Fairness, Opportunity and Security. Policy Series edited by Michael Keating and John Menadue.

We began a series of articles on important policy issues on Pearls and Irritations on 11 May.  There will be over forty articles on sixteen policy areas from over thirty contributors. The series will run for four to five weeks. Policy articles will be about 2000 words each. They are linked to the contributor’s name (below) as they are posted.

Already posted – 11-23 May.

Introduction. Ken Henry
Democratic Renewal
.  Vested interests (John Menadue 2),
.  Loss of trust (John Menadue 1),
.  Post majoritarian future. (Ian Marsh 1),
.  Policy-making practice. (Ian Marsh 2)

The role of government
.  The importance of values. (John Menadue),
.  Role and responsibilities of government. (Michael Keating),
.  Role of government. Ian McAuley)

Foreign Policy
.  Security in the region. (Stephen Fitzgerald),
.  Australian foreign policy (Cavan Hogue),
.  An independent Australian foreign policy. (Richard Butler),
.  What Australia’s foreign policy should look like. (Stuart Harris),
.  Australia, the US and Asia. John McCarthy.
The Economy
.  Fixing the budget (Michael Keating 1, Michael Keating 2)
.  Taxation Reform (Michael Keating)
.  Federalism (Michael Keating, John Menadue)
.  Job Creation and Participation  (Michael Keating)
.  Productivity (Michael Keating)
.  Transport and Infrastructure (Michael Keating and Luke Fraser)
Retirement incomes
.  
A fair, effective and sustainable system. (Andrew Podger)

To be posted from 25 May

Health (John Menadue, Jim McGinty, Jennifer Doggett)
Population/migration/refugees (John Menadue, Peter Hughes, Arja Keski-Nummi)
Communications and the Arts (Kim Williams {Arts}, Terry Flew {Media Regulation in Internet World}, Julianne Shultz {Cultural Identity}, Rob Nicholls {NBN})

Environment and climate change (Ross Garnaut, Peter Cosier, Brendan Mackay)
Indigenous affairs (Fred Chaney, Michael Gracey)
Welfare and Families (Andrew Podger, Peter Whiteford)
Inequality (Peter Whiteford, Michael Keating, Ian McAuley)

Development of our human capital in the fields of education, science, innovation, research and development (Glenn Withers, Chris Bonnor {Schools}, Glenn Withers {Universities})
Security, both military and soft power (Michael Wesley)

Internal security and freedom (Spencer Zifcak {Human Rights Act/Charter}, Susan Ryan)

Media enquiries. Please contact johnmenadue@johnmenadue.com.

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Michael Keating, Luke Fraser. Infrastructure: Improvement or Impoverishment?

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

To paraphrase Paul Keating, right now every galah in the pet shop seems to favour more infrastructure spending. The current Prime Minister wants ‘to be remembered as a Prime Minister who built the roads of the 21st century’. The business community is similarly demanding more infrastructure investment, while both Treasury and Reserve Bank, both of whom might be expected to be a bit more critical of spending proposals, have added their blessing to infrastructure spending.

In recent years, however, total infrastructure investment has already risen sharply. Public capital formation (largely infrastructure investment) was 36 per cent higher in 2013-14 than in 2006-07, and as much as 44 per cent higher in 2009-10, partly in response to the GFC. Capital formation in transport, postal and warehousing in 2013-14 was 48 per cent higher than in 2006-07I, and in only seven years its net capital stock increased by a staggering 39 per cent.

Calls for more assume that all infrastructure investment is warranted economically and will add to national productivity. Yet no attempt has been made to justify this assumption, which is beggared by almost all past experience.

The real problem with much infrastructure is that unlike most investments, the revenue stream and consequent rate of return are negligible or non-existent, whereas normally that rate of return would indicate where more investment is warranted. Happily since the micro-economic reforms in the 1980s and 1990s, investment in power supplies, urban water, communications, and air and sea transport are now mostly subject to market disciplines, and can be presumed to be justified[1]. But that is not the case for investment in road, rail and irrigation infrastructure, which have largely resisted competition reform.  Furthermore, few such projects have been submitted to proper cost-benefit analysis, so it is anybody’s guess as to whether spending taxpayers’ money in this way is justified.

Road spending: $140 billion of debt within a decade?

Most of the transport investment has been in roads. In 2012-13 (the latest year for which figures are available) Australia spent $24.9 billion on its roads – a figure higher than the entire Australian Defence budget for that year. But since 2007-08, a combination of stagnant fuel excise revenue and increasing road expenditures has meant that revenue from motorists no longer covers road spending. Accumulated deficits from road investments between 2007-08 and 2012-13 have now added $26.1 billion to Australia’s public sector debt, and as much as $6.6 billion alone in the latest reported year, 2012-13.

A reasonable projection of planned road expenditures indicates that the accumulated stock of debt to FY2023-24 could be of the order of $114 billion[2].   When added to the already accumulated debt, this amounts to a total accumulated road-derived public sector debt of $140 billion within a decade (a matter until now entirely unreported).

Moreover, despite an obsession with public debt, no government has provided any economic justification for most of this roads expenditure. Rather Infrastructure Australia has been highly critical of Australian road planning and assessment. Its 2013 State of Play report described Australia’s last major public sector infrastructure monopoly as ’standing out’ for poor performance: Australia’s roads ’have no economic efficiency objective’, ‘no coordinated planning or design’, ‘ no review of proposals or results’, and ‘no commercial medium for users to influence capacity or design’.

If investment in productive outcomes is the goal, some road projects touted as the highest priority for the nation make one wonder just how bad the ‘also-ran’ projects must be: Melbourne’s now-cancelled East-West Link project – a multi-billion dollar project with a business case returning as little as 45 cents for every dollar invested – should never have been approved. Sydney’s massive Westconnex tollway project is underway (total cost $14,900 million, 2014 prices), but has not yet been judged fit for government investment by Infrastructure Australia.

Almost all multi-billion dollar road projects have similarly escaped scrutiny: Queensland’s Bruce Highway upgrade (total cost $8,956 million, 2014 prices) is but one example amongst sixty-three $100 million dollar-plus road projects budgeted by governments for the coming 5 years which have not been sanctioned by Infrastructure Australia, despite bipartisan agreement that this must occur (the lone budgeted project to receive approval is the Pacific Highway upgrade).

Reform of road planning, funding and expenditures

The Government’s recent Review of National Competition Policy found that ‘Lack of proper road pricing distorts choices among transport modes … and also contributes to urban congestion… with road users facing little incentive to shift from peak to off-peak periods, greater capacity is needed.’ Accordingly the Review concluded that ‘Reform of road pricing and provision should be a priority. Road reform is the least advanced of all transport modes and holds the greatest prospects for efficiency improvements.’

Cost-reflective pricing is critical to progress. Unlike twenty years ago, technological leaps mean that road pricing based on distance, location, and congestion, is now feasible at low cost. The revenue raised could then signal the genuine (measurable) priorities to which all future investment should be linked.

However, full road pricing may well not be appropriate in all circumstances, or even in a majority of circumstances. For existing roads that have spare capacity and do not help create congestion, it is more efficient to reduce that spare capacity by increasing the traffic even if that means providing a free ride. In addition, many roads may fulfil a community service obligation to ensure that people have access to their homes and places of business, and full cost recovery is then impossible.

For these reasons other approaches to road planning and financing should also be strengthened. Above all, proper system design is required: infrastructure works best as an internally-consistent system, not as discrete projects dreamt up in isolation to alternatives or without due analysis of their interaction with other parts of the whole. System design should ask simple questions: what problem am I trying to solve? What are the opportunity costs of different approaches to solving the problem? To date, no such authoritative design function is in evidence at any level of transport bureaucracy.

Given that road revenues are now failing by tens of billions of dollars to meet road spending, system design can help governments avoid generating further billions of dollars in public sector debt without merit. It enables government to establish a hierarchy of transport solutions based on their ability to satisfy aggregate transport demand and their likelihood of paying for such outcomes by project cash-flows alone.

Second, rules requiring proper independent cost-benefit analysis of projects should be enforced. All major investments in roads should base themselves on proper business cases submitted to Infrastructure Australia. Approval should only be forthcoming if the project is reasonably expected to deliver an economic rate of return after careful assessment of the value of any external benefits and the extent and cost of any community service obligations, which should be publicly transparent.

Rail investment

The next 5 years of government road and rail network budgets see $46 billion of highway and freeway projects, but only $1.6 billion in national rail solutions. Yet transformational rail infrastructure projects appear to be there. For example, in 2010 a national freight railway spanning Australia’s east coast was found by a Commonwealth-commissioned report to be capable of reducing the cost of interstate freight by 48 per cent. Yet in 2015 this railway remains unbuilt, without any substantial capital allocated to it beyond initial planning funds; at the same time, the government has not entertained simple market testing to build such a railroad commercially and immediately, as often occurs internationally.

Similarly there are urban rail projects worth funding, but they are almost never big new extensions to the network. Australian cities do not have the population density to justify major extensions. Even in Sydney – Australia’s most densely populated city with about 50 per cent and 470 per cent more rail passengers than Melbourne and Brisbane respectively (yet with similar network capacity), past investments in the urban rail network have failed to pay off. Thus after allowing for an annual $1.6 billion worth of external benefits from less traffic congestion, pollution and health and safety, the regulator found in 2008 that an economic rate of return was only possible if the total capital stock was written down to a bit less than half its depreciated book value, and much less than half it replacement cost. This strongly suggests that new urban rail lines are unlikely to generate an economic rate of return, even when allowance is made for the external benefits.

A fundamental problem is that urban rail transit systems have only a very small impact on congestion, except for the main roads into the CBD. This is because these urban rail systems are focussed on transporting commuters to and from the CBD, but in Sydney for example, in 2008 these journeys amounted to only 4.5 per cent of all journeys and 11 per cent of the total person kilometres travelled in Sydney as a whole.

Most journeys in modern Australian cities are across town to multiple business nodes. These cannot be served by the urban rail network, at least as presently designed. Usually modern bus services represent the best public transport option for Australian cities, yet serious bus infrastructure remains under-appreciated.

Instead, urban rail projects that would engender an economic return are often modest efficiency and capacity modifications to the existing network: better signalling, more passing loops, increased station capacity, or filling in ‘missing links’, such as perhaps Melbourne’s Metro Rail project. Such projects become more evident through proper attention to system design, but they are obscured if public policy only seeks to feed the political addiction to ‘icon projects’.

Rural water

The situation regarding rural water is very similar to that just described for urban rail. Water for irrigation has consistently been under-priced, and practically no irrigation scheme in Australia has ever generated an economic return[3], even allowing for the external benefits from flood mitigation and other environmental benefits.

The most important irrigation investment in recent years has been the National Water Plan decision to spend $10 billion on improving water flows in the Murray-Darling Basin. From this, approximately $6 billion was to be spent on improving the supply of water to irrigators by efficiency improvements, with the balance to be spent on buy-backs from the most marginal irrigators. If the water pricing rules agreed to by COAG as part of the Competition Policy reforms in the mid 1990s had been adhered to, it has been estimated that this investment would have required the price of water to irrigators to increase between 10 and 30 fold, depending upon how much of the extra water was reserved to improve environmental flows[4]. Of course, the agreement for proper pricing was quickly abandoned, thus destroying the economic value of the investment.

In addition, the present Coalition Government has surrendered to pressure and the amount of water to be bought back has been reduced, notwithstanding there are plenty of willing sellers who want to get out of what is for them an uneconomic industry. But the consequence of this latest change is that the extra money now being invested in efficiency improvements further reduces the economic returns on this investment. 

Conclusion

Australia is racking up very substantial debts to finance unreformed infrastructure. Many investments appear uneconomic and will therefore lower national productivity, or at least the productivity of capital and total factor productivity.

It is scandalous that this investment escapes proper scrutiny, while at the same time the proponents are calling for cuts in other government programs, including education and training programs that would actually increase productivity and participation.

Going forward the Competition Policy reform agenda of the 1980s and 1990s should be completed so that all infrastructure is properly priced before any new investment occurs.

Luke Fraser is the founder and principal of a transport policy and investment advisory focussed on roads and freight. In 2012 he was appointed to the Prime Minister and Premiers Road Reform Project. Prior to this he was for several years a national road freight industry chief executive, as well as a member of the Australian Trucking Association Council, where he was the industry’s lead representative on pricing reform and market investment models. 

