Victorian state budget 2018-19: Pallas tests the limits

Tim Pallas describes his budget as a statement of faith. It is, and not only of faith that Victoria’s extraordinary population boom will continue and necessitate the building of even more schools, roads, railways and hospitals. It’s also a statement of faith in property prices.

Buried within the budget is an assumption about how fast property prices will continue to grow. Amazingly, after briefly dipping to about 2.5 per cent, price growth is assumed to bounce back to more than 5 per cent a year for the last three years of the budget projections and presumably beyond.

The latest figures for Melbourne property prices, released as the Treasurer prepared to deliver his speech, show a drop of 0.7 per cent over the past three months, which is pretty much the same as a plateau, after almost a decade of continual increases.

Had the budget instead assumed steady property prices it would take in about $250 million less than forecast from stamp duty and land tax in 2018-19 and as much as $2 billion a year less by 2021-22.

Treasury officials believe they’ve good reasons for assuming price growth will bounce back.

Historically, average price growth has been more than 5 per cent a year, and,  discounting events such as the global financial crisis, prices have never stopped growing for long.

Also, Melbourne’s rapid population growth is affecting prices in an unusual way. Price growth is slowing in inner and metropolitan Melbourne, but continuing strongly in outer Melbourne.

Treasury’s methodology doesn’t allow it to assume a recession or a crisis, so is forced to assume an overall pickup, even though Pallas has asked it to be conservative.

It is on stronger ground predicting a jump in grants revenue of 10.3 per cent next financial year, most of it from the Commonwealth which doles out GST collections.

The Grants Commission has told it it will be compensated for very strong population growth (about 150,000 people a year, which is the population of Canberra every three years) and also to a lesser extent for getting less than its fair share of Commonwealth infrastructure funding.

In future it is expecting more modest growth in grants revenue of 3 per cent a year, a figure that very much depends on the Commonwealth’s decision about a change in Grants Commission formula due later this year.

Pallas is correct to call it an infrastructure budget, but it is more cautious than it seems. He is spending $13.7 billion on infrastructure in the coming year, but only $2.8 billion of it will be on new projects.

His new road and rail programs amount to $4 billion, but only $383 million will be spent during 2018-19. His new program of schools upgrades will cost $1.4 billion, but only $658 million will be spent during 2018-19.

It is true that major projects take time, but it’s also true that Pallas regards himself as bound by his commitment to keep government debt below the level he inherited in 2014, which is about 6 per cent of gross state product. It’s an unreasonable straitjacket. Victoria’s needs are growing much faster than before he took the job.

In earlier budgets he wasn’t as bound by the straitjacket. He could privatise things to fund infrastructure instead of running up debt. He has more or less run out of things to privatise, which means he feels there are limits to what he can do.

There are also real limits. Victoria is running low on concrete, and running low on the skills that are needed to build what needs to be built, which is one of the reasons so much of the budget is centred around building up skills.

Pallas is pushing up his wages bill by 10.1 per cent in the year ahead to take on the teachers and police and public servants and hospital and other staff to keep up with demands. He is testing the limits where he can.

Peter Martin is economics editor of The Age.

In The Age and Sydney Morning Herald

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Victoria's privatisation, population & property billions

Where are the billions coming from? In part, from property. This financial year Treasurer Tim Pallas will get $6.6 billion from property stamp duty, up from $5.4 billion in 2015-16. He will get $2.4 billion from land tax, up from $1.7 billion in 2015.

The good news is that Victorian property values are staying high. Sydney prices slid 1.7 per cent in the three months to March whereas Melbourne prices slipped just 0.5 per cent.

Going forward, Tuesday’s budget will forecast still high but lower income from stamp duty, a judgment that looks about right. Melbourne’s population growth is the strongest in Australia, which means Melbourne property prices are more likely than most to stay high.

Many more of the billions will come from asset sales. The Turnbull government will pay the Andrews government a touch over $2 billion for Victoria’s share of Snowy Hydro, and a private buyer will pay it an estimated $2 billion for the right to run the land titles registry.

