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Sinking into debt
IPA REVIEW ARTICLE
The past few months have shown just how fragile the perceived orthodoxy of government financial management has been.
Seemingly gone are the days when Australians could rely on their governments to deliver budget surpluses without mortgaging the future through rising public debts. If the latest budgets are anything to go by, federal and state taxpayers can look forward to nothing but deficits and debts stretching far beyond the economic horizon.
To understand where we are today it is often necessary to check back in the rear vision mirror of fiscal history. A moment's gaze into the reflection of the past will show that, in many ways, we are risking a repeat of yesterday's costly mistakes.
It would be a mistake to think that the deficit and debt cocktail is a new phenomenon. Almost all Australian governments indulged in this Keynesian style fiscal duo through the 1980s, some more flamboyantly than others.
Eventually, however, the governments were stung by how continuous budget deficits and rampant public debt, largely of their own making, were eating through our scarce financial and economic resources during the late 1980s and early 1990s.
A 1993 Victorian Commission of Audit report noted that Victoria got itself into a parlous state where it was borrowing not just to finance capital spending, but to meet interest payments and daily operating expenses. A other report for South Australia was scathing about how the State Bank financial disaster had wrecked over seven decades of prudent financial management.
Reports in other jurisdictions told a similar story of woe, with a 1988 NSW audit simply kicking off by stating that ‘New South Wales has been living beyond its means.' The federal government had to wait its turn for a scathing independent fiscal commission report until 1996.
Keynesian budget experimentation by federal and state governments had created a fiscal Frankenstein dependent on the sugar drip of public sector funds, only to be mortally wounded by a slow growing and unreformed economy that couldn't feed it quickly enough.
Having to turn their backs on this failed approach, governments started making concerted efforts to reacquaint themselves with some of the basics of sound public finance.
While there is some residual debate around the edges as to what sound public finance entails, it is neatly described by economists James Buchanan and Richard Wagner in their 1977 book Democracy in Deficit. They described it as being the twin principles of keeping government budgets in balance, or modest surplus, and limiting public debt in peacetime.
Managing a government's books not unlike those of a business or household became the new buzz phrase for governments of both political persuasions. Most governments around the country undertook reforms to better align revenue inflows with costs by restructuring the public sector, putting budgets belatedly in the black. Public debt was eventually paid off by the proceeds of asset sales or by recurrent budget surpluses.
Even still, some governments, like the Keating Beazley federal Labor administration, were slow learners judging by the $10.3 billion budget deficit and $96 billion of debt they left behind for the Coalition to clean up in March 1996.
A look at the combined budgets of the commonwealth and states-in other words, a ‘federation' budget-illustrates that governments enjoyed increasing success in meeting the twin budgetary headlines of surpluses and low net debt.
From 2000-01 to 2007-08, combined general government surpluses rose from $6.5 billion (one per cent of GDP) to $27.3 billion (2.4 per cent of GDP). Meanwhile, net debt fell from $43.5 billion (6.3 per cent of GDP) to minus $70.6 billion.
Just about every government was able to rack up fiscal success, and each drew electoral credit for the seemingly strong results delivered.
The Howard-Costello government was able to wipe away the commonwealth debt ahead of its original schedule, saving taxpayers the interest costs of debt and preventing the crowding out of private investment. It also enjoyed an enviable streak of registering budget surpluses through most of its time in office.
Even Tasmania, a state with a notorious history of fiscal mismanagement, was able to pay back debt and record budget surpluses. With the national economy growing at the rate that it was, well above its historical trend, getting budgets into surplus and paying back debt was almost like shooting fish in the proverbial barrel.
As alluded to above, the high water mark of the new fiscal orthodoxy was reached in 2007-08. Since that time, however, all governments have returned to a 1980s fiscal re-run of deficits and debt. In other words, the fiscal orthodoxy of sound public finance seemed to have been built on sandy foundations that subsequently toppled over.
With all Australian governments having released their 2009-10 budgets, the extent of the fiscal damage expected to be wrought on taxpayers is becoming clear. The expected federation budget will slip from a $27.3 billion surplus in 2007-08 to a $34.7 billion and $56 billion deficits in 2008-09 and 2009-10 respectively.
