Saturday, August 25, 2007

Saturday Forum: How not to save a surplus.

People who dole out their savings into jam jars are not usually thought of as good economic managers.

But this week proclaiming a near-record budget surplus of $17.3 billion for the financial year just ended the Treasurer Peter Costello ascribed it little else.

He mentioned “economic management”, (or “good economic management” or “strong economic management”) three times, but mentioned Australia’s resources boom, China, the extraordinary growth in our terms of trade and luck not at all.

But these outside influences must have had a bit to do with the surprise $17.3 billion surplus announced this week.

Otherwise our economic managers would have seen it coming.

Last May Peter Costello and the Treasury budgeted for a 10.8 billion surplus for the financial year just ended. In December they upped it to $11.8 billion. In May this year, with only six weeks of the financial year to go they upped it to 13.8 billion, and were still massively out despite going on a last-minute spending spree in May and June that burnt off $4.2 billion.

Something is going on that Australia’s economic managers seem unable to forecast let alone control...

Part of it is an explosion in the amount of income coming into Australia and ending up in the government’s hands as company or personal tax.

But there’s something else. Dr Stephen Bartos was until recently the director of the National Institute for Governance at the University of Canberra. Before that he was in charge of the Budget group in the Department of Finance. Now with the Allen Consulting Group he says that the government seems to have underestimated its spending as well.

“Most spending should be predictable,” he says. “Especially social security spending which is closely monitored in real time”.

What he thinks has happened and will be confirmed when the detailed final figures come out is that the government has underestimated its spending on programs. And the reason why it has done that is that it has simply been unable to spend the money the kind of money it set aside.

It takes planning and resources to spend money on new programs. Staff have to be hired, and as has become apparent in the private sector as well, staff are hard to get.

The only way to be sure you can spend a lot of extra money quickly is to hand it out in tax cuts or in the modern equivalent of bank cheques. The government did both in the May budget to about or somewhat beyond the limit of what the Reserve Bank would tolerate.

It had very little choice but to book a big surplus for 2006-2007. But it did have a choice about how it presented that surplus.

What it has done has the experts cringe.

It has doled out $7 billion into one metaphorical jam jar (the Future Fund); $6 billion into another metaphorical jam jar (the Higher Education Endowment Fund) and $2.5 billion into a new jar it has labeled the Health and Medical Investment Fund.

Do people who know about these things regard this jam jar accounting as a bit of a joke, I asked Chris Richardson, the budget specialist at Access Economics.

“Oh yea. Mmmm,” he replied and paused before laughing. “I’m sure you’ve run across people just walking around town like I have who’ve pretty much made that point.”

“It’s not all bad, but I just wish they had taken the punters into their confidence and explained why right now big surpluses, bigger than we’ve got, are actually good for them.”

“Nobody has sat down and said – look it is great that we have got all this money but if we turf it at you it is going to go up in a puff of interest rate smoke, and we need to hang on to it because we might need to turf it at you later.”

“Having failed the honesty test they needed to come up with a Plan B, which is to pretend that they are spending the surplus while they are not actually spending it to any great extent.”

“From a political point of view and from an economic point of view the idea is to talk about putting $2.5 billion into this fund, $7 billion into that fund, $6 billion into that fund, and get people looking at the big numbers and thinking - oh good, they are using the surplus - whereas in fact they are only spending the earnings on it.”

And Chris Richardson sees another problem with the growing use of funds of “jars” in which to put portions of the surplus.

“Right now we happen to agree that infrastructure spending - on medical equipment, on higher education - is a good thing. But these funds are being set up in perpetuity.”

“Spending on those things might not always be our highest priority. Decisions about whether to spend on medical equipment or buildings for higher education should be made on a cost-benefit basis taking into account other perhaps more worthy uses of the money.”

Stephen Bartos at Allen Consulting agrees.

“We are told that the money will be locked away and only its earnings touched for spending only on those purposes. But by the time we pass through a couple of years they could turn out to be entirely the wrong purposes. I mean higher education and medical equipment sound great now but how do we know that that will be the right spending priority for us five years, ten years from now.”

“What if something else, maybe climate change, turns out to be our overwhelming priority? Locking away bits of the surplus for its earnings to be spent on this, its earnings on that, reduces the government’s flexibility. The existence of the funds will prevent us from taking rational decisions about the use of our resources.”

But surely the government could always cuts its general spending on university buildings or on medical equipment to compensate, I ask.

“If that’s the case then setting up the funds is just a con,” Bartos replies.

“It they are going to a adjust spending out of the normal budget allocations for things like health and education because they’ve got these funds in existence then the notion that they have set aside anything additional is just misleading.”

“It is either a con or it restricts the government’s flexibility in ways that may turn out not to be wise later. You can’t have it both ways.”

The creation of specially named pots of money is an idea with a long Coalition linage.

Early in their terms as Prime Minister and Treasurer John Howard and Peter Costello named one of its taxes the Guns Buyback Levy. Then they announced (although never introduced) the Timor levy, the sugar levy and so on.

They weren’t pioneers. State speeding camera revenues had long been notionally allocated to spending on roads, cigarette taxes partially to anti-smoking campaigns, gambling tax revenues for health-related purposes and so on.

Economists call the idea “hypothecation” – because the money raised is hypothetically allocated to a particular purpose. The reality is often different. Australia’s Medicare Levy, the best-known example of a hypothecated tax, collects far less than is needed to fund Commonwealth spending on health.

Efficient administration demands that all the dollars collected by a governments be pooled together, in the same way as all the deposits taken collected by a banks are pooled together.

(If banks didn’t pool all their funds together they would be unable to lend out our money while purporting to have it on call for us as they do. They would have to hold each of our funds in its own specially marked safe just in case we came in wanting to withdraw them.)

Governments get away with the fiction of hypothecation for the same reason the banks do - because each dollar looks the same. In the language of economists, dollars are “fungible”. No-one knows or cares where each particular dollar comes from. It doesn’t matter if the dollars raised for buying back guns are actually spent on something else so long as other dollars raised for other purposes are used to buy back the guns.

This government’s innovation has been to extend the concept of hypothecation from taxes to investments. Its Future Fund will now be notionally investing some money for some purpose, some for another.

Aside from savings bank Christmas Clubs of the 1960’s it is an idea that most of us have outgrown when it comes to our personal finances. We trust ourselves to invest our money where we think it will get the best return and then spend the proceeds (and often the capital) as we think is needed.

The government’s announcements this week suggest that it does not trust itself, or its successors, to the same extent.

It is an approach unlikely to give us confidence in ourselves as electors or confidence in the economic management ability of the governments we elect.

2 comments:

Peter said...

Fred Argy writes:

Hi Peter,

I read your interesting piece on "jam-jar money" in Saturday's paper. I agree with most of it but I think you are too hard on hypothecation. While it reduces fiscal flexibility, it has one big advantage: Australians can see where their money is going – education, the environment, health etc. – and this helps reconnect citizens to the tax system. It offers a unique form of participatory democracy. The evidence is that most citizens do not trust governments and disapprove of taxes for vague, unspecified government spending.

By the way, your web site is very hard to access if ever I want to post a comment. If you welcome comments, what should I do to gain access? I have tried to register without success.

Peter said...

Dear Fred,

Thanks.

You are not the first person to have said that you find it hard to post comments on my blog.

But it seems easy for me. I'll contact you to find out exactly what about it is proving difficult for you.

Kindest regards,

Peter

Post a Comment

COMMENTS ARE CLOSED