State and territory governments will surely welcome recent news of a national economic recovery. A stronger economy will mean additional revenue inflows into treasury coffers, meaning that states might be saved from the fiscal consequences of their spending profligacy.
The risk is that such a revenue-driven reduction in net state budget deficits, standing at $2.9 billion this financial year on the latest projections, may gloss over growing costs that states have found difficult to control.
The largest element of state government operating budgets is their expenditures on public servant wages, superannuation and other entitlements. In 2008-09, states allocated more than $78bn towards gross employee expenses, representing about 46 per cent of total general government sector spending.
By comparison, $43bn was spent for the same purposes in 2000-01. This implies an increase in spending on state public sector workers of 78 per cent over the period, or an average of 8 per cent a year.
This increase in state spending on labour inputs is driven by two main factors: changes in the numbers of people employed by state government agencies and other bodies; and changes in salaries and other benefits paid out to these public servants.
After a period of reduction in the number of state government employees during the 1990s, state public services increased substantially during the recent economic boom. In 2000, there were about 972,000 people on the state government payroll. By 2008, this had risen to about 1.2 million.
Victoria led the way in expanding the bureaucracy in percentage terms, with an increase in the total number of public servants of 37 per cent. NSW, South Australia, Tasmania and the Northern Territory each recorded growth of about 25 per cent or more.
The largest increase in state government staffing was in the area of administration, which grew by at least 57 per cent between 2000 and 2007. There is additional evidence to suggest an increase in the numbers of administrators engaged in service delivery areas such as education, health and policing.
There have been even more dramatic increases in state public sector salaries and entitlements in recent years.
Adjusting for higher education sector staff earnings, it is possible to calculate an implied amount of gross earnings for each state government employee. From 2000 to 2006, gross earnings per employee grew by 4 per cent a year on average. This is above the Reserve Bank of Australia's inflation target band of 2 per cent to 3 per cent. Rising salaries for state public servants, even after accounting for the overall growth in government employment, suggest the increases in overall employee expenses were mainly attributable to public service pay increases during the peak of the previous business cycle.
The seemingly inexorable rise in state government employee expenses proved unsustainable in the light of the combined budget deficit position of the states and territories. A return to fiscal sustainability by the states will require a discipline in controlling spending on labour costs not witnessed in previous years.
Governments have recently announced restraint measures such as caps on public service numbers, voluntary redundancies, a freeze on non-frontline staff recruitment and wage growth targets.
These measures constitute an implicit acknowledgment by the states that action needs to be taken to control bureaucratic costs. The big question is whether existing initiatives will be sufficient for the task.
It is possible to derive estimates of the additional revenue needed by the states to fund their public service costs, over and above that implied by their publicly stated wages policies. During the next four years, it is estimated that taxpayers will need to pay an additional $15.6bn to cover state government employee expenses above wage policy benchmarks. To put this figure into perspective, the aggregate amount of payroll tax revenue collected by state governments last financial year was about $16.5bn. In effect, the states will be approaching taxpayers seeking another payroll tax to subsidise extra public servants and their salary costs.
With signs of life evident in the Australian economy, state governments may be tempted to pull back on the need to pare back their labour costs. Public sector unions are more likely to pursue inflationary wage claims if they perceive state revenue growth to be on the increase.
The obvious problem with this "business as usual" scenario is that it would not address the underlying causes of expenditure growth that contributed to the state fiscal crisis in the first place.
Additional measures could be pursued by governments to reduce the likelihood that public sector employment costs would erode state budgets in the future.
State governments should consider a mechanism enshrined in certified agreements whereby public servant salary growth is paused when budgets are in deficit. Wages policies could also be legislated. Governments that intend to relax the policy should be obliged to publicly report on productivity improvements attained by their workers.
Public sector caps are an appropriate mechanism to help restrain the overall costs of government employment, provided they are backed by appropriate enforcement mechanisms. Ministers and senior officials that oversee breaches in a cap should be liable to some form of sanction.
A return to the reforming spirit of the 90s at the state level, through the devolution of key service delivery functions to private or non-profit organisations, would save taxpayers the burden of supporting a large public sector.
It is important that a recovering economy not lull states into a false sense of fiscal security. The price of a lack of reform putting government employment on a sustainable footing is an eventual re-run of the difficulties that jurisdictions are facing at present.
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