Stopping debt and deficit in the Territory?

Debt was a very popular theme with Malcolm as well …

Like Tony Abbott at a federal level, NT Country Liberals leader Terry Mills has been trying to fan the flames of a shock-horror theme on government debt, deficit and waste. Unlike Abbott, he hasn’t been notably successful at least in the mainstream media.

Mills even organised for the unfortunately named (for a financial guru) Dr Neil Conn to give a speech about it last week, but it received almost no media coverage. Conn is a former Under-Treasurer under successive CLP governments, and was later appointed by the CLP as NT Administrator. Conn’s speech/paper has not been published online by the CLP as far as I can see, but as far as one can tell from a brochure I received it merely echoed this material on the CLP website.

However the fact that Mills’ theme is going nowhere in the mainstream media doesn’t mean it isn’t getting across to those crucial swinging voters in marginals seats.  As I discussed in a post a few days ago, contemporary political campaigning increasingly relies on carefully targetted “under the radar” direct marketing techniques.  We can be absolutely certain that CLP communications with swinging voters will be filled with doom-laden pronouncements about the NT Labor government’s allegedly irresponsible fiscal strategies and the “huge” debt burden they’re running up after squandering the GST “windfall”.

Tony Abbott has had extraordinary success in persuading disengaged voters nationally to accept such propositions about the Gillard government, despite the fact that we actually have just about the lowest debt of any developed western nation as well as remarkably low taxes, inflation, interest rates and unemployment, as Scott “Possum” Steel detailed in an excellent article about the “cognitive dissonance” between reality and public perceptions.

Given Abbott’s success at convincing people that white really is black, it wouldn’t be surprising if the CLP in the Territory is able to convince local disengaged voters of a similar proposition. After all, the NT government IS currently forecasting a budget deficit for the current 2012-13 financial year, and indeed the forward estimates show deficits continuing right through until the out year 2015-16.

But to what extent is that actually problematic?  Is it even unusual compared with other states and territories? And what has caused it? Those are the questions I explore in this article.

To what extent is Territory net debt a real problem?

The CLP’s “shock horror” net debt figures state that it is expected to double to $5.2 billion by 2015-16. However that is the non-financial public sector net debt figure, which includes the debt of government business enterprises like the Power Water Corporation and Northern Territory Land Corporation (see Budget Paper No. 2 Table 2.10 on page 27). That figure isn’t really relevant in assessing the interest repayment burden of accumulated debt on the Territory budget (the purpose for which Mills wants to use it).  PWC borrowings are not serviced from the budget but from power, water and sewerage rates((although the Territory government subsidises Power Water rates to the tune of $800 per household per year so there is some budgetary impact. ~ KP)) while NTLC borrowings are serviced from income from sales of subdivided land.

The more relevant net debt figure is general government sector net debt which currently (2012-13) stands at $2.2 billion and is projected to increase to $3.6 billion by the forward estimates out year 2015-16 (see  Budget Paper No. 2 Table 2.8 on page 24).  That will amount to approximately 74% of total NT government revenue.  However, given that the government can borrow at interest rates of 5% per annum or less, the annual debt servicing cost in 2015-16 will amount to around 3.5% of the government’s budget in that year.  If my mortgage repayment costs amounted to just 3.5% of my household budget every year I’d be ecstatic.

Moreover, this level of net debt is also very modest on an international comparative basis.  The graph below (taken from here)  compares national and NT government net debt with that of other developed nations.  As you can see, our debt levels are tiny by international standards.

Of course the current net debt will be about 60% higher by 2015-16 according to the budget papers, but so too will the Northern Territory’s GDP/GSP.  Most commentators predict that the Territory’s economy will be the fastest growing in Australia over the next few years, averaging around 4.4% per year, that shows net debt as a proportion of GDP/GST in 2015-16 being around 12-13% which is still very small by international standards.

The slightly worrying thing about the Territory’s debt, however, is that the budget papers show that we will not only still have that quite modest level of net debt in 2015-16 but that the budget will still be in deficit in that year, albeit only to the tune of around $250 million. Nevertheless I would expect that there will be a tight budget next year whichever party wins the forthcoming Territory election.  There clearly needs to be a concrete plan to return the budget to surplus over the forward estimates period.  The Henderson government’s failure to map out such a plan in this year’s budget papers marks it as an election year budget albeit a fairly cautious one.

