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FISCAL POLICY RULES AND PUBLIC CAPITAL FORMATION IN AUSTRALIA
Kerry Ann Carne B.Bus (Prof. Acc.), Grad. Dip. App. Ec., C.P.A., M. App. Ec.
Griffith Business School, Griffith University
Submitted in fulfillment of the requirements of the degree of Doctor of Philosophy
February 2007
ABSTRACT
Subsequent to the abandonment of the Bretton-Woods agreement, many governments
experienced worsening fiscal outcomes and subsequent heightening debt levels over
several decades. Many have recently adopted rules-based fiscal policy regimes in an
attempt to correct this. The experience of capital formation by Australian national
and sub-national governments is therefore examined before and after their adoption of
fiscal policy rules. Applying non-parametric and parametric methods to data drawn
from public policy documents, the degree to which the examined governments
complied with the constraints imposed on fiscal measures by adoption of fiscal policy
rules was ascertained. The Australian governments have generally, though not always,
met fiscal constraints imposed by their fiscal policy rules. The absence of penalties
for non-compliance may have contributed to the occasional exceptions to this high
level of compliance. However, intentionality of compliance where observed cannot
be ascertained due to the virtually simultaneous adoption of accrual-based financial
reporting frameworks, and resulting informational effect, and other possible causal
factors.
The degree of compliance varied with the type of fiscal policy rule. In order,
constraints imposed by net debt, followed by net worth and budgetary balance rules
were most frequently met. Possible causes include the significantly enhanced
information set available to governments after adoption of accrual-based financial
reporting networks and the significance attributed by governments to their credit
ratings.
Attention was then focused on the experience of public capital formation and whether
it changed at the date of adoption of net worth fiscal policy rules. The
Commonwealth, Victorian, Queensland and Western Australian Governments
increased the level, growth rate or output elasticity of their investment when they
adopted a fiscal policy rule requiring, at a minimum, that they maintain their net
worth. The Victorian Government’s experience showed the effects of unique
infrastructure financing arrangements. The investment experience of the New South
Wales Government cannot be modelled effectively in this way due to its practice of
transfer of assets to other levels of government during the period of the study.
One potential implication of the research findings reported in this thesis is that the
usual macroeconomic assumption of exogeneity of government expenditures may be
too strong in circumstances where governments have adopted such fiscal policy rules.
Specifically, it appears necessary to review the general assumption that only certain
elements of government expenditures, those that are related to automatic stabilisers,
are business cycle dependent. That is, other government expenditures, those usually
considered to be independent of levels of economic activity, may no longer be able to
be considered to be so when certain institutional arrangements, such as fiscal policy
rules, exist. Instead, constraints imposed by adoption of fiscal policy rules appear
likely to assume the position of determining upper or lower bounds on certain fiscal
measures.
Further, consistent with the literature on supply-side effects of public capital
formation, the jurisdictions experiencing increased growth of public capital formation
subsequent to adoption of fiscal policy rules are those which have experienced higher
growth rates than other jurisdictions. This indicates the existence of a number of
interesting directions for further research.
STATEMENT OF ORIGINALITY This work has not previously been submitted for a degree or diploma in any university. To the best of my knowledge and belief, the thesis contains no material previously published or written by another person except where due reference is made in the thesis itself.
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ACKNOWLEDGEMENTS Grateful thanks to Christine Smith, Tom Nguyen and John Forster, each of whom at various times assumed the responsibilities of principal supervisor, for guidance, encouragement and direction. Thanks also to Peter Crossman for early advice. Thanks also to my family for their support and encouragement throughout the duration of this work. Completion of this dissertation was made possible through support provided by an Australian Research Council funded APAI scholarship. The industry partner associated with this project was the Office of Economic and Statistical Research, Queensland Treasury.
TABLE OF CONTENTS
CHAPTER 1 INTRODUCTION 1.1 TYPES OF FISCAL DECISION-MAKING FRAMEWORKS 1 1.2 RECENT DEVELOPMENTS IN FISCAL POLICY RULES
LITERATURE AND IDENTIFICATION OF RESEARCH GAP 5 1.3 THE SIGNIFICANCE OF FISCAL DECISION-MAKING
FRAMEWORKS 7 1.4 MOTIVATION AND CONTRIBUTION OF THIS STUDY 9 1.5 STRUCTURE OF THE DISSERTATION 11 CHAPTER 2 REVIEW OF RELEVANT THEORETICAL AND EMPIRICAL LITERATURE 2.1 INTRODUCTION 15 2.2 DEMAND-SIDE IMPACTS OF CHANGES IN GOVERNMENT
EXPENDITURE 2.2.1 Neoclassical theory 17 2.2.2 Keynesian theory 19 2.2.3 New classical models - impact of rational expectations 25
2.3 SUPPLY-SIDE EFFECTS OF GOVERNMENT INVESTMENT ON PRIVATE PRODUCTION 26
2.4 THE DEFICIT BIAS 30 2.5 INSTITUTIONAL ARRANGEMENTS AND PUBLIC CAPITAL FORMATION 33 2.5.1 Governmental reporting and budgeting practices 34 2.5.2 Credit agencies’ public debt rating methodologies 41 2.6 EMPIRICAL INVESTIGATIONS OF THE EFFECTIVENESS OF FISCAL
POLICY RULES 48 2.7 SUMMARY 56 CHAPTER 3 FINANCIAL MANAGEMENT FRAMEWORKS AND FISCAL POLICY RULES 3.1 INTRODUCTION 58 3.2 IMPACTS OF FISCAL POLICY RULES 59 3.2.1 The role of penalties 59 3.2.2 Intentional and unintentional compliance 69
3.2.3 What constitutes compliance – prospective or retrospective measurement 68
3.2.4 Bracketing 71 3.3 AUSTRALIAN GOVERNMENTAL FINANCIAL REPORTING
FRAMEWORKS 72 3.3.1 Budgetary Uniform Presentation Framework 72 3.3.2 Cash and accrual bases of accounting 73
3.3.3 Government Finance Statistics (GFS) reporting framework 74 3.3.4 General purpose financial reporting 79 3.3.5 Differences between GFS and GPFR 80
3.4 FISCAL MEASURES 84 3.4.1 The net debt measure 85 3.4.2 Budgetary balance measures 86
3.4.3 Net worth measures 90 3.5 INTERDEPENDENCE OF FISCAL POLICY RULES 91 3.6 CONCLUSION 93 CHAPTER 4 FISCAL POLICY RULE ADOPTION BY AUSTRALIAN NATIONAL AND STATE GOVERNMENTS 4.1 INTRODUCTION 97 4.2 AUSTRALIAN FISCAL POLICY RULES REGIMES 98 4.2.1 Commonwealth Government 100 4.2.2 New South Wales Government 108 4.2.3 Victorian Government 115 4.2.4 Queensland Government 121 4.2.5 South Australian Government 126 4.2.6 Western Australian Government 132 4.2.7 Tasmanian Government 138 4.3 SUMMARY 142 CHAPTER 5 METHODS AND DATA 5.1 INTRODUCTION 145 5.2 FISCAL POLICY RULES AND MODIFICATION OF THE ASSUMED
EXOGENEITY OF GOVERNMENT 146 5.3 ANALYTICAL TECHNIQUES 149
5.3.1 Overview 149 5.3.2 Model specification and rationale 152
5.4 THE DATA 161 5.4.1 Fiscal outcomes 161 5.4.2 Gross fixed capital formation 162 5.4.3 Gross Domestic Product/Gross State Product 166 5.4.4 Issues relating to the bracketed period 167
5.5 SUMMARY 173
CHAPTER 6 COMPLIANCE AND PUBLIC CAPITAL FORMATION 6.1 INTRODUCTION 174 6.2 COMPLIANCE WITH FISCAL POLICY RULES 177
6.2.1 Budgetary balance rules 177 6.2.2 Net worth rules 181 6.2.3 Net debt rules 184 6.2.4 Summary 187
6.3 TRENDS IN PUBLIC CAPITAL FORMATION 188 6.4 NON-DEPENDENCE OF POSITIVE GROWTH IN PUBLIC CAPITAL
FORMATION AND NET WORTH FISCAL POLICY RULES 193 6.5 PROBABILITY OF INCREASED PUBLIC CAPITAL FORMATION
AFTER ADOPTION OF FISCAL POLICY RULES 196 6.6 PARAMETRIC ESTIMATION OF FISCAL POLICY RULES 197
6.6.1 Fiscal policy rules and the relationship between public capital formation and economic activity 197
6.6.2 Fiscal policy rules and the relationship between public capital formation and the passage of time 209
6.7 VARIATION IN PUBLIC CAPITAL FORMATION AND FISCAL POLICY RULES ADOPTION 214 6.7.1 Defining the event and outcome of interest 215 6.7.2 Identifying the period of examination 215 6.7.3 Determining the selection criteria for inclusion in the study 216 6.7.4 Selecting a method for measuring normal and abnormal outcomes 216 6.7.5 Designing the testing framework for abnormal outcomes 219 6.7.6 Results 220
6.8 CONCLUSION 223 6.8.1 Did governments comply with rules? 223 6.8.2 Did public capital formation vary after adoption of rules? 224
CHAPTER 7 CONCLUSION 7.1 INTRODUCTION 227 7.2 RESEARCH DIRECTIONS 231
LIST OF TABLES
Table 1.1 Major types of fiscal policy rules 4 Table 2.1 Moody’s long-term credit ratings 43 Table 2.2 Moody’s financial terms, definitions and ratios 47 Table 2.3 Standard & Poor’s ratios 49 Table 3.1 Possible fiscal outcomes following adoption of fiscal policy rules 64 Table 3.2 Integrated nature of GFS stocks and flows 76 Table 3.3 Outline of GFS Operating Statement 78 Table 3.4 Outline of GFS Statement of Stocks and Flows 78 Table 3.5 Reconciliation of GFS Net Operating Balance with Operating
Surplus/Deficit 83 Table 3.6 Reconciliation of GFS Net Worth with AAS 31 Net Assets 84 Table 3.7 Gross Domestic/State Product, Chain volume measures - percentage
change from previous year 89 Table 4.1 Commonwealth Government fiscal policy rules 100 Table 4.2 NSW Government fiscal policy rules 108 Table 4.3 Victorian Government fiscal policy rules 115 Table 4.4 Queensland Government fiscal policy rules 121 Table 4.5 South Australian government fiscal policy rules 127 Table 4.6 West Australian Government fiscal policy rules 132 Table 4.7 Key adoption and bracketing dates 143 Table 5.1 Dates of adoption of fiscal policy rules and interregnum 168 Table 6.1 Measurement of budgetary balance fiscal policy rules 179 Table 6.2 Budgetary balance fiscal outcomes (general government sector) 180 Table 6.3 Measurement of net worth fiscal policy rules 183 Table 6.4 Net worth fiscal outcomes 183 Table 6.5 Measurement of net debt fiscal policy rules 186 Table 6.6 Net debt outcomes (general government) 186 Table 6.7 Commonwealth Government results 201 Table 6.8 New South Wales Government results 202 Table 6.9 Victorian Government results 203 Table 6.10 Queensland Government results 204 Table 6.11 Western Australian Government results 205 Table 6.12 Summary of results 206 Table 6.13 Results of trend analysis 213 Table 6.14 Calculated values of the test statistic used in event analyses 222 Table 6.15 Critical values of the test statistic used in event analyses 222
LIST OF FIGURES
Figure 3.1 Measurement of fiscal outcomes in the context of a net debt fiscal policy rule 94 Figure 3.2 Measurement of fiscal outcomes in the context of a budgetary balance fiscal policy rule 95 Figure 3.3 Measurement of fiscal outcomes in the context of a net worth fiscal policy rule 96 Figure 5.1 Ratio of GFCF to GDP, Commonwealth Government 169 Figure 5.2 Ratio of GFCF to GSP, New South Wales Government 170 Figure 5.3 Ratio of GFCF to GSP, Victorian Government 171 Figure 5.4 Ratio of GFCF to GSP, Queensland Government 172 Figure 5.5 Ratio of GFCF to GSP, Western Australian Government 173 Figure 6.1 Trends in the ratio of GFCF to GDP/GSP, by jurisdiction 190 Figure 6.2 GFCF over time, by jurisdiction 192 Figure 6.3 Levels of GDP/GSP, by jurisdiction 193 Figure 6.4 Event study timelines 217
Chapter 1: Introduction
CHAPTER 1
INTRODUCTION
1.1 TYPES OF FISCAL DECISION-MAKING FRAMEWORKS
Governments of developed countries face perennial demands for increased service
provision and reduced taxation. The recent phenomenon of population ageing and the
challenge of meeting increased demands for services such as health care, while
drawing funding from a shrinking taxpayer base, seem likely to exacerbate these
pressures. These factors, taken together, may place a premium on fiscal management
in developed economies in future decades. In addition, governments of developing
countries face continual challenges to improve the living standards of their
populations.
One obvious contributor to a solution to the challenge of maintaining living standards
in the face of emerging demographic change, or of improving living standards in
lesser developed countries, is increased productivity. One way in which this could be
achieved is by improving the quality of investment and financing decision-making in
the public sector. In this context, it is useful to consider the frameworks used by
governments in their fiscal decision-making processes.
Fiscal decision-making frameworks can be seen to fall into two categories -
discretionary approaches and rules-based approaches. That is, fiscal policy rules may
be generally seen as an alternative approach to discretionary policy. The two
approaches can be distinguished on two main bases - the basis of authority for, and
the intended period of observance of, the fiscal intentions that comprise them.
One emerging definition of discretionary approaches are those approaches to fiscal
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Chapter 1: Introduction
decision-making that do not incorporate explicitly-stated intentions that are both
enshrined in some authoritative form and intended to apply beyond the life of the
current government.
In contrast, the International Monetary Fund (IMF) (2001) at paragraph 105 defines
fiscal policy rules as “forms of agreement (usually in law) that restrict the fiscal
policy action of government”. Similarly, Kopits and Symansky (1998) at page 2
define such rules as “permanent constraints on fiscal policy, typically defined in
terms of an indicator of overall fiscal performance”. These definitions are accepted
for the purposes of this research, and are further explained below.
Kopits and Symansky (1998) posit that the intended period of observance is crucial to
identification of a fiscal rule. An intention that the rule be applied on a permanent
basis by successive governments is said to be an essential criterion. Therefore it is
necessary to consider the intended period of application when determining whether a
fiscal intention, however expressed, may be identified as a fiscal rule.
However, discretionary approaches may also demonstrate time consistency. Where a
discretionary approach is applied with consistency over a considerable period of time,
differences between the rule based and discretionary approaches become less
identifiable and tend to reside in the method of expression and establishment of the
approach. A “norm” or “principle”, if not enshrined in some authoritative form such
as legislation or international treaty, may be identified as a discretionary approach
even if, in retrospect, it has been observed over a considerable period of time. In
other words, it can be argued that it is the intended period of observance of a fiscal
intention, at the time of its establishment, as well as the method of its establishment,
that provides guidance in identifying whether that intention is part of a discretionary
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Chapter 1: Introduction
or rules-based approach to fiscal decision-making.
Fiscal policy rules, as stated above, may be seen as forms of agreement, either
between governments (as in international treaties such as the Growth and Stability
Pact between European Union member countries, also known as the Maastricht Treaty)
or between a government and its constituency. Where enshrined in some lasting and
authoritative form, an explicitly stated intention of government regarding its future
fiscal activities, in a democratic society, represents an agreement of the latter type1.
There is a high degree of heterogeneity of fiscal policy rules. Rules vary widely in
their target variable, institutional coverage and methods of implementation. In
addition, local terminology varies, with few governments using the term ‘rule’.
Table 1.1 presents major types of fiscal policy rules.
1 The democratic process provides a means whereby the electorate may exercise its voting power to terminate the agreement should it be found unacceptable. In addition, it is elementary that the existence of this voting power, and the threat of its use, tends to restrict a government to actions that it expects the electorate will find agreeable.
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Chapter 1: Introduction
Table 1.1 Major types of fiscal policy rules
Source: Adapted from Kopits and Symansky (1998)
Rules may cover fiscal aggregates (such as budget deficit, borrowings or debt) or
subcomponents of these aggregates. One frequently-occurring rule is the so-called
‘Golden Rule’, which requires that borrowing be undertaken only to finance
investment.
Following Kopits and Symansky (1998), rules may be distinguished by their degree of
stringency, precision and enforcement of the statutory instrument. Relevant issues
include whether rules require ex ante approval only or, additionally, ex post
observance (i.e. whether both prospective and retrospective financial statements
reflect adherence to the stated constraint), what penalties exist (tangible or intangible,
reputation, financial or judicial) and the degree of specificity of the stated constraint.
Type of rule Form
Balance between overall revenue and expenditure (that is, prohibition on government borrowing); or limit on government deficit as a proportion of GDP.
Balance between structural (or cyclically adjusted) revenue and expenditure; or limit on structural (or cyclically adjusted) deficit as a proportion of GDP.
Balanced-budget or deficit rules
Balance between current revenue and current expenditure (that is, borrowing permitted only to finance capital expenditure).
Prohibition on government borrowing from domestic sources Borrowing rules
Prohibition on government borrowing from the central bank; or limit on such borrowing as a proportion of past government revenue or expenditure.
A limit on the stock of gross (or net) government liabilities as a proportion of GDP
Debt or reserve rules Target stock of reserves of extra budgetary contingency
funds (such as social security funds) as a proportion of annual benefit payments
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Chapter 1: Introduction
1.2 RECENT DEVELOPMENTS IN FISCAL POLICY RULES
LITERATURE AND IDENTIFICATION OF RESEARCH GAP
Two interesting developments have recently occurred in the economics and public
finance literature. The first is the detailed assessment of the effectiveness of fiscal
policy rules in achieving fiscal sustainability by both the IMF and the Organisation
for Economic Co-operation and Development (OECD). Kopits and Symansky (1998)
for the IMF concluded that fiscal policy rules could provide a useful contribution to
the achievement of fiscal sustainability if the rules had certain characteristics and
were supported by a complementary program of underlying structural change. The
OECD (2003) adopted a similar view.
The second is the emergence of a body of literature that indicates that public capital
stocks have important impacts on private production. Gramlich (1994) notes that
Aschauer first linked public infrastructure investment and productivity in 1989, and
that supporting work by Aschauer and following work by others (e.g. Nourzad (2000),
Otto and Voss (1994 and 1996)) has further developed on this theme.
An important research issue arising from the above insights is how fiscal policy rules
have affected productivity and growth through their effect on public assets
accumulation. This thesis makes a contribution to exploring this research issue in that
it investigates the nature and extent of any relationship between fiscal policy rules and
the management of debt and accumulation of public assets in Australia.
This general research issue can be further disaggregated into specific elements. One
element is the question of how effective rules have been in terms of achievement of
their stated targets or constraints. As a logical progression, the next element, in an
investigation of the effect of fiscal policy rules on productivity and growth, is how
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Chapter 1: Introduction
appropriate have targets or constraints, established under fiscal policy rules, been to
fostering economic growth.
One aspect of the latter is how rules have affected capital formation. While, in an
economic sense, capital formation refers to accumulation of real assets, in a financial
sense, capital formation refers to accumulation of both assets and liabilities. Past
research on the effectiveness of fiscal policy rules has mainly focused on examining
how rules have contributed to achievement of fiscal sustainability (which has been
interpreted as meaning reductions in debt levels) and on macroeconomic effects via
fiscal multipliers that have varied widely in their coverage, but none of which have
focussed on private capital production elasticities. In other words, the effect of fiscal
policy rules on the assets dimension of public capital formation, and thence on private
sector production, has not yet been considered, either explicitly or in isolation from
other effects. It is this research gap this dissertation seeks to make a contribution
towards filling.
The finding of a link between levels of public asset holdings and growth, together
with recently-developed awareness of the effectiveness of fiscal policy rules in
managing one aspect of the liabilities dimension of public capital formation, raises the
question of the effect of fiscal policy rules on the assets dimension of public capital
formation. Specifically, this refers to the amount and composition of public assets
accumulation. In the case where sub-national governments are examined, the
question also arises as to the relative effect of national and sub-national fiscal policy
rules.
Awareness of the answers to these questions would inform an assessment of how
different fiscal policy rules may be expected to impact, through their effect on capital
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Chapter 1: Introduction
formation, on productivity and growth. Provision of an enriched information set with
respect to this issue may assist governments to choose improved decision-making
frameworks and, eventually, lead to improved fiscal policy, with subsequent positive
macroeconomic effects. Improved information should also be of interest to
international agencies tasked with assisting governments of developing and transition
countries to meet their full growth potential.
1.3 THE SIGNIFICANCE OF FISCAL DECISION-MAKING
FRAMEWORKS
In order to best formulate fiscal policy, it is necessary to understand how the decision-
making frameworks adopted by governments affect the fiscal policy stances
eventually adopted. In order to then extend the analysis to gain an understanding of
how fiscal policy decision-making frameworks have ultimately impacted the
macroeconomy, it is necessary to understand how those stances, when implemented,
have affected productivity and growth. In essence, it is necessary to understand the
linkage between the decision-making framework (in this case, fiscal policy rules) and
the effect on the economy.
Fiscal policy rules impact productivity and economic growth in four main ways.
Firstly, fiscal policy rules determine levels of government outlays in the short run.
The impact of government outlays on the economy is the subject of extensive
scholarly investigation. Mainstream economics of long standing teaches that
government outlays comprises a part of aggregate demand, and that demand, price
and output levels can be manipulated at the aggregate level through fiscal policy. The
potential for a ‘crowding out’ effect of government outlays and the importance of
sources of finance (such as use of public debt), in affecting demand for money and
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Chapter 1: Introduction
interest rates, are also well recognised. New growth theory provides a basis for
recognition that the indirect effects of government service provision (e.g. education)
may also impact on economic growth.
Secondly, it is also well accepted that fiscal policy rules influence the capacity of
government to stabilise output over business cycles by adopting counter-cyclical
policies, effected through automatic stabilisers, customised measures or both. Thus
government may offset price pressures that threaten continued output growth by
adopting a contractionary fiscal policy stance (running a budget surplus, both ex ante
and ex post) or may stimulate a sluggish economy by adopting an expansionary fiscal
stance (running a budget deficit). The latter requires that the government’s fiscal
position is sustainable and that capacity exists to finance such a policy position, either
by drawing down reserves or by accessing debt, which in turn requires a sufficiently
conservative existing debt position to allow for increases without overly burdensome
costs. Fiscal sustainability is a major motivator to adoption of fiscal policy rules.
Thirdly, fiscal policy rules affect the composition of government outlays (between
consumption expenditure and investment) and hence affect the level of public capital
stock. In other words, fiscal policy rules affect the investment decisions made by
governments.
As previously stated, a literature has recently developed that indicates the importance
of public capital formation stocks on private production. For example, Nourzad (2000)
notes that, while the textbook version of Keynesian fiscal policy does not distinguish
between consumption spending and investment by governments, the two types of
spending are likely to have different effects on the economy. Specifically, while
government consumption spending affects the economy through its contribution
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Chapter 1: Introduction
to aggregate demand in the short run, government investment also affects the
economy, not only through aggregate demand in the short run, but also, in the longer
run, through aggregate supply. This is because government-provided infrastructure is
used by firms in their production processes. Use of roads, highways and bridges by
private sector transport providers is a common example. This is what Aschauer (2000)
calls the direct effect of government investment on private sector output growth, the
indirect effect being that the complementary nature of private and public capital in
private-sector productive activity is such that an increase in the public capital stock
raises the return to private capital, which spurs the rate of growth of private capital
stock. The literature is further surveyed in Chapter 2.
Fourthly, fiscal policy rules affect the use of debt by government to finance their
activities. In other words, they affect the financing decisions made by governments.
Kopits and Symansky (1998) trace the effect of fiscal policy rules on debt levels as an
indicator of sustainability. However, some rules go beyond targeting sustainable debt
levels, and target very low levels of debt or impose restrictions on the uses to which
borrowings may be put. Such rules have been criticised (for example by Buiter (2001)
and Quiggin (1995)) as potentially welfare-reducing.
1.4 MOTIVATION AND CONTRIBUTION OF THIS STUDY
The research question to be addressed in this dissertation is whether, in the context of
Australian national and sub-national (i.e. State) government, adoption of fiscal policy
rules coincided with changes in the rate of accumulation of public assets. In
accordance with economics concepts, the latter is termed ‘public capital formation’
within this study.
Consideration of the international experience of fiscal policy rules, as stated above,
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Chapter 1: Introduction
has focussed on the contribution of rules to achievement of fiscal sustainability, where
this was considered to depend primarily on debt reduction. However, rules may also
have an effect on the accumulation of public assets. It is therefore intended to
investigate the nature and extent of any relationship between fiscal policy rules and
accumulation of public assets.
While fiscal policy rules are unlikely to prove the only causal factor in public assets
accumulation, fiscal policy rules provide the framework within which governments
undertake their investment and financing decision-making. Thus, fiscal policy rules
have both direct and indirect impacts on the financial decisions of governments.
However, the proposed research does not exhaust all possible areas of investigation.
For example, little focus is placed on the degree of success enjoyed by governments
in meeting targets or constraints imposed by fiscal policy rules. While coverage is
provided of a variety of data generated by fiscal decisions taken under a fiscal policy
rules regime, this is focussed on understanding more completely the effect on capital
formation i.e. a ‘filling out the picture’ approach is taken. For example, in order to
understand the effect of a fiscal policy rule aimed at maintaining net worth, data may
be provided on complementary ratios such as public investment as a percentage of
Gross Domestic Product (GDP) or Gross State Product (GSP) as well as on aggregate
net worth levels.
Importantly, no effort is made to identify other determinants of public investment.
For example, the political economy aspects of investment decision-making are not
presented or explored.
Capital formation aspects of fiscal policy rules are also not the only growth-relevant
aspect of government outlays. Endogenous growth theory provides a basis on which
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Chapter 1: Introduction
to relate government expenditure on such services as education and health care to
productivity and growth. This area also is not investigated in this research.
Finally, this research does not attempt to assess the on-going issue of the respective
merits of discretionary versus rules-based approaches to fiscal policy. Rather, an
assessment of the effectiveness of rules-based regimes is presented, in order to allow
commentary on governments’ success or otherwise in meeting the constraints that
comprise those rules-based regimes. In addition, the analysis in this thesis does not
extend to the macroeconomic impacts of fiscal policy but rather, focuses on any
impact fiscal policy rules may be observed to have had on public capital formation.
1.5 STRUCTURE OF THE DISSERTATION
In Chapter 2, the relevant theoretical and empirical literature is surveyed. In
particular, the various influences on public capital formation and its impact on the
macroeconomy are described. The focus is on what economic theory has to say about
the effect of government expenditure on the macroeconomy, including how
government expenditure affects the demand and supply sides of the macroeconomy,
the influence of institutional arrangements and the effectiveness of fiscal policy rules
in influencing the level and composition of government expenditure.
Neo-classical and Keynesian theories of the government budget, the deficit bias, the
Ricardian equivalence theorem and the impact of rational expectations on the
effectiveness of fiscal policy are explored for their demand-side impacts. Then
follows description of the supply-side effects of public capital formation on private
production. Institutional arrangements surrounding public investment are discussed,
including governmental budgeting processes and the methods by which international
credit rating agencies assess and assign ratings in a practical supplement to the
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Chapter 1: Introduction
theoretical treatment contained in the previous section. The significance of
governmental budgeting practices is that these practices form the means of decision-
making regarding the level and composition of governmental expenditure and
investment. The significance of credit rating agencies’ methodologies is that, through
their focus on public debt, their ratings have become important elements of Australian
governments’ fiscal strategies in the context of common adoption of credit ratings and
net debt level targets. The empirical literature on fiscal policy rules is then surveyed.
This literature investigates the effectiveness of fiscal policy rules in influencing
government fiscal outcomes and attaining their ultimate goal of economic growth by
enhancing the fiscal sustainability of adoptive governments. This provides a basis for
the reporting of results of analysis undertaken in Chapter 6.
Chapter 3 provides a basis for identification and understanding of fiscal measures (or
outcomes) which may be constrained by adoption of fiscal policy rules. It outlines the
range of fiscal outcomes that may follow adoption of fiscal policy rules, including the
possible role of factors not under the control of government. This enables distinction
of intentional from unintentional fiscal outcomes and thus intentional from
unintentional compliance. In order to generate understanding of the arrangements
under which are reported the fiscal outcomes subsequent to adoption of fiscal policy
rules, governmental financial reporting frameworks employed in the Australian
context are then described. The intended effect of various fiscal policy rules on key
fiscal measures are then specified and described in order to identify a link between
fiscal policy announcements and measures of fiscal outcomes. An important aspect
of an accrual reporting framework, namely its integrated nature and the resulting
interdependencies between fiscal aggregates, is then described. The implication of
this is that interdependencies exist between fiscal policy rules, and hence that certain
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Chapter 1: Introduction
fiscal policy rules may imply constraints on fiscal measures additional to the stated
measure. Understanding of this is necessary to enable interpretation of the effects of
fiscal policy rules adopted by Australian governments.
Chapter 4 presents a brief history of rules-based fiscal regimes internationally and a
detailed coverage of fiscal strategies adopted by Australian national and State
jurisdictions. The latter provides a basis for identifying the date of adoption of fiscal
policy rules (as defined) relating to budgetary balance, debt reduction and net worth.
The precise targets adopted and the sector (general government or total public sector)
to which they apply are identified in order to provide a foundation for empirical
investigation of compliance and public capital formation impacts in Chapters 5 and 6.
Chapter 5 details methods and data used in this thesis to explore empirically
Australian governments’ fiscal outcomes after adoption of fiscal policy rules. This
chapter describes the logical process undertaken to arrive at the research question of
“What happens to public investment when governments adopt fiscal policy rules?”
The expectation is that public investment will increase as a result of adoption of a net
worth fiscal policy rule, if, as assumed, governments comply with the constraint
imposed on their fiscal measures by adoption of that rule and if the composition of net
worth remains unchanged.
Investigation of the research question uses several techniques. These bring multiple
lenses to focus on the research question, strengthening the overall analysis by
overlapping examination which in part mitigates weaknesses of any individual
technique, and permits development of an overall picture from a number of different
perspectives.
The results of application of these different approaches are provided in Chapter 6.
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Chapter 1: Introduction
The primary finding and major contribution of this thesis is that adoption of net worth
fiscal policy rules has, in the Australian context, coincided with changed rates of
public capital formation. This implies that adoption of fiscal policy rules may have
had an influence on governmental investment decision-making. This is significant
when considered in the context of private production elasticities related to public
capital stocks and the resulting changes in levels of economic activity.
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Chapter 2: Review of Relevant Theoretical and Empirical Literature
CHAPTER 2
REVIEW OF RELEVANT THEORETICAL AND EMPIRICAL
LITERATURE
2.1 INTRODUCTION
This chapter describes the various influences on public capital formation and its
impact on the macroeconomy. The line of enquiry is this: Firstly, what does the
theoretical literature have to say about the effects of government expenditure on the
macroeconomy? Specifically, how does government expenditure affect, separately,
the demand and supply sides of the macroeconomy? Secondly, what does the
empirical literature have to say about levels of government expenditure? Thirdly,
how do institutional arrangements influence government expenditure? Lastly, how
effective are particular institutional arrangements i.e. adoption of fiscal policy rules,
in influencing the level and composition of government expenditure?
In pursuing this line of enquiry, Section 2.2 presents neo-classical and Keynesian
theories of the government budget including the Ricardian equivalence theorem and
the impact of rational expectations on the effectiveness of fiscal policy and the deficit
bias. This section provides theoretical background to this study and establishes the
mainstream, currently-accepted view of how government expenditure broadly impacts
the macroeconomy. The focus is on demand-side impacts.
Section 2.3 provides coverage of supply-side effects of public capital formation on
private production. Findings of this literature indicate that public capital formation
has important impacts on private production, providing a rationale for this study and
justification for the research question. This section further supplements the coverage
of demand-side effects of fiscal policy contained in the previous section, providing a
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Chapter 2: Review of Relevant Theoretical and Empirical Literature
more complete view of the effects of government expenditure on the macroeconomy.
Section 2.4 discusses the deficit bias. This behavioural construct has arisen from
empirical observation of governments’ fiscal outcomes over time. It provides a
political economy supplement to the economics literature and contributes further to
our in understanding of the many determinants of government expenditure.
In Section 2.5, institutional arrangements surrounding public investment are
presented, including the process of governmental budgeting and, in particular, the
methods by which international credit rating agencies assess and assign ratings.
Governmental budgeting practices are significant because it is through these practices
that decisions are reached regarding the level and composition of governmental
expenditure and investment. Credit rating agencies’ methodologies are significant
because public debt ratings have become important elements of Australian
governments’ fiscal strategies. Most jurisdictions targeted particular credit ratings
and adopted net debt fiscal policy rules as a means of achieving the targeted rating.
