Publications

Budget Features 1999-2000

Contents

Feature Articles:

• The Accrual Budgeting Framework


• Budget Presentation


• The 1999-2000 Budget: its Public Policy Context


• Economic Strategy Behind the 1999-2000 Budget


• Government Surpluses and Debt


• Taxation Measures


• Identifying Transactions and Incomes of Persons-Tax Reform or Privacy Issues


• Do the Primary Financial Statements Comply with Accounting Standards?


• Statistical Overview

Glossary of Budget Terms

Accrual accounting A system of accounting that recognises costs, revenues, lending and borrowing when they occur. Accrual accounting differs from cash accounting-the traditional basis used by the Commonwealth-which records transactions only when a payment or receipt is made. Thus the timing of the recording of transactions can differ under accrual accounting and cash accounting. Accrual accounting also includes non-cash costs-such as depreciation-and costs which, while incurred, have not yet been paid (e.g. accruing superannuation entitlements). Accrual accounting thus seeks to measure the full cost of providing goods and services in a given period. The 1999-2000 Budget is the first to be presented in an accrual framework.

Accrual budgeting A comprehensive budget incorporating assets, liabilities, expenses and revenues, including cash receipts and expenditures. Under accrual budgeting, agencies are funded for the full cost of their functions, including non-cash costs (e.g. depreciation). Thus the amount an agency is appropriated under accrual budgeting in any one year may exceed its cash costs (although the amount appropriated covers its full costs). Any unspent amount is accumulated for use in future years when required (e.g. accumulated depreciation to replace buildings and equipment).

Additional estimates Extra spending requirements (e.g. for cost overruns in existing programs or for new programs) not foreseen when the Budget was presented. Additional estimates are contained in Appropriation Bills Nos. 3 and 4 and the Appropriation (Parliamentary Departments) Bill No. 2.

Administered expenses Items that agencies administer on behalf of the Commonwealth (e.g. social security payments to eligible recipients). Administered expenses include grants, subsidies and benefits.

Advance to the Minister for Finance Contingency funds, appropriated in Appropriation Acts Nos. 1 and 2, to cover urgent expenditure not foreseen when the relevant Bill was drawn up (e.g. natural disasters) or for which funding provision was inadequate. The advance may also be used to implement changes in priorities, by enabling 'transfers' from the purpose for which they were originally appropriated to another purpose, pending specific appropriation.

Amortisation Refers to the writing off of the value of an asset over its lifetime. The term is usually applied to the writing off of 'intangible' assets such as goodwill or expenditure on software. The term is sometimes used as a synonym for depreciation. (See also depreciation).

Appropriation Refers to the authorisation by Parliament of expenditure of public moneys from the Consolidated Revenue Fund (CRF) for a particular purpose. Annual appropriations under Appropriation Bills Nos. 1 and 2 account for about only 25 per cent of total appropriations (the balance is accounted for by Special Appropriations). A major difference between the 1998-99 and 1999-2000 Budgets is that under the accrual accounting framework used in the 1999-2000 Budget, moneys appropriated for accrued expenses will remain in the CRF until they are required to be spent in future years. In the past, moneys appropriated but not spent lapsed at 30 June.

Appropriation Bill (No. 1) A Bill to appropriate moneys from the Consolidated Revenue Fund for the ordinary annual services of government i.e. recurrent services (e.g. running costs) and recurrent expenditures on already established programs.

Appropriation Bill (No. 2) A Bill to appropriate moneys from the Consolidated Revenue Fund for purposes other than the ordinary annual services of government e.g. payments to the States (i.e. those not covered by special appropriations), and spending on new programs.

Appropriation Bills (No. 3 and No. 4) When funds required exceed the approved appropriations contained in Appropriation Acts 1 or 2 because of spending overruns, the government may seek additional appropriations in Appropriation Bills Nos. 3 and 4. The government may also seek appropriations for new spending in these Bills (see 'additional estimates').

Appropriation (Parliamentary Departments) Bills (No. 1 and No. 2) Bills to appropriate moneys from the Consolidated Revenue Fund for the Parliamentary Departments. Bill No. 2 covers additional appropriations (see 'additional estimates').

Change in net assets In an accrual system, the net change in accumulated assets and liabilities. This measure equals the operating balance plus asset revaluations. Thus a positive operating balance-akin to the profit in a business-will increase net assets. Changes in net assets should be interpreted cautiously. On the one hand, increased asset values may indicate the ability to retire debt through asset sales. On the other hand, capital gains may also reflect higher costs of replacing assets in the future and the corresponding need for higher revenue.

Commonwealth Financial Transactions A monthly statement, in economic type/functional format, of revenue and outlays, the deficit or surplus, and the ways in which the deficit has been financed or the surplus invested. It compares transactions to date with budgeted revenue and outlays and the previous year's figures. Sometimes referred to as the Niemeyer Statement.

Commonwealth Public Account (CPA) The main bank account of the Commonwealth, maintained at the Reserve Bank, through which the day-to-day operations of the budget sector are conducted. It holds the moneys of the Consolidated Revenue Fund. Bodies (e.g. CSIRO) that receive budget funding but maintain their own bank accounts, operate outside the CPA. However, the distinction will become less clear as more agencies operate their own bank accounts.

Consolidated Revenue Fund (CRF) The Fund established by section 81 of the Constitution, which requires that all monies received by the Commonwealth must be paid into this Fund, and so is the main working fund. Section 83 of the Constitution requires an appropriation of moneys by the Parliament before any payment can be made from the CRF. The Financial Management and Accountability Act 1997 (FMA Act) established four funds-the Consolidated Revenue Fund, the Loan Fund, the Reserved Money Fund and the Commercial Activities Fund (the latter two consist of a number of trust accounts) in the Commonwealth Public Account (CPA).

Depreciation Refers to the reduction in the value of an asset though wear an tear. The term is usually applied to physical assets such as plant and equipment. See also amortisation.

Forward estimates When a Budget is brought down, 'rolling' forward estimates are presented for the three years following the Budget year. These estimates assume no further policy decisions (i.e. they are based on existing policies), and are based on estimates of key economic parameters such as inflation and unemployment. Forward estimates are the starting point for budgetary deliberations, since all new policy or savings proposals constitute variations to the forward estimates.

General revenue assistance Grants paid by the Commonwealth to the States and Territories to assist in meeting recurrent outlays. They are the main form of assistance to the States and are 'untied' (i.e. there are no conditions on their expenditure). The Commonwealth Government proposes to replace general revenue assistance (but not Specific Purpose Payments) with the revenue from the GST. In 1998-99, general revenue grants comprised Financial Assistance Grants, Special Revenue Assistance ('transitional allowances' and 'special fiscal needs' grants to the Australian Capital territory), and National Competition Payments.

Horizontal fiscal equalisation The principle underlying the Commonwealth Grants Commission's assessments of per capita relativities, which are the basis for the interstate distribution of general revenue grants. Under this principle, grants are distributed to provide each State and Territory with the capacity to provide public services at an average standard and level of efficiency, for comparable revenue effort.

Inputs Resources in the forms of people, materials, energy, facilities and funds that an agency uses in activities to produce outputs.

Net assets In an accrual system, equal total assets less total liabilities. Net assets take account of both non-debt liabilities (such as accrued superannuation), non-financial assets (such as land and buildings) and equity in public trading and financial enterprises. Net assets in an accrual system thus provide a more comprehensive picture of the government's financial position at a point in time than the cash framework measure of net debt-the difference between gross debt and financial assets. However, the valuation of some assets is highly problematic.

