation and deregulation across the Anglosphere.  From the Keynesian mindset that delivered economic stagflation and turmoil in the 1970s, the U.K. as well as the U.S. and the Antipodes moved to an era of sounder policy and more durable prosperity.  Today, as the cause for small government and free markets appears quixotic, it is easy to forget how depressing things looked three decades ago and how the economic reforms unleashed by the Thatcher Revolution led to a golden age.

In 1979, inflation, unemployment and recession were endemic.  The Soviets had invaded Afghanistan, Islamist fundamentalists had overthrown the Shah in Iran, oil prices had more than doubled, and the West appeared in retreat almost everywhere.  Britain was regarded as the sick man of Europe (think Arthur Scargill's union militancy), the U.S. was suffering a crisis of confidence (think Jimmy Carter's "national malaise" sermon), and Australia and New Zealand were overregulated and overprotected nations, weighed down by chronic inflation (think banana republic).

But things started to change -- even before the Iron Lady's historic election.  In 1976, she met a former California governor for what was scheduled as a routine 20-minute session between two right-of-center politicians from opposite sides of the Atlantic.  The conversation between Lady Thatcher and Reagan instead lasted more than two hours and, as the Gipper later put it, they immediately identified each other as "soul mates" in promoting the cause of small government and economic freedom.

Although John Howard, Australia's conservative treasurer from 1977 to 1983 and later prime minister from 1996 to 2007, never met Reagan, he has confided with Mrs. Thatcher on numerous occasions since 1976.  A leading proponent of free market reforms down under, Mr. Howard played a key role in transforming Australia from a heavily protected closed shop three decades ago into the envy of the industrialised world that could very well be immune to the global recession (as yesterday's new low jobless rate of 5% shows).  Through a combination of circumstance, conviction and competence, these three patron saints of the conservative cause put into practice the classical liberal ideals of Milton Friedman, Friedrich Hayek and Keith Joseph that defined an epoch.

Whereas in the 1970s excessive government regulation and bloated bureaucracies created a crisis of stagflation, the next 30 years witnessed, save a few quarters of negative growth in the early 1990s, uninterrupted economic expansion.  True, there were some policy reversals and setbacks;  even the Iron Lady had no stomach to reform the socialistic National Health System.  But by almost any economic criteria, this free-market agenda of privatisation, deregulation, tax cuts, fiscal prudence and flexible labor relations -- or, as what Mr. Howard's successor Kevin Rudd derisively calls "neo-liberalism" -- has dramatically raised living standards in the Anglosphere and elsewhere.  "Individuals" London's Tory Mayor Boris Johnson put it this week, "were able to take control of their destiny in a new way."

Mrs. Thatcher, Reagan and Mr. Howard reshaped not only their own erstwhile paternalistic parties but the opposition center-left as well.  Tony Blair's New Labour, remember, was the offspring of Thatcherism.

But has the age of Thatcher, Reagan and Howard been consigned to the dustbin of history?  With today's global financial turmoil, U.S. President Barack Obama, U.K. Prime Minister Gordon Brown and Mr. Rudd champion the politics of envy and the discredited economics of the Keynesian welfare state and demand management.

Today's Anglosphere leaders, with the notable exception of New Zealand's John Key, are interpreting this crisis as a mandate for a renewed activist state.  And if that means runaway debts and deficits, so be it.  After all, as John Maynard Keynes put it, in the long run we're all dead.  The specter of big government has returned to haunt the Anglosphere.  Never mind that today's economic ills have more to do with muddled government intervention and poor regulatory oversight of the financial sector than any unfettered global market forces.

The big spending, let-government-solve-it agenda is thus far playing big political dividends, at least in Australia and the U.S., with both Messrs. Rudd and Obama in the polling stratosphere.  Still, they could do no worse than heed Mr. Howard's recent message:

"The notion, gaining traction because of the world's financial turmoil, that in some way markets need extensive re-regulation is based on a false reading of what has happened to the world economy in the past year and also ignores the reasons for the remarkable growth of the middle class in the Asia Pacific region and the consequent reduction in levels of poverty, which have occurred during the past 30 years."  The Gipper and the Iron Lady would say Amen to that.

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Borrowing big to fund promises

This week the Brumby Government handed down its second budget, and the Labor Government its 10th.

Arguably the biggest talking point is the State Government's move to increase borrowings from already stretched capital markets to fund its big-ticket spending promises.

Borrowing by the non-financial public sector is expected to grow by 48 per cent over the next four years to $38.8 billion.

This policy decision adds to the stock of net debt held by the Government.  The budget papers show that net debt will more than double from $19 billion in 2009-10 to more than $31 billion in 2012-13.

One of the major questions is whether this increase in financial obligations by the Government is sustainable.

While Premier John Brumby and Treasurer John Lenders insist that net debt will remain below the AAA credit rating trigger point used by rating agencies, the critical net debt to operating revenue ratio of 118 by 2013 is a far cry from the ratio of 65 in 2001.

Another way to look at the sustainability question is to consider what benefits Victorians might expect from the rising debt.  This is where the budget becomes decidedly murky.

One of the flagship initiatives of the Government is to engage in infrastructure spending, supposedly to "secure up to 35,000 Victorian jobs".  This is despite the budget forecasting employment growth to slide into negative territory in 2009-10, and an increase in the unemployment rate.

There is a lack of economic modelling in the budget surrounding the validity of these job estimates.  A Government press release extolling the "jobs, jobs, jobs" virtues of its spending revealed only 6801 jobs secured.  It is then a case of finding out where the missing extra jobs come from.

Some of these are expected to come from Commonwealth capital grants, public-private partnerships or capital works by public corporations.  But Finance Minister Tim Holding presented figures showing that several of these jobs would be created through the magic pudding of Keynesian-style multipliers.

With such analysis typically not accounting for the tax and other costs of government interventions, perhaps Spring Street was too embarrassed to put the fine details of its fudged figures in the budget for external scrutiny.

One of the troubling features of this state budget is the extent to which the Brumby Government has leant on the Federal Government to do its financial heavy lifting.  It is estimated that 87 per cent of the increase for this financial year over last in general government revenue was accounted for by a rise in Commonwealth grants.

The Government is prepared to go to even greater lengths to surrender Victoria's financial autonomy to the Commonwealth, with the Treasurer last week canvassing a proposal to cut stamp duty in exchange for rising income taxes.  Before it installs the Prime Minister as effective state premier, the Brumby Government continues to rake in property taxes to the tune of almost $600 million to 2012-13.

Looking at the revenue side more generally, the budget figures belie the claims made by the Treasurer that the Government was not in the business of raising taxes.  Taxes are expected to increase by $1.7 billion, or 13 per cent, over the next four years.

There are also elements of revenue by stealth in this budget.  For example, the Government has signalled that it wants to double its inflow of dividends and "tax equivalent" payments out of water and other utilities over the next three years.  This is merely a tax masquerading as a share of profits, with the Government effectively dictating that state-owned monopolies must increase their prices.

These figures explain why Victoria's tax competitiveness, on the basis of figures presented in the Government's own budget papers, has remained naggingly above the Australian average.  Data released by the Commonwealth Grants Commission this week confirms this, with Victoria's total taxes above the national average and the state's overall revenue effort exceeding its capacity to raise revenues.

In relation to Victoria's budget surplus, the reality is that the budget bottom line has long been heading in the wrong direction.  In 2000-01, the Government recorded a $2.2 billion surplus, which is a long way from the 2009-10 estimated surplus that breaks the promise of retaining a surplus target of 1 per cent of revenue.

The erosion of the budget surplus has been the product of explicit policy decisions to spend at a faster rate than revenue is coming into the coffers.  Annual expenditure growth increased from 7 per cent in 2005-06 to 9 per cent in 2008-09.  By contrast, revenue growth for the general government sector remained fairly stable at a high rate of at least 6 per cent.

In other words, during the economic good times, Victoria went on a huge spending spree.  The lesson that such conduct greatly weakens fiscal discipline and sets the scene for an unsustainable debt bubble seems to have been ignored by the Government, as its forecast spending for 2009-10 again outstrips revenue growth.

The recession has made it essential that states return to at least a semblance of fiscal order.  With the 2009-10 Victorian budget, however, the states have made a poor start against this objective.

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Emissions retreat just so Napoleon

Despite the Government announcing it has backed away from early action to reduce carbon emissions, the Prime Minister's website continues to say, "The cost of inaction on climate change will be much greater than the cost of taking action now."

Like others working for Kevin Rudd, his website managers can't keep up with his policy changes.  Costs of "inaction on climate change" have just assumed a new meaning.  At the very least the PM, in postponing the carbon trading tax, is acknowledging that immediate measures to reduce emissions would be costlier than doing nothing.

But his proposed watering down of the already diluted proposals has all the hallmarks of Napoleon's retreat from Moscow.

Ross Garnaut, Rudd's hand-picked consultant on global warming policy, had already said that the white paper was irresponsible in proposing a free supply of emissions to electricity producers and energy intensive firms.  Now Rudd plans to increase that supply further.

Garnaut, Rudd and Penny Wong all talked about failure of a meaningful international agreement on emission reduction at Copenhagen later this year as being unlikely.  Now that such failure is a certainty, the costs of Australian action to the economy are becoming clearer even to mystics who see only evil in production.  Hence the PM's humiliating backdown.  But, never one to acknowledge his own misjudgments, Rudd is spinning this as a means to buying the Opposition's support and as some sort of hiatus to remain in place only while the global economic crisis runs its course.

Doubtless Rudd's postponement of the planned new carbon tax is a prelude to an attempt to replace it with a tax on households to help defray some of the costs of his reckless cash giveaways.

What is increasingly clear is that there will not be a carbon emissions trading scheme.

Australia has an energy-intensive industry structure, a coal-based electricity generation industry and coal and gas as our export mainstays.

Capitalising on our natural advantages in fossil fuel energy has required forging supportive institutional structures, a process that has taken many decades.  Our carefully developed political and administrative framework has allowed the creation of an energy supply industry that is the backbone of our present living standards.  To become one of the world's lowest cost energy suppliers has entailed marrying our resource endowment with entrepreneurial and workforce skills.  All this would have been jettisoned by a tax squarely aimed at destroying that productive efficiency fostered by low-cost energy.