To the extent that net debt iwas a focal point of fiscal strategy, public capital
formation may have reduced as available funds awere used to retire debt or
accumulate financial assets. This section provides a practical supplement to the
theoretical treatment contained in the previous section.
Section 2.6 reviews the empirical literature on fiscal policy rules. This literature
broadly investigates how effective fiscal policy rules have been in influencing
government fiscal outcomes. The current state of thinking is summarized regarding
the efficacy of fiscal policy rules in attaining their ultimate goal of economic growth
by enhancing the fiscal sustainability of adoptive governments. This provides a basis
for evaluation and comparison of results reported in Chapter 6 of this study. Section
2.7 summarises.
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2.2 DEMAND-SIDE IMPACTS OF CHANGES IN GOVERNMENT
EXPENDITURE
2.2.1 Neoclassical theory
The neoclassical theory of the budget examines a closed economy in which the
government may be characterised as a ‘benevolent social planner’ which maximises
the utility of a representative agent who consumes, works and saves. The agent’s
utility function depends on private consumption and leisure but does not depend on
the government’s provision of public goods. Neoclassical theory of the government
budget stresses tax smoothing, wherein budget deficits may be incurred when needed
to cover temporary increases in government spending, with an emphasis on
maintaining constant tax rates to minimise distortions.
An intertemporal budget constraint is imposed and implies that the present value of
the government’s (exogenously determined and stochastic) spending must equal the
present value of taxes2. The level of taxes is therefore determined by the
intertemporal budget constraint. Deficits occur when spending is high and surpluses
occur when spending is low. Time horizons are identical (between agent and
government) and infinite (abstracting from intergenerational aspects and from finite
government terms). The government finances spending in each period by imposing
taxes on labour income, which are distortionary as they affect labour supply. The
2 Some more complex versions of this model allow debt financing of deficits. For example, Barro’s 1979 model allows issuing non-state contingent (i.e. default free) debt to assist smooth tax rates and Lucas and Stokey’s 1983 model allows state contingent debt (Loukoianova and Vahey (2002)).
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model is based on the idea that the government minimises the distortion from taxation
by allocating taxes over time, rather than varying taxation with expenditure.
The individual utility function is concave and has decreasing marginal utilities.
Therefore a policy of constant taxes dominates a balanced budget policy because the
additional tax distortions of the present more than offset the welfare gains of the lower
tax rates of the future (Loukoianova and Vahey (2002)).
Another element of neoclassical theory is the Ricardian equivalence theorem.
Ricardian equivalence, as the name implies, was first proposed by Ricardo3 and
revived by Barro (Hakes and McCormick (1996)). In its perfect form, Ricardian
equivalence is based on strong assumptions of long time horizons, infinitely-lived
families, perfect foresight, absence of liquidity constraints, perfect capital markets and
altruism. Ricardian consumers, aware of the government’s intertemporal budget
constraint, will anticipate that a (lump sum) tax cut that is financed by issuing
government debt will result in imposition of higher future taxes, and will therefore
consider their permanent income to be unaffected and will not change consumption.
Any intended expansionary effect of the debt-financed tax cut will be nullified and
equivalence will exist between taxes and debt. The fiscal multiplier will be zero.
Private saving will fully offset public dissaving and, as national savings therefore
remain unaltered, the interest rate will not respond to variations in the stance of fiscal
policy (Barro (1984), Hakes and McCormick (1996), Kotlikoff, Razin and Rosenthal
(1990)).
3 However, Hakes and McCormick (1996) argue that Adam Smith presented many of the same arguments as Ricardo, framed the equivalence issue in the same manner as modern scholars (asking whether government bonds are net wealth, or whether tax rebates are saved) and furthermore reached qualitatively similar conclusions to Ricardo, though using a less mathematically rigorous approach.
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Barro showed how intergenerational altruism can economically link current and future
generations by current generations choosing to reduce consumption in response to
increased debt, anticipating future increased taxation, and leave bequests to future
generations (interior transfers) with which to pay that taxation. The implication is that
current generations thereby neutralize intergenerational redistribution by the
government.
Many authors criticise the realism of the underlying assumptions noted above and
argue that the practical significance of Ricardian equivalence in its perfect form is
therefore limited. See for example, Kotlikoff, Razin and Rosenthal (1990), Khalid
(1996) and Barskey, Mankiw and Zeldes (1986).
2.2.2 Keynesian theory
Keynesian models stress macroeconomic stabilisation i.e. moderation of the business
cycle as the goal of fiscal policy, indicating a use of expansionary policy during
episodes of economic contraction and contractionary policy during episodes of
economic expansion. These models adopt a focus on demand side management
wherein government can influence aggregate demand directly by changing its
expenditure level. This is the textbook expenditure approach to measurement of
Gross Domestic Product (GDP), expressed as: GDP = C + I + G + X – M where C =
consumption expenditure, I = private investment expenditure, G = government
expenditure, X = expenditure on exports and M = expenditure on imports.
Government expenditure is thus considered to be exogeneous to the model.
Hemming, Kell and Mahfouz (2002) note that the Keynesian approach, in its simplest
form, assumes price rigidity and excess capacity, so that output is determined by
aggregate demand, and an increase/decrease in fiscal outlays has a multiplier effect on
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Chapter 2: Review of Relevant Theoretical and Empirical Literature
aggregate demand and output. Change in government expenditure in turn changes
income levels, which in turn changes expenditure in a series of successive ‘rounds’ of
expenditure and income. The tendency by households to additional consumption
expenditure in response to additional disposable income earned is termed the marginal
propensity to consume (MPC). If all income is either spent or saved, the MPC is that
proportion of each dollar of additional disposable income that is spent4. The
multiplier in this model is positive, exceeds one and its size depends on the
responsiveness of consumption to disposable income (Barro (1984), Stiglitz (1997)
and Gans, King, Stonecash and Mankew (2003)).
Thus the basic formula for the simple multiplier is : Multiplier = 1/(1 - MPC).The
nature of the fiscal change affects the size of the multiplier. Since consumption is
affected by individuals’ disposable income, taxes reduce consumption. The multiplier
is larger for an increase in spending than for a reduction in taxes. This is because an
increase in government expenditure represents a direct injection into the expenditure
flow, a ‘first round’ of increased expenditure which is compounded by successive
rounds as the increased expenditure increases incomes, which in turn are spent. In
contrast, a reduction in taxes works indirectly to affect an increase in expenditure by
increasing disposable income.
In addition, the type of taxation regime in existence has an effect on the size of the
multiplier. Proportional or consumption taxes will result in a smaller multiplier than
will lump sum taxes (Stiglitz (1997)).
Then the basic formula for the simple multiplier with taxes (fixed for simplicity at a
4 The Marginal Propensity to Save (MPS) is that proportion of each dollar of additional disposable income that is saved. The MPC plus the MPS equals one.
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given fraction, t, of income) is: Multiplier = 1/(1- MPC*(1 – t)). A spending increase,
that is fully funded by a tax increase, results in a balanced budget multiplier of exactly
one5. When an increase in government expenditures is exactly matched by an
increase in taxes, the increased taxes reduce disposable income and thus private
consumption, while the expenditure increases disposable income and thus private
consumption. However, the direct injection of expenditure into the circular flow,
compared with the indirect effect of taxation increase (wherein consumption is
reduced via the reduction of disposable income), means that the two effects are not
equal. The increase in consumption is almost completely offset by the increased tax
effect, with the eventual amount of the expansionary effect equalling the amount of
the increase in government expenditure (Stiglitz (1997)).
Extensions to the simple Keynesian view include crowding out (both through induced
changes in interest and exchange rates and through direct substitution of public for
private provision of goods and services) and increases in imports to meet any increase
in domestic demand. These influences affect the size of fiscal multipliers but not their
sign. The extent of crowding out depends on the sensitivity of investment and money
demand to interest rates, openness of the economy, whether the exchange rate is fixed
or flexible and price rigidity.
In a closed economy and in the absence of accommodative monetary policy, an
increase in government expenditures will cause interest rates to rise as the increase in
5 Barro (1984) separates consumption expenditure effects of taxation and government expenditure increases into two classes, one where consumers substitute consumption of publicly-produced goods and services for privately-produced goods and services, and one where consumers reduce consumption generally as a result of reduced disposable income arising from increased taxes. The substitution effect is said to be unaffected by, and occur additional to, the disposable income effect. Barro then posits that a balanced budget multiplier may be less than one. This more common analysis of the balanced budget multiplier does not distinguish between the two consumption effects and essentially ignores the substitution effect.
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national income causes increased demand for money6 (Stiglitz (1997), Gans et al
(2003)). The standard IS-LM model, (see for example Barro (1984)), holds that
private investment responds negatively to changes in interest rates. Thus public
expenditure will ‘crowd out’ private investment. Of course, a reduction in money
demand may be offset by monetary policy easing (unless the demand for money is
infinitely sensitive to interest rates, when monetary policy would be rendered
ineffective).
In addition, the financing method adopted is of some importance. If a fiscal
expansion is financed by build up of public debt, risk premia on interest rates may
increase to reflect the mounting risk of default or inflation, and reduced private
investment and other expenditure may result.
The permanency of a fiscal policy shift is significant. For example, a temporary fiscal
expansion financed by debt will be more effective than a permanent expansion
because the increase in risk premia will be less, reflecting the lower risk of
undermining debt sustainability. Policy credibility will impact this process – if the
government lacks a track record of fiscal prudence, and there is little faith in the
temporary nature of a spending increase or tax cut, interest rates are more likely to
incorporate increased risk premia. This supports the proposition that fiscal policy
rules are a more effective means of attaining fiscal sustainability than are
discretionary policy positions, since by the definition adopted in this study, fiscal
policy rules are intended to apply not only for the term of power of the adoptive
government but for the future as well i.e. for the term of all successive governments.
6 This is in the long run. Gans et al (2003) reverses the order of analysis in the short run, with the price level ‘stuck at some level’, the interest rate adjusting to balance the supply and demand for money and the level of output responding to changes in aggregate demand, which is in part determined by the interest rate.
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These effects may be exacerbated in an open economy with highly mobile capital. If
a fiscal expansion is viewed as a risk to debt sustainability, fears may also be raised
that there will be future balance of payments problems. This may lead to reduced
foreign investment and to capital outflows, adversely impacting economy activity
(Hemming, Kell and Mahfouz (2002)).
Under a flexible exchange rate regime, capital inflows (attracted by higher domestic
interest rates) cause an appreciation of the exchange rate, leading to reduced
competitiveness of domestic products on external markets and offsetting the increase
in aggregate demand by reducing exports. Where capital is perfectly mobile,
complete crowding out will occur, rendering fiscal policy ineffective (unless the fiscal
expansion is financed by drawing down reserves). The extent of crowding out will
vary with sensitivity of investment and money demand to interest rates, and with the
relationship between money demand and income. If investment is an increasing
function of current income, multiplier-accelerator models show that quite large fiscal
multipliers occur despite the crowding out effect.
Under a fixed exchange rate regime, a smaller increase in interest rates will occur than
in a closed economy, and where capital is perfectly mobile, the money supply will
increase sufficiently to offset all of the threatened increase in domestic interest rates,
reducing crowding out and increasing the effectiveness of fiscal policy (and the size
of the multiplier).
Increased government expenditure is deemed productive, that is, it results in increased
provision of public goods and services. These public goods and services may
substitute for some private consumption, for example when the government provides
free services such as libraries. Then people reduce expenditure where those services
are a close substitute for services they might have bought from private sector
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Chapter 2: Review of Relevant Theoretical and Empirical Literature
producers. To the extent that this impacts the marginal propensity to consume and
increases savings, direct crowding out occurs and the fiscal multiplier is reduced.
This analysis abstracts from any effect on the marginal products of labour and capital,
assuming no direct effect on work effort or investment demand. Changes in the real
interest rate are assumed to be the sole mechanism by which changes in government
expenditure impact on investment (Barro (1984)). This assertion is contradicted by
the findings of a number of writers regarding the existence of private production
elasticities in relation to public investment (see Aschauer (1988) and Otto and Voss
(1994, 1996)). These studies are surveyed in Section 2.4.
Neo-Keynesian models allow for price change and show that price flexibility narrows
the range of values taken by fiscal multipliers and limits the effects of the exchange
rate regime. For example, if prices are flexible, in a closed economy, a fiscal
expansion will put upward pressure on prices, which will partly offset the short term
increase in aggregate demand, reinforcing the crowding out effect induced by interest
rate rises and reducing the multiplier.
However, in an open economy with a flexible exchange rate, the extent of crowding
out depends on the response of domestic prices to exchange rate changes. If domestic
prices and exchange rates move together, crowding out will be lower (and multipliers
higher) than with price rigidity, as prices reduce with appreciation of the exchange
rate. With a fixed exchange rate, more crowding out will occur than with price
rigidity, as the current account deteriorates in response to exchange rate appreciation-
induced price increases.
The marginal propensity to import (MPI) equals the proportion of each additional
dollar of income that is spent on imports. The size of the MPI affects the size of the
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Chapter 2: Review of Relevant Theoretical and Empirical Literature
fiscal multiplier. Any increase in income (such as that resulting from an increase in
government expenditure) does not enter the expenditure flow creating additional
rounds of expenditure if it is spend on imported goods and thus becomes income of
citizens of foreign countries. Thus imports are a third leakage (additional to savings
and taxes) from the circular income flow (Stiglitz (1997)).
Wealth effects may contribute to crowding out by affecting aggregate demand. If
changes in interest rates, the exchange rate and prices affect forward-looking
consumers’ perceptions of their financial wealth, wealth-dependent consumption will
also respond. This effect is variously known as the Pigou effect (after its discoverer)
and the real balance effect.
Dynamic effects of fiscal policy relate to the relative offsetting effects of the above
and below factors over time on the value of the fiscal multiplier. For example,
Auerbach and Kotlikoff (1987) note that if indirect (negative) effects such as
crowding out take longer to impact the multiplier than do direct (positive) effects of
increased expenditure, fiscal multipliers are likely to be larger in the short term than
in the long term.
2.2.3 New classical models - impact of rational expectations
In rational expectations models the distinction between temporary and permanent
policy changes is particularly important. Specifically, a permanent fiscal expansion
may lead to an expectation by households and firms that initial increases in interest
rates and appreciation of the exchange rate will become permanent and increase over
time, adding to crowding out, and possibly turning the fiscal multiplier negative. The
significance of this is that, when households hold rational expectations, the longer-
term effects of fiscal policy will matter even in the short term (Hemming, Kell and
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Chapter 2: Review of Relevant Theoretical and Empirical Literature
Mahfouz (2002)). This is likely to strengthen the impact of fiscal policy rules on the
credibility of the adoptive government’s fiscal management, and thus on debt premia,
in the period immediately following their adoption.
2.3 SUPPLY-SIDE EFFECTS OF GOVERNMENT INVESTMENT ON
PRIVATE PRODUCTION
This section reviews the literature that focuses on how public investment impacts on
the macroeconomy. Barro (1984) notes that, while we could model public services as
the output from the government’s production function, this is typically not done.
Macromodels generally simplify matters by neglecting production in the public sector
and implicitly assume that the government buys only final goods and services in the
commodities markets, effectively subcontracting all of its production to the private
sector. Hence public investment, publicly owned capital and government
employment are always zero. To the extent that this is recognized to be unrealistic,
public sector technology and management capability are implicitly assumed to be
identical to that of private producers. This has been combined with an historical
attachment by the public sector to cash accounting. Arguably, until the emergence of
the literature linking public capital with private sector production, this lead to a lack
of awareness of the significance of public capital in determining private production
levels, composition and location.
To the extent that a fiscal expansion benefits supply, fiscal multipliers will increase in
size. Supply side effects of fiscal policy thus are of particular relevance to a study of
the effect of fiscal policy on public capital formation. This is because the ultimate
rationale of such a study is to gain an understanding of the impact of public capital
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Chapter 2: Review of Relevant Theoretical and Empirical Literature
formation on private sector production and, in turn, on productivity and growth.
Dadgostar and Mirabelli (1998), in a review of studies of the effect of public capital
expenditure on the economy, state that the empirical research on the effect of fiscal
policy on GDP comprises three major groups. The first group focus on the
relationship between real GNP or employment and aggregate demand management.
Well-known economists such as Grossman and Barro have contributed to this group
of studies.
The second group focus on the sensitivity of the composition of national income to
the choice between tax and debt financing of current government expenditure i.e.
whether government expenditure directly substitutes for private consumption and
saving. Dadgostar and& Mirabelli (1998) report mixed findings, specifically that
Kochin in 1974, Ernest Tanner in 1979 and Kormendi in 1983 carried out empirical
studies that support the Ricardian equivalence proposition and generally concluded
that the method of financing for a given stream of government expenditure (tax or
debt) does not have any significant relationship with aggregate demand. Further,
Dadgostar and& Mirabelli (1998) report that Erenburg in 1993 found for the US that
deficit spending has no significant effect on private investment. Dadgostar and
Marabelli (1998) also find for Canada that the level of government debt has no effect
on private sector investment spending in both one and two period lagged models.
They further state that Feldstein in 1982 and Aschauer (1988) have found some
degree of substitution between government spending and private consumption.
However, none of these studies tested the relationship between public capital
expenditure, investment and productivity. This is the focus of the third group of
studies, which consider the supply side effects of government capital expenditure on
output and productivity. Aschauer (1988) finds that private sector investment
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Chapter 2: Review of Relevant Theoretical and Empirical Literature
spending is enhanced by expected increases in government infrastructure spending.
Aschauer (1989) finds a correlation between ‘core infrastructure’ (highways, water
and sewer systems, mass transit and airports) and various measures of private sector
productivity. Aschauer (1997) finds the relationship between US public capital and
economic growth is not linear - at a certain level, the tax burden associated with
financing and maintaining public capital reduces the returns for private industry and
reduces growth. An optimal public-private ratio was estimated at 61% and the
recommendation was to reduce government consumption spending and increase
government investment in order to reach this level.
Dadgostar and Marabelli (1998) find for Canada that the effect of government
investment expenditure on private sector investment spending was statistically
significant and positive. In particular, the composition of government expenditure
affects the marginal efficiency of private capital and leads to increases in the level of
private investment.
Nourzad (2000) finds a positive and statistically significant effect of public capital on
labour productivity in 24 developed and developing economies during the period
1976 to 1989. Nourzad (2000) cites conflicting findings by a number of authors such
as Eisner, Hulte and Schwab, Tatom, Holtz-Eakin, Barth and Bradley, Barro and
Levine and Renelt , and concludes that the use of differing methodologies has
contributed to this lack of unanimity.
Otto and Voss (1994) find that public capital had a significant and positive impact on
private production and private total factor productivity in Australia over the period
1966-67 to 1989-90. Using a Cobb-Douglas production function for the private
economy, assuming exogenous technological change and differentiating between
private and public capital, output elasticities for public capital of about 0.40 are found.
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Chapter 2: Review of Relevant Theoretical and Empirical Literature
Otto and Voss (1996) use data of greater frequency and econometric techniques to
account for non-stationary series. They confirm the complementarity of public and
private capital and revise their estimate of the elasticity of Australian public capital to
approximately 0.17, roughly half that of private capital. This means that for every
dollar invested in public capital, private output increases by 17 cents.
Hemming, Kell and Mahfouz (2002) note that the analysis of fiscal multipliers
traditionally focuses on short-term demand-side effects, while supply-side impacts are
seen to be longer-term in nature. However, there are certain exceptions to this. The
extent of crowding out, and thus the size of the multiplier, may depend on both
demand-side and supply-side effects even in the short term. For example, consider
the situation where a fiscal expansion is injected into an economy already operating at
full capacity and there is no ability to increase productive capacity in the short term.
In this case, the fiscal expansion has to be totally crowded out and will result in
contraction in the private sector. In the longer term, this may be addressed by
policies that promote supply-side responses, such as accumulation of public assets
that increase the marginal efficiency of private capital. Additionally, supply-side
effects of fiscal policy may increase short-term demand if these effects promote
expectations that longer-term growth will increase.
Tax mix is relevant to supply-side effects. Changes to labour income taxes may affect
the supply of labour and changes to capital taxes may affect domestic (and
internationally-sourced) savings and investment. Hemming, Kell and Mahfouz
(2002) note that conclusions have yet to be reached on the empirics of the impact of
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tax changes on the supply of labour and capital, and thus on growth.
This section has surveyed the literature on the effects of public expenditure on private
production. While differing findings have resulted from the use of different
methodologies, this literature generally indicates that public capital formation has
significant impacts on private production.
The repeated experience of large fiscal imbalances and rapid build-up of public debt
in a number of OECD countries during the 1970s and 1980s represents a systematic
deviation from both the neoclassical and Keynesian principles of fiscal policy. This
experience led to concerns that political forces, together with budget compilation and
implementation procedures, cause an inherent bias towards deficits. The term ‘deficit
bias’ was coined to describe this phenomenon, which is described below.
2.4 THE DEFICIT BIAS
A ‘deficit bias’ is said to occur when democratically-elected governments consistently
run deficits regardless of the state of the business cycle – in particular failing to
reverse deficits incurred in economic contractions during subsequent periods of
expansion. It is in the context of the ‘deficit bias’ that fiscal rules have emerged.
Alesina and Perotti (1995) classify political economy models of fiscal policy into
models based on ‘fiscal illusion’ (in the spirit of public choice literature), models of
debt as a strategic variable, models of distributional conflict, models of
intergenerational redistribution, models of geographically dispersed interests and
models emphasizing the effects of budgetary institutions. These models indicate a
number of possible reasons for a tendency to deficits. Alesina and Perotti (1995) use
this classification of models in an attempt to answer the questions of why large and
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persistent deficits have occurred during the decades of the 1970s and 1980s, but not
previously, and only in certain countries, but not in others.
The public choice literatures typically rests on key assumptions of opportunistic
policy makers (who use fiscal deficits to increase their electoral chances) and naïve
voters (who do not punish the policy makers because they either overestimate the
benefit of current expenditures or underestimate the future cost of current expenditure
i.e. the tax burden). Thus voters suffer from fiscal illusion as to the consequences of
re-electing policy makers who repeatedly enact deficits.
Strategic models of debt focus on the use of debt accumulated to finance budget
deficits by current governments as a means of constraining the actions of future
governments. Thus the tendency to deficits arises due to the conflict between
spending priorities of different political parties. In such a case, the current
government does not fully internalise the cost of running a current budget deficit,
because the constraint imposed on future spending may be borne by a different
government. The extent of electoral uncertainty is also a factor in determining the
extent of the deficit bias present in such a situation, both in its impact on governments
uncertain of their continued incumbency in power and in its impact on voters
uncertain of who will govern in the future. Such voters will generally favour current
politicians that promise them large current transfers, even if those transfers are debt
financed (Alesina and Perotti (1995)).
Models of distributional conflict emphasize the effect of conflict between different
social groups such as political parties, interest groups or members of a governing
coalition. Such conflict can delay adoption of fiscal probity measures due to lack of
agreement on how to share the burden of the fiscal adjustment. These models predict
that greater difficulty in implementing fiscal adjustment measures will be experienced
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by fragmented or divided governments and polarized societies than where more
consensus exists.
Intergenerational redistribution models take the perspective that public debt
redistributes the tax burden across time and hence debt-financed public deficits may
effectively act as a form of intergenerational transfer. Alesina and Perotti (1995) cite
Cukierman and Meltzer, and Tabellini as highlighting cases where public deficits
were used as a form of negative bequest to transfer resources from richer future
generations to the poorer current generation.
Models emphasizing geographically-based constituencies stress that representatives of
one constituency may overestimate the benefits of public expenditure in their district
compared with its financing costs. This is because those costs are typically borne by
all taxpayers rather than by the legislator’s constituents only, whereas the benefits of
that expenditure largely accrue to the constituents. These models focus more closely
on institutional detail, are closer to the political science literature and study the
interaction between the organisation of legislatures and fiscal decisions.
Models emphasizing the effects of budgetary institutions explain the persistence of
fiscal imbalances and/or excessive levels of government expenditure in the context of
whether a deficit bias can be corrected by institutional reform such as appropriately
designed fiscal policy rules. One difficulty with such rules is the necessary trade-off
between simplicity of rules and the ability to retain policy flexibility. For example,
Alesina and Perotti (1995) cite Corsetii and Roubini as highlighting the trade-off
between deficit bias and the margin for stabilisation in the context of a closed and
open economy. They conclude that allowing the government a margin for
stabilisation policy does not contribute to worsening the deficit bias. Further they
conclude that the deficit bias is enhanced in an open economy because the
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Chapter 2: Review of Relevant Theoretical and Empirical Literature
government, in a model without default risk, faces an infinitely elastic supply of funds
at the given world interest rate and additional borrowing to finance more expenditure
does not attract the higher cost of higher interest rates. In addition, some US states
with balanced budget rules run smaller budget deficits, while state budgets having
fiscal restraints show significantly reduced cyclical responsiveness. Milesi-Ferretti
(1997) indicates that the extent of decentralisation of the budget process has an impact.
Specifically, decentralized budgetary procedures are more likely to lead to deficits
bias due to failure by spending ministers to appropriately internalise the cost of their
expenditure (in contrast to the extent to which a prime minister or finance minister
would likely internalise the cost of expenditures, due to their differing
responsibilities).
As previously stated, fiscal policy rules were adopted by a large number of
governments in an apparent attempt to reverse the tendency during the 19870s and
1980s to run budgetary deficits and thus, to accumulate high levels of public debt.
However, the contention that a government deficit has an expansionary impact on the
macroeconomy is based on an assumption that consumers and investors will behave in
a particular way which could be characterised as suffering from a form of fiscal
illusion. The Ricardian equivalence theorem, described in the previous section,
challenges this assumption.
2.5 INSTITUTIONAL ARRANGEMENTS AND PUBLIC CAPITAL
FORMATION
This section outlines the role of institutional arrangements in determining fiscal
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outcomes. In particular, the significance of governmental budgetary practices in
Australia is discussed. That institutional factors such as budgetary practices are
significant is supported by Poterba (1996) who points to the development of a search
for politico-economic explanations for deficit policies, observed in the form of large
and persistent budget deficits across nations, which are not obviously related to short-
term spending needs and thus are not explained by the existing literature.
Another important factor, impacting on Australian governments’ public capital
formation, is the methodology by which credit ratings agencies assign ratings to
public debt. Most Australian jurisdictions surveyed not only adopted fiscal policy
rules targeting net debt reduction, they also targeted a particular credit rating. In such
cases, the net debt target was a means by which to achieve the targeted credit rating.
For other jurisdictions an explicit credit rating target was not adopted but the rule
relating to net debt was likely to have been set at least in part to ensure maintenance
of a good credit rating. This focus on cash flow, with its implications for capacity of
governments to meet debt obligations as they become due, is likely to have impacted
on governments’ decisions to acquire financial assets rather than real assets.
2.5.1 Governmental reporting and budgeting practices
Arrangements governing public resource allocation constitute the background to the
operation of fiscal policy, whether policy is determined under a discretionary regime
or under a regime based on fiscal policy rules. A significant literature exists on the
conduct of government in Australia, a review of which is outside the scope of this
paper. Rather, this section focuses on the mechanisms by which Australian state and
national governments allocate resources and report performance.
34
Chapter 2: Review of Relevant Theoretical and Empirical Literature
Public resource allocation is performed primarily during the budgeting process.
Various authors have observed that government budgets are much more than merely
prospective financial reports (e.g. Kelly and Wanna (2004), Guthrie (1998), Boxall
(1998) and Robinson (2002b)). Kelly and Wanna (2004) at page 95, state:
“Government budgets are much more than financial documents; they are
strategic and resource allocation plans, economic projections and policy
statements, statements of government intention expressing policy
priorities, and means of resolving societal conflict. Whether in
parliamentary or presidential systems, budgets articulate the political
relations between budget guardians and spenders, between policy-specific
and whole-of-government objectives, and between the executive and
legislature.”
Australian governments’ budgets are produced before the beginning of the July – June
financial year, usually in May7. The national government budget is typically
produced first, as it provides tangible evidence of intended national government
grants to State governments, which comprise an important part of State government
revenue. State government budgets are then produced. Some governments also
produce amended budgets containing new initiatives during a mid-year review
process, at which progress toward budgeted goals and six-monthly financial reports
are reviewed.
Governments monitor progress toward budgeted financial statements, typically on a
monthly basis throughout the budgeted year. They also report estimates of actual
financial results (termed ‘estimated actuals’) or audited financial results (termed
7 However, the month of budget presentation sometimes varies as a result of unusual circumstances, such as when an election is held close to the usual time of production of a budget, as occurred in Queensland in 1999.
35
Chapter 2: Review of Relevant Theoretical and Empirical Literature
‘actuals’) for the budgeted year in budgetary financial reports produced for the
following year. These retrospective financial statements are produced in the same
format as the budgeted financial statements, that is, they are produced in accordance
with the Government Financial Statistics (GFS) framework, which are also provided
by governments to the Australian Bureau of Statistics (ABS) and form inputs to ABS
national accounting.
Also, retrospective general purpose financial reports (GPFR) are produced and a
variety of non-financial reporting is undertaken. In particular, two frameworks are
used by Australian governments to present financial reports – GFS and GPFR. These
frameworks are described in detail in Chapter 3. Movements are underway to
harmonise the two frameworks to provide a common reporting framework (Kaufmann
2002).
In addition, in producing financial reports, two conceptual bases have historically
been used – the cash basis and the accruals basis. The accruals basis is in current use
by all Australian governments, having replaced the previously-used cash basis around
the end of the 1990s. The differences between these two bases and their implications
for an empirical investigation relating to fiscal policy rules are analysed in detail in
Chapter 3.
Under the Westminister system of government, the budget is in fact an Act of
Parliament (usually termed an Appropriation Act) which authorizes payments
proposed by the government according to its policies and priorities (Government of
New South Wales 1998-99 Budget Paper 3). Following Churchill (1992), the
Westminister system of government effectively forced the public sector to report on a
cash accounting basis in order to parallel the budgeting process with its focus on a
cash or ‘funds’ basis. However, with increasing pressure on government to adopt
36
Chapter 2: Review of Relevant Theoretical and Empirical Literature
operational principles more in keeping with private sector enterprises, and the need
for an information set that provides richer treatment of assets and liabilities,
governments have adopted accrual accounting as the basis for their prospective
(budgeting) and retrospective (historical) financial reporting.
Robinson (2002a) at page 3 argues that Australian governments modified cash
accounting:
“ … into a system of expenditure accounting and budgeting … wherein the
acquisition of goods and services was recognized and subjected to
budgetary constraints in the financial year when those goods or services
were received, regardless of whether they were paid for in that year or
payment was deferred and a liability … incurred.”
Use of the cash conceptual basis by the national and state governments was largely
(though not completely) abandoned in Australia at the end of the 1990s as part of the
accrual output budgeting (AOB) reforms (see Kelly and Wanna (2004) and Robinson
(2002a)). Bartos (2000) notes that Australia was the third country to introduce
accrual budgeting and at that time had the largest public sector accrual budget in the
world.
Though each format has over time been produced using both the cash and accruals
conceptual bases, as previously stated, the two frameworks now used are based on
accruals concepts8. The suitability of the accrual basis for producing public financial
reports (either ex ante or ex post and in accordance with the GFS or GPFR
8 Kelly and Wanna (2004) noted that the national government still provides some special purpose financial reports, produced on a cash accounting basis, as supplements for decision making purposes during budgetary activities.
37
Chapter 2: Review of Relevant Theoretical and Empirical Literature
framework) for any level of government is the subject of a spirited debate. Perceived
benefits of the accruals basis include:
(a) an improved capacity to monitor efficiency in the allocation and use of
government resources and thus, enhanced sustainability of fiscal policy (ABS
(2000)), though members of the debate are divided on the validity of using this
information in assessing government performance, on the basis that profitability
is not a valid concept to apply to core government entities (see Robinson (1998));
(b) the richer information set it provides relating to assets and liabilities (though
members of the debate are divided on the validity of using this information in
decision-making, on the basis that government asset valuation methods are
inappropriate and lead to distortions in assessing service costs, making pricing
decisions and project valuation (Moll, Humphrey and Chow (2004));
(c) improved microeconomic efficiency of government service provision as a result
of its provision of a managerial decision tool and usefulness in the monitoring of
managerial performance at agency level (not supported by Robinson (1998), but
supported by most AOB enthusiasts and argued in national and state government
policy documents); and
(d) its provision of superior measures of the sustainability and intergenerational
equity implications of fiscal policy (Robinson (1998)).
In addition, debate exists as to the characteristics of reports at different levels of
aggregation. For example, Moll, Humphrey and Chow (2004) describe the debate
surrounding the usefulness of whole-of-government consolidated GPFR.
