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End the fuel subsidy

May 29th, 2009

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.

The Born Losers buy

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  1. May 29th, 2009 at 14:00 | #1

    “Rapid population growth calls for substantial investment in infrastructure, but much of this infrastructure does not yield a financial return”.

    While I appreciate the point, I am seriously unhappy with using the word “investment” to describe anything but an outgoing aimed at building or maintaining future revenue. That is, while schools, hospitals, sewage systems etc. are all desirable for other reasons than future revenue gains, in general I would categorise them as a form of extended consumption – just as I would an individual’s “investment” in buying a house for his or her own use. I would even accept spending on certain categories of education (for instance), when that does flow via future higher earning power of individuals to greater state government revenues – but not when that accrues to other states or the commonwealth, or even other countries (with expatriates and emigrants), and not when it results in a race to the bottom through credentialism, and certainly not for any misguided reforms that are reasonably foreseeably harmful (like some approaches to literacy). And, of course, I would never give the benefit of the doubt to government claims that there would be such future gains, since for political reasons they so often claim that for things that are nothing of the sort.

  2. Donald Oats
    May 29th, 2009 at 14:36 | #2

    The thing about investment (or extended consumption if that is what you feel it is) in school and university infrastructure is that it may assist in raising the quality of the educational experience by the students. At the university level, if the investment/spending improves the ranking among students, it follows that Australia will attract overseas students to Australia, which offsets the outgoing Australian students.

    Personally the difference between being able to sit in a lecture hall, or to have basic stuff like blinds on the windows and ceiling fans for dealing with summer heat, and not being able to even get into the room for overcrowding – well extra modernised lecture halls and tutorial rooms are wise investments – oops I mean spending.

  3. May 29th, 2009 at 14:59 | #3

    As I said, I appreciate the point. It’s just that the terminology throws the gates open for much spending that doesn’t even satisfy these other criteria, by labelling it investment.

  4. Donald Oats
    May 29th, 2009 at 17:16 | #4

    Upon further lucubration, I’m inclined to agree with you, P.M. Lawrence #3.

  5. carbonsink
    May 29th, 2009 at 21:23 | #5

    Here in Northern NSW we have a latitude based fuel subsidy. The closer you get to the border, the bigger the subsidy. No really, we do.

  6. May 29th, 2009 at 21:29 | #6

    I am lost. So the Commonwealth levies a 38 cent per litre tax on such things as unleaded petrol and the Queensland Government (!) gives a rebate of 8.1 cents on the tax that the Commonwealth levies and collects.

    Or am I missing something very basic? This would be stupid even by Queensland political standards.

  7. SJ
    May 29th, 2009 at 23:27 | #7

    As far as I can tell, Harry, you’ve been lost for a long time. In this particular case, however, you aren’t missing anything, that’s just the way it is.

    PML Says:

    As I said, I appreciate the point. It’s just that the terminology throws the gates open for much spending that doesn’t even satisfy these other criteria, by labelling it investment.

    This is just nonsense. If you’re worried about useless spending, complain about it. Don’t complain about the use of common words that most of us understand.

  8. May 30th, 2009 at 00:31 | #8

    That’s not nonsense, what is nonsense is calling any spending for the long term investment. If you understand that investment to include that sort of spending, well, since I don’t, you’re plain wrong to claim there is already common understanding – there is a fundamental difference between what we’re driving at. What’s more, even if you were right, it would show that there is a distinction that isd not being brought out. Because I am not (here) “worried about useless spending”, I am worried about leaving a loophole for wolf-in-sheep’s-clothing spending.

  9. jquiggin
    May 30th, 2009 at 08:26 | #9

    As with lots of terms, it depends on what you want to do with it. Considered from the perspective of someone trying to balance the state’s books, an expenditure that doesn’t generate a future flow of revenue is probably best classed as consumption.

    But, considered in terms of economic welfare, anything that generates a flow of future services is an investment, whether those services are sold or given away.

  10. May 30th, 2009 at 13:25 | #10

    That only works so long as the book entries immediately make massive provision against the “investment” turning out worthless, just as there should be immediate write offs of the “unintended investment” that happens when a firm’s inventory piles up because it can’t sell it and won’t cut back production. If that doesn’t happen, you give politicians the loophole of “we’re not spending, we’re investing”, as in “investing at the race track”.

  11. Alice
    May 30th, 2009 at 13:37 | #11

    Actually PM Im inclined to agree

    I dont see spending on schools and universities as “Investment” spending. Im inclined to see it as overdue recurrent expenditures of government that they have been lax in attending to over at least the past decade – so yes that makes it overdue Government consumption.

  12. sdfc
    May 31st, 2009 at 00:57 | #12

    PML

    What is capital investment if not “extended consumption”. In accounting terms it’s called depreciation or amortisation.

    I don’t remember revenue coming into the definition of investment, from what I can recall it is all about future use. Investment can’t be so narrowly defined as applying only to revenue generating assets. In fact so obvious are the benefits of an educated and healthy workforce not only to society but to the productive capacity of the economy it’s tempting to think your taking the p*ss.

  13. Socrates
    May 31st, 2009 at 21:52 | #13

    Agreed – end it!

    Even if there was not an oil shortage or a GHG problem there are many good reasons why the petrol subsidy is a bad idea. It distorts rational location choices in business and housing and so de facto encourages urban sprawl. It discourages use of public transport, increasing public loss/subsidy on it too. People tend to make travel mode choice decisions based on immediately apparent costs like fuel rather than overall running costs, so the effect of the subsidy is disproportionate.

    Not only has government been advised to get rid of the subsidy, but there has been advice for at least ten years to convert fixed charges like registration and 3rd party insurance to per km costs via additional levies to fuel. It is a far more rational approach that means peopel driving short distances don’t subsidise those driving much further.

  14. June 2nd, 2009 at 13:38 | #14

    FYI your post was very prescient

    Queensland fuel subsidy scrapped -> http://www.brisbanetimes.com.au/queensland/fuel-subsidy-scrapped-20090602-bthm.html

  15. Flavio Menezes
    June 3rd, 2009 at 09:24 | #15

    It is a pity that it took a global financial crisis for the fuel subsidy to be abolished. For a list of (many) reasons to abolish the subsidy see my opinion piece available at

    http://apo.org.au/commentary/subsidising-fuel-wont-deal-long-term-problems

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