Michael Keating is a former Head of the Commonwealth Department of Finance. Subsequently he was Chairman of the Independent Pricing and Regulatory Tribunal of NSW, and responsible for pricing much of that State’s infrastructure services.

[1] Note that in recent years there has been substantial over-investment in electricity transmission and distribution which is a natural monopoly and therefore not subject to market disciplines.

[2] This projection is based on the National Land Transport Agreement for 2014-19 for Commonwealth road expenditures and assumes no real growth in State and Local Government road expenditures. The CSIRO has projected falling revenues from fuel excise over the next decade and beyond, but the revenue projections used here conservatively assume unchanged excise tax revenue in nominal terms and that the other revenue elements increase at the 10-year average. Sensitivity testing suggests that indexation of fuel excise would still leave a substantial deficit from present road investment plans. A forthcoming academic paper (L. Fraser) examines these matters in greater detail.

[3] Irrigators have never paid a cent for water from the Snowy Scheme. Instead all of the costs are recovered from electricity consumers, and notwithstanding that irrigators have first rights to that water.

[4] Michael Keating, Australian Economic Review, Infrastructure: What Is Needed and How Do We Pay for It? 2008, pp. 231-8.

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Andrew Podger. A fair, effective and sustainable retirement incomes system.

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

In his introduction to this series, Ken Henry said he could not recall a poorer quality debate, on almost any issue, than what we have had in Australia in recent times. Ian Marsh, in his contribution, advocated pursuing bi(multi)partisanship opportunities as far as possible.

Sadly, Henry’s comment seems most apt when it comes to retirement incomes policy, and Marsh’s call seems a long way off after the Prime Minister and Treasurer ruled out a comprehensive review of the policy after the recent Budget. This is despite the Treasurer recently saying in relation to taxation that all options were on the table, and the Opposition indicating a willingness to work with the Government. In addition, there has been some excellent work in academia over recent years, and a quality report from David Murray’s Financial Services Inquiry which highlights the importance of drawing all the threads of the retirement income system together. We can only hope some others in the Government can find a way to allow proper discussion and wide engagement on this critical issue for everyone.

Careful analysis of Australia’s retirement income system would reveal it has considerable strengths, but also some serious weaknesses and challenges, most of which have not been addressed by the Government’s Budget proposals – either this year or last year.

Such an analysis requires, first, some agreement on the objectives of the system. David Murray’s Financial Services Inquiry made an important contribution in its simple admonition to articulate in legislation the objectives of the superannuation system, the primary one being, ‘to provide income in retirement to substitute or supplement the age pension’. Such a focus would avoid debate being hijacked by those promoting housing investment, or infrastructure financing, or broader wealth accumulation and so on.

The wider retirement incomes system in fact has two objectives:

  • The alleviation of poverty amongst the aged (addressed mainly by the age pension); and
  • The maintenance of income and living standards at and through retirement (addressed mainly by superannuation).

These core objectives are complemented by general principles such as value for money and sustainable cost, simplicity and understandability, and stability and certainty.

Australia’s ‘multi-pillared’ system (to use the language of the World Bank) has considerable strengths. Its ‘foundation pillar’, the age pension financed by general revenue, addresses poverty alleviation reasonably effectively and efficiently. The level of the pension is slightly below the OECD benchmark for poverty (50% of median income) so the headline poverty rate amongst our elderly is quite high (35% compared to an OECD average of 12.5%0, but the severity of poverty is lower (the average gap being 12.4% compared to the OECD average of 18.4%). With significant increases in the pension over the last decade and more, and with increasing numbers having superannuation as well as the pension, our main underachievement against the first objective concerns those fully reliant on the pension who are in private rental accommodation whose after housing costs are much higher than those who own their own home or are in public housing. The case for increasing rental assistance is strong.

Perhaps our system’s greatest strength comes from our emphasis on ‘pillar two’ mandated contributions and ‘pillar three’ tax-encouraged voluntary savings. These pillars are mostly fully funded instead of a ‘pillar one’ national superannuation scheme with unfunded promised benefits as is common in Europe and North America. In theory at least, our approach imposes less risk on governments and future taxpayers, and hence offers greater intergenerational equity.

At the current mandated contribution rate of 9.5%, most people will accumulate superannuation savings which, with some age pension, will be able to deliver at least 70% net income replacement in retirement after 35 years of contribution. The rates are higher at low income levels because pension eligibility is higher. This suggests we have the mandated contribution rate about right already if one accepts the international standard of adequate income maintenance of between 70 and 80%. Raising it further would only force people on low incomes to save more when their needs are greater in order to improve retirement incomes that are already sufficient. Most people on or above median earnings are already contributing more than the mandated amount taking advantage of the incentives available and, on average, it seems they also are likely to have sufficient accumulated savings to achieve 75% replacement rates.

The problem is that these income replacement rates are only potentially available. That our system does not in fact deliver them and ensure they last everyone’s full life is perhaps its greatest weakness. It certainly contrasts with every national superannuation scheme in other countries, and indeed with our own age pension.

We allow people too much freedom to take benefits in the form of lump sums. This can leave people with insufficient funds for their later retirement years and make them overly reliant on the age pension. Evidence gathered by the FSI suggests that this is not as yet a major concern but it could become one.

Of more concern according to the FSI is that too many people are trying to manage longevity risk on their own. To do this, they are holding back consumption from their accumulated savings so as not to run out of savings before they die. The result is lower consumption (and a lower standard of living than their accumulated savings suggest they should be able to have in retirement), and much larger bequests to the next generation than they would have planned (and much more than the system was intended to provide). Also, some still live to a very old age and run the risk of running out of savings.

There is also capacity to exploit the tax concessions to accumulate wealth including for planned transfer to the next generation rather than genuine retirement purposes.

Our system needs products that deliver retirement streams and provide insurance against the risk of longevity, and for policies which promote the take up of these. The FSI proposed requiring superannuation funds to offer their members a ‘comprehensive retirement income product’ which would include a longevity insurance element. It hoped these products would become the default retirement benefit products which most will take up, and thereby also addressing in part some of the ‘market failures’ such as adverse selection. This may not be sufficient and, eventually, consideration may need to be given to a mandated approach and to complementary measures to address market failure such as the options identified in the Henry Report including the issue of longevity bonds and the sale of annuities by government to supplement the age pension. These might be more likely to make lifetime annuity products available and limit capacity for people to use superannuation tax concessions for purposes other than retirement income.

The structure of our system makes us much better prepared for demographic and economic changes, but we still have serious cost challenges. The 2015 Intergenerational Report projects the cost of age pensions will grow from 2.9% GDP to 3.6% over 40 years unless the legislation changes. Health and aged care costs are projected to grow further. These increases will need to be managed and, if possible, curbed while ensuring the programs still deliver what the community needs and prefers.

What the IGR did not report was the cost of superannuation tax concessions which are growing faster than the age pension and are concentrated on those on high incomes. We should not however exaggerate the scale of these.

Treasury estimates of close to $30 billion are based on a ‘comprehensive income tax’ benchmark or TTE approach (taxing contributions and fund earnings as income and exempting the benefits). This may apply to your bank account but it is clearly excessive as it eats into the real level of savings. Last year Treasury presented estimates of the tax expenditures if a ‘comprehensive consumption tax’ or TEE benchmark was used. This suggested the costs of superannuation concessions are around $12 billion. But even that is arguably more than the revenue forgone that might be reaped if we agree the purpose of superannuation is to spread lifetime incomes to maintain living standards in retirement. That would suggest an EET approach, the orthodox approach used elsewhere but way too hard for us now given policies of the last 25 years. I have not seen any estimate of our tax expenditures on this basis, but they would be much lower as few retired people would have large amounts of other income so the tax rate would be much lower than their marginal rate when making contributions.

Given it is not feasible now to replace the current regime with an EET one, the question is what tax arrangement might most closely replicate an EET one, containing the costs and ensuring tax equity. I suspect the Henry Report approach would get pretty near to it by allowing a 20 percentage deduction from contributor’s marginal tax rate when setting the contributions tax. In practical terms, this would mean applying a 30% contributions tax for all those with incomes at the top marginal tax rate and no change for the vast majority of contributors; Henry also proposed a flat 7.5% tax on fund earnings at both the accumulation and drawdown phases.

The Government is right to draw attention to the costs of the age pension even if our challenges are small compared to those facing many others. But we also need to be realistic and to consider carefully how the pension will fit with superannuation as our population ages and the transition to retirement shifts and varies.

Australia has already been remarkably successful in reducing eligibility for pensions amongst women under 65, and has legislated to increase the age pension age to 67. When considering possible further increases consideration needs to be given to the implications for those with limited capacity to continue work, and the savings actually generated by such a change. The savings may be modest given the falling numbers of full-rate pensioners and the increasing proportion of these already on welfare before transferring to the pension. The Government’s proposal to increase the age to 70 in the 2030s was designed to maintain the ratio of working years to retirement years: that has some attractions but we need to look more carefully at the effects of the increase to 67 first and review whether the overall impact of a further increase would be acceptable.

The Government proposed last year to change the pension index to the CPI rather than AWOTE. That was always far too tough, reducing relativities with community incomes very substantially if continued for a lengthy period. But as Minister Morrison suggested in February, there is a case for modifying the current AWOTE approach which will over time increase the pension relative to community incomes. Using the CPI for automatic increases then having independent reviews to make adjustments for community income changes every two or three years would in fact be very sensible, and could form the basis for a uniform approach to indexation of all welfare payments. The welfare lobby might like to reconsider its opposition to any change in pension indexation arrangements.

Tightening the means test offers another way of achieving savings but it is important to recall that the original intention of the superannuation reforms was to allow most retired workers to supplement age pensions not to fully replace them. We have already seen a drop in the proportion of the aged on full-rate pensions from around 60% to 50% and this is projected to drop to 30%. The proportion on part-rate pensions however is increasing, so the forecast involves only a modest reduction in the total pensioner population.

To achieve a much greater reduction would require radical changes which could have adverse implications. The income and assets levels at which pension eligibility ceases are of course a function of the level of the pension and the means test withdrawal rates. The income test withdrawal rate has already been increased to 50%: a higher rate could affect incentives to continue part-time work. The Government has proposed an increase in the assets test withdrawal rate but few (including in the welfare sector) seem to realise this involves an effective wealth tax of 7.8% removing incentives to improve assessable assets above the threshold, contrasting sharply with superannuation tax arrangements intended to encourage saving.

More sensible suggestions include Henry’s proposal for a single merged income test which converts assets into appropriately deemed income: this would not radically change the numbers eligible for some pension, but would provide a more coherent effect on incentives to work and save. Another is to include the home in the assets test beyond some threshold, allowing people to continue to receive the pension but requiring repayment from their estate through a reverse mortgage arrangement. But in all likelihood over half our retired population will continue to receive some age pension, and that should not be regarded as bad so long as the system as a whole is delivering adequate incomes efficiently and at an affordable cost.

All this goes to demonstrate how a bi-partisan review of our retirement income system could build on its strengths, make it more effective and sustainable, and give people full confidence as they plan for their retirement years.

The demographic changes now underway should not be presented as a crisis; they represent a triumph of increased life expectancy and years of health living at older ages. They provide new opportunities for people to contribute to society and their families and communities as they transition from full-time employment. Our retirement income system can provide the security people need against poverty and reduced living standards while offering the flexibility for people to manage this new transition to retirement in the way they want.

Andrew Podger, Professor of Public Policy, Australian National University. He was previously the Public Service Commissioner and Secretary of the Departments of Health and Ageing, Housing and Regional Development, and Administrative Services.

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Michael Keating. Improving Productivity.

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

After more than seventy years of ever increasing living standards Australians have come to expect further such increases as their right. But these increasing living standards are for the most part dependent on increases in productivity. So as Nobel Prize winner, Paul Krugman put it, while productivity may not be everything, it is just about everything.

Unfortunately in the last decade Australia’s productivity growth has slowed compared with the 1990s when it accelerated, probably partly in response to the micro-economic reforms of the 1980s and 1990s. Perhaps for that reason business and a lot of the commentariat seem to think that productivity improvement requires more micro-economic reform; to the point where commitment to micro-economic reform is becoming a litmus test of ‘good government’.

