Chapter 2

Governments participate in economies through a variety of means; these were surveyed in Chapter 1. The annual budget is a central (but by no means the sole) instrument in this participation. In Australia in 1999-00 government (state, federal and local) current outlays, not including public trading enterprises, were 35.4 percent of GDP. Through the Commonwealth budget passed $152 billion; Australia's GDP in the same year was $621 billion.⁽¹⁾

The annual budget appears to be a regular, well-defined process, but it is evolving, and has been doing so for hundreds of years. It has evolved from the ad hoc taxation and spending powers of kings and emperors. More recently there has been much more emphasis on seeing that budgetary processes integrate more closely with other managerial processes, and that they incorporate measures and incentives concerned with efficiency.

This Chapter commences by looking at the historical development of modern budgets, drawing in particular on the work of Naomi Caiden. It then moves on to look at the two sides of budgets, revenue and expenditure, with observations on the processes of budgetary reform.

A Historical Perspective

Naomi Caiden defines a budget as "a document that proposes income and expenditure for an annual period".⁽²⁾ It is a plan. As with most plans, when it comes to implementation there will be variations arising from contingencies, from inadequate forecasts, and limitations in the control mechanisms.

Caiden also points out that government budgeting has evolved, and is still evolving. Primitive public finance (of the pre-budgeting period) is characterized by:

Caiden argues that we may be entering another phase, the post-budgetary phase, with some of the elements of earlier times. Governments are losing control; there is fragmentation as authorities go 'off budget', and there is a degree of privatization occurring. These she outlines in an American context, but they may equally apply in Australia. For example Australia, through switching from government financed pensions to employer funded superannuation, is privatizing its retirement income schemes. In encouraging private health insurance this is essentially a privatization of tax collection.⁽³⁾

At times budgetary processes break down, with far flung consequences. The most significant event in Australian budgetary history was in 1975, when the Whitlam Government attempted to carry on in government without budgetary appropriations, passage of the budget bills being blocked by the Senate. The consequence was the dismissal of the Whitlam Government. In 1992, because of a fight between the state governor and state congress, the Californian legislature refused to pass budget appropriations. The Californian government kept writing checks to pay employees, contractors and suppliers, but these were illegal, not being backed by any appropriation. The government wrote IOUs, but generally banks and commercial houses did not honor them, or if they did, only at a large discount.

Macro Context of Budgets

As pointed out in Chapter 1, governments are major actors in the economy. In developed countries the amount of national product passing through the public sector has been growing, reflecting in part the community's demand for public goods and for government re-distribution. The figure below, repeated from Chapter 1, shows Australia's recent record of Commonwealth outlays.

Basically, as the economy slowed the public sector kept growing, before stabilizing in the mid eighties. The Commonwealth was faced with an economy with limited taxation capacity and the initial response was deficit funding. That is, spending more than is raised in taxes and other sources of revenue. Attempts to control aggregate outlays met with limited success, although there were major re-distributions of budgetary outlays. (For example there has been a long term decline in government capital outlays, and the Fraser government withdrew somewhat from health care funding.) The Fraser government did not attempt much managerial reform, other than implementing Freedom Of Information legislation and subjecting more administrative decisions to scrutiny. By and large the Fraser Government's agenda was about reducing the size of the public sector, not reforming it.

By 1983 governments turned to improving their own efficiency. The Commonwealth brushed the dust off the 1975 Coombs Report,⁽⁴⁾ which had found that the Government was effective, but was not efficient. That is, it did what it should do, effectively, but it consumed more resources than necessary in so doing. At the same time there was a feeling that the public service was out of control, pursuing its own agenda. Thynne, writing in 1983, shows the feeling of the time, which was a desperate need to bring back accountability and responsiveness.⁽⁵⁾ There was therefore a dual need for budgetary and managerial reform, which tended to go hand in hand.

By the mid eighties there was a growing feeling again that it was important to reduce the size of government. The turning point in policy was marked by Keating's "banana republic" speech in 1986.

