State budget analysis: Focus switches from COVID-19 emergency to health, skills, infrastructure and climate

State and territory governments have shifted their focus from surviving the COVID-19 emergency to rebuilding health facilities and services, and building their economies in a sustainable way.[1]

Meeting skill shortages, promoting gender equality and transitioning to net zero all feature in the FY23 budgets but so too does boosting infrastructure spend – which is not necessarily consistent with the first three objectives. Moreover, building roads, rail and transport infrastructure equates to expansionary fiscal policy despite already strong economic activity post COVID-19 lockdowns. Expansionary monetary policy (albeit quickly tightening) has also been adding to the froth. 

State government spending has decreased from COVID-19 highs, and most states have projected a path back to surplus. But fiscal deficits are still expected to remain in most jurisdictions at least over the next two years and particularly in New South Wales and Victoria (which together account for 90 per cent of the deficits projected in FY23 and FY24). The Western Australia budget is an outlier – it is recording net operating surpluses due to high commodity prices and stronger than expected economic conditions.

But high levels of state government spending combined with the largest Commonwealth deficits since war time, means the public sector is unusually active in the economy. That is problematic at a time when the economy is running at full capacity and risks crowding out the private sector, as both government and private employers bid for the same capital and labour. 

2021-22: a year of unknowns

Looking back on FY22, there were several unforeseen challenges for Australia. These included the delta and omicron lockdowns, delays in the COVID-19 vaccine rollout, supply and skill shortages, severe floods along the east coast, the war in Ukraine and surging inflation.

The delta lockdowns were by far the biggest challenge for governments, and their impact is apparent in the FY22 economic estimates. Victoria, New South Wales, Tasmania and South Australia all made downward revisions to estimates of Gross State Product (GSP) for FY22. 

Another challenge has been the substantial increase in inflation. All jurisdictions upwardly revised their consumer price index (CPI) forecasts substantially. While national annual inflation was at 5.1 per cent in the March quarter, it ranged between 4.4 per cent (Sydney) and 7.6 per cent (Perth) in the main capital cities. The Reserve Bank of Australia  has moved to contain inflation, raising the cash rate to 1.35 per cent over the past three months, with further increases expected.

This means cost of living has been front of mind for consumers. With inflation outpacing wages growth since June 2021, real wages are declining and have fallen to December 2014 levels.  Countering this, households have seen an improvement in their balance sheets due to high levels of fiscal support and less spending during lockdowns, which is expected to somewhat cushion the cost of living pressures and higher interest rates.

For state governments it has meant pressure to implement relief, such as electricity and cost of living rebates, and to lift government employees wage growth which has been frozen or capped for several years. Flood recovery costs have also had to be met unexpectedly.

But FY22 also provided a lot of positives.

The resilience of consumers despite prolonged lockdowns, the strength of the labour market and the governments’ readiness to spend all propped up economic growth. Economic scarring seems to have been minimal and there were downward revisions to forecast unemployment for every single state. 

Fiscal support during COVID-19 has stretched state budgets

Due to lockdowns and increased government spending, expenses increased between FY19 and FY22, on average by 29 per cent per state or territory, with New South Wales and Victoria having an expense growth rate of 50 per cent and 43 per cent respectively. This has led to a stretch in both states’ budget deficits, with an increase in revenues only partly offsetting the impact. Between FY22 and FY24, both states are expected to see much larger net operating deficits than previously expected.

In contrast, Western Australia has seen the strongest net operating surplus on record in FY21, on the back of strong economic growth and elevated commodity prices. This means the Western Australia Government has been able to materially reduce its net debt levels and regain its AAA credit rating. 

State and territories are expected to see an increase in net debt in FY22 compared to FY21, with the exception of Western Australia. However, the increase in FY22 net debt is estimated to be lower than assumed in previous budgets, meaning that states had to borrow less than forecast. This is partly a commodity price story, with mining states such as Queensland and Western Australia seeing an increase in royalty payments for FY22 to the significant tune of $2.9 billion and $2.8 billion respectively (compared to mid-year updates). It’s also due to the fact that the labour market, despite the delta and omicron lockdowns, is much stronger than previously expected helping to boost tax revenue.  