Victoria will get $16.8 billion from the Commonwealth Grants Commission in goods and services tax collections, that’s about $900 million more than it expected. It’ll reflect both Victoria’s bigger than expected population, and its lower than expected share of Commonwealth infrastructure grants. The Grants Commission’s formula requires it to compensate for Commonwealth stinginess after enough years have passed, and the Abbott and Turnbull governments have been stingy long enough for the compensation to kick in.

And the Commonwealth is at last becoming more generous. The $5 billion promised for a Melbourne Airport rail link and the $1.42 billion promised for regional rail are making things easier.

The economy itself is helping. One in every ten jobs in Victoria has been created in the past 3½ years, since the election of the Andrews government. One in every seven dollars sloshing around in the economy wasn’t there before Andrews was elected and (coincidentally) Victoria’s population growth took off.

It’s impressive, but doesn’t quite explain how Tim Pallas can promise to spend $10 billion a year on infrastructure for the next four years and still bring in a surplus.

The answer lies in a quaint state budget accounting convention. When the money is spent, it isn’t spent as far as the budget is concerned. All that appears on the budget are the interest payments on the borrowings to spend the money, and later depreciation on the infrastructure that’s been built. You can literally borrow to spend as much as you want on infrastructure in a state budget and still report the surplus you would have had if hadn’t.

Once small, the interest component of the budget is climbing. That needn’t be a problem if the infrastructure is worthwhile, which most of it probably is. Privatisations have kept the debt relatively low. On Tuesday Pallas will say it's less than he inherited from the Coalition.

In The Age and Sydney Morning Herald

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Victoria fills up as the rest of the nation moves in

In the past 12 months, 82,800 Australians have moved to Victoria from interstate, around 500 carloads a week.
At the same time, 65,600 Victorians have left.
The gap - a net influx of 17,200 - is an all-time record. Victoria's population is being swelled by more migrants from interstate than ever before, and by far more than any other state, even Queensland, which used to be the go-to state for the rest of nation.
Perhaps as a result, or perhaps as a driver, employment in Victoria has surged by 97,300 in the past year, accounting for almost all of the nationwide employment growth of 104,600.
In contrast, the once-booming jobs market in NSW produced only 2000 extra workers.
New population figures show that a jump in interstate migration, in overseas migration and in births lifted Victoria's population by 157,500 to 6.1 million in the year to September - an increase of 2.1 per cent, compared to 1.2 per cent in the rest of the nation.
Victoria now accounts for 25.2 per cent of Australia's population, the most since the share slid during the early 1990s recession.
Net foreign migration to Victoria reached a record 68,600 in the year to September. The natural increase (births minus deaths) reached 41,700, also a record high.
Domestic migrants to Victoria came predominantly from NSW (29,500), Queensland (15,200) Western Australia (11,500) and South Australia (9700).
The main destinations for Victorians moving interstate were NSW (22,900), Queensland (20,800) and Western Australia (7100).

Bureau of Statistics projections released with the population figures show Melbourne overtaking Sydney as Australia's biggest city in 2056.
The central projection puts Melbourne's population at 8.2 million, almost double the present 4.6 million, and Sydney's at 8.1 million, up from 5 million.
The slower growth in Sydney reflects congestion and geographical constraints of the sea and a mountain range.
By 2056, Victoria is projected to have a total population of 9.9 million and NSW 11.1 million.
A faster growth scenario has Melbourne well above Sydney at 9.2 million to 8.4 million, and a slower growth scenario has Sydney slightly ahead of Melbourne at 7.7 million to 7.4 million.
Australia's population is projected to be somewhere between 35 million and 45 million. The central projection is 39.7 million, up from the present 24.3 million.
In The Age and Sydney Morning Herald

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Budget 2016: Pallas rides high while Morrison dithers

Who wouldn't want to change places with Tim Pallas? Scott Morrison would. Pallas is offering Victoria surpluses as far as the eye can see; Morrison is offering Australia continuing deficits. Pallas is swimming in revenue yet on the lookout for more; Morrison isn't, and isn't keen to raise much more. Pallas has the confidence of the ratings agencies; Morrison has them worried.

Here's how Pallas explains his determination to continue to raise a bit more here, a bit more there, even though Melbourne's real estate boom is showering him with a record $6 billion a year in stamp duty: "You've got to be prepared to show that you can defend your bottom line by taking decisions about revenue, whether or not you need to. That's how you get a AAA credit rating, mate, and that's how you keep it."

