Opinion & Commentary
Building up to a national impact
The recently completed round of budgets for 2007-08 reveals that deficits, borrowing and capital spending are back in fashion with state governments. Having spent a decade retrenching debt, most of the states are now increasing it again as a deliberate policy. This u-turn poses a macro-economic risk and, depending on how far it goes, potentially a longer term risk to the states’ fiscal strength.
State Treasurers are not fibbing when they say they are running surpluses, but they are talking about net operating surpluses. This is a valid accounting concept, akin to a company’s reported net profit before tax, but the cash result and the fiscal balance are better measures of a budget’s short-term economic and financial impact because they account for capital expenditure in full in the year it is incurred.
The cash result is the measure emphasized in federal budget analysis. On this measure, the states collectively are budgeting for a general government sector deficit of $3.5 billion in 2007-08 and for further cash deficits out to 2010-11 (although not all states are in this situation, with the deficit being fully accounted for by NSW, Victoria, Queensland and South Australia). A commensurate federal cash deficit would be around $5 billion in 2007-08, which would no doubt have sent the financial markets apoplectic.
The emergence of state budget deficits is explained by an upsurge in capital expenditure by 20 per cent to $17 billion in 2007-08. There is no consensus among economists as to whether, or to what extent, borrowings should be used to shift the burden of general government capital expenditure from current to future taxpayers. It is clear, however, that due to the states’ past prudence and luck, they are starting from such low levels of debt that the prospective increase poses no threat to their fiscal sustainability.
The upward trend is, however, unmistakable and there are grounds for concern about how far it might go if the states’ appetite for capital expenditure expands further or if the favourable economic assumptions underlying budget estimates are invalidated. The Loan Council, although it remains as a constitutional requirement, is nowadays ineffective as an administrative constraint on borrowings, which leaves market discipline and every state’s fear of losing its coveted AAA debt rating as the main constraint. For now, the markets will gobble up the enlarged AAA debt offering without demanding higher interest rates, but their enthusiasm could wane rapidly if the states push too hard.
The scale of planned capital spending more than doubles to $39 billion, and that of new borrowings to $20 billion in 2007-08, when state government trading enterprises (GTEs, such as electricity and water utilities) are brought into the picture. GTE investments and borrowings are supposed to be commercially based, but as the Productivity Commission reminded us last week this is not always the case. This is a concern when it is the taxpayer that ultimately guarantees GTE debt.
The bigger risk for now is macro-economic – the pressure on already stretched resources from the rapid growth in states’ capital spending. The projected 18 per cent increase in state public sector (including GTE) capital expenditure could contribute about 0.6 percentage points to the growth of total demand in 2007-08, which is quite large considering that public investment constitutes less than 5 per cent of total demand. This will put upward pressure on costs in some sectors and the states will likely find that the resources simply are not available to implement their plans in full.
This macro-economic aspect poses a dilemma for states as they ramp up capital spending in response to criticisms of infrastructure deficiencies on their watch.
That dilemma would not be as acute if they had been more disciplined in their operating expenditures, rapid growth of which has left budgeted net operating surpluses quite skinny at just $2.5 billion in 2007-08. Larger operating surpluses would have enabled the states to spend up on infrastructure without running cash deficits.
It is also likely that the infrastructure problem is being overstated as a generalisation and that the states do not need to run so hard to respond to it.
As a final thought, perhaps it is time to think about mechanisms for Commonwealth-state fiscal policy coordination. Macro-economic management is rightly thought of as a Commonwealth responsibility, but state policies do have macro-economic consequences.
Robert Carling is a Senior Fellow at The Centre for Independent Studies