The chronology of reform of retrospective financial reporting is as follows. Since
38
Chapter 2: Review of Relevant Theoretical and Empirical Literature
1983, Commonwealth statutory authorities have been required to prepare historical
GPFR and department business undertakings were expected to prepare these data on
an accrual basis. During the 1980s, the Australian Accounting Research Foundation
and standard settings boards (Australian Accounting Standards Board and Public
Sector Accounting Standards Board) promoted the idea of GPFR for both public and
private sector (Guthrie (1998)). Since 1 July 1992, local government bodies (the
lowest tier of government under Australia’s model of federalism) have produced
historical accrual financial GPFR, as a consequence of the introduction of Australian
Accounting Standard AAS27 Reporting by Local Governments (AAS27). Since 1997,
national and state government departments have been required to produce historical
GPFR following the introduction of Australian Accounting Standard AAS29
Reporting by Government Departments (AAS29). Commonwealth Government
departments had produced audited GPFR since 1994–95.
From 1 July 1999, the Commonwealth Government and the respective State and
Territory Governments (i.e. New South Wales, Queensland, South Australia,
Tasmania, Victoria, Western Australia, the Australian Capital Territory and the
Northern Territory) have been required to provide consolidated whole-of-government
historical GPFR as a consequence of the introduction of Australian Accounting
Standard AAS31 Financial Reporting by Governments (AAS31) (Moll, Humphrey
and Chow (2004)). Some had produced these reports prior to the introduction of
AAS31.
The chronology of prospective financial reporting (budgeting) reform in Australia is
as follows. Since 1991, the national and most state governments9, by agreement, have
produced budgetary financial reporting in a uniform format termed the Uniform
9 The Victorian Government is an exception in that it provides most of its publicly available budgetary financial reports in GPFR format.
39
Chapter 2: Review of Relevant Theoretical and Empirical Literature
Presentation Framework (UPF). The UPF is based on GFS reporting standards and
adopts a GFS format which is described in detail in Chapter 3.
GFS reports were produced on a cash conceptual basis until 1998-99. The UPF was
amended in 1997, and again in 2000, to accommodate the change of GFS to an
accruals basis. This reform was driven by the revision by the International Monetary
Fund of its Manual on Government Finance Statistics to an accruals basis and the
subsequent broad adoption of accrual-based budgeting by governments world-wide.
The financial reporting reform described above was also accompanied by broader
resource allocation reforms. Kelly and Wanna (2004) distinguish between the
adoption of the accrual conceptual basis for (retrospective and prospective) reporting
and adoption of new governance (outputs-outcomes) frameworks that were an
additional component of AOB. They conclude that the evaluation of accrual based
prospective financial reporting can only be fully comprehended in the context of the
larger set of reforms that have occurred simultaneously at the end of the 1990s.
Described as a revolution in government accounting by Boxall (1998)) and as
representing huge changes in the mechanism of central financial control by Robinson
(2002b)), these combined developments have comprised a central part of wider
ranging public sector changes collectively referred to as New Public Management
(NPM) reforms.
These reforms were described by Kelly and Wanna (2004) at page 96 as :
“ … the fundamental logic of public sector budgeting … (is shifted) … to
include the independent pricing of outputs, the use of market prices and
contestable prices, and the use of diverse output delivery agents through
40
Chapter 2: Review of Relevant Theoretical and Empirical Literature
tendering and outsourcing.”
The intent of the reforms is described by Kelly and Wanna (2004) at page 96 as to:
“… reduce the incidence of budget lock-in, lessen the influence of
incrementalism, and to better align the responsibility for decision making
with the accountability for performance.”
The extent to which these benefits have been achieved remains the topic of debate.
These reforms have also been accompanied by changes in Australian governments’
capital management approaches. Paradoxically, the amended focus away from inputs,
resulting from the amended resource frameworks adopted, has been accompanied by
an increased focus on capital inputs to the public production process i.e. the use of
public assets in the government production process. This development has been the
subject of some criticism. For example, Johnstone (1999) argues that this new focus
on comparing service prices between public and private potential providers
incorporates a cost comparison methodology which is mistaken in its treatment of the
costs to government agencies of owning and using capital assets, and that this tilts the
analysis against any in-house (i.e. public sector provider) bids.
This section outlined practices through which public resource allocation, and thus,
public capital formation, occurs. An understanding of this is justified in light of the
methodological contribution made by this thesis i.e. that institutional arrangements
such as fiscal policy rule adoption are found to be influential in determining public
investment levels and, in turn, potentially productivity and GDP growth outcomes.
41
Chapter 2: Review of Relevant Theoretical and Empirical Literature
2.5.2 Credit agencies’ public debt rating methodologies
A full coverage of the methodologies by which credit ratings agencies determine
ratings is beyond the scope of this study. However, a brief coverage is provided
below because of the significance that debt ratings have assumed in governments’
fiscal policy rules.
Credit ratings agencies, such as Moody’s Investors Service (Moody’s) and Standard
and Poor’s Ratings Services (S&P’s)10, facilitate the functioning of capital markets by
expanding the information set of investors. They do this by assigning to publicly-
traded debt instruments of private and public corporations a rating which signals the
default risk imbedded in those instruments.
According to Moody’s (1998) at page 3:
“A rating is essentially an opinion on the ability and willingness of an
issuer to pay its debt obligations on a full and timely basis.”
Investors use this information in determining the required return and thus, given a
fixed income stream, the price they are willing to pay for the financial asset
represented by that debt. Debt ratings, then, are significant to debt-issuing
governments for several reasons. The first arises from the previous discussion. That
is, a government’s interest expense is in part determined by the risk rating assigned to
its debt. Secondly, debt ratings are widely considered to signal the sustainability of a
government’s fiscal management practices and therefore acquire significance that is
not only financial but also political in nature. Thirdly, credit ratings agencies mention
in their ratings reports any accounting practices deemed questionable and therefore a
10 While a number of credit rating agencies exist, only three are recognized worldwide. The third of the three is Fitch Ratings (Ylagan (2005)).
42
Chapter 2: Review of Relevant Theoretical and Empirical Literature
view exists that agencies have accrued some additional significance as pseudo-
auditors of accounting methodologies (Glater (2003)). Debt ratings vary by term and
are assigned to categories of long, short and medium term. Table 2.1 presents ratings
assigned by Moody’s to long-term debt.
Table 2.1 Moody’s long-term credit ratings
Source: Moody’s (2004)
Countries are assigned a foreign currency country rating which provides a ceiling on
the foreign-currency denominated debt ratings of debt issuers domiciled in that
country, including both the national and sub-national governments. According to
Moody’s (1998) at page 5:
“ …the country rating is intended to capture the risk that, in a currency or
foreign exchange crisis mode, the sovereign government may choose to
limit foreign currency payments by the entities subject to its sovereignty.”
43
Chapter 2: Review of Relevant Theoretical and Empirical Literature
In assigning a foreign currency country ratings, factors considered include: (a) risk of
political regime change, which could lead to a general repudiation of debts, civil war
or invasion; (b) whether the country has a well-defined system of contract law, which
allows for legal procedures for collection of unpaid debts including seizure of
collateral; (c) whether the country has a deep financial system of proven effectiveness
in making payments and is technically secure against breakdown; (d) stability of the
regulatory/legal environment against malleability, corruption, etc; and (e) the extent
of any tendency toward hyperinflation (Moody’s (2004) page 57).
Certain factors relevant to assigning a foreign currency rating are also relevant in
assigning a local currency rating. Guidelines for rating debt issued in local currency
are higher than guidelines for rating debt issued in foreign currency since, according
to Moody’s (2004) page 58:
“ … even if a government reschedules its debt, this does not necessarily
lead to large-scale disruption of the local currency payments system.”
However, the default risk on local currency instruments is considered to be usually
lower than that on foreign currency instruments. Factors relevant in assigning a rating
on local currency instruments include the government’s ability to mobilize currency
to meet its domestic currency commitments. It is frequently the case that
governments are more able to mobilize domestic resources than foreign resources.
Additional factors include the structure of the economy and its capacity generally, to
mobilize resources, which might be affected by the period of establishment of the
government, and the size of the public sector relative to its usable resource base.
Factors influencing the rating of a national government are also likely to be relevant
to a sub-national government. Additionally, the extent to which a national
44
Chapter 2: Review of Relevant Theoretical and Empirical Literature
government would support a fiscally-constrained sub-national government is relevant
to the credit rating of the sub-national government. According to Standard & Poor’s
(2004), the Australian State governments’ relationship with the Commonwealth
Government is a supporting credit factor. In addition, there is a direct link between
the country ceiling and the credit rating of a sub-national government. However, the
ceiling does not apply to debt instruments denominated in domestic currency and so
the domestic currency debt rating of a sub-national government may exceed the
country ceiling of the national government.
Moody’s approach to rating sub-national governments can be grouped into five broad
categories: 1. institutional framework; 2. economic fundamentals; 3. government
finances; 4. debt profile and 5. government structure and political dynamics (Moody’s
(2004)). Of these, budgetary performance and debt profiles are the most impacted by
fiscal policy rules and thus are of most relevance to this study.
In assessing government finances, Moody’s considers the budgetary framework, that
is, the structure of its revenue and expenditure base, as well as its budgetary
performance. Critical components of the budgetary framework include the extent of
the government’s taxation powers (i.e. breadth of tax sources such as sales tax, real
estate, corporate, or income tax, stability of taxation sources, control over tax rates,
extent of dependence on fiscal transfers from upper-tier government) and functions
assigned to the government, or assumed by it and the degree of financial flexibility
arising (as an indicator of the capacity to adjust spending if faced with significant
budgetary imbalances). Key indicators of budgetary performance include the ability
of the government to fully cover its operating costs with its recurring revenue base,
thus protecting the timely payment of debt service, and its ability to generate a surplus
45
Chapter 2: Review of Relevant Theoretical and Empirical Literature
from its operating account to finance a portion of its capital program. Emphasis is
placed on the ability of assets to generate cash for use in meeting debt obligations
rather than with the value of assets as stated on the debt issuer’s balance sheet.
Debt profile analysis recognizes differences between direct debt and contingent
liabilities and also takes into account likely future borrowing needs and refinancing
requirements. Direct debt analysis focuses on the statutory framework for debt
issuance and specific characteristics of the debt. The statutory framework for debt
issuance comprises issues such as the legal structure through which a government is
allowed to issue and service debt, relative ranking of payment obligations with other
debt or financial obligations and whether any particular security is pledged to support
payment or whether the entire revenue base is pledged as a source of payment.
Specific characteristics of the government’s debt include its overall level, the relative
burden it imposes on the revenue base, structure of the debt, the extent to which any
foreign currency risk is managed, where debt is foreign-currency denominated, and
short term debt exposure resulting from market access and interest rate risks.
Analysis of the significance of contingent liabilities addresses such issues as the
extent to which a government may become liable for debt issued by other entities such
as through explicit guarantees, ownership or other factors.
Table 2.2 lists ratios used by Moody’s, and defines relevant financial terms. Perusal of
the table indicates a strong focus on budgetary balance and minimization of net debt.
As could be expected, the methodologies of Moody’s and S&P’s show significant
similarities. For example, S&P’s report for 2004 indicates that critical criteria used in
rating the State of Victoria included (a) balance sheet measures (ratio of non-financial
public sector net financial liabilities to operating revenue, net direct debt of the
46
Cha
pter
2: R
evie
w o
f The
oret
ical
and
Em
piric
al L
itera
ture
Tab
le 2
.2 M
oody
’s fi
nanc
ial t
erm
s, de
finiti
ons a
nd r
atio
s
Rat
ios
Fina
ncia
l ter
ms
Def
initi
on
Ow
n So
urce
of R
even
ue a
s % o
f To
tal R
even
ue
Ow
n-So
urce
Rev
enue
In
clud
es lo
cally
col
lect
ed re
venu
es le
vied
by
or o
n be
half
of th
e lo
cal/r
egio
nal a
utho
rity.
Incl
udes
loca
l tax
es, u
ser f
ees,
inve
stm
ent
earn
ings
and
tran
sfer
s fro
m st
ate-
owne
d en
terp
rises
. In
terg
over
nmen
tal R
even
ue a
s % o
f To
tal R
even
ue
Inte
rgov
ernm
enta
l Rev
enue
A
lso
know
n as
Inte
rgov
ernm
enta
l Tra
nsfe
rs. I
nclu
des a
mou
nts
rece
ived
from
hig
her l
evel
s of g
over
nmen
t, w
heth
er in
tend
ed a
s ge
nera
l fis
cal a
id o
r as c
ost-s
harin
g fo
r par
ticul
ar sp
endi
ng c
ateg
orie
s In
tere
st E
xpen
se a
s % o
f Tot
al
Rev
enue
To
tal R
even
ue
Incl
udes
taxe
s, in
terg
over
nmen
tal t
rans
fers
, tra
nsfe
rs fr
om st
ate-
owne
d en
terp
rises
, fee
s and
all
othe
r rev
enue
s. Fi
nanc
ing
Surp
lus/
(Req
uire
men
t) as
%
of T
otal
Rev
enue
Fi
nanc
ing
Surp
lus/
(Req
uire
men
t) ne
t of
cap
ital e
xpen
ditu
res,
as %
of
Tota
l Rev
enue
Fina
ncin
g Su
rplu
s/(R
equi
rem
ent)
Def
ined
as T
otal
Rev
enue
less
Tot
al E
xpen
se.
Net
Gov
ernm
ent D
ebt p
er C
apita
N
et D
ebt a
s % o
f GD
P N
et D
ebt a
s % o
f Tot
al R
even
ue
Net
Gov
ernm
ent D
ebt
= G
ross
deb
t les
s sel
f-su
ppor
ting
debt
and
sink
ing
fund
s.
Net
For
eign
Cur
renc
y D
ebt a
s % o
f G
ross
Deb
t N
et F
orei
gn C
urre
ncy
Deb
t =
Gro
ss fo
reig
n cu
rren
cy e
xpos
ure
net o
f cur
renc
y sw
aps.
Shor
t-ter
m D
ebt
Incl
udes
all
debt
out
stan
ding
with
a m
atur
ity o
f les
s tha
n on
e ye
ar,
incl
udin
g cu
rren
t mat
uriti
es (n
et o
f am
ount
s to
be p
aid
from
sink
ing
fund
s) o
f lon
g-te
rm d
ebt,
as w
ell a
s flo
atin
g ra
te d
ebt.
Shor
t-ter
m D
ebt a
s % o
f Gro
ss D
ebt
Gro
ss d
ebt
Incl
udes
dire
ct d
ebt o
f the
gov
ernm
ent a
nd c
ontin
gent
liab
ilitie
s suc
h as
gua
rant
eed
debt
. So
urce
: Ada
pted
from
Moo
dy’s
(199
8)
47
Chapter 2: Review of Theoretical and Empirical Literature
general government sector to operating revenue); (b) management capacity
(commitment to fiscal discipline); (c) financial performance (surpluses including after
capital spending); (d) riskiness of revenue stream (proportion of revenue dominated
by core government revenues and low risk government-owned trading enterprises); (e)
strength and diversity of the economic base; (f) fiscal flexibility (per cent of revenue
received in grants from the federal government and therefore not under the State’s
control) compared with expenditure responsibility and (g) liquidity (debt profiles,
holdings of cash and liquid assets) (Standard & Poor’s (2004)). Table 2.3 lists the
relevant ratios used by Standard & Poor’s in formulating their ratings, segmented by
government sector.
This section has outlined the methodologies of two of the most important credit
ratings agencies. All examined governments assigned particular significance to debt
ratings in determining their fiscal strategies and several targeted a specific debt rating
to be achieved for its general government debt. This is presumably in response to
awareness that credit agencies’ debt ratings are effective in determining interest rates
on public debt, as reported in Poterba (1996).
2.6 EMPIRICAL INVESTIGATIONS OF THE EFFECTIVENESS OF
FISCAL POLICY RULES
The type of fiscal policy rules covered in this thesis are to be distinguished from the
type of fiscal policy rules often addressed by writers of mainstream economic
textbooks such as Dornbusch et al (2006). That analysis addresses fiscal policy rules
targeting macroeconomic aggregates such as levels or rate of growth of Gross
Domestic Product in absolute or per capita terms. Dornbusch and the great majority
of studies dismiss that type of fiscal policy rules as being flawed in terms of
48
Cha
pter
2: R
evie
w o
f The
oret
ical
and
Em
piric
al L
itera
ture
Tab
le 2
.3 S
tand
ard
& P
oor’
s rat
ios
Sect
or
Rat
ios
Non
-fin
anci
al p
ublic
sect
or
Cor
e go
vern
men
t Fi
nanc
ial p
erfo
rman
ce
Net
lend
ing/
reve
nue
Cas
h su
rplu
s (de
ficit)
/rece
ipts
C
ash
surp
lus a
fter c
apita
l exp
endi
ture
Bal
ance
shee
t N
et d
ebt/r
even
ue
Net
fina
ncia
l lia
bilit
ies/
reve
nue
Dire
ct d
ebt/r
even
ue
Bud
geta
ry p
erfo
rman
ce
Acc
rual
ope
ratin
g ba
lanc
e/op
erat
ing
reve
nue
Net
lend
ing/
oper
atin
g re
venu
e C
ash
surp
lus (
defic
it)/re
ceip
ts
Net
inte
rest
exp
ense
/ope
ratin
g re
venu
e
Acc
rual
ope
ratin
g ba
lanc
e/op
erat
ing
reve
nue
Net
lend
ing/
oper
atin
g re
venu
e C
ash
surp
lus (
defic
it)/re
ceip
ts
Net
inte
rest
exp
ense
/ope
ratin
g re
venu
e D
ebt b
urde
n N
et d
ebt/o
pera
ting
reve
nue
Net
fina
ncia
l lia
bilit
ies/
oper
atin
g re
venu
e N
et d
ebt/o
pera
ting
reve
nue
Net
fina
ncia
l lia
bilit
ies/
oper
atin
g re
venu
e
Key
fina
ncia
l rat
ios
Net
ope
ratin
g ba
lanc
e/op
erat
ing
reve
nue
Net
cas
h flo
w fr
om o
pera
tions
/rece
ipts
N
et in
tere
st e
xpen
se/o
pera
ting
reve
nue
Net
inte
rest
cov
er
Cap
ital e
xpen
ditu
re g
row
th
Cap
ital e
xpen
ditu
re/(e
xpen
ses +
cap
ex)
D
ivid
ends
/ope
ratin
g in
com
e C
ash
surp
lus (
defic
it)/re
ceip
ts
Net
lend
ing/
oper
atin
g re
venu
e
Ope
ratin
g re
venu
e/G
SP
Ope
ratin
g ex
pens
es/G
SP
Cas
h op
erat
ing
bala
nce/
cash
rece
ipts
A
ccru
al o
pera
ting
bala
nce/
oper
atin
g re
venu
e N
et in
tere
st re
venu
e/op
erat
ing
reve
nue
Net
lend
ing/
oper
atin
g re
venu
e C
ash
surp
lus(
defic
it)/re
ceip
ts
Cap
ital e
xpen
ditu
re/to
tal p
aym
ents
Sour
ce: a
dapt
ed fr
om S
tand
ard
& P
oor’
s (20
04)
49
Chapter 2: Review of Theoretical and Empirical Literature
usefulness for economic management purposes. In contrast, the fiscal policy rules
surveyed in this study target fiscal aggregates appearing in governmental financial
statements, such as a measure of operating balance or of net assets, as described in
detail in Chapter 4. Thus, the coverage of the mainstream textbook literature is, with
few exceptions, of limited relevance to the primary focus of this study..
A comprehensive coverage of the characteristics of different types of fiscal policy
rules can be found in Kopits and Symansky (1998). They state that the ultimate
rationale for adoption of fiscal rules is sustained growth, through short or medium-
term macroeconomic stabilisation (including price stability), to be achieved by
attaining a government financial position that is sufficiently flexible to enable a
moderate countercyclical role through the operation of automatic stabilisers. For
example, flexibly-implemented balanced budget rules may be used to offset the deficit
bias inherent in the politically rational behaviour of democratically elected
governments, restoring sufficient fiscal capacity to enable a countercyclical role. The
OECD (2003) broadly agrees.
Debate continues as to whether this objective is better served by discretionary policy
or by design and implementation of sensible fiscal rules. The debate rests on the
observation that while rules such as a strict balanced-budget requirement could impair
the short-run stabilisation and tax smoothing roles of fiscal policy, lack of fiscal
discipline may also reduce the countercyclical role of fiscal policy and render it
procyclical.
Kopits and Symansky (1998) and the OECD (2003) agree that fiscal rules may also (a)
enhance the effectiveness of monetary policy (by reducing the burden on it), (b)
achieve longer-run fiscal sustainability, with a rule that requires accumulation of
financial assets at least equal to total contingent liabilities serving intergenerational
50
Chapter 2: Review of Theoretical and Empirical Literature
equity (by preventing potential future increases in public indebtedness associated with
e.g. accumulating employee entitlements or prospective ageing of the population), or
(c) prevent negative spillovers within a federation (when implemented at sub-national
levels of government). Rules-based approaches may provide time consistency that
may not result from discretionary approaches.
Kopits and Symansky (1998) and the OECD (2003) also acknowledge that rules based
approaches may reduce transparency of fiscal policy by encouraging one-off practices
or creative accounting to meet strict targets. Similarly to discretionary approaches,
the nature of the adjustment implemented under rules influences the macroeconomic
repercussions of the rule. Where one-off measures, reductions in investment, tax
increases or temporary wage freezes are used, maximum beneficial effects on
investment, employment and growth will not be gained.
Kopits and Symansky (1998) at page 12, state that:
“Binding fiscal policy rules are likely to influence the level and
composition of government expenditure and taxation ... For the most part,
economic performance under fiscal rules has been mixed.”
Where governments of advanced economies, such as CFA franc zone and European
Union countries, United States states, Indonesia, Canada (at both the national and sub-
national levels) and New Zealand, have adopted fiscal policy rules and made attempts
to comply with them, those economies have experienced declines in inflation and
interest rates, reduced crowding out effects on private investment and experienced
some alleviation of external imbalance (Kopits and Symansky (1998). However,
these gains have come at the price of tax increases or distortions in the composition of
government expenditures. In certain cases, reductions in public investment has been
used to achieve the reduced expenditure required or taxes have either been increased
51
Chapter 2: Review of Theoretical and Empirical Literature
or their administration distorted such as by advancing payments, sometimes leading
also to reduced transparency in financial reporting.
Kopits and Symansky (1998) assess the macroeconomic effects of balanced-budget
rules and rules limiting government deficits and debt by, firstly, drawing on the
literature to ascertain likely effects of compliance with these rules on interest rates
and growth, and, secondly, using a set of stochastic simulations of the effect of rules
adoption and compliance on output variability in the short term. Using the IMF’s
MULTIMOD model, simulations were run for Germany and the United States (US).
These simulations found a US multiplier of about 1 for spending decreases and 0.7 for
tax increases. For Germany, fiscal multipliers of approximately half those of the US
were found. Interest rates were found to be sensitive to a change in the public debt
ratio, with an increase of government debt equal to 25 per cent of GDP leading to an
increase in long run interest rates of between 125 and 500 basis points.
Overall, it was found that, where rules are sufficiently flexible to allow for the
operation of automatic stabilizers, fiscal rules contribute only marginally to short-run
output variability while sometimes providing a degree of fiscal discipline unlikely to
be attained through discretionary approaches. Thus rules are able to assist with
correcting the deficit bias and contribute to improved economic outcomes. However,
in developing economies, compliance with fiscal policy rules that constrain
government borrowing from domestic sources may lead to increases in indebtedness
to external sources.
A later study by Hemming, Kell and Mahfouz (2002) surveyed the emerging literature
52
Chapter 2: Review of Theoretical and Empirical Literature
regarding impacts of fiscal policy rules. They note that estimates of fiscal multipliers
may be derived from macroeconomic model simulations and reduced form equations,
and that the former may be carried out as empirically estimated macroeconomic
models or as calibrated general equilibrium models. With respect to simulations, they
report that (a) a range of multiplier estimates are typically reported; (b) in all cases of
simulation analysis excluding the impacts of credibility, short-term multipliers were
positive, ranging from 0.1 to 3.1 with most expenditure multipliers between 0.6 and
1.4 and most tax multipliers between 0.3 and 0.8; (c) expenditure multipliers vary
between countries; (d) most models confirm that short-term tax multipliers are smaller
than are short-term expenditure multipliers, and the difference varies between
countries; (e) alternative monetary regimes have little effect on short-term fiscal
multipliers; (f) analysis including credibility effects find that debt reduction has fiscal
multiplier effects that are generally positive but small, even when credibility is low,
but that can be negative if credibility is high; and (g) long-term multipliers are smaller
than short-term multipliers due to crowding out effects and some long-term
multipliers are negative.
Simulations of calibrated general equilibrium models have focused on steady-state
fiscal policy impacts, again on macroeconomic aggregates such as output. The main
conclusions drawn by Hemming, Kell and Mahfouz (2002) included (a) positive
multipliers, resulting from unanticipated increases in government spending, typically
in the range of 0.3 to 1.2; (b) differential impacts of permanent and temporary
changes in expenditure; (c) differential impacts on employment of unanticipated debt-
financed increases in government expenditure depending on assumptions regarding
the effect of public employment on private capital and labour productivity; and (d)
dependence of the output effect of a deficit-financed tax reduction on type of taxation,
53
Chapter 2: Review of Theoretical and Empirical Literature
with resulting multipliers ranging from positive to negative.
Studies generating reduced form equations estimates of fiscal multipliers usually but
not exclusively produce positive short-term as well as long-term expenditure
multipliers. The overwhelming majority of these studies use US data.
Poterba (1996) reports the US experience with fiscal policy rules prohibiting
budgetary deficits during the 1980s and 1990s. Following a failed attempt to pass a
balanced budget amendment in 1982, continued deficits led to the circumstance by
1985 where the national government was borrowing to meet interest commitments.
The Gramm-Rudman-Hollings bill was enacted in 1985 and required phased
reductions on the deficit culminating in a balanced budget in 1990-91. The bill was
prescriptive as to what expenditure reductions were to be made to achieve this target.
The Bill was declared unconstitutional in 1986 however new legislation was passed in
1987. A series of deferrals of the deficit targets were passed and accounting
manipulations used to achieve only some of the targeted expenditure reductions, with
the result that substantial deficits remained at the end of the 1980s. Poterba (1996)
cites Reischauer as having estimated that half the deficit reduction was due to these
factors. Poterba (1996) also cites Gramlich as stating that, to the extent that primary
deficits dropped at the time of enactment of the legislation, this was probably
coincidental. However, Poterba (1996) also reports Hahm at al as stating that the
fiscal policy rules had some effectiveness. Overall, Poterba (1996) finds that results
available to date are insufficiently precise to enable more specific judgements about
the effects of rules on fiscal outcomes. Further budgetary reform was enacted in 1990,
with increasingly specific requirements regarding the timing of reductions in
expenditure. Again, conclusions appear to have been hard to draw regarding the
54
Chapter 2: Review of Theoretical and Empirical Literature
efficacy of these arrangements.
Poterba (1996) states that examination of the effect of fiscal policy rules at the sub-
national level in the United States also does not lead to clear cut conclusions. Nearly
all states, excepting only Vermont, have balanced budget rules which exhibit
significant variation from state to state. For example, Poterba (1996) at page 24 states:
“ … in forty-four states, the governor must submit a balanced
budget…thirty-seven states impose a stricter standard, requiring that the
legislature enact a balanced budget … (which)…nonetheless allow for
actual revenues and expenditure to diverge from balance if realisations
differ from expectations … (and)… the actual budget may be in deficit and
the state can borrow to carry this deficit forward to future years … the
third and strictest type of balanced budget rule combines a requirement
that the legislature enact a balanced budget with a prohibition on deficit
carry-forward … in 24 of the 37 states that require the legislature to enact
a balanced budget.”
In addition, state fiscal policy rules frequently apply to only the general fund and do
not apply to special funds, capital spending funds and trust funds. Also, most states
have no formal mechanisms for enforcement of their fiscal policy rules. Poterba cites
a number of studies on state-level budgetary outcomes, for example, Abrams and
Dougan as finding that balanced budget fiscal policy rules have not had substantial
effects on US state fiscal outcomes and Bohn and Inman as finding that balanced
budget fiscal policy rules have a statistically significant effect in reducing deficits and
that this arises from lower expenditure levels rather than increased taxation. Related
55
Chapter 2: Review of Theoretical and Empirical Literature
studies of the effectiveness of net debt fiscal policy rules find that only stringent
requirements, such as that state debt must be approved by the entire electorate in
referendum, are highly negatively correlated with state indebtedness (Poterba (1996)).
A criticism of fiscal policy rules is that compliance has lead to distortions in the
composition of government expenditures (unwarranted cuts in public investment),
lack of transparency in the budget process (adoption of creative accounting and one-
off measures) or distortions in the tax structure or administration processes. Simes
(2003) considered the Australian government history of use of fiscal rules in the
context of the institutional arrangements under which fiscal policy is set. The study
did not extend, however, to empirical analysis of the impact of fiscal policy on capital
formation, productivity or growth.
2.7 SUMMARY
This chapter described mainstream economic theories of the effect of government
expenditure on the macroeconomy. While neoclassical theories focus on tax
smoothing, Keynsian theories of varying complexity typically focus on impacts on the
demand side of the economy, with most attention paid to the size and sign of fiscal
multipliers. Observations of a deficit bias by elected governments provide an
empirical counterpoint to these theories. The increasing focus on supply side impacts
provides justification for the focus of this study, namely, the experience of public
capital formation in the context of fiscal policy rules adoption by Australian
governments.
Attention is then paid to institutional arrangements, and Australian governments’
budgeting practices are described, including reforms during the past twenty years.
This provides an introduction to the more detailed treatments provided in Chapters 3
56
Chapter 2: Review of Theoretical and Empirical Literature
and 4. A particular set of institutional arrangements relevant to pricing of public debt,
i.e. credit ratings agencies’ methodologies, is also presented because of its potential
importance in reducing public capital formation.
Finally, a review of the empirical literature regarding the effectiveness of fiscal policy
rules in influencing macroeconomic or fiscal out comes is presented. Studies
focusing on the effect of fiscal policy rules on macroeconomic aggregates indicate
generally positive outcomes result from fiscal policy rules adoption, but that the
outcomes vary according to the level of advancement of the economy under scrutiny,
with generally less favourable outcomes found for less advanced economies. Studies
focusing on the effect of fiscal policy rules on fiscal aggregates have less clear cut
findings however generally find that effectiveness is limited at best. Significantly,
there has been no previous study published that focuses on an empirical determination
of the impact of fiscal policy rules, as defined in this thesis, on fiscal or
macroeconomic outcomes (including public capital formation or GDP/GSP) in the
Australian context. As mentioned in Chapter 1, this thesis seeks to contribute to
overcoming this gap.
57
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
CHAPTER 3
FINANCIAL MANAGEMENT FRAMEWORKS
AND FISCAL POLICY RULES
3.1 INTRODUCTION
Previous chapters have described fiscal policy rules and the results of empirical
exploration of the fiscal and other outcomes associated with their adoption. In order
to explore fiscal outcomes in the Australian context, it is necessary to understand how
those outcomes are measured.
The purpose of this chapter is fourfold. Firstly, it outlines the range of fiscal
outcomes that may follow adoption of fiscal policy rules. The discussion, which
occurs in Section 3.2, focuses on the possible role of factors not under the control of
government, in order to distinguish intentional from unintentional fiscal outcomes
(and thus intentional from unintentional compliance).
Secondly, it describes the governmental financial reporting frameworks employed in
the Australian context, including their evolution over time and similarities and
differences between them. This occurs in Section 3.3.
Thirdly, Section 3.4 specifies and interprets the intended effect of fiscal policy rules
on key measures of fiscal outcomes. The aim is to identify a link between fiscal
policy announcements and measures of fiscal outcomes. The latter may take the form
of either a line item, or the difference between two or more line items, in financial
reports. Reporting frameworks have changed over time and, accordingly, fiscal
measures used to record outcomes have also changed over time. The impact of these
58
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
changes is also traced.
Fourthly, Section 3.5 outlines interdependencies between fiscal policy rules that arise
as a result of the integrated nature of financial reporting frameworks. As a result of
these interdependencies, certain fiscal policy rules may imply constraints on fiscal
measures additional to the stated measure. Section 3.6 concludes. This chapter thus
provides a basis for identification and understanding of fiscal measures which may be
constrained by adoption of fiscal policy rules.
