Why the States hold the key to pandemic recovery


The States and Territories didn’t always agree on how to respond to the twists and turns of COVID-19, but together with the Federal Government they agreed on the big picture roadmap to manage the crisis, writes Suncorp Chief Economist Paul Brennan.


Why the States hold the key to pandemic recovery

A critical element in that big picture response was the joint Federal and State budgetary stimulus that succeeded in limiting the loss of jobs. But particularly for the States and Territories it has exposed their fragile financial funding positions and their ability to contribute to economic reforms that could drive the nation forward in the post COVID world.

In the first phase of the crisis the Federal Government provided the lion share of fiscal stimulus with the International Monetary Fund (IMF) estimating expenditure and revenue measures by the Federal Government are worth $267bn, or a massive 13.75% of GDP.  

However, with JobKeeper and other support programs either ending or being replaced with more targeted programs, RBA Governor Lowe has noted the role of state and territory governments in supporting the national fiscal response. He called for the states to spend an additional 2% of GDP over the next two years to almost double their cumulative fiscal stimulus from the current 2.5% of GDP.  

Lowe’s suggestion is for the additional spending to be temporary and targeted on energy, transport, housing and schools. These are areas where state governments already have a responsibility and as such would broaden the scope of fiscal support across more parts of the economy.  

But just as the federal government faces calls for permanent increases in spending on aged care, state and territory governments are also under pressure from with their own jurisdictions for what will amount to permanently higher spending. And the States and Territories do not have the taxing options of the Federal Government, like a Medicare style levy, to meet significant spending pressures. 

Some of these financial pressures on the States have been turbocharged by the pandemic.

Most notably, the movement of population to regional centres, if sustained, will require more longer-term investment in regional infrastructure including hospitals, schools, transport, recreation facilities, mitigation and digital capability. 

At the same time state governments will likely be reluctant to reduce support for their capital cities, which have suffered from the closure of the international border, zero immigration and accelerated population outflows. While Sydney and Melbourne particularly see themselves as global cities, competition to attract global talent, capital and emerging technologies will probably be more challenging as the world looks for new drivers of growth.  

The States and Territories are also the first responders to natural disasters, which by definition are geographically concentrated. Whether it is providing financial support for affected communities and regions or taking measures to mitigate or to adapt to climate change, State governments will face increasing calls on their budgets.  

The States and Territories will also be asked to play an increasing role to meet the challenge of lifting the nation’s productivity. The most recent Productivity Commission five-year review identified services, particularly related to health care, education and cities, where reforms could deliver significant national income gains. In so doing they noted that “at the grass-roots level, state and territory governments often have the most responsibility for service delivery, and therefore the strongest capacity to introduce policy innovations.” 

However, economic reforms often involve upfront costs before the benefits are realised. An example is the NSW Government’s recent budget proposal to give property buyers the choice of paying either stamp duty or land tax. Removal of stamp duty on property conveyance was a key recommendation of the Henry review of taxation and recently Henry again called for its replacement with land tax. However, the Treasury estimates the NSW Government proposal will cost the state budget $11bn in the first four years before ultimately it is revenue neutral.  

Adding to these financial woes, the revenue base of the State Governments is highly reliant on funding from the Commonwealth Government. Moreover, around half of the funding from the Commonwealth comes in the form of specific purpose payments for health, education, housing and other expenditure. The remainder is nearly all redistributed as untied payments funded by GST revenue collected by the Commonwealth on behalf of the states. It is therefore ironic that some of the states do not support an increase in the GST rate.  

Last year the states could finance their large deficits and growing debt at record low interest rates. Even the loss of NSW’s and Victoria’s prized AAA rating had little impact on their funding costs. But since then long-term bond yields have almost doubled as market pricing factored in economic recovery from the pandemic and fears of inflation. This highlighted how quickly conditions in funding markets can change, challenging budget forecasts, the cost-benefit calculus of spending programmes, and reinforcing the urgency of Commonwealth-state government financial reforms.  

These financial reforms also will be an important building block to unlocking broader economic reforms as Australia seeks to achieve a strong and sustained recovery from the pandemic. 

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