Is the Territory’s debt even unusual compared with other states and territories?

As can be seen from the table below (from here) ALL states and territories are currently running budget deficits and all will still be carrying significant levels of net debt in 2014-15.  As I’ll explore further below, the main reason for this is the post-GFC flattening of expected GST revenue on which all states and territories are reliant to varying degrees (the Territory much more so than the rest) to fund the basic services, facilities and infrastructure that they are .obliged to provide

Nevertheless, it appears that things aren’t quite as negative in some of the States as they are here.  According to the latest federal budget (Budget Paper No. 3):

In aggregate, the States are estimating general government sector operating deficits in 2012?13, improving to operating surpluses by 2014?15. The circumstances in individual States vary.

Victoria and Western Australia are estimating operating surpluses in 2012?13 and each of their forecast years.

All other States are expecting operating deficits in 2012?13, with Queensland and South Australia expecting to reach operating surpluses by 2014?15.

In aggregate, the States are not expecting own?source taxation revenue as a proportion of GDP to return to pre?GFC levels prior to 2014?15. States are also forecasting a decline in their non?tax revenue (as a proportion of GDP).

In other words, four of the six states will be back in surplus by 2014-15 while the Territory will still be in deficit the following year.  That underlines the point already made that we are certainly going to see a tough budget next year whoever wins the imminent election.  In fairness, it should be stressed that the Territory is much more reliant on GST funding than the states.  More than 60% of the Territory’s total budget revenue is GST funding.  Another 20% or so comprises various Commonwealth Special Purpose Payments, with only 20% being generated locally. Nevertheless, we will need to cut our coat to the available cloth and, as I’ll discuss below, it’s very unlikely that GST revenues will return to pre-GFC levels in the foreseeable future.

If it hadn’t been an election year I’m sure we would have seen a much tougher budget this year.  It isn’t all that difficult to see where cuts could be made, some of them probably relatively painless.  For example, the biggest single reason for the ongoing deficits (apart from reduced GST revenue) is the government’s commitment to spend some $1.8 billion over 5 years on major upgrades to power, water and sewerage infrastructure.  That necessity in turn arose from serious neglect of maintenance by both CLP and Labor governments going back at least 15 years, which resulted in a succession of major prolonged power outages in Darwin’s northern suburbs in 2008-9. It may be possible to spread the $1.8 billion over a couple of extra years, which would save a bit although not as much as you might think for reasons discussed earlier.  However, whether that’s feasible would depend on just how critical and urgent the upgrades actually are to system reliability.

Another but more politically sensitive solution would be to increase government taxes and charges to business.  At present the Territory has the lowest business taxes in Australia, which is no doubt why businesses are notably silent about Terry Mills’ fiscal scare campaign.  It would be a suicidal government that would increase business taxes in an election year, but next year is another matter entirely.

What has caused the states and territories to go into debt?

As already mentioned, the major reason for the Territory’s current fiscal predicament, like that of the states, is the reduction in expected GST revenue in the wake of the GFC. According to the budget papers, mineral royalties have also been lower than budgeted for reasons I don’t fully understand.

The Territory was also expected by the Commonwealth to ante up more money than it probably wanted to fund more nurses, teachers and police for remote Indigenous communities as part of the Intervention aka Stronger Futures.  In the wake of the Little Children Are Sacred report it was no longer politically viable for Labor to maintain the “CLP-lite” strategy where it featherbedded Darwin’s suburbs, where government is won and lost, while largely neglecting remote Indigenous electorates which it regarded as safe for the ALP.  The continuance of that strategy over Labor’s first 6 years in office ironically both won Clare Martin a record majority in 2005 and cost her the Chief Ministership in 2007.

Nevertheless, the main contributing factor to debt and deficit is the GST shortfall.  Terry Mills’ rhetoric, like that of some State LNP leaders in recent times, seeks to characterise GST revenue as a huge “windfall” to the states and territories which the Henderson government has somehow squandered by failing to retire accumulated debt (which he conveniently fails to mention was racked up by successive CLP governments over the previous 23 years).