3.2 IMPACTS OF FISCAL POLICY RULES
This section addresses the issue of penalties and their role in motivating governments
to comply with constraints imposed on fiscal measures by fiscal policy rules. The
possible role of factors outside the control of government is also addressed in order to
distinguish intentional from unintentional fiscal outcomes. The ex post or ex ante
nature of fiscal outcomes, constrained by fiscal policy rules, is then addressed.
Finally, an approach is outlined by which to recognise the potential impact of fiscal
policy rules prior to their formalisation.
3.2.1 The role of penalties
Following adoption of fiscal policy rules, a range of possible outcomes exists. Much
of the literature on fiscal policy rules assumes that governmental fiscal behaviour, and
thus fiscal outcomes, can be expected to change after the adoption of fiscal policy
rules. The adoption of fiscal policy rules is thus assigned a determinative role in
generating behavioural change. For example, Kopits and Symansky (1998) at page 1
state:
“In many countries the deterioration (in fiscal performance) recently has
59
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
been reversed – in a number of cases, as part of the convergence toward meeting
fiscal rules.”
The OECD (2002) at page 125 states:
“Fiscal sustainability demands structural reforms … as well as effective
fiscal rules.”
Milesi-Ferretti (1997) at page 1 states:
“Numerical fiscal rules can play a role in enhancing fiscal responsibility
insofar as they are adopted in a framework for budgetary
reform …otherwise they are … likely to be less effective….”
Tanner (2004) at page 1 notes that:
“Fiscal rules ... are often thought to inhibit counter-cyclical public
borrowing ….”
However, whether or not adoption of fiscal policy rules leads to behavioural change
may depend on the existence of penalties for non-compliance. Kopits and Symansky
(1998) include among characteristics of a best practice fiscal rule the notion of
enforceability. They note that institutional arrangements, including penalties, vary
widely internationally and that it is unclear which arrangements are most effective.
This implies that constitutional or legal statutes are needed and should be
accompanied by penalties for non-compliance, supported by some form of authority
for enforcement of those penalties. Finally, they state that clear, agreed consequences
of non-compliance should be included and that these arrangements should suit
individual countries’ institutional arrangements.
However, it is observable that actual fiscal policy rules often do not meet these ideal
60
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
standards. Many fiscal policy rules have no formal penalties accruing to the adoptive
government. This is the case with all fiscal policy rules adopted by Australian
governments. Most governing legislation simply does not include any provision for
penalties for non-compliance. For example, the relevant New South Wales legislation,
the General Government Debt Elimination Act 1995 (‘the Act’), contains specific
provisions for absence of penalties. In Part 6, the Act specifies that nothing in it
places on any person an obligation enforceable in a court of law or administrative
review body. The Part further provides that failure to comply with the Act does not
affect the validity of any legislation, does not prevent introduction or passage of any
future legislation and does not affect the validity of actions taken by public officials or
agencies nor does it expose any person to civil or criminal liability. Thus, only
reputational penalties may possibly result from non-compliance with fiscal policy
rules by Australian governments.
In such cases, no legislative or financial penalties are imposed on governments that do
not comply with their own rules. This contrasts with examples of fiscal policy rules
where financial or judicial penalties are, at least notionally, enforceable against
transgressing governments. Examples of the latter are highlighted by Kopits and
Symansky (1998) at page 3. They include judicial penalties for non-compliance with
yearly current balance rules applying to national and sub-national governments in
Germany; judicial penalties applying to European Union members for non-
compliance with a rule prohibiting borrowing from central banks and limiting gross
debt to 60 percent of Gross Domestic Product; and financial penalties applying to
CFA franc zone11 members for non-compliance with rules limiting borrowing from
11 The CFA Franc Zone is a common currency area spanning most of the former French colonies of West and Central Africa. CFA stands for ‘le franc des Colonies Francaises d’Afrique’
61
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
central banks to twenty per cent of the previous year’s revenue. Certain of these
penalties are supra-national and there is an extensive literature arguing that most have
proven to be largely ineffective.12 Thus, the international experience indicates that
penalties associated with fiscal policy rules may not be determinative of governmental
attempts to change fiscal behaviour in accordance with fiscal policy rules. A further
question also arises regarding the ability of governments to comply with fiscal policy
rules even when willing to do so.
3.2.2 Intentional and unintentional compliance
Table 3.1 provides a schematic format that summarises the possible levels and causes
of compliance and non-compliance with an example rule (in this case, a rule requiring
budgetary balance) together with an indication of the likely impact and attempts to
model outcomes. In column 1, the type of rule is presented as a starting point. An
indication of whether governments, having adopted fiscal policy rules, then comply
with them, may be gained by examination of the relevant fiscal measures over time to
reveal whether changes occur in those measures at the time of adoption. Column 2
presents the two possibilities regarding fiscal outcomes, i.e. fiscal outcomes do or do
not change at the time the fiscal policy rule is adopted.
However, a determination that fiscal outcomes changed when a fiscal policy rule was
adopted does not provide conclusive proof either of behavioural change or its absence.
This is because exogenous factors may intervene which are not under the control of
government (further discussed below). Thus, it is not possible to assign to fiscal
policy rules a causal role in changes in fiscal outcomes. For this reason, a distinction
is drawn regarding the intentionality of either compliance or non-
12 See, for example, Tanzi (2005) and Faini (2006).
62
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
compliance with constraints imposed on fiscal measures by adoption of a fiscal policy
rule. A circumstance of continued intentional compliance is included, reflecting a
possible motive for rules adoption of sustaining a positive trend. Column 3 lists these
‘levels of compliance’ that could occur for each possible outcome.
Column 4 then expounds the fiscal outcome that will logically follow from each level
of compliance, based on fiscal accounting frameworks. In column 5, possible
explanations for each level of compliance are presented. Column 6 then specifies the
resulting analytical outcome.
63
Cha
pter
3: F
inan
cial
Man
agem
ent F
ram
ewor
ks a
nd F
isca
l Pol
icy
Rul
es
Tab
le 3
.1 P
ossi
ble
fisca
l out
com
es fo
llow
ing
adop
tion
of fi
scal
pol
icy
rule
s
1. E
xam
ple
of
rule
2.
Pos
sibl
e ou
tcom
e 3.
Lev
els o
f co
mpl
ianc
e 4.
Fis
cal
outc
ome
5. E
xam
ple
of r
easo
n fo
r ou
tcom
e 6.
Ana
lytic
al o
utco
me
1. In
tent
iona
l co
mpl
ianc
e
1.
Bud
get i
s ba
lanc
ed.
1.G
over
nmen
ts c
ompl
ied
with
rule
s an
d ex
ogen
ous f
acto
rs d
id n
ot
inte
rven
e to
pre
vent
com
plia
nce.
1. A
naly
sis w
ill c
orre
ctly
de
tect
impa
ct.
Fisc
al
outc
omes
ch
ange
at
time
of
rule
s ad
optio
n
2. U
nint
entio
nal
com
plia
nce
2.
Bud
get i
s ba
lanc
ed.
2.G
over
nmen
ts d
id n
ot a
dopt
m
easu
res t
o en
sure
com
plia
nce
but
exog
enou
s fac
tors
inte
rven
ed to
cr
eate
com
plia
nce
(e.g
. un
antic
ipat
ed in
crea
ses i
n re
venu
e or
dec
reas
es in
exp
endi
ture
oc
curr
ed).
2. A
naly
sis w
ill in
corr
ectly
de
tect
impa
ct.
3. In
tent
iona
l non
-co
mpl
ianc
e
3.
Bud
get i
s no
t ba
lanc
ed.
3.G
over
nmen
t did
not
com
ply
with
ru
les a
nd e
xoge
nous
fact
ors d
id n
ot
inte
rven
e to
cre
ate
com
plia
nce.
3. A
naly
sis w
ill c
orre
ctly
de
tect
no
impa
ct.
4. U
nint
entio
nal
non-
com
plia
nce
4.
Bud
get i
s no
t ba
lanc
ed.
4.G
over
nmen
ts a
dopt
ed m
easu
res t
o en
sure
com
plia
nce
but e
xoge
nous
fa
ctor
s int
erve
ned.
4. A
naly
sis w
ill in
corr
ectly
de
tect
no
impa
ct.
Bud
get i
s to
be
bala
nced
Fi
scal
ou
tcom
es
do n
ot
chan
ge a
t tim
e of
ru
les
adop
tion
5. C
ontin
ued
inte
ntio
nal
com
plia
nce
5.
Bud
get i
s ba
lanc
ed.
5.G
over
nmen
t was
obs
ervi
ng im
plic
it ru
les b
ased
regi
me
prio
r to
adop
tion
of ru
les a
nd c
ontin
ued
to d
o so
.
5. A
naly
sis w
ill in
corr
ectly
de
tect
no
impa
ct.
64
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
The existence of automatic stabilisers (i.e. elements of expenditure and revenue not
under the control of governments and variable with the business cycle) is accepted in
mainstream economics (for example, see McTaggart, Findlay and Parkin (2006)).
This relates mainly to national governments to whom accrue most of the
responsibilities for business cycle stabilisation. However, the fiscal positions of
Australian State governments (and sub-national governments of many other nations)
are also dependent on the business cycle. In Australia, this is due to State
governments’ current reliance on: (a) cyclically-related revenue sources of federal
taxes on consumption, namely the Goods and Services Tax, which is now fully
distributed in accordance with fiscal federalism arrangements to State governments
after deduction of administration costs (A New Tax System (Commonwealth-State
Financial Arrangements) Act 1999 Schedule 2), and (b) State taxes and duties such as
stamp duties, which are strongly affected by property market conditions and which in
turn are business cycle dependent given the critical role in these markets of interest
rates and income levels (NSW Government (2002) at page ii).
The interdependence of fiscal measures is described in this chapter in Section 4.5.
This interdependence is such that exogeneity of revenue items may also affect
governmental expenditure and investment behaviour, either in the current fiscal year
(typically termed the ‘budget year’ in budget documents) or in future fiscal years.
The extent to which this may occur in the budgeted year depends on the flexibility
with which governments undertake budget monitoring practices following budget
formulation. For example, where unanticipated revenues are received, and this is
detected mid-year, a government may spend in excess of budgeted expenditure in the
knowledge that the increment to revenues will at least equal the increment to
expenditure. In these circumstances, a non-negative budgetary outcome will still be
attained and a budgetary balance rule will not be abrogated. In such cases, legislative
65
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
authority for expenditure, in excess of expenditure authorised by the original bill of
supply, may be obtained by passing an additional bill of unanticipated expenditure.
While a full political economy of budget determination is outside the scope of this
study, this tendency of jurisdictions to spend windfall revenues, rather than reducing
other revenue-raising avenues and maintaining expenditure unchanged, is known in
the political economy literature as the ‘flypaper effect’ (Hines and Thaler (1995),
Courant and Ribinfeld (1990) and Courant, Gramlich and Rubinfeld (1979)). To the
extent that those windfall revenues are not fully spent, better-than-budgeted financial
operating outcomes result.
Therefore, an examination of fiscal measures for evidence of change at the date of
adoption of fiscal policy rules may or may not show that changes occur in those
measures at the time of adoption of fiscal policy rules, even if governmental
behaviour changed in compliance with those rules following their adoption. At least
two possible reasons can be identified.
Firstly, if fiscal measures change at the time of adoption of fiscal policy rules, this
may be because governmental behaviour changed in intentional compliance with
those rules. Such an outcome assumes that behaviour prior to adoption of fiscal
policy rules would not produce financial outcomes in accordance with the rule, and
further, that exogenous factors do not intervene after the adoption of such rules.
Secondly, the state of revenues and expenditure, especially unplanned revenues, could
present an appearance that rules are being followed although governments have not
changed their behaviour to ensure compliance. In other words, exogenous factors
intervene. This has possibly occurred in the province of Alberta, Canada, where rules
relating to budgetary balance may have been met primarily due to receipt of
66
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
unexpectedly high oil revenues (Kneebone (2003)). This could be termed accidental
or unintentional compliance.
If fiscal measures did not change at the time of adoption of fiscal policy rules, three
conclusions are possible. Firstly, it is possible that governments did not observe the
rules after adoption i.e. governments did not change their behaviour and the fiscal
policy rules can be said to have had no effect on fiscal measures. This could be
described as intentional non-compliance.
Secondly, governments may have changed behaviour to comply with fiscal policy
rules, only to have exogenous factors intervene to prevent compliance. This could be
termed unintentional non-compliance.
Finally, it is possible that governments had been observing the rules prior to their
formal adoption and continued to do so after adoption. In other words, governments
had been obeying an implicit rules-based regime prior to their announcement (and,
usually, legislation) of those rules. Possible motives underlying this include testing,
where the government follows a rule for a period of time to observe its effects, and/or
their ability to obey the rule, prior to committing publicly to that rule. Behaviour
following adoption of fiscal policy rules could be characterised as (continued)
intentional compliance in this case. In such a case, a change in behaviour may be
traceable to a period prior to official adoption of fiscal policy rules13.
In addition, it is not necessarily the case that fiscal policy rules were ineffective in
13 As discussed further in Section 3.2.4, it is for this reason that a ‘bracketing’ approach is adopted. Under the bracketing approach, where budgetary or other documentation contains information sufficient to identify the commencement of such a regime, the period of adoption of fiscal policy rules is assumed to commence at that time.
67
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
influencing government behaviour, even if that behaviour was established prior to
formal adoption of those rules. The rules may have held government to a pattern of
behaviour from which it may otherwise have diverged. That is, governments may, in
the absence of fiscal policy rules, have chosen to reverse their previous positions.
This inability to ascribe causation, relating to fiscal behavioural change or non-change,
subsequent to adoption of fiscal policy rules, is in accordance with normal statistical
inference decision rules wherein the null hypothesis can be said to be unable to be
rejected rather than that the alternative hypothesis has been disproven. For example,
see Selvanathan, Selvanathan, Keller and Warrack (2004). Nevertheless, this inability
to specify causation between fiscal policy rules adoption and changed fiscal behaviour
complicates the analysis. For this reason, a number of analytical techniques are used,
with the advantage that multiple lenses are used to focus on the research question,
incorporating a number of different perspectives. Chapter 5 provides further
explanation.
3.2.3 What constitutes compliance – prospective or retrospective measurement
In addition, it is necessary to clarify what constitutes compliance. Kopits and
Symansky (1998) note that fiscal rules can be defined in terms of the degree of
stringency, precision and enforcement of the statutory instrument by which rules are
established and that a narrow definition would require both ex ante and ex post
compliance, subject to tangible penalties.
Compliance, whether intentional or unintentional, is necessary in order to gain the
credibility benefits, such as reduced risk premia on public debt, that are among the
usual motivations for adoption of fiscal policy rules. If an ‘announcement effect’ is
created (wherein adoption of fiscal policy rules leads to an increase in the credibility
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Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
of a government’s fiscal policy) prior to establishment of a record of compliance, this
beneficial effect will quickly dissipate if non-compliance is observed.
In the Australian experience, fiscal policy rules have been typically formulated as
requiring ex ante observance. That is, they are formulated in terms of budgetary
measures only. In this case, only budgeted fiscal measures need meet the constraints
imposed by fiscal policy rules and actual fiscal outcomes, measured retrospectively,
are deemed irrelevant. Hence, formulation of budgets, in which relevant fiscal
measures comply with constraints imposed by fiscal policy rules, is a necessary
condition to adherence to fiscal policy rules. A strict interpretation of fiscal policy
rules indicates that such budgetary adherence is both necessary and sufficient to
constitute adherence.
However, when fiscal rules are interpreted in the context of governmental financial
management practices (wherein governments monitor actual fiscal outcomes for
uniformity with budgeted fiscal outcomes) and in light of the argument in the previous
paragraph, it is clear that budgetary adherence alone is insufficient. A further
condition is necessary for adherence to fiscal policy rules. That condition is that
retrospective fiscal outcomes14, or the relationships between them, also comply with
those budgets. That is, fiscal policy outcomes, when measured retrospectively, must
also comply with budgeted (prospective) fiscal policy outcomes.
That all Australian governments intend compliance with their fiscal policy rules is
evidenced by the fact that each has reported annually on their ex post performance in
meeting the constraints imposed on fiscal measures by fiscal policy rules. As
previously discussed, this may relate to compliance levels 1, 2 or 5 of Table 3.1.
14 Historical fiscal outcomes are termed ‘actuals’ in budgetary documentation.
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Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
Intentions regarding compliance can be determined by examination of prospective
financial statements. However, it is not always possible to determine, by examination
of historical financial statements, whether the historical outcome was intentional or
unintentional. Where non-compliance has occurred, the intentionality or otherwise of
the outcome can to some extent be determined by comparison of prospective and
historical financial statements. For example, if a budgetary balance rule has not been
met, and comparison of prospective with historical financial statements reveals that
this was due to actual expenditures in excess of budgeted expenditures, of a type not
under the control of government, then it can be reasonably concluded that non-
compliance was unintentional. However, in some cases, it is not possible to
determine the intentionality of the outcome by such an examination due to the lack of
detail provided in financial statements.
Hence, in examining fiscal measures for evidence of compliance or otherwise, and
ignoring the question of intentionality, it is necessary to examine those fiscal
measures in their ‘ex post’ form. That is, the fiscal measures must be examined in
historical financial reports rather than in budgeted financial reports. Such measures
are examined in this study using Government Finance Statistics (GFS) data in Chapter
6.
Further, an awareness of when the effect of fiscal policy rules can be expected to
commence is necessary to an examination of compliance.
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3.2.4 Bracketing
Section 3.2.2 presents a range of possible observable outcomes subsequent to
adoption of fiscal policy rules. These include intentional compliance, intentional non-
compliance, unintentional non-compliance and unintentional compliance. Where the
first occurs, and this represents a change in behaviour, a change in fiscal outcomes
may be discernible. However, where an implicit rule has been adopted and obeyed
for some time prior to its being made public, a change in fiscal outcomes may not be
discernible. In such a case, a change in behaviour may be traceable to a period prior
to official adoption of fiscal policy rules.
For example, suppose a government announced an intention to legislate a specific
fiscal policy rule in Year 1 and passed the legislation in the following year (‘Year 2’).
In such a case, it is reasonable to expect that the government’s fiscal strategy in Year
1 would reflect fiscal constraints imposed by the fiscal policy rule in that year. This is
despite the fact that legislation enacting the fiscal policy rule did not take effect until
Year 2. Such a delay could be explained by time taken to draft legislation, legal
‘sitting times’ whereby legislation must be tabled for a minimum period before the
parliamentary vote and the passage of time before the Governor gives assent.
For this reason, where budgetary documentation contains information sufficient to
identify the commencement of such a regime, for example, when announcing the
formulation of impending legislation, for purposes of analysis, the period of adoption
of fiscal policy rules can be argued to extend from this time to the first reporting
period (inclusive) for which the existence of fiscal policy rules can be identified.
This approach is termed ‘bracketing’ and is analogous to the event window adopted in
event studies methodology. The event window usually includes the event date as well
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Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
as a period before the event, in order to capture the effects of any pre-announcement
anticipation or information leakage (Alankar (2003) page 92).
3.3 AUSTRALIAN GOVERNMENTAL FINANCIAL REPORTING
FRAMEWORKS
Australian national and sub-national governments present financial reports in both
prospective (budgetary) and retrospective (historical) formats, and in accordance with
both generally accepted accounting principles used by the accounting profession and
national accounting principles used by economists and statisticians.
3.3.1 Budgetary Uniform Presentation Framework
The Commonwealth Government of Australia (2000) at page 1 states:
“The May 1991 Premiers’ Conference agreed to the introduction of the
Uniform Presentation Framework (UPF) in 1991. The primary objective
of the UPF is to ensure that Commonwealth, State and Territory
governments provide a common ‘core’ of financial information in their
budget papers … (and)… facilitate a better understanding of individual
governments’ budget papers and provide for more meaningful
comparisons of each government’s financial results and projections.
The format of the UPF is based on the reporting standards of the
Australian Bureau of Statistics (ABS) Government Finance Statistics (GFS)
framework. This ensures a high degree of consistency in the preparation
and presentation of financial data. In 1997 all jurisdictions agreed to a
revised Uniform Presentation Framework which simplified, rationalised
and enhanced reporting requirements, while maintaining consistency with
the ABS cash-based GFS. The revised framework also
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previewed the shift from a cash to an accrual reporting framework.”
Australian national and sub-national governments thus have by agreement presented
prospective financial statements (contained in budgetary documentation) in
accordance with a Uniform Presentation Format (UPF) since 1991, including
prospective financial statements based on the reporting standards of the GFS (then
cash-based) framework. In 1997, governments agreed to a revised UPF containing
prospective financial statements which were, however, still formulated according to
cash-based GFS standards. In 2000, jurisdictions agreed to an amended UPF (to be
adopted by most governments from 2000-2001) containing prospective financial
statements formulated according to the newly-developed accrual-based GFS
framework.
3.3.2 Cash and accrual bases of accounting
The differences between cash and accrual-based accounting frameworks relate mainly
to temporal aspects of expense and revenue recognition. This is the subject of an
extensive literature and the interested reader may find further coverage in any first
year accounting textbook, for example, see Deegan (2005). Cash-based accounting
frameworks trace flows of cash only at the time of the flow. For example, in a cash-
based accounting framework, the purchase of an asset is recognised as an expense
equal to the total amount of the purchase price in the reporting period in which the
purchase took place. By comparison, in an accrual-based accounting framework, such
a transaction would result in recognition, during the reporting period in which the
purchase took place, of acquisition of an asset and of a depreciation (or amortisation)
expense equal only to the portion of the value of the asset consumed during the
reporting period in which the purchase took place. The remainder of the value of the
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Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
asset would be recognised as an expense during subsequent reporting periods as the
economic benefits encapsulated in the asset were consumed during those periods.
Similar differences apply to recognition of accruing revenues and expenses.
Adoption by Australian governments of differing bases for accounting frameworks
during the period examined in this study created problems for empirical testing
relating to the adoption of fiscal policy rules. These problems, and their resolution,
are discussed in Chapter 6.
3.3.3 Government Finance Statistics (GFS) reporting framework
GFS is a financial measurement framework under which all Australian governments
are required to provide historical financial reports to the Australian Bureau of
Statistics (ABS). It is based on the System of National Accounts 1993 and the
international statistical standard developed by the International Monetary Fund.
The ABS (2005a) at page 1 states:
“The term ‘government finance statistics’ refers to statistics that measure
the financial activities of governments and reflect the impact of those
activities on other sectors of the economy ...
The GFS system covers all activities of governments that can be measured
in money terms. The system focuses on monetary measures of transactions
and other economic flows that involve governments, and the money values
of assets and liabilities held by governments. Examples of activities
covered by GFS include government spending, lending, taxing, and
borrowing. As well, the statistics include information about the value of
government investments and debt ...
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The Australian GFS system is based on two important international
statistical standards… the system of national accounts embodied in System
of National Accounts 1993 (SNA93), issued jointly by the United Nations
(UN), the International Monetary Fund (IMF), the Commission of
European Communities, the Organisation for Economic Co-operation and
Development (OECD) and the World Bank … (and)… the international
statistical standard for compiling GFS developed, in consultation with
member countries, by the IMF.”
Table 3.2 provides a schematic presentation of the conceptual framework underlying
the current accrual-based GFS framework which highlights the integrated nature of
stocks and flows.
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Table 3.2 Integrated nature of GFS stocks and flows
Stocks Flows Stocks
Other Flows
Opening Balance Sheet
$
Transaction Flows
$
Revaluations $
Other Changes
in Volume
of Assets
$
Closing Balance Sheet
$
GFS Revenues (1) GFS Expenses (2)
GFS Net Worth (3) = (4 – 7 – 8)
GFS NOB = (1 – 2) =
Change in Net Worth due to transactions
Change in Net Worth
due to Revaluations
Changes in Net Worth due to Other
Changes in
Volume of
Assets
Assets (4) Non-financial assets (5)
GFS Net Lending (+)/Borrowing (-) = (1 – 2 – 5) = (6 – 7 – 8)
GFS Net Lending (+)/Borrowing (-) = (1 – 2 – 5) = (6 – 7 – 8)
Financial assets (6) Liabilities (7) Shares and other contributed capital* (8)
Note 1: Blank sectors indicate that items described in row headings are included in items described in column headings. Note 2: No items are logically classifiable to the shaded areas. Note 3: * This item is zero for the general government sector. Source: ABS (2000) page 6
GFS divides the above framework into four separate statements. Firstly, there is the
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Operating Statement (which includes details of GFS revenues, GFS expenses15 and the net acquisition of non-financial assets). Secondly, there is the Statement of Stocks and Flows (which links the Operating Statement to the Balance Sheet, showing opening balances of assets and liabilities, flows affecting these elements during the reporting period, and their closing balances). Thirdly, there is the Balance Sheet (which shows assets, liabilities and GFS Net Worth for several years to provide an analytical time series). Fourthly and finally, there is the Cash Flow Statement (which identifies sources and applications of cash flows).
Tables 3.3 and 3.4 provide an outline of the GFS Operating Statement and Statement
of Stocks and Flows respectively. Important analytical balances derived in the
Operating Statement (Table 3.3) are GFS Net Operating Balance (equalling
transactions in revenues less transactions in expenses) and GFS Net
Lending/Borrowing (equalling Net Operating Balance less transactions in the net
acquisition of non-financial assets).
The Statement of Stocks and Flows (Table 3.4) provides the analytical balance of
GFS Net Worth (equalling assets less liabilities for the general government sector).
15 The ABS (2000) states at page 7 “In a broad conceptual sense, GFS revenues are defined as transactions that increase net worth and GFS expenses as transactions that decrease net worth”.
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Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
Table 3.3 Outline of GFS Operating Statement
Source: ABS (2000) page 7
Table 3.4 Outline of GFS Statement of Stocks and Flows
Note: * This item is zero for the general government sector. Source: ABS (2000) page 8
The GFS framework defines institutional sectors within government, in accordance
with the Standard Institutional Sector Classification of Australia, as comprising the
non-financial corporations sector, the financial corporations sector and the general
government sector (ABS (2005a) at page 11).
Transactions only (excludes Revaluation and Other Changes in
Volume of Assets) $
GFS Revenues Less GFS Expenses
Equals GFS Net Operating Balance Less Net acquisition of non-financial assets Equals GFS Net Lending(+)/Borrowing(-)
Stocks Flows Stocks Other Flows
Opening Balance Sheet
$
Transaction Flows
$
Revaluations $
Other Changes
in Volume of Assets
$
Closing Balance Sheet
$
Assets (1) Non-financial Assets Financial Assets Liabilities (2) Shares and other contributed capital * (3)
GFS Net Worth (1 – 2 – 3)
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3.3.4 General purpose financial reporting
In addition, governments have provided historical general purpose financial reports
(GPFR) in accordance with generally accepted accounting principles, and with the
purpose of meeting the requirements of Australian Accounting Standard 27 (AAS 27):
Financial Reporting by Local Governments, Australian Accounting Standard 29 (AAS
29): Financial Reporting by Government Departments and Australian Accounting
Standard 31 (AAS 31): Financial Reporting by Governments, since inception of those
standards.
GPFR for governments typically comprise an income or operating statement (a
statement of flows of revenues and expenses culminating in an operating surplus or
deficit result for the reporting period), a statement of financial position or balance
sheet (a statement of stocks of assets and liabilities, with equity calculated as a residue
of assets after deduction of liabilities, and equal to net worth) and a cash flow
statement (a statement of flows of cash underlying the operating statement and
statement of financial position). Supplementary reports may also be provided.
In their simplest form16, linkages between accrual-based general purpose financial
statements are as follows. Flows of revenues and expenses reported in the operating
statement impact stocks of assets, liabilities and equity reported in the statement of
financial position. The overall impact of those flows (the Operating Result) attained
in the operating statement flows into the statement of financial position. The change
in net equity and net worth between one reporting period and the next equals the
operating result in the latter reporting period.
16 This is in the absence of abnormal or extraordinary items, which were shown ‘below the line’ (i.e. after calculation of the operating result, these items are added or deducted to attain an operating result after abnormal and extraordinary items) until 1 July 2000.
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3.3.5 Differences between GFS and GPFR
GFS share many similarities with general purpose financial reporting in accordance
with generally accepted (accrual) accounting principles, being based on the same
information sources.
The ABS (2005a) at page 2 states:
“The main sources of information for compiling GFS in Australia are the
data systems that support the public accounts of the Commonwealth, and
each state and territory government. These accounts are largely geared
towards financial accountability and control and are in a format reflecting
accounting standards and legal and administrative imperatives in each
jurisdiction. The accounts that are the main sources of information for
compiling GFS in Australia generally comply with Australian accounting
standards for government entities.”
However, differences exist between the two approaches, arising from their different
roles and conceptual bases. The ABS (2005a) at page 2 further states:
“The accounting concepts established by these standards are generally
consistent with the statistical concepts employed in GFS. In developing
Australia’s GFS system, the ABS has worked closely with government
accountants and the Australian Accounting Standards Board and has
endeavoured to identify and document the small number of unavoidable
differences between the GFS system and accounting standards.”
The Commonwealth Government of Australia (2000) at page 5 notes:
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“There are a number of conceptual differences between GFS and AAS31
that mainly reflect the economic focus of the former and the accounting
focus of the latter ... GFS data is broadly consistent with the data on
government transactions in the Australian National Accounts and
reflected in measures of economic activity.”
Consequently, the two approaches produce different headline measures. The
Commonwealth Government of Australia (2000) at page 5 further notes:
“… the GFS framework yields the net lending, or fiscal balance, measure,
which is important in assessing the impact of a government’s policies on
the economy. This concept is not found in AAS31 standards.”
The Commonwealth Government of Australia (2000) at page 13 states:
“The key measures in the GFS accrual framework are: GFS net operating
balance, GFS net lending (fiscal balance), cash surplus, net debt, net
worth, change in net worth, and net financial worth.”
The major difference between the two approaches lies in the treatment of asset
revaluation increments or decrements. The Queensland Government (2006) at page
179 states:
“The primary difference between GFS net operating balance and the
accounting surplus calculated reporting under Australian Accounting
Standards (AAS) is that valuation adjustments are excluded from the GFS
net operating balance.”
and
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“The primary difference between GFS net operating balance and the
accounting surplus calculated reporting under Australian Accounting
Standards (AAS) is that valuation adjustments are excluded from the GFS
net operating balance.”
This accords with the Commonwealth Government of Australia (2000) at page 5,
statement that:
“The GFS excludes revaluation income and expenses because they are
outside the control of government.”
As a result, for example, because the impact of an asset revaluation decrement is not
included in a GFS operating result, the reporting entity may report a GFS operating
surplus, and yet also report diminution of net worth, in the same reporting period
under this measurement approach. Equally, when the impact of an asset revaluation
increment is not included in a GFS operating result, the reporting entity will report an
increase in net worth in excess of the GFS operating surplus.
According to the Commonwealth Government of Australia (2000) at page 18, the
GPFR Operating Result and GFS Net Operating Balance also reflect differing
treatment of provisions for doubtful debts, bad debts written off from provisions and
treated as capital transfers, abnormal items, distributions to owners (dividends) and
capitalised interest.
Table 3.5 shows reconciliation of GFS Net Operating Balance with the GPFR
Operating Result reported in accordance with AAS31.
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Table 3.5 Reconciliation of GFS Net Operating Balance with Operating Surplus/Deficit
GFS Net Operating Balance minus Provisions for doubtful debts plus Bad debts written off from provisions and treated as capital
transfers plus/minus Gains/losses on assets, including derivatives plus/minus Adjustment for abnormal/extraordinary items (a) plus Distributions to owners (dividends) plus Capitalised interest Plus/minus Other adjustments (b) equals AAS 31 Operating Surplus/Deficit (a) Due to changes to Australian Accounting Standards, separate identification of abnormal items will not be required on the face of financial statements in respect of reporting periods beginning on or after 1 July 2000. (b) Calculated as a residual. May include adjustments for superannuation, coverage and unidentified differences. Source: ABS (2000) page 20
The Commonwealth Government of Australia (2000) at page 21 states that measures
of net worth also differ between GFS and GPFR:
“GFS Net Worth … (and) … AAS 31 Net Assets … are equivalent for the
large part. The GFS Net Worth measure represents total assets less
liabilities ... The AAS 31 Net Assets measure, in concept, represents Total
Net Assets (total assets less total liabilities) less outside equity interests,
though in the illustration in the standard outside equity interests are not
deducted from Total Net Assets – rather they are separately disclosed.”
Table 3.6 shows the reconciliation of GFS Net Worth with AAS 31 Net Assets.
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Table 3.6 Reconciliation of GFS Net Worth with AAS 31 Net Assets
Source: Author’s own compilation based on ABS (2000) page 22
At the time of writing, efforts are underway to harmonise GPFR and GFS standards
(ABS (2005a) page V).
