In a state of dysfunction
Despite what most people think these days, state and territory governments still matter. By managing more than $167 billion of spending, including on law and order, education and health, they have a significant influence over the national economy.
While the states remain relevant, they have a major credibility problem. The lack of infrastructure provision and inefficient service delivery has played a major role in this. The year 2008 will be seen as one where the credibility of state governments as responsible budget managers took a severe battering.
The latest midyear budget estimates reveal the extent of the short, sharp deterioration in state and territory finances. The combined general government budget balance will decline from $4.2 billion, as originally forecast for this financial year, to $813 million. Four jurisdictions - NSW, South Australia, Tasmania and the ACT - are anticipating a collective $950 million deficit in 2008-09.
Although some states anticipate temporary deficits only, the estimates over the next four years reveal the full extent of the budget meltdowns. The budget balance of states and territories combined will decline from $15.8 billion to $4.5 billion, a reduction of 71 per cent.
State governments point to revenue deficiencies when explaining their growing budget gap.
Over the next four years, tax revenues for all jurisdictions are expected to fall by $7.5 billion compared with what was originally forecast. The most affected taxes include property, motor vehicle and payroll taxes.
Some states have announced increases in taxation. NSW and Queensland will increase land taxes, with Queensland also raising vehicle registration fees. Some states are also defying an agreement with the commonwealth by deferring the scheduled abolition of nuisance taxes.
These actions might help avert temporary deficits in some cases, but might prolong subdued economic activity and risk the relocation of firms to lower-taxing states.
It must be recognised that taxes will still be growing over the next four years. It is estimated that tax growth will exceed a benchmark of consumer price index plus population growth by almost 2 per cent.
Over the next four years, states and territories will increase their spending from $690.5 billion to $708.1 billion. In 2008-09, spending has been revised upwards by $5.2 billion. This spending trend is well in excess of any revised changes in revenue.
The long-serving state governments have clearly formed an overspending habit. From new regional slush funds and corporate welfare programs to hiring more solicitors and bailing out film studios, the extra spending will deliver severe budgetary pain if economic conditions worsen. More bureaucrats and wage increases for existing public servants will add to the states' fiscal pressures.
States and territories need to pare their expenditure. It has gone well beyond that cited by economists as the appropriate preserve of collective action. 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.
Private-sector alternatives exist in the remaining areas of state government spending. These include not-for-profit schools, private hospitals and privately funded infrastructure. There is little need for states to provide universalised services that in effect make people pay twice for the privilege of using private alternatives.
Privatising social services for those on middle to higher incomes can eliminate the excess spending and provide much needed tax relief. States should also seek to cut wasteful and inefficient spending.
The states should also revitalise and strengthen their fiscal responsibility programs. Some states have fiscal responsibility legislation (including, surprisingly enough, NSW!) while others have charters or policies for fiscal sustainability. Clearly, these have failed.
State and territory governments should implement strong tax and expenditure limitations to prevent their budgets from growing out of kilter.
A constitutional or legislative framework could be introduced, requiring governments to balance their budgets. Governments should also constrain revenue growth to less than gross state product or inflation plus population growth.
The states' budgetary dysfunction is largely a self-inflicted one.
They portray their situation as a revenue issue caused by global economic ructions, but the insatiable appetite for spending is the real problem.
The only way for states to restore their credibility is to engage in real reform and submit to strong fiscal rules.