Strongly performing industries will be at a premium in a world economy that's likely to be facing sluggish conditions for many more years.  Even the most complacent optimists can no longer take as given the income derived from our present industry structure.  Compounding the effects of the global economic meltdown's external assault on living standards with some purpose-made domestic measures is now revealed as a sledgehammer blow to the welfare of all Australians.

Formally announcing a total abandonment of the carbon trading scheme must be the next step.  Such action is necessary, and the sooner the better as the prospect of the proposed tax hangs like a sword of Damocles over any prospective investment decisions involving energy.  Australia can never afford to carry such baggage and the global financial crisis merely brings this home.

Inadvertently, the PM's website remains spot-on in saying, "There is no greater challenge now facing our world and our nation than dangerous climate change."  The challenge is to his Government's credibility at having commissioned endless reports, undermined the integrity of Treasury forecasting and created a monster department of hundreds of globe-trotting drones to promote phantom opportunities that a carbon tax would offer Australia.  The "dangerous climate change" is the shift in the climate of business opinion and community opinion more generally, as the reality of a crippling new energy tax looms.

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What goes up ...

We've all heard Enoch Powell's observation:  "All political lives, unless they are cut off in midstream at a happy juncture, end in failure."  Politicians, the British Conservative argued, always seek one more success, and their ambition pulses as long as their heart beats, but sooner or later they fall.  Anyone interested in reading the Australian book version of the same idea should consult Peter Hartcher's To the Bitter End:  The dramatic story behind the fall of John Howard and the rise of Kevin Rudd (Allen & Unwin), which Peter Costello launched in Canberra last week.

When he celebrated a decade in power in March 2006, John Howard was on the highest political mountain.  Unemployment was at a historic low, his fellow citizens were fat and happy, and Australia was the envy of the industrialised world.  The Wall Street Journal and London's Daily Telegraph compared him favourably to Ronald Reagan and Margaret Thatcher respectively.  He was seemingly invincible.  And yet his successful 12-year-old government was annihilated 18 months later, and our second-longest-serving prime minister lost the seat he had held for nearly 35 years.  It was not supposed to end like that.

Hartcher, international editor of the Sydney Morning Herald and one of Australia's leading political commentators, explains why it all ended in tears:  longevity of the government, WorkChoices and climate change.  All of these are plausible explanations for the coalition's election loss, but Hartcher's account of those final months is a mixed one.

At times, he produces a dramatic, albeit overstated, behind-the-scenes narrative of Howard's downfall.  At other times, however, Hartcher tells us what we already know about the leadership rivalry:  the intense disputes over fiscal policy (the treasurer was a true fiscal conservative, whereas the PM was a big spender);  Ian McLachlan's note on the alleged 1994 deal to pass the torch of leadership to Costello after two terms;  Costello's failure to challenge a wounded Howard who had lost the support of all but one of his cabinet colleagues (Philip Ruddock) during that turbulent September week of the Apec summit;  and the Athens Declaration of May 2005 when the PM responded to journalists' questions about whether he'd stay and fight Kim Beazley at the next election;  and so on.

From the outset, Hartcher depicts Howard in September to November 2007 as being "out of touch, too old, too tired".  It's not just that he fell asleep during one important strategy meeting, a charge Howard emphatically denies.  It's also his "intense mood swings" in the run-up to the election two months later.  "He frequently vented his frustrations on senior staff, yelling and shouting," Hartcher writes.  "The oscillations of the Prime Minister's moods were so punishing on those around him that they had persuaded Arthur Sinodinos to leave Howard's employ the year before, after more than a decade as his aide."

All of Howard's senior aides with whom I've spoken deny these accusations.  "There were obviously stressful days, but I don't think I ever heard him even raise his voice," Howard's senior foreign policy adviser Andrew Shearer told me.  "For example, I was with him more than anyone else during the Apec week -- surely a good reason to shout if ever there was one [given the relentless speculation that he'd resign] -- and can testify to his extraordinary resilience and civility under massive pressure."

"John Howard's treatment of staff is best reflected by the remarkable stability in its composition over such a long period in government," argues long-time chief of staff Sinodinos.  Other confidantes, such as press secretary David Luff and political adviser Stephen Galilee, vouch for their boss's grace and dignity under constant pressure during the second half of 2007.  "Unfailingly," speechwriter John Kunkel wrote last year, "he was calm, polite, professional and appreciative."  All of this is a far cry from the moody, emotional and intemperate prime minister portrayed by Hartcher.  Howard, in other words, was no Captain Whacky.

Still, Hartcher has some interesting things to say about Rudd's thin skin and political opportunism.  We learn, for example, how he intellectually seduced the Left to win the Labor leadership in late 2006, only to become an economic conservative to neutralise Howard in 2007.

What Hartcher rightly has to say about the succession issue that haunted Howard and Costello to the bitter end may well haunt Kevin Rudd and Julia Gillard.  With the Prime Minister in the polling stratosphere, that sounds inconceivable.  But just as the skies were very blue and clear for Howard in March 2006, so the skies are blue and clear for Rudd today.  And just as Howard could not defy the Powell theory of the inevitability of let-down, so will Rudd eventually come down.  After all, if political giants -- from Woodrow Wilson to Margaret Thatcher to Bob Hawke -- could not survive the epidemic of disappointment that has raged through the profession for decades, why should the nerdy Rudd, whom Howard once told intimates was a "class swot", escape their fate?

Ever since he became Labor leader in December 2006, Rudd has been overwhelmingly popular with the Australian people.  But as we head into the next federal election, and as the economic crisis starts to take its toll, it is a fair bet that "events" against which Harold Macmillan famously warned -- bad decisions, unintended consequences of policy, screw-ups in cabinet, a deteriorating economy -- could force the thin-skinned Rudd onto the political back foot.  Even a friendly press won't be able to sugar-coat the bad news.

Read Hartcher and one is left thinking that just as succession talk haunted Howard and Costello, and Bob Hawke and Paul Keating before them, it is bound to dog Rudd and Gillard (as long, of course, as the opposition cleans up its act).  According to Hartcher, there is no succession understanding between the pair.  But he also points out that it was Gillard who brought the essential bloc of Caucus votes, principally from the Left faction, to the joint Rudd-Gillard ticket that allowed Rudd to beat Beazley in December 2006.  Hartcher says she came up with at least as many votes as Rudd -- and probably more, according to her key people.

If this is indeed the case, and Rudd's popularity takes a dive, then prepare for another succession crisis in the nation's capital.  As it happens, two biographies on Gillard are due for publication in the run-up to the next election.  The timing could not be better.

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State finances at the crossroads: The states' budget problem, and what to do about it

EXECUTIVE SUMMARY

• The economic and fiscal performance of the states has a significant impact on Australia's economic fortunes now and in the future.  With taxing, spending and financial management policies and strategies at its disposal, state activities have a critical impact on the economy.
• The taxing and spending approaches by the states have dragged down Australia's economic performance in recent years and, if left unaddressed, could hamper the nation's recovery from the looming recession.
• It is forecast that the states will reach a total budget deficit of $10 billion this coming financial year, with borrowings to grow to $81 billion by 2011-12.
• The fiscal situation facing the states is a product of past policy events.  State and territory governments have been the beneficiaries of a revenue windfall of record proportions, with taxes and grants delivering $167 billion in revenue from 2000-01 to 2007-08 above what they originally forecast.
• Armed with windfall revenues, the states have engaged in spending of $987 billion over the same period.  Not to be outdone, actual spending was $157 billion over the initial forecasts published by the states.
• The Australian states used taxpayers' money to create boom conditions for bureaucrats, with much recurrent spending directed towards hiring public sector employees and increasing their wages.
• Money spent by governments appears to have delivered only mixed performance outcomes in key areas of service delivery.
• After nearly a decade of budgetary plenty, which saw state budget surpluses reach a height of 0.8 per cent of GDP by 2005-06, governments are now facing crippling budget deficits and rising public debt.
• States are eager to blame their budget woes on Wall Street.  The reality is that the "spend quickly for today" approach by the states has driven the worsening outcomes.
• Reforms must be implemented to eliminate structural budget deficits and bring the fiscal houses of the states back into order.
• Budgets can be repaired by cutting inefficient state taxes, making spending more focused on core services, and enforcing strong fiscal responsibility rules.
• The preparedness of states and territories to turn their backs on their big-spending ways should be the criterion by which their 2009-10 budgets are judged.

SECTION ONE:  THE IMPACT OF THE STATES
ON NATIONAL ECONOMIC PERFORMANCE

The activities of state governments ⁽¹⁾ have a profound impact on the national economy.  Spending by state governments -- $155 billion in 2007-08 -- is the equivalent of 14 per cent of national GDP.

In the wake of the ructions in global financial markets much of the media and policy focus has been on the budgetary decisions of the federal government.  Relatively little attention has been devoted to state governments.  But state governments retain significant influence over economic growth and productivity -- through their taxing, spending and fiscal management.  If these policy levers have been mismanaged, as has been the case in recent times, the states can hamper the ability of the national economy to recover from the recession.

STATE GOVERNMENT BUDGET DEFICITS

On the basis of the latest published estimates, the aggregate state and territory government deficit is expected to be in the order of $1.2 billion in 2008-09.  The total deficit of all state budgets could be as high as $10 billion by 2010-11 (this compares to a potential federal budget deficit for 2009-10 of $50 billion). ⁽²⁾

This is a far cry from the aggregate state budget surpluses of $8 billion in 2005-06, and reflects a significant deterioration in the fiscal sustainability of state government operations.

STATE GOVERNMENT DEBT

Whilst Western Australia, South Australia and Tasmania continued to reduce their borrowings from 2000-01 to 2007-08, other jurisdictions reversed their previous fiscal strategy of the 1990s to, in some cases, dramatically increase their general government borrowing (Figure 1).  With state governments now embarking on capital works programs financed by debt, the amount of borrowings can be expected to dramatically increase.

Figure 1:  State general government sector borrowing, 2000-01 to 2011-12

Source:  State and territory government budget papers.

