Wednesday, 19 February 2014

Mid year prognosis


The Premier’s Mid Year update revealed an unsustainable budget position. No policy prescriptions were offered. Likewise Mr Hodgman’s plan, offers no solutions. The government plans to spend more in 2013/14 as a % of operating revenue than it did in 2012/13. The forward estimates reveal cash deficits in the future. The government hasn’t detailed how future deficits will be funded. The government is unlikely to meet any of its key performance indicators (KPIs) over the next 4 years. Nor has it announced any policy changes to help satisfy KPIs in the future. Mr Hodgman’s plan offers no comfort as 97.5% of outlays are the same as those of the government. He has refused to issue his revised costings following the Premier’s update. Both parties intend to spend an unacceptably low amount on infrastructure. Even with the most important election in a generation the Libs are yet to publicly announce their KPIs, their fiscal strategies, as required. Electors are being presented with alternative plans, neither of which will lead the government onto a sustainable pathway.

What did the Mid Year update reveal?

The Mid Year report or Revised Estimates Report 2013/14 to give it its correct title confirms what we already knew, the GST pool has further shrunk and the likely abolition of carbon pricing will cause serious reduced dividend payments from electricity companies.

Most of the changes incorporated in the revised estimates result from changes in circumstances (parameter changes) rather than policy changes.

The government will have total outlays of $1.07 for each $1 of operating revenue for 2013/14.

The original budget planned to spend $1.04 for each $1 of operating revenue.

How does this compare to last year 2012/13?

Total outlays in 2012/13 were $1.04 for each $1 of operating revenue. This was only achieved with severely reduced infrastructure spending with less than 50% of budgeted amounts being spent.

How about the forward estimates?

The forward estimates, usually contain blue sky promises, but for each of the years 2014/15 to 2016/17 the government plans to spend more than it will receive in operating revenue.

How will it fund the cash deficits?

This is an unknown at this stage.

Over the past 4 years the government has funded cash deficits by internally borrowing amounts from funds intended for other purposes, and then arranging temporary overnight borrowings to repay missing amounts on each balance day.

Soon there won’t be any more such funds to borrow and the government will need a more permanent line of credit.

One can only assume the line of credit will come from Tascorp and the rate of interest will be zero as there doesn’t appear to be increased borrowing costs over the forward estimates in the Mid Year update.

The Premier has at last stopped crowing about the government being net debt free.

Is a cash deficit the same as the government’s measure of net operating deficit?

No, the latter is a profit and loss measure which excludes capex and loan repayments for instance. It also includes one off capital grants from the Australian Government which makes the resultant figure an inappropriate measure of sustainability.

Whether the government makes a profit or a loss is largely immaterial. Whether or not there are cash surpluses or deficits is more relevant. Cash surplus/deficits include all ins and outs including capex and loan repayments.

Sometimes there is little difference between the two measures but sometimes there are.

Take 2010/11 for example, the year which started with Mr Bartlett in charge and ended with Ms Giddings holding the fort. The net operating balance for that year showed a $23 million deficit. Lots of one-off Nation Building capital grants were received which when spent didn’t appear in the net operating balance calculation. The cash deficit which included all ins and outs was a whopping $338 million.

Arguably cash flow information is simpler and easier to understand. It’s how the Australian government describes its fiscal position. When the Feds talk about a $18 billion deficit they mean cash outlays exceed cash inflows by $18 billion.

Will the government be able to reduce internal borrowings?

Only marginally, and only because funds already received from the Australian Government to rebuild the Royal Hobart Hospital (RHH) will be needed as intended. Either cash surpluses or external borrowings are required.

Internal borrowings will be approximately $963 million by 30th June 2014. Three years later the figure is estimated to be $768 million.

What do the government key performance indicators reveal?

The KPIs for a sustainable budget position and the government net debt free status will not be achieved in the foreseeable future.

In other words the government admits its budget position is unsustainable.

