23 March 1999
Mr Jack Simos
Policy Director
Office of the Leader of the Opposition
Parliament House
Macquarie St
SYDNEY 2000

Dear Mr Simos

I refer to your letter of 22 March 1999 requesting my analysis of the Coalition’s budget strategy for the period 1999-2000 to 2002-03 on various bases set out in your letter. You provided me with a large amount of supporting material, including spending commitments made by the Coalition and costings by the NSW Treasury.

I note that the Coalition takes as a starting point the Government’s estimates from the 1998-99 Half-Yearly Budget Review February 1999 published by the Treasurer and, in particular, Table 3.2. You have provided a table, Comparison of Budget Strategies --Coalition vs Labor, which in my view accurately summarises the effect on those estimates of the alternative policies proposed by the Coalition.

In the table attached to this letter ("comparative table") I have compared the main items in the strategies of the Government and the Coalition up to 2001-02 (I have not gone to 2002-03 because there are no forward estimates for that year). In my comments below I draw on this table and on my analysis of 14 March of the Government’s forward estimates.

First, while the Government’s forecast increase in tax revenues appears somewhat conservative, that is probably appropriate given the considerable uncertainties which the Australian economy faces as a result of the Asian crisis and the continued fall in commodity prices. Further, ABS data on State Final Demand for the December Quarter of 1998 released on 12 March suggest that, while growth continued strongly in Victoria and Queensland, the NSW economy may already have peaked and have commenced a cyclical slowdown. The large fall in housing commencements during that quarter, as announced last Friday, and the slowing in growth of employment in the last three months to only 0.3 per cent compared with the previous three, add weight to that perspective.

One cannot help wondering if the high rates of NSW taxes have started to impact at the margin - perhaps the State is experiencing a sort of reverse Laffer curve effect. Whatever, the downward revision (compared with budget time) in the Government’s forecast of growth in the NSW economy and in NSW employment over the next three years appears to provide an appropriate underlying basis for the forward estimates. (Notwithstanding that the NSW unemployment rate is currently at 6.7 per cent, it does, however, raise a question mark over the forecast improvement to 7 per cent, from 7.5 per cent at Budget time, in the average unemployment rate over that three years. Changes in unemployment , of course, lag behind changes in demand).

Second, it is difficult to accept as realistic the Government’s estimate that there would be virtually no increase in current outlays excluding interest between the current year and 2001-02. Of course, as the latest Grants Commission report shows, NSW is spending well above average in a number of areas and there appears scope to achieve significant savings by improved efficiency in service delivery and/or changes in policy. However, the estimates are compiled on a no policy change basis and that cannot be the reason for the low estimate.

It follows that the Coalition is justified in making some allowance for both savings through improved efficiency and for making new spending commitments. The savings proposed to be achieved by the Coalition are partly based on assessments in Reports by the Council on the Cost of Government, which suggest scope for some significant savings, as well as Auditor General Reports. The Coalition has conservatively estimated potential for savings of $557 million pa in a full year but has included a smaller allowance than this in its strategy. Taking account also of the Grants Commission’s analysis, I see no difficulty in the Coalition finding the efficiency savings it proposes, which are equivalent to an average of about 1.5 per cent of total current spending over the next three years.

As to the savings of interest (net of dividends and tax equivalent payments) from the electricity industry privatisation, the Coalition has not adopted the Treasury figures included in the forward estimates. I understand that the main reason for this is that the Coalition believes that the Treasury’s estimate of dividends forgone is too high particularly given that retail competition is scheduled to commence from January 2001. While I acknowledge that there is logic behind this view, and while I note that the Coalition’s estimated savings are consistent with Treasurer Egan’s earlier claims that net savings would be $500-700 million per annum, it may have been more conservative to stick with the Treasury’s figures.