The shift in emphasis from technical efficiency to containment of budgetary outlays was consistent with a model of public expenditure which saw the principle instrument in allocative efficiency to be control of the total level of government expenditure.⁽⁶⁾ Public choice theorists suggest that governments have an inbuilt tendency to growth, and over-provision of public goods. The wisdom of a broad objective of containing government expenditure is questionable; however. There is no observable relationship between the size of the public sector and economic growth.⁽⁷⁾ Research shows that it isn't so much the size of government expenditure that counts; rather it is the composition of expenditure that counts. Most empirical studies find that government investment expenditure, other than military expenditure, aids economic growth.^(8),(9) The objective to "cut government" is an outgrowth of a public idea which sees the public sector as a value-depleting burden on the value-creating private sector.⁽¹⁰⁾

Usually there is an assumption that the Government's deficit reduction strategy necessarily implies constraining budgetary expenditure.⁽¹¹⁾ But it may also be reasonable to assume that deficit reduction can be achieved in other ways. A growing economy generates more taxation revenue, and reduces demand for transfer payments. There is no indication that the community is seeking to trade off consumption of public goods for an increased consumption of private goods. In fact, the Australian community seems to be generally satisfied with the current level of taxes and public sector activity, though it would like some re-allocation, away from defense and general administration, and towards environmental protection, roads, law and order and education.⁽¹²⁾

Sometimes, the argument for reducing the size of government is on purely libertarian grounds, but most often the proposition is that large government is a burden on the "productive" sector of the economy. Reducing the size of government becomes an imperative, therefore.

It is hard to make an economic case for a particular "size" of government. Government is far from homogeneous; the suggestion that we can have "more" or "less" government treats all government as a single entity. What is important is the efficiency of government. A small government, if inefficient, retards economic growth. Despotic military dictatorships provide examples. And large government, if efficient, can enhance economic growth. What is important is not the size of government, but its efficiency.

Empirically, there is no good evidence that economic growth and the size of government are related. Advocates of small government often point to countries like Japan, with small government and (until recently) high growth; conversely one can point to countries like Peru, with small government and low growth. Even among rapidly developing countries there is no consistent story; highly successful countries like Germany and Singapore have larger public sectors than Australia. Those who have researched the relationship between size of government and economic performance have found no relationship.⁽¹³⁾

The table and graph below shows the alignment, or rather the lack of alignment, between countries' ranking on the world competitiveness index and the size of their public sectors, as indicated by the share of government expenditure in GDP. If small government were strongly associated with competitiveness, we would expect that the countries at the top of the table would have small governments. In fact, there is no discernable correlation between size of government and competitiveness. It is notable that the Northern European democracies, most of which have very large public sectors, generally rank well ahead of Australia in terms of competitiveness. Netherlands, for example, owes its position to conscious policy of open trade combined with a very active government domestically, and Finland to strong infrastructure investment.⁽¹⁴⁾

Table 3. World competitiveness and size of public sectors
Country	Ranking on world competitiveness index	Govt expenditure as percentage of GDP
United States	1	33
Finland	3	41
Netherlands	4	43
Switzerland	5	27
Luxembourg	6	27
Ireland	7	32
Germany	8	45
Sweden	9	54
Iceland	10	34
Canada	11	40
Denmark	12	52
Australia	13	32
United Kingdom	15	42
Norway	16	42
Japan	17	27
Austria	18	44
France	19	46
Belgium	20	50
New Zealand	21	16

Source: World competitive ranking from The Economist 22 April 00, Government expenditure from OECD, 1997 data except for Denmark (1996). No OECD data available for Singapore (#2) or Hong Kong (#14)

Adding expenditure restraint to the reform agenda has muddled the task of public service managers, and has probably pushed their agenda towards reducing outlays, even when this conflicts with allocative efficiency. Therefore the assignment to public servants has objectives which conflict in major areas:

Revenue and Expenditure

Budgets are concerned both with expenditure and revenue. The difference between revenue and expenditure is the surplus or deficit. Intuitively, prudence suggests a deficit is undesirable, but there are qualifications to such folk logic.

First, revenue and expenditure (and therefore deficits and surpluses) until recently have been measured in cash terms, rather than in accrual terms, and there is still not a full transition to accrual accounting in government (a point to which we return in Chapter 4). Governments can raise revenue from asset sales, for example, or they can cut expenditure by reducing capital or maintenance expenditure. In other words, the "bottom line" can be made to look good by depleting the stock of public assets. In the 2000-01 Budget, for example, much was made of debt reduction, but there was little mention of the corresponding reduction in government assets on the other side of the balance sheet. To use a household metaphor, it would probably be imprudent to sell the car and use taxis instead; the one year cash position would look good, but the long term costs would be very high.