Tasmania has the lowest net debt to GSP ratio at 9 per cent, while the Northern Territory’s ratio is the highest at 23 per cent. Combining Commonwealth, state and territory net debt levels, Australia has a debt to GDP ratio of 41 per cent, which is expected to increase to 57 per cent by FY26. However, this is still fairly low on an international comparison. 

Managing the pressure on state finances

Fiscal sustainability remains a key priority for state and territory governments given the large budget deficits. All state governments are forecasting a pathway back to surplus by FY26, with Victoria taking the longest time to achieve this. However, fiscal stimulus from state governments will remain relatively high due mainly to the largest two states, New South Wales and Victoria.

In contrast, Western Australia has record operating surpluses across the forward estimates due to its revenue windfalls and strict expense controls of the past five years. Expenses are expected to fall for most states in 2022-23 (except Queensland) given the withdrawal of short term COVID-19 measures to support the economy.

Some states have introduced policies to support fiscal sustainability. The New South Wales Government introduced both revenue measures (such as increased betting tax and foreign investor surcharge land tax) as well as savings measures (such as lower wages growth for senior executives and efficiency dividends of up to 3 per cent across the outyears) to maintain sustainable debt levels. These measures are expected to save $2 billion.

Victoria continued its efficiency measures and is also partially privatising VicRoads to establish a future fund to offset borrowings.

Queensland introduced a three tier progressive royalty structure for coal to benefit from higher prices which is estimated to generate an additional $1.2 billion over the forward estimates. [2]

The rising cost of living places pressure on state and territory governments to increase wages for government workers. Wages growth has been slower than forecast and public sector wages in particular are lagging. The Wage Price Index increased 2.4 per cent over the year to March, with public sector wages up only 2.2 per cent. In an environment of high inflation, this means real wages growth is negative. A pick-up in wages growth is the biggest risk to the governments’ fiscal positions, given wages are their largest cost at around 30-40 per cent of expenditure.

Many state governments are trying to limit wage increases in the public sector by capping rises, with New South Wales offering the most generous increase of 3 per cent, followed by Western Australia (after capping wage rises by $1,000 per year), Queensland and Tasmania at 2.5 per cent. Victoria reduced its cap on wages growth from 2 per cent to 1.5 per cent, while the Northern Territory is offering lump sum payments of $4,000. These increases are far below current inflation, and this has led to pockets of industrial action around the country. 

New spending focus on health and infrastructure

Health systems across Australia are facing ongoing pressures with high levels of demand and staff being furloughed. This is evidenced by ambulance ramping at record levels in many states. This has led to significant funding boosts for health with states and territories allocating a combined $45 billion in their 2022-23 budgets (with additional funding ranging from $60 million in the Northern Territory to $23 billion in Queensland). Much of this spend is to alleviate pressures on the system or boost capacity, however, these initiatives will take some time to flow through to frontline services –  especially given many states are facing skill shortages in the sector.

State and territories are undertaking record levels of infrastructure investment, which has assisted the economic recovery. Across the forward estimates there is over $300 billion of infrastructure investment in the pipeline, mainly on road, rail and transport infrastructure. The high volume of projects being undertaken at a time when the construction market is experiencing capacity constrains due to supply chain disruptions and skill shortages, represents risks for state governments, in both cost escalation and delivery delays.  

Migration policies to ease skill shortages

The strong labour market in all states and territories has brought with it constraints around skill shortages. The Australian Bureau of Statistics (ABS) reported that in June this year, 31 per cent of employing businesses had difficulty finding suitable staff.  

The impact of border closures during the pandemic adds up, with Australia facing a cumulative migration shortfall of 494,035 migrants. While both interstate and international borders are now open, net migration is picking up only slowly. On top of this, disruptions due to the pandemic, high visa application volumes and record numbers of people stuck on bridging visas has led to substantial delays. The approval process for the median short-term temporary skilled visa is currently 83 days, up from 53 days in March.