Operating balance In an accrual system, is revenues less expenses. It excludes spending on capital assets but includes non-cash costs (such as depreciation) and costs which, while incurred, have not yet been paid (e.g. accruing superannuation liabilities). The operatingbalance thus reflects the full cost of providing goods and services.

Outcomes The results, and consequences of actions by the government on the community. Planned outcomes are the results or consequences that government wants to achieve for the community. Actual outcomes are the results or consequences actually achieved.

Outputs The goods and services agencies produce on behalf of government for external organisations or individuals. Outputs include goods and services produced for other areas of government external to the agency.

Performance measures Measures to assess the extent of success in achieving outcomes. Performance measures relate to outcomes, outputs, third party outputs and administered items. They are used when there is a direct casual link between an action and a change in performance. Performance measures are a more precise measure than indicators.

Price The amount the government pays for the delivery of agreed outputs.

Real Adjusted for inflation. For example, grossdomestic product (GDP) is the nominal (current price) value of GDP adjusted for inflation to yield real (constant price) GDP values. This process (deflating) is to a range of other data. For example, real growth in outlays is measured by deflating nominal outlays by the GDP deflator, a measure of price changes throughout the entire economy.

Seignorage The net revenue derived by any money-issuing body e.g. a note-issuing authority. The difference between the face value of coins and the cost of their minting is an example of seignorage.

Special (or Standing) appropriation Moneys appropriated by a specific Act for a specific purpose (e.g. unemployment benefits, and grants to the States for schools). Special Appropriations do not require annual authorisation by the Parliament, as they do not lapse at the end of each financial year; rather, Special appropriations continue until their authorising legislation is either amended or otherwise lapses. They may or may not be for a specific amount of money or particular period of time. A distinction is sometimes drawn between Standing and Special Appropriations. Standing Appropriations refer to an open-ended appropriation of the Consolidated Revenue Fund by the enabling Act of a legislatively-based program. The amount appropriated will depend on the demand for payments by claimants who have satisfied program eligibility criteria as specified in the legislation. Special Appropriations can be regarded as somewhere between Standing and Annual Appropriations. While a specified amount is provided, it is included in a separate Bill authorising the particular program, and can be specified for any number of years. Special Appropriations account for around 75 per cent of underlying outlays.

Specific Purpose Payments Commonwealth payments to the States and Territories for designated purposes e.g. for housing under the Commonwealth-State Housing Agreement, legal aid, and government schools. SPPs comprise current and capital grants, and are classified into three categories: SPPs paid to the States; those paid through the States for on-passing to local government, other bodies (e.g. universities) and individuals; and a small number of SPPs made directly to local government.

Tax Expenditures Concessions in the tax system, which reduce the tax liabilities of particular groups of taxpayers. The concessions reduce or delay collection of taxation revenue, and constitute a call on the Budget similar to outlays. Superannuation concessions are the single largest tax expenditure.

References

This glossary draws on those on the Department of Finance and Administration web site. The 'Guide to the Commonwealth Budget Papers 1999-2000 ' issued with the Budget Papers contains a glossary at page 22.

Introduction

John Kain

Since the 1996-97 Budget, the Department of the Parliamentary Library (DPL) has endeavoured to complement the official Budget documentation by providing Senators and Members with a Budget Review brief produced from the independent perspective of the Department's own research specialists. Budget Review was designed to provide parliamentarians with timely background and selective Budget analysis and commentary with a focus on those Budget measures that were thought to be of particular policy significance.

This publication, Budget Features 1999-2000, has a similar general purpose to the earlier Budget Reviews but is necessarily different in style to respond to the major changes in Budget reporting methods being introduced in the current Budget. It is emphasised that while being selective in the focus given to individual elements of the broad array of the Budget measures, it is not the intention of this brief to make value judgements about the public interest implications of individual Budget initiatives or to aim to provide a comprehensive treatment of the Budget.

In essence, these changes in reporting methodology stem from the Government's April 1997 decision to implement an accrual based financial management framework for the Commonwealth. It is the Government's stated intention that the new framework should give Commonwealth finances a more 'business like' focus and discipline by accounting for the full cost of service delivery, incorporating a 'whole of government' approach to budgeting and by directly linking expenditures to outputs produced and outcomes achieved.

Because of the central significance of the new accrual reporting regime to the overall Budget presentation and the bottom-line Budget results, this edition of Budget Features contains some in depth explanation and commentary on the accrual framework of public accounts aimed at the lay reader and with a particular emphasis on its implications for Budget reporting and presentation. It begins with an explanation of the Accrual Budget framework.

It should be noted that the former system of Budgetary analysis which addressed the effects of specific Budget Measures on individual Programs and Sub Programs is no longer feasible under the new reporting arrangements as individual Programs may not necessarily equate with the new Output measures which underpin the accrual reporting system. Thus, it may be that any single Program may now be split across a number of Portfolio Output measures; as a result the sort of information on Program effects of Budget measures is no longer so readily discernible notwithstanding the objective of achieving greater transparency under the new reporting framework.

Indeed, in its reporting of expenses (as distinct from outputs) the new accounting framework would appear to be less transparent than the former reporting arrangements, particularly at the more disaggregate levels. In the case of some portfolio activities, the aggregation of data into such broad outcomes prevents any meaningful analysis at the functional program level. In compiling this publication, difficulties have been encountered in tracing program data in the official Budget Statements, even when referred to in Ministerial media releases. Complications such as these have necessarily influenced the scope and character of the analysis contained in this publication and the degree of consistency of analytical presentation across portfolio activities.

Quite apart from the change to accrual reporting, the 1999-2000 Budget embraced another major policy initiative of the Government in the form of the ANTS (A New Tax System) (1) package. The impact of ANTS is pervasive throughout the forward estimate elements of the Budget and a number of the feature articles contained in this publication address some of the major macroeconomic issues arising in this context. However no attempt is made to analyse the individual ANTS initiatives as these have already been dealt with very extensively in other recent DPL publications.

This publication consists of three main elements:

• Feature articles which provide Budgetary overviews and analysis and also deal in a more detailed fashion with some discrete policy issues arising from Budget initiatives. They address some of the fundamental facets and underpinning methodology behind the Budget and as such are of special policy significance and warrant more detailed assessment. The articles include a layperson's introduction to the accrual reporting framework, commentary on the public policy and economic context of the Budget, a searching analysis of Budget surpluses and debt issues from the longer term perspective, discussion of the Budget's tax measures and associated policy issues and a concluding article providing a statistical overview of the Budget.
• Portfolio directions commentaries are of a more descriptive nature and address Budget directions from the individual portfolio perspective.
• Selective analyses of particular Budget measures follow each portfolio overview, providing short, succinct commentaries cover revenue, expense and capital measures where there is a substantial financial impact and/or where there are significant policy implications.

Budget Features 1999-2000 has necessarily been prepared in some haste with a view to making it available to parliamentarians as soon as possible after the handing down of the Budget. As noted above, the task of interpreting the Budget and compiling this publication was a major challenge this year because of the very substantial restructuring of the Budget reporting framework and because of differences in the level of detailed numerical information and reporting practices apparent between the Portfolio Budget Statements of the various portfolios. Nevertheless every effort has been made to ensure its accuracy in the time available.

1. Address for Bills Digest page together with full list of relevant Bills Digests

Feature Articles

The Accrual Budgeting Framework

Richard Webb

The 1999-2000 Budget differs from previous budgets in two main ways. First, the Budget and associated documentation are presented in an outcomes and outputs framework. Previous budgets were based on a program approach. Second, the budget uses an accrual budgeting framework. Previous budgets used a cash framework. This article reviews the reasons for introducing accrual accounting and budgeting and the outcomes/output framework, their advantages and limitations, and experience elsewhere of accrual budgeting.