Second, governments can pursue counter-cyclical (Keynesian) economic management. During a recession it is normal for governments to run a deficit, to be counterbalanced against a surplus when the economy recovers. As the economy recovers tax revenues increase, and demand for welfare expenditure decreases. There is no reason why budgets should balance every year. Again to use a household metaphor, most people go through periods of borrowing and saving over their lifetime. The problem for governments (and households) is when economic recovery does not come, or when its fruits are less than anticipated. Persistent deficits reduce long term budgetary flexibility.

Third, it is quite normal for any entity to borrow, generally provided its net asset position is maintained. Deficits must be funded by taxpayers in the future, but capital expenditure confers benefits on those same taxpayers. Just as in a household a mortgage is the payment for the benefit of having a house, in the public sector servicing public debt is the payment for long life assets, such as roads. education etc. The problem comes when borrowing is used to finance current consumption.

This is not to say that the deficit does not matter, but it is important to look beyond the simple "bottom line" to see how a given deficit (or surplus) has been achieved.

Government Revenue - Taxation

Taxes provide the funds for public budgets, and they have a legal basis in that they are compulsory. Past such simple description, however, there is no straightforward and consistent definition of what constitutes a "tax". Definition is, perhaps, easier by exception rather than by exclusion. In the Commonwealth non-tax revenue is only 9 percent of budget revenue, and covers interest on loans, dividends from GBEs, and some small items such as rent received for Commonwealth properties.⁽¹⁵⁾ Asset sales are not counted as tax, but they do not appear on the revenue side of budgets; they are hidden as "offsetting receipts" on the expenditure side of budgets.

An essential element of taxation is the concept of transfer. Taxes are transfers, and are not linked with any immediate receipt of benefit. User fees levied by GBEs are not taxes. They are payments for goods and services, similar to transactions in the private sector.

But this is a gray area. There are many transfers, not defined as "taxes", but which have many attributes of taxes. For example, excess profits earned by utilities involve transfers. They have many of the same distributional and allocative effects as taxes. Tariff protection (except that part collected by way of customs duty), is not called a "tax", but it is nonetheless a transfer from consumers to producers. In some countries, particularly the USA, health insurance premiums are a compulsory levy on payrolls, but, because they are collected by private firms, and not by government, they do not count as a tax.

Some taxes look very much like user charges. Many governments place specific levies on goods and services to pay for specific services. This breaks the notion of centrality of budgets, and such taxes, not popular among finance departments, are known as hypothecated taxes. For example, New South Wales imposes a two cent a liter fuel levy, which is hypothecated to road funding. This is called a tax, but it could be called a user charge. In Australia the Commonwealth Constitution specifies (S81) "All revenues or moneys received by the Executive Government of the Commonwealth shall form one Consolidated Revenue Fund ...". Essentially this prevents the Commonwealth from collecting taxes into special accounts; they first have to pass through Consolidated Revenue and then be appropriated. (GBEs are able to collect user charges, however, as they are not part of "Executive Government".)

Different texts outline different principles. A simple set of criteria is equity, efficiency and simplicity.⁽¹⁶⁾ The criterion of efficiency is another term for allocative neutrality; that is, the system should not result in a different pattern of resource allocation from that which would prevail in a competitive market. Other criteria are ability to pay (not quite the same as equity) and proportionality to benefits received.⁽¹⁷⁾ Naomi Caiden uses a different classification, classifying taxes according to the criteria of resource mobilization (i.e. how much tax is collected and how widely it is collected), accountability, and administrative control (which is a measure of the bureaucratic control on taxes.)⁽¹⁸⁾

No tax system could be designed to meet all these needs. There is conflict between them. To take each in turn:

Equity has several dimensions. Usually when we think of equity we implicitly think of two types of equity - horizontal and vertical. The notion of horizontal equity is that two individuals with identical means should pay the same amount of tax. The notion of vertical equity is that individuals with more means should pay more tax than those with less means. A system is said to be progressive if taxes rise at a greater rate than means. If A's means are twice those of B's, a progressive tax would take more than twice as much from A as from B. A flat or proportional tax takes twice as much from A as from B, while a regressive tax takes less than twice as much from A as from B.

Means are not easy to measure, however. Income is one measure, but people also have commitments, and income may be shared between several individuals, as in a large family. Income is not always received in the form of cash; in some countries, especially in rural communities, there is a thriving barter economy. And even within one country $X in one place has less purchasing power than $X in another place, as anyone who has compared living costs in Canberra and Sydney would know.