Most state governments continue to invest in skills and workforce development, however some have introduced policy initiatives targeted at the current skills shortages. The Western Australia Government established the $195 million Reconnect WA package, which gives eligible working holiday makers a $2,100 payment to work and travel in certain regions. This includes an accommodation allowance of $40 per night for up to six weeks (or 12 weeks for Australians) and a one-off payment up to $500 to help with travel costs. This package also includes two new scholarship programs to attract international students to Western Australia.

Other key initiatives include $15 million for the VET Emerging Industries initiative in Queensland to develop flexible industry strategies and help businesses to hire more diverse employees (this initiative extends the Skilling Queenslanders for Work program in the last budget); and $145 million for the Regional Investment Activation Program in New South Wales to address skills gaps in key sectors and create jobs.

Early childhood education reform a step towards gender equity

Gender equity was another key feature in some state budgets. Fortunately, the recovery in the labour market from the pandemic has been relatively inclusive, despite females being impacted more at the start of the pandemic. Females are now leading the way in the economic recovery, experiencing a stronger increase in employment, hours worked and participation compared to pre-pandemic levels.

But there is still a long way to go. According to the World Economic Forum’s Global Gender Gap Index 2021, Australia is ranked 70^th on female economic participation, behind countries including Kazakhstan and Tanzania. Women are on average paid 86 per cent of the male wage – implying a 14 per cent gender pay gap for Australia.[3]

The whole economy benefits from gender equality. Research by the Victorian Government found that Australia’s GDP would grow 11 per cent if the gender employment gap was closed, and companies with 30 per cent or more women in leadership positions are 15 per cent more profitable. Moreover, a stronger female participation rate would help ease prevalent skill shortages.

The state budgets included several welcome policies on the gender equality front, led by New South Wales and Victoria. Australia’s two largest states will invest $15 billion over the next ten years to improve early childhood education, including the establishment of a year of new schooling for four-and five-year-olds.[4] This reform will encourage primary caregivers – who tend to be female – to go back to work earlier or to take on more hours earlier. In New South Wales, it will begin from 2030 and fall a year before what is known as kindergarten. Victoria plans to start from 2025, before what is known as prep.

Other key initiatives include $120 million for women’s health in New South Wales, including currently costly fertility treatments; $940 million in initiatives to improve outcomes for women in Victoria; Victoria is also the first state to introduce ‘Gender Responsive Budgeting’ ensuring their Budget considers the gender impact of all public policy and investment; $4 million in South Australia to support women in small businesses; $3.8 million of funding in Tasmania to increase gender diversity, including promoting women in leadership; and $363 million to introduce a package of reforms around women’s safety in Queensland, including domestic violence.

A continued focus on climate change  

State governments have continued to demonstrate their willingness to take action on climate change, assisting Australia to meet its targets under the Paris Agreement. States have focused on increasing investment in renewable energy generation and storage, and providing grants and rebates to industry to assist transition and support projects.

Big ticket items include $1.2 billion for Renewable Energy Zones in New South Wales to help transition the state’s energy away from coal towards renewables; South Australia investing over $500 million to construct a green hydrogen facility; Queensland committing around $250 million to several renewable energy projects from its $2 billion Renewable Energy and Hydrogen Jobs Fund; and Western Australia allocating $500 million towards its Climate Action Fund. Although highlighted as a measure to assist funding pressures, the Queensland Government has introduced progressive coal royalties from 1 July 2022 which, in effect, could speed up the transition from coal to renewable energy. 

Conclusion

Overall, state and territory governments have focused on skill shortages, gender equality and the transition to net zero. Spending could have been even more harmonised between states, with a priority to implement policies sooner.

In terms of skills shortages related to migration, the states are somewhat constrained given it is only the federal government that can reduce delays to visa processing times and expand visa classes. The recently announced Jobs and Skills Summit in September is a welcome opportunity to tackle skill shortages on a national level. States also need to align future training policies to ensure a sustainable pipeline of skilled workers.

Most states have provided funding for initiatives to address climate change and assist in the transition to renewable energy, however, more co-ordination is required to address the energy issues facing Australia.