Furthermore, business’ definition of more micro-economic reform focuses principally upon reforms of tax and workplace relations. However, taxation and workplace relations legislation are highly contentious policy areas; indeed they represent the two most amended areas of Commonwealth legislation since Federation, reflecting key ideological differences in the traditional political divide between labour and capital. So reform of taxation and industrial relations is especially contested, as is any possible impact on productivity.

Less contested are the frequent demands for more infrastructure investment, including from those like the Reserve Bank who should know better. The reality is that too often infrastructure is seen as a free good, with remarkably little concern for whether such investment is warranted. More relevant for future productivity, as the recent Review of Competition Policy has reminded us, is that micro-economic reform in the past was principally about increasing competition.

Accordingly this article explores what drives increases in productivity, what is the likely outlook for productivity and what difference can policy make to that rate of productivity increase. In particular, it will be important to ascertain what proposals for so-called micro economic reform are really in the public interest and what mainly reflect the self-interest of the proponents.

Technological progress

Through history economic transformations and the associated productivity gains have been almost entirely in response to technological progress. The Stone Age was characterised by the technology of that Age, and all progress since then reflects new technologies, such as the invention of printing, new modes of transport and power, weapons etc., right up to the present impact of ICT. So the starting point for increasing productivity would logically be to consider the scope for accelerating the pace of technological change.

Of course, the differences in the technology levels experienced in different countries reminds us that institutions and policies can make a difference to the rate of adoption and adaptation to new technologies. So there is potentially a role for government to encourage and facilitate the rate of technological progress. Nevertheless, this role is less when a country, like Australia, is at or close to the global technology frontier and has limited scope to catch-up on others.

Furthermore, in this century productivity (at least as measured) seems to be slowing down, not only in Australia, but also in most of the other advanced economies. This slower productivity growth could in turn be consistent with a lower rate of global technological progress, making it more difficult for Australian government policy to engender faster productivity growth in the next decade or so.

What drives technological progress and its adoption

The key drivers of technological change are in fact familiar, as are the policies that can underpin these drivers, although they do not always receive due recognition by government and business.

First, continuing government investment and support for both public and private research and development is critical, as the economic returns are slow to be realised and difficult to appropriate. Even though most innovations are global, unless Australia is engaged directly in research we risk being slow adopters of new technologies. In addition, governments can play a role in encouraging closer links between researchers and industry, through the CSIRO and programs such as the Cooperative Research Centres which are jointly funded and managed by government, business and academia. It is therefore of considerable concern that government funding for research and development, and for the CSIRO and the Cooperative Research Centres have been substantially cut in recent years.

Second, skills are critical to the adoption and adaptation to new technologies. Governments need to foster a high degree of technological literacy and the necessary knowledge and skills to ensure the rapid adoption and use of externally developed technology.

Third, technology creation is not just the product of professional technologists or technology companies. We also need a workforce that is trained to use new technologies effectively, and productivity will be enhanced if our workers can quickly adapt to the use of new technologies. But too much of present-day training is highly specific to today’s jobs, making that adaptation more difficult. Workers also need more generic skills that allow them to understand better how and why technology works, rather than just being able to follow the manual and/or relying on experience. Instead training structures and content should provide them with the adaptability skills to allow them to quickly and effectively use the new technologies that will characterise tomorrow’s jobs.

Again it is of concern that in recent years the funding for tertiary education and training have also been cut substantially. The risks to future productivity growth are considerable, and all these cuts risk proving to be false economies as lower economic growth may further reduce Australia’s long-run fiscal sustainability.

Fourth, new technologies often require re-organisation of a firm’s business model and organisational structures, so that the quality of management makes a difference to the adoption and adaptation to new productivity-boosting technologies. The government’s programs of assistance to small business can help inform management of changes necessary to adapt to new technologies and the re-skilling that their firms will need to undertake. The impact of labour market regulation on the capacity of management to pursue changes in the organisation of work is also potentially important, and will be further considered in a discussion of labour market reform below.

The role and impact of micro-economic reforms

So given the over-whelming importance of technological progress for future productivity growth, what might be the impact of the various micro-economic reforms proposed and as listed briefly above.

Competition policy is the most important of these reforms. Competition is a significant driver of technological progress as firms strive to obtain a competitive advantage by developing and quickly adopting new technologies. Even within the boundaries of existing technologies competition typically provides the key impetus to increase efficiency which is then reflected in productivity gains. The recent report of the Competition Policy Review, by the Harper Committee, provides an authorative list of desirable reforms, of which the three with the greatest likely impact on our economic performance are:

  1. Establishing choice and contestability in government provision of human services can both improve the quality of the services by empowering service users, and improve productivity at the same time. Progress along these lines is already being made for some government funded services, and in some instances costs have been driven down. One problem, however, is that the experience so far is that the service users do not always have adequate information to make a fully informed choice, and consequently the quality of service provision can deteriorate unless there are good regulatory systems.
  1. Ensuring cost-reflective pricing of infrastructure would improve the efficiency of use of much infrastructure and would encourage better investment appraisal of future infrastructure proposals. By contrast, at present many uneconomic infrastructure investments gain approval, and represent a waste of scarce savings. Roads are the worst offender, but as recognised by the Harper Committee, reforms begun in electricity and gas need to be finalised and water reform needs to be reinvigorated. These issues will be discussed at greater length in another article on Infrastructure to be published in this policy series.
  1. Using pricing or other signals to guide the allocation of our land and other natural resources towards their highest-value use, and in this context ensuring that planning, zoning and environmental regulations are applied sensibly.

Each of these reforms proposed by the Harper Committee to competition policy could improve Australia’s economic performance and quality of living standards into the future. However, they would not necessarily show up as an increase in labour productivity, at least as measured.

Workplace relations

Workplace relations, and particularly how work is organised in the workplace, can make a difference to the productivity of that workplace. Cooperation and trust based on fairness will provide a foundation for flexible workplace relations that will help ensure the most effective use of the firm’s existing capital and will also encourage new innovations and accelerate their adoption. The key question is, however, to what extent does Australia’s present system of workplace relations need yet another round of reforms and what can we expect from more such reform?

In 2012 the leading labour market economist, Professor Jeff Borland made the most exhaustive examination available of the impact of the various industrial relations reforms (Work Choices and Fair Work) in the 2000s. After considering the evidence on wages growth and earnings inequality, labour market adjustment, labour productivity growth and industrial disputes, Borland concluded that there was “Little evidence … of an effect from the industrial relations reforms made in the 2000s”. By contrast he did find “some evidence of an effect from the reforms to Australia’s industrial relations system that occurred in the 1990s”, when Australia switched from a centralised arbitration system of industrial relations in favour of enterprise-based bargaining. In Borland’s view “the limited effects of the reforms in the 2000s can be explained by the nature of those reforms – being primarily oriented to changing the relative bargaining power of employers and employees, rather than enhancing overall economic performance”.

Similarly the independent and comprehensive review of the Fair Work Act, also in 2012, found that “since the Fair Work Act came into force important outcomes such as wages growth, industrial disputation, the responsiveness of wages to supply and demand, the rate of employment growth and the flexibility of work patterns have been favourable to Australia’s continuing prosperity, as indeed they have been since the transition away from arbitration two decades ago”. While that review was concerned by the slower rate of productivity growth, it was “not persuaded that the legislative framework for industrial relations accounts for this productivity slowdown”.

Indeed there seems little doubt that since the advent of enterprise bargaining, Australia does have a more flexible industrial relations system. The then Secretary of the Treasury commented that “if it were not for our flexibility … Australia could not have avoided the worst of the impacts of the Global Financial Crisis’. More recently the evidence shows that relative wages adjusted quickly and flexibly to accommodate the increased demands by the mining and construction industries associated with the resources boom and without any upward pressure on inflation more generally. Equally the proponents of further system changes have not yet shown that changes in work organisation cannot be readily negotiated within the existing framework, so long as they are not a blatant attempt to reduce workers’ pay.

So in the light of all the evidence what exactly is another round of changes to the industrial relations system meant to achieve? Such changes are hardly likely to directly increase productivity. Instead the business agenda for workplace relations reform seems to be to provide a cover for cost-cutting rather than increasing productivity. As Borland puts it recent reforms and those now being proposed are “primarily oriented at distributive goals rather than efficiency goals. This leads him to conclude that “private interest can explain current lobbying for further reforms to Australia’s industrial relations system”.

Accordingly Borland’s end conclusion seems eminently sensible that “reform of Australia’s industrial relations system should not be an area of policy-making priority for governments”. Instead what does need improvement is how employers manage and organise the work to use their employees’ skills most productively. Too often employees report dissatisfaction that their skills are being under-utilised, and that the work could be organised more productively by allowing greater autonomy and discretion to individual employees and teams.

There are also problems in industries such as health where traditional demarcations need to be broken down and multi-skilling, broad-banding of positions, up-skilling and team work increased. John Menadue (postings 25 & 27 January) has shown how this would bring substantial productivity gains by releasing high-level specialist staff to focus on the tasks that only they can do.

But none of these improvements in how work is organised require changes to the workplace relations system; rather they require better management. Indeed, the fact that there are examples of such successful re-organisation strongly suggests that regulatory system does allow managers to manage productively. To the limited extent that it can, the government should therefore be encouraging this sort of better management, rather than forever tinkering with the legislative framework for workplace relations.

Tax reform

There may well be other reasons why Australia’s tax system could be improved, but any changes are likely to have only a marginal impact on productivity. Indeed the evidence suggests no correlation between actual levels of taxation and per capita GDP; one reason being because any such analysis fails to take account of how those taxes were spent.

To the extent that present Australian taxes do affect productivity, it is probably because of how they affect the allocation of savings and investment, and not so much through their impact on incentives to invest or work.

Tax reform was addressed further in another article in this series, but suffice to say that most tax proposals have distributional goals or at least distributional consequences, and thus often reflect self-interest, even if that is masquerading as in the public interest.

Conclusion

Productivity is mainly determined by technology and its use. In a globalised world there is only a limited influence of a national government like Australia’s to influence the development of new technologies and their adoption. Most important is the creation of an innovative culture through support for research, development and education and training, and forging closer links between the scientific communities and industry. On the recent record, with substantial budget cuts, there is plenty of room for improvement. Further micro-economic reforms should also be pursued where they have merits, with a focus on competition policy.

More generally, it seems quite possible that living standards in all the advanced economies, including Australia, will rise more slowly over the next few decades than over the sixty years leading up to the Global Financial Crisis. Accordingly a key policy responsibility will be to change popular expectations if they have to adjust to this new reality. And in that case overselling what can be expected from micro-economic reform will only exacerbate this adjustment problem.

Michael Keating AC was formerly Secretary of Department of Finance and Secretary Prime Minister and Cabinet

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Michael Keating. Improving Employment Participation

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

The rate of employment participation and the productivity of those employees together determine the average per capita incomes of Australians, and therefore our living standards. In addition, being employed creates many of the social contacts and sense of self-esteem that are vital to our individual well-being. While arguably the best way to reduce inequality is to create the conditions where those disadvantaged people who are presently on the margin of the workforce get work, or in other cases get more work.

In short increasing employment participation is most important if governments want to improve living standards, individual well-being, and equality.

What has happened to employment participation in Australia

In March Australia’s employment participation rate was 60.8 per cent, representing an average of a 66.9 per cent rate for males and a 54.9 per cent rate for females. Interestingly this rate of employment participation for the population is the same as fifty years ago, but the composition of employment has changed markedly. The male employment participation rate is now as much as 18 percentage points lower than in 1966, whereas the female rate is 15 percentage points higher.

The fall in male employment participation is closely associated with the decline in ‘blue collar’ employment. This decline principally reflects the impact of technological change, rather than changing trade patterns and globalisation, as the output of the relevant industries increased or was at least maintained over most of the fifty year period. In contrast, the rise in female employment participation probably reflects a combination of changing social attitudes and the rise in the number of job opportunities in the service industries.

Almost all this long-term decline in employment participation for those males in the main working ages from 25 to 55 was accounted for by those men who did not complete secondary school and have no further qualifications. Furthermore, for both men and women the employment participation rates are much lower for those who did not complete year 12 and have no further qualifications – 71.3% for men and 59.7% for women in 2011. By comparison employment participation rates for those who have completed secondary school and/or have further qualifications are 88.9% for men and 81.6% for women. That is a difference of 17.6 percentage points for men and 21.9 percentage points for women in employment participation according to levels of educational qualifications.