However the proposition that GST is a huge “windfall” is fundamentally misconceived anyway.  The GST deal was only ever intended to make up for the baseline revenue the states and territories had lost when the High Court declared their various liquor, tobacco and petrol “franchise fees” constitutionally invalid in 1998. Moreover, the states and territories were required to abolish a raft of existing taxes and charges as a condition of receiving the GST revenue in the first place.  And the state taxes it was designed to replace were always inadequate to meet state funding needs anyway.  That’s why older readers will recall that the predictable newspaper headlines every state budget day always read “beer, smokes and petrol up again”.

Of course, for the first few years after GST was introduced in 2000 it seemed as if it was a huge and unexpected windfall.  GST revenue exceeded expectations every year, and both the states and territories (including the NT) were able to retire existing debt.  But it turned out this was just a temporary and fairly short-lived phenomenon.  Australians had gone on an orgy of borrowing and gearing up to buy real estate through the nineties and early noughties.  After the Hawke/Keating government deregulated the exchange rate, interest rates and financial markets generally, banks and other lenders were queuing up to lend money to Australians at much cheaper rates than had previously been available and on easier terms.  Many people took the opportunity to buy a new and larger home and to invest in residential rental properties.  Property prices went up and up and up seemingly without end. People felt richer and richer as a result, and many decided they could afford to max out their credit cards on consumer spending as well.

That’s why GST revenue kept exceeding expectations.  But it was never going to last, and it all came to a screaming halt after the GFC.  Since then Australians by and large have been saving, reducing debt and living within their means.  And that’s a very good thing too, although retailers like Gerry Harvey probably don’t agree. It also means that state and territory governments, which had become accustomed to receiving an ever-growing GST pot of money each year, are being forced to wean themselves off the habit by cutting back on often very basic services.

The longer term significance of these developments is that it has again thrown into sharp relief the complete inadequacy of federal-state financial relations.  The states and territories are radically underfunded to allow them to discharge their basic responsibilities to provide health, education, roads and the like.  Moreover they don’t have access to income tax revenue after the Commonwealth hijacked it in a dodgy scheme sanctified by the High Court during World War II. The phenomenon is known as Vertical Fiscal Imbalance and it is arguably the most urgent governance problem Australia faces.  Yet neither Julia Gillard nor Tony Abbott is addressing it or even mentioning it in passing.

Terry Mills would be doing us all a favour if he stopped spouting nonsense about GST “windfalls” and began preparing for the real possibility that he may soon be a Chief Minister doing battle with the Commonwealth (whether in the guise of Gillard or Abbott really doesn’t matter) for a fair funding deal.

For readers interested in a more thorough understanding of Commonwealth-State fiscal relations, I’ve reproduced below an extract from an excellent paper by Professors Anne Twomey and Glenn Withers prepared for the Council of Australian Federation and titled Australia’s Federal Future.

—————————————————————-

3.7 FEDERALISM AND THE GST

The argument is often made that the States, despite having been given ?nancial security through the revenue from the GST, have failed to ful?l their responsibilities, so the Commonwealth is obliged to intervene and assume or oversee State responsibilities in the interests of the Australian people.

The impression is often given that the GST funds were granted in addition to existing State funding, providing the States with a great windfall. In fact, the GST was designed to replace a range of existing State taxes plus the former general Financial Assistance Grants from the Commonwealth. The States remain reliant on the Commonwealth for substantial continuing funding through Speci?c Purpose Payments (SPPs). The ability of the States to raise their own revenue has been reduced by the requirement that States abolish certain types of State taxes. The Commonwealth remains in full and effective control of the amount of funding received by the States, because it can reduce the amount of new SPPs at its discretion as the amount of GST transfers grow. Moreover, if one takes into account the abolition of State taxes required by the GST inter-governmental agreement, the grants received by the States from the Commonwealth in 2006 amount to 5.5 per cent of GDP – exactly the same percentage as in 1996. Indeed, the (net) payments to the States over the entire post-GST period remain at levels below the pre-GST average of 6 per cent of GDP for the whole period of the 1980s and 1990s.