Australian governments have mostly, but not always, chosen to measure fiscal
outcomes in terms of line items, or the difference between two or more line items,
comprising part of financial reports produced in accordance with the GFS
frameworks. In a few cases, Australian governments have chosen measurement in
terms of GPFR items. This has complicated empirical investigation of fiscal
outcomes in the context of fiscal policy rules. The nature of these complications, and
action taken in response to them, is detailed in Chapter 6.
3.4 FISCAL MEASURES
The following sections proceed from the above general discussion to outline more
specific outcomes regarding fiscal policy rules, focussing in particular on outcome
measures relating to net debt, budgetary balance and net worth fiscal policy rules.
3.4.1 The net debt measure
Net debt is a measure derived from other measures presented in the GFS Statement of
GFS Net Worth
plus/minus
Adjustments (a)
equals
AAS 31 Net Assets
(a) Calculated as a residual. Includes adjustments for capitalised interest,
provision for bad debts, superannuation, coverage, valuation and unidentified differences.
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Stocks and Flows and GFS Balance Sheet. It is provided separately in the GFS
Balance Sheet for reference purposes.
In general, net debt refers to the difference between debt owed and financial assets
owned by the government. According to the Commonwealth Government of
Australia (2000) at page 16:
“Net debt comprises the stock of selected gross financial liabilities less
financial assets. … The net debt measure is limited in that it does not
include accrued employee liabilities or outstanding claims associated
with insurance type activities, which can be substantial.”
Specifically, net debt is calculated as debt (equal to Borrowing + Deposits held +
Advances received) (for the general government sector) less financial assets (equals
Cash and deposits + Advances paid + Investments, loans and placements) (ABS
(2005a) page 54).
The measure is unchanged regardless of which reporting framework is adopted.
The Commonwealth Government of Australia (2000) at page 16 states that:
“The concept of net debt is the same under cash and accrual-based
financial reporting.”
Governments adopting net debt fiscal policy rules usually target reduced net
debt, often for each annual reporting cycle. This was the case for all of the
Australian governments examined.
3.4.2 Budgetary balance measures
Fiscal policy rules adopted by selected Australian governments are detailed in Chapter
5. Fiscal rules commonly relate to budgetary balance i.e. a requirement that flows of
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Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
revenue and expenditure items must equal in total. Most Australian governments
have committed to a balanced or surplus budget, however, this was sometimes subject
to the state of the business cycle. In addition, the expected level of surplus (e.g. zero
or positive), sectoral coverage (e.g. General Government or Total Public sector) and
method of measurement (e.g. GFS Net Operating Balance or GPFR Operating
Balance) varied between governments. Therefore, these budgetary balance rules must
be interpreted with an awareness of the meaning of the terms in which those rules are
formulated (the topic of the following sections of this chapter).
Basis of measurement – cash or accrual
When measured on a cash basis, budgetary balance implies that cash incomings equal
cash outgoings of all kinds (including on capital items). Such an outcome would
produce a zero result in a cash-based operating statement. When measured on an
accruals basis, budgetary balance implies that accrual revenues equal accrual
expenditures. However, due to differences between cash and accrual reporting
frameworks, the two outcomes are significantly different, with the difference relating
mainly to timing of recognition of revenues and expenses (see Section 3.3.1). In
addition, the meaning of budgetary balance in an accrual-based GFS framework
differs from the meaning of budgetary balance in an accrual-based GPFR framework,
due to different treatments of adjustments for revaluation of assets. See Section 3.3.4
for further discussion.
Basis of measurement - GPFR
The relevant fiscal measure to a budgetary balance fiscal rule, measured in GPFR
terms, is the Operating Result. That is, a government which formulated a budgetary
balance fiscal policy rule with reference to fiscal outcomes measured in GPFR terms
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Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
would use Operating Result as the targeted fiscal measure. For example, if that
government sought budgetary balance, the target would be expressed as a zero
Operating Result. More commonly, a positive Operating Result is sought. In these
cases, the target is expressed as ‘budgetary surplus’.
Basis of measurement – accrual-based GFS
When budgetary balance is measured in accordance with accrual-based GFS, as
previously described, two relevant fiscal measures exist, being GFS Net Operating
Balance and GFS Net Lending/Borrowing. Fiscal outcomes, relating to budgetary
balance and measured in accrual-based GFS terms, are usually measured in terms of
GFS Net Lending/Borrowing. When this line item is zero, the result is often termed
‘fiscal balance’. This is essentially a reference to cash inflows broadly equalling (‘in
balance with’) cash outflows.
Robinson (2002a) at page 294 states that fiscal balance is:
“… officially defined as equal to the operating balance minus a … ‘capital
adjustment’ ... (which)…equals general government capital expenditure minus both
depreciation and general government asset sales receipts; it is, in other words, net
investment…”
From 1999-2000 to the end of the period examined, the Australian government
committed to a target related to fiscal balance on average over the economic cycle.
Fiscal balance is described in the Commonwealth Government 1998-99 budgetary
documents as the accrual counterpart of the underlying cash balance, and consistent
with the Australian National Accounts concept of net lending. It equals the accruals
operating result less revaluations (changes in the value of assets and liabilities
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Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
resulting from non-transaction flows such as changes in price of foreign exchange),
plus depreciation and less capital expenditure. For this reason, fiscal balance is
described as implying general government saving equal to general government
investment in the Commonwealth Government’s 2000-01 budgetary documentation.
The stringency of a fiscal policy rule requiring fiscal balance defined in such terms
depends on the quantum of net investment. As Robinson (2000) explains, the
meaning of fiscal balance is such that where net investment is negative, this means
that operating results may be negative (to a level equal to, but not exceeding, the
negative level of net investment) without abrogating the target. However, where net
investment is positive, a fiscal balance requirement means that operating balance must
at least equal net investment. Such a requirement is thus more stringent than a
budgetary balance requirement measured in terms of GFS Net Operating Balance.
Period of measurement – annual or cyclical
The operating result may be measured in terms of the reporting period i.e. the relevant
financial year. However, there is some incidence of governments adopting a fiscal
policy rule requiring budgetary balance subject to the state of the business cycle. For
example, the Commonwealth Government in 1998-99 adopted a fiscal policy rule
targeting budgetary balance on average over the economic cycle. While the specific
meaning can vary between jurisdictions (and is often not specified), the general intent
of such a rule is usually to impose fiscal responsibility while enabling the government
to fulfil a stabilisation role.
The meaning of a rule requiring budgetary balance on average over a business cycle is
that while the rate of growth of the economy is projected to be positive (and, usually,
above some threshold level), the operating outcome (whether measured in terms of
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Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
GFS Net Operating Balance or GFS Net Lending/Borrowing) for the government
should be at least non-negative i.e. zero or positive. However, the rule also allows for
a negative operating result where trend growth rates are either negative or below some
threshold level, which may be the average of the known past rates of economic
growth plus anticipated rates over the remainder of the cycle. Calculation of such an
average is obviously complicated by difficulties of prediction.
Anticipating the discussion in following chapters, Table 3.7 provides rates of change
in chain volume measures of Gross Domestic Product and Gross State Product for the
period 1995-6 to 2003-04, for the Commonwealth, New South Wales, Victorian,
Queensland and Western Australian Governments. It shows that, with the exception
of Western Australia in 2001, rates of growth were positive during the entire period.
Table 3.7 Gross Domestic/State Product, Chain volume measures - percentage change from previous year
Source: ABS 2005 (b)
As growth rates have been constant during much if not all of the period examined, a
fiscal policy rule requiring budgetary balance on average over a business cycle may
be interpreted as intending that positive operating results should be achieved in each
year examined.
1995-
96 1996-
97 1997-
98 1998-
89 1999-2000
2000-01
2010-02
2002-03
Commonwealth (GDP) 4.1 3.9 4.5 5.2 4.0 1.9 3.8 3.2 New South Wales (GSP) 4.9 4.1 4.6 4.2 4.5 3.2 1.8 2.2 Victoria (GSP) 4.4 2.9 4.7 6.8 3.7 1.5 4.1 2.8 Queensland (GSP) 3.6 4.7 4.4 6.3 6.3 1.4 6.4 5.5 Western Australia (GSP) 5.0 2.5 6.0 4.0 3.0 -1.3 5.6 5.6
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3.4.3 Net worth measures Basis of measurement – cash or accrual
Cash-based reporting frameworks provide only partial balance sheets detailing
selected financial assets and liabilities only (Commonwealth Government of Australia
(2000) page 13). Under such frameworks, the concept of net worth reduces to a
concept of net financial worth. This is equivalent to net debt when liabilities exceed
financial assets i.e. when net financial worth is negative.
Accrual-based reporting frameworks provide full balance sheets from which can be
derived a measure of net worth. However, as previously described, the concept of net
worth varies between GFS and GPFR frameworks, described in the following two
sub-sections.
Basis of measurement - GPFR
Sections 3.3.2 details the accrual-based GFS measure of GFS Net Worth and Section
3.3.4 specifies the differences between GFS Net Worth and the concept of net worth
reported within GPFR. A net worth fiscal policy rule formulated in GPFR terms will
typically target Net Assets, as was the case in the New South Wales and Victorian
jurisdictions.
Basis of measurement – accrual-based GFS
A government which formulates its net worth fiscal policy rule in GFS terms will
typically use GFS Net Worth as the relevant fiscal measure. It may thus establish a
net worth rule requiring that GFS Net Worth be at least maintained or increased, or
increased by some minimum amount. The Commonwealth, Queensland and Western
90
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
Australian Governments adopted the former approach.
Basis of measurement – annual or cyclical
Net worth fiscal policy rules may also target some measure of change on an average
basis over a business cycle. The preceding discussion regarding cyclical
measurement of a budgetary balance target also applies in such a case. That is, as
growth rates have been constant during most of the period examined, a fiscal policy
rule requiring increased net worth on average over a business cycle may be interpreted
as intending that increased net worth should be achieved in each year examined.
3.5 INTERDEPENDENCE OF FISCAL POLICY RULES
Interdependence of fiscal policy rules arises from the previously-described linkages
between fiscal measures and financial reports. Such linkages are most marked where
financial reports are accrual-based, as cash-based reporting frameworks do not have
the integrated nature of accrual-based frameworks.
However, interdependence of fiscal policy rules also depends on whether the fiscal
outcome, constrained by the rule, is measured in a GPFR or GFS framework, even
when the GFS methodology used is accrual-based, and hence, both are accrual-
based17. Further, when the operating outcome is measured in an accrual-based GFS
framework, whether interdependence exists between a budgetary balance rule and net
worth rule depends on the terms in which the budgetary balance outcome is measured
i.e. GFS Net Operating Balance or GFS Net Lending/ Borrowing.
This essentially reduces to consideration of whether the fiscal outcome is measured in
cash or accrual terms, regardless of the basis of the reporting framework used. This is
17 GPFR are, by definition, accrual-based.
91
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
because a target of positive net lending (reported under an accrual-based GFS
framework) is equivalent to a target of positive operating outcome (reported under a
cash-based GFS framework). Many budgetary balance rules are measured in cash
terms and typically target non-negative GFS Net Lending (and hence are substantively
net debt reduction rules). As previously described, when taken alone, such a
requirement may be met by a negative Net Operating Balance where Net Acquisition
of Non-Financial Assets is also negative (and at least as large as the negative Net
Operating Balance) (Robinson (2002a) page 294).
Examination of Table 3.2 indicates that such an outcome leads to diminution of net
worth in the absence of positive Changes in Net Worth due to Revaluations or
Changes in Net Worth due to Other Changes in Volume of Assets. However, if a net
worth rule requiring non-negative change to net worth also exists, this outcome is
prevented and a budgetary balance rule leads to the more intuitive outcome of non-
negative GFS Net Operating Balance. In addition, where a budgetary balance rule
(measured in accrual terms) is met and a positive GFS Net Lending outcome is
attained, as long as the combined effect of Changes in Net Worth due to Revaluations
and Changes in Net Worth due to Other Changes in Volume of Assets is non-negative
(or, if negative, does not exceed the GFS Net Lending outcome), GFS Net Worth will
increase and a net worth rule will be met. In addition, if the GFS Net Lending/
Borrowing surplus is retained partly or wholly in the form of financial assets or
applied to reduction of debt, a fiscal policy rule requiring diminution of net debt will
also be met.
92
Chapter 3: Financial Management Frameworks and Fiscal Policy Rules
CONCLUSION
Figures 3.1 to 3.3 inclusive diagrammatically summarise approaches whereby fiscal
outcomes may be measured by Australian governments which have adopted fiscal
policy rules. Figure 3.1 depicts alternative possible ways of measuring fiscal
outcomes constrained by adoption of net debt fiscal policy rules. Figure 3.2 addresses
budgetary balance fiscal policy rules and Figure 3.3 provides this information for net
worth fiscal policy rules.
This provides a basis for specifying fiscal measures affected by adoption of fiscal
policy rules. Chapter 4 outlines the history of fiscal regimes adopted by Australian
governments, including fiscal policy rules adopted during the 1980s and 1990s.
Adoption dates for rules-based regime are specified, including the measurement
approaches used i.e. the fiscal measures targeted. Chapter 5 outlines methods and
data used to determine, in Chapter 6, the extent to which Australian governments have
succeeded in complying with fiscal targets. In addition, Chapter 6 presents results of
investigation of whether adoption of a net worth fiscal policy rule by the Australian
national and five State governments has coincided with changed levels of public
investment.
93
Cha
pter
3: F
inan
cial
Man
agem
ent F
ram
ewor
ks a
nd F
isca
l Pol
icy
Rul
es
Figu
re 3
.1 M
easu
rem
ent o
f fis
cal o
utco
mes
in th
e co
ntex
t of a
net
deb
t fis
cal p
olic
y ru
le
T
ype
of r
ule
Fr
amew
ork
B
asis
of
mea
sure
men
t
Fi
scal
mea
sure
by
whi
ch m
easu
red
Pe
riod
of
mea
sure
men
t
Com
plia
nce
(whe
ther
in
tent
iona
l or
non-
inte
ntio
nal)
cons
titut
es
cash
acc
ount
ing
c
ash
a
nnua
l
N
et d
ebt
GPF
R
acc
rual
N
et
cas
h
D
ebt
GFS
cy
clic
al
acc
rual
no in
crea
se in
Net
Deb
t ove
r fin
anci
al y
ear
no in
crea
se in
Net
Deb
t ove
r cy
cle
(as d
efin
ed)
94
Cha
pter
3: F
inan
cial
Man
agem
ent F
ram
ewor
ks a
nd F
isca
l Pol
icy
Rul
es
Figu
re 3
.2 M
easu
rem
ent o
f fis
cal o
utco
mes
in th
e co
ntex
t of a
bud
geta
ry b
alan
ce fi
scal
pol
icy
rule
Typ
e of
rul
e
Fram
ewor
k
Bas
is o
f m
easu
rem
ent
Fi
scal
mea
sure
by
whi
ch m
easu
red
Pe
riod
of
mea
sure
men
t
Com
plia
nce
(whe
ther
in
tent
iona
l or
non-
inte
ntio
nal)
cons
titut
es
ann
ual
cas
h ac
coun
ting
c
ash
cyc
lical
B
udge
tary
GPF
R
acc
rual
c
yclic
al
bala
nce
annu
al
cas
h
c
yclic
al
GFS
a
nnua
l
a
ccru
al
Net
cas
h flo
w (i
n-
flow
s les
s out
lays
) po
sitiv
e ne
t cas
h flo
w o
ver
cycl
e (a
s def
ined
)
Ope
ratin
g Re
sult
posi
tive
Ope
ratin
g R
esul
t ov
er fi
nanc
ial y
ear
posi
tive
Ope
ratin
g Re
sult
over
cy
cle
(as d
efin
ed)
GFS
Def
icit/
Su
rplu
s
annu
al
GFS
Net
Ope
r-
atin
g Ba
lanc
e or
GFS
Net
Le
ndin
g/Bo
rr-
owin
g
posi
tive
GFS
Def
icit/
Su
rplu
s ove
r fin
anci
al y
ear
posi
tive
GFS
Def
icit/
Su
rplu
s ove
r cyc
le (a
s de
fined
) po
sitiv
e G
FS N
et O
pera
ting
Bala
nce
or G
FS N
et
Lend
ing/
Borr
owin
g ov
er
finan
cial
yea
r
posi
tive
GFS
Net
Ope
ratin
g Ba
lanc
e or
GFS
Net
Le
ndin
g/Bo
rrow
ing
over
cy
cle
(as d
efin
ed)
posi
tive
net c
ash
flow
ove
r fin
anci
al y
ear
cycl
ical
95
Cha
pter
3: F
inan
cial
Man
agem
ent F
ram
ewor
ks a
nd F
isca
l Pol
icy
Rul
es
Figu
re 3
.3 M
easu
rem
ent o
f fis
cal o
utco
mes
in th
e co
ntex
t of a
net
wor
th fi
scal
pol
icy
rule
Typ
e of
rul
e
Fram
ewor
k
Bas
is o
f m
easu
rem
ent
Fi
scal
mea
sure
by
whi
ch m
easu
red
Pe
riod
of
mea
sure
men
t
Com
plia
nce
(whe
ther
in
tent
iona
l or
non-
inte
ntio
nal)
cons
titut
es
an
nual
C
ash
acco
untin
g
c
ash
cy
clic
al
annu
al
Net
wor
th
G
PFR
accr
ual
N
et A
sset
s
cycl
ical
an
nual
cash
G
FS
c
yclic
al
ac
crua
l
GFS
Net
Wor
th
ann
ual
cy
clic
al
Net
fina
ncia
l ass
ets/
lia
bilit
ies (
if ne
gativ
e, e
qual
s Net
D
ebt)
posi
tive
chan
ge in
net
fin
anci
al a
sset
s/ li
abili
ties
over
fina
ncia
l yea
r
posi
tive
chan
ge in
Net
As
sets
ove
r fin
anci
al y
ear
posi
tive
chan
ge in
Net
As
sets
ove
r cyc
le (a
s de
fined
)
Net
fina
ncia
l ass
ets/
lia
bilit
ies (
if ne
gativ
e, e
qual
s Net
D
ebt)
posi
tive
chan
ge in
net
fin
anci
al a
sset
s/lia
bilit
ies
over
fina
ncia
l yea
r
posi
tive
chan
ge in
GFS
N
et W
orth
ove
r fin
anci
al
year
po
sitiv
e ch
ange
in G
FS
Net
Wor
th o
ver c
ycle
(as
defin
ed)
posi
tive
chan
ge in
net
fin
anci
al a
sset
s/lia
bilit
ies
over
cyc
le (a
s def
ined
)
posi
tive
chan
ge in
net
fin
anci
al a
sset
s/lia
bilit
ies
over
cyc
le (a
s def
ined
)
96
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
CHAPTER 4
FISCAL POLICY RULE ADOPTION BY
AUSTRALIAN NATIONAL AND STATE GOVERNMENTS
4.1 INTRODUCTION
Fiscal policy rules are defined for this thesis as forms of agreement, either
between governments or between a government and its constituency, that are
enshrined in some lasting and authoritative form so as to remain effective beyond
the life of the adoptive government. For example, if a government adopts a fiscal
strategy targeting a particular fiscal outcome, but fails to put in place any
mechanism that causes that target to both bind and outlive itself, that
arrangement would not constitute a fiscal policy rule for purposes of this study.
Typically, fiscal policy rules are made binding on the initiating and succeeding
governments by legislation. This is in accordance with Kopits and Symansky
(1998) who state that an intention that a rule be applied on a permanent basis by
succeeding governments is essential to designation of a fiscal target, contained in
a fiscal strategy, as a fiscal policy rule (see Chapter 1).
The purpose of this chapter is to detail the fiscal strategies adopted by Australian
national and State jurisdictions and identify the dates on which they adopted
fiscal policy rules (as defined) relating to budgetary balance, debt reduction and
net worth. A general version of fiscal policy rules is interpreted (in Chapter 3) as
constraints on fiscal measures reported in accordance with either GPFR or GFS
accounting frameworks. This general application of fiscal policy rules is applied
to the specific fiscal policy rules adopted by Australian governments, allowing
identification of the precise targets adopted and the sector (general government
97
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
or total public sector18) to which they apply. This is the foundation for the
empirical investigation of compliance and public capital formation described in
Chapters 5 and 6.
4.2 AUSTRALIAN FISCAL POLICY RULES REGIMES
The background to Australian fiscal policy rules regimes is international,
stretching back to just after World War 2. Australian governments did not
operate in isolation, but relied on international precedent in determining their
fiscal regimes.
The Bretton Woods agreement comprised an early if indirect form of fiscal rule,
effecting more than the widely-acknowledged and evident commitment to
pegged exchange rates (Williamson (1985)). Williamson states that Bretton
Woods imposed three implicit rules on parties. The first of these is said to have
allowed (or required) adjustment of exchange rates where disequilibrium existed
(in order to achieve ‘external balance’ in the medium term). The second required
that monetary and fiscal policies be aimed at achieving full employment in the
short run (termed ‘internal balance’). The third related to maintenance of
reserves of foreign currency and/or gold as a buffer to enable the continual
pursuit of internal balance.
Kopits and Symansky (1998) trace the commencement of negative fiscal trends
in major groups of countries to the breakdown of the Bretton Woods system in
the late 1960s or 1970 and subsequent abandonment of the gold standard. While
various examples of fiscal policy rules can be found dating from the 1940s, the
1990s saw more widespread adoption of fiscal policy rules. This occurred as
numerous governments sought to correct deterioration in their fiscal positions 18 The total public sector comprises the general government and public corporations sectors.
98
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
during the preceding decades, having achieved only moderate success at
reversing this trend through discretionary policies. Kopits and Symansky (1998)
list the Netherlands, European Union members, New Zealand, Germany, Japan,
United States sub-national governments, Canada, Indonesia, Argentina, Chile,
Ecuador, Hungary, Peru, CFA franc zone members, Brazil, Egypt, Morocco,
Philippines and the Slovak Republic as having adopted fiscal policy rules of
various types. OECD (2002) also reports Switzerland as having adopted fiscal
policy rules. Listed by Kopits and Symansky (1998) as considering adoption of
fiscal policy rules were the United States national government19 and Costa Rica.
Also considering adoption of fiscal policy rules were Brazil, India and Nigeria
(IMF (2004)).
The Commonwealth and all State Australian Governments except the Tasmanian
Government adopted fiscal policy rules during the 1990s20. Most of these
governments adopted fiscal policy rules relating to budgetary balance, debt
reduction and net worth. However, the measurement approach, and thus targeted
fiscal measures, varied between jurisdictions. As noted in Chapter 6, outcomes
also varied between jurisdictions.
19 The proposal was defeated in 1997 (Milesi-Ferretti (1997). 20 Territory governments were excluded from the analysis due to their relatively small size in terms of population and economic activity.
99
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
4.2.1 Commonwealth Government
Table 4.1 presents the experience of fiscal policy rules adoption by the
Commonwealth Government.
Table 4.1 Commonwealth Government fiscal policy rules
Fiscal policy rule type
Measure adopted
Target Relevant Sector
Date of adoption
Bracketing span
Budgetary surplus
1998-99 cash-based GFS Net Operating Balance 1999-2000 to 2003-04 accrual-based GFS Net Lending/ Borrowing
Balance 1998-88 budget sector 1999-2000 to 2003-04 general government
1998-99 1996-97 to 1998-99
Debt reduction
Net Debt 1998-99 to 1999-2000 Reduction to 10 per cent GDP by 2000-01
General government
1998-99 1996-97 to 1998-99
Net worth GFS Net Worth
Improvement over the medium to long term
General government
1999-2000
N/A
The fiscal trilogy
In 1984, in response to steady growth in the size of government and a
deteriorating fiscal position, the Australian Government adopted a fiscal ‘trilogy’,
that: (a) taxes would not be increased; (b) government expenditure would not be
increased; and (c) the budget deficit would be reduced both in current terms and
as a proportion of GDP (National Commission of Audit (1996) page 3).
100
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
Each part of the trilogy was to apply in 1985-86 and over the life of the
Parliament, and as such, do not meet the requirement that fiscal policy rules
remain effective beyond the life of the initiating government. That is, no
effective mechanism was adopted to make the strategy binding on either the
initiating or succeeding governments.
The government continued this strategy of fiscal consolidation until the early
1990s when the recession induced recurring budgetary deficits. In 1993-94, a
medium term fiscal strategy was adopted with a target of budgetary deficit equal
to approximately one per cent of GDP by 1996-97 (National Commission of
Audit (1996) page 3). This strategy also fails to meet the criteria by which fiscal
policy rules are defined in this study, as it did not include an enforcement
mechanism to make the strategy binding on the initiating and succeeding
governments.
1996-97 Introduction of The Charter of Budget Honesty Bill and commencement
of bracketing
In 1996, the government introduced, for legislation in 1998, a Charter of Budget
Honesty Bill. The aim of the Charter was to provide for greater discipline,
transparency and accountability in fiscal policy (Commonwealth of Australia
(1996) page 3).
The Commonwealth of Australia (1996) states (at page 2) that:
“ … the adoption of the new fiscal framework through legislation
has the objective of applying the new arrangements to all future
governments by law…”.
101
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
For this reason, targets adopted under the Charter are considered to constitute
fiscal policy rules for purposes of this study.
The proposed Charter of Budget Honesty was included in the 1996-97 Budget
papers and it is for this reason that bracketing21 commences in this year. That is,
while fiscal policy rules were not considered to have been adopted until their
formalization in 1998-99, it is to be anticipated that changed government
behaviour, if any, could commence in this year. This is because targets adopted
for fiscal measures from this year onward are consistent with provisions of the
Charter of Budget Honesty. The Charter of Budget Honesty specifies principles
on which fiscal policy was to be based, rather than identifying fiscal measures
and specifying targets. Thus, minor changes have been made to measures and
targets during ensuing years. The exact measures and targets are described
below.
The Charter of Budget Honesty Act 1998 (in Sections 2 and 9) commits each
succeeding government to produce a medium-term fiscal strategy each year, to
specify shorter-term fiscal measures against which fiscal policy is set and
assessed and to state targets for these measures. The requirement that the
government’s fiscal strategy be based on principles of sound fiscal management
is at Section 2. These are specified (at Section 8) as including prudent risk
management (including with reference to general government debt and
contingent liability levels), ensuring that fiscal policy contributes to achieving
adequate national savings and stabilization, adopting spending and taxation
levels consistent with reasonable taxation stability and predictability, maintaining
taxation integrity and consideration of intergenerational effects.
21 Bracketing is described in Section 3.2.4.
102
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
In accordance with this proposed Charter of Budget Honesty, the short-term
fiscal strategy announced in the 1996-97 budget targeted reduced underlying
budget deficits as a prerequisite to a medium-term fiscal strategy of movement to
underlying budgetary balance22. The relative fiscal measure (GFS Net Operating
Balance) was stated in accordance with the cash-based GFS framework applying
at the time. The mechanism adopted to achieve this outcome was expenditure
constraint. A commitment was also made to revenue constraint, specifically, to
adopt no new taxes or increase any existing taxes (although no undertaking to
limit total taxation or other revenue was made). While the improvement in
underlying balance was expected to reduce general government net debt, aided
by application of proceeds of substantial equity asset sales, the ultimate aim of
the medium-term strategy was to increase national saving (Commonwealth of
Australia (1996) pages 1 to 5).
The objective of the medium-term fiscal strategy was unchanged in the 1997-98
budget, i.e. reduced underlying deficit in order to increase national saving and
reduce general government net debt. The target of reduced underlying budget
deficits every year was amended, to enable the stabilization role to be effectively
undertaken. The target became reduced underlying budget deficits on average
over the course of the economic cycle. Two more stringent targets were also
adopted, to achieve underlying balance by 1998-99 and maintain surplus (i.e.
positive underlying balance) beyond 1998-99 while economic growth was
22 “Underlying budget balance” is described in Commonwealth of Australia (1996) at page 2 as measuring directly the budget sector’s contribution to public sector net lending i.e. savings less investment, and as being negative if in deficit and positive if in surplus. The underlying budget outcome reflects a flow-of-funds concept.
103
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
‘solid’23. Commitments to expenditure and revenue constraints adopted in 1996-
97 were retained (Commonwealth of Australia (1996) pages 1 to 5).
1998-99 - Formalization of fiscal policy rules
The Charter of Budget Honesty Bill was passed into law in 1998. For this reason,
fiscal policy rules are deemed to have been adopted in 1998-99. Reflecting this,
in 1998-99, the primary objective of Commonwealth Government medium-term
fiscal strategy was to maintain underlying budgetary balance, on average, over
the course of the economic cycle. The relevant fiscal aggregate (GFS Net
Operating Balance) continued to be stated in accordance with the cash-based
GFS framework, as had been the case since 1996-97. This required an
underlying budgetary surplus in 1998-99 as well as surpluses in forward
estimates years for which estimated economic growth was sound.
A continuing objective of increasing national saving and, particularly, net debt
reduction is evidenced by the accompanying intention to halve net debt from its
level of 20 per cent of GDP in 1995-96 to 10 per cent in 2000-01. Existing
commitments to taxation and expenditure constraint were retained
(Commonwealth of Australia (1998) pages 1 to 5).
In 1999-2000, the objective of Commonwealth fiscal strategy was unchanged.
However, the primary target was redefined, under the newly-adopted accrual-
based GFS budgetary framework, as maintaining fiscal balance (Commonwealth
of Australia (1999) pages 1 to 5). As in Section 3.4.2, when the GFS Net
Lending/Borrowing measure equals zero, the result is often termed ‘fiscal
balance’. This is the accrual counterpart of the underlying cash balance, and is
23 No definition of the term ‘solid’ was provided.
104
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
consistent with the Australian National Accounts concept of net lending.
The focus of budgetary balance also moved from the budget sector to the general
government sector from this time. The Commonwealth of Australia (1999 b) at
page 2 stated:
“The Commonwealth budget sector consists of those departments
and agencies whose day-to-day transactions are recorded in the
Official Commonwealth Public Account. The general government
sector has a slightly wider definition than the budget sector (eg
including ABS, CSIRO) and includes resident public entities which
are mainly engaged in the production of goods and services outside
the normal market mechanism for consumption by governments and
the general public. Costs of production are mainly financed from
public tax revenues. Goods and services are provided free of charge
or at nominal charges well below costs of production.”
As in Chapter 3, the essential difference between cash and accrual bases of
accounting is the timing of recognition of expenses and revenues and the
resulting different financial reporting formats. Accrual-based accounting
frameworks provide the capacity to produce full balance sheets. The change in
accounting methodology thus provided an improved information set on the basis
of which were established five fiscal targets supplementary to the primary target.
Of these, four were unchanged. These were maintenance of budgetary surpluses
over the forward estimates period where economic growth prospects were
deemed sound, reduction of the ratio of general government net debt to GDP to
10 per cent by 2000-01, expenditure constraint and taxation constraint. The fifth
105
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
was improvement of the government’s net assets position over the medium- to
long-term (Commonwealth of Australia (1999) page 1). This constituted
adoption of a net worth fiscal policy rule.
In 2000-01, 2001-02, 2002-03 and 2003-04, the primary target of fiscal balance
on average over the course of the economic cycle were unchanged. The
Commonwealth of Australia ((2000) page 1, (2002) page 1 and (2003) pages 1-5
to 1-6) stated that supplementary objectives included:
“.. maintaining fiscal surpluses over the forward estimates period
while economic growth prospects remain sound, no increase in the
overall tax burden from its 1996-97 level and improving the
Commonwealth net worth position over the medium to longer term.”
The net debt and expenditure constraint aims were not included in the 2000-01
strategy statement, on the basis that each had been achieved. Nor were they
reintroduced in the remainder of the period under scrutiny (Commonwealth of
Australia (2001) page 1–3, Commonwealth of Australia (2002) page 1–5,
Commonwealth of Australia (2003) pages 1-5 to 1-8). This is a continuation of
the 1996-97 strategy, restated in accrual terms and with the addition of the net
assets target. From 2003-04, the net assets component was restated as net worth
(which is conceptually the same measure in accrual-based GFS terms).
Dating, interpretation and interdependencies of Australian Government fiscal
policy rules
As previously stated, adoption of fiscal policy rules relating to budgetary surplus
and debt reduction by the Commonwealth Government is dated to 1998-99 (the
106
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
first financial year following legislation of the Charter of Budget Honesty Act
1998 (Cw)). Bracketing is applied from 1996-97, when the policy was first
announced. From 1996-97 to 1998-99, the budgetary balance target (of reduced
annual underlying budget deficits) was measured in cash-based GFS terms. The
concept of net worth is not measurable in these terms. Adoption of a fiscal
policy rule relating to net worth is dated to 1999-2000, when accrual-based GFS
was adopted for reporting purposes. Bracketing is not applied to adoption of the
net worth fiscal policy rule.