Thinking perhaps of his federal counterpart, or of state governments past, Pallas says: "If you basically show that you are really good at keeping in surplus but all you're doing is dispersing the benefit of bounty or providence, it will count against you – you've got to also show you are prepared to secure and protect your revenue base."

It's what the ratings agencies are telling Morrison. Here's the Moody's agency this month expressing a lack of confidence in a federal treasurer who talks about cutting spending but isn't too keen on sandbagging revenue: "Without such measures, limited spending cuts are unlikely to meaningfully advance the government's aim of balanced finances by the fiscal year ending June 2021, and government debt will likely continue to climb, a credit negative for Australia."

Morrison's treasury is losing more and more to negative gearing and will lose even more now Morrison and Turnbull have acted as if it is a protected species; GST revenue isn't holding up as it once did; and the temporary deficit reduction levy is about to come off, even though the deficit hasn't been reduced. Yet with the notable exception of ultra-high-income superannuation tax concessions, Morrison has shown next to noscant interest in plugging the leaks.

It would be bad enough, were company tax revenue not also collapsing – although hopefully on a temporary basis – and record-low wage growth all-but neutering bracket creep as an engine of income tax growth.

Pallas is inching up taxes on foreign home-buyers and absent landowners, and royalties on the miners of brown coal. He's doing it while raking in billions from the fastest home price growth in the nation, and while planning to invest an unprecedented amount in the infrastructure that will support that population.

In his words, there's about to be a "change in the pace and feel of the government".

"It will inconvenience you," he says. "And not just around the Melbourne Metro. Metropolitan Melbourne itself could resemble a worksite."

Pallas is planning to fund the Melbourne Metro and the Western Distributor himself, without funds from the Commonwealth, plus 50 level crossings, the biggest upgrade of schools in the state's history, and much more, right up to the limit that his advisers tell him it's safe to borrow, which is 6 per cent of gross state product.

When he gets the money from the sale of the long-term lease over the Port of Melbourne in the coming financial year, he'll borrow more to move back up to that limit, just as any prudent chief executive would, where the projects can be shown to have benefits that exceed their costs.

He says he is "not prepared to run a lazy balance sheet".

"Public debate about government debt has often focused on the desirability of eliminating net debt," his budget papers say. "A reluctance to use debt can deter sensible investments in productivity-enhancing infrastructure. Intolerance for debt has the potential to slow economic growth and limit opportunities to improve the quality of life of Victorians.

"Without debt financing, Victoria would not have much of the core infrastructure enjoyed today. The International Monetary Fund has pointed out that infrastructure is under pressure, particularly in urban areas, and that Australia has an infrastructure deficit. The IMF considers that a boost in infrastructure spending funded by borrowing would have short and long-run benefits."

Morrison is less ambitious.

Rather than protect revenue or do much of the hard work needed to identify specific savings, he is expected to hit the public service with another overarching "efficiency dividend". Rather than tackle taxation rorts (superannuation excepted), he'll try to strip unemployment benefits from "rorters" by making it harder still for them to get the dole.

His budget mightn't even include the infrastructure commitments his prime minister has been working towards. They might be postponed until during the election campaign so they can be announced after the budget, when they won't show up in the bottom line.

Instead of removing benefits from welfare recipients, Pallas says Victoria will tackle dependency by introducing New Zealand-style social impact bonds, in which private investors will be asked to stump up the money for alcohol and drug rehabilitation and juvenile recidivism programs. If the projects pay off, reintegrating people into society and boosting Victoria's economy, the investors will get extra.

Pallas is luckier than Morrison, and being part of a state rather than a federal government means he is naturally more more attuned to the welfare of his citizens. But personal and political differences come into it as well.

It isn't clear from his speeches why Morrison got into politics, except perhaps to ensure that business is "not unreasonably burdened" by government. That's what he said in his first speech to Parliament. He seems to believe in not getting in the way.

Since he and Turnbull have been in their jobs, there's always been some sort of crisis or election around the corner, something that's prevented them from governing. Their greatest curse has been the three-year parliamentary term, as well as the false start with Tony Abbott. It's made it hard to be bold.