During the same period, the Commonwealth’s revenue rose by a further 2 per cent to 20 per cent of GDP. This is a $20 billion windfall for the Commonwealth well ahead of State and Territory gains both absolutely and proportionately.

Therefore, it cannot sensibly be argued that the States are now ‘? nancially independent’ because they receive funding from GST revenue. If the Commonwealth had been serious about giving the States ?scal autonomy, it would have ensured that the States had access to revenue that covered, and eventually exceeded, the loss of State taxes plus the combination of Financial Assistance Grants and the SPPs. It did not do so. Instead, it ensured that the States remained dependent upon Commonwealth funding. It is disingenuous to suggest that the States are failing in their responsibilities because they require Commonwealth funding and that the Commonwealth should therefore take over State policy functions, when this is the system that the Commonwealth deliberately created.


4.5 FISCAL FEDERALISM

Fiscal federalism in Australia has been marked by the progressive concentration of ?nancial power in the hands of the Commonwealth and the reduction in the capacity of the States to raise suf?cient revenue to fund their spending responsibilities. …

During World War II, the Commonwealth obtained effective control over income tax as an emergency measure. Income tax overtook excise as the dominant source of revenue-raising. After the War, the Commonwealth declined to surrender its dominance of income tax. Again, the High Court upheld its power to do so.

One of the few effective sources of revenue-raising left to the States was the business franchise fees it imposed with respect to tobacco, liquor and petroleum. Although the validity of such fees was upheld by the High Court in a series of cases from 1960 onwards, the High Court held in 1997 that they amounted to excises and were therefore within the exclusive legislative power of the Commonwealth.

This cost the States approximately $5 billion per year in own-source revenue.

The revenue from the GST was intended to substitute for the lost franchise fees as well as replace Commonwealth Financial Assistance Grants to the States. However, the 1999 GST inter-governmental agreement required that certain State taxes also be abolished and that others be reviewed in the future.

This further reduced the capacity of the States to raise their own taxes. The States now receive Commonwealth funding from two main sources. GST revenue is paid to the States according to a formula applied by the Commonwealth Grants Commission aimed at producing ‘horizontal ?scal equity’ across the jurisdictions. The intention is to ensure that the less-well-off States can provide services at an equivalent level to the more populous States. The other main source of revenue is Speci?c Purpose Payments (SPPs). These payments are tied to conditions imposed by the Commonwealth. In this way, the Commonwealth can dictate aspects of State policy. In 2006, SPPs amounted to approximately 42 per cent of the total payments made by the Commonwealth to the States.

The product of these changes is a ?scal system characterised by substantial imbalance in revenue collection between the Commonwealth and the States, plus substantial imbalance between the Commonwealth and the States in spending, which together are termed Vertical Fiscal Imbalance (VFI). There is, however, a substantial degree of equalisation across the jurisdictions in the distribution of Commonwealth grants, termed Horizontal Fiscal Equalisation (HFE). As explained in section 3.7, the GST has not diminished these characteristics; instead, it has accentuated them. …

Strong sustained economic growth and Commonwealth control over income and corporate tax have combined to deliver a windfall gain for the Commonwealth in recent years. This has allowed the Commonwealth to adjust statutory tax rates down, while still growing its own revenue receipts faster than the States and claiming to be a benefactor for the States. …

A problem with this situation is that the particular service delivery functions of the States and Territories mean that their costs are likely to rise faster than those of the Commonwealth for basic economic reasons beyond issues of good management.

This is because it is harder to enhance productivity in service functions provided by the States, which involve direct personal delivery, than it is in Commonwealth functions, such as tax collection and social service disbursement, which are IT-intensive rather than labour intensive.

When this pressure on State unit costs is combined with growth in the scale of activity required in these service areas, the cost pressure on States and Territories is dramatic. For example: prison populations have been growing at 4 per cent per annum, acute-care hospital activity at 8 per cent per annum and children in care noti?cations at 15 per cent per annum over recent years.