Outcomes

The program approach was criticised as being excessively focussed on the inputs that departments devote to programs, and that departments tended to see programs as ends in themselves rather than as means to ends. Consequently, it was argued, insufficient attention has been given to the objectives that the programs seek to achieve. By specifying desired outcomes in the budget documents-the results or impacts on the community or the environment that the government intends to achieve-it is hoped that departments will focus their attention more on the attainment of objectives and better ways of attaining them. The Department of Finance and Administration, for example, has three outcomes: sustainable government finances; improved and more efficient government operations; and efficiently functioning Parliament.

Departments will be required to report in their annual reports on how successful they were in achieving desired outcomes. That is, departments will report actual outcomes-the results, impacts or consequences of actions by the Commonwealth on the community-against desired outcomes, and be required to explain why actual outcomes diverged from desired outcomes. It should be noted that actual outcomes include the consequences of all factors, not just those under the influence of the Commonwealth Government.

A limitation of formulating outcomes at a portfolio or agency level is that the outcomes cannot take account of activities undertaken for similar or related purposes by other portfolios. For example, the provision of regional services includes not just some of the services provided under the Transport and Regional Services portfolio but under other portfolios such as communications and health. The Ministerial Statements (e.g. 'Regional Australia: Meeting the Challenges') identify related cross-portfolio activities. A criticism of the outcomes as they have actually been formulated in the budget papers is that some are very general, thus limiting their usefulness in enhancing the accountability of departments and agencies. In some cases, the general nature of the outcomes seems to reflect the disparate nature of portfolio activities.

Outputs

Outputs are the goods and services produced by agencies on behalf of government for external organisations or individuals, that contribute to achieving outcomes. Outputs include goods and services produced for other areas of government external to the agency. The provision of policy advice is an output of a number of departments. More than one output can contribute to an outcome. For example, in the Department of Finance and Administration, the public sector financial management output group, the property and contract management output group, and the government information output group jointly contribute to the 'improved and more efficient government operations' outcome.

Accrual Accounting

Historically, departmental financial accounts-like the budget-were prepared on a cash accounting basis. Under cash accounting, transactions are recorded only when there is a transfer of funds. Cash accounting has the merit of being simple to apply and understand. Cash accounting, however, can be misleading when it misstates the cost of providing goods and services by assigning costs to the wrong time period or activity.

Commonwealth departments have for a number of years prepared their financial statements on an accrual accounting basis to provide more accurate estimates of the cost of providing services than under cash accounting. Accrual accounting is a system that recognises costs, revenues, lending and borrowing when they occur. Thus the timing of the recording of transactions can differ under accrual accounting and cash accounting. Accrual accounting also includes non-cash costs-such as depreciation-and costs which, while incurred, have not yet been paid (e.g. accruing superannuation entitlements). Accrual accounting thus seeks to measure the full cost of providing goods and services in a given year.

But accrual accounting's limitations must also be borne in mind. First, there is the problem of asset valuation. This can be problematic when there are no clear indicators of how assets should be valued. The valuation of assets will also affect the value of depreciation of those assets allocated to different years. A second problem arises in the attribution of costs to different activities. Some costs can be directly allocated to activities where the costs are directly related to those activities. However, there is often no clear basis for assigning costs, especially those costs that do not vary greatly with the level of service provision or cannot be closely identified with a particular activity. The allocation of these 'fixed' or 'overhead' costs can be quite arbitrary. Third, while accrual accounting takes account of the 'stock' of assets and liabilities at a point in time and the 'flow' of revenues and outlays during a period of time, it cannot take account of all future outlays and revenues. Nonetheless, on balance, accrual accounting generally provides better estimates of the costs of service provision within a given year and for particular activities than does cash accounting.

Financial Statements

The Budget Papers contain four standard accounting statements-the operating statement, the balance sheet, the cash flow statement and the capital budget. These have parallels with the financial statements that commercial companies prepare. However, it should be noted that there are important differences between the budget accounting statements and those prepared by companies, and so caution should be exercised when drawing these parallels. Most obviously, 'revenue' in a business comes from the sale of goods and services whereas sales account for only a small proportion of much departmental revenue, the bulk coming from appropriations. Nevertheless, it may be useful to think of the operating statement as akin to the profit and loss statement of a business. A departmental balance sheet is akin to the balance sheet of a business. However, the difference between assets and liabilities in a company balance sheet represents shareholder equity, whereas 'equity' in departmental balance sheets is best though of as the 'residual interest in assets after deduction of liabilities'. The cash flow statement shows the source and disposition of cash during the year.

The balance sheet under accrual accounting provides a more 'realistic' reporting of privatisation. That's because revenue from the sale of assets is offset by a decline in the value of net public assets. For example, the sale of a financial asset (e.g. equity in a government corporation) results initially in an increase in cash holdings, which offsets the value of the investment (assuming that the sale proceeds equal the book value of the investment). The fall in the value of financial assets was not reported under the cash accounting system. If the proceeds of the sale are used to reduce public debt, there is an equal reduction in both assets and liabilities, with net equity unchanged.

Accrual Budgeting

Whereas accrual accounting measures the full cost of providing services within a given year, accrual budgeting provides the finances for that cost. Accrual budgeting thus 'aligns' the budget with departmental financial accounts prepared on an accrual accounting basis. Differences will arise in any one year between the funds appropriated under accrual budgeting and the cash departments spend. For example, funds will be appropriated to cover the cost of the depreciation of assets such as plant and equipment. However, these funds will only be spent as cash when the asset is replaced. In effect, accrual budgeting 'sets aside' funds for asset replacement. Similarly, the increase in superannuation obligations to public servants will be recognised as an expense incurred, and funds will be appropriated for that purpose, even though the cash payment of these obligations will not occur for future years. In some years therefore, cash outlays will exceed accruals outlays but in other years will be less.

Experience Elsewhere

Most OECD countries present their budgets in cash terms. While a number have shown interest in accrual accounting, this has been mainly in the context of ex post financial statements rather than for ex ante budgetary purposes. The Netherlands proposes to introduce accrual accounting and budgeting in all government services where it is deemed useful, but at the aggregate level, will continue the cash system of budgeting and reporting. The United Kingdom has indicated that it intends to move away from a purely cash basis of reporting. Only New Zealand and Iceland have adopted accrual budgeting for their whole-of-government financial statements and budgets. The experience of both countries is that accrual accounting has increased their focus on longer-term issues. For example, New Zealand values highways and other infrastructure, and includes them as assets in the balance sheet. This has led to increased attention to the management of these assets and their maintenance. Iceland's decision to include future civil service pension obligations as liabilities in the balance sheet has led to increased awareness of their implications.

The Australian States have produced, or are in the process of producing, accrual budgets. In New South Wales, under the provisions of the General Government Debt Elimination Act 1995, the 1998-99 Budget included for the first time, financial statements for each General Government Sector agency and for the Sector as a whole, prepared on an accrual accounting basis. In South Australia, the 1999-2000 Budget to be presented on 29 May 1999 will be the first to be presented in an accrual/output format. In Tasmania, the outcomes/output methodology was fully adopted for the 1996-97 Budget. In Western Australia, the 1997-98 Budget reported agencies' key outcomes and outputs, while the 1998-99 Budget linked outputs to outcomes, and output costs were presented on an accrual basis. In Queensland, the outcomes framework will be implemented from 1 July 1999.