It is also interesting to compare Australia’s employment participation rates with other countries, especially as it is often suggested that because Australia’s female participation rate tends to be lower than in the other English speaking countries that have similar cultures and institutions, policies to assist women could help lift their participation. First, the difference between female participation in Australia and the other countries is, however, quite small (see Table 1). Second, for those women who have tertiary qualifications there is practically no difference between their employment participation and their overseas counterparts.

 

Table 1 Employment Participation rates by educational attainment, 2013
Per cent

Male participation rates Female participation rates
All aged 15-64 Tertiary education All aged 15-64 Tertiary education
Australia 77.6 90.6 66.4 79.4
Canada 75.4 85.0 69.6 79.0
New Zealand 78.5 89.4 67.9 79.8
United Kingdom 76.1 89.0 66.6 79.3
United States 72.6 84.9 62.3 76.0

Source: OECD Employment Outlook, 2014

In short, it is people whose educational qualifications are poor and who lack skills who have the most scope to increase their employment participation. So if we want to increase employment participation, with all the benefits that would bring, then the focus should be on policies to improve the job prospects of low-skilled and disadvantaged people.

Job Creation

A common view is that unemployment reflects a lack of jobs, or employment opportunities. Right now the 6 per cent unemployment rate probably reflects some shortage of demand, due to generally sluggish economic conditions post the GFC. But full employment is generally judged to occur at around a 5 per cent unemployment rate, so that increasing demand generally would not mean a lot more than a one per cent increase in employment participation[1].

Further demand increases to try to lower unemployment below 5 per cent may well be frustrated by skill shortages, as experienced only a few years ago prior to the GFC. The reality is that ongoing structural adjustment means that unskilled people tend to have difficulty competing for the jobs that are available, and it is almost impossible for governments to create more unskilled jobs on a sustainable basis.

Accordingly the focus for improving employment participation must be on:

  • improving the skills of low-skilled people so that they can compete for the jobs that will become available through sound demand management policies; and
  • maintaining the currency and further improving the skills of those people further up the occupational skills ladder so that they can progress further and thereby create vacancies for newly skilled people below them to get a job. 

Education and Training

The fact is that we now have enough experience of providing education and training packages to disadvantaged people that we broadly know what is needed and what works. The key policy requirements are as follows.

First, and most important, is to provide more money, especially as the funding for these programs has been cut substantially in recent budgets. In fact these programs have never been funded to meet the need, and a lot more people should be enrolled. The former Australian Workforce and Productivity Agency (AWPA) in its 2013 National Workforce Development Strategy recommended additional funding of at least $200 million each year for Vocational Education and Training alone to train less advantage people, and this amount should probably be further increased to make up for the recent cuts and weaker labour market.

Second, the best results are obtained by increasing the funding per person. Too often in the past political pressures have required programs to maximise the number of people enrolled, but as a result the available funds are then spread too thinly to optimise the cost effectiveness in terms of sustained employment outcomes.

Third, the most disadvantaged people who have been out of work for some time usually need other supporting “wraparound” services. These services can involve personalised case management to deal with these peoples’ lack of confidence and to help them overcome personal barriers, including by coordinating other services such as housing and health. Often these most disadvantaged people need to progress through more than one training program, starting with something like Adult and Community Education to build up their confidence, re-engage with learning, and to develop their social and employability skills.

Fourth, programs need to be directed not only to those who are not presently employed, but also to those people who have lower skills and or who risk their skills becoming superseded through ongoing technological change and other structural adjustment pressures.

Fifth, the nature of the training needs to be changed to be less focussed on the specific requirements of a particular job and/or a particular employer. Job specific skills are important, and they also can help engage the trainees, many of whom have an aversion to class-room based learning, and prefer to learn as much as possible on the job. But these job specific skills do need to be accompanied by more generic skills that better equip employees to adjust to changing job requirements.

While policy action to increase participation by improving people’s skills will not be cheap, the social and economic cost of doing nothing more will be much higher. Indeed AWPA showed that the increase in qualifications and skills consistent with its recommendations could reasonably be expected to lead to a 1.7 percentage point upward adjustment to the participation rate in 2025. The consequent impact on employment and GDP would be a 2 percentage point increase, and tax revenue would be about $12.4 billion higher in 2025 compared to a continuation of policies as they were in 2013. On the other hand, by 2025 the additional cost of AWPA’s recommendations would be only about $2 billion, meaning a net gain to the Budget of $10 billion.

Clearly increasing employment participation by investing more in skills is a very good investment socially, economically and fiscally. It should be an over-riding priority.

Alternative proposals to increase participation

While as has been shown there is an over-whelming case for more investment in education and training, there are other proposals which are justified by their alleged positive impact on employment participation. These will briefly be assessed below. 

Lower wage costs

Wage costs obviously affect the demand for labour. Here the emphasis has been on upskilling the least qualified people so that their productivity is increased and they can compete, and compete for jobs further up the occupational scale where there are more jobs. The alternative would be to cut the wage rates of people with lower skills, with the two most common proposals being to lower penalty rates and/or the minimum wage rate.

There is not a lot of evidence available to enable a judgement as to what impact this might have on the demand for labour and therefore on employment of less skilled people. But it is probable that the impact would not be great – and nothing like as big as the impact from upskilling.

In particular one interesting piece of evidence comes from a comparison of the experience with the minimum wage in Australia and the United States. As is well known the minimum wage is exceptionally low in the US relative to the average, whereas in Australia minimum wage is higher relative to the average wage than in most other advanced countries. However, in 2012 the employment participation rate for Australians aged 25-64, who had less than upper secondary education was 66.2 per cent, while for equivalent Americans it was only 52.9 per cent, or a whole 13 percentage points lower[2].

As there would be a high correlation between low education levels and employment on the minimum wage, it does not seem that the lower minimum wage in the US is achieving much in terms of employment participation, and accordingly lowering the minimum wage would be equally unlikely to increase employment participation much in Australia. And of course, there are other reasons for supporting a reasonably high minimum wage.

Improving the incentives to work

The two main proposals to improve the incentives to work are to:

  • Improve the accessibility and reduce the cost of child care to the family
  • Lower marginal tax rates so that people gain more from extra work.

Taxpayer support for childcare is largely an issue of equity. It is a moot point how much employment participation by women would be affected by additional support to reduce the cost of child care to the family. Female employment participation by professional and other women with tertiary education is already comparable with other similar countries (Table 1). It may be that less costly child care might make more difference for women in less well paid jobs, however, as these costs would be a greater burden for lower income families.

What is reasonably certain is that reducing the cost of child care could be quite expensive. Indeed the recent Productivity Commission report on child care estimated that adoption of the recommendations would increase employment participation by mothers (primarily in low and middle income families) by 1.2 per cent, but this is only equivalent to a 0.1 per cent increase in total employment.

Cost is also the big inhibitor to reducing the marginal tax rates so as to increase the incentives to work. The present alleged disincentives arise because the interaction of the tax and income support systems can result in effective marginal tax rates (EMTRs) as high as 60 per cent, although only over a fairly limited income range. Nevertheless most pensioners and beneficiaries who want to work part-time, face an EMTR of around 30 per cent or a bit more. What is not well established is how much this acts as a disincentive, and therefore how much extra employment and extra hours worked might result from reforms to lower EMTRs.

One indication of the relative costs and benefits from policy reforms of this kind is available, however, from some work done by the Melbourne Institute of Applied Economic and Social Research. The Institute estimated that a package of changes in income tax rates, family benefit tax and pension and benefit withdrawal rates that came into effect on 1 July 2006 would increase the available labour supply by less than 50,000 workers, or less than half a per cent, at a full-year cost of $11.4 billion in each year.

Conclusion

In short what this analysis shows is that employment participation in Australia could be increased significantly. By far the most promising means would be to increase the investment in education and training to improve the skill-base of the economy, and especially the employability skills of disadvantaged people. Other proposals to reduce the cost of child care and reforms to lower effective marginal tax rates may well be useful, but they come at a considerable cost and are unlikely to have nearly the impact on employment participation that can be expected from policies to increase skills.

These education and training policies would greatly benefit the economy the government’s budget, our society, and many disadvantaged individuals.

Michael Keating is a former Head of the then Department of Employment and Industrial Relations, and a former member of the Boards of the Australian Workforce and Productivity Agency and the South Australian Training and Skills Commission.

[1] Employment participation would rise by more than the fall in unemployment because some people who do not declare themselves to be unemployed would successfully rejoin the labour force under conditions of full employment.

[2] Source: OECD Employment Outlook, 2014

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Michael Keating. The Future of Federalism

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

Six months ago Tony Abbott announced that he wanted to ‘create a more rational system of government for the nation that we have undoubtedly have become’. A worth aspiration, but what does it mean in reality?

Fundamentally there are two contending doctrines regarding the future of federal-state relations in Australia. One view is that we should be working towards a clearer separation of the respective roles and responsibilities of each of the two levels of Government. The other view is that the two levels of government inevitably have to share responsibilities, and that the best way forward must be a system of cooperative federalism based on better arrangements for sharing joint responsibilities in the future.

This article will examine each of these two contending viewpoints, and their respective implications for the future of our federal system of governance. The conclusion is that each viewpoint has its merits, and in the best traditions of Australian public policy pragmatism, an amalgam of the two based on the nature of the different responsibilities for each of the different functions is probably the best outcome.

Separate roles and responsibilities

There is considerable intellectual attraction in the philosophical proposition that our system of government should be arranged so that:

  • policies and service delivery are as far as practical the responsibility of the level of government closest to the people receiving those services, and
  • each level of government is sovereign in its own sphere, with minimum duplication between the Commonwealth and the States.

Of course this proposition is not new; indeed the champions of States’ rights insist that this is what the framers of the Constitution intended. Furthermore a clearer separation of roles and responsibilities, coupled with commensurate revenue raising capacity, should enhance democratic accountability. It should also help improve efficiency by reducing duplication and ending the blame game where the buck is passed back and forth between governments.

Liberal governments have traditionally been attracted to these ideas, although their actual policies have often led to increased power and intervention by the Commonwealth in areas such as schools, irrigation and roads. The most important transfers of power from the Commonwealth to the States have, however, been initiated by Liberal governments. First payroll tax was passed over to the States and more recently the GST was introduced with the States receiving all the proceeds.

Shared responsibilities but separate roles

Despite the intellectual attraction of each level of government having its own clearly identified separate roles and responsibilities, there are in fact good reasons why the national government has become increasingly involved in functions that were originally the responsibility of the States:

  1. The actual decision to federate was always intended to lead to the development of a national market, but a consequence of that, along with increasing globalisation, is that common standards and regulation is required across many fields including rail gauges, heavy transport, workplace relations, company law, competition policy, food standards and the recognition of qualifications.
  2. The responsibilities of governments have grown, with the Australian Government now having constitutional responsibility for income support, medical services, pharmaceuticals, and public health. In addition, it is the Australian Government that is expected to manage the macro-economy, ensure full-employment and price stability, and promote national development including population growth, employment participation, and productivity.
  3. These various national responsibilities are not self-contained, and they inter-relate with and can be affected by many other government functions.
  4. The national government must necessarily dominate taxation policy and revenue collection, especially where factors of production are highly mobile, and thus the vertical fiscal imbalance which is such a feature of the Australian federation is to at least some extent also inevitable.

For these reasons any reforms of our Federal system of government need to ensure that the capacity of the national government to meet the legitimate expectations regarding its responsibilities is maintained. In particular, it will be important to consider for each government function how strong is the national interest in this function, either because of the national government’s direct responsibilities or because of the implications for its other key responsibilities.

So while some rationalisation of responsibilities of some government functions may well be sensible, where the national interest is not critical, there are other functions where the national interest is strong. In this latter case, the government responsibilities for the functions should continue to be shared, and the reforms need to focus on better arrangements for sharing those responsibilities.

Rationalisation of roles and responsibilities to achieve greater separation

The Abbott Government is now looking at these issues afresh and expects to release a White Paper on Federalism later this year. A strategy for radical change in our federal system could involve a big cut to the total $50 billion for specific purpose program funding to the States, of which hospitals ($16.4 bn), schools ($16.4 bn), infrastructure ($6.8 bn) and skills and workforce development ($1.8 billion) account for 83 per cent of that total. This cut in State revenue could be balanced by a substantial increase in the GST so that the State budgets were no worse off, or even a little better off. The revenue saved by the Commonwealth from the specific purpose programs could be used to pay sufficient compensation to low and middle income households so that they would not be too disadvantaged by the increase in the GST. The remaining surplus from the specific purpose program savings (probably about two thirds of the original total savings) would then be available to finance Budget repair (if necessary), other expenditure priorities and/or income tax cuts.