Governments are also planning to accumulate a debt bubble the likes of which Australia has never seen. According to the latest figures, federal and state and territory governments will move away from a negative net debt position to putting a fiscal mortgage on future generations. Net debt will grow from $57 billion expected this year up to a massive $212 billion by 2012-13.
How did it all come to this? Why did governments, after having worked to set their budgets on a sustainable path from the 1990s, travel down the Keynesian fiscal path yet again?
One version of recent events, often expressed by governments themselves, was that dysfunctional global financial markets and a domestic economic slowdown had led to an erosion of revenue. This, in turn, led to a budget meltdown experienced by all governments federal and state. While this official narrative may seem convincing at first glance, it conveniently ignores that, on the budget front, there are always two variables to tango. The other factor in the whole equation is spending, and trends in this area reveal something quite different.
Looking more closely at the federation budget, from 2000-01 to 2007-08 a gap between general government revenue and spending growth started to open up.
As the recent commodity boom was gathering a head of steam, revenues were growing at about seven per cent per annum reaching a high of eight per cent growth in 2007-08. However, not to be outdone, government spending was also growing to eventually exceed the growth in revenue in both 2006-07 and 2007-08.
In other words, governments spend as quickly as they could receive money and, in fact, got ahead of themselves as they acquired an expenditure habit. In 2008-09, a year in which the federation budget (the combined budgets of the states and the Commonwealth) slipped into a deficit, government spending grew by 13.6 per cent compared to a measly 0.4 per cent in revenue growth.
On the basis of current estimates, the excess of spending over revenue growth is expected to continue right through to 2010-11 with borrowed money used to fuel even more government expenditure.
To put it in simple terms, the current budget problems faced by governments across the country amount to a spending, and not a revenue, problem. Much of this dark side of fiscal behaviour was concealed by the budget surpluses enjoyed by government throughout most of this decade, but once fiscal circumstances changed the bias toward increasing expenditure has become fully exposed.
The basis for the pro-spending bias was explained by Milton Friedman in a 1993 pamphlet called ‘Why Government is The Problem.' In it, he stated that
the general rule is that government undertakes an activity that seems desirable at the time. Once the activity begins, whether it proves desirable or not, people in both the government and the private sector acquire a vested interest in it. If the initial reason for undertaking the activity disappears, they have a strong incentive to find another justification for its continued existence.
This argument certainly rings true in the Australian context. Rather than cut spending in response to the current circumstances of declining revenue growth, as any business or household would readily do, governments have found new reasons to maintain expenditure and find new days to do it.
You're paying for these:
- $150,000 to relocate an existing heritage building in Bruthen, VIC.
- $20,000 to construct seating at a skate park in Maffra, VIC.
- $300,000 to build an environmentally-themed playground in Keysborough, VIC.
- $200,000 to replace a toilet block in Bathurst, NSW.
- $30,513 to upgrade tourist welcome signs in Tenterfield, NSW.
- $10,000 to build a composting toilet for a hall in Hernani, NSW.
- $8,000 to install a public charging station for electric scooters in Albany, WA.
- $9,000 to create a community produce garden in Victoria Park, WA.
- $60,000 to complete stage 1 of skate park construction in Rosebury, TAS.
- $15,000 to purchase and install stage curtains at King Island Town Hall, TAS.
- $7,250 to refurbish council chambers in Two Wells, SA.
- $17,000 to install a jumping pillow at a playground in Wudinna, SA.
- $40,000 to construct a Eucalyptus Distillery Museum in Inglewood, VIC.
- $23,000 to construct a BMX track in Gardiner, VIC.
- $295,000 to build a community golf driving range in Kilsyth, VIC.
- $202,000 to install outdoor fitness equipment in the Shire of Yarra Ranges, VIC.
- $300,000 to create an ‘Eco-living Education Centre' in Mt Martha, VIC.
- $53,000 to build a ‘Men's Shed' for the male community of Wingham, NSW.
- $9,000 to replace a Croquet playing surface in Halliday's Point, NSW.
- $1.4 million to construct a youth facility including iPod and wireless docks and a skate park in Eddison Park, ACT.
- $77,000 to refurbish council owned historic buildings in Cobar, NSW.
- $480,000 to construct a hydrotherapy pool complex in Boonah, QLD.
- $200,000 to construct a wading pool in Mt Gravatt, QLD.