Victorian budget built on unstable foundations

by John Daley and Danielle Wood

Published by The Drum, Wednesday 6 May

Victorian Treasurer Tim Pallas’s first budget includes numbers that Joe Hockey only dreams about.

The Victorian Government will spend more on health, education and infrastructure while delivering (slim) budget surpluses each year for the next four years. Net debt will decline from 6.0 to 4.4 per cent of gross state product. And taxes barely move higher beyond additional taxes on foreign real estate buyers and absentee property owners – who don’t vote.

But despite his beautiful numbers, Mr Pallas would do well to heed the lesson his federal counterparts are now enduring: don’t bank on the good times lasting forever.

During the commodity boom, the commonwealth government was awash with money but returned almost all the additional revenue through tax cuts and higher spending on benefits. The revenue boom was temporary but the spending was permanent, creating headaches for future treasurers.

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Victoria is experiencing its own boom, based on residential property, rather than iron ore. Melbourne property prices have jumped since mid-2013, generating a windfall in stamp duty collections. Stamp duty revenues from transfers of land are forecast to grow by 17 per cent in 2014-15, following 27 per cent growth in 2013-14. This delivers a big boost to the bottom line – stamp duties on property account for about a quarter of the taxes collected by the Victorian Government. Strong growth in stamp duty revenues has helped offset weaker growth in payroll and gambling taxes.

The other big winner for the budget is GST revenues. Victoria’s GST revenue is forecast to be $12.8 billion in 2015-16, up 6.3 per cent from 2014-15. This reflects the healthy growth in total GST takings as consumer prices rebound and also an increase in Victoria’s share of the revenues, mainly at the expense of Western Australia as the GST distribution formula catches up with the west’s higher mining royalties. But this boost will be temporary as the fall in iron ore prices will push Western Australia’s share higher after 2016-17.

The Government’s revenue forecasts rightly assume that the property market will cool over the next few years. But they remain vulnerable to a more substantial slow-down. Each 1 per cent decline in property values reduces the 2018-19 budget bottom line by $116 million. And of course, lower prices may also lead to lower turnover, further depressing stamp duty revenues. There are also doubts about whether the budget is right to forecast that payroll, gambling and motor vehicle taxes will all grow at or above historic trends. Growth in these taxes has been sluggish in recent years.

The budget also barely mentions a major challenge to Victoria’s budget position – reduced commonwealth funding for schools and hospitals. Under commonwealth government policy adopted in the May 2014 budget, from 2018-19 state governments will have to fund all increases in real spending per person for hospitals and schools. This shows up in the budget papers as a $500 million fall in commonwealth grants in 2018-19. But if health spending outpaces economic growth, as it tends to do, this will create an ever widening funding gap for state governments in the years beyond 2019.

The budget papers note that this funding situation is “unsustainable” but give little indication of what the Government will do about it. The expressed hope that the Commonwealth will “partner” with the states to make up the shortfall is wishful thinking given the commonwealth’s own budget troubles. There is no sign of a plan B.

Good luck on revenues, and wilful blindness to longer term spending pressures, allowed the Victorian Treasurer to deliver more good news in the form of additional spending. Much of the money is going on new recurrent spending with the Government boosting spending growth to 3 per cent each year (up from the 2.5 per cent forecast by the previous government).

The problem is that this spending cuts into surpluses, which will only be $1.2 billion (2 per cent of revenues) in 2015-16 and $1.8 billion (3 per cent of revenues) in 2018-19. This leaves the budget highly vulnerable to surprises, particularly if property prices stutter.

The hard decisions can’t be put off forever. The budget flags a review of property taxes to be completed by the end of 2015. This review should be used to build the case for state governments to make more of their most efficient tax base – broad based property taxes. A modest levy on property could help address the looming funding gap for hospitals and schools. Over time, it could pave the way for reduced reliance on inefficient and volatile stamp duty revenues.

These type of reforms are best pursued during the good times. But unless he squares up to them, the Victorian Treasurer may find himself more sympathetic to Joe Hockey’s plight than he ever thought he would be.