The staggering State

 

Following the Bartlett tsunami the Premier has managed to point the State in roughly the right direction from a budgetary aspect although she is still being sparing with her analysis of our predicament if the media release (here) which accompanied the release of the State’s Mid Year Financial Report MYFR is any guide.

The Premier is struggling to send a positive message when she reverts to the old line that “the Report showed the Government remained on track to avoid going into net debt”.

Most readers would draw the fairly obvious conclusion that we are net debt free.

But nothing could be further from the truth.

In a week when forest protesters were severely chastised for their lack of truth one may have expected the Premier to choose her words more carefully.

But fortunately for the Premier the Ta Ann Defence has now become available. “I didn’t say we didn’t owe anything Your Honour, I simply said we were net debt free. Isn’t that misinformation, I hear you say? No it’s a misinterpretation of the term ‘net debt free’..... I thought Peter Gutwein was the only person who didn’t understand the difference between a debt and a liability.”

No Ms Giddings even people acquainted with financial matters don’t share your interpretation. I know accounting standards may allow it, but the simple fact is that 99.9% of people are unaware of the relevant standards and you are taking advantage of the esoteric to deliberately mislead.

The General Government sector which includes only departments and agencies, and not GBEs/SOCs, may only owe a small amount to the Australian Government, about $260 million, which is less than available cash thereby making the debt free claim possible, but the inescapable reality is that the General Government has a liability for unfunded superannuation of $5 billion which it has to drip feed every fortnight.

Furthermore half the net assets of the General Government sector are represented by the value of its 100% shareholding in all of the GBEs and State Owned Corporations (SOCs). And they certainly have lots of borrowings, some of which, in Transend’s case in the 2010/11 year, were needed so that amounts due to the General Government could be paid thus ensuring the latter remained net debt free.

So it’s misleading to continually maintain that we are net debt free. We need to elevate the public discussion when we talk about debt and talk about the whole State sector, that is the Government plus all its wholly owned subsidiaries, and not just the General Government itself.

A close look at the figures as at 30th June 2011 reveals we were only ‘debt free’ at that time due to the fortuitous receipt of cash in advance from the Feds of $424 million particularly the $270 million Wilkie RHH money. Without that, the Premier would not have been able to claim her bogus net debt free status.

The final figures for 2011 reveals we had a negative net debt of $416 million. In other words our available cash exceeded the narrowly defined debt by $416 million.

But for Andrew Wilkie and the Feds the result may well have been a red number.

Ever wonder why the Premier wasn’t too fussed about reprimanding Mr Wilkie?

She knew the RHH funds were going to be clawed back by reduced GST receipts in future years and she didn’t care? She was desperate for early receipt of the cash so she could keep crowing about our ‘debt free’ status.

Secretly she was chuffed with Mr Wilkie.

But just another example of a half truth from the Premier.

The Premier’s measure of budget sustainability is the General Government’s Net Operating Balance (NOB) and it contains an estimate of interest on the unfunded superannuation liability, yet the liability itself is not included in the measure of debt. Work that out.

Then there’s the hoary old chestnut about how “Tasmania has now lost $1.9 billion in GST and State tax revenue in the wake of the Global Financial Crisis.” I too lost a few $ million the other week when the last 5 numbers didn’t come up in the Tattslotto draw!

How much longer do we have to put up with this? The numbers seems to be getting bigger instead of fading away. Where do they come from?

The following graph explains a little, in the matter of the GST revenue anyway, from last year’s Budget Papers

 

The 2008-09 figures (black broken line) showed projected GST increases expected before the GFC, remember it was a time of blue sky forever. The next year 2009-10 (thin black unbroken line) showed a considerable fall in expected GST receipts. The latest Budget 2010-11 (grey unbroken line) was the estimate for the current year, but following the MYFR we are now again tracking the thin grey unbroken line approximately, in other words back to where we were after the GFC first struck.

In the interim however we thought the good times had returned in the form of the broken grey line (the 2010-11 Budget) ‘cos that’s when the 2010 election intervened and David Bartlett and his accomplices toasted victory with a splurge in the ensuing Budget. The folly of this was previously described in Bartlett’s Mess. Public policy makers were still a little perplexed when GST receipts initially fell much more sharply than growth generally. No one had considered permanent changes in some of the underlying GST parameters, savings rates for instance.

But Bart ploughed on regardless.

If he’d waited for the dust to settle a little we would now be in the situation envisaged immediately after the GFC, instead of having to painfully wind back the extravagances of the post 2010 election.

Referring once again to the above graph, the area between the black broken line and the grey unbroken line represents what Ms Giddings continually refers to as lost revenue, as if it has somehow been stolen, instead of simply an expectation that has evaporated, or what might have been had the sun never set.