Taking into account the asset holdings of governments, the consequence of this spike in borrowing is that the states' general government net debt will increase (Table 1).  After a sustained effort to reduce net debt -- to the point of achieving negative net debt outcomes -- it is expected that jurisdictions will once again have growing net debt on their balance sheets over the next few years.  The level of net debt incurred by jurisdictions is significantly higher when taking into account the borrowings of government trading enterprises.

Table 1:  State net debt, 2000-01 to 2011-12

	2000-01	2007-08	2008-09 (e)	2009-10 (e)	2010-11 (e)	2011-12 (e)
GGS	2,587	-23,294	-13,359	-4,862	455	6,184
NFPS	25,677	29,903	54,774	78,042	94,263	108,683

GGS denotes the general government sector, and NFPS the non-financial public sector.

Source:  State and territory government budget papers.

The additional borrowing by the states and territories over the next few years is on top of a confirmed $200 billion in borrowings to be undertaken by the commonwealth. ⁽³⁾  On the basis of currently available estimates, state borrowings will represent 22 per cent of commonwealth borrowings in 2008-09 and rise to 40 per cent by 2011-12 (Figure 2).  In per capita terms, state borrowings are expected to increase from $2,077 in 2008-09 to $3,588 by 2011-12.

Figure 2:  State general government sector borrowing as a percentage
of commonwealth government borrowing, 2008-09 and 2011-12

Source:  State and territory government budget papers.

WHY DOES THIS MATTER?

Prior to the advent of Keynesianism, it was largely agreed by economists that prudent financial management by a government essentially mirrored that of an individual, family or firm.  Norms of prudence were regarded as the key virtue in government budgeting, and budgets should be in balance, if not in surplus.  When capital expenditures were financed by debt, sinking funds for amortisation were to be established and maintained. ⁽⁴⁾

The pre-Keynesian norms for sound public finance were exemplified in writings by the late nineteenth/early twentieth century economist C.F. (Charles Francis) Bastable.  In his 1903 book, Public Finance, Bastable suggested that "under normal conditions, there ought to be a balance between these two sides [expenditure and revenue] of financial activity.  Outlay should not exceed income, ... tax revenue ought to be kept up to the amount required to defray expenses." ⁽⁵⁾  To be sure, Bastable also considered that a modest surplus was also appropriate to account for extenuating circumstances affecting revenue or expenses.

Changes in the stance of fiscal policy at the state level have arguably been counterproductive not only in terms of its adherence to time-tested rules of appropriate fiscal conduct, but to the Australian economy as a whole.  As the state budget papers indicate, state and territory governments rapidly reduced their surpluses during the height of the recent economic boom.

As was argued in final report of the 2008 Senate Select Committee Inquiry into State Government Financial Management, these actions drove inflationary pressures throughout the economy. ⁽⁶⁾  For example, the substantial growth in the number of state public sector employees, and increases in their salaries, contributed to shortages in the availability of skilled, professional labour.  After a period of insufficient infrastructure investment -- including a reluctance to pursue private-public partnerships (PPPs) on a greater scale -- a sudden and rapid increase in capital spending by governments contributed to rising materials, construction and labour costs.

Now, with a profile of slowing economic growth nationally, the underlying states' structural budget deficits have been exposed.  There is a risk that states will seek to plug their fiscal gaps through increases in their narrow, inefficient taxes.  Over the past six months the following tax increases have been announced:

• New South Wales:  a new two per cent marginal tax rate on high-value land holdings, increases in nominal duty rates, rising parking levies and coal royalty rates, additional revenue due to a change in land holder duty, and deferred abolition of nuisance duties
• Queensland:  a new 0.5 per cent land tax surcharge, increasing motor vehicle registration fees, increasing gaming machine tax rates, and deferral of transfer duty on core business assets
• South Australia:  deferral of nuisance duties on non-quoted marketable securities and non-real property transfers.

In Victoria the government announced an infrastructure contribution charge for developers in growth areas, while an attempt to broaden the stamp duty base was quashed in March by the state parliament.  That these, and other, increases in revenue have been announced in the teeth of a national recession will only tend to prolong Australia's economic downturn, to the detriment of positive employment and investment outcomes.

State governments are also turning to public sector debt to further increase expenditure.  The creation of a debt bubble by states and territories is highly problematic on a number of fronts:

• Knowing that the cost of debt is paid for by future taxpayers encourages politicians to indulge in excessive spending.
• State governments have a historical tendency of supporting unproductive projects.  Capital spending in the general government and trading enterprise sectors alike are invariably driven by a host of non-commercial objectives.  Current and future generations bear the economic consequences of inefficient infrastructure, while future generations bear the costs of repaying the debt.
• The interest costs on state semi-government bonds must be paid ultimately by taxpayers, effectively displacing tax reductions or services expenditure in other areas.
• Public debt raised today must be serviced and retired sometime into the future, meaning that a future tax liability is to be imposed upon individuals who had not consented to the raising of debt.
• During a period of pervasive credit constraints in international financial markets, public debt financing by the states is likely to put upward pressure on interest rates in the long term and threaten private capital accumulation nationally.
• Taxpayers become increasingly exposed to fluctuating capital market conditions and other risks that could increase borrowing costs.  In the Australian context, it has been well established that the Rudd federal government's guarantee on wholesale debt securities issued by banks impaired the capacity of state governments to attract purchasers of their bonds especially during late 2008-early 2009.

The erosion of sustainable state budget settings acts as a significant drag on Australia's economic prospects.  Despite the prevailing view expressed by politicians and government officials that the state budgetary crisis is a consequence of the cyclical downturn in revenues, the analysis presented in this paper reveals that the weak fiscal disciplines exercised by the states have contributed to their own structural budget problems.  In other words, the present budgetary difficulties facing states are the product of their own past decisions.

The state governments must put their fiscal houses back in order.  Such efforts will yield substantial community benefits at any time of the economic cycle.  This paper proposes three reforms to slim down big-spending state governments, resting on reductions in inefficient taxes, developing more focused expenditure priorities, and stronger fiscal rules.

SECTION TWO:  STATE GOVERNMENT REVENUES

Over the course of this decade the general government sectors of the states and territories have enjoyed an unprecedented growth in their revenues.  Indeed, the states' revenue growth from 2000-01 to 2007-08 was far in excess of what governments had originally estimated -- in other words, delivering a major revenue windfall. ⁽⁷⁾

STATE OWN TAXATION REVENUE

The major taxes levied by the states include those imposed on employers' payrolls, land and properties, and taxes on gambling, insurance products and motor vehicle transactions and usage. ⁽⁸⁾

From 2000-01 to 2007-08, actual taxation revenue increased by an average annual rate of 7.4 per cent.  Tax increases were largest in Queensland (12.2 per cent per year), Western Australia (12.1 per cent) and the Northern Territory (8.6 per cent).

By comparison, as noted in state budget papers, jurisdictions had originally forecast their tax revenues to grow on an annual basis by 3.2 per cent.  The overall result was that the states and territories enjoyed a substantial tax revenue windfall of $27.3 billion over the period (Figure 3).

Figure 3:  Actual versus forecast state own taxation revenue

Including fees and fines for various years.

Source:  State and territory government budget papers.

As a consequence of the introduction of the GST, which entailed the abolition of a number of nuisance state taxes, the actual amount of state tax revenue collections were initially below those levels forecast prior to the tax reform.  However, from 2003-04 actual tax collections began to exceed the budget forecasts with the tax windfall trend continuing through to 2007-08.

One of the major drivers of the states' tax windfall has been the ballooning amount of taxes collected as a result of the recent (but now receding) property boom across Australia (Box 1).  Taxes on payrolls and insurance also made significant contributions to the excess taxation revenues received by the states for much of this decade thus far.

During its 2000-01 to 2007-08 resource boom, Queensland received the largest state tax windfall of $11.6 billion.  This was followed by Victoria ($6.0 billion), Western Australia ($5.8 billion), NSW ($1.3 billion) and South Australia ($1.2 billion).

Box 1:  The operation of state property taxes The states and territories impose a range of taxes and charges on the ownership and sale of residential and commercial property. Land tax is generally levied on commercial, industrial and some non-owner-occupied residential land.  Transfer (or conveyancing) duty is levied on the value of property purchased.  Other levies, such as for metropolitan improvement programs of funding fire and other emergency services, are imposed on property owners. Property taxes contribute about nine per cent of total Australian taxation revenue compared with an OECD average of about six per cent.  The majority of Australia's property tax revenues are collected by the states. From June 2002 to June 2008, property prices in Australia increased at a substantial rate.  For residential property alone, the prices of new (project) and established homes rose by 34 per cent and 65 per cent respectively.  The spike in property prices was the result of a variety of factors, including rising real incomes, land supply restrictions and government subsidies to encourage home ownership. These price trends had a significant effect on state government property tax collections.  In 2000-01, the states and territories collected about $9 billion from various property taxes -- or about 27 per cent of total state own tax revenue.  By 2007-08, state property tax revenues rose to about $22 billion, representing about 41 per cent of state tax revenues.  This trend occurred despite the abolition of a range of nuisance property-based taxes, such as mortgage and lease duties in most states, as a consequence of the 2000 national tax reform initiative. A range of deleterious economic impacts have been associated with the states' property tax regime.  Transaction-based stamp duties tend to deter labour mobility, and distort housing choices for people at different stages in their life cycle. The land transfer duty system adds significantly to the cost of purchasing a home, particularly for young aspirant homeowners and existing homeowners looking to buy more compact housing in retirement age, and therefore creates an inefficient use of housing stock. Despite land taxes being lauded in some circles as the "ideal tax", in practice they can distort production and locational decisions.  Further, land taxes regularly subject taxpayers to surprising year-on-year changes in liabilities driven by a bureaucratic land valuation system. In general, property taxes have repeatedly been identified by economists as amongst the most inefficient state government taxes. Source:  ABS, House Price Indexes:  Eight Capital Cities, cat. no. 6416.0;  Richard J. Wood, 2009, "Textbook example is not grounded in earthy reality", The Age, 13 March;  OECD, 2007, Revenue Statistics 1965 to 2006;  State and territory government budget papers.

