Monday, May 9, 2011

State's prayer: 'Get us out of debt, but not yet'

IT WAS the young St Augustine who prayed: "Lord, make me chaste but not yet." Last week he was joined in the pews by the young Baillieu government.

After denouncing the Brumby government for taking on new debt to build infrastructure, Team Ted's first budget did just the same. It increased spending, cut taxes, and paid for it by almost trebling the state's debt from $8 billion in mid-2010 to a projected $23 billion in mid-2015.

At the same time, like its predecessor, it pledged to stabilise the debt in a few years' time but now at $23 billion, rather than the $16 billion Labor promised last year.

Both sides are united in the same prayer: "Lord, make me stop living off debt but not yet."

Last Tuesday's budget focused justifiably on keeping Ted Baillieu's campaign promises. Most were humane, targeted programs to benefit pensioners, low-income earners and first-home buyers, and to boost services such as public transport and mental health.

Treasurer Kim Wells argued that the government could not tackle the debt while implementing these promises.

That it chose to keep its promises tells us something about Baillieu. But that it put off tackling the debt indeed, allowed it to treble also tells us that his rhetoric about the "ruinous" fiscal position left by Labor is just rhetoric.

The Brumby government had serious flaws, but its handling of state finances was responsible, as the state's AAA credit rating testifies.

But now the focus switches to what comes next. And that could be very different.

The day after the budget, Wells foreshadowed that next year's budget will be tough. By then, the government will have received the final report of the Vertigan review of state finances that will examine how and where spending can be cut.

The panel's first report last month claimed the state's finances were already in underlying deficit, and on an "unsustainable" course. It urged spending cuts of $2 billion a year to put things back on track and finance future investment in infrastructure.

Rather than using debt to help finance infrastructure spending, as governments have done for centuries, the Vertigan panel called on the government to:

Pay off all infrastructure spending within 10 years claiming the main benefits of new infrastructure projects are to the generation that builds them, not future generations.

Pay off its existing debt as soon as possible.

Ensure that net infrastructure investment, as defined by the Bureau of Statistics, is around 0.5 per cent of gross state product each year. By contrast, Tuesday's budget envisaged it will be just 0.02 per cent of GSP in 2013-14, and 0.12 per cent in 2014-15.

These are very challenging goals particularly for a government that has begun its term by increasing spending and debt. The government has yet to respond, and Wells declined to do so last week. But he agreed in principle that infrastructure spending should be financed by taxes, not debt.

"Over the long term, we want to be able to generate enough cash in the operating surplus to be able to fund our infrastructure works," he said. "I find it difficult to believe we are going to fund infrastructure projects with debt in the long term."

But to finance them with cash, you need either more cash (a.k.a. higher taxes) or big cuts in spending. And if Baillieu is to meet voters' expectations of better infrastructure, he will have to spend even more on it. His government, like Brumby's, could promise to stabilise the debt only because it plans to turn down the flow of infrastructure spending to a level that, on the Vertigan panel's definition, would barely keep assets at current levels.

The issues the panel raised are real, so it's a pity its report was so flawed. It began by falsely claiming the government's April statement on state finances "suggested the current level of debt may be significantly larger than previously reported". It didn't, and they weren't.

Its claim that government spending has jumped sharply to an unsustainable trend ignores the reason why: the federal stimulus that staved off the global financial crisis was paid through the states and that spending is deflating already. The state's share of Victoria's spending including infrastructure was 12 per cent at the end of the Kennett government, and rose to 12.5 per cent in the three years to 2008. That was needed, and it was sustainable.

The panel's argument that infrastructure investment should be paid for by the current generation because its main benefits flow to them is just nonsense. The railway network built in Melbourne in the late 19th century benefited the millions of people who have lived in Melbourne since far more than it benefited the relative few living in Melbourne at the time. The same is true of roads, schools, hospitals, parks, dams even desal plants.

Baillieu has an alternative: to rely on future growth and sustained fiscal discipline, with some spending cuts, to allow him to build more infrastructure without increasing debt faster than the state's output.

After all, he needs a solution that is compatible with winning re-election.