Income is only one measure of well being; wealth is another. Over one's lifetime income and wealth may fluctuate as shown alongside. Wealth and income taxes, therefore, tend to fall on different age groups. Some countries collect wealth taxes through death duties. (Australia abolished death duties because they were very easy to evade.) Most measures of wealth relate only to private wealth held in the form of assets which can be valued in money terms. They do not measure wealth provided by public goods (e.g. roads, access to parks, a clean and safe environment, clean streets) and they do not measure non-tangible private wealth in the form of intellectual capital (e.g. a good degree or a set of acquired skills).

Taxes should not distort overall resource allocation. That is a reasonable principle, but it is hard to apply. If taxes promote certain activities while discouraging others, then there will be a sub-optimal allocation of resources within a country (assuming these re-allocations are not intended to correct for market failure). That means, for example, that income received by way of cash, fringe benefits and capital gain should all be taxed in the same way. This causes considerable administrative difficulty. If there is a consumption tax one theory suggests it should be applied at a uniform rate across all goods and services, as was proposed in the first version of the Coalition's 1993 election manifesto, Fightback! and in the initial 1998 proposals for a GST. In practice, many governments exempt certain essentials, such as food and clothing from consumption tax, and apply higher rates to certain luxury items. This leads to allocative absurdities and inequities (see box).

In pursuit of efficiency and equity, simplicity often suffers. In most developed countries there are big bureaucracies collecting taxes. The budget appropriation for the Australian Taxation Office is around $1.5 billion dollars a year, or one percent of tax collected. There are also compliance costs in the private sector, including preparing accounts, preparing monthly or quarterly business activity statements, collecting withheld taxes from wage and salary earners, a thriving tax minimization industry, and armies of advising lawyers and accountants. (Mention should also be made of University staff teaching taxation courses.) Private and public sector effort in collecting and administering taxes can place a high economy-wide demand for accountants and lawyers, who may be in short supply in developing countries. It may be quite sensible public policy in such countries to accept a second best taxation system in order to ensure that the corporate sector has enough access to accountants for normal business purposes and that the public sector has enough accountants to service the public sector.

This is not the same as equity. Some individuals and businesses have little liquidity. In developed countries wealth is often held in large, non liquid form, especially housing. In developing countries successful businesses need large amounts of working capital to expand their businesses; farmers may need to make large investments in machinery to modernize.

In some countries there is a rentier class, and it may be politically expedient (as well as a useful way to whittle away at feudal privilege) to apply high taxes to "unearned income". For example, taxes on rural landlords may be associated with initiatives in land reform.

Taxes generally involve redistribution, but there are limits. When taxpayers in one region are consistently taxed to pay for welfare or public goods in another region they are likely to protest. In Australia there has generally been a net flow of taxation revenue from New South Wales and Victoria to the smaller states. (The results are evident to anyone who compares roads and urban amenities across state borders.) Resistance to regional redistribution may be a real burden to a country trying to improve infrastructure, health and educational standards in a depressed region, especially if there is little ethnic affinity across the nation.

This does not mean people will always be opposed to taxes to fund welfare for the less fortunate. Philosopher John Rawls discusses the notion of an "original position", in which people must design the distributive principles in a society in which they do not know what place they will occupy themselves.⁽¹⁹⁾ In such situations egalitarianism prevails. Even the well off don't know when misfortune will afflict them, and they generally do not know whether their children will share their good fortune.

Sometimes it is politically impossible to impose taxes across a whole economy. Some powerful groups may simply refuse to comply. In some countries established social classes may be able to avoid taxes through control of the political processes. Illegal activities, such as smuggling to avoid customs duty and bribery of tax officials may become endemic. Corporations may be "footloose", ready to move to another country if the government tries to impose too high a corporate tax rate.

Tax evasion can become problematic if it is widespread, or if it is perceived to be widespread. If the population perceives tax evasion to be rare, and believe that there is a real chance of detection and penalty, then there will be compliance. But if people believe tax evasion is widespread, then even honest citizens will take the attitude that they don't want to be the suckers who pay the taxes for the rest of the community. (This is a form of prisoners' dilemma situation, covered in detail in Chapter 17.) It is important for tax authorities therefore, not only to minimize evasion, but also to reassure the population that it is minimized.

Sometimes countries will have a concentrated resource and export base, which provides a ready source of taxation revenue. This can leave a country in a vulnerable situation and an underdeveloped taxation system, as Papua New Guinea found with its dependence on Bougainville, and as Saudi Arabia has found with its dependence on oil. Public revenues can become too dependent on commodity cycles.