It is widely accepted that the states and territories levy some of the most inefficient taxes in the Australian federation.  A 2001 State Business Tax Review commissioned by the Victorian government found that "stamp duties do not rate highly on efficiency grounds" and that the efficiency of land and payroll taxes are also severely compromised. ⁽⁹⁾  Joyeux and Abelson found that transaction taxes on housing imposed a deadweight loss on the national economy of some $375 million per annum. ⁽¹⁰⁾

In 2008, Access Economics ranked the relative efficiency of state taxes and found that motor vehicle taxes on business, insurance duties and non-residential property conveyancing duties were amongst the most inefficient of taxes collected in Australia. ⁽¹¹⁾  An assessment of NSW taxes by the Independent Pricing and Regulatory Tribunal (IPART) found that state taxes rated poorly in efficiency terms compared to commonwealth taxation. ⁽¹²⁾  The more intensive use of these inefficient tax bases to, say, reduce the gap between budget expenditures and revenues in the next few years will tend to impede Australia's growth performance during the next recovery

COMMONWEALTH PAYMENTS

One of the most significant changes in state finances since World War II was the introduction of the GST national tax reform package in 2000.  As part of the reform, the states would receive the proceeds of GST revenue (less administrative costs of tax collection) in exchange for the abolition of a number of efficiency-impeding state taxes. ⁽¹³⁾

One of the key rationales for introducing the GST reform was to equip state and territory governments with sufficient revenues to provide services for which states are responsible.  As it has turned out, the GST has more than lived up to its initial promise with governments underestimating its revenue-generating capacity (Box 2).

Under the reform arrangements, it was agreed that no state would be made financially worse off from the GST.  Each state is entitled to receive a Guaranteed Minimum Amount (GMA) from the commonwealth, calculated as the amount states would have received under the former financial assistance grants and state tax regimes.  The difference between the GMA and GST revenue provision for each state would be met by commonwealth Budget Balancing Assistance (BBA) funding.

It was originally expected that the states would not become net beneficiaries of the GST reform package until 2006-07.  However, the actual strong growth in GST revenues has meant that the states have enjoyed GST receipts in excess of their GMA entitlements (and hence no need for BBA to fill the budgetary gap) since 2003-04 (Table 2).  Since 2000-01, the states and territories have enjoyed a GST windfall close to $10 billion over and above the GMA compensation threshold.

Table 2:  GST revenue provision in excess of Guaranteed Minimum
Amount, states and territories, 2000-01 to 2007-08, $ millions

	NSW	Vic	Qld	WA	SA	Tas	ACT	NT	Actual total	GMA	GST windfall
2000-01	7,258	5,099	4,658	2,375	2,279	988	473	1,226	24,355	27,138	0
2001-02	8,132	5,593	5,019	2,518	2,477	1,060	544	1,290	26,632	30,709	0
2002-03	9,080	6,365	5,888	2,910	2,859	1,247	616	1,515	30,479	31,380	0
2003-04	9,667	6,961	6,553	3,158	3,146	1,394	658	1,681	33,219	32,172	1,047
2004-05	9,884	7,346	7,329	3,624	3,293	1,435	680	1,730	35,323	33,354	1,969
2005-06	10,362	7,833	7,689	3,804	3,442	1,496	723	1,834	37,182	35,654	1,528
2006-07	10,938	8,588	8,092	3,968	3,605	1,568	778	2,015	39,552	37,440	2,112
2007-08	11,916	9,429	8,549	3,984	3,914	1,665	846	2,207	42,330	39,054	3,276

Source:  Commonwealth government budget papers.

In addition to the GST and other untied assistance payments, states and territories also receive tied funding to deliver policy objectives specified by the commonwealth in areas including education, health, social security, housing and transport. ⁽¹⁴⁾  As part of the national tax reform agreement, the commonwealth gave an undertaking to states to maintain the aggregate level of specific purpose payments.

Putting all forms of commonwealth assistance together, the states have received a revenue windfall of $73.3 billion over and above initial projections (Figure 4).

Figure 4:  Actual versus forecast commonwealth payments to states, 2000-01 to 2007-08

Including current and capital grants, and subsidies for various years.

Source:  State and territory government budget papers.

From 2000-01 to 2007-08, Queensland was the greatest beneficiary of the commonwealth payments windfall, receiving grants in the order of $17.9 billion over and above the amount originally forecast.  Victoria ($16.7 billion), NSW ($14.7 billion), Western Australia ($10.9 billion) and South Australia ($6.8 billion) also received significant windfalls in commonwealth untied and tied payments.

Ironically, the smaller states -- that, in part, benefit from an implied redistribution of GST revenue due to public service cost and revenue "disabilities" -- tended to have the smallest actual increase in commonwealth payments over the period, as well as the lowest windfalls in revenue from this source.

The flow of grants from the commonwealth to the money hungry states is not without its financial or economic consequences.  For example, general revenue assistance could distort state tax policies by lowering a jurisdiction's perceived marginal cost of funds. ⁽¹⁵⁾  Grants could also distort public service provision as states act strategically in an attempt to optimise their grant shares. ⁽¹⁶⁾  The expectation of bailout funds from the commonwealth alleviates incentives to undertake systemic reform to grow their own economies.

TOTAL STATE REVENUE

On the basis of total revenues received, it is clear that states and territories have enjoyed a funding windfall in excess of that originally budgeted (Figure 5).  From 2000-01 to 2007-08, the states have received an "own revenue + grants" windfall in excess of $167 billion.

Figure 5:  Actual versus forecast state total revenue, 2000-01 to 2007-08

Source:  State and territory government budget papers.

State own sources of revenue have shown remarkable buoyancy during a period of strong economic growth.  During the period under analysis, state taxes and non-tax revenues increased by $66 billion in excess of original forecasts.

New South Wales had the largest windfall with $40.5 billion in general government revenue from commonwealth and own sources in excess of forecast amounts from 2000-01 to 2007-08 (Table 3).  Following was Victoria ($40.2 billion) and then Queensland ($34.4 billion), Western Australia ($25.9 billion) and South Australia ($13.2 billion).

Table 3:  Actual versus forecast total revenue, states
and territories, 2000-01 to 2007-08, $ millions

	Forecast	Actual	Windfall
New South Wales	276,351	316,822	40,471
Victoria	192,807	233,045	40,238
Queensland	169,367	203,775	34,408
Western Australia	87,600	113,503	25,903
South Australia	67,947	81,184	13,237
Tasmania	21,007	26,319	5,312
Australian Capital Territory	16,516	20,447	3,931
Northern Territory	18,284	21,797	3,513
Total	849,879	1,016,891	167,012

Source:  State and territory government budget papers.

It is notable that the two largest states -- NSW and Victoria -- had the greatest windfall despite the greater capacity of Western Australia and Queensland to secure gains from royalty revenues levied on commodities.  The so-called "two speed economy" effect did not prevent NSW and Victoria from experiencing enormous revenue windfalls, which in turn helps explain the relatively lower rate of economic growth in those two states.

SECTION THREE:  STATE GOVERNMENT EXPENDITURES

The economic consequences of poorly targeted and excessive spending by the states have been identified over a long period of time.  For example, the substantial growth in the number of state public sector employees, and increases in their salaries, contributed to shortages in the availability of skilled, professional labour which, in turn, drove inflationary pressures throughout the broader economy.

From 2000-01 to 2007-08, the states and territories had initially forecast their cumulative spending to total $830.3 billion.  However, actual cumulative spending over the period was in the order of $987 billion.  This represented additional expenditure over initial forecasts to the tune of $156.8 billion, or a 19 per cent gap over the period (Figure 6).

Figure 6:  Actual versus forecast state total expenditure, 2000-01 to 2007-08

Source:  State and territory government budget papers.

The actual rate of spending in Queensland was the highest of all states, with expenditure increasing by an average of 8.4 per cent per year.  The Northern Territory (7.5 per cent per annum), Victoria (7.2 per cent), WA (7.1 per cent) and the ACT (6.8 per cent) also recorded significant increases in spending on average each year.

Comparing actual expenditure with initial budgeted forecasts, NSW spent over their forecast to the tune of $47.0 billion from 2000-01 to 2007-08 (Table 4).  Victoria ($38.9 billion), Queensland ($27.5 billion), Western Australia ($17.9 billion) and South Australia ($12.9 billion) rounded out the biggest spenders of the federation.

Table 4:  Actual versus forecast total expenditure, states
and territories, 2000-01 to 2007-08, $ millions

	Forecast	Actual	Windfall
New South Wales	264,928	311,939	47,011
Victoria	188,944	227,842	38,898
Queensland	168,153	195,646	27,493
Western Australia	86,010	103,868	17,858
South Australia	67,506	80,370	12,864
Tasmania	20,509	25,152	4,643
Australian Capital Territory	16,091	20,473	4,382
Northern Territory	18,120	21,779	3,659
Total	830,261	987,069	156,808

Source:  State and territory government budget papers.

GROWTH IN PUBLIC SECTOR EMPLOYEES AND GOVERNMENT WAGES

One of the striking features of the states' expenditure has been the extent to which this has been reflected in a significant increase in the number of public sector employees and their remuneration packages.

While the states themselves do not present information on the number of their employees in a consistent manner, ⁽¹⁷⁾ the ABS publishes data on the total number of public sector employees by state and level of government.  This information not only incorporates numbers of employees within the general government sector, but other components of state governments including government trading enterprises (GTEs) and universities.

As shown in Figure 7, the number of state public sector employees has grown from about 1.1 million in 2001 to about 1.3 million in 2008.  While NSW has had the biggest growth in absolute terms, strong increases in employee numbers over the period were recorded in the commodity boom jurisdictions of the Northern Territory (28.7 per cent increase), WA (25.5 per cent) and Queensland (25.2 per cent).  The non-commodity state of Victoria increased the number of its public sector employees by 25.7 per cent, a particularly significant result for a jurisdiction where its government trading enterprise (GTE) sector is relatively smaller in its scope.

Figure 7:  Number of state public sector employees, 2001 to 2008

Data for 2001 presented as at May of that year, and as at June for 2008.