Clearly substantial savings in specific purpose programs will have to focus on the funding for the three big functions of hospitals, schools and infrastructure and the scope to hand back responsibility to the States for these functions, and/or to otherwise achieve savings. As noted that will require an assessment of how closely each program relates to other Commonwealth responsibilities, and its significance for meeting those other responsibilities.

Starting with hospitals, I consider that hospitals are so closely related to the Commonwealth’s responsibilities for medical services, that it would be counter-productive for the Commonwealth to withdraw totally from hospital funding. Health planning and delivery needs to be more closely integrated, not separated into different programs that are administered by different governments. In addition, the amount of hospital funding has already been reduced in the previous Budget, so it is assumed that no further savings are made in Commonwealth funding for hospitals.

Similarly in the article that I posted on fixing the Budget two days ago I suggested that the Commonwealth should make savings of at least $10 billion over the next four years by ceasing to fund uneconomic infrastructure that should not be built by any government. Further infrastructure savings for the Commonwealth alone could be achieved by handing the responsibility for funding back to the States for all infrastructure, other than nationally significant projects; at a rough guess these saving might amount to another $3.5 billion each year.

That leaves schools as the most significant function for potential rationalisation. Here the Commonwealth might consider totally withdrawing, thus saving $16.4 billion in 2015-16 and rising in future years. The justification would be that the Commonwealth has only limited influence now on school outcomes and schools are not all that closely related to Commonwealth responsibilities for tertiary education, which in turn are closely related to other Commonwealth responsibilities for the labour market.

Some rough ball park figuring suggests that if say the Australian Government:

  • Withdrew from funding state schools
  • limited its funding of infrastructure to nationally significant projects that would have an identifiable influence on the national economy,
  • withdrew its funding from many other smaller specific purpose programs

then perhaps as much as $20 billion per annum could be available for GST compensation, fiscal repair and tax cuts.

To fully compensate the States, however, they would probably demand around $25 billion in extra GST revenue, because of the $80 billion cuts in the last Budget to health and schools over the next decade. This $25 billion extra GST revenue could be achieved by:

  • some base broadening from the present 50 per cent of coverage of consumption to around a 75 per cent coverage
  • an increase in the tax rate from the present 10 per cent to 15 per cent, or
  • some combination of the two.

It would, however, be in the States’ interest to concentrate on base-broadening as GST revenue would then be more likely to rise faster in future.

After compensating middle and low income households for the additional cost impact of the increased GST, the Commonwealth would then have around $12 billion annually from the specific purpose program savings to finance a 7 per cent reduction in the income tax cut or meet other priorities; less than the 10 per cent income tax cuts introduced by Howard and Costello in 2001.

Clearly less ambitious packages involving less rationalisation of Federal-State responsibilities could be envisaged. That would mean less increase in GST and less reduction in income tax.

In particular, I think a better rationalisation of functions would be achieved if the Commonwealth took over sole responsibility for vocational education and training (VET), as a swap for withdrawing from funding State Schools. VET is closely related to Higher Education which is already largely funded by the Commonwealth. Indeed some institutions provide both forms of tertiary education, and they will need to become more closely integrated in the future.

In addition, VET should play a key role in improving skills that are vital to increasing employment participation and productivity, enhancing national development and reducing the inequality of incomes. For these reasons skills and workforce development are already primarily a Commonwealth responsibility, with VET providing one, albeit a critical means through which the Commonwealth realises these key responsibilities.

Such a swap of responsibilities of schools for VET between the Commonwealth and the States would halve the savings to the Commonwealth, meaning that the need to find additional GST revenue would be reduced by $7.5 billion from $25 billion under the first package to $17.5 billion under this alternative package. However, the savings to the Commonwealth Budget from specific purpose programs would also be reduced by $7.5 billion to just under $4.5 billion. Consequently the scope for tax cuts or meeting other expenditure priorities in this alternative package would be quite small. Indeed, it might even be non-existent if there was still a fiscal deficit because of insufficient savings from other Commonwealth expenditures or failure to sufficiently broaden the income tax base.

One other point to note is that if the reform packages outlined above fully realised, then the scope for income tax cuts identified in either package would result in tax cuts beyond those necessary to offset the impact of bracket creep. So in each case average income tax rates would actually be reduced, although not by much in the second package. Furthermore, if some of the compensation for the impact of the GST increase on low to middle income household budgets took the form of tax cuts, then this scope for reducing average income tax rates would be even bigger.

One big problem, however, with any package rationalising Commonwealth-State responsibilities along these lines is that the Abbott Government has said it will not act on the GST without unanimous support, and indeed it cannot act without the agreement of all the States and Territories, plus the Senate. Maybe this agreement would be forthcoming after an election if the Government based its election campaign around this sort of reform package. I also consider that Labor should support at least the rationalisation of responsibilities by swapping its funding for State schools for a take-over of VET. The fact that this would involve an increase in the GST does not seem to me to be an argument against this rationalisation, as it would lead to more efficient government programs and help put State finances on a firmer footing. 

A better sharing of Commonwealth-State joint responsibilities

Even a radical rationalisation of Commonwealth-State responsibilities is likely to leave the Commonwealth and the States sharing some responsibilities. But how best to share these joint responsibilities has been a long running problem, so we also need to consider how these programs can be better designed and managed to achieve better results.

Historically the Commonwealth and the States have focussed on the inputs for shared programs, often based on an agreement about how much each would provide in funding. A better way forward is to reach agreement on the outputs and outcomes to be achieved, and then determine consequent funding. The actual delivery of those services, however, should usually be the sole responsibility of the States, or some other provider where the market is opened up to choice (for example, as is happening for vocational education and training in an increasing number of States). The idea is that the Commonwealth will focus on what needs to be achieved, but the States would then have considerable discretion as to how these output and outcome targets will be achieved, having regard to their own local circumstances. In effect there is a purchaser-provider relationship between the Commonwealth and the States for the delivery of services, although in this case the provider works as a joint partner in planning and funding the services.

Increasingly other providers are, however, entering what is effectively a managed market for publicly funded services, often with better results. Indeed the Australian Government is increasingly by-passing the States in seeking partners for the delivery of government services. Where the Government contracts with multiple accredited providers, this allows for more variety of service provision so that people are then able to choose the provider which is best able to meet their personal needs. Indeed this would be the model, if as proposed above the Commonwealth took over sole funding responsibility for VET. The Commonwealth would then continue the present practice of allowing trainees to select their provider from an accredited list, which would include TAFE providers, and the Commonwealth would then directly pay the provider.

Experience so far suggests that there can be problems of quality control with this purchaser-provider model of service delivery. Tighter regulation may be necessary, but governments can also use the power of their purse to ensure improvements in quality over time, by only accrediting those providers who continue to meet standards and/or who have achieved the best outcome results. This approach and the competition now being experienced may also lead to the State providers improving the quality of their services too, and consequently less pressure on the Commonwealth to intervene in the actual delivery of services.

Where the Commonwealth and the States continue to share responsibilities for planning and funding the services, a more informed way of achieving agreement on the outcomes and outputs to be achieved is proposed by John Menadue in an accompanying article. In brief, Menadue proposes a Joint Commonwealth/State Health Commission in any State that is willing to agree, which would pool all funding sources. Such a joint approach to future planning and funding seems to offer the best chance of achieving the necessary focus on each individual patient’s multiple health issues through the full integration of all health services and their funding. This is particularly important in an area like health where consumer sovereignty cannot be assumed, unlike many other public services where it is more reasonable to assume that after clients have received professional advice they are the best judge of what they want.

Nevertheless, while these ideas for sharing responsibilities better seem to offer a path towards a more cooperative system of Federalism, they are not without their own problems. First progress is inevitably slow as the future arrangements for each service needs to be considered on its merits. Second there is an unresolved issue as to what sanctions might be available where a State fails to meet the agreed output/outcome targets, especially if that reflects under-funding by the State.

Conclusion

An interesting question is whether any government will be prepared to embark on a radical reform of Federal-State relations by withdrawing a large amount of funding for specific purposes, and increasing the GST instead, even if that did offer the best chance, or even the only chance of funding significant future income tax cuts.

The package of reforms for Federal-State relations proposed here would involve some rationalisation of responsibilities that are currently shared, and the net loss of funding to the States would have to be financed by some increase in the GST. However where, as is almost certain, some functions continue to be shared then it will be necessary to continue the reforms started by the Hawke-Keating Government, and further developed by the Rudd Government in favour of new and better ways to share joint responsibilities. But assuming that this alternative approach involves only a modest withdrawal from funding specific purpose programs, there would be little or no scope for income tax cuts beyond those necessary to offset the impact of bracket creep.

Furthermore, even a radical rationalisation of responsibilities would still leave the States being significantly dependent financially on the Commonwealth, although less so the more specific purpose payments are cut and the GST increased. But so long as the States continue to be significantly dependent financially then their claims to sovereignty are compromised, and some continued sharing of responsibilities will continue.

Dr Michael Keating AC was formerly Secretary of the Department of Finance, and Secretary of the Department of Prime Minister and Cabinet.

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John Menadue. Making the Federation work better.

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

State governments spend about 25% of their budgets on health and another 25% on education. A cooperative arrangement between the commonwealth and state governments in one of these areas would greatly improve the operation of our federation. This article will focus on possible cooperation in health.

A State handover of health services to the Commonwealth, as suggested by Tony Abbott many years ago, would be one way to overcome the waste and buck-passing between the Commonwealth and State governments in health. Kevin Rudd suggested that his government might take over state hospitals. Opinion polls suggested that the public would support this approach. But Kevin Rudd backed away. In passing it should be noted that the Commonwealth has no recent experience in running hospitals. It is not an easy task.

But as a Commonwealth takeover is most unlikely, an alternative would be to establish a Joint Commonwealth/State Health Commission (Joint Health Commission) in any State where the Commonwealth and a State government can agree – a coalition of the willing, a Commonwealth/state partnership on a state by state basis.

It is envisaged that the joint commission, with shared Commonwealth/State governance would be responsible for funding, planning and integrating all health services in that State. Consistent with an agreed plan, the Commission would then buy health services from existing providers – Commonwealth, State, local, NGO and private.

A political agreement between the Commonwealth and any State is essential. If this political agreement is achieved, we would see a more cohesive and integrated health service, delivered much more efficiently. Once the benefit was clear in one State, hopefully other States would follow.

I believe that this proposal would have strong public support. We are tired of the blame game.

Either the Commonwealth government or any State government could initiate the breaking of the impasse.

Background

The Commonwealth Government provides about 43% of national health funding and the State Governments and territories 26 %. Another 31% of funding is from non-government sources (mainly individual users of health services).

In both the NSW and SA health reviews that I chaired some years ago, a view was widely expressed that it’s all very well for State governments to review their health systems, but a major problem is the inefficiency, fragmentation, gaps, cost and blame shifting which results from the different roles of the Commonwealth and State governments in health’. This view was expressed, not only by those working in the health system, but also by the community generally. It was also frequently expressed by the media. The problem of divided responsibilities is well understood. The public doesn’t really give a hoot who plans and delivers health services. The public’s real concern is that the services are provided efficiently and equitably.

Integration of commonwealth and state health functions are essential. Professor John Dwyer, in this blog, estimated   that more than 600,000 state hospital admissions per year could be saved if there was more timely community intervention which is funded by the Commonwealth.

A solution requires a political agreement between the Commonwealth government and at least one State. The political issue cannot be avoided and attempts to get around this issue are likely to be unsuccessful, time-consuming and cumbersome. A bureaucratic or organisational response to a political problem will be unsatisfactory. The issue must be addressed politically. If there is political agreement, governance, financial, administrative and other issues could be successfully managed.

Such an approach would not produce a unified national health system, but six (excluding the territories for the moment) joint health systems which are State-based. Nonetheless, this would be superior to the present division and fragmentation. The six State-based joint commissions may also better reflect the different history and needs of respective States. One size doesn’t necessarily fit all.