The KPI covering  the level of infrastructure spending, to spend more on new assets than the old ones are depreciating, looks like being met but only because of the RHH upgrade.

What is the government’s plan to remedy the failure to meet KPIs?

Unknown at this stage.

When Ms Giddings first took over mid way through 2010/11 a series of savings measures were implemented.

This time given the cash position is even worse it was surprising to see no policy changes.

No desire to frighten the horses so close to an election?

A stoic acceptance of our lot?

Happy to pass a plateful of problems to Mr Hodgman knowing he will be unable to do the things he is now promising?

In the past few years one solution to a failure to meet a KPI was simply to alter it.

This is yet to be attempted following the Mid Year report.

It will be a task for the May budget.

Is infrastructure spending apart from the RHH being neglected?

Yes, alarmingly so.

When cash is tight infrastructure spending is one of the first casualties. In 2012/13 budgeted capex was $434 million. Only $198 million was eventually spent. Depreciation for the year was $246 million. Capex was therefore $48 million short of the minimum required to satisfy the KPI.

Without RHH capex of $32 million during the year the shortfall would have been $80 million.

This low level of infrastructure spending is bound to cause future problems.

How does Mr Hodgman’s plan now sit in light of the Mid Year update?

Given that 97.5% of outlays are the same as those in the government’s budgets, Mr Hodgman’s Plan for a Brighter Future is looking gloomier.

The Libs’ planned savings over the forward estimates will not be enough to change course, even if the plan can be delivered in full at the intended time.

Cash deficits will continue.

Mr Hodgman plan reflects an unsustainable structure.

Media reports have suggested the Libs have updated their costings but Mr Hodgman has confirmed the figures will not be publicly released.

Maybe he’s borrowed a leaf from Scott Morrison’s media management handbook?

What are the Libs’ plans for infrastructure?

Only that they favour a more co-ordinated approach, little more than a motherhood statement.

The Hodgman detailed plan only covers a revised net operating balance calculation which is much the same as the government’s figure. It’s a P&L statement only and as a consequence there is no mention whatsoever of capital infrastructure spending.

One can only assume the amounts are the same as the appallingly low government figures.

If they are greater the Libs will need to explain the source of the additional funds and include some borrowing costs in their plan.

Even without increased capex, the Libs need to include some borrowing costs as the position they will inherit if successful has deteriorated since their plan was formulated nearly a year ago..

Costing of Election Policies

Rather than leave electors with nagging doubts about the costs of the Lib promises, the Charter of Budget Responsibility Act provides that Treasury undertake costing of an election policy where requested to do so by the Leader of an Opposition Party, from the date of the dissolution of the House of Assembly on 12 February 2014 to the date of the Election on 15 March 2014.

What are the Libs’ KPIs?

The KPIs or fiscal strategies are yet to be unveiled.

The Libs’ alternative budgets issued in response to the 2011/12 and 2012/13 budgets contained fiscal strategies, cut and pasted without amendment from a draft report prepared for the Victorian government by a committee which included former Treasury boss Don Challen.

The Libs didn’t bother to check the strategies against the plans.

Some were unachievable, another was pointlessly low. The infrastructure strategy was that net infrastructure spending be at least 0.5% of Gross State Product. That implies only $125 million per year which can be achieved simply with the RHH upgrade.

No need for other infrastructure spending.

Some strategy.

All strategies were removed from the Libs’ latest Plan for a Brighter Future.

Aren’t the Libs required to reveal their fiscal strategies?

Yes, the Charter of Budget Responsibility Act requires a Leader of an Opposition Party to publicly announce a fiscal strategy statement and provide a copy of that statement to the Secretary of Treasury within 15 (working) days of the commencement of the caretaker period for the election.

Given the commencement of the caretaker period on 12 February 2014, these fiscal strategy statements are required to be made public by 5 March 2014.

Better late than never, although given the government’s record over the past few years fiscal strategies don’t have to be achievable. They can be motherhood statements.