On the expenditure side, NSW Treasury has substantiated about 90 per cent of the Coalition’s recurrent and capital commitments and the estimates included in your summary alternative budget reflect those costings. I see no reason to question any of these costings and the cost of the remaining 10 per cent of commitments appears mostly to reflect announcements of amounts of spending.

While I am somewhat concerned at the extent of the additional current spending commitments, the comparative table attached indicates that, after allowing for savings, the rate of increase in Coalition current spending excluding interest and superannuation between the current year and 2001-02 would be about 2.2 per cent pa. Bearing in mind that the estimate is coming off the excessively high base established under the present Government, that should allow for the provision of services to cope with population growth and, with offsetting productivity improvements, cost increases. However, given the evident and urgent need for NSW to reduce taxes (which I am pleased to see has been endorsed by the Shadow Treasurer), it will be important for the Coalition to make as much room as possible for effecting such reductions by strictly limiting further new spending when in Government.

Third, the Coalition has also made substantial additional capital spending commitments. However, with one important exception, these commitments can all be financed from the unallocated capital works funds revealed in the Treasurer’s statement of 15 March 1999 ("Govt Commitments To Add Less Than 1% To Budget Costs"). That is, they do not add to the forward estimates of capital outlays, which continue the declining trend (relative to State GSP) established under the Government.

The exception is the $2.6 billion customer "dividend" which the Coalition proposes to pay to electricity account holders in 2000-01 as part of its plan to privatise the electricity industry. This proposal is consistent with my advice last year that, if there were "surplus" proceeds available from privatisation after eliminating government debt, one appropriate option would be to provide NSW residents with a return of some of their capital. (I find it surprising that some sections of the media have questioned the intrinsic merits of such a strategy). Accordingly, while my understanding is that the Australian Bureau of Statistics GFS accounting procedures will treat this dividend as an outlay "above the line" but will treat the proceeds of electricity sales as a receipt "below the line", the estimated Budget deficit that results in 2000-01 is appropriately converted to an adjusted Budget surplus on the basis that it is a one-off that does not affect the underlying budgetary position. This adjustment is similar to the one being made by the Government in 1998-99 to take account of the one-off payment of $3,268 million in relation to the superannuation conversion offer.

This brings me, fourthly, to the estimated Budget results. The Government’s Half-Yearly estimates reflect its oft stated objective (but one which has yet to be achieved) of reaching a sustainable adjusted surplus. As my note of 14 March pointed out, given the Government’s high spending proclivities (about which Premier Carr boasted at the time of the last election), and the low forward estimate of current spending on a no policy change basis, the surpluses which it has projected have no credibility. Treasurer Egan has indeed already announced (on 15 March) additional current spending which reduces the projected Half-Yearly total surplus for the next three years from $1409 million to $1070 million and has indicated that this will be further reduced by election day.

The Coalition’s estimates also project adjusted surpluses and it might equally be argued that its capacity to sustain such surpluses is yet to be tested. As indicated, it will be vital for the Coalition to exercise strict control over spending once in government. Even so, the achievement of sustainable surpluses is less important for the Coalition given that the electricity privatisation plan will eliminate general government sector debt by 2000-01. The fact that the Coalition is projecting surpluses over the next three years which total $158 million less than the Government’s current projections is therefore of no concern in this context. Indeed, once government debt has been paid off the case for running cash (as distinct from operating) surpluses disappears.

Fifthly, the Coaltion has estimated that its Energy Reform Plan involving the sale of the electricity industry will yield about $25 billion or $23.8 billion net of workers packages and residential pricing concessions. This is based on the estimate made by Deutsche Morgan Grenfell in the Hogg Report of August 1997, which recommended to the Government that privatisation of the industry was an "absolute necessity." While the electricity industry has become somewhat more competitive since that report, the fact that the much smaller Victorian electricity industry has yielded about $21 billion suggests that the $25 billion estimate should readily be achievable.