The states may also be now more interested in what is proposed here because the 2014 budget suggests that over the next 10 years the Commonwealth will contribute $ 50 b less to state hospitals than the outgoing Labor government proposed. There was no certainty that this 10 year funding would have remained in place but I don’t think there is any doubt however that the Abbott government will attempt to shift more responsibility to the states for hospitals and schools.

A Joint Health Commission in any State where the Commonwealth and the State could agree would have the following characteristics.

1. Coverage of Joint Health Commission

The wider the coverage the better to ensure real and comprehensive resource allocation and integration of services across the full continuum of care. The following programs should be included as the planning responsibility of the Joint Health Commission.

  • State Health (including Health Care Agreement)
  • High level residential aged care
  • Department of Veterans’ Affairs (DVA)
  • Home and Community Care (HACC)
  • Commonwealth Regional Health Services in rural and remote areas.
  • Medical Benefits Scheme (MBS)
  • Pharmaceutical Benefit Scheme (PBS)
  • Aboriginal Health
  • Local Government health
  • NGOs (e.g. nursing services)
  • Public health

State Health, HACC, etc. would tender for the provision of services to the Joint Health Commission. Similarly, local government and NGOs would tender, although allocations to them would probably need to be made through the State Health department.

Private hospitals could probably be excluded from this coverage, as they depend on private contributions rather than direct government funding – except for occasional seed money. But provision should be made for private hospitals, along with local government and NGOs, to tender for supply of services to a Joint Health Commission, (see 3 below). The private delivery of health services should be encouraged where it is consistent with the state-wide plan and is delivered efficiently.

Importantly, existing providers would continue to operate and provide services, and where appropriate, ministers – both Commonwealth and State – would continue to be responsible for their own services. But those services would be purchased by the Joint Health Commission as part of a state-wide plan, which I refer to under ‘functions’ below.

2. Pooled Funding of Joint Health Commission

The Joint Health Commission would receive a negotiated pooled allocation of funds from the Commonwealth and the State government. which reflected the coverage of programs for which it would be responsible (see 1 above), with appropriate population growth and cost indexation add-ons. As a starting point the shares of the two governments would reflect their current funding shares. Changes in the shares and total funding would be subject to the advice of the National Health Performance Authority (NHPA). That Authority would provide public advice to the two governments. The two governments would need to agree on annual funding arrangements.

Whilst confidence in the funding formula is developed, it might be useful to consider shadow funding in the first 3 years and move to actual pooling of funds thereafter.

3. Functions of Joint Health Commission

  1. a) Shared Resource Allocation through the purchase of various services from providers – Commonwealth, State and local government, and NGOs as part of a joint strategic plan.
  • In this case, shared resource allocation can be achieved through the establishment of a minimum set of Commonwealth and State programs.
  • The major changes associated with the JHC would provide an opportunity to move from producer dominated health care delivery to an output/patient focussed delivery system. So many of our health programs reflect provider interests; the MBS reflecting the interests of doctors and the AMA, the MBS reflecting the interests of the Pharmacy Guild and Big Pharma and public hospitals reflecting the interests of their providers, state governments. Patients are a secondary concern. We need to shift to a patient focussed health system in such key areas as chronic, acute and occasional care.
  • Funding would be allocated with agreed short and long term integrated outcomes, rather than siloed program outcomes, with specified standards and levels of performance.
  1. b) Shared Performance Management

Oversee continuous improvement of the health system, monitor progress and establish reform targets and timelines:

  • Development of standard measurement
  • Benchmarking
  • Patient-centred best practices

The NHPA provides an excellent opportunity for the establishment of a system that can meet the needs of consumers, community and health services. The NHPA can provide an approach that examines health status and outcomes, determinants of health, and health system performance.

The NHPA should facilitate the mapping of progress for the population of a State, region or service. It could also be used to examine progress in tackling a particular health problem (e.g. aboriginal health), and to take a wider look at the interface between health and other government departments, the private sector and non-government organisations.

4. Joint Health Commission Governance

The following features could be included, and would ensure full Commonwealth and State government input into the state-wide plan:

  • Membership of the board should be high level to enable strategic decision-making on broad and longer-term issues.
  • Maximum transparency and disclosure of the Joint Commission’s work and final recommendations in order to neutralise special pleading and vested interests and to ensure public understanding and support.
  • The board of directors must have clear ‘governance’ responsibility and not a junior role. They should reflect the broad interests of the whole community and not be seen as representative of the Commonwealth or State or ‘insider interests’ that so dominate health systems in Australia.
  • Independent chair appointed by the two Ministers from a short list provided by the respective Commonwealth and State Health CEOs. It might be useful to have the chair from another State.
  • Apart from the chair, no jurisdiction to have more than 50% representation.
  • Representation could include other Commonwealth and State jurisdictions (e.g. Indigenous Affaires) and people having experience in the private sector.
  • The board would appoint the CEO who would be responsible to the board and not the two jurisdictions.
  • The board would approve the strategic plan and budget.
  • A constitution may be useful to provide more user-friendly objects, role, function and operating procedures, including engaging the private sector.
  • Subsidiarity should be an important principle for governors in developing the state-wide plan. Management and service delivery should be driven down to the lowest and most local level possible, consistent with state and nation-wide standards.
  • The Board should have a small secretariat, but rely on Joint Health Commission for planning etc. It must avoid a new level of bureaucracy.
  • Board costs would be shared by Commonwealth and State.
  • The Commonwealth and State minister would be responsible for negotiating high-level policy principles, including overall funding on the advice of the board. This would help reduce the risk of the board dividing on Commonwealth/State lines. Ministers must reach broad agreement if the Joint Health Commission is to work.
  • The board should be responsible to the Commonwealth and State minister, with one financial report to both. If there is not agreement between the two ministers, there would be a public dispute resolution procedure which would encourage cooperation and dialogue between the two ministers. This would encourage public trust in the integrity of the process. I would expect that this would produce an agreement in almost all cases. If resolution is not possible, the Commonwealth minister would prevail; given the need for a stronger national role and that the Commonwealth Government provides 43 % of national health funds compared with 26 % by the states.

These governance arrangements could be reviewed in 5 years.

Summary   

A Joint Health Commission established upon agreement of any State with the Commonwealth would be a substantial improvement on the present arrangements. It would help break the impasse on federalism and better integrate health services. It requires a political decision between the Prime Minister and premier.

The public is tired of the blame shifting and fragmentation in health and would respond to a sea change such as this. Such a joint health commission in any State that agreed would help achieve what both of them are seeking in health – a better integrated health system and a favourable community response, A committed Commonwealth government could use its financial leverage to make such an offer attractive to the states.

A Joint Health Commission in any one State could begin to address the ‘big ticket’ problems in health delivery – the Commonwealth/State fragmentation, an eroding primary health care system, an antiquated workforce structure and obvious system failures in safety and quality.

Of course, the fragmentation in health is not just caused by Commonwealth-State fragmentation. The two big Commonwealth programs – MBS and PBS – are not effectively integrated.

All these big-ticket issues are lost sight of in the argy-bargy of Commonwealth/State blame and cost shifting.

Not only would a Joint Health Commission in one State be a substantial improvement, it would also be very symbolic, demonstrating that governments can address hard political issues in a cooperative way.

We must stop asking continually for more money or tweaking the health dollars, when many problems are structural. A lot of health spending is counter-productive – throwing money at problems to get them out of the media or for short-term political gain, rather than solving systemic problems. Any increase in health dollars must be accompanied by system change. A Joint Health Commission starting in one State is a sound way to begin breaking the impasse.

The key is political will by ministers. If there is the political will, the governance problems can be resolved.

There is no reason that the principles proposed above in health could not be applied in other fields such as education.

John Menadue AO was formerly Secretary Department of Prime Minister and Cabinet, Secretary Department of Trade, Ambassador to Japan and CEO of Qantas.

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Michael Keating. Taxation Reform

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue. 

Oliver Wendell Holmes, the great American jurist, is reputed to have said, ‘I like to pay taxes. In this way I buy civilisation.’ However, in contrast to Holmes’ noble ideal, too often today we hear people railing about the burden of taxation, as though it is in some way an unfortunate even illegitimate imposition upon ourselves, our economy, and our way of life.

Lower taxation has been embraced by all political parties without any evidence that, given our already low starting point, less taxation will in fact lead to higher economic growth, let alone pay for itself. Indeed there is no evidence that the advanced economies with high growth rates of per capita income have lower levels of taxation. Nor have past cuts in our income tax led to faster growth, such as when the top income tax rate was reduced from 60 per cent to 45 per cent.

So as John Howard put it when he was Prime Minister, tax cuts should be considered ‘after you have met all the necessary and socially desirable expenditures’ (my emphasis). And as I argued in previous articles (posted 6/4/2015 and 23/7/2014), all the evidence is that these expenditure demands, even if efficiently funded, are most unlikely to be fiscally sustainable without a modest increase in taxation relative to GDP.

Indeed Australia already has lower taxation than almost any other advanced nation, but we aim to provide the same level of public services and welfare as the others.

Thus the biggest challenge facing modern governments is the gap between expectations on them and their capacity to deliver. In these circumstances, encouraging unrealistic expectations of tax cuts is only making government more difficult.

In fact each of the major tax reform packages in 1985 and 2000 did not achieve any reduction in total taxation. Instead they were about changing the tax mix in favour of more efficiency, revenue protection and/or more equity. Although some tax rates were lowered – notably income tax to offset past bracket creep that had pushed more people into higher tax brackets – but these reform packages did not lead to any reduction in taxation overall.

Revenue Outlook

Projections in the Budget and the Intergenerational Report (IGR) show the ratio of Australian Government taxation revenue to GDP rising from 21.9 per cent in 2014-15 to an assumed maximum ratio of 23.9 per cent reached around 2020, and then maintained beyond. This 23.9 per cent ceiling for future taxation is the same on average as during the Howard Government years following their tax reforms starting in 2001-02.

Consequently if taxation revenue went back to where it was after the Howard Government’s tax reforms and before the GFC it would be about 2.0 percentage points higher than now. Furthermore, as I argued in yesterday’s blog on Fixing the Budget, restoring taxation revenue to this extent over the next few years would most likely be consistent with what needs to be done on the revenue side of the Budget to maintain long run fiscal sustainability. It would also be consistent with what the Government apparently regards as an acceptable level of taxation.

One significant difference, however, is that my proposals (below) do not rely on bracket creep as taxpayers move into higher tax brackets, whereas as much as 85 per cent of the increase in taxation revenue presently projected in the Budget relies on bracket creep.

The problem with this reliance by the Government on extra revenue through bracket creep is that according to the Treasury someone on full-time average earnings can expect to enter the second highest 37 per cent tax bracket in 2015-16 if the present income tax rate scale is maintained, and the average tax rate faced by such a taxpayer will have increased by 5 percentage points between 2013-14 and 2023-24. Furthermore, unchecked bracket creep in income taxes tends to be highly regressive, impacting more than proportionately on lower income earners.

As in the past, any government is therefore likely to want to provide future income tax cuts, at least sufficient to offset the impact of unchecked bracket creep. The Government itself recognises this and has promised lower taxes after the Budget returns to surplus. But this is not expected until sometime after 2020, and by then the Government will be relying on all of the extra revenue from bracket creep until that time. On the other hand if some of that extra revenue from bracket creep were returned to taxpayers through a reduction in income tax rates, then of course this would increases the amount of extra revenue or extra expenditure savings that would need to be found elsewhere.

Tax Reform Options

Accordingly it is necessary to consider the alternatives to this reliance by the Government on bracket creep to boost its income tax receipts. Instead I propose to consider the options for another round of tax reform, but especially having regard for the present deficit budget outlook and future expenditure demands, and the consequent need to raise more revenue both at the Commonwealth and State levels of government.

Strategically there are three broad approaches in these circumstances to taxation reform:

  • Broadening taxes
  • Adjusting the mix of taxes
  • Changing the tax rates

Typically tax reform involves a balanced mix of all three approaches. The task is to convince the public that the outcome is a more efficient system, especially in terms of its economic impact, that will raise the revenue that is necessary, but not more than necessary, and that it is fair.