Pallas and Premier Daniel Andrews face the voters only every four years, and so are actually able to govern. It's Victoria's secret weapon. It ought to be national.

In The Age and Sydney Morning Herald

Victorian State Budget 2016: Pallas redoubles bets on economic growth

Blessed with the highest population growth and the fastest property price growth in the nation, as well as the fastest economic growth this side of Darwin, Tim Pallas has decided to double down.

He is going to invest the proceeds in schools, roads, rail links and hospitals that will allow it continue.

At around the turn of this century NSW made a different decision. Enjoying faster population growth than Victoria, it under-invested in the things that were needed to make the state work, partly to pay for the stadiums that housed the Olympics. Its population growth slid below Victoria's and never recovered.

Victoria's treasurer could have given the bounty back in tax cuts. He could have allowed the surplus to soar. He could have spent it on monuments of little value as did NSW. Instead, he wants to use it to ensure the city and suburbs and regions work.

He'll spend a record $7 billion in the coming financial year, followed by as much, if not more, the next year, and up to $8 billion in 2020-21. Not all of it is on projects that are yet known. It includes what Mr Pallas calls "headroom". It's the amount his treasury officials believe is safe to spend on worthwhile projects when they are identified.

Heading the list is the Melbourne Metro, all the way through to completion in 2026. If a "future Commonwealth government" wants to help, Mr Pallas will accept its money, but he is sick of being messed around.

He says Melbourne is on track to overtake Sydney as Australia's biggest city from 2030. So he is spending big on suburban rail lines, regional lines and the Western Distributor, all "without a dollar from the Commonwealth government". He is going to spend $900 million upgrading and building schools, "the biggest single school investment in Victoria's history".

It's a commitment that can only be safely made by someone who thinks he'll have the money.

Income from stamp duties has shot up 23 per cent in the past year. He is raking in $1 billion more than he expected this time last year. Treasury is wisely expecting some pullback, a slide of 6.4 per cent in 2016-17, and then growth, eventually reaching a long-run average of about 6 per cent a year. There's not much science to its projection. Treasury staff freely concede they don't know when or if prices will pull back. The only reason for expecting growth to eventually revert to the long-term trend is because it's the long term trend.

If property prices turn down sharply and stay down, Mr Pallas might find he doesn't have the money he thinks he will have. But his decision to boost spending on the things that make the city more livable will enhance his odds. The extra spending should itself ensure that Australians keep flocking to Victoria and gain jobs, boosting revenue further.

He is certain it won't deprive him of his prized triple-A credit rating. In fact he says the only chance he has of losing it is if the Commonwealth loses its top rating first, something that's entirely possible.

The ratings agencies have been told the investment is for projects that will set up Victoria for the future, ones that pass a strict cost-benefit test. Spending on the ordinary business of government is set to climb by less than revenue over each of the four years. To keep the agencies happy he is lifting an array of taxes and charges by far more than he is cutting payroll tax, by around $150 million more each year.

In The Age and Sydney Morning Herald

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Melbourne booms while the rest of Victoria sinks

Melbourne has pipped Sydney to become Australia's fastest-growing city, but risks a "lost decade" after years of underinvestment in public transport.

The latest spatial breakdown of economic growth produced by SGS Economics and Planning puts Melbourne at the top of the pack at 3.1 per cent, a growth rate exceeded only in regional Western Australia and the Northern Territory. Sydney's economy is growing at 3 per cent, Brisbane's 0.9 per cent and Perth's 0.3 per cent.

Adelaide is growing faster than the other second-tier capitals at 2.1 per cent, Canberra at 1.4 per cent, and Tasmania (no separate results are calculated for Hobart) at 1.6 per cent.

But regional Victoria is languishing. Away from Melbourne the calculations put Victorian growth at just 0.3 per cent, a rate that fails to cover population growth, meaning income per person is going backwards.

"It's been a bad year for both manufacturing and agriculture," said SGS partner Terry Rawnsley. "The closure of the Alcoa refinery in Geelong hit manufacturing, and we had drought in the Wimmera. Agriculture is seasonal so things might improve, but Melbourne is where the growth is."

