A new report on Victorian public finances underscores why state governments require stronger fiscal rules to promote budget responsibility. The report, commissioned by the Baillieu government and authored by Michael Vertigan, Don Challen and Ian Harper, has found the budget of Australia's second largest state is unsustainable in the medium term.
It suggests lax cost controls have led to operating expenses exceeding revenue inflows during the past decade, wielding significant pressure on the state's bottom line. Importantly, the report illustrates that the Victorian budget had been propped up by federal government grants, which are counted as part of state revenue. Victoria's $600 million budget surplus of 2009-10 would have been a $1 billion deficit in the absence of commonwealth support.
This study should make other states sit up and take notice of the risks they face in setting their budgets on a more fiscally sustainable course. After all, the revenue and cost pressures are being experienced by all jurisdictions.
For a start, important sources of state revenue growth are drying up. With retail sales remaining weak for some months, there are estimates bandied about that states could lose up to $6bn in expected GST revenues over the forward estimates. A slowing in house sales and lower employment growth is likely to constrain stamp duty and payroll tax receipts respectively.
However, it is the expenses side of the budget that state governments need to pay closer attention to. The largest cost pressure for governments are salary and other expenses for growing numbers of public servants. Last year the states employed 1.4 million workers, compared with fewer than 1.1 million in 2001, with the average rate of public sector employment growth exceeding total employment in all jurisdictions except resource-rich Queensland.
Public sector unions in South Australia and Tasmania are warning against government job cuts to balance state budgets.
Meanwhile, new governments in NSW and Victoria are finding out just how unrelenting public sector unions can be when it comes to salary growth demands over inflation. With the costs of services such as health and education outstripping general price inflation, the budget process is a tortuous one in which governments battle to keep spending within available income. Yet much of this budget torture is self-inflicted, reflecting an inability to stick to basic financial management rules. A desire for political popularity often means yielding to community expectations for more spending. This leads to governments getting caught out if their narrow revenue bases don't collect as much money as expected.
A stronger regime of fiscal rules, replacing the largely unenforced state legislative provisions and policy guidelines, would be effective in ameliorating these pressures and entrenching appropriate fiscal behaviour. If states and their local governments maintained limits on their spending growth, with taxpayers rebated for revenues exceeding the spending growth rule, they would have returned between $146bn and $260bn in cumulative rebates since 2000-01. Residents in NSW, Victoria and Queensland, states that have experienced budget troubles, would have been among the big winners from this reform.
To reinforce this rule, budgets should be balanced on an annual basis and caps on state-local net debts introduced to prevent governments shifting the costs of providing present services into the future. This fiscal restraint would have had a range of benefits, quite apart from rebating excess revenues back to taxpayers who can more efficiently spend on their own priorities. Enforceable fiscal rules, including penalties for breaches of the spending limits, would encourage governments to prioritise more attentively between spending demands, rather than spend more on everything today and hope for the best for revenue growth tomorrow.
A crucial part of this would be for governments to restrict their spending to core activities that the private sector cannot provide profitably. Politicians would also have greater incentives under stronger fiscal rules to eliminate accumulated programs that no longer reflect economic and social circumstances. Growth in the size of government at the state and local levels would remain within more reasonable limits, in itself an important objective to increase private sector activity and economic growth.
State governments have been active in the past 20 years in improving the transparency of their financial operations. There have also been some important, if imperfectly applied, attitudinal changes by state politicians to avoid the reckless fiscal experiences of the 1980s. However, as the Victorian report illustrates, governments haven't completely ridden themselves of the big-spending bug. With Victoria providing the early warning signs of budget troubles on the horizon, states should take action to institute the next generation of budget reform for fiscal responsibility.
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