Retaining company tax and broadening taxes

Judged against these criteria it is suggested that the best options to start with would be to:

  • Not cut the company tax
  • Broaden the tax base

Despite the lobbying by the business community, there is no need to cut the company tax rate. This would mainly advantage foreign investors, but the evidence is that Australia has no difficulty in attracting foreign investment. Instead, because of dividend imputation a cut in company tax would lead to lower imputation credits, and not benefit Australian investors much; indeed it could disadvantage Australian investors if it was financed in part by removing dividend imputation.

In a previous posting (22/7/2014) I discussed the possibilities for broadening the tax base. In brief, the possibilities that would seem to have the most positive impact as well as raising extra revenues are

  • Reducing the favourable taxation of superannuation. The present tax concessions are more than necessary to encourage this form of savings for retirement, and they are inequitable, with more than half their value accruing to the top 20 per cent of income earners.
  • Removing the 50 per cent capital gains discount. This discount is a distortion and its removal would help improve the efficiency of the housing market in particular, and make homes more affordable to new home buyers. Some commentators have similarly argued that negative gearing should no longer be allowed under the income tax, but strictly this is not a distortion because interest is a normal deduction before deriving taxable income.
  • Restoring carbon pricing which is the most efficient and effective way of reducing carbon emissions and the risk of climate change.
  • Removing the tax credit for fuel excise and increasing that excise. There is no economic case for subsidising one type of input to only some producers. Indeed it would be better to encourage greater fuel efficiency by increasing its price over time, up to say the price levels in New Zealand, and then fully indexing the excise rate.
  • Improving the anti-avoidance measures. The Government is proposing some such action in this Budget, but much more needs to be done and can be done to protect the revenue.

A rough estimate is that these measures would increase annual tax revenues by around $29 billion when fully implemented; that is equivalent to filling the remaining gap of around 1.5 per cent of GDP that is needed to ensure ongoing fiscal sustainability after allowing for the expenditure savings identified in yesterday’s article on Fixing the Budget. 

Changing the tax mix in favour of more reliance on the GST

The other major possibility for base broadening which would increase the revenue substantially is the GST. The proceeds, however, of the GST accrue entirely to the States, and so they cannot be used directly to improve the Federal Budget. Nevertheless, if these extra GST transfers were used to offset reductions in some other payments by the Australian Government to the States, then such an increase in the GST could help restore and maintain Australia’s fiscal sustainability over time.

The implications of such a strategy based on an increase in GST revenue will mainly be discussed in tomorrow’s article on Federalism. Suffice to say here that the coverage of the GST is now only 47 per cent of total consumption, down from a peak in 2005-06 of 56 per cent, which was close to the OECD average, but much less than in New Zealand where 96 per cent of consumption is taxed.

If the GST base were broadened to include expenditures on food, child care, private health and private education, and water, sewerage and drainage, the total GST revenue would be roughly doubled raising revenue by more than $50 billion extra each year. While an increase in the tax rate from the present 10 per cent to 15 per cent on the present GST base would raise around another $25 billion each year, and on the extended base it would raise around another $100 billion annually.

The experience of the Howard Government, however, when it first introduced the GST was that a very large part of the proceeds were used to compensate lower to middle income families who were deemed to be disproportionately disadvantaged by the new tax. If that precedent continued to apply it might be prudent to assume as much as one third of the extra revenue would be needed for this purpose and not available to improve long-run fiscal sustainability. Indeed if the GST base were broadened as described above to include expenditures on food, health and education that are regarded as essential, then the pressures for compensation might be even greater[1].

Of course less substantial changes in the GST could readily be contemplated. The size of the package would probably depend mainly upon what is the preferred basis for future Federal-State financial relations and the overall governance arrangements for the Australian nation. As already indicated these issues will be explored in tomorrow’s article, but even if no substantial change in our federal-state financial relations is envisaged, a modest package of GST reforms to increase the revenue would be a good option if the other policy changes already canvassed do not prove sufficient to ensure on-going fiscal sustainability in the long run.

Increase in the income tax rates

As noted the income tax rates will effectively increase over time if nothing is done because of bracket creep as incomes rise and tax payers move up the rate scale. But this is an arbitrary and unfair way of raising additional revenue if that were needed. Instead in that case it would be better as a matter of deliberate decision to introduce a new income tax rate scale. Such a new rate scale could at least maintain the present progressitivity of the income tax rather than letting it degrade in an arbitrary way.

A further consideration is the overall tax mix. Many argue that Australia is too dependent on the taxation of income and that there should be more reliance on taxation of expenditure. In fact if we allow for various forms of compulsory social security contributions plus payroll taxes then direct taxes in Australia comprise around 63 per cent of total taxation compared to an OECD average of 61 per cent. This suggests that the present balance between direct and indirect taxation in Australia may well be sustainable. Nevertheless if additional revenue is needed to ensure long-run fiscal sustainability then it would be prudent to consider the options for increasing the GST before an increase in income tax rates.

Dr Michael Keating AC was formerly Secretary of the Department of Finance, and Secretary of the Department of Prime Minister and Cabinet.

[1] According to the Treasury, as a proportion of total spending, lower-income and higher-income households spend a similar proportion on GST-exempt goods and services in aggregate. However, while households may spend a similar proportion of their total spending on GST-exempt goods and services in aggregate, this is not necessarily true for the individual exempted categories of spending. For example, lower-income households may be more likely to spend comparatively more of their total spending on GST-exempt food, medical products and health services, or residential rent. Conversely, higher-income households may be more likely to spend comparatively more of their total spending on GST-exempt education or childcare services.

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Arja Keski-Nummi   Andaman Disaster – Regional Cooperation on Refugees

Current Affairs

The crisis in the Andaman Sea provides an opportunity for the Australian Government through our Foreign Minister Julie Bishop as Co-chair of the Bali Process on People Smuggling, Trafficking and Related Transnational Crime to give the process some teeth and credibility in the region. This is a good opportunity for us to help others just as they have helped us in the past with regard to people movements.

Five countries that are part of the Bali Process are facing a crisis that is drawing negatively the attention of the international community on the region; unprecedented since the Indo Chinese outflows of three decades ago.

Australia should be approaching the other Co-chair, Indonesia, to work with affected countries in examining what can be done to both tackle the people smuggling/trafficking ventures that are preying on vulnerable people in Bangladesh and Myanmar and how best to ensure the safety and security of people who have been affected by such predatory behaviour.  In its 2013 communiqué ministers “underscored the importance of addressing humanitarian and protection needs in managing irregular movement”.

Now is the time to enliven the April 2013 communiqué of the Bali Process Ministerial meeting in which in its penultimate paragraph:

“Ministers recognised that the root cause of irregular movements in the region were complex and multidimensional and encouraged members to continue to work with countries of origin, including through development cooperation, to address where possible underlying factors which made people vulnerable to irregular movement.” 

This communiqué called for greater regional cooperation and work on:

  • People smuggling and trafficking. From the reporting we have seen on this latest humanitarian disaster a people smuggling venture has quickly turned into trafficking.
  • Development of a “protection-sensitive regional approach” – the aspirations of which are to have consistent assessment processes for asylum seekers, and where appropriate and possible harmonised arrangements or the establishment of regional assessment arrangements.
  • Identifying in the region the perceived increase of labour trafficking and how this might be tackled by working with civil society groups and business.
  • Working with countries to address the root causes of such movements

All of these concerns are present in the current situation of the people on the boats in the Andaman Sea.

We should with our Co-chair seek to convene a special high-level ad-hoc group under the Bali Process banner to pull together a practical cooperative action plan that would provide assurances to affected destination countries that the burden is not theirs alone.  This group could comprise the five affected countries, Australia as co-chair and the three international agencies UNHCR, IOM and UNODC.

Such assistance could include:

In Destination Countries:

  • Assistance with initial screening and identification of people with protection concerns or who are victims of trafficking. A multinational task force (comprising nationals of destination countries as well as other Bali Process countries such as Australia and new Zealand) led by UNHCR to undertake that initial screening,
  • Flying in emergency assistance for shelter and medical support with the agreement of affected countries
  • Creation of safe havens pending final determinations –where the burden of costs is shared.
  • Assistance with local integration in certain circumstances through regional social investment projects in housing, health and education services that benefit the indigenous communities as well as new arrivals.
  • Commitments to resettlement of recognised refugees over a period of time.
  • Greater support for return through assistance in innovative new labour creation projects through social investment projects and micro financing schemes.

In Source Countries:

For the Rohingya the solution lies with Myanmar conforming to international norms in relation to the treatment of its citizens.  While Myanmar does not recognize the citizenship of a segment of its population and actively discriminates against them through property, education, movement and marriage laws this situation will continue.  The solutions have to lie in policy changes with the Myanmar government. As Myanmar emerges out of its self-imposed isolation regional institutions such as ASEAN have the opportunity to provide a constructive environment within which Myanmar can address the policy problems of this issue.  Complementary to this an ad hoc group as proposed above could provide practical assistance to ASEAN in mapping out strategies for supporting Myanmar in improving the conditions of Rohingya in Myanmar.

Bangladesh has been a source of labour migration for decades.   Traffickers prey on the vulnerabilities of people desperate for work where there is none. Overpopulation, corruption, lack of opportunities, international demand for cheap labour all play into the hands of traffickers.  There is no easy solution to this cocktail of misery compounded by a lack of political stability in Bangladesh. While the Bangladesh Government has created a legal and administrative infrastructure to combat trafficking – “The Human Trafficking Deterrence and Suppression Act 2012” and the “National Plan of Action for Combating Human Trafficking for 2012 – 2014” and coming out of these instruments established a number of different strategies covering training, awareness and education as well as greater law enforcement measures, the problem remains overwhelming. According to the 2014 US Department of State Trafficking in Person Report, of 215 cases initiated for prosecution in 2013, a total of fourteen people were convicted of trafficking.  There are no reliable figures on how many people were trafficked in this time but conservative estimates put it in the tens of thousands. Given these most recent developments, a Bali ad-hoc group with Bangladesh as an active participant can continue a process of working with Bangladesh in strengthening the strategies it has in place and working with civil society in the country in providing protections and safe haven for people at risk of being trafficked.

Smugglers and Traffickers – the raison d’etre of the Bali Process is to combat People Smuggling and Trafficking. Despite many countries in the region enacting laws against people smuggling and trafficking and the imposition of ever-greater penalties for smuggling and trafficking it remains one of the more lucrative and risk free ventures in the region.  Tackling this through laws and awareness campaigns while important is not enough. These loose coalitions of interest groups and syndicates are like a many-headed hydra quickly adapting and changing techniques and operations to prevailing conditions. Again the issue must be tackled at its source – in this instance most likely Bangladesh. The proposed ad hoc group could start the development of a strategy to support Bangladesh and other countries named in the US State Department TIP reports to strengthen its approaches against traffickers and recruiters and the victim of smugglers and traffickers.

This is a global problem, which will only increase, and we cannot isolate ourselves from it. While for the time being Australia may have stopped the boats – this policy is not sustainable into the longer term. It is in our national and regional security interests to help stabilize populations and to play our part in the region. 

Arja Keski-Nummi was formerly First Assistant Secretary in charge of refugees in the Department of Immigration and Citizenship.

Posted in 3. CURRENT AFFAIRS, Australia and Asia, Guest bloggers, Politics, Refugees and asylum seekers | Tagged , , , , | Leave a comment

John Dwyer. Politics trumps health policy yet again.

Current Affairs.  Health.

A new medical school in Perth will create more problems than it will solve.

 As must also be true for many colleagues who have been focussed on evidence based solutions to the serious shortage of Australian trained doctors working in rural communities, I am frustrated and annoyed by the Prime Minister’s capricious decision to fund a new medical school in Perth. In an attempt to solve the maldistribution of Australian trained doctors that has resulted in almost 50% of the General Practitioners available to people in rural and remote communities having been trained overseas, governments have applied a “market place” philosophy to the problem. This logic suggested that if we doubled the number of Australian trained doctors there would inevitably be competition for rural careers, as metropolitan opportunities would all be taken! In 2016 our intake of Australian students into medical schools will peak and many readers will know that (a) we are already having difficulty in finding quality clinical placements to maintain educational standards and (b) the flood of new graduates has done nothing to ease the shortage of Australian doctors working in “the bush”. This continuing problem is responsible for much unacceptable inequity with health outcomes in all categories being less satisfactory for rural Australians. Were rural patients able to access medical services as readily as their city cousins it would increase Medicare payments by two billion dollars a year!

