States heading for a debt problem

The state treasurers are meeting in Canberra today to discuss spending on infrastructure among other things. Robert Carling from The Centre for Independent Studies says that if the states want to be able to spend on infrastructure, they have to keep a tight rein on operating expenses for years to come as the debt of state governments has risen dramatically in the last years.

Details of the expansion of Commonwealth government debt, past and projected, have been given a thorough airing, particularly since the change of government last September. But the growth of state government debt has received rather less attention.

A new publication from The Centre for Independent Studies, States of Debt, aims to fill this gap by compiling data on trends in public debt of the states individually and in aggregate, analysing the reasons for the growth in debt, and canvassing what, if anything, should be done to stop it.

States’ finances were unquestionably robust before the global financial crisis, with budget surpluses and negative net debt the order of the day. Since 2007, however, they have spent much more than they have taken in, thereby using up the financial safety margin they enjoyed.

Large operating surpluses dried up as revenue growth eased and expenses growth kept charging ahead. At the same time capital expenditure rose dramatically in a drive to upgrade infrastructure. This combination of elevated capital expenditure and shrinkage of operating surpluses led to large cash deficits and borrowing requirements.

In the six years to 2013 general government net debt of all the states rose by $70 billion from a negative level to $43 billion. Non-debt financial liabilities (such as unfunded public service superannuation obligations) brought the total to $191 billion.

For the broader non-financial public sector, which includes public corporations as well as general government agencies, the 2013 figures were $127 billion for net debt and $319 billion for net financial liabilities. An examination of states’ mid-year budget reviews shows that all the above aggregates are projected to increase further up to 2017.

Impressive as these aggregates are, States of Debt does not argue that the states’ debt burdens are currently unbearable when they are expressed as a percentage of relevant variables such as annual revenue. Rather, the problem is the direction of the trend and the absence of anything in prospect to stop it.

Queensland, South Australia and Tasmania are in the worst positions, with Western Australia some way ahead of them. These states have all had credit rating downgrades since 2009. Should current trends continue, NSW and Victoria are at risk of joining them.

To be fair, all the states to varying degrees have prudently reined in their operating expenses in recent years after the galloping growth of earlier years. But revenue growth has sagged even more. Revenue growth will pick up over the next few years, but this will not be strong enough to put net operating results back into the black to the extent needed unless states keep a tight rein on operating expenses at the same time.

Operating expenses (half of which at the state government level are labour costs) need to increase at a lower rate than revenue for years to come. This is the new ‘austerity’ for state governments. If this happens, the states will be able to fund capital (infrastructure) spending to a greater extent internally (from operating surpluses) rather than adding to their debt burdens. If it doesn’t happen, the states’ financial capacity to spend on infrastructure will be compromised. All those calling for renewal and upgrading of the nation’s infrastructure should take note.