From 1999-2000, the budgetary balance target was redefined as maintaining
fiscal balance, on average, over the course of the economic cycle. Robinson
(2000) argues that such a measure is inherently biased against capital
accumulation due to the interaction between GFS Net Operating Balance and Net
Investment previously described. However, as discussed in Section 3.4.4,
interdependences between fiscal measures are such that, as the Commonwealth
Government also adopted a secondary target of maintaining or increasing net
worth from 1999-2000, both requirements taken simultaneously mean that
positive budgetary balance (GFS Net Operating Balance) was also targeted from
1999-2000. Although this was expressed as an average over the economic cycle,
as pointed out in Section 3.4.2.3, consistent economic growth rates during the
period since adoption of this rule implies that the target may be interpreted on an
annual basis. The combined effect of these factors is that positive GFS Net
Operating Balance was targeted in each year.
4.2.2 New South Wales Government
Table 4.2 summarises the fiscal policy rules adopted by the New South Wales
107
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
Government.
Fiscal strategy 1988-89 to 1991-92
The NSW government in its 1988-89 Budget adopted a five-year, medium-term
financial strategy which remained in place until 1991-92 (National Commission
of Audit (1996) Appendix G page 8). The four goals of the strategy related to
the budget sector which comprises budget-dependent general government sector
Table 4.2 NSW Government fiscal policy rules
Fiscal policy rule type
Measure adopted
Target Relevant sector
Date of adoption
Bracketing span
Budgetary surplus
1996-97 to 2000-01 cash-based GFS Net Operating Balance 2001-02 to 2003-04 accrual- based GFS Net Lending/ Borrowing
Surplus commen-cing 1998-99
General government
1996-97 1995-96
Debt reduction
Net Debt Reduct-ion to a ‘sustain-able level’ by 2004-05 and elimin-ation by 2020
General government
1996-97 1995-96
Net worth GPFR Net Assets
Positive rate of change (in real terms)
General government
1996-97 1995-96
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
agencies and is therefore a component of the general government sector24. The
goals were to balance the budget in order to constrain debt, expenditure
constraint (with a target of zero real growth in recurrent expenditure), increased
investment in infrastructure, and revenue reform (by maximization of non-
taxation revenue and reduction of taxation revenue) (New South Wales
Government (1990) page 14). The budgetary balance requirement was originally
expressed in terms of the NSW Government’s Consolidated Fund and changed in
1991-92 to a measure based on the GFS format which was cash-based at that
time (New South Wales Government (1991) page 13).
Fiscal strategy 1992-93
In 1992-93, the strategy was restated with an overall target of capping budget
sector net debt in real terms over the medium term. This was to be achieved by
expenditure restraint, capping of capital payments in real terms after an isolated
increase in 1992-93, taxation increases and accessing equity held in government
trading enterprises by dividend and sale (privatizations) (New South Wales
Government (1992) pages 1-6 to 1-9).
Fiscal strategy 1993-94 to 1994-95
The 1993-94 budget financial strategy retains the target of capped budget sector
real net debt, but sets a target date of 1995-96 and adds a target of budgetary
24 NSW Government (2005a) at page 1-2 states “The general government sector includes all NSW Government agencies that receive Parliamentary appropriations or are regulatory in nature. Budget dependent general government sector agencies receive an appropriation from the Consolidated Fund. Non-budget dependent general government sector agencies are generally self-financing through the imposition of regulatory and user charges. Non-budget dependent agencies may also return a surplus to the Consolidated Fund.” Non-budget dependent general government sector agencies include the Registry of Births, Deaths & Marriages, Workers’ Compensation (Dust Diseases) Board and the WorkCover Authority.
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balance thereafter (New South Wales Government (1993) page 1-5). The 1994-
95 budget restates objectives of debt containment and elimination of the
budgetary deficit (New South Wales Government (1994) page 1-3).
While the intended period of application exceeded the life of the initiating
government, no effective mechanism existed to support this and hence none of
the preceding strategies are considered to constitute fiscal policy rules as defined
for purposes of this study. Rather, adoption of rules is considered to have
occurred later, as described in the next section.
1995-96 – The General Government Debt Elimination Act (NSW) 1995 and
commencement of bracketing
The General Government Debt Elimination Bill (‘the Bill’) was tabled in June
1995 (New South Wales Government (1995) page 2). The 1995-96 budget
marked adoption by the (newly-elected) New South Wales Government of a new
financial strategy in accordance with the Bill. Following enactment in late 1995,
the Bill became the General Government Debt Elimination Act (NSW) 1995 (‘the
Act’. ) The Act at Part 2 includes short term fiscal targets of ‘sustainable’25
general government budgetary surpluses in (cash-based) GFS terms by 1998-99,
medium-term fiscal targets of reduction of general government sector net debt to
a ‘sustainable level’26 by 2004-05 and long-term fiscal targets of elimination of
general government net debt by 2020 and unfunded State sector superannuation
liabilities by 2030.
25 Sustainability with respect to this target was defined as “a level at which the budget can absorb the full impact of an economic cycle without the need for significant corrective action on the revenue or expenditure side”. 26 No definition of the term ‘sustainable’ with respect to this target was provided.
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The Act also includes fiscal principles and states that the government should aim
to pursue policy in accordance with those principles, but that departure from
those principles is allowable if reasons are given for the departure and an
approach is outlined to enable a return to them. Fiscal principles stated at Part 3
included maintenance or increase of general government sector net worth,
taxation restraint, and expenditure restraint.
Net worth is defined in the Act at Part 4 as meaning net assets indicated in
audited financial statements annually tabled in Parliament. This is therefore a
GPFR not GFS measure. In confirmation of this, New South Wales Government
(1996) at page 1-4 measures progress in relation to this target in terms of
Consolidated Financial Statements and Public Accounts—which are both GPFR
financial statements (though only the Public Accounts are audited). These
reports differ only in their time coverage (New South Wales Government
(1997c), New South Wales Government (1997b) ). This net worth measure was
stated in real terms and is more stringent than a nominal measure.
From 1995-96 onward, fiscal policy has been set in accordance with these
principles (New South Wales Government (1996), New South Wales
Government (1997a) , New South Wales Government (1998), New South Wales
Government (1999), New South Wales Government (2000) ; New South Wales
Government (2001a)).
1996-97 – Enactment of the Bill and adoption of fiscal policy rules
The Bill received assent on 19 December 1995 (General Government Debt
Elimination Act 1995 No. 83 (NSW) page 1). For this reason, adoption of fiscal
policy rules by the New South Wales Government is dated from 1996-97, the
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
first full fiscal year following enactment of the Act. As previously stated, fiscal
policy from 1995-96 onward was set in accordance with the Act.
Until 1999-2000, the medium-term budgetary target was budgetary balance,
measured in cash-based GFS terms, on an annual basis. From 1999-2000, this
was measured over the course of a full business cycle (New South Wales
Government (2001a) page 1-20). A new focus on fully funding accruing non-
debt liabilities such as superannuation was also evident in this budget. Although
GFS had moved to an accrual basis in 1999-2000, the budgetary target was still
defined in cash terms in 1999-2000 and 2000-01. From 2001-02, the budgetary
surplus target was relabelled as net lending27 surplus. That is, the relevant fiscal
aggregate became accrual-based GFS Net Lending/ Borrowing.
2002-03 onwards - The Public Finance and Audit Amendment (Budgeting and
Financial Reporting) (NSW) Act 2002
In 2002, the NSW Government passed the Public Finance and Audit Amendment
(Budgeting and Financial Reporting) Act which amended the General
Government Debt Elimination Act 1995. The amendments aimed to update the
Act to reflect the shift from cash-based to accrual-based reporting, clarify fiscal
principles and distinguish between principles and ‘implementation instruments’28.
However specific targets remained unchanged in 2002-03 and 2003-04, as the
legislation merely reflected changes which had already been adopted in fiscal
strategies.
27 New South Wales Government (1999) at page 1-15 describes net lending as “the accrual measure most closely matching … changes in net financial liabilities”. New South Wales Government (2001a) at page 1-20 further describes net lending as “‘broadly equivalent to the former Government Finance Statistics cash result while being derived from the Cash Flow Statement.” 28 This term is used analogously to the term ‘targets’.
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Dating, interpretation and interdependencies of New South Wales Government
fiscal policy rules
Adoption of fiscal policy rules in New South Wales, relating to budgetary
surplus, net debt and net worth, is therefore dated to 1996-97 (the first financial
year after enactment of the legislation). The targets were to be achieved
regarding budgetary surplus by 1998-99, regarding net debt by 2004-05 and
regarding net worth from 1996-97. However, changes in fiscal behaviour
(leading to achievement of these targets by those dates) in all cases were to be
undertaken from 1996-97. For this reason, adoption is dated to that year with
bracketing applied from 1995-96, when the legislation was first introduced.
However, as previously outlined, measurement of budgetary balance targets has
differed over time. From 1995-96 until 1998-99, the target was reduction in
budgetary deficits until annual positive GFS Net Operating Balance in cash-
based GFS terms could be achieved by 1998-99. (As previously discussed, GFS
Net Operating Balance in cash-based GFS terms is the broad equivalent of GFS
Net Lending/Borrowing in accrual-based GFS terms.) From 1999-2000 to 2000-
01, identical surpluses were targeted but these were now to be achieved on
average over the course of a full business cycle29. From 2001-02, positive GFS
Net Lending/Borrowing in accrual-based GFS terms was targeted on average
over the course of the business cycle.
As in the case of the Commonwealth Government fiscal policy rules, if Net
Investment is negative, GFS Net Operating Balance may also be negative
without abrogating the target of positive GFS Net Lending/Borrowing. However,
29 Again, as growth rates have been constant during the period examined, the fiscal policy rule may be interpreted as intending that positive budgetary balance should be achieved in each year.
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
as with the Commonwealth Government, this is mitigated by the New South
Wales Government’s adoption of a principle of net worth maintenance. Thus the
New South Wales Government fiscal policy rule target of positive GFS Net
Lending/Borrowing must also be interpreted as intending that positive GFS Net
Operating Balance should be achieved. Additionally, although the target was
stated as an average over the economic cycle, consistent economic growth rates
during the period implies that the target may be interpreted on an annual basis.
That is, positive GFS Net Operating Balance should be achieved in each year.
Throughout the period, net debt reduction was also targeted. Additionally, the
principle of net worth maintenance in real terms persisted during this time.
4.2.3 Victorian Government
Table 4.3 presents the history of fiscal policy rules adoption by the Victorian
Government.
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
Table 4.3 Victorian Government fiscal policy rules
Fiscal policy rule type
Measure adopted
Target Relevant sector
Date of adoption
Bracketing span
Budgetary surplus
GFPR Operating Result
Surplus of at least $100M per annum
General government
2000-01 N/A
Debt reduction
Net Debt Non-positive rate of change
General government
2000-01 N/A
Net worth GPFR Net Assets
Increase of $100M per annum
General government
2000-01 N/A
Fiscal strategy 1991-92 to 1992-93
In 1991-92, in a context of mounting public debt, persistent budgetary deficits
and reduced infrastructure provision, the Victorian Government adopted a debt
management strategy targeting budgetary surplus and ultimately, public debt
reduction (National Commission of Audit (1996) page 8). This strategy was also
evident in the 1992-93 budget.
Fiscal strategy 1993-94 to 1999-2000
In October 1992, the (newly-elected) Victorian Government announced a three-
year medium-term fiscal strategy, based on expenditure reductions and revenue
increases, targeting budgetary balance by 1995-96 and reductions in public sector
debt. The strategy was formulated in cash-based GFS terms and applied to the
budget sector. As targets were achieved (such as budgetary balance in 1994-95),
the fiscal strategy was modified accordingly.
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
The National Commission of Audit (1996) at pages 8 to 9 states that fiscal targets
for 1995-96 to 1998-99 included:
“..achievement of, by no later than 1998-99, a sustainable current
account surplus sufficient to cover depreciation of the budget sector
capital stock without increasing the State’s overall tax level,
maintenance of budget sector investment on infrastructure … at an
average of around 1.25 per cent of GSP and application of net
proceeds of privatisation to debt reduction.”
The National Commission of Audit (1996) at page 8 further states that the
strategy also included:
“…longer term budget objectives to reduce State debt and debt
servicing ratios to levels consistent with the restoration of Victoria’s
former AAA credit rating and to bring Victoria’s overall tax effort
into closer alignment with the average of the Australian States.”
The Victorian Government adopted an accrual-based budgeting and reporting
framework in 1998-99 (Victorian Government (1998) at page 1). Accordingly,
the budget balance target was amended to maintenance of an operating surplus
sufficient to fully fund infrastructure investment (a more stringent measure)30. It
continued to apply to the budget sector.
By 1998-99, the fiscal strategy included a number of long-term budget targets,
30 Under accrual principles, this measure requires a budget surplus be attained after expenses that include additional non-cash outlays (such as accruing superannuation liabilities) not previously counted in the cash-based approach, as well as the depreciation non-cash outlay which was previously counted. The policy further required that this excess be at least equal to infrastructure investment.
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
including maintaining public sector debt at levels consistent with a triple-A credit
rating, maintaining a budget operating surplus sufficient to fully fund
infrastructure investment and bringing Victoria s tax rates into alignment with the
national average. It also included medium-term targets of reducing liabilities,
including net debt, by privatisation and maintaining budget sector investment at
around 1 per cent of GSP (Victorian Government (1998) page 1). The strategy
was stated in budget sector terms. In 1999-2000, the budget sector investment
target was reduced to a minimum 1 per cent of GSP (Victorian Government
(1999) page 1).
While some of the previously-discussed fiscal strategies included terms such as
long-term objectives and medium-term operational targets, indicating an
intention that the strategy apply beyond the life of the initiating government, no
authoritative mechanism or legislation was in place to achieve this. That is, the
strategies either were not binding on either the adoptive government or its
successors. Therefore, none of these strategies are considered to constitute fiscal
policy rules.
2000-01 - The Financial Management (Financial Responsibility) Act (Vic) 2000
and adoption of fiscal policy rules
In April 2000, the (newly-elected) Victorian Government passed the Financial
Management (Financial Responsibility) Act 2000 (the ‘Act’). Section 4 of the
Act provides that the Act binds the Crown as far as the legislative power of the
Parliament permits.
The Act amends the Financial Management Act (Vic) 1994 to include, at
Sections 23C, a requirement that the government operates in accordance with
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
several broadly worded financial management principles. These principles (at
Section 23D) include prudent management of risks (arising from general
government debt, public corporations ownership, changes in the structure of the
taxation base and, generally, management of government assets and liabilities),
pursuit of expenditure and revenue policies consistent with stable and predictable
levels of the tax burden, taxation integrity, and consideration of the inter-
generational effects of policy.
The Act further requires, at Sections 23E, 23F and 23G, that the government
provide a statement of its short and long-term financial strategy and long-term
and short-term objectives in each budget and budget update. These strategies
and objectives must be based on the previously-mentioned principles of financial
management. Further, the Act provides that specific key financial measures must
be specified and targets for those measures established. Sections 23H, I and J of
the Act provides that the government must prepare estimated financial statements,
which set out the projected financial results for the budget sector resulting from
the stated fiscal strategy, and that these statements must be based on generally
accepted accounting principles. In other words, the Victorian Government’s
fiscal policy rules are to be measured in accordance with GPFR.
In accordance with this legislation, in 2000-2001 the Victorian Government
amended the budget sector budgetary surplus target (sufficient to fully fund
budget sector infrastructure investment) to a general government sector31
operating surplus of at least $100 million in each year. (The budget surplus
measure was equivalent to the GFPR Result from Ordinary Activities (later
renamed (GPFR) Operating Surplus/Deficit), with the accrual-based GFS Net 31 While the Victorian Government (2000a) at page 14 states that the target relates to the budget sector, the Victorian Government (2002b) at page 1 states that the general government and budget sector are the same for the Victorian Government.
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
Operating Balance reported as an alternative measure (Victorian Government
(2000a) pages 15, 23 and 197). Further, the Victorian Government removed the
medium-term operational target of budget-sector investment of 1 per cent of
GSP. Instead, a $1 billion infrastructure reserve was established (funded by a
large surplus in the previous year and added to from surpluses in subsequent
years), from which to fund investment over subsequent years. However, no
specific level of investment per annum was targeted.
Finally, the Victorian Government adopted long-term taxation restraint and
general government net financial liabilities constraint policies, with a short-term
target being to maintain a triple-A credit rating (Victorian Government (2000a)
page 14). Net financial liabilities include net debt and net non-debt liabilities
such as net unfunded superannuation liabilities (Victorian Government (2000a)
page 22). As a result, this is not explicitly a net debt rule. However, the focus of
the credit rating agencies on net debt and the adoption of the AAA credit rating
as a short-term target are considered justification for interpretation of this as an
implicit net debt fiscal policy rule.
The budgetary surplus and liabilities constraint targets were unchanged in 2001-
02, 2002-03 and 2003-04 (Victorian Government (2001a), (2002a) and (2003a)).
However an additional measure by which to report budgetary surplus was added.
From 2003-04, a standardized operating surplus was also reported, equal to the
general government GPFR Operating Surplus/Deficit less the difference between
the actual and expected rates of return on financial assets. While the taxation
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
constraint objective changed to one of simplification reforms, targeting of
taxation reduction continued.
Dating of fiscal policy rule adoption by the Victorian Government
Thus adoption of fiscal policy rules relating to budgetary balance and debt
reduction by the Victorian government is dated to 2000-01 and no bracketing is
applied. Dating of adoption of fiscal policy rules relating to net worth or
investment, however, warrants further discussion.
While the Kopits and Symansky definition of a fiscal policy rule includes that a
rule is typically defined in terms of an indicator of overall fiscal performance,
inclusion of the term ‘typically’ indicates that this is not an essential component
of the definition. Further, as previously stated, between 2000-01 and 2002-03,
the Victorian Government fiscal policy rule targeted a general government sector
operating surplus of at least $100 million in each year and the operating surplus
measure adopted was the GPFR Operating Surplus/Deficit (though alternate
measures were also reported). It was previously established in Section 3.2.4 that
interdependence between fiscal measures is such that achievement of a positive
GPFR Operating Surplus/Deficit has the effect of increasing net worth in GPFR
terms. Therefore, the budgetary balance rule adopted is also substantively a net
worth rule. Thus adoption of a fiscal policy rule relating to net worth by the
Victorian government is also dated to 2000-01 (and bracketing is not applied).
4.2.4 Queensland Government
Table 4.4 details fiscal policy rules adopted by the Queensland Government.
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
Table 4.4 Queensland Government fiscal policy rules
Fiscal policy rule type
Measure adopted
Target Relevant sector
Date of adoption
Bracketing span
Budgetary surplus
Cash-based GFS Net Operating Balance 1997-98 Accrual-based GFS Net Operating Balance 1999-2000 – 2003-04
Positive General government
1999-2000
1997-98
Net debt Net Debt Negative General government
1999-2000
1996-97
Net worth GFS Net Worth
Positive rate of change
Total public
1999-2000
1996-97
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
Fiscal strategy early to mid-1990s
As early as 1990-91, the Queensland Government adopted a fiscal strategy
comprising three main elements. The first element was fully funding accruing
long-term (e.g. superannuation and workers compensation) liabilities. The
second was borrowing restraint, where assets deemed ‘social’ (i.e. non-revenue
generating, such as schools and hospitals) were funded from recurrent revenues,
and borrowing was only undertaken to acquire assets capable of generating
revenue at least equal to the interest charges applicable to that debt. (This does
not equate to a budgetary balance target, even in the cash terms used at the time,
though a surplus budget in cash terms does not conflict with this requirement.)
The third element was revenue restraint, comprising a commitment not to
introduce new taxes or increase fees and charges on average at a rate exceeding
inflation (National Commission of Audit (1996) page 9, Queensland Government
(1991) pages 5 to 6).
In 1991-92, the policy of maintaining financial assets sufficient to fully meet
accruing superannuation liabilities was extended to include full actuarial funding
of motor vehicle third party insurance liabilities. The borrowing and revenue
restraints were maintained unchanged (Queensland Government (1991) pages 5
to 6). The 1992-93, 1993-94 and 1994-95 fiscal strategy showed no change from
1991-92 (Queensland Government (1992) page 4, Queensland Government
(1993) page 5, Queensland Government (1994) page 5). In 1995-96, the
objective of taxation restraint was restated as “maintaining Queensland as the
low tax State” with other strategy components unchanged (Queensland
Government (1995) pages 3 to 4).
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
1996-97- foreshadowing the Charter of Social and Fiscal Responsibility and
commencement of bracketing
In 1996-97, the (newly elected) Queensland Government set its fiscal policy
parameters in accordance with a proposed charter of fiscal responsibility. The
proposed charter had objectives of maintaining competitive taxes, establishing an
efficient regulatory system, efficient service delivery and maintaining the State’s
net worth32. The net worth objective was adopted despite the usage of a cash
budgeting methodology at that time. As previously discussed in Section 3.4.3,
cash-based reporting methodologies provide insufficient information to either
estimate net worth or to estimate a budgetary outcome sufficiently inclusive of
all expenses to enable an estimate of changes in net worth resulting from
operations in a reporting period. Net worth, when measured on a cash basis,
essentially reduces to a measure of net financial worth. Thus it is considered that
this objective comprises an implicit objective of net debt reduction or
maintenance. This is supported by the borrowing constraints adopted in the
strategy.
In accordance with these objectives, the 1996-97 budget maintained ‘core fiscal
policy parameters’ of low taxes, fully funding contingent liabilities, not
borrowing for recurrent expenditure, and restricting borrowing to infrastructure
projects which could generate a revenue stream sufficient to service the debt.
Thus, the previous objectives of taxation restraint and funding liabilities were
retained unchanged. The borrowing restraint objective was changed in part. In
particular, the restriction of borrowing to acquire assets, capable of generating
revenue at least equal to the interest charges payable on that debt, was further
32 This appears to refer to the total public sector.
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
narrowed to infrastructure projects only. In addition, the ban on borrowing for
non-revenue generating assets was changed to prohibit borrowing for recurrent
expenditure (Queensland Government (1996) page 4).
These ‘core fiscal policy parameters’ were also adopted in 1997-98, and specific
fiscal strategies were added, including generalized restraints on revenue raising
(comprising both taxes and charges) and a positive budgetary outcome
(Queensland Government (1997) page 4). Thus, the budgetary target was cash-
based GFS Net Operating Balance.
In 1998-99, the ‘core fiscal policy parameters’ were also adopted. So too were
the additional elements of revenue restraint (comprising no taxation increases,
revenue concessions, a limit on increases in charges to not more than Consumer
Price Index increases), the requirement to attain budgetary surplus in cash-based
GFS terms, and maintenance or increase of total State net worth (Queensland
Government (1998) page 4). Budgetary documentation for this year contains a
commitment to develop a Charter of Social and Fiscal Responsibility. A
commitment was also given to develop the next budget on an accrual basis. Both
of these commitments were subsequently fulfilled (Queensland Government
(1998) page 4).
1999-2000 - The Charter of Social and Fiscal Responsibility and fiscal policy
rules adoption
Amendments were made to the Financial Administration and Audit Act (Qld)
1977 (the “Act”) requiring that the government prepare a Charter of Social and
Fiscal Responsibility (‘a Charter’) and table it in the Legislative Assembly
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
within 90 days. The amended Financial Administration and Audit Act (Qld)
1977 at Section 6B states that the purpose of the Charter was to:
“… state the broad social and fiscal objectives of the government
and establish a framework for assessing … performance in achieving
the objectives.”
The amended Financial Administration and Audit Act (Qld) 1977 at Section 6C
requires that the government is required to have regard, in preparing the Charter,
for fiscal policy principles including transparency, accountability and prudent
risk management. It is a further requirement of the revised Act, at Section 6D,
that the Charter include the government’s financial objectives including,
particularly, the prudent management of the State’s net worth. Amendment,
withdrawal and replacement of, the Charter is allowed however withdrawal of a
Charter is ineffective until a replacement is tabled in the Legislative Assembly
(Financial Administration and Audit Act (Qld) 1977 Section 6E ).
The first Charter, produced in August 1999, outlined the government’s fiscal
strategy elements. These were termed ‘principles’ and included: (a) taxation
restraint (maintenance of State taxation levels competitive with taxation levels
imposed by other states and territories), (b) maintenance of an overall general
government budgetary surplus, measured in (accrual-based) GFS terms, at least
equal to additional interest charges applicable to new borrowings for investment
in real assets, (c) restriction of borrowing for investment purposes only (and
where consistent with maintaining a AAA credit rating) and subject to the
requirement of maintaining an operating surplus (i.e. after inclusion of interest
expenses), (d) maintenance of financial assets sufficient to cover all accruing and
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
future liabilities of the general government sector, and (e) maintenance, and (if
possible) an increase of total public sector net worth (Queensland Government
(1999) pages 1 to 4).
Again, the strategy is basically unchanged (though with greater restriction on
debt usage). The strategy was adopted in the 1999-2000 budget which was
produced in September 1999, after legislation of the Charter (Queensland
Government (1999) page 1). For this reason, the Queensland Government’s
adoption of fiscal policy rules is dated to 1999-2000.
The fiscal strategy was unchanged in 2000-01 to 2003-04 inclusive despite
production of a new Charter in October 2001 (Queensland Government (2000)
pages 9 to 10, Queensland Government (2001) pages 4 to 5, Queensland
Government (2003) page 2, Charter of Social and Fiscal Responsibility
Queensland Government October 2001 page 5). The new Charter stated the
Queensland Government’s revised whole-of-government outcomes.
Dating of fiscal policy rules adoption by the Queensland Government
Adoption of fiscal policy rules by the Queensland government relating to
budgetary surplus, debt reduction and net worth maintenance are thus dated to
1999-2000, with bracketing applied from 1996-97 for debt reduction and net
worth fiscal policy rules (when principles comprising the Charter were first
announced and its formulation foreshadowed). Bracketing is applied from 1997-
98 for the budgetary balance fiscal policy rule.
4.2.5 South Australian Government
Table 4.5 summarises fiscal policy rules adopted by the South Australian
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
Government.
Table 4.5 South Australian government fiscal policy rules
Fiscal policy rule type
Measure adopted
Target Relevant sector
Date of adoption
Bracketing span
Budgetary surplus
Accrual-based GFS Net Lending/ Borrowing (excluding depreciation effects)
Positive (excluding depreciation)
General government
2002-03 N/A
Debt reduction
Net Debt Negative rate of growth
General government
2002-03 N/A
Net worth N/A N/A N/A N/A
1993-94 - Debt Management Strategies
The National Commission of Audit traces fiscal consolidation strategies adopted
by the South Australian Government to 1993-94. According to the National
Commission of Audit (1996) pages 9 to 10:
“In 1993, South Australia implemented a debt management strategy
(DMS) in agreement with the Commonwealth Government as part of
the Commonwealth’s special assistance package to assist in the bail-
out of the State Bank of South Australia. The main element of that
strategy was to reduce net debt to sustainable levels.”
First four year plan 1994-95 to 1997-98
This strategy was extended in 1994-95 to a medium-term strategy of four-year
plans. The first four-year plan, covering 1994-95 to 1997-98, targeted, firstly,
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
movement toward budgetary balance or surplus (through reduced expenditures
particularly salaries) at least equal to capital investment, by non-commercial
sector agencies, secondly, debt reduction in real terms and, lastly, progressive
accumulation of financial assets equal to superannuation liabilities (by 2024), in
the non-commercial sector (National Commission of Audit (1996) pages 9 to 10,
South Australian Government (1998) pages 3, 6 to 7). These targets were
measured in cash-based GFS terms (South Australian Government (1998) page
3).
Second four year plan 1998-99 to 2001-02
In 1998-99, the budget documentation included the provision of an accrual
budgeting presentation in addition to the cash-based GFS presentation and a
second four-year plan, to cover the period to 2001-02. This plan retained the
objectives for the non-commercial sector. The first of these was net debt
reduction (based on an assumption that electricity utilities sale proceeds would
be used to reduce debt and interest expenses) with the aim of achieving an AA
plus credit rating in the short term and an AAA credit rating in the medium term.
The second was elimination of unfunded superannuation liabilities (although the
target date for this was extended by ten years to 2034). The third was
maintenance of a competitive tax regime and the last was ongoing achievement
of budgetary balance (the goal of budgetary balance having been met in 1997-98)
(South Australian Government (1998) pages 6 to 8).
The budgetary balance measure continued to be measured in cash-based GFS
terms, i.e. in accrual terms equivalent to the cash-based GFS Deficit/ Surplus.
The measure was therefore GFS Net Lending/Borrowing. The South Australian
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
Government (1998) at page 7 states that the equivalent measure, in terms of
GPFR, requires:
“…the achievement of a non commercial sector operating surplus
before depreciation equal to or greater than the total capital
investment in the non commercial sector.”
and that:
“… this is equivalent to the previous Australian Bureau of Statistics
Government Finance Statistics measure adapted from a cash to an
accrual basis.”
Financial statements on a cash basis were included in budget documentation,
although accrual-based financial statements were also provided in order to meet
the government’s responsibilities under the Uniform Presentation Framework33.
Because expenditure increased in real terms, measures to increase taxation and
non-taxation revenue were introduced to achieve this aim (South Australian
Government (1998) page12). These objectives were retained in 1999-2000,
2000-01 and 2001-02 (the remainder of the four year period) (South Australian
Government (1999) pages 2.1 to 2.2, South Australian Government (2000) pages
2.2 to 2.3, South Australian Government (2001) page 2.10 to 2.11). An AA plus
credit rating was achieved in December 1999 (South Australian Government
(2000) page 2.2). In 2001-02, taxation reduction in accordance with national
taxation reform was undertaken.
All of the preceding strategies fail to meet the definition of fiscal policy rules
adopted for the purpose of this study. This is because, although the strategies
33 The Uniform Presentation Framework was described in Section 3.3.3.
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
were intended to apply beyond the term of the initiating government, they were
not formulated in terms sufficiently authoritative to ensure that outcome.
2002-03 - The Charter of Budget Honesty, Fiscal Responsibility Framework and
adoption of fiscal policy rules
In May 2002, the new South Australian Government introduced the Public
Finance and Audit (Honesty and Accountability in Government) Amendment Bill
(SA) 2002 (‘the Bill’). The Bill required preparation of a Charter of Budget
Honesty (‘the Charter’) to improve the transparency of the government’s fiscal
management by detailing fiscal principles and targets.
The 2002-03 budget was prepared in accordance with the Charter. It retained for
2002-03 the objectives of positive general government sector budgetary balance
in cash-based terms, negative growth in net debt (to reach, on average, zero net
borrowing in the long term) and accumulation of financial assets sufficient to
equal accrued superannuation liabilities by 2034. Revenue-increasing measures
were adopted to achieve these targets. In addition, a new period of measurement
was announced, targeting balanced budgets, on average, over any four-year term.
As budgetary presentation had moved to a GFS accrual basis for the general
government sector (although cash-based GFS statements were also provided for
the non commercial sector), the fiscal target for the general government sector
became accrual-based GFS Net Operating Balance at least equal to investment
(but less depreciation). The intent was to ensure zero net borrowing. This target
therefore broadly equalled accrual-based GFS Net Lending/Borrowing.
However, the operating result was defined as excluding depreciation and hence
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Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
remained similar to the previous cash-based target (though slightly more
stringent as accruing liabilities are included in the operating result). In addition,
for reasons discussed in Chapter 3, achievement of such a result did not
necessarily equate to maintenance of net worth.
The strategy also adopted a new focus on prudent management of financial risks
in order to attain or maintain at least an AA plus credit rating. This added risk
recognition, associated with the existence of contingent liabilities such as
guarantees, to the previous aims of net debt reduction and financial assets
accumulation. While this was not presented as an explicit net debt rule, the
South Australian Government (2002 at page 2.6) states that:
“… risks associated with State finances are managed firstly by the
measures taken as part of other fiscal principles that act to constrain
the growth in net debt and unfunded superannuation liabilities.”
Hence, it is considered that this constitutes an implicit net debt rule. Similarly to
the Queensland Government’s emphasis on credit rating retention, the focus by
the South Australian Government on maintaining an AA credit rating, and the
emphasis placed on net debt by credit ratings agencies, further supports this.
Finally, the South Australian Government (2003) at page 1.5, reports against net
debt, indicating that net debt reduction was an intended outcome of this target.
The strategy included restrictions on borrowings by public non-financial
corporations to where commercial returns could be demonstrated (South
Australian Government (2002) pages 2.3 to 2.6).
In 2003-04, the primary fiscal target was budgetary balance on average in the
general government sector, measured as positive net lending before revaluation
131
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
effects. That is, the target was still measured on a basis similar to cash.
Liabilities funding, risk management and restrictions on the borrowings of public
non-financial corporations continued unamended.