Here is the irony. To solve this problem we do need new medical schools but not schools situated in metropolitan areas providing a standard metropolitan centric curriculum. Here is the major cause of frustration. At least three thorough enquiries seeking evidence-based strategies to address the above inequity have been conducted in the last four years and all have agreed on the major initiatives required. These have been presented to government and as far as I know only one of the suggestions has been accepted (but not implemented).

There is abundant national and international experience that tells us that medical students who will actually want and pursue a rural career are students who are emotionally, intellectually and even financially wedded to a preference for rural life and hence a rural career. The closest we have come to applying this knowledge involves all medical school having a quota for 25% of their students to be “rural”. The definition of what constitutes “rural” is ridiculous. You are so designated if you have spent five years of your life in a rural postcode. You could have been born in Broken Hill, moved to Melbourne when you were five and not laid eyes on a cow since then but still qualify as “rural” student. The accepted suggestion referred to above would see medical schools fined if they did not achieve their 25% quota.

At least five universities have been lobbying government for funds for rural based medical school.  In general these would involve expansion of excellent existing rural clinical schools into rural medical schools. I have been heavily involved in developing an evidence-based initiative proposed by a Charles Sturt/ Latrobe partnership for the Murray Darling basin. As had been true for other universities both the Gillard and Abbott governments have said they were attracted to the models but there was no money available. In the background many existing medical schools, concerned that such developments might require them to reduce the number of students they admit, have argued against the establishment of rural schools. Now to have the Abbott government, without consultation with key players, announce a Perth based medical school is nothing short of disgraceful; a “keep WA happy” imperative trumps any need to improve the health of rural Australians.

What are the key recommendations that we must continue to pursue despite the damaging political intransigence so far on display? Space will only permit a summary.

Create opportunities for whole of medical education requirements to be fulfilled in the country, too many medical graduates dependent on city placements for vocational training will not return to a rural community. For this reason rural medical schools should be based on undergraduate programs. Admission to a rural based medical school will involve “affirmative action” philosophies to provide for example, the flexibility to overcome rural high school educational disadvantage and an interview to assess genuine “rurality”. Students will enjoy a rural specific curriculum with an emphasis on early development of procedural skills and a focus on indigenous health issues. The medical course will have strong inter-professional learning modules that will involve shared learning with other health related students. Team learning to prepare for team medicine is an imperative for the best use of a scare workforce in the country. Graduates will be guaranteed an internship in a rural based hospital. It is worth debating the merits of redistribution of existing medical school placements rather than increasing further the number of enrolled students.

A lot of work by dedicated knowledgeable professionals from a number of universities, rural community advocates, the now defunct Health Workforce Australia and numerous rural health organisations has generated the above suggestions and all would have expected that a rural based medical school with the above features would be the “next cab of the rank”.  ‘How naïve’ says Mr. Abbott.

John Dwyer is Emeritus Professor of Medicine at UNSW. 

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Michael Keating. Fixing the Budget – Part 2

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

The previous article on fixing the Budget concluded that the Government’s plan to balance the Budget by 2019-20 was not really credible. It relies too much on unsustainable increases in taxation as a result of bracket creep, and too many of the expenditure savings are unfair and unlikely to be realised.

This article will instead outline an alternative strategy for fixing the Budget. The starting point is the reported deficit equivalent to 2.6 per cent of GDP for the current fiscal year which is nearly over. As the economy recovers and reduces its present spare capacity some improvement in the Budget bottom line can be automatically expected. Thus to achieve a modest Budget surplus policy decisions to reduce spending or increase taxes need to amount to an annual total of around 2.5 per cent of GDP. It is further suggested that the timetable for this return to fiscal stability set by the Government involving a reduction in the deficit equivalent to about 0.5 per cent of GDP each year is about right.

As discussed below fair and effective policy decisions to produce a 2.5 per cent net improvement in the Budget balance should be possible. However, savings of this magnitude, even over four years, are substantial. As the Government has itself now recognised significant savings will not be achieved by further raids on the public service or on foreign aid which account for a relatively small part of the total budget and have already been severely cut.

Instead the major areas of expenditure and potential savings are in health, schools, and infrastructure, while pensions might also be tightened up marginally. What is needed is a long-term plan that will progressively lead to major reforms of these functions. Past experience in the 1980s and 1990s is that the public will accept the savings needed for fiscal repair if they are seen to flow from genuine reforms that are shown to be necessary, fair and effective. Indeed John Howard has been reported as drawing the same conclusion only a couple of weeks ago.

While the reforms proposed in this article are discussed in more detail in later postings in this series, their fiscal implications are summarised here.

Expenditure savings

The decisions in last year’s budget that met most resistance and were ultimately rejected were largely attempts to tighten eligibility and reduce income support payments or to increase user charges. The problem with this approach is that Australia’s welfare system is not regarded as over-generous and is already very tightly targeted – indeed the most tightly targeted in the world. Similarly user charges or co-payments are also substantial for many government funded services such as tertiary education and health services.

Modest changes to further tighten eligibility, say by increasing the stringency of the age pension means test, such as those in the 2015-16 Budget, will probably win approval on equity grounds. However, the changes in the 2014-15 Budget that left most low income people substantially worse off were bound to seem unfair.

Instead expenditure savings are much better focused on reforms whose avowed purpose is to improve the efficiency and effectiveness of government programs, and thus give better value for the money spent.

The main savings measures directed to improving program efficiency have been the decisions to change the payments to the States for schools and hospitals, saving $80 billion over the next decade. These savings effectively presume that efficiency of schools and hospitals can be improved commensurately and that the States, which operate these institutions, are best placed to identify the necessary efficiency improvements.

Arguably schools efficiency could be increased through some combination of larger class sizes, more face to face teaching time, and less support services. The counter-argument is that the quality of education and outcomes would suffer. On the other hand, the 25 per cent increase in real per student expenditure over the twelve years to 2011 (and probably more since) does not seem to have produced any improvement in quality. Logically some of that 25 per cent real increase in funding could be reversed without damage. Indeed educational research suggests that improvements in the professional development of teachers and the provision of more specialist teachers for those with special needs is much more valuable than the relatively expensive reductions in class size and extra auxiliary staff.

There are, however, strong arguments that any efficiency savings in schools achieved through reduced staffing should not be used to reduce total school spending. Instead these savings should be used to improve the capabilities of schools serving disadvantaged communities.

The Gonski Report showed the extent to which school funding needed to be redeployed if we are to get better outcomes. At present that Report’s recommendations are unlikely to be implemented unless funding can be switched in favour of poorer schools. The consequent improvements in educational outcomes for national productivity and participation would lead to much bigger gains than using school efficiency savings to improve the Budget balance.

The introduction of case-mix funding where hospitals funding is determined by the efficient cost of each procedure has led to reductions in costs. In some States there is scope for further progress in this way, but in others this system is now mature, and the scope for further efficiency gains is more problematic. Changes in the organisation of the workforce, as proposed by John Menadue (postings 25 & 27 January), to reduce the present demarcation, and increase multi-skilling, broad-banding, up-skilling and teamwork of all medical staff could also produce further gains. These are roughly estimated to amount to annual savings of as much as $8 billion, although less than half of these savings would occur in State run hospitals.

Furthermore, there is no certainty that these savings through better use of the workforce skills in State hospitals will ever be pursued. Instead it may well be that the Commonwealth will agree with the States at a meeting in July to increase their funding by increasing the GST. This would take the pressure off the States to seek these productivity improvements and could leave entrenched the various vested interests opposed to changes.

The largest savings in health expenditures are, however, most likely to come from various changes aimed at keeping people out of hospital, and these mainly do not involve the States. Furthermore, these savings are generally agreed by health experts as revealed in previous postings on this blog.

Most importantly primary health care would be re-organised to make better use of nurses, allied health workers and ambulance staff; and this would achieve much of the $8 billion savings identified above in relation to workforce practices.

Second, programs and funding would be reorganised to serve communities rather than providers. Alternatives to fee for service payment structures, at least for chronic and long-term care, would create incentives for delivering high quality care that is cost-effective, rather than the present incentives to over-service.

Third, the Health Insurance Rebate, which is clearly not cost-effective and mostly a subsidy to higher income people and their specialists, should be abolished, saving at least $7 billion annually.

John Menadue has estimated that these reforms could eventually save $15 billion annually, although he recommends spending some of the proceeds on making dental care more readily available. The Grattan Institute has a more conservative estimate of the savings from a less ambitious package, but still finds $9 billion annually from health expenditures. Professor John Dwyer has argued that even Menadue’s estimated savings are too low, and Dwyer cites overseas experience to suggest that these reforms would lead to 30-40 per cent reduction in hospital admissions over ten years.

Whatever is the correct estimate of these health expenditure savings, implementation of the reforms would of course result in a substantial saving to the States. All the responsibility for these reforms, however, lies with the Australian Government and not with the States and its Budget is the biggest potential beneficiary.

If we want to prevent a long run rise in inequality then pensions need to keep pace with average weekly earnings, even if the timing of the increase is adjusted to allow more discretion to respond to budgetary circumstances than at present. Indeed the gap between pensions and other benefits, such as NewStart presents an equity problem, and this gap should be reduced notwithstanding the cost to the Budget. In addition, the evidence suggests that pensioners who do not own their home and rent are doing it tougher than home-owners and that rent assistance is another priority for an increase.

Effectively the scope for further Budget savings in social security payments is very limited. Tightening means tests to allow for the family home is probably the main opportunity. It would improve equity, and could be done in ways that did not damage the pensioner’s income, but reduced any bequests after death.

Raising the age of eligibility further is another savings option proposed by the government. This may have merit some time in the future, when the skills of older people are higher than now, and they could compete for jobs. But for the moment too many older workers are not competitive in the labour market to make this a viable option. Instead it is more likely that for the next several years many of these low-skilled older workers would continue on other pensions and benefits if they were no longer eligible for the age pension.

On the other hand major savings in infrastructure spending could be made if the reforms proposed (in an article to be posted next week) were introduced to ensure:

  • cost reflective pricing of all infrastructure,
  • better planning and design of transport improvements, and
  • much tighter project assessment based on mandatory cost-benefit analysis.

The Australian Government is planning to spend $37.9 billion on roads alone in the six years from 2014-15 to 2019-20 inclusive, but all bar one of the projects envisaged have not met the above criteria. Accordingly the opportunities for fiscal savings that would actually improve cost-effectiveness and productivity are very substantial; a conservative estimate is that insisting on the above criteria would save at least $10 billion over the next four years, and probably more.

Conclusion

The Government’s projections show that the Budget will record a small surplus by 2019-20. This surplus is shown as continuing, although declining at least until 2025-26. However, as yesterday’s first article on Fixing the Budget demonstrated the assumptions underpinning these Budget projections must be doubted. Instead, the longer-term ‘presently legislated’ scenario in the Intergenerational Report provides a more realistic assessment of future Budget outcomes under this Government’s policies, especially in the longer term. Thus the IGR suggests that even if a surplus were reached in 2020, the Budget would subsequently start slipping back to unsustainable structural deficits later on.

Overall a rough estimate is that net savings in expenditures reaching around $20 billion annually should be possible in the Australian Government Budget over the next 4-5 years, mainly from health and infrastructure if genuine reforms were introduced. That would reduce expenditures by about 1 per cent of GDP compared to the cost of presently legislated policies.

Further additional savings in health and infrastructure might be possible beyond 2020, along with some in other areas, so that about half the projected fiscal gap of 2.5 per cent of GDP in 2055 might be closed by expenditure savings. But it is difficult to envisage that all of the projected fiscal gap could be closed without an increase in projected revenue roughly equivalent to 1.5 per cent of GDP. Unlike the present Budget, however, this revenue increase should not come from the proceeds of bracket creep. Instead it should be the result of deliberate decisions to broaden the tax base and/or to increase tax rates.

Indeed, much of the criticism of the 2014-15 Budget was based on the view that more of the fiscal tightening should have been on the revenue side of the Budget. Still it is also important that reforms are introduced in major spending areas such as health, schools and infrastructure and savings are realised, as people should not be asked to pay more taxes to finance inefficient expenditures.

The scope for reforming taxation will be discussed in the next article to be posted tomorrow.

Dr Michael Keating AC was formerly Secretary of the Department of Finance, and Secretary of the Department of Prime Minister & Cabinet.

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