Source:  ABS, Wage and Salary Earners, Public Sector, Australia, cat. no. 6248.0.55.001;
ABS, Employment and Earnings, Public Sector, Australia, cat. no. 6248.0.55.002.

As this decade has worn on, the states have boosted the number of public servants.  While there is some variation between the states, the rate of growth in the number of public sector employees grew from 2.6 per cent in 2002 to 4.8 per cent in 2008.

The ABS also provides details of state public sector employee numbers by industry classification (Table 5).  Employees in government administration, education, health and community services (accounting for about 80 per cent of all state government workers) would constitute the majority of general government sector employees hired by states and territories.

The number of education and health workers increased by 15 per cent respectively from 2001 to 2007.  As a proportion of total state public sector employees, however, the number of people in these industry classifications fell by 1.2 percentage points.

There has been a significant increase in the number of people working in government administration.  In 2007, 160,900 people worked in administration compared to 98,600 in 2001 -- an increase of 63 per cent over the period.  State government administration personnel grew from nine per cent of the total number of public sector employees to 12.6 per cent.

Table 5:  Number of state public sector employees, selected industry classifications, 2001 to 2007

	Government administration	Education	Health and community services
2001	98,600	442,300	318,700
2002	117,600	450,000	317,500
2003	123,800	455,200	323,800
2004	129,300	483,100	337,700
2005	132,600	494,000	349,400
2006	148,300	503,100	349,400
2007	160,900	513,500	365,200

Source:  ABS, Wage and Salary Earners, Public Sector, Australia, cat. no. 6248.0.55.001.

Since 2000-01 employee entitlement expenses increased by an average of 8.3 per cent per annum, well in excess of inflation over the period.

Compared to initial forecasts as outlined in budget documents, the states and territories expended an additional $54.6 billion on general government sector employee wages and salaries, and superannuation expenses (Figure 8).  This additional spending above forecast on government employees represents about 33 per cent of the total windfall received by states and territories from 2000-01 to 2007-08.

Figure 8:  Actual versus forecast state general
government employee expenses, 2000-01 to 2007-08

Source:  State and territory government budget papers.

This was almost twice the windfall states and territories received from their own taxes, and are illustrative of the states' failure to contain their own public sector wage costs in key areas of service delivery such as education (Box 2).

Box 2:  State government pay deals with teacher unions The teacher unions have also looked upon state governments as booty to be expropriated.  After a fourteen-month campaign of pickets and stop-work periods, the Victorian government in mid-2008 caved in by providing an average 17.8 per cent pay increase to teachers applicable over four years. This decision, motivated by a desire to make Victoria's government school teachers the "best paid" in the country, has sparked a zero-sum game bidding war by teacher unions in other states.  In one of its first decisions in office, the new Western Australian government granted an immediate six per cent pay increase for teachers and school administrators.  Premier Colin Barnett stated that "the increase would make Western Australian teachers the highest paid in Australia." This was followed by a pay decision in NSW, where teachers received a 12 per cent pay increase over three years. Currently, South Australian teachers are calling for wage increases of 21 per cent over three years.  This is despite increasing unemployment, a budget deficit in that state, and teachers being awarded an interim pay increase of 3.75 per cent in February.  In early April, the Queensland Teachers' Union cited rising interstate teacher wages as a rationale for more wages for teachers in that state. The problems posed by government employee union wage campaigns, such as those conducted by government school teachers, are explained by Charles W. Baird: "Governments and the multitude of government agencies that actually employ public sector workers are, within their jurisdictions, monopoly providers of goods and services to taxpayers who cannot refuse to pay for those services whether they want them or not.  Taxpayers do not have competing courts, police agencies, fire departments, welfare bureaus, garbage collectors, government schools, etc. from which to select.  Any monopoly that hires workers can more easily pass on inflated labor costs to its customers than can enterprises which face competitors.  Moreover, in the government sector employers and employees have a common interest -- viz. to seek more and more resources from taxpayers." Without a stronger commitment by political representatives to use a firm hand in containing government wage costs, taxpayers will continue to be drained by the seemingly free-flowing transfer of funds to middle- and upper-class bureaucrats. Source:  Charles W. Baird, "Public Sector Labor -- Management Cooperation and Unions", (accessed 18 April 2009)

Another way to look at the growth in state government employee is to consider trends in the relative importance of employee expenses to operating expenses.  According to ABS government finance statistics, expenses for state general government sector employees increased from $41 billion in 2000-01 to over $69 billion in 2007-08.  As a proportion of gross operating expenses, this represents an increase from 57 per cent to 60 per cent over the period.

On a state-by-state basis it is clear that employee expenses have consumed more of the state budget in every state except Tasmania (Figure 9).  On the basis of currently available estimates published by states, this figure is expected to increase over the next four years.

Figure 9:  State general government employee expenses as
proportion of gross operating budgets, 2000-01 to 2007-08

Source:  ABS, Government Finance Statistics, Australia, cat. no. 5512.0.

IMPACT OF GOVERNMENT SPENDING ON BUDGET OUTCOMES

It is clear that the states and territories received a flow of revenue that was much more than they needed.  This is reflected in the fact that states were able to retain an aggregate budget surplus of up to 0.8 per cent of GDP by 2005-06 (Figure 10).

Figure 10:  State accrual net operating balance, 2000-01 to 2011-12

Expected net operating balance results incorporate latest forecasts outlined in state budget updates and media releases.

Source:  ABS, Australian System of National Accounts, cat. no. 5204.0;
Commonwealth government 2008-09 Updated Economic and Fiscal Outlook;
State and territory government budget papers.

However, early warning signs that the states' financial management strategy could not be sustained have now come to a head with the spectre of deficits in the budgetary outlook.  Starting with the news of a horror NSW budget deficit of $712 million expected for this financial year, a torrent of bad budget news emanated from the state capitals with announcements that four other states (Queensland, South Australia, Tasmania and ACT) had joined the deficit club.  As noted above, there are expectations that budget deficits across the states could total up to $10 billion this coming financial year.

There is little question that malfunctioning global financial markets and a domestic economic slowdown over the past year have exerted pressure on state budgets.  However, state treasurers have blamed the totality of their parlous budgetary situations on the economic downturn.  For example, the NSW Treasurer Eric Roozendaal stated that "the budget will come under pressure as a result of the current cyclical downturn in revenues," ⁽¹⁸⁾ whilst South Australian Treasurer described the state as having taken a "massive hit from the fallout on Wall Street." ⁽¹⁹⁾

However, this interpretation of recent events obscures the contribution of spending to the states' budgetary turmoil.  Figure 11 compares the year-on-year percentage changes in revenue and expenditure, to illustrate the budgetary conduct of state governments during the recent economic good times.

Since 2005-06, the growth in total revenues had weakened from 8.3 per cent to 6.1 per cent.  By contrast, state and territory expenditure growth had risen appreciably since 2004-05 to the extent that spending growth -- by that time, running at eight per cent -- began to outstrip revenue from 2006-07.  On the basis of latest published estimates presented by the states for this financial year, the gap between expenditure and revenue growth has grown even further.

Figure 11:  State total revenue and expenditure, percentage
change from previous year, 2001-02 to 2007-08

Source:  State and territory government budget papers.

The contention that the budgetary problems faced by the states are driven by spending increases has been confirmed by a number of independent commentators.  The South Australian Auditor General stated that South Australia "may have developed a culture of expecting growing revenues to continue to support increasing expenses," ⁽²⁰⁾ while Victoria's Auditor General cited growth in public sector employee wages as a pressure point on that state's finances. ⁽²¹⁾  A number of submissions to the 2008 Senate Select Committee Inquiry into State Government Financial Management also pointed to the financial and economic risks posed by the states' expenditure growth.

In effect, governments continued to spend -- and thereby erode their budget positions -- as if the economic good times would never end.  Even as revenue growth started to flatline and deteriorate, state premiers and treasurers continued to pump money out of their treasuries to favoured interest groups and seemingly without sufficient regard for the appropriateness, efficiency or effectiveness of spending.

The problem with such a lack of fiscal discipline is that governments find it more difficult to responsibly manage their fiscal affairs.  As explained by Nobel Prize winning economist James M. Buchanan:

"Beneficiary groups, recipients of direct transfers or of governmentally financed programs, tend to be concentrated, organized, and capable of exerting influence over elected politicians.  By contrast, taxpayer groups, those who pay taxes, tend to be widely dispersed and, indeed, tend to include almost everyone due to the fact that taxes are general rather than specific.  As a result of the asymmetry, it becomes easier to get political decision makers to expand budgets than to contract them." ⁽²²⁾

As discussed above, the fact that some jurisdictions have announced tax increases over the past six months or so reveals a deep-seated reluctance to pursue the alternative option of correcting spending levels to accommodate slowing revenue receipts.

SECTION FOUR:  MEASURES OF STATE
GOVERNMENT PERFORMANCE

Over the last decade state governments have devoted significantly more taxpayer resources to a wide variety of programs.  The biggest spending increase was recorded in the area of health care, rising by $17.9 billion from 2000-01 to 2007-08 (or 8.9 per cent per annum).

Education expenditure rose by $12.2 billion (5.8 per cent per annum), followed by public order and safety ($7.2 billion, or 8.8 per cent per annum), transport ($5.2 billion, or 5.8 per cent per annum) and social security and welfare ($5.0 billion, or 9.4 per cent per annum).

There is little question that more spending appeals to most members of the general community, but the key question is does it deliver results?  It is difficult to estimate the productivity of government services, and caution should be applied when interpreting trends over time, however the available evidence suggests that the dramatic increase in state government spending has not been accompanied by equally dramatic performance improvements -- at least in the two big spending areas of health and education.

HEALTH (PUBLIC HOSPITALS)

Key performance indicators for public hospitals -- also owned and managed by states and territories -- suggests that taxpayers are receiving an insufficient return on the substantial amounts spent on the provision of health services.

Results for the number of licensed or available public hospital beds per 1,000 people, a basic indicator of service provision, are decidedly mixed across the states.  Whilst NSW, Tasmania and the ACT have increased the number of beds for patient use, the number of available public hospital beds has declined in the face of a rising population (Figure 12).  This trend has coincided with growth in the rate of public hospital separations nationally of 3.6 per cent per annum.