Appropriation Bills

There are also three 'omnibus' bills which seek Parliamentary approval for a large number of appropriations. These are presented on Budget night and form the basis of the Budget debates in both Chambers. These are first, Appropriation Bill No. 1, which appropriates monies for the 'ordinary annual services' of the Government and for defence purposes. Ordinary annual services refer to recurrent services (e.g. running costs) and recurrent expenditures on already established activities. Appropriation Bill No. 2, appropriates monies for non-recurrent services, payments to the States (i.e. those not covered by special appropriations), and expenditures on new programs. The Appropriation (Parliamentary Departments) Bill has, since 1982-83, appropriated monies for the Parliamentary Departments. The allocation of items between Appropriation Bills 1 and 2 is largely unchanged under the new framework. However, amounts for asset replacement have been moved to Appropriation Bill  No. 1 while new capital acquisitions have been moved to Appropriation Bill No. 2.

Budget Presentation

Richard Webb

This article looks at some features of the new budget format from a user's perspective with a particular focus on the availability of information that Parliamentarians often seek.

The presentation of the 1999-2000 Budget Papers and associated documentation differs considerably from previous years because of the adoption of accrual accounting, and the move from the program structure to the outcomes and outputs framework. While implemented simultaneously, there is no necessary link between accrual accounting and the outcomes/output framework. Nonetheless, they share the goal of making government more accountable by increasing the transparency of departmental activities. The main two sources of information on the Budget remain the Budget Papers themselves and the Portfolio Budget Statements (PBS). The main features of the budget documents and the relationships among the Budget Papers and the Portfolio Budget Statements (PBS) are contained in the Guide to the Commonwealth Budget Papers 1999-2000. While Budget Paper No. 1 contains information at the aggregate level on portfolio activities, more detailed information at the portfolio and outcomes and outputs levels is mostly contained in Budget Papers Nos 2 and 4. They respectively contain information on budget measures (also contained in the PBS), and activities funded by Appropriation Bills Nos 1 and 2. The PBS also contain information on administered expenses which, on average, account for 75 per cent of expenses and are appropriated mainly under special (or standing) appropriations.

While providing information at the outcomes and outputs levels, the new format necessarily entails some loss of information. One is information on expenses on a functional basis. For example, it is not possible to derive spending for manufacturing industry as a whole as was contained previously in Budget Paper No. 1. A second example is where an agency pays for new computer equipment to be used agency-wide (i.e. across several outcomes). This has hitherto been identified separately but now cannot now be, as it is spread across different outcomes. Nor is it possible to identify separately the activities of particular organisations such as the Australian Geological Survey Organisation. Indeed, unless an agency has a separate appropriation, it is often difficult to find information on its activities, which are subsumed within the outcomes/output framework.

One of the major deficiencies of the new presentation relates to administered expenses. In the PBS, details of estimated expenses for 1998-99 are listed-including by the Acts under which special appropriations are paid-but no such listing is available for 1999-2000. Rather, the PBS show a total of estimated administered expenses. For example, DoFA's third outcome is an 'efficiently functioning Parliament'. The PBS contain details of estimated expenses for 1998-99 of $221.9 million. But the PBS do not contain similar information for 1999-2000; not even expenses incurred under six authorising Acts are shown. Rather, all that is shown is the estimated total of $221 million for 1999-2000. This lack of detailed information is a particular deficiency in the case of portfolios where administered expenses account for virtually all of their activities and spending.

The 1999-2000 Budget: its Public Policy Context

John Kain

This article is a synthesis of and commentary on some of the key public policy priorities and directions identified in the Budget Strategy. It is primarily concerned with the aggregate public finance parameters consistent with the nature of the Budget Strategy as set out in Budget Paper No. 1, Budget Strategy and Outlook 1999-2000.

The Economic Growth Objective

The 1999-2000 Budget maintains the Howard Government's long standing strategic objective of striving for maximum possible economic growth and the maximum possible rise in measured living standards taking account of key economic parameters bearing on growth, in particular, the rate of inflation and the size of the current account deficit (CAD). The achievement of such economic growth is seen as the key to further substantial reduction in the rate of unemployment.

The Budget implicitly recognises that some inflation is almost inevitable, if not desirable and that given existing private sector savings and investment patterns, a sizeable current account deficit is likely to remain a feature of Australia's economic outcomes for the foreseeable future. The Government's economic strategy outlined in the Budget emphasises that 'achieving the goals of strong economic growth and minimal inflation will require ongoing policy attention to ensure that inflation and current account pressures do not constrain the economy's capacity for growth. Policy must maintain discipline on inflation and public saving, consistent with the medium-term frameworks for monetary and fiscal policy, taking account of the need to maintain adequate demand growth'.(1)

Addressing the Current Account Deficit

How does the Budget address the current account deficit? In the past, a range of Government policy responses have been implemented in response to a growing CAD. At various times in the 1980s, the Commonwealth sought to dampen domestic demand as a means of easing the demand for imports which in turn would take the pressure off the CAD. But measures aimed at easing the level of activity in the domestic economy through increases in interest rates have tended to increase foreign capital inflow in response to the higher Australian interest rate regime.(2)

This Budget and the forward Budget Strategy does not seek to ease domestic demand across the board but rather, to focus on reducing public sector borrowing so that ultimately the CAD will reflect only private sector saving and investment decisions rather than government borrowing. This will require achieving the Government's medium term fiscal goal which it refers to as 'fiscal balance', on average, over the course of the economic cycle.

Implications of Achieving 'Fiscal Balance'

In practical terms, a fiscal balance strategy implies that relatively large surpluses are budgeted for in years of robust economic growth while in those parts of the economic cycle when economic growth is subdued or negative, budget surpluses may be more modest or that a budget deficit may be appropriate. This caveat on the continued attainment of budget surpluses is made quite clear in the Budget Strategy where it is stated that ' ... It [the 1999-2000 Budget] delivers on the Government's commitment to maintain budget surpluses while economic growth prospects remain sound' [italics added].(3)

Quite apart from containing the size of the CAD, the Government maintains that restoring the Commonwealth Budget to surplus has played a very important role in retaining the confidence of financial markets and in sustaining a low interest rates environment. The Budget Strategy also observes that improvements in the fiscal balance as a result of the Government's program of fiscal consolidation have been associated with increases in Commonwealth general government saving and public sector saving which have in turn helped maintain overall national saving during a period of declining private saving.

Nurturing Private Investment

The Budget Strategy suggests a rather benign attitude on the part of the Government towards the efficacy of private sector investment and savings decisions. Although the economic history of modern economic states often reveals instances where private investment decisions were not always soundly based or necessarily consistent with public national interest, the Budget Strategy implies a degree of confidence in private investment decisions-even where such decisions may increase the CAD and/or imply further downward pressure on government outlays in order to accommodate a higher level of private 'disssaving'.

