Budget repair hopes rest on a brief storm

by John Daley and Brendan Coates

Published by The Weekend West, Saturday 16 May

Having ridden the mining boom and spent the proceeds, WA must now weather the downturn.

State mining royalties have collapsed as iron ore prices tumbled. The State Government is now tracking to record WA’s first Budget deficit in 15 years of $1.3 billion – in 2014-15.

This outcome is helped by the Commonwealth’s one-off grant to WA of $499 million, even if it came too late to be reflected in the official Budget papers. The deficit is expected to widen to $2.7 billion next year.

Yet the collapse in the Budget bottom line is forecast to be brief.

The Budget is expected to return to the black in just three years. A surplus of $874 million in 2017-18 will be followed by a whopping $2.2 billion surplus in 2018-19, a larger Budget surplus than WA has delivered in any year since 2007-08, at the height of the mining boom.

The parallels with the Federal Budget released on Tuesday are striking. Like the Commonwealth, the WA Budget is hit by revenue writedowns.

Relative to the forecasts made a year ago, the Government now expects to collect $10.2 billion less between 2014-15 and 2017-18.

As for the Commonwealth, the collapse in iron ore prices is the culprit. Weaker mining royalties are responsible for the bulk of these lower revenues. The Budget assumes that the iron ore price will be slashed from $US120 a tonne last year to $US47 a tonne today. Yet even after these falls, royalties will still finance 14 per cent of the WA Budget next year, up from 7 per cent a decade ago.

And like the Federal Budget, the planned return to surplus is primarily the result of optimistic revenue forecasts, rather than new savings measures. After falling 2.7 per cent next year, revenues are projected to recover quickly, growing 8.2 per cent in 2016-17 and 9.1 per cent in 2017-18.

These projections assume large increases in mining export volumes and rapid growth in State tax revenues. Expectations that taxes – particularly payroll tax – will grow 8 per cent next year and more than 6 per cent in each of the three years after that seem optimistic when the economy is barely expected to grow.

Unless the WA Government is very lucky, there is more pain to come.

Other decisions contribute relatively little to Budget repair.

New measures contribute less than $400 million to the Budget bottom line each year.

A long-term lease of the Fremantle port and privatisations of the TAB and electricity generation assets are long overdue reforms that will help free up the balance sheet.

But these privatisations won’t help close the Budget deficit because the interest costs they save will roughly match the future revenues given up.

“Recycling” the capital to fund new infrastructure projects is likely to lead to net increases in future Budget deficits.

A recovery in WA’s share of GST distributions will help repair the Budget, as the collapse in mining royalties feeds through into the formula used by the Commonwealth Grants Commission to calculate the States’ shares of the GST revenue pie. The State Budget forecasts WA’s share of national GST revenue will rise from 3.4 per cent next year to 7.7 per cent in 2018-19, but this is still well below the State’s population share of more than 11 per cent.

But the WA Government can’t expect a renegotiated GST redistribution to solve its Budget problems. Other State Treasurers have their own Budget pressures and are unlikely to cede GST revenue to help WA in a fix.

The Commonwealth also has its own Budget issues and WA was probably lucky to get half a billion dollars this year notionally for unspecified infrastructure, but in effect an ex gratia payment for the falling GST revenues. So what should the WA Government do?

It might be able to solve some of its Budget problems by improving the efficiency of service delivery, particularly in health. Per patient, WA’s public hospital costs are among the highest in the country. In 2010-11, after taking into account differences between patients and hospitals, each WA patient cost $784 more than in Victoria.

Closing even some of that gap would make a big difference in a system with more than 600,000 patient visits a year.

On the revenue side, State tax reform would help. The Government could make better use of its most efficient tax base – broad-based property taxes such as the Emergency Services Levy. A modest increase could help address the looming funding gap for hospitals.

Over time, it could pave the way to reduce inefficient and volatile stamp duty revenues.

But a WA Government is unlikely to grasp the nettle of difficult spending and revenue decisions while it continues to project future Budget surpluses based on optimistic revenue assumptions.

The best way to get through a storm is to be realistic about the weather, and to take precautions accordingly.