Therefore, the States need a greater share of revenue over time to support their functions, but it is the Commonwealth’s revenue share of GDP that has been growing – allowing debt retirement and tax rate cuts, while still supporting Commonwealth expenditure obligations and new spending initiatives. This allows claims of good economic management to be made, although these claims owe much to the legacy of earlier bold economic reform, including co-operative reforms undertaken by the States, recent Chinese economic growth, and Reserve Bank independence and good judgement in interest rate determination.

Some VFI is not unusual in a federation. However, its extent in Australia is the most extreme of any federation in the industrial world. Figure 10 shows VFI across the 1990s in ?ve major federations for which comparable data are available. Australia had the lowest share of State and local own-purpose spending, the lowest share of State and local own-revenue, and the largest relative gap between these two.

About Ken Parish

Ken Parish is a legal academic, with research areas in public law (constitutional and administrative law), civil procedure and teaching & learning theory and practice. He has been a legal academic for almost 20 years. Before that he ran a legal practice in Darwin for 15 years and was a Member of the NT Legislative Assembly for almost 4 years in the early 1990s.
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Nicholas Gruen
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Nicholas Gruen(@nicholas-gruen)
9 years ago

I’ve always maintained a respectful skepticism about claims that VFI is bad for you. After all, from the textbook we get that most taxes should be federal because they’re more efficient – less distortions because people find it harder to avoid than state taxes (apart from the ‘artificial’ reasons imposed by our constitution and legislation which allows states less efficient tax methods.)

On the other hand the states are closer to people, so a better party to spend the money.

Now the standard argument against VFI is that if states don’t tax the money – if they don’t feel the (electoral) pain of doing so – they won’t value the money highly enough so they won’t get the value for money that a taxing government would. But I don’t really understand that argument. If I were a self-seeking state government, I’d be wanting to spend whatever money I got – whether from taxing or from the Commonwealth – as efficiently as possible (considered either from the perspective of economic or political health.)

So in this analysis at least, the tax base is more efficient and the spending is as efficient as it would be if there was less VFI. I used to ask this when I was at the PC but, although I got much seriousness, I didn’t get any convincing answer.

The only clear argument consistent with these simple principles is that VFI might be a problem if either the ‘optimal’ or the preferred level of government involvement differs because states. But I’ve never really heard that argument put seriously in Australia. If it were taken seriously, I can’t believe the difference would be more than a per cent or two of state product.

So I don’t get it.

conrad
conrad
9 years ago

“However that is the non-financial public sector net debt figure, which includes the debt of government business enterprises like the Power Water Corporation and Northern Territory Land Corporation”

I wouldn’t mind getting some other figure that adds the debt to the figure but then shows the likely revenue generation. The problem with not counting it is that it’s easy for governments to hide future liabilities everyone will have which are essentially inescapable. A second figure for similar projects that are private but where the government is contracted to pay for the service for very large amounts of time would also be very handy.

Nicholas Gruen
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Nicholas Gruen(@nicholas-gruen)
9 years ago

Why does the extra money have to be raised by GST. What’s wrong with other tax revenue. There are a lot of arguments being run together here methinks. The best arrangement might not be to pay the states more in grants, but have the Feds help underwrite infrastructure costs.

James
James
9 years ago
Reply to  Ken Parish

My personal idea is granting personal income tax revenue raised in a state back to the state. Bonus points if you can then let the states set their own personal income tax rate, although still collected by the ATO, as people are a lot less mobile than companies.

emess
emess
9 years ago

Given that water usage per capita in the NT is way above average, and part of that expenditure by Power and Water Corporation is to pay for expansion of the system, it would seem that an increase in water charges would be a good way to go.

For example, a two step tariff that encompassed a price averaging the same as the other states for Australian average domestic water use, and then a higher tariff for usage thereafter might be the way to go. If consumers paid the extra, showing that they were willing to bear the cost of the new dams etc, then fair enough. If, on the other hand, they were not willing to bear that cost, then the reduction in consumption would postpone the need for the capital works. A win either way. This is easily feasible, considering that Darwin and Alice Springs use more than twice as much per capita as anywhere else in the country. Even if we tweaked this for the higher temperatures in the NT, it would still either save water and delay new capital works, or it would increase revenue significantly.

Some european capitals pay over three dollars per kilolitre from the first kilolitre.