Governments do not always seek accountability in taxation. Naomi Caiden identifies accountability as one of the great reforms in moving from "private" to official taxes, and fears that we may be reverting to more privatized taxes.⁽²⁰⁾ Off-budget infrastructure deals, such as the Sydney Harbor Tunnel, the Citylink toll roads in Melbourne and the Sydney airport railroad, are cases in point. Governments can hide "taxes" off budgets through moves to encourage private agencies to do what can be done more efficiently through the taxation system. Private health insurance and compulsory private superannuation have been mentioned as examples of "privatized" taxes.

Taxation collection requires a complex set of economic institutions and society wide traditions, which it is often easy to take for granted. To collect taxes a country needs a banking system, literacy and numeracy in the population, money, accounting standards, communication infrastructure etc. Small businesses, for example, need to be in the habit of keeping business records, perhaps in an accrual form. It would virtually impossible to prepare a business activity statement without a computer and accounting software.. The absence of such systems in poor countries can make it very hard to collect taxes. To the extent that taxes fund such systems, or at least provide the start up capital, especially education and communication, such countries may be caught in a vicious cycle.

Income taxes are comparative latecomers; in the early days of the Australian Federation customs duties were the main source of government revenue. Only in postwar years have income taxes assumed their central place in government revenues.

Most federal taxes (67 percent) are on personal and corporate income. This has fallen from 75 percent before the introduction of the GST. The GST is shown below as "Commonwealth taxation", although strictly it is a state tax collected by the Commonwealth.

Commonwealth Taxation - Composition %
	1999-00	2000-01
Individual income tax	55	44
Corporate income taxes	20	23
GST	0	14
Other indirect taxes	22	16
Other taxes (FBT etc)	3	3
Total	100	100
Source: Derived from Commonwealth Budget Paper #1 2000-01, Part 5

Sales taxes and excise are consumption taxes. The distinction between sales and excise taxes is mainly historical. Excise taxes have been around a long time, and apply to items like liquor, cigarettes and gasoline. Excise taxes go back a long way; sales taxes are comparatively modern. Excise is usually levied on physical units - so many cents per liter of gasoline etc, while sales taxes are levied on an ad valorem basis - a certain percentage of wholesale or retail price.

Some excise taxes are sumptuary taxes (also called sin taxes), reflecting a paternalistic government attitude to try to discourage consumption of certain goods. In other words, governments try to use taxes to re-allocate consumption and production. If tax rates are raised high enough then consumption will be discouraged to the extent that higher taxes will result in lower revenue. The diagram below shows how tax revenue starts to decrease as it pushes demand back towards the Y axis of the demand curve. There are few cases of finance departments yielding opportunities for tax revenue to the wider public purpose; perhaps cigarette taxation provides a rare exception where very high taxes discourage consumption sufficiently to decrease tax collections.

Most countries impose sales tax at point of final sale. Some countries, especially those in the European Community, and now Australia, tax each stage of production, a value added tax. The final tax incidence is similar to that which would be collected by a consumption tax at point of sale. Proponents of value added taxes accept that, being multi-staged, its administrative costs are higher but it is harder to evade, because each firm in the production chain has an incentive to ensure that its suppliers have paid their taxes.

Sales taxes are necessarily more regressive than income taxes. This is because as income rises, consumption starts at a high level and does not rise as steeply as income. People on very low income actually consume more than their income (by running down saving or going into debt), while people on high income consume less than their income. Therefore a consumption tax falls proportionately heavily on people with low income. Within households a consumption tax may have a different incidence to an income tax, especially if those who earn income and spend money are different people.

State and local governments in Australia are beset with problems of a narrow tax base. Precluded from income taxes, sales taxes and customs duty, states have turned to a variety of taxation instruments such as stamp duties, property taxes, licence fees and payroll taxes, which are often regressive, administratively expensive and distortionary in nature. A major source of state revenue is the operating surplus of public trading enterprises, especially electricity distribution. This is essentially using monopoly profit to finance government revenue, which has equity and efficiency problems, outlined in Chapter 15. Another source, now counting for 10 percent of state and local taxes, is the taxation of gambling.

Government Expenditure Reform

First there has been a general move away from line item budgeting to program budgeting. Line item budgeting is described by commentators like Emy and Hughes, but even they fail to describe its full horrors.⁽²¹⁾ A single department may have had as many as forty line appropriations, and was not permitted to swap expenditure from one item to another. There were separate allocations for telephone and postage, for travel, travelling allowance, domestic and overseas. Controls were very much on inputs, rather than on outputs or outcomes. The only level of audit possible was to ensure there had been compliance with appropriation.