Driving Melbourne's economy has been a rapid growth in the financial sector and a boom in apartment building, but Mr Rawnsley says both are at risk from years of underinvestment in public transport.

"Putting aside the regional rail link which has just opened, Melbourne's last big investment was the city loop in 1985. It expanded the capacity for people to get into the city, and the banks moved their operations to the Docklands. But by 2009 or 2011 that capacity was exhausted and the trains became extra crowded. While you can throw extra rolling stock at the problem, you really need an uplift in capacity."

Mr Rawnsley says the Melbourne Metro won't be completed until 2026 and the government's program of removing level crossings will achieve only incremental benefits...

"Like Sydney after the Olympics, we are facing a lost decade because of infrastructure which has failed to keep pace. Global and national firms are likely to bypass Melbourne because they won't be able to get their workers to work. They will go to Sydney or Brisbane or Auckland instead."

The 2014-15 accounts show Sydney was responsible for 23.3 per cent of Australia's gross domestic product and Melbourne 17.7 per cent. The next most important locations are Brisbane (9.6 per cent), Perth (9.5 per cent), regional Queensland (8.9 per cent), regional NSW (8 per cent), and regional Western Australia (7.5 per cent). Regional Victoria accounted for just 4.4 per cent.

In order to demonstrate the different economic fortunes in different parts of Australia, SGS Economics calculates what the Reserve Bank should do to interest rates in each location to allow it to grow at its long-term potential. In Sydney the bank should lift its cash rate from 2 per cent to 3.5 per cent, in Melbourne it should keep it steady at 2 per cent, and in much of regional Australia, including regional Victoria, it should cut it to 1 per cent.

The exceptions are regional Western Australia and Northern Territory where the Bank should increase rates to 2.75 per cent and 5 per cent.

In The Age and Sydney Morning Herald

 

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No budget blockbuster as Victoria's new team settles in

Tim Pallas has delivered a 'back to basics' budget rather than a blockbuster.

He had to.

Last year the Coalition promised the East West Link, the Melbourne Rail Link, the Cranbourne-Pakenham rail corridor, the CityLink – Tullamarine widening, the Monash Children's Hospital and a stack of other projects as part of a what it said would be Victoria's biggest-ever infrastructure spend.

How it funded it is something of a dirty secret. Instead of growing by the usual 3 per cent, the government's operating expenses were to grow by just 0.7 per cent in 2015-16. It was planning to squeeze the ordinary business of government in order to deliver flashy promises. Over four years ordinary spending was to grow by an annual average of 2.5 per cent at a time when Victoria's population was growing by 1.8 per cent and prices by 2.6 per cent.

Some of the slower growth due to a one-off transfer of some functions to the Commonwealth, but even taking that into account, the projected spending on the ordinary business of government was unreasonably low. It was keener on building hospitals than staffing them.

Pallas has restored spending growth to 3 per cent. It means he'll be able to pay for wage rises and put on staff. Spending on wages accounts for about 40 per cent of his budget. That spending will climb an impressive 7.1 per cent in 2015-16 as part of a shift back to building up services. The treasury believes wages will climb only 2.5 to 3 per cent, meaning there will be plenty of room to spend the rest of the increase on more staff in hospitals, schools and emergency services. Surprisingly, the budget papers don't say how many extra people will be  put on. It's likely to be whatever can be funded after wage rises have been taken into account. The higher the wage rises, the smaller the number of extra staff who will be used to boost services.

The government's decision to boost services won't win it headlines. But it believes that over time people will notice.

To find the money it has eaten into the surplus. It is promising $1.2 billion in 2015-16, less than half the $3 billion projected in the Coalition's last budget. And it has wound back infrastructure spending. In 2015-16 it will spend $5.2 billion instead of $7.5 billion.

Abandoning the East West Link explains some of the lower spending, as does a deliberate decision to spend more slowly.

Pallas told the budget press conference that he would rather get things right than build them quickly. The RACV identifies Chandler Highway bridge across the Yarra as Melbourne's number one congestion point. It's where four lanes converge into two. It'll cost $108 million to widen, but rather than do it immediately Pallas will spend only $2.1 million in 2015-16 and the rest over the following two years. He'll get it right, but we will have to wait until late 2018.