The Budget Strategy suggests that in the contemporary Australian economy which is bearing the fruits of past structural reforms, the private sector is now in a better position to make well informed investment judgements; specifically it observes that:

And even where private investment decisions may cause a blow out in the CAD (if only because of the inadequacy of private sector saving levels) the resultant growth in Australia's external debt is not necessarily seen as a problem:

The Government's confidence in the efficacy of private sector investment decisions is repeated elsewhere in the Budget Strategy where it is implied that even where such investment can only be sustained by borrowing from foreigners, 'private investment should generally produce benefits in terms of higher future incomes that justify the costs of servicing external borrowing'.(6)

Notwithstanding this, it is apparent that the Government feels strongly motivated to contain the size of Australia's current account deficit as far as it can without adversely affecting the private sector. No doubt it is very much aware that the Asian countries that suffered most following the 1997 Asian all had high current account deficits. Yet Thailand, where the crisis first hit, was running government surpluses as were other badly affected Asian countries. The Australian Government has gone out of its way to insist that Australia is different, chiefly because reforms mean that the current account deficit better reflects private outcomes with full knowledge of the economic environment. Joseph Stiglitz, chief economist with the World Bank has challenged the view that more or better knowledge, reform etc. could have prevented the Asian crisis.(7) There is, however, some evidence that Australia's exchange rate arrangements and management have served to insulate Australia from the adverse consequences of occasionally high current account deficits.

Encouraging Private Savings

Nevertheless the Budget Strategy is mindful of Australia's relatively low level of overall national saving and that private saving levels (relative to GDP) having been declining in recent times. It observes however that:

Quite possibly this reflects the usual tendency for both public and private savings to move pro-cyclically. In short, the Government believes that if it leads the private sector by raising its savings levels, then the private sector is likely to 'follow by example'. It is not clear from the Budget Strategy as to what mechanisms would promote such a response from the private sector.

The Supplementary Fiscal Targets

The strategy outlines a number of Supplementary Fiscal Targets as follows:

• maintaining fiscal surpluses over the forward estimates period while economic growth prospects remain sound
• halving the ratio of Commonwealth general government net debt to GDP from almost 20 per cent in 1995-96 to 10 per cent by 2000-01
• directing sufficient resources to high priority areas, while significantly reducing the ratio of expenses to GDP through to the turn of the century
• no increase in the overall tax burden, and
• improving the Commonwealth's net assets position over the medium to long term.

It observes that substantial progress has already been achieved on the second and third of these targets, while tax revenue as a percentage of GDP has remained below the 1996-97 ratio.Of course the definition of what constitutes Commonwealth taxation revenue has a central bearing on this outcome, an issue which is discussed in some detail in the accompanying article in this publication, Economic Strategy Behind the 1999-2000 Budget.

What is particularly interesting in the context of the move to accrual reporting is the last-mentioned target, ie the goal of improving the Commonwealth's net assets position over the medium to longer term. Net assets refers to all the physical and financial assets and liabilities of the Commonwealth. The improvement in the Commonwealth's net assets from year-to-year would appear to be a new public policy objective which has been formally facilitated through the new financial accounting framework. In effect, the goal of improving the Commonwealth's net assets along with the goal of improving the Commonwealth's net debt position amounts to a strengthening in the Commonwealth's balance sheet. This in turn is seen by the Government as enhancing Australia's capacity to withstand economic shocks by reducing the adverse swings in financial market confidence.Critics of this rationale might point to the prospect that by 'taxing more than you need to', there will be an accumulation of public assets at the expense of private assets.

Improving the Commonwealth's Net Assets

Apart from the benefits of a strengthened Commonwealth balance sheet in terms of enhancing the national economy's capacity to withstand external economic shocks, the Budget Strategy outlines other sound reasons to keep tab of the Commonwealth's net assets position over time.

In particular, it notes that tracking the Commonwealth's net assets will provide:

In addition, it may be that a comprehensive assets tracking system at the Commonwealth level will assist in making more informed assessments of the public benefits and costs of undertaking public asset privatisation initiatives.

In this context, the Budget strategy refers to the expected improvement in the level of net assets as a percentage of GDP over the forward estimates period; this would arise in part from the proposed sale of the remainder of the Government's equity in Telstra. The Budget Strategy observes that in line with accounting standards, Telstra is currently recorded in the Commonwealth's balance sheet at book value, which is significantly below its expected market value. That is, the estimate of the Government's current net asset position is, in fact, distorted by this valuation issue. As Telstra is sold, however, this undervaluation is undone, contributing to the significant improvement in the measure of net assets.

Of course the book value of the Commonwealth's equity in Telstra is significantly below the market value of those shares. Contemporary accounting standards would only allow the Commonwealth to value its equity according to share price once the Commonwealth owned less than one half of the company.

This distortion introduced by what some economists would see as quite arbitrary accounting standards (essentially developed around private sector conventions and requirements) serves to highlight the potential shortfalls in the use of the net assets concept for public sector decision making purposes. It may well be that more appropriate public sector accounting standards may evolve over time to assist in making better informed public decisions.

Implications of the 'Fiscal Balance Objective'

A practical implication of this objective is that over the medium term the Commonwealth will withdraw from the capital market as a net borrower. In short, it would seem that in future, public investment outlays in any one year would be financed out of the Budget surpluses accruing in the year that the investment is undertaken (or otherwise within a very short time from when the public investment is undertaken).

This approach is quite at variance to long standing approaches to public investment where in the past, it has been accepted practice to undertake borrowings to finance capital works which will yield benefits not only in the year in question or to the current generation of taxpayers, but to future generations as well. Ideally, the period of repayment of such loans would roughly approximate the period over which taxpayers and the general public would benefit from the particular investment. Such approaches have been considered as appropriate and fair from an inter-generational point of view and is in accordance with commercial business practices as well.

The notion that governments should finance all of the public infrastructure requirement from currently generated budget surpluses would appear to be quite a radical departure from past Australian approaches to public investment; to the extent that other objectives dictate that governments will put a cap on the overall national tax burden (relative to GDP), the 'fiscal balance' approach would seem to dictate a very severe contraction in levels of public investment in the future. It would also imply that in future, public investment would onlybe undertaken within the permissible limits set by the 'fiscal balance' objective, regardless of the economic worth of potential capital works which cannot be accommodated because of the pre-determined fiscal limits.(10) Such a constraint on public investment could of course be overcome by providing appropriate machinery (e.g. tax concessions) for the private sector to undertake the investments instead. But of course such a transfer of investment responsibility would not of itself reduce national debt levels arising from infrastructure investment requirements - it simply transfers it from the public to the private sector. A related issue is whether or not the private sector will necessarily choose to take up such investment opportunities and, to the extent they do select such opportunities, whether the private sector will necessarily select the investments which yield the highest return to the community or accord with national (public interest) priorities.

The 'fiscal balance' approach also has some noteworthy inter-generational equity implications. For one thing, the current generation would not only be meeting the full costs of long term investments whose benefits stream will extend to future generations, but in addition the current generation will continue to bear the costs of investments undertaken by past generations, at least for the immediate future until all Commonwealth debt has been eliminated. This means that the present generation bears the transition costs of moving to the 'fiscal balance' approach.

Finally it should be noted that the 'fiscal balance' approach is not something which is intrinsic to accrual accounting; indeed, in some respects it would appear to be the antithesis of what might be expected under an accrual financial management approach. Certainly it does anything but mimic private business practice-indeed, if a private firm consciously determined that its investment strategies should be wholly funded by and limited to the size of current day profits, it would almost certainly have a very short life expectancy.

Concluding Comments: The Broader Public Policy Context of the Budget

Although the Budget Strategy is predominantly concerned with aggregate public finance considerations, the Government emphasises that it has been developed within a framework which takes into account its broader economic and social objectives. In this respect, the Government states that the Budget responds to the following broad priorities:

• delivering on its election commitments
• building a modern, fair and efficient taxation system
• promoting an economic climate conducive to high levels of sustainable economic and employment growth
• fulfilling Government social obligations through supplying essential public goods and services and providing a social safety net for those in need
• and ensuring that government resources are used as effectively and efficiently as possible.