The headline figure for budget sustainability is the Net Operating Balance (NOB) figure and that was minus $246 million. Worse than the expected $113 minus figure. Sounds bad but what does it all mean?

The NOB is essentially an operating profit figure so a positive number is preferable. A negative figure is tolerable so long as it’s not repeated too often and in large amounts ‘cos that will almost certainly imply that cash reserves are being drained.

The problem with using NOB as a measure of budget sustainability is that it includes capital grants as income. It’s like including bequests from Grandma as income. NOB is boosted when capital grants are received, but when spent as required there is no impact on NOB as capital spending is not included in a P&L statement. The MYFR acknowledges the problem by setting out the underlying NOB, the NOB without the one off grants, at $387 million negative for 2011/12 which gradually improves to a negative $96 million by 2014/15.

However at no time in the next 4 years does the Government expect to make an underlying profit. Losses totalling $765 million are expected in that period. This is the headline figure that people should confront. Not the lesser amounts which include the one off Fed capital grants as income.

How are we going to cash flow these losses and still have cash left over to keep spending on new plant buildings roads etc? The Feds only supply specific funds for some of our capital needs. We have to find the rest ourselves.

The NOB losses do contain some book (non cash) items. Depreciation of course. Also the nominal interest on the unfunded superannuation liability mentioned above, and the costs of superannuation benefits for current defined benefit members which the Government isn’t required to fund at this stage.

Offsetting the effects of non-cash items is the cash that the Government has to find to fund retired defined benefit members entitled to lump sums and pensions. These amounts aren’t included as expenses in the calculation of NOB but rather as reductions in the unfunded liability on the balance sheet. In the cash flow statement these benefit payments are included as operating cash outflows, but it would be more transparent if they were instead included as a financing outflow. We could then more easily see how much cash is devoted to servicing the large liability that conveniently is not counted in the calculation of net debt.

So what does the Government’s cash flow look like? A good starting point is the graph produced by the Auditor General in his presentation to MPs in November 2011.

 

At the end of June 2011 the Government had $620 million in the bank (the blue bit) but $424 million was cash from the Feds earmarked for specific projects (cash in advance from the Feds including the $270 million RHH Wilkie money needed by the State to retain its debt free status—- see above), leaving only $196 million (the red line) as the Government’s unallocated cash balance.

The cash position at 31st December 2011 is $495 million but we aren’t told how much relates to specific purpose Fed funds. We only get that info once a year, every November in the Treasurer’s Annual Financial Report which few bother to read.

The revised total net cash outflow after all outlays expected for 2011/12 is $237 million i.e. a rundown of cash of $237 million. The original budget predicted a $308 million rundown.

So why the improvement of $71 million? The TOTE sale produced $103 million in cash and $75 million in capital mainly RHH capital outlays has been deferred. Offsetting these are continuing rises in some expenses, notably wages, supplies and consumables. Some revenue will be down, notably GST revenue by $13 million, returns from GBEs by $12 million and State duties by a whopping $30 million.

The estimated cash position at the end of the Forward Estimates in 2014/15 has deteriorated by $149 million to $333 million despite the sale of TOTE. We can now look forward to 3 years of cash deficits with a small cash surplus of $80 million expected in 2014/15. But don’t forget that not $1 in cash will be outlaid in respect of current defined benefit superannuation members. Amounts appropriated each year to cover the Government’s contributions for such members will instead be retained by Government and used to prop up the cash flow.

Put simply, if the Government were required to set aside regular contributions for defined benefit member as it does for other employees, it would need to find a new source of cash preferably a large bountiful source.

The implication is that the current structure of Government is inappropriate given current revenue and expenditure. When one checks past financial statements the State probably has had an unsound structure since before the GFC.

The Premier is merely tinkering at this stage, still hoping that a fairy godmother may appear. She is yet to confide the full extent of our woes.

We sometimes become transfixed on the troubles of Government sector and forget about the larger picture, the overall State sector which includes all the GBEs. As an accountant I get a little obsessed with cash flows when trying to put matters in context.

The Government sector if one ignores dividends etc from GBEs of $206 million and capital grants from the Feds of $141 million is expected to show operating cash loss of $145 million for 2011/12. Remember this is before expenditure on new plant roads etc. This is catastrophically awful.

The GBE sector on the other hand will generate an operating cash surplus of $709 million.

Far from the parent being burdened by the subsidiaries, the opposite is true. It needs to be recognised the importance of the cash generated by the GBEs (largely the electricity entities). We should adopt a much more positive view towards them. After all they could well be our saviours.