Are there other likely outlays overlooked by the major parties?

Aurora Energy’s atrocious mismanagement of the Tamar Valley power station led to a ministerial directive handballing the problem to an unwilling Hydro Tasmania, resulting in a loss to HT of $335 million as well as the burden of an extra $205 million in debt just when it had recapitalised the Woolnorth and Musselwroe wind projects.

At the time the government gave Hydro Tasmania an undertaking it would review its capital structure. This can only mean funds from the government to HT.

From where?

The reduction in dividends from HT implies reduced profits by HT and reduced debt serviceability.

Both parties are silent.

Where to?

The Mid Year update has conclusively confirmed that the government’s budgets are unsustainable.

Just as mountaineers rope themselves together, Ms Giddings’ and Mr Hodgman’s plans are linked.

If one is unsustainable so is the other.

That is the stark reality facing electors on March 15th.

 

17 comments:

  1. It is now that the fire sale of Aurora and the water corp is scheduled to take place

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  2. Only Aurora? We will see the Hydro gone by 2016 if Erich has his way.

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  3. And the World Heritage Area. The Liberals are now keen to sell that as well for mining, forestry, coastal development, nuclear, toxic and other waste disposal, canal developments, casinos, etc. The WHA opportunities are endless.

    John I now see the solution to our problem. All prospective members of Parliament must have completed at least one unit of basic economics at university level before they can sit in Parliament. Most of them clearly do not understand even the basic concepts of supply, demand and efficient resource allocation. To help cover the existing incumbents, remedial classes in Economics 101 will be compulsory starting in April 2014.

    What a sad pathetic bunch of morons!

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  4. Hi John
    Enjoy reading your articles, as real information on state finances are very hard to find.
    Obviously our only hope is to drastically reduce spending and services, or increase our economy and private investment. Gordon has a list of investments he doesn't want - I wonder if we could start a discussion on exactly WHAT can lift us out of this mess. For my part I believe changing our settings be they planning, taxation whatever to encourage investment in our fine foods/wine and tourism is our best way out. How about you John, Gordon ...... what would you do?
    Jason Hall ( electrician, farmer, owner of big new house and very big new mortgage! )

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    1. There’s a tendency to talk about Tassie’s problems as one big mess. I think we need to distinguish between the sustainability of the government and the health of Tassie generally.

      Whilst the two are inextricably linked they are nonetheless separate.

      I write about the problems of government finance.

      I think the role of government in the case of a small place like Tassie needs to be redefined.

      I think the macroeconomic role of the State government is vastly overstated.

      I don’t want to see a reduction in government spending. I think it’s got an important role.

      Most public servants aren’t dead-weights on an economy. Their contributions boost output.

      We get compensated via the Commonwealth Grants Commission’s determination of our GST entitlement so that we are able to provide similar services to other States. It’s therefore not a Q of money but rather the entrenched culture in some areas, the knowledge gained from years of experience, not to worry too much about sticking to budgets, governments will always bail you out.

      In the essential areas like health and education, we need to be the best not just the equal of other States, that’s what will attract human capital the most important source of capital in any economy.

      There are chunks of the public service we could do without. I find it hard to believe that since the crisis began 5 years ago no functions have been abolished. Sections of DED and maybe DIER always come to mind. Most businesses grow and survive despite not because of government and DED is always a source of wonderment.

      We need to find at least 5% from abolishing some functions and raising a little more tax via fairer taxes. There are some who pay too much, but many who pay hardly anything.

      If the government was put on a more sustainable footing and succeeded in providing the best in essential services (and infrastructure) then the economy would grow.

      There’s a tendency for politicians to think they need to grow the economy by dabbling and providing handouts as we are current witnessing, and that in turn will fix government finances.

      That’s a deluded view. The effects of growth on government finances is a medium to long term thing.

      Pollies have it arse about. They should fix government finances, stick to essential services and the economy will take care of itself.

      Pollies surround themselves with too many economists, when what they need are a couple of smart insolvency experts.