The manner in which the Budget proposes to implement government measures responding to these priorities is the subject of further discussion and analysis in the following sections of this Budget Features brief. 

1. 'Budget Strategy and Outlook', Budget Paper No. 1, 1999-2000, p. 1-7.
2. Such measures also deterred actual investment which might have assisted in boosting net exports and delayed price adjustments that would otherwise have taken place through exchange rate changes.
3. 'Budget Strategy and Outlook', Budget Paper No. 1, 1999-2000, p. 1-15.
4. 'Budget Strategy and Outlook', Budget Paper No. 1, 1999-2000, p. 1-17.
5. 'Budget Strategy and Outlook', Budget Paper No. 1, 1999-2000, p. 1-8.
6. ibid., p. 1-16.
7. J. Furman and J. E. Stiglitz, 'Economic crises: Evidence and insights from East Asia,' Brookings Papers on Economic Activity, 1998, vol. 2, pp. 1-135.
8. ibid., p. 1-16.
9. ibid., p. 1-19.
10. Proponents of public investment might argue that a government that fails to ensure that investment is undertaken in projects with net economic welfare benefits could be seen as abrogating its responsibility for promoting growth and rising living standards

Economic Strategy Behind the 1999-2000 Budget

David Richardson

The 1999-2000 Budget provides for a solid surplus of revenues over 'expenses' (the new term for 'outlays'). Future projections are discussed as well as how they are affected by fiscal policy, including those government plans that may not be achieved. The general state of the economy is also discussed as well a closer look at two particular topics, the savings behaviour of households and the current account deficit on the balance of payments.

Introduction

Underlying the 1999-2000 Budget are the Government's plans for a goods and services tax (GST) and the proposed sale of the government's remaining share in Telstra. While doubts have emerged that these will now be achieved in their entirety and, in that case, some of the current budget figuring is going to have to be altered, this article is written assuming the Government manages to achieve its plans.

Main Features

This Budget provides for a surplus of $5.4 billion in 1999-2000, or 0.9 per cent of Gross Domestic Product (GDP), following an estimated surplus of $3.1 billion in 1998-99, or 0.5 per cent of GDP. In future years the surplus is forecast to reach $7.2 billion in 2000-01 and $5.2 billion in 2001-02. That keeps the surplus hovering around one per cent of GDP for the next few years. Behind these estimates are a forecast growth rate of 3 per cent in 1999-2000 and a projected growth rate of 3.5 per cent in 2000-01 and thereafter. Note that for 2000-01 and beyond the projected 3.5 per cent growth rate is chosen because it represents Australia's historic average. In this sense there are no real estimates after 1999-2000, just projections that do not reflect any assessment of likely economic conditions at that time.

In 1997-98 Commonwealth revenues were 26.2 per cent of GDP. Revenues are estimated to fall slightly to 25.9 per cent of GDP in 1998-99 and 25.3 per cent in 1999-2000. With the new budget reporting formats we are no longer able to look at precisely where the estimates differ from the forecasts made at the time of the last budget. However, the differences appear to be dominated by 'parameter variations' or the effects of higher than expected economic growth. This has shown up in higher individual and other income taxes. On the outlays side unemployment numbers were lower than expected while the lower than expected inflation meant savings in expected adjustments to pensions and benefits. Expenses (formerly 'outlays' on a cash only basis) were 27.4 per cent of GDP in 1997-98 falling to 25.4 per cent estimated for 1998-99 and virtually remaining constant at 25.3 per cent of GDP in 1999-2000.

In 2000-01 revenue is projected to drop suddenly form 26.3 per cent of GDP to a projected 22.9 per cent of GDP. Likewise expenses fall from 25.3 per cent of GDP to 21.9 per cent of GDP. This reflects the effects of the change in mixes of taxes and payments to the States and Territories following the GST which is planned to be introduced on 1 July 2000. In 2000-01 the Commonwealth expects to collect GST worth $27.409 billion and make matching payments to the States and Territories. The Budget Papers record the GST receipts but also nullify the effect of the GST by recording an equal 'negative tax' being the 'transfers to the States and Territories in relation to GST revenue.' In this way the GST revenue and the matching outlays are removed from the aggregates. This is justified in the following terms:

The effect of adding back the GST to revenues is to increase revenue to 27.1 per cent in 2000-01, up from 26.3 per cent in 1999-2000. Adding back the payments to the States and Territories increases expenses to 26.1 per cent of GDP in 2000-01, up from 25.3 per cent in 1999-00. Depending on one's judgement of the issues involved there is a great difference in the perceptions of the Budget. Either revenues and outlays are still on a downward trend as a share of GDP if we exclude the GST or they have reversed the trend and are increasing with the GST in the measures.

Fiscal Policy

Some commentators have said that there is too much stimulus in the Budget while others have congratulated the Government for producing surpluses. Here we show how those two apparently conflicting views can both be correct. This is done by decomposing the 1999-2000 budget fiscal balance estimates into the components due to policy changes and the components due to parameter changes. In this way we can also examine how the fiscal balance would have behaved in the future without any policy changes since the last budget.

Table 1: Budget Estimates-the Effects of Policy and Parameter Changes

There are some major features that stand out in table 1. First, there is a powerful fiscal stimulus associated with the policy changes since the 1998-99 Budget. This is shown in the line of negative figures in the row for 'total policy changes'. A stimulus of $871 million in 1998-99 rises to $6920 million in 2001-02. The second main feature is the 1999-2000 surplus figure in which the stimulus just mentioned is more than offset by parameter changes, mainly stronger than expected economic growth resulting in higher tax receipts and lower social security payments. Without that the 1999-2000 surplus would almost disappear.

The final row in table 1 gives the no policy change estimates of the fiscal balance. This row shows that were it not for the decisions in, and leading up to, the 1999-2000 Budget Australia was set to produce very substantial surpluses in future years.

Economic Context

Since 1991-92 growth has been consistently above 3 per cent but has stayed below 5 per cent (on a year on year basis). Despite the Asian crisis in the September quarter 1997, growth in every quarter since then has remained above 4 per cent on an annualised basis. Consistent with economic growth, employment has been growing while unemployment has been on a strong downward trend since the early 1990s. The growth performance has permitted unemployment to fall from an annual average of 11.0 per cent in 1992-93 to 7.4 per cent for March 1999. Total employment increased from an annual figure of 7.634 million in 1992-93 to 8.703 million in March 1999. The US economy has been referred to as the 'Goldilocks economy', because it is not growing too strongly, or too slowly, its just right. Australia could also be said to be enjoying Goldilocks growth.

There are some notable features of the last two years. First, GDP growth has been particularly strong but the bulk of that growth came from consumption expenditure, especially private consumption but also government consumption expenditures in the most recent period. The strength of private consumption is also reflected in new low levels of household savings at 1.3 per cent for the December 1998 quarter.

By contrast with consumption, capital formation has slowed down and is contributing almost nothing to growth. The other noteworthy feature of the table is the contribution of the external sector. Exports have had a positive impact taking the two years together. This is significant given that they are only around 20 per cent of GDP. It is likely that the reduction in the value of the $A has stimulated some additional export activity. However, it is also possible that the increase reflects higher mineral exports from new facilities that are now coming on stream but reflect decisions made when commodity prices were much higher.

In real terms the export sector has been a source of growth, however, that is offset by the increase in imports that tends to detract from growth. (Growth would have been higher had the spending been directed at local goods and services.) The negative entry for imports in Table 2 indicates that an increase in Australian spending has gone on imports and so detracted from GDP growth in Australia.