Figure 12:  Number of licensed or available public
hospital beds per 1,000 people, 2000-01 to 2007-08

Source:  Australian Institute of Health and Welfare (AIHW),
Australian Hospital Statistics, various years.

There is clearly scope for improvement with regard to the timely treatment of patients presenting themselves at public hospital emergency departments.  According to the Australian Institute of Health and Welfare, the percentage of emergency department visits seen on time has improved only in NSW, Queensland and South Australia.  In most jurisdictions, there is a less than a 70 per cent chance that emergency patients will be seen in a timely manner.

The percentage of elective patients waiting for more than a year for treatment in a public hospital has increased in all jurisdictions except NSW, Victoria and Queensland (Figure 13).

Figure 13:  Percentage of public hospital elective patients
waiting more than 365 days for treatment, 2000-01 and 2006-07

Source:  Australian Institute of Health and Welfare (AIHW)
Australian Hospital Statistics, various years.

In April 2009, the Victorian Auditor General published a report that found significant problems in reporting hospital performance in that state, including "data inaccuracies, data manipulation and poor quality control processes" surrounding procedures used to allocate funding to hospitals. ⁽²³⁾  These revelations serve to reaffirm the importance of providing relevant and accurate information for the community to make robust assessments of the performance of government services that they fund.

EDUCATION (SCHOOLS)

Despite a huge increase in funding by the states towards school education, which in part has contributed to a marked reduction in student-staff ratios in schools, there is little evidence to suggest a sustained improvement in educational outcomes attained by students over the past few years.

Data on the proportion of school students meeting minimum acceptable benchmarks for reading, writing and numeracy are regularly cited as an indicator of learning outcomes.  There have only been noticeable improvements in Year 7 reading skills in NSW, writing skills in South Australia and numeracy skills in Victoria. ⁽²⁴⁾

Other test results show a decline in performance by students against agreed national test benchmarks over time.  Student numeracy skill test results are of a particular concern, with the proportion of Year 7 students meeting the national numeracy benchmark falling in Queensland (by 6.4 percentage points), NSW (5.8 per cent), the ACT (2.2 per cent) and Western Australia (0.3 per cent).  The proportion of students meeting the numeracy benchmark remained steady in South Australia.

The results of other student testing methodologies are available on an internationally comparable basis.  The Trends in International Mathematics and Science Study (TIMSS) collects Years 4 and 8 achievement data in maths and science testing.

The 2007 results from TIMSS showed mixed results for Australia.  Year 4 students showed some improvement in maths achievement, however Australia's ranking for Year 4 mathematics was below countries such as Hong Kong, Singapore, Japan, Kazakhstan, Russia, England, Latvia, Netherlands, Lithuania, United States and Germany. ⁽²⁵⁾  In addition, Australian Year 8 maths and Year 4 science achievement levels remained static yet there was a significant decline in science achievement for Year 8 students.

The OECD Programme for International Student Assessment (PISA) also provides internationally comparable test results for scientific, reading and mathematical literacy.  The 2006 results indicate that there is still considerable scope to close the learning outcomes gap between individual states and the leading country in each test category (Table 6).

Table 6:  State and territory PISA mean test scores, 2006

	Science	Mean score gap	Reading	Mean score gap	Mathematics	Mean score gap
NSW	535	28	519	37	523	26
Vic	513	50	504	52	513	36
Qld	522	41	509	47	519	30
WA	543	20	524	32	531	18
SA	532	31	514	42	520	29
Tas	507	56	496	60	502	47
ACT	549	14	535	21	539	10
NT	490	73	460	96	481	68

The "mean score gap" is the difference between the mean test score for a given state and the mean test score for the leading country in each test category.  Countries with the highest mean scores in 2006 in each category were as follows:  science (Finland, 563);  reading (Korea, 556) and mathematics (Taiwan, 549).

Source:  Sue Thomson and Lisa De Bortoli, 2008, Exploring scientific literacy:  how Australia measures up:  the PISA 2006 survey of students' scientific, reading and mathematical literacy skills, Australian Council for Educational Research.

Given the importance of an educated and healthy population, systemic underperformance in the delivery of quality school and hospital services by the states is likely to act as a drag on national economic competitiveness and productivity.  As will be discussed below, governments should actively explore increasing the role of the private sector in many areas of current state services as a way to improve outcomes.

SECTION FIVE:  OPTIONS FOR REFORM

The above analysis has demonstrated that states and territories have been significant beneficiaries of a growth in revenue that exceeded all expectations.  Governments reacted to the revenue windfalls by engaging in a "spend quickly for today" strategy.  However, to put it mildly, the jury is well and truly out when it comes to the appropriateness of the spending activities and the efficiencies attained.

Compounding the difficulties posed by the spending record throughout this decade is the fact that excessive spending during a period of economic expansion -- and not a cyclical revenue downturn -- has sown the seeds for the states' structural budget dysfunction as witnessed today.

The pertinent question to be asked now is what should state governments do about this?  Given the likely impact that the states' approach to financial management over this decade has thrown sand at the wheels of national economic growth, answering this question becomes vital for our future economic prospects.  This section proposes three broad ranging reform ideas that should be implemented by states to get their fiscal houses in order.

THE POWER TO SPEND IS LIMITED BY THE POWER TO TAX, SO CUT TAXES

Modern approaches to public choice theory suggest that the growth in public sector expenditure is dependent on the ability of governments to acquire revenue. ⁽²⁶⁾  To put more simply, government compulsorily acquires revenue in order to spend it.

Meaningful reductions in state tax burdens can make a substantial contribution to reduce spending pressures that have now contributed to poor fiscal outcomes.  Tax cuts, financed by reductions in wasteful, inefficient areas of government spending, will have two additional beneficial effects:

• in the short run, it will enable businesses to retain more of their own income to invest, employ and grow their operations
• in the long run, it will reduce the efficiency costs of taxation and thus expand the productive capacity of state and national economies.  This is particularly relevant in the Australian context where, as noted above, states have been found to utilise some of the most inefficient taxes across all levels of government. ⁽²⁷⁾

In late 2008 we released a major study that benchmarked the liabilities of taxation imposed on business in each state. ⁽²⁸⁾  Adopting a "reference business" approach based on World Bank competitiveness studies, we calculated state business tax liabilities for:  payroll tax;  land tax;  stamp duties on the sale and purchase of land and buildings, vehicles and insurance premiums;  vehicle registration fees and (for selected industries only) workers' compensation premiums.

The benefit of our analysis is not only that state business tax liability can be analysed on a comparable basis, but interstate variations in liability points to those locations where excessive tax burdens exist (Table 7).

Table 7:  State business tax liabilities, 2008

	Payroll tax	Land tax	Land transfer duty	Insurance duty	Vehicle duty	Vehicle registration fees	Total
NSW	160,645	18,001	34,282	5,049	2,179	2,200	222,356
Vic	136,146	7,302	47,383	6,158	2,463	2,969	202,421
Qld	136,587	20,623	31,267	4,310	1,232	3,369	197,388
WA	140,273	4,525	38,311	6,158	4,002	2,353	195,621
SA	137,421	29,099	41,243	6,773	1,817	2,714	219,067
Tas	139,716	28,033	32,032	4,926	2,463	3,010	210,179
States' average	141,798	17,930	37,420	5,562	2,359	2,769	207,839

WA taxes including Metropolitan Regional Improvement Tax.
Excluding workers' compensation premiums.

Source:  Author.

If jurisdictions initially look to tailored tax reductions in specific areas of excessive taxation, as part of a broader strategy to significantly reduce tax burdens across the board over time, this would unleash a "double dividend" that not only encourages market growth but tightens the reins of unwieldy state budgets.

SMALLER STATE GOVERNMENTS BY FOCUSING ON WHAT'S REALLY NEEDED

In his classic text An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith explained that government should fund those limited activities "though they may be in the highest degree advantageous to a great society, [they] are, however, of such a nature, that the profit could never repay the expense to any individual or small number of individuals." ⁽²⁹⁾

In 2007-08, about 22 per cent of state general government spending was on the core functions of law and order, justice and administration, and interest expenses on debt and superannuation liabilities. ⁽³⁰⁾

State expenditures, in other words, have been devoted to functions far beyond that cited by economists as the appropriate preserve of collective action.

In order to reduce government spending enabling budgets to get back into balance, the states need to regain their focus on what kinds of services are essential for the community -- such as funding education and health services, keeping streets and communities safe, and contributing towards infrastructure development -- and jettisoning those that are not -- such as sport stadiums, public art galleries, "picking winners" industry grants, international trade roadshow junkets or, as in the case of Queensland, maintaining unionised public works departments.

Even in the current era of growing state government, private sector alternatives are abundant in the remaining areas of government spending.  A simple "Yellow Pages" telephone book test shows that there exists a complex services "ecosystem" of not-for-profit primary and secondary schools, for-profit or not-for-profit hospitals, child care centres, welfare and charitable organisations, art galleries and recreational facilities, and private infrastructure development groups.

It should be noted that individuals and families that use these private alternatives are also funding (through state own revenues or GST) standardised state government services.  To prevent these and other families from paying twice for the privilege of using non-governmental services, the states and territories should embrace "purchaser-provider" standards in service delivery.  This means that governments would retain a funding role, while opening up the direct provision of services to non-governmental entities.

There are some clear candidates for reform along these lines.  For example, existing government schools, including in socially disadvantaged areas, could be operated by non-profit or for-profit entities.  Students could receive portable student funding entitlements from governments, adjusted for educational needs, which can be used to pay for school education.

In the area of health care, more public hospital patients could be treated in private hospitals with government funding for treatments following the patient.  Current public hospitals could be operated by non-government providers, as has occurred previously in Victoria, Queensland, South Australia and Tasmania.

These and other reforms would lead to state government expenditure being more focussed on the core functions of government.  This can greatly reduce the burden of taxes and other revenues upon businesses and citizens, ⁽³¹⁾ and ease the administrative complexities associated with managing a 1950s model of universal service delivery.  All of these impacts would, in turn, favourably improve the likelihood of states maintaining better budget discipline into the future.