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    2. Hi John,
      Good points. Would be interested in a thumbnail sketch of other sectors in Tas and size of the state government relative to the private sector.

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  5. These comments could form the basis of another one of your excellent blogs. Entirely agree with your thinking. In a small place like Tassie, Government services need to be run at super efficiency. Opportunities for reform need to be taken whenever possible. But as you say, our pollies see things arse about. More handouts and more subsidies (eg. cheaper electricity for major industry???) makes for a weaker, less efficient economy.

    The problem is that most Tasmanians are rent seekers of one kind or another, and our political system only encourages this behaviour.

    Tassie has lots of commercial opportunities but we don't have a positive "can do" culture. Instead we turn commercial opportunities into political and ideological battlegrounds. People I talk to on the mainland know to keep clear of Tasmania as a place to invest.

    Can we appoint Jeff Kennett as the State administrator? He's not my favourite person, but he would certainly shake us out of our complacency.

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  6. Hi John,

    I agree completely with your sentiments and will try and incorporate some of your logic into my campaign. Good to see Ruth Forrest is listening too with her opinion piece in last weeks Mercury. ps Wrt your comment that we perhaps need "a little more tax via fairer taxe's." I have always thought that consumption taxes such as the GST are perhaps the fairest and broadest of all, and it doesn't seem to have done New Zealand any harm to have a GST set at 15%. Such a rate would cause Australians to man the barricades but how about an increase of 1% to 11%, Would that be enough to keep the wolves at bay and remove some of the stupid taxes (like payroll tax) and reduce the reliance upon cruel taxes that prey on problem gamblers? Ofcourse the original GST was meant to have been accompanied by cuts to State taxes, which in many cases didn't happen. What assurance can we have that they won't once again place their snouts into the public trough and splurge it all on public sector pay rises and increases in number?

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    1. Payroll tax is not necessarily a stupid tax per se; it’s the way it is implemented that’s the problem. It’s the narrow base and high rate that’s the problem.

      Successive governments have stuffed the tax and given it a bad name.They keep raising the threshold making it unfairer just to buy votes. They hand out rebates instead of trying to make it fairer for everyone.

      If you read the Henry Report you will find the chapter on payroll tax in the section covering consumption taxes. ‘Cos that is what it is, it’s a prepaid consumption tax. If it was paid by all workers at a low rate that’s what it would be. It wouldn’t be anti employment, ‘cos everyone would pay it at a low rate.

      It's not generally realized that most other advanced economies levy payroll tax at much higher rates than Australia. Notwithstanding they may be called social security or national insurance contributions and are used to pay age pensions, unemployment benefits and the like, they are nonetheless payroll taxes. Both the UK and USA levy such taxes at rates exceeding 10%.

      Why is it that only employers with payrolls over $1.25 million pa pay the tax? Why doesn’t everyone pay whether employed or self-employed? At a low rate say 3% it wouldn’t be anti employment because everyone would pay. Imagine all public servants and parliamentarians paying 3%. That would raise $60 million pa alone. Imagine the celebrating amongst all the anti public service brigade if that happened.

      A payroll tax levied at a low rate with a broad base is like a GST collected in advance. It would be fairer than GST because it would be based on incomes. The Australian government could collect it on behalf of the States as it does GST. But unlike the latter it needn’t go into a pool prior to distribution which would mean states like WA would get every $ raised, unlike GST.

      And remember when you’re looking at tax efficiency and equity, it’s not the legal incidence that is important but rather the economic incidence. In other words it’s not who pays the tax, it’s where the burden falls.

      We need more parliamentarians who understand tax theory.