The following table looks at the contributions to growth over the last two calendar years.

Table 2: Contributions to Growth: Selected Items, % change

Outlook

For the last couple of years Treasury has been forecasting slowdowns in the economy, but more gentle slowdowns than forecast by the private sector. According to the latter we should have experienced a severe decline in GDP growth and significantly higher unemployment. For example, the last Budget forecast GDP growth of three per cent for 1998-99. That compares with the estimated outcome of 4.25 per cent. At the time of last year's Budget forecasts, ratings agency Standard and Poor's pointed out that the Government's forecasts were higher than those of most financial market economists and that the Government's 'forecasts remain at the more optimistic end of the general range of expectations amongst economic forecasters.'(2) As it has happened, while Treasury's estimates have erred on the under side, its performance has been much better than the private forecasts. This year the Treasury has again forecast growth of three per cent only this time the private forecasters seem to have converged around Treasury's estimates. Chris Caton, chief economist with Bankers Trust, is reported to have said 'private sector economists should disagree with Treasury forecasts at their own peril. Last year there were mumblings about their forecasts being too high, but they turned out more accurate than most.'(3) For what it is worth the April National Australia Bank survey of business continues to show a strong economy with strong sales and profits.(4) Likewise, the latest Westpac/Melbourne Institute index of consumer sentiment rose 1.7 per cent in April suggesting a very positive outlook for consumer spending in particular.

Based on past experience more than 3 per cent growth is required to make serious inroads into unemployment. The 4.25 per cent growth for 1998-99 meant 2.25 per cent employment growth that was consistent with unemployment falling from 8.3 to 7.75 per cent (June to June). This is not a strong conversion of growth into reductions in unemployment, mainly because of the 2 per cent productivity growth. In 1997-98 the conversion was even worse when 4.6 per cent growth produced 1.4 per cent employment growth and unemployment only fell from 8.7 to 8.3 per cent. In that year productivity growth was 3.2 per cent.

This year's three per cent growth forecast is forecast to produce an employment increase of 1.75 per cent which is, by recent standards, a very good rate of conversion of growth into employment. It assumes productivity growth of only 1.25 per cent. Unfortunately the forecast rate of employment growth is not enough to lift unemployment above present levels and an unemployment rate of 7.5 is forecast for June 2000. For the moment though there are still positive signs for employment/unemployment. On the day the Budget was delivered, the latest ANZ job survey figures were also released showing job vacancies up 1.6 per cent for the month to the best levels since the 1990s recession. Saul Eslake, the ANZ chief economist, has said that the growth in vacancies was enough to reduce unemployment to 7.25 per cent by July.(5)

On the inflation front, over the last couple of years we have consistently come in below the Reserve Bank's (RBA) inflation target of two to three per cent. Now Treasury is forecasting that inflation will move into the RBA's target range with a year average CPI increase of 2 per cent and 2.25 June to June. Part of the reason for the upward movement in inflation is the fall in productivity that is supposed to prevent higher unemployment. However, the expected fall in productivity means that more of each wage increase is translated into per unit cost increases for price setters. The best outcome would again be that Treasury has underestimated growth so that it comes in sufficiently high to maintain a low inflation economy but with jobs growth out pacing the growth in the labour force.

Over recent years Australia has shared in the low inflation high growth economy enjoyed by the US. There are signs that the low inflation part of the equation may be coming to an end in the US. On Friday 14 May the US consumer price index was published and showed inflation was 0.7 per cent in April 1999 following a 0.2 per cent increase in March (the US inflation figures are published monthly rather than quarterly as in Australia). The 'core' inflation measure that leaves out food and energy costs also rose from 0.1 per cent to 0.4 per cent. The markets are now worried that these are the first signs that inflation is back as a serious issue.(6) So far the increase in inflation seems to be mainly associated with higher oil and other commodity prices. As a result of the latter the Australian share market has seen a substantial increase in the value of resource stocks. Since we have followed the US lead in recent times the present experience must be a concern.

Consumption and Savings

Private consumption is 59 per cent of income (1997-98 figure) so its behaviour is the dominant influence on the state of the economy as a whole. Treasury forecasts household consumption to increase by 3.75 per cent in 1999-00 which underpins the three per cent growth in GDP. The importance of capital gains for consumption expenditures was mentioned earlier. The Reserve Bank also notes the importance of new financial instruments such as home equity lines of credit that enable consumers to have greater access to their own wealth through borrowing against the home.(7) Clyde Cameron, when talking about capital gains taxation, once said 'you can't eat your capital accretions.' The banks may have found a way to let their customers do almost that. Certainly customers are now able to more finely tune their desired debt equity ratios. Whatever the reason, consumption expenditures have held up very well.

Strong growth in consumption implies falling levels of savings and we do indeed find that household savings are now down to new lows at 1.3 per cent of household disposable income.(8) Household savings in the US have just turned negative for the first time. This does not mean people are necessarily spending more than they are earning. They are likely to be spending out of their capital gains which do not show up in the national accounts. That is also likely to be the case in Australia. Profits from the property and share market, including on the Telstra float and the AMP demutualisation, are financing consumption expenditures.

Household disposable income does not include accretions in wealth through the capital gains that have been implicated in the healthy consumption expenditures. In 1997-98 household gross income was $491.975 billion (ABS cat no 5206.0). over the same period the total assets of the household sector grew by $162 billion from $2044.6 billion to $2206.6 billion(9). Adding in capital gains implies savings rates of around 26 per cent.

At 26 per cent the savings rate out of income plus capital gains appears to be a healthy savings effort on the part of households. If we re-work savings rates for the total economy by adjusting for capital gains then gross savings increases from 19.9 per cent of GDP to 37.4 per cent of the expanded definition of income.(10) Such figures appear to put us in the ranks of countries such as Hong Kong, Singapore and Japan. However, while showing the effect of adding in capital gains helps to rationalise Australia's otherwise low savings rate, it does not really provide much comfort. As traditionally measured in the national accounts the concept of savings indicates the ability to provide resources for investment out of current production. Capital gains cannot provide any real production potential that might be allocated towards the investment effort. By contrast savings out of income, or more correctly, the difference between income and consumption, does genuinely free productive effort for use in making capital goods (or exports that might be exchanged for capital goods).

If we were to suddenly increase the level of savings there would necessarily be a simultaneous reduction in consumption expenditures. That would free up resources that might be applied in making capital goods. However, the problem for macroeconomic management is that the reduction in consumption is likely to cause a fall in sales leading to a fall in production and so lower incomes. The resources freed for use in making capital goods may simply be wasted in idleness. We certainly know that a lower level of consumption over the last few years would not have given us the jobs growth we did in fact experience. Hence for policy purposes we have to regard the issue of savings as double edged sword. As a long term strategy it is desirable to increase the savings/investment levels. On the other hand, going about it in the wrong way puts current economic prosperity at risk.

Current Account Deficit

The Treasurer has made the point many times that the budget deficit is linked to the current account deficit (CAD)on the balance of payments. As Treasurer, Hon. P. Costello, said to the Press Club the day after the Budget:

It therefore appears policy is based on the belief that there is a direct link between domestic savings, including the budget surplus, and the CAD with cause and effect running from savings to the balance of payments. This of course harks back to the old twin deficit thesis that said that an increase in the budget surplus produces an equivalent improvement in the deficit on the CAD.

When we turn to Budget Statement No 2: Economic Outlook there is an important section called 'net exports and the current account balance.' This section discusses the various influences on the current account balance-the Asian crisis, commodity prices, the Australian demand for imports and so on. Obviously all of those factors are important. Interestingly there is not one word about the influence of the budget balance or total Australian savings on the CAD. From a policy perspective this is extremely important.