The Coalition’s summary table Comparison of Budget Strategies shows all the net proceeds of the electricity sales "below the line" under "Advances (net)". This is consistent with the ABS’ handling under GFS procedures, which can be expected to accept that the net proceeds of such equity sales are effectively a return "advance" to the "owner", which for this purpose is the general government sector. Similarly, although the summary table contains an item "Reduction in Debt (net)" which is not used by the ABS, that item in fact corresponds to the ABS’ "Borrowing and advances received (net)" and is the same in concept.

Of course, the rate at which general government sector debt per se is reduced will depend, inter alia, on the timing of maturities and market availability and some of the proceeds will need to be invested for a time (some will in any event be set aside in the Millenium Fund). However, such investments still represent a reduction in net debt.

Overall, therefore, my analysis suggests that the Coalition’s Budget strategy is both responsible and coherent. Over the next three years, the Coalition’s proposals involve only fractionally higher current and capital expenditure (excluding the customer dividend), and fractionally lower surpluses, than the latest estimates by the Government, whose record suggests that its current spending and surpluses estimates are not credible. Moreover, the Coalition’s proposals need to be seen against the background of its plan to privatise the electricity industry and to use the proceeds to eliminate government debt. In those circumstances the need to run cash surpluses will progressively diminish over the next three years and, indeed, by end 2000-01 it will no longer exist.

I should add that, in my view, the proposal to privatise the NSW electricity industry is very much in the interests of NSW residents and an essential component in improving the capacity of the NSW economy to compete in an Australia (and a world) where the efficiency of infrastructure is a vital element in attracting investment. It is now widely recognised that the private sector generally operates such infrastructure assets more efficiently, provides better service and is more innovative. Thus, contrary to some perceptions, the sale of public assets does not involve a "loss" to the community but a gain: the assets work better. That is why more than 15,000 privatisations have occurred world-wide in recent years.

Another essential component in improving the competitiveness of the NSW economy is to reduce NSW taxes from the high and uncompetitive level which they have reached and which I highlighted in my analysis of 14 March. I would like to have seen some more specific proposals from the Coalition in this regard. I hope that it is a matter that the Coalition will address at an early date when in Government.

Finally, let me say that I applaud the Coalition’s decision to make fully transparent its alternative Budget strategy. One can only express the hope that the media will be responsible enough to recognise this and to undertake a serious and substantive comparison of the two strategies.

Yours sincerely

Des Moore

^Excluding one-off payment of $3,268 million relating to the supernation conversion offer.

*Half-yearly review figures amended to take account of the Treasurers's Statement of 15 March outlining additional Government commitments. Assumes no additional commitments after 15 March. Note that the increase of 6.9 per cent is equivalent to an average increase of 2.3 per cent pa in current -spending excluding interest and super over the three years from 1998-99 and 2001-02. This compares with the average increase of 5.7 per cent pa over the four years 1994-95 to 1999. If current spending were to increase at 5.7 per cent pa from 1998-99 to 2001-01 it would be $3.9 billion higher than estimated in 2001-02

#Takes Half-Yearly review as the starting point, adds new spending commitments after allowing for available unallocated capital works funds, and deducts savings in net interest and other items.

~Excluding one-off customer dividend of $2.6 billion.

+The Half-Yearly Review (page 9) estimates general government sector net debt (excluding temporary borrowings to fund the superannuation conversion offer) at $13,263 million at end June 1999. Under government estimates further reductions in net debt (including temporary borrowing) would largely reflect the projected budget surpluses estimated in the Half-Yearly Review, amended as above.

@Under Coalition proposals the reductions in general government sector net debt would reflect estimated budget surpluses plus the proceeds of electricity sales net of amounts required to pay off electricity debt and to finance workers' packages and residential pricing concessions, making the general government sector a net creditor by end June 2000. In practice some of these proceeds would be invested either in the Millenium Fund or in short term investments awaiting the redemption of debt. Such investments count as a reduction in net debt.