STRENGTHEN FISCAL RULES TO KEEP GOVERNMENT LEAN, BUT NOT MEAN

Since the last disastrous flirtation by the states with "budget deficits as pro-growth policy" in the late 1980s, particularly by the southern states, jurisdictions have gradually adopted a variety of legislative mechanisms and policies to promote more sustainable fiscal outcomes (Table 8).  These changes have been accompanied by other reforms including revisions of accounting standards adopted by government agencies and greater consistency of budget presentations to aid transparency.

It is clear from recent experience that the existing fiscal rules and policies have been ill-equipped to the task of restraining strong public sector growth, whereby excessive recurrent spending growth has led to a failure to maintain sustainable state public finances over time.

The tax-and-spend fiscal actions by state governments over much of this decade also appear to be impervious to other important constraints such as political competition and interstate and global resource mobility.  Therefore, to help strengthen overall fiscal discipline exercised by the states, it will be necessary to circumscribe their ability to rapidly spend and to erode the budget bottom line.

Table 8:  State fiscal responsibility legislation and policies

Jurisdiction	Legislative or policy framework
New South Wales	Fiscal Responsibility Act 2005 specifies medium and long term fiscal liability and debt targets, and principles of budget surplus, constrained net services costs and managing public sector employee costs, intergenerational equity and maintain or increase general government net worth. Maintain net operating surplus.
Victoria	Financial Management Act 1994 outlines principles of sound financial management, including prudent financial management risk, tax and spending to ensure taxation stability and predictability, tax system integrity, intergenerational equity, and disclosure of financial information. Short term objective of net operating surplus equivalent to one per cent of revenue, and long term maintain substantial budget operating surplus.
Queensland	Charter of Social and Fiscal Responsibility includes principles of competitive tax environment, affordable services, borrowing for capital investment only, managing financial risk and building state net worth. Maintain overall general government operating surplus.
Western Australia	Maintain general government sector operating surplus, maintain or increase public sector net worth, retain AAA credit rating, and tax competitiveness.
South Australia	Maintain at least net operating balance in general government sector, reduction in net financial liabilities to revenue ratio, effective tax regime, value for money services, fully fund superannuation liabilities, prudently manage risks, and borrowing to invest on commercial terms.
Tasmania	Maintain general government net operating surplus on average over rolling four-year period, reduction in debt and liability burdens, competitive business and tax environment, infrastructure investment, and risk management.
Australian Capital Territory	Maintain general government net operating surplus, maintain AAA credit rating, manage debt prudently, fully fund superannuation liability, maintain quality services, and tax revenue at sustainable levels.
Northern Territory	Fiscal Integrity and Transparency Act 2001 outlines principles of sound fiscal management and public reporting of fiscal performance. Achieve general government net operating balance in medium term, appropriate infrastructure investment levels, competitive taxes, and reduce net debt plus employee liabilities.

Source:  State and territory government budget papers;  state legislation websites.

An effective way to keep state government conduct within appropriate fiscal bounds is to renovate the existing generic fiscal rules by combining balanced budget rules with tax-and-expenditure limitations (TELs).  A balanced budget rule is a statutory or constitutional condition that a jurisdiction must achieve a balanced budget on a year-on-year basis.  A TEL is a statutory or constitutional provision that limits the growth of government expenditures or revenues, generally either to a ratio of population growth plus inflation growth, income growth or economic growth, and in some instances allowing taxpayers to approve or reject spending or tax increases through a referendum process.

These stronger forms of fiscal rules are predominant in the United States.  According to the US National Conference of State Legislatures, 30 American states currently operate under a TEL with 23 states having spending limits, four with tax limits and three with a combination of both.  About half of the existing TELs are constitutional provisions and the other half are statutory. ⁽³²⁾

In practice, there is significant variation in the design features of TELs imposed by the American states.  One of the more prominent TEL models in the US is the Colorado Taxpayer Bill of Rights (TABOR) -- a constitutional measure introduced in 1992.  Under TABOR, all tax increases must be approved by taxpayers and that existing TELs (passed in 1977 and 1991) cannot be weakened without taxpayer approval.  TABOR limits growth in state expenditure and tax increases to inflation plus population growth, with any revenue collected in excess of the limit be refunded to taxpayers. ⁽³³⁾

A voluminous literature has emerged investigating the fiscal effects of these constraint mechanisms in the US, with many studies finding them to be effective in constraining public sector growth (Box 5).

Box 5:  How effective have TELs been in containing the growth of American state governments? A number of empirical studies have been undertaken to explore the effectiveness of TELs in the American states.  In one of the first panel data studies controlling for population and income factors that influence spending, Elders (1992) found that TELs significantly reduce the growth of US state governments. Stansel (1994) compared state spending growth rates with TELs to the national average before and after the passage of TELs.  He found that state expenditure of 0.8 per cent above average before TEL implementation, and 2.9 per cent below average after passage.  When comparing states with and without TELs, Stansel estimated there was a 5.3 percentage point restraint in the level of per capita state expenditure in TEL jurisdictions. Reuben (1995) addresses the issue that earlier studies critical of the impacts of TELs may have had biased results.  Using a model with instrumental variables to separate the impact of TELs from any changes in voter tastes, she found that spending declines by 1.8 per cent due to TELs. Bails and Tieslau (2000) incorporate a range of fiscal institutions, including TELs and balanced budget requirements, in their panel study to find that real per capita state and local expenditure in TEL states is $42 lower than in states without TELs.  In states with both TELs and balanced budget rules, spending is reduced by $135 on a per capita basis. More recent studies have refined the empirical analysis by accounting for differences in TEL design.  Based on this type of analysis, New (2001) finds that TELs passed by initiative, which limit increases in revenue and spending to the sum of inflation and population, and that immediately return surplus funds to taxpayers tend to be more effective in reducing government spending. Source:  Harold E. Elder, 1992, "Exploring the tax revolt:  An analysis of the effectiveness of state tax and expenditure limitation laws", Public Finance Quarterly 20 (1):  47-63;  Dean Stansel, 1994, "Taming Leviathan:  Are Tax and Expenditure Limits the Answer?", Cato Policy Analysis no. 213;  Karen Reuben, 1995, "Tax Limitations and Government Growth:  The Effect of State Tax and Expenditure Limits on State and Local Government", MIT Department of Economics Working Paper;  Michael J. New, 2001, "Limiting Government through Direct Democracy:  The Case of State Tax and Expenditure Limitations", Cato Institute Policy Analysis no. 420.

What would be the indicative fiscal impact of the introduction of TEL across Australian states and territories?  Figure 14 illustrates the cumulative revenues -- and hence the implied savings to taxpayers -- if the states adopted either a broad-based TEL regime fixing revenue growth to either one of three rules:

• inflation growth plus population growth (real per capita rule)
• GSP growth (economic growth rule), or
• GSP growth, minus a factor of x (Davidson-Novak rule). ⁽³⁴⁾

Figure 14:  Cumulative revenue under alternative government
sector tax and expenditure limitation rules, 2000-01 to 2007-08

For GSP and GSP-x TEL scenarios, it is assumed that when GSP (or GSP-x) growth in a state is less than zero then permissible revenue growth is set at zero.  For GSP-x rule it is assumed that x is set by all states to one.

Source:  State and territory government budget papers;
ABS, Australian Demographic Statistics, cat no. 3101.0;
ABS, Consumer Price Index, Australia, cat. no. 6401.0;
author's calculations.

A real per capita TEL rule would have reduced the cumulative call on taxpayers to the tune of $26.4 billion from 2000-01 to 2007-08.  This is broadly equivalent to the tax windfall received by states over that period.  Queenslanders would have received the largest cumulative revenue saving of $10.6 billion, followed by residents of Western Australia ($7.1 billion revenue saving), South Australia ($3.8 billion), Northern Territory ($1.7 billion) and NSW ($1.2 billion).

Alternatively, an economic growth TEL setting revenue growth to that of the overall economy would have reduced general government revenues by a cumulative $107.8 billion -- equivalent to almost two-thirds of the states' revenue windfall.  Residents in NSW would have received the biggest benefit from a GSP revenue growth rule TEL, with a reduction in revenue of $32.9 billion, followed by Victoria ($23.6 billion), Queensland ($23.4 billion), Western Australia ($11.0 billion) and South Australia ($9.7 billion).

A GSP-x TEL (where x is set at one) would have further limited cumulative revenues acquired by governments.  Under the Davidson-Novak rule, state residents across Australia would have saved $146.6 billion from 2000-01 to 2007-08.  In NSW, the cumulative revenue savings would have been in the order of $45 billion, followed by Victoria ($32.9 billion), Queensland ($31.4 billion), Western Australia ($14.6 billion) and South Australia ($12.7 billion).

It is important to note that a TEL is not necessarily a recipe for reducing the size of government, but for ensuring that adopting jurisdictions stick to a budget plan reducing the risk of taxing and spending at 37 rates beyond what is necessary.  During the recent economic boom, states increased revenue by seven per cent on average each year.  This created an environment where spending increased rapidly at a similar rate in recent years.

If states adhered to a condition whereby revenues rose by a combination of CPI growth and population growth then revenue would have increased by 4.7 per cent per annum.  Under GSP or GSP-x growth rules, state general government revenue would have increased by a far more manageable 3.4 per cent and 2.4 per cent per annum respectively.  Revenues still rise under the TEL scenarios presented in this paper -- in other words, government is kept lean but not mean, compared to the current revenue free-for-all.

As noted above, a fiscal constitution for the states should also include a requirement to balance the yearly budget.  This rule would ensure that government agents are obliged to consider ways of funding their spending decisions.  It would also prevent governments from hoarding excess revenues, and not returning these takings back as tax cuts to the population.

If a real per capita TEL requirement were combined with a balanced budget rule across all states, and if jurisdictions maintained their expenditure as forecast, taxpayers could have enjoyed a cumulative $186.6 billion revenue reduction.  A similar revenue savings dividend could have been achieved by a combination of the Davidson-Novak TEL and balanced budget.  An economic growth TEL plus balanced budget condition would have delivered total revenue savings of $167.5 billion from 2000-01 to 2007-08.