Dating of fiscal policy rules adoption by the South Australian government
Adoption of fiscal policy rules relating to budgetary balance and net debt
reduction by the South Australian Government is dated to 2002-03 (and no
bracketing is applied). It is not considered that the South Australian Government
adopted a fiscal policy rule relating to net worth.
4.2.6 Western Australian Government
Table 4.6 summarizes the West Australian Government’s adoption of fiscal
policy rules.
Table 4.6 West Australian Government fiscal policy rules
Fiscal policy rule type
Measure adopted
Target Relevant sector
Date of adoption
Bracketing span
Budgetary surplus
Accrual-based GFS Net Operating Balance
Positive
General government and total public sector
2000-01 1997-98
Debt reduction
N/A N/A N/A N/A N/A
Net worth GFS Net Worth
Positive rate of change
Total public sector
2000-01 1997-98
Fiscal strategy 1992-93
A focus on net debt reduction by the Western Australian Government first
appeared in 1992-93. Key targets were (a) containing increases in total State net
132
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
debt to at least one per cent less per annum on average than economic growth, (b)
accelerated repayment of general government debt leading to reductions in real
terms in the general government net financing requirement over the following
four years, and (c) an ultimate objective of regaining an AAA credit rating in the
medium term (Western Australian Government (1992) page 16).
Fiscal strategy 1993-94 to 1996-97
Following a change of government, the fiscal strategy was strengthened in 1993-
94. The strategy was extended to eliminate the overall deficit on the
Consolidated Fund by the end of the government’s term in office. (This can be
considered a partial budgetary balance requirement, as the Consolidated Fund is
typically the main but not the only fund from which monies are sourced to
finance capital acquisitions and recurrent expenditures.) This also implies a
more stringent requirement regarding growth of total State debt, from a reduction
in the rate of growth to a reduction in the level (Western Australian Government
(1993) page 3). Additionally, the Western Australian Government (1993) at
page 3 stated that it aimed:
“… over the medium term to eliminate borrowings for non-income
generating general government services.”
The aim of ultimately regaining an AAA credit rating was retained.
The 1994-95 strategy again targeted net debt reduction and partial budgetary
balance (a surplus in the Consolidated Fund), to be achieved through expenditure
restraint and despite taxation restraint (Western Australian Government (1994)
pages 1 to 2). The 1995-96 strategy retained its focus on net debt reduction and
133
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
taxation restraint. The strategy also extended the target of partial budgetary
balance to budgetary surplus for the total public sector (Western Australian
Government (1995) pages 1 to 4). This is the equivalent of an operating surplus
in cash-based GFS terms, for the total public sector.
The 1996-97 strategy incorporated all of the elements of the 1995-96 strategy
and extended revenue restraint, previously applied through taxation measures, to
non-taxation measures (Western Australian Government (1996) pages 1 to 4).
The Western Australian Government (1996 at page 1) states that by May 1996
(the date of delivery of the 1996-97 budget), Western Australian government
debt had been placed on a positive credit watch towards regaining AAA status.
Attaining AAA status remained a key target of the budget strategy.
Again, none of these strategies meets the definition of fiscal policy rules adopted
for the purpose of this study. This is because the strategies were not intended to
apply beyond the life of the initiating government, nor were they formulated in
terms sufficiently authoritative to ensure that outcome.
1997-98 - The Government Financial Responsibility Bill (WA) 1998 and
commencement of bracketing
The 1997-98 budget papers announced the introduction of a fiscal targeting
framework to be specified in legislation. This framework was outlined in the
Government Financial Responsibility Bill (‘the Bill’). The Bill provided, at
Section 6, broad fiscal principles as a basis for formulation of future fiscal policy
including intergenerational equity, policy stability and predictability in relation to
134
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
spending and taxing policies and prudent risk management34. Section 10 of the
Bill provided that the government was to plan financially in a way consistent
with the principles, but that departure from the principles was allowable within
the proposed legislative framework conditional on provision of an explanation of
why the departure was necessary and a plan for reversion to compliance with the
principles.
Section 7 of the Bill specified financial elements to be calculated in accordance
with the principles of external reporting standards. Section 4 provided that both
GFS and GPFR comprise external reporting standards, however Section 8
specified that financial statements are to include matters usually addressed in
GPFR as indicated by AAS31 (in particular, any reported measure of operating
surplus or total equity).
Section 11 required that the Government release a financial strategy statement at
least annually, and that the statement set out medium-term targets in relation to
the financial elements. Similarly to other legislation, the targets were not
legislated but were to be specified and monitored in budget documentation.
For 1997-98, the targets included, firstly, maintenance or increase in net assets
(i.e. GPFR Net Assets). Secondly, debt management was targeted, measured as a
reduced ratio of net interest cost to gross own source revenue35 for the total
public sector. This was achievable either as a result of net debt reduction,
reduced interest rates on outstanding debt (including potentially increased
outstanding debt) or increased gross own source revenue. Thirdly, a target of
expenditure reduction (reduced real per capita expenditure for the Consolidated
34 Western Australian Government (1997) page 153. 35 This typically comprises fees and charges.
135
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
Fund on average over 1997-98 to 2000-01, to be measured on a cash basis
pending introduction of accrual based methodology) was adopted. A fourth
target was accrual operating surplus, before extraordinary items, for the whole of
government, on average over 1997-98 to 2000-01, based on generally accepted
accounting principles rather than on GFS principles (and thus measured as GPFR
Net Surplus/Deficit). A fifth target was general government operating surplus
after deduction of net advances. Termed “underlying surplus”, this was the
equivalent cash-based GFS measure to the accrual operating balance target and
therefore equal to accrual-based GFS Net Lending/Borrowing. Sixthly, risk
management was targeted, including an intention during the period 1998-99 to
2000-01 to begin to accumulate financial assets to offset against accrued
superannuation liabilities as well as a program of privatization of government–
owned businesses. The final target was operating revenue sufficient to achieve
other targets, particularly the operating and underlying surplus targets (Western
Australian Government (1997) pages 153 to 161).
The aim of achieving an AAA credit rating was maintained, noting that an AA
rating had been attained with Moodys and that the State’s credit rating had been
placed on positive watch by Standard and Poors’ for a possible upgrade to an
AAA rating (Western Australian Government (1997) page 157). The Bill
included an additional financial management principle, namely a general
requirement that employment and economic effects be considered when
formulating expenditure and taxation policies (Government Financial
Responsibility Act (WA) 2000 section 6(d)).
In 1998-99, the Western Australian Government adopted an accrual budgetary
136
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
framework. The 1997-98 position was reaffirmed in 1998-99 and 1999-2000,
with the exception that the expenditures target was converted to an accrual basis
from 1998-99 and was required to be met each year, rather than on average, from
1999-2000 (Western Australian Government (1999) pages 12 to 14). Each
change effected a more stringent approach.
2000-01 - The Government Financial Responsibility Act (WA) 2000 and adoption
of fiscal policy rules
The Bill received assent on 5 July 2000, becoming the Government Financial
Responsibility Act (WA) 2000 (the ‘Act’). The 2000-01 Western Australian
Government budget was formulated for the first time in accordance with accrual-
based GFS adopted for the purpose of uniform presentation36. (One result of this
was that the general government sector became the focus of discussion on
financial aggregates.) Accordingly, the budgetary balance target was restated, as
a positive accrual-based GFS Net Operating Balance for both the general
government and total public sectors. The targets of maintenance of net worth,
debt management (so as to achieve an AAA credit rating) and expenditure
restraint were maintained (Western Australian Government 2000 pages 10 to 12).
However, the relevant measure for the net worth rule became accrual-based GFS
Net Worth for the general government sector.
The 2001-02 budget retained financial targets of retaining an AAA credit rating,
maintenance or increase of net worth of the total public sector, and general
36 Refer to Section 3.3.3 for a description of the Uniform Presentation Framework.
137
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
government sector accrual-based GFS operating surplus37 (i.e. positive accrual-
based GFS Net Operating Balance). The objective of achieving an accrual-based
GFS operating surplus for the total public sector was abandoned. The credit
rating retention target was interpreted in terms of two financial aggregates.
These were maintaining a ratio of net debt to non-financial public sector38
revenue not above 45 percent (which still allows net debt to rise if revenue rises),
and zero or negative growth of real per capita expense for the general
government sector. In addition, a new target of maintaining tax competitiveness
(a form of taxation restraint) was adopted (Western Australian Government
(2001) pages 7 to 12). This replaced the residual approach to revenue
management apparent in the previous framework.
The strategy was unchanged in 2002-03 (Western Australian Government (2002)
pages 7 to 14) and 2003-04, with one exception. In 2003-04, the ratio of net debt
to non-financial sector revenue target rose to being not above 47 per cent (from
not above 45 per cent) (Western Australian Government (2003) pages 9 to 15).
Dating of fiscal policy rule adoption by the Western Australian government
Adoption of fiscal policy rules by the Western Australian Government relating to
net worth and budgetary balance is dated to 2000-01, and bracketing is applied
from 1997-98. In the absence of a target specifically requiring reduction of net
debt, it is not considered that the Western Australian Government adopted a
37 That this is substantially unchanged from the previous year, despite a change of governing political party in the interim, attests to the efficacy of financial framework legislation, when that legislation contains clearly enunciated targets or principles, as a means of achieving longevity of financial targets. This is the case even when those targets are not included in the legislation, and are left to be set in annual Budget documentation at the discretion of successive governments of potentially differing political persuasions. 38 The Western Australian Government (2002) at page 8 describes the non-financial public sector as comprising the general government and public non-financial corporations sectors.
138
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
fiscal policy rule requiring net debt reduction at any time during the period
studied.
4.2.7 Tasmanian Government
In contrast to other jurisdictions, the Tasmanian Government did not adopt fiscal
policy rules during the period examined. The reason for this conclusion is the
absence of any effective mechanism whereby fiscal strategy objectives could be
made to outlast the life of the initiating government. The various fiscal strategies
adopted during the period are described below.
First five-year fiscal strategy
The National Commission of Audit (1996) at page 10 states:
“In 1990-91, Tasmania introduced a five-year financial strategy
with the initial assistance of the Commonwealth. That strategy set a
consolidated fund NFR39 target of $40m in 1994-95.”
This strategy, to cover the period 1990-91 to 1994-95, was aimed primarily at
debt containment and stabilizing increasing debt servicing costs.
Second five-year fiscal strategy
A new five-year financial strategy was announced in the 1994-95 budget. This
included reducing general government net debt to not more than 10.5 per cent of
Gross State Product by June 2000. This was to be achieved by applying the
proceeds of asset sales and by limiting further Consolidated Fund deficits to $35
million. The strategy also included maintenance of net interest costs as a
39 NFR means net financing requirement and deficit.
139
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
proportion of total revenue at or below the 1994-95 level, and taxation restraint
(to a point where taxation levels were to fall below the average of all States)
(National Commission of Audit (1996) page 10). Successive Tasmanian
governments applied this framework to 1997-98 (National Commission of Audit
(1996) page 10, Tasmanian Government (1998) page 11).
Third five-year fiscal strategy
The (newly-elected) Tasmanian government introduced a new fiscal strategy in
1998-99. The 1998-99 strategy was intended to apply until and including 2003-
04 (a five-year strategy with 1998-99 representing a transitional year due to the
delivery of the budget five months after the start of the financial year in
accordance with the timing of the State election). The strategy targeted, firstly,
reduced net debt. Specifically, total State Government net debt was to be
reduced to below 20 per cent of GSP by 2003-04, general government net debt
was to be reduced to below 10 per cent of GSP by 2003-04, there was to be no
increase in net debt even if GSP increased and there was to be a reduction in the
net interest cost ratio to below 5 percent by 2003-04. Secondly, the strategy
targeted reduced net liabilities by accumulation of financial assets at least equal
to accruing superannuation liabilities from 1999-2000. Thirdly, the strategy
targeted a budgetary surplus for the total public sector (in cash-based GFS terms)
and Consolidated Fund by 1999-2000. A fourth target was use of major asset
sale proceeds to either reduce debt or acquire real assets (related to the budgetary
surplus measure). Fifthly, reduction in total real non-salary recurrent operating
costs (a partial expenditure restraint target) was to be attained. Finally, the
strategy required taxation restraint (specifically, no new taxes or increase in
140
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
taxation rates) (Tasmanian Government (1998) pages 10 to 15).
In 1999-2000, the operating surplus target was boosted by further specifying a
general government surplus not less than 2.5 per cent of general government
revenue on average between 1999-2000 and 2003-04. The taxation restraint
objective was expanded to include targeted tax reduction. The asset sale
proceeds, partial expenditure restraint and net debt reduction targets were
unchanged (Tasmanian Government (1999) pages 14 to 17).
The budgetary surplus, asset sales, partial expenditure restraint, taxation
reduction, net debt and liabilities reduction targets continued to apply in 2000-01
and 2001-02 (Tasmanian Government (2000) pages 17 to 22, Tasmanian
Government (2001) pages 12 to 16).
Six-year fiscal strategy
A new six-year fiscal strategy was announced in the 2002-03 Budget, on the
basis that all targets of the fiscal strategy had already been established. The new
strategy targeted, firstly, a general government sector budgetary surplus
sufficient to achieve net debt targets (on a cash-based GFS basis). Secondly,
debt and liability targets were adopted, specifically, general government sector
net debt below $450 million by June 2005, and zero by June 2008 (and general
government sector net interest costs of zero by June 2008), total public sector net
debt below $1 billion by June 2008 and accumulation of financial assets
equivalent to total public sector accrued superannuation liabilities by June 2018
and to general government total liabilities by June 2017. Thirdly, competitive
taxation levels and, finally, maintenance of investment in real terms were
targeted (Tasmanian Government (2002) pages 16 to 19).
141
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
These were repeated in 2003-04 (Tasmanian Government (2003) pages 11 to 15),
the year the Tasmanian Government adopted an accrual basis for budgeting40.
The cash-based operating surplus target was reinterpreted into equivalent accrual
terms as the fiscal surplus (Tasmanian Government (2003) page 17).
Dating of fiscal policy rule adoption by the Tasmanian government
Despite the announced intention that these fiscal strategies apply for a period
longer than the life of the initiating government, in the absence of any
authoritative mechanism or legislation by which to enforce this, these fiscal
strategies do not meet the definition of fiscal policy rules adopted for purposes of
this study.
4.3 SUMMARY
Table 4.7 summarizes fiscal policy rules adopted by the Australian national and
State governments.
40 The Tasmanian Government had adopted in 1996 a Financial Management Reform policy incorporating progressive adoption of accrual reporting, accrual accounting and accrual financial management. However it was not until 2003-04 that budgeting was carried out in accrual terms in accordance with the Uniform Presentation Framework, and fiscal targets accordingly established in accrual terms (Tasmanian Government December 2003).
142
Cha
pter
4: F
isca
l Pol
icy
Rul
e A
dopt
ion
by A
ustra
lian
Nat
iona
l and
Sta
te G
over
nmen
ts
Tab
le 4
.7 K
ey a
dopt
ion
and
brac
ketin
g da
tes
Net
wor
th r
ule
Bud
geta
ry b
alan
ce r
ule
Net
deb
t rul
e A
ccru
al a
ccou
ntin
g Ju
risd
ictio
n A
dopt
ion
date
B
rack
eted
fr
om
Ado
ptio
n da
te
Bra
cket
ed
from
A
dopt
ion
date
B
rack
eted
fr
om
Ado
ptio
n da
te
Bra
cket
ed
from
C
omm
onw
ealth
19
99-2
000
N/A
19
98-9
9 19
96-9
7 19
98-9
9 19
96-9
7 19
99-2
000
N/A
N
ew S
outh
Wal
es
1996
-97
1995
-96
1996
-97
1995
-96
1996
-97
1995
-96
2002
-03
1995
-96
Vic
tori
a 20
00-0
1 N
/A
2000
-01
N/A
20
00-0
1 N
/A
1998
-99
N/A
Q
ueen
slan
d 19
99-2
000
1996
-97
1999
-200
0 19
96-9
7 19
99-2
000
1996
-97
1999
-200
0 19
96-9
7 So
uth
Aus
tral
ia
N/A
N
/A
2002
-03
N/A
20
02-0
3 N
/A
N/A
N
/A
Wes
tern
A
ustr
alia
20
00-0
1 19
97-9
8 20
00-0
1 19
97-9
8 N
/A
N/A
19
98-9
9 19
97-9
8
Tas
man
ia
N/A
N
/A
N/A
N
/A
N/A
N
/A
2003
-04
N/A
143
Chapter 4: Fiscal Policy Rule Adoption by Australian National and State Governments
With the exception of Tasmania, each of the jurisdictions adopted fiscal policy rules
and enshrined them in legislation. Most of these jurisdictions adopted fiscal policy
rules relating to net debt, budgetary balance and net worth, with the exception of
South Australia (net worth) and Western Australia (net debt).
There was a strong focus on cash bases of measurement of the budgetary balance
rules even after adoption of accrual-based financial reporting and budgeting
frameworks. Net worth rules were measured, necessarily, in accordance with accrual
bases of measurement though these varied between GFS and GPFR. The
measurement of net debt rules is unaffected by selection of either a cash or accrual
basis or by selection of GFS or GPFR financial reporting frameworks.
The next chapter (Chapter 5) presents methods and data to be used to analyse the
fiscal outcomes resulting from adoption of the fiscal policy rules by Australian
governments. Results are presented in Chapter 6.
144
Chapter 5: Methods and Data
CHAPTER 5
METHODS AND DATA
5.1 INTRODUCTION
The research question is “What happens to public investment when governments
adopt fiscal policy rules?” In addressing this question, both inductive and deductive
processes have been used. Most studies test an existing theoretical structure.
However, no such structure exists with respect to public capital formation. This is
due to the assumed exogeneity of government behaviour in most macro-models and
resulting lack of attention paid to this area in mainstream economics (described in
Chapter 2). Hence an inductive process is used to develop initial conclusions. These
are then subjected to rigorous examination using deductive processes including
techniques of statistical inference.
This chapter sets out the methods and data used to explore Australian governments’
fiscal outcomes in the context of fiscal policy rules. Methods used draw on
information presented in previous chapters and accepted methodologies for examining
relationships of this type.
Several techniques are used in order to strengthen the overall analysis by overlapping
examination. This mitigates the weaknesses of an individual test and permits different
perspectives.
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Chapter 5: Methods and Data
5.2 FISCAL POLICY RULES AND MODIFICATION OF THE ASSUMED
EXOGENEITY OF GOVERNMENT
This section describes the process undertaken to arrive at the research question. The
process is explained with reference to inductive and deductive thought processes and
scientific method. The research question is amexamined in the context of existing
economic theory and in particular with relation to potential shortcomings of that
theory.
The significance of a finding that is consistent with identified patterns is explained. A
pattern, the likely increase in public investment as a result of adoption of a net worth
fiscal policy rule, is identified. The likely cause of that pattern is identified as
compliance with the constraint imposed on fiscal measures by adoption of fiscal
policy rules. This is based on an assumption of unchanged composition of net worth.
An initial general conclusion is developed, i.e. that governments, having adopted
fiscal policy rules, act in a constrained manner to meet the fiscal constraints self-
imposed by adoption of fiscal policy rules. If this is so, adoption of fiscal policy rules
can be expected to coincide with ex post fiscal outcomes that meet the constraint
imposed on the relevant fiscal measure. Specifically, adoption of a fiscal policy rule
that the budget will be balanced should lead to a greater incidence41 of positive
operating balance reported in historical financial statements after, compared with
before, adoption of the fiscal policy rule. Similarly, a higher incidence of reduction in
net debt should occur after adoption of a fiscal policy rule requiring that net debt will
be reduced. In the case of adoption of a fiscal policy rule requiring maintenance or
increase of net worth, and assuming unchanged composition of net worth, public
41 The inability of governments to control all factors leading to a specific fiscal outcome, as previously discussed, leads to a conclusion that total compliance, i.e. one hundred per cent incidence of positive operating balance reported in historical financial statements, is unlikely.
146
Chapter 5: Methods and Data
investment is more likely to be at least maintained or increased after rules adoption.
The significance of the assumption of unchanged composition of net worth is now
explained. Increased public net worth does not necessarily infer increased public
capital (real assets), as net worth is a residual measure of net assets remaining after
deduction of liabilities from gross assets. As gross assets include both real and
financial assets, net worth could increase as a result of increases in financial asset
holdings, even though no increase in real assets has occurred. Alternatively, net
worth could increase as a result of reduction in liabilities with gross assets unchanged.
However, the ceteris paribus assumption is invoked on which to base an expectation
that, where a fiscal policy rule has been adopted requiring maintenance or increase of
net worth, holdings of real assets will also be maintained or increased. That is, the
composition of net worth will remain unchanged. Thus it is considered that adoption
of a net worth fiscal policy rule indicates an intention to increase public capital. This
is considered reasonable on the basis of observed stability of government service
provision. Further, this assumption adopts a conservative position, in that most
jurisdictions adopted net debt rules as well as net worth rules, as outlined in Chapter 4.
If any change to net worth composition occurred as a result of rules adoption, the
adoption of net debt rules would tend to indicate that net worth composition might
change toward a greater proportion of financial assets, or a lesser proportion of
liabilities. If so, this would make detection of changes in public investment more,
rather than less, difficult to detect.
The proposition that public investment is likely to be at least maintained or increased
147
Chapter 5: Methods and Data
after net worth rules adoptionis implies an important qualification of the usual
macroeconomic assumption of exogeneity of government expenditures. It is generally
assumed that only certain elements of government expenditures are business cycle
dependent. These are related to automatic stabilisers (e.g. see McTaggart, Findlay
and Parkin (2006) page 534)). The remainder of government expenditure is therefore
considered to be independent of levels of economic activity, regardless of the level of
government considered i.e. a national or sub-national government. Automatic
stabilisers are generally seen to affect only national governments. This is because it is
generally the national level of government in a federal system that bears responsibility
for transfer payments and collects income-dependent taxes. However, in Australia,
there is a strong correlation between State government revenues and the business
cycle. Adoption of certain fiscal policy rules may in part act as a mechanism of
transmission between levels of economic activity and governmental outlays.
The supposed fiscal policy rule transmission mechanism is as follows. There are
typically long lead times in amending revenue-raising capabilities, such as by
changing taxes or tax rates, for all levels of government. Thus, at least temporarily,
the state of the business cycle is likely to exert significant positive influence on a
government’s total revenues. Suppose a government has self-imposed a constraint on
its budgetary balance by adoption of a fiscal policy rule requiring a positive operating
outcome. That government’s revenues will be determined by the state of the business
cycle. The interdependence of fiscal measures is such that other fiscal measures are
impacted. If the government seeks to obey the fiscal constraint imposed by its
budgetary balance fiscal policy rule, it must restrict its recurrent expenditures,
including transfer payments, to less than approximately the amount of its revenues42.
42 The exact relationship between revenues and allowable expenditures in the context of a budgetary balance fiscal policy rule is dependent on the financial reporting framework used. Chapter 3 provides
148
Chapter 5: Methods and Data
This may have caused Australian State governments’ expenditures to fluctuate with
the business cycle in a manner closer to that of the Commonwealth government than
might otherwise have been the case.
Further, if the government in question has also adopted a fiscal policy rule requiring
reduction of net debt, this restricts its investment capability by limiting financing
sources to the amount of its operating surplus. Finally, if that government has also
adopted a fiscal policy rule requiring increase in net worth, the upper limit to its
possible increase in net worth is the amount of its budgetary surplus.
However, as previously discussed, increases in net worth do not necessarily lead to
increases in public investment. Increases in net worth can be achieved by increasing
financial assets rather than by increasing capital formation. The focus of this study is
public capital formation and, specifically, on whether public capital formation
changed following adoption of a net worth fiscal policy rule for any Australian
government.
These tentative conclusions comprise a theory, parts of which can be tested using
deductive techniques. The deductive process is characterised as comprising three
steps; firstly, development of a hypothesis, secondly, testing of that hypothesis using
empirical data and, finally, conclusion regarding support for, or rejection of, the
hypothesis (Samuel and Gupta (1993)). Samuel and Gupta (1993) further state that
deductive thinking is closely allied with scientific method. Scientific method, often
also characterised as a hypothetico-deductive approach, involves seven steps. These
are defining a problem, planning a research design, planning the sampling process,
collecting data, analysing data, arriving at conclusions and reporting the results.
information on the specific financial elements used to estimate operating balance and net worth measures in the two financial reporting frameworks used by Australian governments.
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The following sections describe methods of analysis and data used to investigate in
part the tentative theory presented above. Fiscal outcomes are examined using
techniques of statistical inference. This allows specific conclusions tempered by a
specified level of statistical uncertainty.
5.3 ANALYTICAL TECHNIQUES
5.3.1 Overview
Firstly, the relevant fiscal measures of operating balance, net worth and net debt are
examined to determine to what extent compliance with adopted fiscal policy rules,
whether intentional or otherwise, occurred. Compliance can be ascertained by
comparison of targets, identified in Chapters 3 and 4, with relevant ex post fiscal
outcomes. The usefulness of establishing compliance is that it provides a basis for
interpretation of findings of other analyses. For example, suppose a finding is made
that public capital formation increased after adoption of net worth fiscal policy rules.
Awareness of whether the government under examination had, or had not, complied
with the constraint imposed by adoption of the net worth fiscal policy rule enables a
richer interpretation of that finding than if the finding were made without that
awareness.
After establishing the extent of compliance, an examination is made of whether the
rate of public capital formation changed after adoption of net worth fiscal policy rules.
Public capital formation is chosen for examination in light of emerging evidence that
public capital stocks have important impacts on private production (see Gramlich
(1994), Aschauer (2000) and Otto and Voss (1994 and 1996)) and the subsequent
issue of whether fiscal policy rules have affected productivity and growth through
their effect on public assets accumulation.
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A selection of statistical techniques is used, motivated by a desire to develop a
number of perspectives on the topic of the study. These multiple perspectives are
intended to avert a narrowness of focus and provide broad coverage of the subject of
interest, namely, public investment by governments which have adopted net worth
fiscal policy rules. In addition, each test has a range of strengths and weaknesses and
use of a number of techniques enables overlapping examination (or triangularisation)
as a means of strengthening the analysis.
An initial visual examination is carried out to determine patterns and trends. This is
then supplemented by more rigorous examination of public capital formation in the
context of net worth fiscal policy rules. Examination is carried out by use of
statistical inference and econometric techniques.
An initial scrutiny of the experience of all jurisdictions is carried out using two non-
parametric tests and cross-sectional time series data. The first technique is a test of
independence to ascertain whether occurrence of positive rates of growth of public
capital formation is influenced by adoption of net worth fiscal policy rules.
Essentially, if the test rejects the hypothesis of independence, this would be one
possible indication that adoption of fiscal policy rules was associated with some
change in the way public capital formation proceeded. The second technique is a test
of differences between population proportions. The purpose of this test is to assess
whether adoption of net worth fiscal policy rules was associated with a change in the
likelihood that public capital formation would increase in any given year. For
example, if fiscal policy rules encouraged governments to favour growth in public
investment more than before, this could result in the latter variable experiencing
positive growth more frequently than previously. Specifically, the test seeks to
determine whether there is a significant difference between the proportion of positive
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instances of growth of public capital formation before and after adoption of a net
worth fiscal policy rule.
Regression analysis is used to ascertain the degree to which variations in economic
activity and fiscal policy rules adoption contribute to variations in public capital
formation. The data are then examined for trends that might indicate that increases in
public capital formation are explicable by either the passing of time or by
governments increasing nominal outlays over time. A finding that a time-based trend
is significant would indicate a potential lack of relevance of fiscal policy rules
adoption to changes in public capital formation. Alternatively, a finding that the
passing of time is not a significant predictor of changes in public capital formation
would tend to support findings in the previous analysis.
Finally, an event study methodology is employed to assess the impact of adoption of a
net worth fiscal policy rule on public capital formation. Use of event studies
methodology provides another perspective on the phenomenon under investigation,
with the advantage that its validity is based on different statistical assumptions.
Further, analysis can be carried out on each jurisdiction for each year using this
approach.
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5.3.2 Model specification and rationale
Non-parametric techniques
A test of independence of attributes is presented to ascertain whether occurrence of
positive rates of growth of public capital43 formation is associated with adoption of a
net worth fiscal policy rule. This analysis provides an initial albeit simple lens by
which to view public capital formation over time. The analysis is carried out in real,
per capita terms in order to test the capacity of the relevant governments to maintain
service levels, based on observed rivalry of many government services and assumed
constant capital productivity and composition of service provision.
The only technical requirement for this simple, non-parametric test is that the
minimum number of observations in any cell be 5. Sufficient data exist to meet this
requirement when all jurisdictions are aggregated. Accordingly, pooled cross-
sectional time series data are used. This introduces a possible weakness of the
analysis in that clarity of performance between jurisdictions is lost but the earlier,
simpler analyses and the later analyses on individual jurisdictions mitigate this loss by
offering insights into such individual performances.
The null hypothesis is that the attributes are independent, i.e. occurrence of positive
growth of public GFCF is independent of existence of a net worth fiscal policy rule.
The alternative hypothesis is that the attributes are dependent, i.e. occurrence of
positive growth of public GFCF may depend on existence of a net worth fiscal policy
rule. The test statistic is Chi-Square distributed for 1 degree of freedom.
43 Rates of growth of public capital formation are calculated and a binary series constructed with a value of 1 where the rate of growth was non-negative and 0 where negative. This is undertaken using a Laspeyres transformation in preference to using a log transformation as the Laspeyres transformation produces a binary series, whereas logs do not.
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A test of differences between populations is employed to ascertain whether a different
proportion of non-negative instances of growth of public capital formation occurs
before and after adoption of a net worth fiscal policy rule. Again, the data are cross-
sectional time series.
The two possible outcomes of each trial are that the rate of growth is negative or the
rate of growth is positive. The two populations compared are the recorded growth
measures of GFCF measured on a real per capita basis before and after adoption of net
worth fiscal policy rules. The population parameter of interest is the population
proportion, i.e. the proportion of trials for which the outcome is a success, where
success is defined as “the rate of growth is positive.”44 The sample proportion is the
sample statistic used as an estimator of the population proportion.
The null hypothesis is that the proportion of instances of positive rates of growth is
equal between before and after adoption of a fiscal policy rule for each jurisdiction.
The alternative hypothesis is that the proportion of instances of positive rates of
growth after adoption of a net worth fiscal policy rule is greater than the proportion of
instances of positive rates of growth prior to adoption of a net worth fiscal policy rule.
The test statistic is the standardised normal random variable z of which the critical
value is 1.96 given a level of significance of .05 and a one-tailed (right-tailed) test.
This investigation is similar in nature to the previous and it is to be expected that the
two will provide similar results. Similarly to the test of independence, this technique
views the phenomenon under consideration as qualitative data. This technique differs
from the previous technique in that its validity is based on an assumed normal
distribution of the population proportion. However, this test yields a result equivalent
44 Again, rates of growth of GFCF are calculated and a binary series constructed using the Laspeyres method with a value of 1 where the rate of growth is non-negative and 0 where it is negative.
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to that obtained with the Chi-squared test of independence, and the square of the z
value obtained for this test is equal to the Chi-square value obtained for the latter test
(Sheskin (2004) page 511).
Use of two such similar methodologies is justified because using different tests
overcomes in part issues associated with the nature of the data. In addition, use of
non-parametric tests does not confront the issues of the stationarity of time series data
which can act to reduce the suitability of use of parametric tests. Equally, use of
subsequent parametric methodology provides a check and further substantiation of the
findings of the non-parametric tests.
Multivariate linear regressions
More sophisticated analysis employing conventional ordinary least squares
methodology is then carried out to ascertain the degree to which, firstly, variations in
economic activity and, secondly, passage of time, both coupled with fiscal policy
rules adoption, explains variations in public capital formation.
Investigation of the impact of variations in economic activity is undertaken due to the
close relationship between economic activity and government revenues and the
posited relationship between government revenues and government outlays. For the
Commonwealth Government, there is a broadly accepted correlation between the
government’s revenue base and economic activity, related to the concept of automatic
stabilisers (e.g. see McTaggart, Findlay and Parkin (2006) page 534). State
governments’ revenue bases in turn are largely determined by the size of
Commonwealth Government revenues as well as by the size of their own revenue
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base. Most Commonwealth Government revenues were derived from income taxes in
the period prior to the adoption of the Goods and Service Tax on 1 July 2000, and
from a combination of income taxes and goods and services taxes in the period
thereafter. These revenues form the basis for calculation of grants to State
governments, which comprise a significant proportion of State governments’ revenues.
States’ own revenues include payroll taxes and stamp duties and a strong correlation
typically exists between the business cycle and these revenues (see New South Wales
Government (1994) page 1-5).