The Commonwealth has not moved to full program budgeting and has no immediate plans to do so. It is very close to it, however, with specific program appropriations split into program costs and running costs, the latter covering mainly administrative and staffing expenses. Each agency budget now comprises a clear separation of departmental and administered expenses.

Line item budgeting used to get a bad press, but it can serve a useful function. Wildavsky⁽²²⁾ defends it on the basis that it allows for flexibility. That's an ironic twist, but it does allow for program flexibility, as administrators can switch allocations between programs, just so long as they do not switch between line items. Also, a line item budget gives tight fiscal control. This may be very important if the government wants to fine-tune fiscal policy, and, say, use public sector employment for policy ends. For example, in a poor country it may be very important that appropriations be used to employ people, and that there not be a substitution of capital for labor, particularly if that capital represents a drain on scarce foreign exchange.

Some agencies actually retain line item budgeting as an internal control, and, in effect, generate a matrix budget - each item of expenditure having a program appropriation and a line control.

With program budgeting comes the need to measure performance. Development of output-oriented performance information has been an essential element of program budgeting. There are risks, in that resources will go to those areas which show the most easily quantified results, and that the indicators will become not simply a tool of management information, but a prime controlling force.

Program budgeting and development of performance indicators bring an opportunity to change audit requirements. Basic auditing is concerned with compliance - "Was the money spent as appropriated?". Line item budgeting makes such audit relatively easy. With appropriations to programs, and development of output measures, it becomes easier to carry out efficiency audits. Commentators like Cole, however, point out that parliamentary committees and others are still concerned with beancounting - that is, an undue concern with inputs, at the expense of looking at outputs.⁽²³⁾

Perfpormance monitoring of government services, state and federal, is performed by the Steering Committee for the Review of Commonwealth/State Service Commission - in essence this is the Productivity Commission. Every year it reports on a wide range of performance information in education, health and community services.

In Australia managerial reform came hand in hand with program budgeting. The Commonwealth's Financial Management Improvement Program, launched in 1984, was as much about corporate planning, with its emphasis on evaluation and clarifying objectives, as about improving financial management.⁽²⁴⁾ Another major reform occurred in 1987, when the Hawke government cut the number of departments, thus allowing for much more flexibility in appropriations within portfolios. Other more recent reforms include market testing and devolution of personnel functions.

Financial reform has had a mixed report card. The Australian academic John Howard comments favorably on a number of financial management reforms, including asset management, cash management, risk management, contracting out etc.⁽²⁵⁾ Cole, on the other hand, points out that reforms designed to make the public sector more accountable have been counter-productive, limiting the scope of management to implement efficiency improvements. Accountability imposes costs, and necessarily involves some diversion of resources from other tasks. Certainly the reforms have allowed for more end-of-year flexibility, with carry-over of funds, more freedom to purchase services from outside agencies (previously many services had to be supplied by the Department of Administrative Services), and some rewards for improving efficiency, in that agencies can keep some of the gains from improving efficiency. (If efficiency improvements result in lower costs and therefore lower appropriations there is little incentive to seek them.)

Reforms, in themselves, have also increased the reporting burden on government. Many administrative reforms, made in the name of emulating private sector practice, have been counter-productive, and many financial reforms, while improving agencies' bottom lines, have actually been counter to national economic interests.⁽²⁶⁾ For example, it is doubtful whether contracting out has achieved the savings it was intended to - research by Graeme Hodge at Monash University suggests that contracting out achieves saving only for simply specified services such as cleaning and trash collection.⁽²⁷⁾

This is public service parlance for decentralization. There has been a withering away of central agency control in Australia. The Public Service Board, for example, was once one of the most powerful economic agencies in Australia.

Devolution may not necessarily lead to the improvement in flexibility and efficiency associated with delegation which it is expected to achieve. With the weakening of central controls there is no pressure for agencies to practise internal devolution, for example, by pushing responsibility down the line. 'Letting the managers manage' may mean letting them manage badly. And devolution has often meant cost shifting - from one Commonwealth agency to another, from a Commonwealth agency to a state agency, or from a Commonwealth agency to the private sector.