These indicative estimates suggest one thing:  under a stronger fiscal rule regime, state government activity could have been kept on a fiscal diet without sacrificing the delivery of core responsibilities or diluting budget discipline.

CONCLUSION

It has become fashionable in recent times for economists and policymakers to instinctively train their gaze back to the 1930s for remedies to the current economic downturn.  As the state governments scour through the pages of that tumultuous decade, they would do well to reflect on the following passages uttered in Melbourne in the winter months of 1930:

"Australia must be treated as a whole, and the reactions of interstate finance and of State ... finance are essential to a complete view.  In this matter the fortunes of the whole are the fortunes of the parts, and the failure of any of the parts will be the failure of the whole.

The characteristics of the Budget position are that ... nearly all the States have had Budget deficits for at least three years.  These have resulted in accumulated deficits largely unprovided for except by temporary methods of finance ...

Apart from the actual Budget position there is an unfunded ... [national] ... floating debt of about £3,000,000, and over and above that there are internal maturing securities between now and December of ... some £24,000,000 for the States ...

The yield of taxation, already at a heavy level in relation to the national income, is substantially dropping, and may be expected to drop more. ...

In short, Australia is off Budget equilibrium ... and faced by considerable unfunded and maturing debts ... in addition to which she has on her hands a very large programme of loan works for which no financial provision has been made." ⁽³⁵⁾

These words, spoken by Sir Otto Niemeyer in his capacity as adviser to the Scullin federal government, have a familiar, yet most unwelcome, ring to them for the states and territories in the current climate.

As this paper explains, the budgetary problem befalling the states at present is an accumulation of problems built up over the course of this decade.  In particular, the end of the recent national economic boom period has blown the cover off state government spending that has proven to be unsustainable.

Indeed, the spending highs have sown the seeds of the collective deterioration of the bottom lines of state budgets now being witnessed, bringing the capacity of jurisdictions to perform the basics of financial management into question.  The persistence of these budget shortfalls, if left unattended, is likely to threaten the prospects of an economic recovery that Australia needs to help head off rising unemployment.

With the 2009-10 budget season about to commence in earnest, the light of scrutiny will be shone on the fiscal plans offered by states and territories with greater intensity than before.  Solid evidence that incumbent governments are finally prepared to engage in reforms that pare back spending, enabling them to live within their means, should be the ultimate criterion by which their budgetary offerings should be judged.

---

ENDNOTES

1.  References to "states" include the Australian states and territories.

2.  Peter Martin, 2009, " 'Tough calls' on budget as deficit for $50bn", The Age, 28 April.

3.  It has been revealed that the commonwealth is considering exceeding its self-imposed $200 billion limit to at least $300 billion.  David Uren, 2009, "Deficit spike may lift rates as Government considers $300bn debt blowout", The Australian, 24 April.

4.  James M. Buchanan and Richard E. Wagner, 1977, Democracy in Deficit:  The Political Legacy of Lord Keynes, Liberty Fund Edition, Chapter 2.

5.  C.F. Bastable, 1903, Public Finance, Liberty Fund Edition, p.611.

6.  Parliament of Australia, The Senate, 2008, Select Committee on State Government Financial Management, Report, September.

7.  The methodology used to estimate revenue and expenditure windfalls in this paper is based on an unweighted comparison of the earliest available forecast of general government sector revenue (expenditure) applicable to a given year against the actual revenue (expenditure) figure published in state budget papers.

8.  According to a 2007 study by the Business Council of Australia, the states and territories raise 33 taxes on business alone.  See Business Council of Australia, 2007, Tax Nation:  Business Taxes and the Federal-State Divide.

9.  Victorian Government, 2001, Review of State Business Taxes Full Report.

10.  Roselyn Joyeux and Peter Abelson, 2007, "Price and Efficiency Effects of Taxes and Subsidies for Australian Housing", Economic Papers 26 (2):  147-169.

11.  Access Economics, 2008, Analysis of State Tax Reform, Report for Financial Industry Council of Australia.

12.  IPART, 2008, Review of State Taxation.

13.  Some states, in defiance of the original IGA agreement, have chosen to retain a range of taxes originally agreed to be abolished.  For example, over the past six months NSW, Queensland and South Australia announced the retention of nuisance taxes earmarked for abolition under the IGA, to be abolished at a later (unscheduled) date.

14.  While the states are not free to spend these tied funds for purposes as they see fit, tied specific purpose payments are recorded in state budgets as a revenue source and the expenditure of these funds are recorded on the expenses side of states' budget operating statements.

15.  Peter Swan and Gerald T. Garvey, 1995, "The equity and efficiency implications of fiscal equalization", Swan Consultants Pty Ltd;  Bev Dahlby and Neil Warren, 2003, "The fiscal incentive effects of the Australian equalisation system", Economic Record 79 (247):  435-446;  Bev Dahlby, 2008, The Marginal Cost of Public Funds:  Theory and Applications, MIT Press, Cambridge.

16.  Jeff Petchey, 2008, "A theoretical analysis of equalisation and spatial location efficiency", Curtin University, School of Economics and Finance, Working Paper No. 08.02.

17.  Some jurisdictions publish annual reports containing information on the number of general government sector employees.  No state provides information on the numbers of public sector employees in their budget papers.

18.  Parliament of New South Wales, 2009, Legislative Council Hansard, 3 March.

19.  Greg Kelton, 2008, "Global financial crisis hits SA for $200m", Adelaide Advertiser, 27 September.

20.  South Australia Auditor-General's Department, 2008, Annual Report for the year ended 30 June 2008 -- Part C:  State Finances and Related Matters, Government Printer, Adelaide, p.6.

21.  Victorian Auditor-General's Office, 2008, Auditor-General's Report on the Annual Financial Report of the State of Victoria, 2007-08, Victorian Government Printer, Melbourne.

22.  James M. Buchanan, 1983, "I limiti alla fiscalità", quoted in Antonio Martino, 1989, "Budget Deficits and Constitutional Constraints", Cato Journal 8 (3):  695-711.

23.  Victorian Auditor-General's Office, 2009, "Auditor-General's Report:  Access to Public Hospitals:  Measuring Performance", Media statement, 1 April.

24.  In this context, a noticeable improvement in learning outcomes is defined as a three percentage points or more increase in the proportion of Year 7 students achieving the agreed national benchmark in reading, writing or numeracy tests in a given jurisdiction.  All data presented are from 2001 to 2007, except for South Australia (2002 to 2007).

25.  Sue Thomson, Nicole Wernert, Catherine Underwood and Marina Nicholas, 2008, Highlights from TIMSS 2007 from Australia's perspective, Australian Council for Educational Research;  Justine Ferrari, 2008, "Doesn't add up:  Borat kids beat Aussies in maths and science", The Australian, 10 December.

26.  Geoffrey Brennan and James M. Buchanan, 1980, The Power to Tax:  Analytical Foundations of a Fiscal Constitution, Cambridge University Press, Cambridge;  Randall G. Holcombe, 2005, "Government Growth in the Twenty-First Century", Public Choice 124:  95-114.

27.  A number of studies have emerged in recent years highlighting the inefficiencies of current state taxation.  A 2001 State Business Tax Review commissioned by the Victorian government found that "stamp duties do not rate highly on efficiency grounds" and that the efficiency of land and payroll taxes are also severely compromised.  Joyeux and Abelson found that transaction taxes on housing imposed a deadweight loss on the national economy of some $375 million per annum.  In 2008, Access Economics ranked the relative efficiency of state taxes and found that motor vehicle taxes on business, insurance duties and non-residential property conveyancing duties were amongst the most inefficient of taxes collected in Australia.  An assessment of NSW taxes by the Independent Pricing and Regulatory Tribunal (IPART) found that state taxes rated poorly in efficiency terms compared to commonwealth taxation.  See Victorian Government, 2001, Review of State Business Taxes Full Report;  Roselyn Joyeux and Peter Abelson, 2007, "Price and Efficiency Effects of Taxes and Subsidies for Australian Housing", Economic Papers 26 (2):  147-169;  Access Economics, 2008, Analysis of State Tax Reform, Report for Financial Industry Council of Australia;  and IPART, 2008, Review of State Taxation.

28.  Richard J. Wood, 2008, Business Bearing the Burden:  The Size and Impact of State Government Business Taxes:  The State Business Tax Calculator, Occasional Paper (accessed 17 April 2009).

29.  Clearly, this definition of a "public good" is distinct from the erroneous notion -- often peddled by political actors, public sector unions and other pro-spending vested interests -- that a public good is one that is "good for the public."

30.  Richard J. Wood, 2009, "In a state of dysfunction", The Australian Financial Review, 14 January.

31.  Numerous surveys also illustrate that outsourcing the delivery of services to the private sector will yield significant cost-saving dividends for the community.  In a summary of 71 studies, Mueller stated that "state-owned companies were found to be significantly less efficient than privately owned firms supplying the same good or service.  The provision of a good or service by a state bureaucracy or by a state-owned company generally leads to lower residual profits, and/or higher costs and lower productivity." A survey of international studies by the Industry Commission also found that taxpayers can secure ongoing cost savings as a result of the contracting of government services.  See Industry Commission, 1996, Competitive Tendering and Contracting by Public Sector Agencies, Report No. 48;  Dennis C. Mueller, 2003, Public Choice III, Cambridge University Press, Cambridge.

32.  Bert Waisanen, "State Tax and Expenditure Limits -- 2008", National Conference of State Legislatures (accessed 12 February 2009).

33.  Michael J. New, 2001, "Limiting Government through Direct Democracy:  The Case of State Tax and Expenditure Limitations", Cato Institute Policy Analysis no. 420.

34.  The Davidson-Novak TEL refers to a rule whereby revenue to be permitted to grow at the rate of gross state product (GSP), less a factor of x nominated by governments.  See Sinclair Davidson and Julie Novak, 2008, Sustaining Growth:  Reforms for Tasmanian Prosperity, Part One, Report for Tasmanian Chamber of Commerce and Industry.

35.  E.O.G. Shann and D.B. Copland, 1931, The Crisis in Australian Finance 1929 to 1931:  Documents on Budgetary and Economic Policy, Angus & Robertson:  Sydney, p.19-21.