The Prime Minister and Treasurer frequently criticize the States for going into debt and warn that it will put pressure on interest rates (e.g. see Rudd torpedoed twice: PM Weekend Australian 16-17 June). It is disappointing that the Coalition is running such an irrational line.
This criticism makes no sense from a prudential viewpoint. State governments are still showing big operating surpluses and very strong balance sheets: the states current borrowing program will bring total state debt levels to only 4 or 5% of state GDP over the next five years (compared with 25% in the early 1990s). More importantly, borrowing for infrastructure will leave the states’ net worth the true test of a sound balance sheet unchanged or even improved.
From a wider economic perspective, such infrastructure (expanding water facilities, relieving ports infrastructure etc,) will add to productive capacity over time.
In the longer term such investment, will ease pressure on interest rates. In the interim (investment gestation) period, the Federal Government, which after all has ultimate responsibility for macroeconomic management, needs to defer some tax cuts or spending programs if it wants to avoid inflationary pressures or interest rate increases. If it does that, we end up with unchanged interest rates and a better balance between public and private investment and between investment and consumption and a more productive economy or at least one which better meets the preferences of Australians.
Every other government in the world (and every sensible corporation) recognizes that, where governments are better at managing the infrastructure risks than the private sector, long-life capital spending should be funded out of debt – not revenue. It is good economics because it avoids overloading the tax burden up-front or the need to use more costly private financing alternatives or deferring essential investment.
And it is more compatible with inter-generational equity. Sure, it means bequeathing more debt to future taxpayers but they will also inherit more wealth – and all the associated benefits e.g. long-lived infrastructure, improved knowledge, a better public health care system, superior economic, cultural, political and legal institutions, a more stable and cohesive society etc. Nor should it worsen the long term revenue gap stemming from an ageing population as the tax base will benefit from the new infrastructure.
Instead of damning the States, the Federal government should be taking much more responsibility for infrastructure financing than it does for two reasons. Relative to the States, it has gained much more revenue from the commodity price boom (some $300 billion better off since the late 90s) and its revenue base will benefit most from the boost to the economy generated by new infrastructure.