The other cost of devolution is a loss of political control over administrative matters. This may be desirable from a pure Westminster point of view, which posits a clear distinction between 'policy' and 'administration', but as commentators like Ian Thynne point out, there never was such a clear-cut division between policy and administration anyway.⁽²⁸⁾

In Australia a large proportion of economic activity is within government business enterprises. Around 10 percent of Australia's GDP is accounted for by GBEs.⁽²⁹⁾ They are generally in capital intensive industries such as power, water supply, transport and communications. Thus they account for only 6 percent of employment but 19 percent of capital stock. Improving their performance is important because they are such a large part of our economy and because funding GBE deficits and providing them with working capital makes large calls on budgetary resources. Performance improvement has generally been through a process of commercialization, that is, ensuring they operate more like private businesses, while governments retain public ownership and broad control. Practically such measures have included:

Also governments have sold many GBEs, partially or wholly, and have contracted out services in undertakings such as hospitals. These both come under the rubric of privatization.

A problem with GBE reform is that, once removed from day to day government control and from the budgetary process, many tend to act like traditional private sector monopolies, with restricted provision of services (a point we'll cover in Part 4 when we look at monopoly, consumer transfers and deadweight loss), high internal costs and bloated, overpaid bureaucracies. Measures to combat these include performance benchmarking (requiring an authority to meet certain productivity targets, such as the number of KwH of electricity generated per employee), and price control, at least for basic or high volume services.

Problems in Budgeting

The biggest problem still facing governments is inflexibility. The figure below shows how the Commonwealth has been in an ongoing budgetary squeeze. All governments have been cutting down on capital expenditure and the Commonwealth has been squeezing payments to the states.

Two large and reasonably inflexible loads on the Commonwealth are welfare and health care. Both the states and the Commonwealth face increasing pressure for health care funding, because of an ageing population and the availability of new medical technologies. This leaves governments with little budgetary flexibility, and means that many potentially beneficial programs have to be sacrificed for less beneficial programs which have the inertia of being so well established - one of the inevitable costs of incremental budgeting.

The states, for their part, have been in a similar bind. Their major outlays are for education, health care and interest on state debt. They have responded by cutting services and by cutting capital expenditure. Much of this cutback has been in areas ultimately funded by the Commonwealth, such as interstate roads. This capital cutback is not unique to Australia. Many commentators suggest that, in view of the interdependence of the private and public sectors, such cutbacks have seriously weakened the productive performance of modern economies.⁽³⁰⁾ Asset sales, particularly when governments sell assets in depressed markets, can be similarly against the interests of good economic management.

The Commonwealth budget process in Australia starts with monetary and fiscal targets. (See the next chapter for a detailed description of the Australian budget cycle). It is, essentially a 'top down' approach. That is, it starts at the macroeconomic level, being decomposed down the line, in contrast to 'bottom up' approaches, like zero based budgeting, where budgets are built from their smallest elements.

The process is one of reconciling global targets with the incremental demands of program managers and their clients. The process is an iterative one between Cabinet and Ministers, until an acceptable budget is settled on. Ultimately the concern is to meet fiscal and monetary aggregates.

The concern with simple public sector and monetary aggregates leads to pressure for privatization of major government functions, even when such privatization is not necessarily in the public interest.⁽³¹⁾

In particular, governments under fiscal stress are under pressure to privatize distribution and allocation functions, even though traditional public provision of these functions may be more efficient for the economy as a whole.

To take the example of health care, which is a major re-allocation from the well to the ill, from the young to the old, and from the well-off to the poor, there is a strong case for funding health care through government budgets. This rests on the administrative efficiency of taxation as a distribution mechanism and on the capacity central funding agencies have to control the market strength of service providers (medical practitioner trade unions, pharmaceutical companies, and hospitals).⁽³²⁾ Yet those concerned with budgetary aggregates often argue for scaling back on Medicare and associated health programs in order to meet budgetary targets.

Once a program is privatized it is no longer subject to scrutiny. One agency which does look at the allocative and efficiency costs of off-budget transactions, however, is the Productivity Commission, which tries to quantify these in specific cases (such as inquiries on the costs of tariff protection in Australia's manufacturing industries). And the Australian National Audit Office is concerned with the processes of privatization and contracting out.

Another example of privatization relates to local urban services. In parts of the USA there are housing estates being developed with their own private local governments, essentially being real estate development corporations, which provide security and public goods such as lighting, playgrounds, streets etc. Metaphorically and literally these communities erect fences around their estates. This is a very tangible example of what Caiden refers to as regression to a medieval pre-budget era.

The budgetary process with its supportive network of instruments of control is largely concerned with financial management. It is less concerned, however, with economic management except in so far as it meets monetary and fiscal targets. Efficient microeconomic management does not necessarily flow from compliance with budgetary processes. In the private sector a firm which simply keeps its ledgers and financial reports up to date, and keeps within its cash budgets will not necessarily be profitable or efficient. Parts 2 and 3 of this book address these issues.

