First big policy test for NSW Labor is budget repair

The NSW budget on September 19 will be the first big policy test of the state’s new Labor government.

The test is not just whether they shift the trajectory of deficits and debt, but how they do it — while managing the soaring cost of major infrastructure projects and the consequences of rash election promises such as removing the cap from public sector wage increases.

NSW Treasurer Daniel Mookhey may get some revenue boost from the stronger housing and labour markets of recent months, but this will be nothing like the avalanche of extra revenue that has fallen into the federal Treasurer’s lap, at least up until recently.

Whichever side won the March election was going to have a major budget repair task ahead of it. This was partly because of the one-off costs of the pandemic. Remarkably, operating expenses in the three years to 2021/22 — a period that covers the rolling peaks of the pandemic — were $63 billion higher than if the pre-pandemic trend line of operating expenses had continued.

But it wasn’t just the costs of the pandemic. The Coalition government in its last few years was loosening the purse strings across a broad front of operations and projects, having applied strong budget discipline in its first seven or eight years.

The Baird government was right to privatise electricity businesses, which has helped pay for the subsequent ballooning of infrastructure spending. But the money going out has gone way beyond the money that came in from privatisation.

The result has been a massive increase in state debt, which Mookhey has rightly said puts NSW at the cusp of another credit rating downgrade. The situation is not nearly as bad as in Victoria, but NSW is the second most heavily debt-burdened state.

There are various measures of this. On one of them — general government gross debt — the increase has been from $32 billion in June 2018 to the most recent (March 2023) estimate of $129 billion in June 2023.

Measured as a percentage of a year’s revenue, this has gone from a prudent 42 per cent to an alarming 122 per cent, and heading for 162 per cent in 2026 according to the last published forward estimates. (On the same measure, Victoria is heading for over 200 per cent.)

So Mookhey faces a major task to shift the trajectory and stabilise debt over the next few years. He should be thinking of this under three broad headings.

The first is operating expenses: the recurrent costs of providing ongoing government services, and particularly wage costs.

Operating expenses were grossly inflated by the pandemic, but this is no longer an excuse for expenses remaining billions of dollars a year above any reasonable trend line drawn from pre-pandemic years.

The task is to remove the excesses that crept in when discipline went out the window in the pandemic years. It is to shift the focus from how much is spent on services to the results of the services. It is to reform the way services are delivered to get the same or better results at lower cost. And it is to rethink the rash election promise on public sector wages before it blows up the budget.

The second heading is infrastructure spending, which across the NSW public sector has gone from an annual average of $14 billion in the five years to 2015/16 to an average of $23 billion since then and is expected to peak at $30 billion this year and next.

A case can be made that NSW was overdue for an infrastructure upgrade and that borrowing for infrastructure is more acceptable than borrowing to pay wages. However, the current level of spending is financially unsustainable and the pressure on construction resources and cost over-runs are major issues.

There are plenty of inquiries under way;  but why not one more, into the systemic reasons for cost over-runs in major projects and the changes needed to minimise them. In the meantime this budget will need to look at what in the existing project pipeline can sensibly be cancelled, deferred or modified.

Finally, there is taxation. Genuine reform of the state’s inefficient taxes would be welcome, but one of the Labor government’s first acts was to reverse the previous government’s modest start to reform of property transfer duty and land tax.

They have followed this up with a pre-budget announcement of their own version of Queensland’s swingeing increase in coal royalties, which is not reform but just an opportunistic revenue grab,

 The big question for the budget is whether NSW goes down the same path as the Andrews government in Victoria of imposing large and economically damaging increasesin state taxes for revenue purposes.

NSW and Victoria make up more than half the national economy. We need sound economic and financial management from them, but Victoria is a trainwreck.  Now it is time for NSW to show it can do much better.

Robert Carling is a Senior Fellow at the Centre for Independent Studies and a former IMF, World Bank and federal and state Treasury economist.