Tuesday, 10 February 2009

A better way forward

Thirteen months away from a crucial State election, and the Messiah is yet to appear. Dominated by forestry and Tarkine issues, it is sometimes easy to forget about some of the other matters that bear upon the lives of mortals. Like dollars and cents and hospitals. So it was pleasing to see Alex tackle the neglected subject, and review the State’s Mid Year performance for the period ended 31st December 2008 ( The State Budget update: Panic or celebrate ). But there was little I could agree with, neither his description of the current situation , nor his proposed solutions.

There currently exists a sound base for the future, if only there was a greater willingness to understand the present. And also a greater willingness of the Government to reveal the options for the future. And a greater desire by those in Opposition to do more than merely oppose.

Alex stated that “(t)he rapid rise in superannuation, both as an employee expense and the nominal interest on the superannuation liability suggests this massive liability is still not under control”. The forward estimates for super expenses predict a slight fall in nominal terms over the next 4 years. The nominal interest on the super liability has increased, but that is simply a reflection on the increased liability due to revised actuarial assumptions used following the current global turmoil. I don’t think the super liability is as bad as it’s painted. The unfunded defined benefit schemes are closed to new members, their ages are known, and their mortality can be reliably estimated. Their salaries can be projected. The liability is not massive and it’s not out of control.

One of the problems caused by the timing of a State Budget (in May) is that the final results for the year ending June 30th are not available at that time. Hence the ‘comprehensive result’ (which measures movements in the State’s net assets over the year) will often have an incorrect starting point in the Budget. The net assets were originally budgeted to increase by $487.7m to $10.77b but the revised net assets of the State (contained in the Treasurer’s Annual Financial Report for 2007/08 dated October 2008) showed the net assets of the State at 30th June 2008 to be $11.38b. The revised ‘budgeted comprehensive result’ for 2008/09 contained in the Mid year Report is minus $166.7m as Alex has pointed out, which will take the State’s net assets back to $11.2b.

So over the full year 2008/09 it is estimated the State’s net assets will fall by $166.7m.Which is not too bad seeing as though the increased super liability is $478m. As stated above the increased liability results from revised actuarial calculations following the fall in the value of the assets in the partially funded schemes. If one looks at the super liability at 30th June 2007 it was $3.68b and a year later only $3.71b. The original liability at 30th June 2009 was estimated to be is $3.89b but the fall in the value of the existing assets caused a revision of the liability in the Mid Year Statement to $4.35b.

Even if there are similarities between the State Government’s behaviour and that of James Hardie, I’m not convinced with Alex’s approach to tackling the alleged super crisis.

One cannot pay off the super liability ‘in one hit’, because it is a liability arising from defined benefit schemes where the precise liability may not be known for many years to come. Gradually setting aside amounts as the Government is doing seems the sensible alternative. What to do with these set aside amounts in the interim is the more pertinent question which I will consider below.

Shifting the GBE’s plus some cash into a separate entity with a Government guarantee seems a pointless exercise. We currently have a General Government Sector which together with some GBE’s makes up the Total State Sector. If the Government guarantees the new entity (which it needs to do because of its defined benefit scheme obligations) what’s the point of the separation? Like taking money out a savings account just to put in a Xmas Club account, what’s the point? Any shortfall will still have to covered by the Government.

Doing as Alex suggests will also result in a pretty lopsided RBF from an asset allocation viewpoint. At 30th June 2008 RBF had funds under management of $3.4b, invested in equities, property, cash and alternative investments. The latter category comprised 15% of the Fund and included for example, infrastructure assets. To give some idea how much of the Fund is invested in an individual asset, RBF were persuaded by Macquarie Group to invest $100m or 3% of its total Funds in a geared consortium run by Macquarie which bought the Hobart Airport. This is deemed to be an ‘alternative asset’. At about the same time the boys from Martin Place also persuaded RBF to part with another $72m or 2% of its Funds to invest in another geared property consortium which owns retirement villages. These %’s are an indicator of the amount that a prudent Trustee will invest in any one asset. The Trustees may struggle to incorporate large assets, such as our GBE’s in their investment strategy. The assets will mostly be classed as ‘alternative assets’, leaving the Fund a little unbalanced.