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  7. Of course we need more parliamentarians who understand tax theory, that's why I'm asking questions on this blog! The trouble with payroll tax is that it is still perceived to be a "tax on employment" and I imagine would be a bit toxic to the Liberals to tinker with, even if it was to to be made fairer. The GST on the other hand, is perceived to be a tax on consumption that nasty rich people can't avoid with their smart accountants. If they choose to buy Ferrari's at $.5m, at least 50k goes back to the taxpayers, unless it's Ferrari ute of course, in which case I guess tax deductions apply if it is used to carry hay bales lol, Seriously, looking at it purely from a practicality point of view I wonder how difficult it would be to implement a top up State GST. I am led to believe that most new cash registers are designed for US markets that typically include different state and federal taxes, Surely it wouldn't also be that difficult for the ATO to just pass back to Tas the additional 1% (or whatever, levied) untouched (or un-topped up through fiscal equalization). I know what I would like to see as part of this campaign. Instead of the treasurer/shadow treasurers sham debate, I would like to see a debate with you, Saul Erslake, Bruce Felmingham, a libertarian economist and maybe senior economists from both the ATO and treasury address the issues you raise and the options to address them!

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    1. A State based GST top up arrangement would be resisted by all. Systems in place just wouldn’t cope. Having to record sales on a state by state basis would lead to all sorts of attempts to shift sales from state to state.

      A State based income tax gets mentioned from time to time as a solution to revenue problems of states but it never gets far. The source of income, whether it’s State A or B is always a problem.

      With payroll taxes companies in multi jurisdictions already lodge monthly payroll tax returns in each State. To me it would be much simpler to lodge only one form incorporated in an ATO PAYG withholding form (for employers) extend it to smaller employers and then for self employed persons to pay via the ATO PAYG instalment system. The ATO could collect the tax but strictly on behalf of the States.

      Tassie couldn’t go it alone. But all States will run into the same problems as we, it’s just that given our size, lack of flexibility and unwillingness by our leaders, we are ahead of the field.

      If States are to survive they need to raise their own taxes, they can’t expect the Feds to raise all funds and merely distribute to the States. If that happens the second tier of our three tier system will soon disappear.

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  8. Do you know of any local economists who are advocates of http://www.fee.org/the_freeman/detail/the-man-behind-the-hong-kong-miracle#axzz2tX2McRoB

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  9. John thanks for the detailed reply to my question,
    I wish politicians would put as much thought into how to build a sustainable economy ( tax base ), as they do into how to distribute it. I reckon that free most of them up from about 99% of their workload, but that's just not the Australian way is it.

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  10. John I tried to clarify via a blog with Will Hodgman today but as I understand it over 20% of their budget savings are predicated on giving no money to Forestry Tasmania. Their assumption is that by logging more FT can make up the shortfall and remain solvent. Is that how you read it? Has FT ever made a $30 million profit approx without Government subsidy even with unlimited logging?

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    1. That’s right.

      Will has obviously never looked at (or understood) a set of FT’s financials. The latest financials confirm that FT’s direct cost of sales is more than its forest revenue.

      It makes a loss every time it chops down and sells a tree.

      The Auditor General drew attention to this in his latest report on FT.

      If there’s no gross margin (revenue less direct costs) then there’s nothing to pay overheads and wages.

      That is FT’s problem.

      Hence the need for government funds every year, mainly to pay employee costs which for 300 employees are $25 million pa.

      When Will talks about growing the industry he fails to realise that if a product sells at a loss, if you sell more of it, you make a greater loss.

      Check with any accounting 101 student.

      It’s going to take a few years at least to improve the price for FT’s products, given long term contracts etc.

      The direct costs of sales don’t include a cost for roadworks or a cost for replanting, both of which are considered to be capital outlays.

      So from FT’s viewpoint it needs to make a gross margin sufficient to cover wages and overheads, but there needs to be enough to allow for capital outlays which will increase as logging coupes are further remote from the mill door/ port.

      Will Hodgman is dreaming. The cornerstone of his plan to withhold funds from FT won’t work.

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  11. Thank you. Given how much of their budget savings are predicated on ending this subsidy the whole thing would seem to be a bit farcical. Putting politics to one side it dismays me the lack of understanding around the media discussions of this stuff.

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