End the fuel subsidy
A comment reminded me that I hadn’t posted last week’s Fin article, advocating abolition or phasing out the fuel subsidy in Queensland> It’s over the fold. Also, since letters about me in the Fin usually have a heading like “Quiggin wrong”, or worse, let me thank Greg McKenzie whose letter commenting on the article was headed “Quiggin the best”. Thanks!
The only way out for Bligh
The Rudd government faced a difficult task in framing last week’s Federal Budget. But ‘difficult’ is a relative term. For a national government with access to the income tax, which can always be adjusted to produce more revenue, there are always plenty of options, even if none of them are appealing.
The situation facing state governments is far worse. The tax rate only large source of revenue, the GST is fixed by Commonwealth law at 10 per cent, and any adjustments to the base are also at the discretion of the Commonwealth. Payroll tax is more flexible, but no government would want to increase payroll taxes in a recession. Another large chunk of revenue comes from Commonwealth grants. The remaining sources of state revenue consist of narrowly based taxes, largely dependent on transaction volumes, and vulnerable to economic fluctuations.
Expenditures are similarly inflexible. State governments are the frontline providers of most of the public services Australians depend on, from police to public hospitals. Cutting such expenditures to balance budgets at a time of economic downturn is both socially and economically nonsensical.
At least state governments have the capacity to borrow, and have been supported in the current crisis by Commonwealth guarantees. The disastrous situation in the US, where core public services are being shut down at the state level, even as the Federal government seeks to stimulate the economy through additional spending, provides a good illustration of what not to do.
The Queensland government faces a particularly difficult situation. Rapid population growth calls for substantial investment in infrastructure, but much of this infrastructure does not yield a financial return. The existing mechanisms of fiscal federalism are focused on current expenditure needs and are poorly adapted to a situation where one state has greater capital expenditure needs than others.
Before the recent state election, the government took the tough, but necessary, decision to accept a downgrading of its credit rating rather than cut necessary investment. Unfortunately, it ducked some other tough choices. In particular, the government promised that it would continue to maintain its fuel subsidy scheme, or at least ‘a fuel subsidy’.
The fuel subsidy, unique to Queensland, began with a 1997 decision by the High Court, which struck down the ‘franchise fees’ on petrol sales charged by other state governments. The Federal government respond by introducing an 8.1 cent/litre excise tax, the proceeds of which were handed over to the states. Rather than strengthen its long term budget balance, the Borbidge government introduced a subsidy scheme to return the revenue to motorists.
The scheme rapidly became a sacred cow in Queensland politics, with the cost rising over time to nearly $600 million a year. But it never worked as planned. The gap between fuel prices in Queensland and New South Wales routinely fell short of the 8.1 cent tax differential.
Eventually the Bligh government commissioned Bill Pincus QC to investigate. He concluded that the scheme was ‘flawed from the start’, and invited the government to scrap it. Instead, the government made cosmetic changes and carried on.
But with even further deterioration in revenue, the government now has little choice. As Premier Bligh noted recently, the loss in GST revenue alone has been more than $700 million. Scrapping the fuel subsidy would nearly fill this particular hole, though it would only go part of the way to restoring budget balance. With fuel prices well below their 2008 peak, there will never be a better opportunity to reverse the mistake made in 1997.
If the government is unwilling to scrap the scheme outright, it could adopt a proposal I have been advocating for some time, which would, at least arguably, be consistent with the promise to maintain a fuel subsidy for the government’s present term.
Instead of immediate abolition, the fuel subsidy could be phased out over a period of five years, and the savings allocated to a special-purpose fund. Each year, new bonds would be issued, to be serviced by the funds saved from the fuel subsidy. New debt would be matched to new net revenue.
At current expenditure levels and interest rates, the new revenue allocated to the infrastructure fund would be around $120 million for each of the five years, and this would be sufficient to fund interest and capital payments on around $1.2 billion in new infrastructure investment per year, for a total investment program of $6 billion. This would finance a substantial part of the ambitious program now proposed by the government.