I agree with Alex, a different ownership structure for GBE’s may produce better long term investment decisions, but the Government can solve that problem by giving different guidance to the GBE’s.

Finding and understanding Government financial information is a challenge. The Treasurer’s Annual Financial Report issued in October each year is an easier read than most, because it’s presented more like a Company’s set of accounts. This Annual Report will detail the balances of all the Special Deposit accounts, at 30 June 2008, $208m in the infrastructure fund, $60m in the housing fund, so much in the Hawthorn Footy Club account etc. The Superannuation Provision Account (SPA) had a balance of $1,250m, an increase of $105m for the year. This is the amount that has been set aside to meet the State’s future unfunded super liability.

But the Government has quite sensibly been using this money to fund its working capital requirements. Why have $10,000 in a savings account when there’s still money owing on the mortgage. Not that there is much owing on the General Government’s mortgage, only about $230m owed to the Feds re Housing and that’s on concessional terms. Since about 2003, the Government has operated what they call a Temporary Debt Repayment account (an overdraft really). At 30th June 2008 this ‘overdraft’ was $1.1b.

The total value of the Special Deposit accounts and the working accounts for each department was approximately $2.4b, less the ‘overdraft’ of $1.1b, left the Government with $1.3b in cash.

Even with the revised budget projections the cash amount is still projected to grow to $1.5b in 3 years time. The Government is gradually reducing the ‘overdraft’ by about $40m each year whilst its cash balance gradually increases because of net additions to the SPA account

But as the ‘overdraft’ reduces and the SPA account increases why can’t the Government borrow some of the SPA to build new infrastructure. The SPA will be repaid before any super liability needs to be paid. It seems a better use of cash flow than paying off the super liability in one hit as Alex has suggested. If the cash is transferred to RBF then RBF will simply divide it up amongst asset classes and invest it here and there as is does with other investments. If however the Government was able to use the cash in the SPA account for its own projects whilst always ‘repaying’ itself for the funds borrowed from the SPA account, and always having enough to meet any unfunded liability, then we may all be much better off.

Alex has misread this year’s projected cash position. There is estimated to be a cash surplus from operations (before finance and investments in GBE’s) of $24.5m. But the Government has put $100m into Aurora to allow for the unexpected purchase of the Tamar Valley Power Station following the demise of Babcock and Brown. With a few other smaller amounts, the actual cash deficit this year is expected to be $106m. The original budget figure was a surplus of $143m. The Government at this stage is predicting cash surpluses for the next 3 years.

Alex has suggested that as revenues in total are roughly as budgeted, there is no need to panic. This is possibly true, but maybe a little complacent. The overall figures may disguise it, but the recent downturn has highlighted the volatility of some tax receipts, stamp duties in particular.

Saul Eslake in commenting on this year’s Preliminary Outcomes for the 6 months ending 31st December 2008, said “it is not the function of State Governments to run counter-cyclical fiscal policies (that is a responsibility of the Commonwealth), and …… the revenue base of State Governments is insufficiently robust” Politicians of every hue are prone to overstate their role in macro management. Their role is more akin to a local Council than the Federal Government. If the pollies were a little more realistic about our State tax system, it would soon become apparent that our tax base is not only volatile but far too narrow and inequitable and arguably unsuited to the changing age composition of our population With the Ken Henry Tax Reform inquiry in full swing, it’s an opportune time to cast self interest, parochialism and partisanship aside and throw around a few ideas for a tax structure that may allow us to build a new hospital, for instance. So far few ideas have emanated from our leaders. The State’s current favourable cash position and debt position despite all the tales of woe, give us an unparalleled opportunity to build a better tax system.

It’s embarrassing, pathetically so, to follow the RHH deliberations, as to how we, one of the richest societies in the world, cannot even decide how to replace a hospital, parts of which are 70 years old. Inexcusably pathetic.

We need to get a better understanding of how the State’s finances work and decide a better way forward. And soon.

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