Notes

Naomi Caiden "A New Perspective on Budgetary Reform" Australian Journal of Public Administration Vol 48 #1 March 1989

Peter Groenewegen Public Finance in Australia: Theory and Practice (Prentice Hall NSW 1990)

John L Mikesell Fiscal Administration - Analysis and Applications for the Public Sector (Brooks/Cole CA 1991)

2. Naomi Caiden "Patterns of Budgeting" in A Schick Perspectives in Budgeting (American Society for Public Administration, 1987).

3. Ian McAuley "Private Health Insurance - Redefining the Issues" Australian Rationalist #47 Spring 1998.

4. Royal Commission on Australian Government Administration (Coombs Report) (AGPS 1975)

5. Ian Thynne "Accountability, Responsiveness and Public Service Officials" Ch 4 in Alex Kouzmin Public Sector Administration: New Perspectives (Longman and Cheshire, Melbourne, 1983)

6. See public choice models, for example "The Pure Theory of Public Expenditure" in Peter Groenewegen Public Finance in Australia (Prentice Hall 1990).

7. Economic Planning Advisory Council The Size and Efficiency of the Public Sector EPAC Council Paper #44 (EPAC, Canberra 1990).

8. David Aschaeur "Is Government Spending Productive?" Journal of Monetary Economics Vol 23, 1989.

9. Isabel Argimon Does public spending crowd out private investment?: Evidence from a Panel of 14 OECD Countries (Banco de Espana, Madrid, 1995)

10. John Alford "Towards a New Management Model: Beyond 'Managerialism' and Its Critics" Australian Journal of Public Administration Vol 52 #2 June 1993.

11. See, for example, Stephen Sedgewick, Secretary of Department of Finance The State of the Service IPAA Annual Oration 28 October 1993.

12. Economic Planning Advisory Commission Public Expenditure in Australia (EPAC Commission Paper #3 October 1994)

14. Sheryle Bagwell "Going Dutch a pointer to the Third Way" Australian Financial Review 20-25 April 2000.

16. H V Emy and O W Hughes "Government Budgeting" Ch 12 in Australian Politics: Realities in Conflict (Macmillan 1988)

17. John L Mikesell Fiscal Administration Analysis and Applications for the Public Sector (Brooks Cole 1991)

18. Naomi Caiden "Patterns of Budgeting" in A Schick Perspectives in Budgeting (American Society for Public Administration 1987)

20. Naomi Caiden "A New Perspective on Budgetary Reform" Australian Journal of Public Administration March 1988

21. H V Emy and O W Hughes "Government Budgeting" Chapter 12 in Australian Politics: Realities in Conflict (Macmillan, Melbourne 1988)

22. Wildavsky, A "A Budget for all Seasons: Why the Traditional Budget Lasts" Public Administration Review Nov-Dec 1978

23. R W Cole "The Public Sector: The Conflict Between Accountability and Efficiency" Australian Journal of Public Administration Vol 48 #1 March 1989

24. Parliament of the Commonwealth of Australia Not Dollars Alone: Review of the Financial Management Improvement Program (Report of the House of Representatives Standing Committee on Finance and Public Administration. AGPS 1990)

25. John Howard "Attacking the Budget Problem" Essay 6 in Alex Kouzmin and N Scott Dynamics in Australian Public Sector Management: Selected Essays (Macmillan Melbourne 1991)

26. Ian McAuley "Dumbing down in Canberra - a guide to the public service reform industry" Two part series in Dissent Autumn/Winter 2000 and Summer 2000/2001/

27. Graeme Hodge Contracting out Government Services - A review of international evidence. (Montech, Monash University, 1996)

30. See the work of David Aschaeur, e.g. "Infrastructure: America's Third Deficit" Challenge March-April 1991, and "Does Public Capital Crowd out Private Capital" Journal of Monetary Economics September 1989

31. Here I'm using the term privatization in a broad sense as Caiden uses it, and not just in reference to selling government enterprises or contracting out.

32. Ian McAuley Health Care Markets - A Policy Discussion Paper Consumers' Health Forum 1988

Chapter 2 - Budgeting and Public Sector Reform

Introduction

A Historical Perspective

Macro Context of Budgets

Revenue and Expenditure

Government Revenue - Taxation

Government Expenditure Reform

Problems in Budgeting

Notes