Let us accept that the section on net exports and the CAD is an accurate diagnosis of the problems. There is a case for sitting out the commodity downturn and waiting for the world recovery that would restore the current account balance back to more normal levels. In addition it would appear that initiatives from the industry and trade ministers could contribute towards reducing the current account deficit. In other words, to address these balance of payments issues, policy should address the structural factors that lie behind the items that go to make up the balance of payments.

Increases in the budget surplus are analogous to increasing household savings. The previous section showed that an increase in savings/reduction in consumption may reduce income and employment. Higher budget surpluses may reduce the CAD, but that really only follows if the effect of the budget surplus is to reduce economic activity which in turn lowers imports (and encourages Australian producers to sell product in overseas markets).

1. Budget Strategy and Outlook, 1999-2000: Budget Paper No 1, p. 4-12.
2. The Australian Financial Review, 15 May 1998.
3. ibid., 13 May 1999.
4. ibid., 11 May 1999.
5. Ibid., 11 May 1999.
6. BBC News, 14 May 1999, at http://www.bbc.co.uk
7. Reserve Bank of Australia, Semi-Annual Statement on Monetary Policy, May 1999.
8. ABS, Australian National Accounts: National Income, Expenditure and Product, Cat No 5206.0, December Quarter 1998, 3 March 1998. The figure in the text is a trend estimate. The seasonally adjusted figure for the December Quarter is actually 0.8 per cent.
9. ABS, Australian National Accounts National Balance Sheet, Cat No 5241.0.40.001, 1997-98, 28 April 1999.
10. Capital gains estimates are based on the increase in total assets between June 1997 and 1998. Now this figure, the difference between the two totals, will be equal to capital gains plus net savings. Since net savings is already included in the gross savings figure given in the text, it is deducted from gross savings so as to avoid double counting in presenting the final figure for savings.
11. Hon. P. Costello, Address to the National Press Club, Wednesday 12 May 1999, Transcript No. 99/38.

Government Surpluses and Debt

David Richardson

This article addresses some of the issues that arise out of the large government surplus budgeted for 1999-2000 and projected into future years. Part of the Government's objective is to reduce net government debt to zero when the planned sale of Telstra is included. Fairly soon, when there is no more debt that can be retired, the Government may have to address the issue of how to invest the surplus (the opposite of how to fund a deficit). That prospect raises important issues.

Introduction

An important part of the fiscal objective under the Howard Government has been the achievement and maintenance of a budget surplus. In the present financial year, 1998-99 the surplus should come in at $3.1 billion or 0.5 per cent of Gross Domestic Product (GDP). The estimate for 1999-2000 is a surplus of $5.4 billion or 0.9 per cent of GDP. In cash terms and taking asset sales into consideration, the headline cash balance is a surplus of $8.4 billion in 1998-99 rising to $23.0 billion in 1999-2000.

To the extent that there has been any criticism of the surpluses, it has related to using them to fund reductions in overall tax burdens on the one hand or the potential for using the surplus in the interests of particular lobby groups on the other. There has not been much discussion of the intrinsic merit in running surpluses. Government surpluses raise two main issues that need to be addressed:

• How should governments use the funds they accumulate as a result of running surpluses?
• Should governments raise more in taxes than they need to spend on providing government surpluses?

The Budget Papers are ambiguous on the long-term aim of fiscal balance versus surpluses. Instead the objective of achieving budget surpluses is put in terms of Australia's present position in the economic cycle. The Budget Papers say:

This passage suggests that over the cycle the intention is to err on the side of achieving surpluses rather than balance. It is likely that the size of the surplus will be taken by the markets and the media as an indication of the Government's commitment to fiscal discipline. Markets are likely to applaud surpluses and decry any movements towards deficits. The alternative objective is to aim for fiscal balance on average over the economic cycle.

We begin by examining how the government debt is likely to behave in the foreseeable future.

Commonwealth Debt

Government surpluses are seen as a valuable measure to increase national savings as well as retire outstanding government debt. This was one of the main stated objectives of the Government. In his Budget speech the Treasurer, Hon. P. Costello, foreshadowed that by the year 2002-03 the Commonwealth Government should be debt free.(2) The Treasurer said:

The following table gives the estimates for the level of outstanding Commonwealth debt over coming years.

Table 1: Commonwealth Debt

The numbers reported in the second column of the table clearly show the quick reduction in debt that is expected to occur in the next five years.

The reduction in net debt includes the debt retired as a result of the planned sale of the remaining Commonwealth shareholding in Telstra. The published figures are not sufficiently transparent to provide an estimate of how much the debt reduction is expected to result from the reduction of the surplus compared with the proposed sale of Telstra. (It is not possible, either, to find in the Budget Papers for this and earlier years the actual proceeds of the one-third sale of Telstra that has already taken place.) What we do know is that at current market prices, the remaining 8.577 billion shares in Telstra would be worth around $64 billion (based on 12 May closing prices and allowing for a five per cent selling cost.). By the time any sale could take place it would more than wipe out the remaining Commonwealth debt on present values.

Table 1 above the final column provides an estimate of the debt that would be outstanding if debt were to be reduced by the cash surplus alone. Allowances have to be made for the difference between accrual and cash accounting and various other complications. Bearing those in mind the table above would suggest that the Budget Papers are likely to be factoring in estimates for selling Telstra at about $50 billion spread over the next few years. To state the obvious, the pattern of debt would look markedly different if the Government were not able to sell Telstra.

Paradoxically, as debt is trending towards zero, the 1999-2000 Budget makes provision for the establishment of the proposed Australian Office of Financial Management (AOFM). This is intended to be a specialist agency that 'will significantly enhance the Commonwealth's capacity to manage its net debt portfolio, offering the prospect of savings in debt service costs and an improvement in balance sheet net worth over time.'(4)

The reason for this is that it is envisaged that the government bonds on issue will not be reduced to the full extent warranted by the projected surpluses. Instead the Budget Papers say:

Among other things the Government is saying that the financial markets need to have a good quantity of government bonds on issue. Government bonds are the best and most risk-free financial security in the market and it is these that the market uses as the benchmarks against which other financial assets are judged. It is important for the smooth operation of the financial markets that there continues to be a good depth in government securities of various maturity structures.

This must mean that the funds flowing into the government as a result of the surpluses will be used to invest in other financial assets instead of retiring government debt as is the intention expressed in the Budget Papers. 'Retiring debt' should be thought of in a net sense when it is mentioned by government officials.

In a lot of the commentary it seems to be taken as an article of faith that lower government debt is an unambiguously bad thing. Government debt can be a useful devise for financing large project/s so that some of the burden of the cost of the projects is borne by later generations that benefit from them. However, most of Australia's current debt has accumulated over the early 1980s and early 1990s when the economy needed the fiscal stimulus implied by government deficits-even if that only amounted the automatic stabilising effects resulting from the tendency towards deficits in recessions. It would have been very painful if we had tried to keep the budget in balance during these periods and the result may have been to push the economy further into recession. Carrying debt is a natural consequence of wanting to smooth out fluctuations in the business cycle. The average level of debt over the cycle is going to reflect, among other things, the extent to which the economy has required fiscal pump priming.

It is useful to compare Australia's position with some of the other main industrial countries. The following table pulls together figures for countries' fiscal balances and their net government debt.

Table 2: Fiscal Balance and Net Debt in Australia and Selected Industrial Countries.