A bold incoming government would have abandoned concern about maintaining a surplus and borrowed to do the things it wants to do now. Where a project has immediate benefits it should easy enough to convince the rating agencies that it's better to borrow than wait.

But that's what a bold government would do. This one is cautious with its finances. Exceedingly so.

It'll fully fund the Gonski reforms to schools as agreed with the Commonwealth government, but only for the 2016 and 2017 school years. After Abbott pulls the plug in 2018 Pallas is offering no guarantees.

Victoria's new government is settling in.

In The Age and Sydney Morning Herald

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What's Pallas getting right that Hockey is getting wrong?

What's Tim Pallas doing right that Joe Hockey is doing so wrong?

On Tuesday, Victoria's new treasurer will deliver surpluses as far as the eye can see. A week later in Canberra, Joe Hockey will deliver only deficits. Pallas will claim to have met every one of his election commitments. Hockey could only hope to meet his.

Partly it's the advice they got before their elections. Hockey's told him what he wanted to hear. He could abolish the carbon tax, keep paying out compensation for the carbon tax, abolish the mining tax and cut the company tax rate and match Labor on funding schools and hospitals while paying down debt.

Pallas'> advisers were more cautious. Tearing up the East West Link would save billions (despite the concern about letting the few hundred million the Coalition had already spent go through to the keeper). While building level crossings and the Melbourne Metro would be expensive, the spending would build up slowly.

But mainly it's where they are making their money. Victoria's budget is powered by real estate. In the past year Melbourne house prices have surged 7 per cent. Every new sale hands Pallas a whack of stamp duty. Hockey's budget used to be powered by iron ore. But in the past year prices have plunged 38 per cent.

What can we expect from Pallas on Tuesday? Less than you might think. The end of the East West Link contract means he will commit to less infrastructure spending than Denis Napthine did in his final budget.

But it makes sense. Napthine didn't release the benefit-cost analysis behind the East West Link before the 2014 election because it was appalling. It showed the project would return a benefit of just 45¢​ for each $1 spent. More than half of the money would be wasted. When it expanded the benefit by factoring in so-called "agglomeration benefits" (what happens when businesses cluster near each other) it got a loss-making return of 84¢ per $1 spent.

Labor won't make that mistake. Melbourne Metro will return about $1.90 per $1 spent. Infrastructure Australia (the body that never got to look over the East West Link) ranked it as among Australia's best projects. Many of Labor's level crossing projects look good as well. Labor is committed to these projects as well as the Westgate Distributor and widening the Tullamarine Freeway because it took them to the election, but after them it'll turn off the tap for a while.

All future road and rail projects, including small and medium-sized ones, will have to run the gauntlet of Infrastructure Victoria, a new body it'll set up in the second half of the year. Its reports will be made public. If the projects don't stack up, it'll say so.

That's why Pallas won't be announcing any new projects in Tuesday's budget. He'll have to wait until Infrastructure Victoria has run its ruler over them. He will set aside a small amount for the sort of small projects he thinks will get up (they will be buried in sections with names such as "unallocated capital expenditure" and "decisions taken but not yet announced") but he won't commit to them until the new umpire has taken a look.

He won't even commit to Melbourne's second container port. Labor took to the election a clear preference as to its location, but said it would decide only after advice from Infrastructure Victoria.

It's a new way of governing. It'll make budgets and elections less contentious. And it'll mean that when the government next changes hands the new mob will be far less likely to repudiate contracts after discovering that the old mob hadn't been telling the truth.

Pallas has been lucky in other ways as well. He is expecting a large sum from the long-term lease over the Port of Melbourne. When he uses the proceeds for his own projects including Melbourne Metro and those approved by Infrastructure Victoria he'll be eligible for the 15 per cent Commonwealth contribution introduced by the Abbott government to encourage asset recycling. And the Grants Commission has just given him $400 million over the next four years by changing the way it divides the goods and services tax revenue between the states, much to Western Australia's annoyance.

Two treasurers will be delivering budgets over the next two weeks. One of them will be relaxed.

In The Age and Sydney Morning Herald

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