On ABC’s Stateline program last Friday (here) the presenter Airlie Ward discussed with UTas’ Richard Ecclestone the possibility the Government may have to surrender certain functions. They are correct in my view. It’s the only way forward as we are unwilling or unable to solve the classic dilemma that we face, why it costs more than it should to deliver services even making allowances for the rural nature of much of Tasmania. Ms Ward was keen to abolish the Department of Economic Development. Certainly worth serious consideration although she should have discussed in a little more detail the ridiculous structure of the Department which comprises a Department and an Authority (Tasmania Development and Resources chaired by Dennis Rogers) which operate under the same roof.

The refusal to consider looking at the sources of revenue is pig headed stupidity. Peter Gutwein refuses to countenance the possibility of anything but a reduction in current taxes. Mr Gutwein talks about the way to higher tax revenue is to grow the economy, but the link between growth and higher taxes is a little tenuous at best.

Payroll tax tracks Gross State Product GSP which will grow between 1.5% and 2.25% in the next few years. The next most significant State tax is conveyancing duty which has just suffered a 20% cut in receipts in each year of the forward estimates despite there being only minimal changes to GSP estimates. $134 million of conveyancing duties have just been cut from the forward estimates in the MYFR on top of $112 million in the original 2011/12 Budget.

We have a serious problem with our State tax base trying to find stable revenue sources needed by a service provider such as the State Government.

The fall in conveyancing duty is largely the backwash from the ridiculous First Home Buyers Scheme which simply added to demand pressures by driving prices upwards benefiting vendors rather than buyers, cheered on by State Governments who benefited via increased stamp duty revenues linked to house prices.

For all intents and purposes it was a type of Ponzi scheme as First Home Owners were encouraged by Governments to join the ranks of home owners pushing up prices and hence stamp duty revenues to Governments.

The costs of the ‘scheme’ to Governments via the grants and concessions were greatly outweighed by stamp duty revenues raised by State Governments. But as soon as the grants and concessions were reduced the Ponzi scheme slowed. Sounds familiar? That’s what we are now witnessing. Every boom is followed by a bust. Simply growing the economy won’t necessarily increase duty revenue. It follows a different cycle. As recent buyers see the equity in their homes flatlining, they can at least take comfort from the fact they assisted filling State coffers during the good times. First Home Buyers were initially gleeful but may live to rue the day.

Gambling taxes have plateaued and land tax is untouchable. The latter’s narrow base and relatively high rate has given taxation a bad name.

People accept GST, remitting it to the ATO mostly in a cheerful and obliging fashion. There is little sense that the tax is a form of misappropriation by Government.

Not so with land tax. People are more likely to regard it as a misappropriation. It’s accepted as part of a rates bill but not as a State tax. It’s a burden.

Which implies we’d be better off without it.

Even the most extreme libertarians believe in Governments, maybe only to help protect their private property. Ownership is a legal right, laws require Government and Government implies taxation.

Why do we talk about tax being a burden all the time? We all want health care, education, roads, protection from murderers and fraudsters.

Tax shouldn’t be seen as a burden.

A constant cry is that wage increases in the largely service sector of the Government sector should be confined to productivity increases. But this is based on some pretty shaky economics. Much of the Government service sector is characterised by low labour productivity because that is the nature of the job. As a rule labour productivity grows slower than in the rest of the economy. It’s often been said that the labour productivity of a quartet playing Mozart hasn’t changed in 200 years. Sure IT changes have helped in some areas of the service sector but relative to other parts of the economy, labour productivity has probably grown more slowly. Wages in the service sector need to keep increasing otherwise labour will disappear, so the cost of services inevitably increases faster than costs in the rest of the economy which means that the Government sector needs to grow revenue at a faster rate than the economy in general.

It’s nonsense to keep repeating the mantra that to grow revenue we only need to grow the economy, especially when we are talking about funding Government labour intensive services.

It’s much more than a matter of the problems caused by an aging economy.

It’s understanding the nature of labour productivity in a service economy and how it differs from other sectors.

This is not to say that we should give up on ways to increase labour productivity in the Government sector.

There is still much to be gained.

It’s the functions that need a serious review if we are to remain afloat.

Not imposing austerity on crucial service areas ‘cos that causes even greater problems, but axing some functions completely.

If anything the post GFC shake out has confirmed we need a less volatile revenue base. The Government can’t afford to borrow simply because there is no evidence it can service the increased borrowings. Tapping the GBE’s for more will be difficult because they’re already stretched particularly as a result of Government demands contained in the last Budget. The Government has just about exhausted its options.

Our politicians and public policy leaders need to show a bit more initiative and an enhanced understanding of our situation.

So far clichéd populist drivel is all we’re hearing.

At this stage we’re treading water while the Premier tinkers and takes advantage of distractions in the forests while the Opposition waits for Government without the remotest idea of the task ahead. Their alternative Budget is now completely redundant

What are needed are significant structural changes to the Government sector, probably higher State taxes but at the very least a little more enterprise, understanding, expedition and a sense of purpose.