Additionally, for both Commonwealth and State governments, inclusion of this
explanatory variable can be justified in terms of a notional capital-output ratio, where
each level of output requires a certain amount of capital, some of which is public
capital.
The focus is on rates of growth of public capital formation (or investment) and thus a
log-linear model is used. Intercept and slope dummy variables are employed so as to
enable separate identification of changes, if any, in the level and rate of change of
growth in public capital formation at the time of adoption of net worth fiscal policy
rules. Each jurisdiction is investigated separately, for the first time enabling
observations to be made regarding the impact of fiscal policy rules on behaviour at the
jurisdictional level.
Investigation is then carried out using a trend variable to ascertain the extent, if any, to
which changes in the rate of public capital formation are attributable to the passage of
time. This is investigated in order to mitigate the possibility of spurious findings in
earlier analyses and to further investigate the general observation that the ratio of
GFCF to GDP/GSP declines over time for all jurisdictions.
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The rationale is that government investment may include a component that is time
dependent due to political economy issues related to budgetary size (see Alesina and
Perotti (1995), Tabellini and Alesina (1991) and Drazen and Grilli (1993))). This is
based on an observation that governments frequently announce increased expenditures
as an indication of policy validity. This would indicate that public capital formation
in any year was more influenced by public capital formation in the preceding year
than by other factors such as existence of fiscal policy rules. Such occurrences could
be explainable by factors underlying the deficit bias described in Chapter 2 (assuming
constancy of outlays components). This analysis essentially provides a check on the
previous regression analysis and investigates whether significant relationships found
in those analyses are merely due to such issues of political economy.
Analytical deficiencies include problems of serial correlation in time series data.
More important, however, is the difficulty of assigning precise relationships to various
causal factors that may influence observed variations in government fiscal behaviour.
In the context of multiple possible causes of variations in public capital formation, the
analysis in this study cannot be said to indicate conclusively the impacts of fiscal
policy rules adoption. This is because, as previously detailed, various other influences
(such as adoption of fiscal policy rules relating to other fiscal aggregates and adoption
of accrual accounting methodologies) exist simultaneously. As a result, test results
may be (in part or whole) the result of these influences rather than (primarily or
exclusively) the result of adoption of a net worth fiscal policy rule.
Event study
Finally, an event study methodology45 is employed to measure the impact of adoption
45 MacKinlay (1997) reviews, summarises and provides a concise history of event study methodology.
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of a net worth fiscal policy rule on public capital formation. Use of event studies
methodology provides another perspective on the phenomenon under investigation.
This additional perspective has the advantage that its validity is based on different
statistical assumptions. In addition, the technique is not dependent on use of dummy
variables enabling use of a greater part of the information set provided by quantitative
data.
The methodology borrows heavily from MacKinlay (1997). An event study measures
the impact of a specific event (e.g. adoption of a net worth fiscal policy rule, as
defined in Chapter 2) on outcomes (e.g. growth of public capital formation, as
described in Section 6.2). This provides a less aggregated means of analysis than
previous analyses, in that it uses all the information contained in quantitative data and
is carried out for individual jurisdictions and individual years. It also provides an
alternative lens in that it does not use qualitative variables and thus analysis over the
post-event window also is not limited in this manner. Thus a particular strength of the
event study methodology, when used with a non-interregnum data series (the concept
of an interregnum is defined at Section 5.4.4), is that the methodology enables
identification of individual years for which abnormal levels of GFCF may have
occurred.
The flow of analysis of an event study may be generalised to comprise the following
steps. Firstly, it is necessary to define the event of interest and outcome to be studied.
Secondly, the period over which the study will be carried out must be identified. The
third step is identification of the selection criteria for the inclusion of a given entity in
the study, noting any potential biases which may have been introduced through the
sample selection. Fourthly, an appraisal must be carried out of the event’s impact,
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including selecting a method of measuring normal and abnormal outcomes46. Finally,
the testing framework for abnormal outcomes must be designed, including defining
the null hypothesis and determining any techniques to be used for aggregating
abnormal outcomes for the entity under consideration.
Event studies have been criticised by Alankar (2003). In the context of finance,
Alankar (2003) argues that multicollinearity exists between stock and time-specific
dummy variables that are components of an event study. This multicollinearity is
argued to prevent estimation of time-specific fixed effects, which measure abnormal
returns and represent investor responses to an event. Further, additional collinearity
between the explanatory variables and the time dummy variable is argued to prevent
identification of the betas of the pricing model used. Alankar (2003) indicates that
aggregation of time series into a single portfolio series, setting time effects to zero for
dates far from the event and estimation over these dates only, is the technique
typically used to overcome this problem. This portfolio approach is argued to have
become the default methodology in event studies due to its intuitive aspects and
simplicity. This estimation procedure is further criticised on the basis that it utilises
incomplete information. Further it is argued that the problems of this approach are
magnified as the number of non-zero time-effect coefficients increase. However, as
the event study undertaken in this study is carried out on a jurisdiction-by-jurisdiction
basis, and hence no aggregation is necessary, this criticism does not appear to apply to
this study.
Event studies were originally developed to test the hypothesis that the stock market
46 These terms are defined later in this section. Following MacKinlay (1997), the abnormal return is the actual ex post fiscal outcome over the event window minus the normal fiscal outcome over the event window.
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was efficient (Bhagat and Romano (2002)). The methodology did this by evaluating
the extent to which publicly available information became embedded in stock prices
over time. Immediate, total absorption would mean that an investor was unable to
earn abnormal profits by trading on the information after its release. This would be
consistent with an efficient market hypothesis, when efficiency is defined in this
restrictive manner. However, a broadening of use of the methodology resulted as
evidence accumulated that the stock market was efficient. Event studies became used
for analysis of the impact of any event which created abnormal movement of a
designated variable, where a link between the event and the variable was theorised.
MacKinlay (1997) states that event studies can be applied to a range of firm specific
and economy wide events such as mergers and acquisitions, earnings announcements,
debt or equity issues and announcements of macro-economic variables such as a trade
deficit. In the context of such a general application of the methodology, the question
of statistical power is particularly relevant.
The statistical power of an event study diminishes as the sample size decreases
(Bhagat and Romano (2002)). In this study, where every jurisdiction is separately
tested, the sample size is one. As a result, the statistical power is considered to be low.
This is because the variability of abnormal returns with a sample size of one is higher
than otherwise. Additionally, the announcement-period return of a lone sample
component may plausibly be affected by other information unrelated to the event
under study. Difficulties may arise in determining the effects of this information
separately from the effects of the event.
Furthermore, the power of the methodology decreases as the length of the event
window increases (Bhagat and Romano (2002)). In this study, the length of the event
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window varies between jurisdictions. Where the event window for one jurisdiction is
longer than for another, the statistical power of the methodology is accordingly
reduced. This is acknowledged with respect to results for the Queensland and Western
Australian jurisdictions.
Ways of increasing the statistical power of the methodology include (MacKinlay
(1997)):
”… increasing the sample size, shortening the event window or …
developing more specific predictions to test.”
However, in this study, it is considered that the advantages of obtaining insights for
individual jurisdictions outweigh the possible advantages attainable by aggregation.
In addition, information obtained from publicly available data clearly indicate the
length of the event window. Finally, the specific nature of constraints, imposed on
fiscal measures by adoption of fiscal policy rules, limits capacity for developing more
specific predictions to test.
5.4 THE DATA
This section specifies data sources and indicates techniques used to address
difficulties of data availability. Crucially, these techniques include recasting cash-
based data series in equivalent accrual terms. The appropriate use of nominal or real
values and absolute or per capita levels is examined. The case for an extension of the
bracketing period is examined.
5.4.1 Fiscal outcomes
GFS Net Operating Balance, GFS Net Worth and GFS Net Debt data are sourced from
ABS Catalogue 5512.0 Government Finance Statistics 2004-05. GPFR Operating
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Surplus/Deficit and Net Assets data for the Victorian Government are sourced from
Financial Reports for the State of Victoria for each of years 2000-01 to 2003-04.
GPFR Net Assets data for the New South Wales Government are sourced from New
South Wales Budget Sector Consolidated Financial Statements July-December 1996,
Public Accounts of the New South Wales Public Sector 1996-97, New South Wales
Financial Statements for General Government for the twelve months ended 30 June
1999 and New South Wales Report on State Finances 2000-01 to 2003-04. The data
are expressed on an historical cost basis which is consistent with nominal terms.
GPFR Net Assets data for the New South Wales Government have been deflated by
application of an implicit price deflator obtained from the ABS Catalogue 5206.0
Australian National Accounts: National Income, Expenditure and Product (Table 53
State and Local, General Government GFCF). Use of this deflator is based on an
implicit assumption that the rate of price change for State government assets is
equivalent to the rate of price change for local government GFCF.
Findings based on this analysis have to be interpreted in light of the extensive range of
methodological difficulties that attach to valuation and deflation of most elements of
balance sheets, particularly public sector balance sheets. In addition, the deflation of
balance sheets is complicated by the use of differing asset revaluation practices
between jurisdictions.
As discussed in Chapter 3, GFS are derived from jurisdictional accrual accounting
data. These data are based on historical cost. However, fixed (mostly physical) assets
are revalued periodically in accordance with accounting standards in an attempt to
align asset values with current prices and thereby address this issue. Therefore,
reported GFS values for public capital suffer from the same difficulties of
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Chapter 5: Methods and Data
measurement as do GPFR measures of public assets.
5.4.2 Gross fixed capital formation
Public gross fixed capital formation (GFCF) data for the general government sector of
the Commonwealth Government is sourced from the ABS Catalogue 5206.0
Australian National Accounts: National Income, Expenditure and Product, Dec 2005,
for 1984-85 to 2003-04 inclusive. These original data are chain volume measures.
Public GFCF data for the general government sector of the New South Wales,
Victoria, Queensland and Western Australian governments are sourced from the ABS
Catalogue 5220.0 Australian National Accounts: State Accounts, for 1984-85 to 2003-
04 inclusive. The data are original and presented in nominal terms.
Fiscal policy rules are typically formulated in nominal terms only. An example is that
net worth should increase. A literal interpretation of this is that the nominal value of
net worth should increase in each year reported47. In other words, the relevant fiscal
measure is not targeted to increase in per capita or real terms48. However,
measurement in real terms has the obvious advantage that deflation of nominal
measures removes the effects of price changes and allows a closer focus on the level
of economic services, encapsulated in public assets, provided by governments over
time.
Similarly, fiscal outcomes reported in response to fiscal policy rules typically are
reported in absolute terms only. However, if one adopts an assumption of constant
47 This is unless the rule is formulated in terms of averages over a business cycle. However, as argued in Section 4.4, the consistent growth experience during the period over which rules have applied renders such a formulation equivalent to a requirement that nominal net worth should increase in each year. 48 There is one exception to this. The New South Wales Government has adopted target of maintaining and, if possible, increasing its total net worth in real terms.
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Chapter 5: Methods and Data
levels of capital productivity49, and if the intent of those rules was to achieve
sustainability of service provision, maintenance of net worth per capita in real terms is
necessary to sustain service provision over time. Use of a per capita measure has its
basis in the observable fact that many core government services, such as education
and health care, are rivalrous in nature. This means that, if public capital productivity
is assumed to be stable, no economies of scale and thus constant returns to scale occur
and thus capital input requirements for these services increase proportionately with
population. (This analysis, of course, is less appropriate when the composition of
service provision changes, as may occur for example as a result of significant
demographic change.)
Therefore, a fiscal policy rule requiring that net worth be maintained may reasonably
be interpreted as meaning that net worth will be maintained in constant, per capita
terms. For this reason, public capital formation in constant, per capita terms is
investigated.
GFCF State government data are also converted into constant terms by application of
implicit price deflators obtained from the ABS Catalogue 5206.0 Australian National
Accounts: National Income, Expenditure and Product (Table 53 State and Local,
General Government GFCF). This again assumes that the rate of price change for
State government GFCF is equivalent to the rate of price change for local government
GFCF. These data are also calculated in per capita terms using estimated resident
population data from the ABS Catalogue 3105.0 Australian Historical Population
49 Relaxation of this assumption to account for increased productivity of technologically more advanced capital inputs is beyond the scope of this paper.
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Statistics 2006.
General government sector and government corporations together comprise the total
public sector hence use of general government sector data excludes capital formation
by government corporations. This approach has the disadvantage that it fails to
recognise when governments use dividends from government corporations to achieve
desired operating outcomes for the general government sector. Dividends from
government owned corporations are reported as revenue in general government sector
operating statements. Thus a general government sector operating surplus may be
attained by payment of a dividend from a government owned corporation to a general
government sector entity. A general government sector operating surplus can occur at
the same time as a reduction of total public sector net worth by this mechanism.
Such a reduction of total public sector net worth may reduce the ability of government
to produce services overall. For example, electricity and water services are
commonly provided by government owned corporations – with important
implications for private production. These services by government owned
corporations are generally provided on a user-pays basis. However, it is in terms of
the general government sector that the majority of fiscal policy rules are formulated.
Therefore, exploration of general government data most closely accords with the
intended coverage of fiscal policy rules. In addition, this approach is adopted to more
closely consider investment for provision of public or merit goods, which are mostly
provided by the general government sector.
The jurisdictions included are the Commonwealth, New South Wales, Victorian,
Queensland and Western Australian Governments on the basis that these governments
adopted net worth fiscal policy rules. The South Australian and Tasmanian
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Governments are not included as it has been determined that these governments did
not adopt net worth fiscal policy rules (see Section 4.3). State jurisdictions are
considered due to the preponderance of public capital formation by State governments
compared with the Commonwealth Government. The Commonwealth jurisdiction is
also considered in order to determine whether behavioural effects, if any, differ
between levels of government within the Australian federal system (see Section 3.2).
GFCF data for the period between 1984-85 and 1997-98 were reported on a cash basis
and so excluded Assets acquired below fair value, Assets donated and Assets acquired
under finance lease), which are included in the accruals-based data reported for 1998-
99 to 2003-04. With the exception of Assets acquired under finance lease in New
South Wales, these components were subtracted from the latter series in order to
provide a single series covering the entire period on a consistent basis for use in this
study. Assets acquired under finance lease were retained in the New South Wales
data as this component is highly significant, comprising over twenty per cent of the
total. In no other jurisdiction are Assets acquired under finance lease material to the
total.
The data therefore should not be interpreted as indicative of levels but do provide a
totally consistent basis for calculating rates of growth, in the assumed absence of a
change in rates of usage of finance leases and donations as financing sources.
5.4.3 Gross Domestic Product/Gross State Product
Annual GDP data are sourced from the ABS Catalogue 5204 Australian National
Accounts: National Income, Expenditure and Product 2005.
Annual GSP data from 1999-2000 to 2003-04 inclusive are sourced from the ABS
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Chapter 5: Methods and Data
Catalogue 5220.0 Australian National Accounts: State Accounts 2004-05 (Table 1).
Both data sets are original and in chain volume terms. Annual GSP data from 1984-
85 to 1999-2000 inclusive are backwards extrapolations of the chain volume terms,
calculated in accordance with unpublished original data sourced from the Australian
Bureau of Statistics (at average 1998-90 prices), in accordance with the ABS’ advised
splicing methodology50. These data are also calculated in per capita terms using
estimated resident population data from the ABS Catalogue 3105.0 Australian
Historical Population Statistics 2006.
The following section describes adjustment of the data series to take account of the
effect of a transitional period during which governmental behaviour may have been
influenced by the impending adoption of fiscal policy rules.
5.4.34 Issues relating to the bracketed period
Section 3.2.4 introduced the term ‘bracketing’ as a means of identifying a transition
period during which governmental fiscal behaviour may have been influenced by the
relevant policy rules before their formal adoption. This transitional period was
identified from public documents in the manner described in Chapter 4. Using this
concept, the following analyses are carried out on data series that omit data points for
either the bracketed period (including the date of adoption of rules) or an extension of
the bracketed period, termed an ‘interregnum’. The intent is to remove ‘noise’ from
the data and obtain a clearer picture of fiscal outcomes before and after the
transitional period.
Table 5.1 summarises the relevant dates. In each case, the bracketing approach is
adopted for the interregnum and used in subsequent analysis.
50 Verbal communication with relevant ABS officers.
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Chapter 5: Methods and Data
Table 5.1 Dates of adoption of fiscal policy rules and interregnum
The ratio of GFCF (in chain volume measures and on a per capita basis) to GDP/GSP
(also real per capita) is plotted for each jurisdiction. The ratios are visually examined
for pattern emergence around the time of adoption of fiscal policy rules relating to net
worth, in Figures 5.1 to 5.5 inclusive. This ratio is useful as an indication of public
investment intensity which is used as a proxy for public capital stock productive
capacity. Any change in the ratio is indicative of changes in the relative emphasis
adopted by a government in its decision-making related to outlays.
Information thus gained is used to either confirm use of the bracketing period as the
interregnum or to provide an alternate expanded period for use as the interregnum.
This approach is taken because of the possibility that governments may have adopted
changed behaviour at times different from times at which information (relating to
adoption of fiscal policy rules) emerged in documents in the public domain such as
budget papers. Exercise of judgement in data selection in this way is analogous to the
approach adopted in event analyses methodology, where an event window is
determined on a similar basis.
Jurisdiction FPR adoption date
Bracketing span
Interregnum span
Commonwealth 1999-2000 1999-2000 1999-2000 NSW 1996-97 1995-96 to
1996-97 1995-96 to 1996-97
VIC 2000-01 2000-01 2000-01 QLD 1999-2000 1996-97 to
1999-2000 1996-97 to 1999-2000
WA 2000-01 1997-98 to 2000-01
1997-98 to 2000-01
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Chapter 5: Methods and Data
Figure 5.1 Ratio of GFCF to GDP, Commonwealth Government
0.0025
0.0030
0.0035
0.0040
0.0045
0.0050
0.0055
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
Source: ABS Catalogue 5206.0 National Income, Expenditure and Product Dec 2005 Note: GFCF and GDP/GSP are expressed in real per capita terms.
Figure 5.1 suggests a break in the ratio of GFCF to GDP for the Commonwealth
government at the date of adoption of fiscal policy rules in 1999-2000 and supports
the application of bracketing. The interregnum thus comprises 1999-2000 and one
data point is omitted from the series, reflecting a short transition period during which
governmental behaviour underwent change with respect to public capital formation.
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Chapter 5: Methods and Data
Figure 5.2 Ratio of GFCF to GSP, New South Wales Government
0
0.002
0.004
0.006
0.008
0.01
0.012
0.014
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
Source: ABS Catalogue 5206.0 National Income, Expenditure and Product Dec 2005 Note: GFCF and GDP/GSP are expressed in real per capita terms.
In Chapter 4, it was determined that, while the New South Wales Government
formally adopted fiscal policy rules from 1996-97, the transition period may have
started as early as 1995-96.
While the visual analysis of Figure 5.2 suggests a break at this point, this may be
spurious due to the large negative value for 1995-96. This is due to a large negative
value of nominal GFCF in 1995-96 of -$5,236M which further investigation reveals
resulted from transfer of regional road assets to local councils of $6,179M and asset
devaluations totalling $2,742M which were partly offset by acquisitions of $3,685M
(NSW Government (1997) page 1-6).
This potentially leads to a problem for analysis of the New South Wales
Government’s experience (see Section 5.7). In the absence of additional information,
the bracketing approach is adopted and the interregnum covers the period 1995-96 to
170
Chapter 5: Methods and Data
1996-97. Two data points are therefore omitted from the series.
Figure 5.3 Ratio of GFCF to GSP, Victorian Government
0.007
0.008
0.009
0.010
0.011
0.012
0.013
1984-85
1986-87
1988-89
1990-91
1992-93
1994-95
1996-97
1998-99
2000-01
2002-03
Source: ABS Catalogue 5206.0 National Income, Expenditure and Product Dec 2005 Note: GFCF and GDP/GSP are expressed in real per capita terms.
In Section 4.3.3, it was determined that the Victorian Government adopted a fiscal
policy rule relating to net worth in 2000-01 and no evidence for bracketing was found.
Visual analysis of the Victorian data (in Figure 5.3) indicates a general downward
trend to 1992-93 followed by a fairly regular shark-tooth pattern prior to adoption of a
net worth fiscal policy rule. The figure does not provide further information to that
obtained from public domain documents. In the absence of conflicting information
regarding the commencement of bracketing, the interregnum thus comprises 2000-01
only and one data point is omitted from the series. Similarly to the case of the
Commonwealth Government, this suggests a short transitional period to adoption of
fiscal policy rules.
171
Chapter 5: Methods and Data
Figure 5.4 Ratio of GFCF to GSP, Queensland Government
0.011
0.013
0.015
0.017
0.019
0.021
0.023
0.025
1984-85
1986-87
1988-89
1990-91
1992-93
1994-95
1996-97
1998-99
2000-01
2002-03
Source: ABS Catalogue 5206.0 National Income, Expenditure and Product Dec 2005 Note: GFCF and GDP/GSP are expressed in real per capita terms.
In Section 4.3.4, the Queensland Government’s adoption of a net worth fiscal policy
rule was dated to 1999-2000 and bracketed from 1996-97. Visual analysis of Figure
5.4 indicates a break at 1999-2000 and, in the absence of conflicting information
regarding the commencement of bracketing, the interregnum thus comprises 1996-97
to 1999-2000 inclusive. Four data points are omitted from the series. The transitional
period is therefore longer than that for the Commonwealth, New South Wales and
Victorian Governments and equal longest with the Western Australian Government.
172
Chapter 5: Methods and Data
Figure 5.5 Ratio of GFCF to GSP, Western Australian Government
0.008
0.010
0.012
0.014
0.016
0.018
0.020
1984-85
1986-87
1988-89
1990-91
1992-93
1994-95
1996-97
1998-99
2000-01
2002-03
Source: ABS Catalogue 5206.0 National Income, Expenditure and Product Dec 2005 Note: GFCF and GDP/GSP are expressed in real per capita terms.
As described in Section 4.3.6, the Western Australian Government adopted a net
worth fiscal policy rule in 2000-01 and bracketing was applied from 1997-98. Visual
analysis of Figure 5.5 does not conflict with adoption of these dates for the
interregnum. Four data points are omitted from the series. The transition period for
Western Australia is thus equal longest, with Queensland, of all jurisdictions.
The bracketing period, identified from public pronouncements, is adopted as the
interregnum in all cases. Data points for the interregnum period are removed in
interregnum models. The intent is to remove observations that reflect partial effects
of fiscal policy rules adoption during this transitional period. This should enable
clearer identification, using the techniques described in the previous section, of any
differences in behaviour both before and after fiscal policy rules adoption.
173
Chapter 5: Methods and Data
5.5 SUMMARY
This chapter explains the methodologies by which the fundamental research question
of this study is investigated. The research question is defined as “What happens to
public investment when governments adopt fiscal policy rules?” and a suite of
empirical methods for testing associated hypotheses are constructed and described.
The extent of compliance with constraints on fiscal measures, imposed by fiscal
policy rules relating to budgetary balance, net debt and net worth, is to be determined.
Statistical techniques, by which estimates are to be determined of relationships
between public investment, economic activity, adoption of fiscal policy rules and the
passing of time, were then described. These include non-parametric tests of
independence and of differences between population proportions, and parametric
estimation using multivariate linear regressions and an event study. Use of the
selected techniques is rationalised on the basis that this allows development of broad
perspectives and triangularised examination of public investment by governments
which have adopted net worth fiscal policy rules.
Key data sets of public gross fixed capital formation and economic activity were
described, including transformations that have been applied to overcome issues of
suitability of the data for use in the techniques employed. Selection of data points for
omission in accordance with the concept of bracketing and an interregnum period,
indicative of a transitional period, were discussed.
174
Chapter 6: Compliance and Public Capital Formation
CHAPTER 6
COMPLIANCE AND PUBLIC CAPITAL FORMATION
6.1 INTRODUCTION
This chapter explores the experience of Australian governments’ fiscal outcomes in
the context of fiscal policy rules, using methods and data described in Chapter 5. This
enables scrutiny of whether governments complied with their own fiscal policy rules
and if fiscal policy rules have affected governmental fiscal behaviour.
This analysis is an attempt to correct the lack of theoretical and empirical coverage of
government’s role in the economy and to aid in the development of future studies.
The non-parametric methods adopted explore two issues. The first is whether
adoption of fiscal policy rules was associated with some change in the way public
capital formation proceeded. The second is whether adoption of net worth fiscal
policy rules was associated with a change in the likelihood that public capital
formation would increase in any given year. The parametric methods used broadly
enable findings from three perspectives. The link between economic activity and
public capital formation is investigated. A check is performed to determine whether
this is attributable merely to the passing of time. Finally, the impact of adoption of a
net worth fiscal policy rule on public capital formation is explored. Findings in regard
to these aspects of public investment provide insights, that are not possible given the
current lack of economic treatment, regarding government outlays.
In particular, findings indicating that public investment has increased since adoption
of net worth fiscal policy rules would represent an important modification of the usual
assumption of exogeneity of governmental outlays other than automatic stabiliser
175
Chapter 6: Compliance and Public Capital Formation
expenditures. This may well be applicable to all governments, not just the Australian
governments examined here. The extent of external usefulness of this study depends
primarily on the reporting methodologies adopted by different governments, but its
validity rests on a methodology for marshalling complex sets of government data.
External validity will be greatest with respect to governments which adopt similar
reporting methodologies to GFS or GPFS.
The remainder of the chapter is organised as follows. The initial step is to determine
the extent to which governments were successful in meeting constraints imposed by
adoption of fiscal policy rules, by comparing fiscal targets with ex-post fiscal
outcomes (in Section 6.2). Operating balance, net worth and net debt data are
presented in a simple format. However, as discussed in Section 3.2.2, due to
uncontrollable factors impacting governmental fiscal outcomes, this does not
necessarily provide an indication of the intention, or otherwise, of governments to
meet constraints.
Attention is then focussed on whether an association exists between adoption of fiscal
policy rules and changes in the public capital formation process in any of the
jurisdictions (in Sections 6.3 to 6.7). Public capital formation is examined both before
and after adoption of a net worth fiscal policy rule (by the national and four State
governments) using techniques of analysis that are as simple and as robust as possible
given the complexities of the data. This analysis does not attempt to answer all of the
questions that might arise. In particular, it does not explore questions of political
economy or of the desirability of fiscal policy rules.
Section 6.3 presents the relevant time series and discusses the general trends and
patterns they exhibit. This is followed by a statistical and econometric analysis of the
176
Chapter 6: Compliance and Public Capital Formation
data. A test of independence of attributes is presented in Section 6.4 to ascertain
whether occurrence of positive rates of growth of public capital formation is
influenced by adoption of net worth fiscal policy rules. In Section 6.5, another non-
parametric test is employed. This is a test of differences between population
proportions. It aims to assess whether adoption of net worth fiscal policy rules was
associated with a change in the likelihood that public capital formation would increase
in any given year.
Ordinary least squares methods are then carried out in Section 6.6. This ascertains the
degree to which variations in economic activity and fiscal policy rules adoption
contribute to an explanation of variations in public capital formation. The model is
linear in the coefficients. Intercept and slope dummy variables are employed so as to
enable separate identification of changes, if any, in the level of public capital
formation as well as in its relationship with economic activity level at the time of
adoption of net worth fiscal policy rules. Each jurisdiction is investigated separately,
for the first time enabling identification of behaviour at the jurisdictional level. In the
same section, we shall also consider an alternative model, where public capital
formation is postulated to depend on a time trend, rather than on economic activity.
The results from the two models turn out to be quite similar.
Finally, an event study methodology is employed in Section 6.7 to assess the impact
of adoption of a net worth fiscal policy rule on public capital formation. Use of event
studies methodology provides another perspective on the phenomenon under
investigation, with the advantage that its validity is based on different statistical
assumptions.
Section 6.8 addresses the research questions of whether or not governments complied
177
Chapter 6: Compliance and Public Capital Formation
with their own fiscal policy rules and whether these fiscal policy rules appear to have
affected fiscal behaviour, especially public capital formation.
6.2 COMPLIANCE WITH FISCAL POLICY RULES
This section investigates how frequently governments have complied with constraints
self-imposed by adoption of fiscal policy rules. Australian governments typically
formulated fiscal policy rules as requiring ex ante observance, i.e. in budgetary terms.
However, to establish compliance, it is necessary to scrutinise ex-post fiscal measures
(see Section 3.2.3).
6.2.1 Budgetary balance rules
The measure adopted, nature of the constraint, sector to which the measure relates and
adoption dates are presented in Table 6.1. This information is presented for the
Commonwealth, New South Wales, Victorian, Queensland, South Australian and
Western Australian Governments. It is considered that the Tasmanian Government
did not adopt fiscal policy rules (see Section 4.3). This information provides a basis
for comparison of ex-post fiscal measures with targets in order to establish the extent
of compliance, though not intentionality (as previously discussed).
Table 6.2 provides the relevant ex-post fiscal outcomes specified in Table 6.1. These
are provided for the period from adoption of fiscal policy rules to 2003-04. The
exception is New South Wales, for which accrual-based GFS data are unavailable for
1996-97 and 1997-98. The data are presented in nominal terms, in accordance with
the terms in which all budgetary balance fiscal policy rules were formulated.
178
Cha
pter
6: C
ompl
ianc
e an
d Pu
blic
Cap
ital F
orm
atio
n
Tab
le 6
.1 M
easu
rem
ent o
f bud
geta
ry b
alan
ce fi
scal
pol
icy
rule
s
Gov
ernm
ent
Mea
sure
ado
pted
T
arge
t R
elev
ant S
ecto
r
Dat
e of
ado
ptio
n C
omm
onw
ealth
1998
-99
ca
sh-b
ased
GFS
Net
Ope
ratin
g Ba
lanc
e (e
quiv
alen
t to
accr
ual-b
ased
GFS
Net
Le
ndin
g/Bo
rrow
ing)
19
99-2
000
to 2
003-
04 a
ccru
al-b
ased
GFS
Net
Le
ndin
g/ B
orro
win
g
Bal
ance
19
98-8
8 bu
dget
sect
or
1999
-200
0 to
200
3-04
ge
nera
l gov
ernm
ent
1998
-99
NSW
19
96-9
7 to
199
9-20
00 c
ash-
base
d G
FS N
et
Ope
ratin
g Ba
lanc
e (e
quiv
alen
t to
accr
ual-b
ased
G
FS N
et L
endi
ng/B
orro
win
g)
2001
-02
to 2
003-
04 a
ccru
al- b
ased
GFS
Net
Le
ndin
g/ B
orro
win
g
Surp
lus f
rom
199
8-99
Gen
eral
gov
ernm
ent
1996
-97
Vic
toria
G
FPR
Ope
ratin
g Re
sult
Surp
lus o
f at l
east
$1
00M
per
ann
um
Gen
eral
gov
ernm
ent
2000
-01
Que
ensl
and
Acc
rual
-bas
ed G
FS N
et O
pera
ting
Bala
nce
Bal
ance
or s
urpl
us
Gen
eral
gov
ernm
ent
1999
-200
0 SA
A
ccru
al-b
ased
GFS
Net
Len
ding
/ Bor
row
ing
(exc
ludi
ng d
epre
ciat
ion
effe
cts)
B
alan
ce o
r sur
plus
(e
xclu
ding
de
prec
iatio
n)
Gen
eral
gov
ernm
ent
2002
-03
WA
A
ccru
al-b
ased
G
FS N
et O
pera
ting
Bala
nce
Surp
lus
Gen
eral
gov
ernm
ent
and
tota
l pub
lic
2000
-01
179
Cha
pter
6: C
ompl
ianc
e an
d Pu
blic
Cap
ital F
orm
atio
n
Tab
le 6
.2 B
udge
tary
bal
ance
fisc
al o
utco
mes
(gen
eral
gov
ernm
ent s
ecto
r)
1998
-99
1999
-200
0 20
00-0
1 20
01-0
2 20
02-0
3 20
03-0
4 Ju
risd
ictio
n A
ccru
al-b
ased
GF
S N
et L
endi
ng(+
)/ B
orro
win
g(-)
($m
) C
omm
onw
ealth
4,
717
11,8
145,
836
-3,5
156,
391
6,40
6 N
SW
-13
1,43
166
7 56
963
86
SA (e
xclu
des
depr
ecia
tion)
814
860
A
ccru
al-b
ased
GF
S N
et O
pera
ting
Bal
ance
Q
ueen
slan
d
1,
062
-856
-8
9517
3,33
7 W
A
200
229
289
832
G
PFR
Ope
ratin
g Su
rplu
s (+)
/Def
icit(
-)
VIC
12
17.1
27
3.4
235.
999
0.1
Sour
ces:
AB
S C
atal
ogue
551
2.0
Gov
ernm
ent F
inan
ce S
tatis
tics 2
004-
05, V
icto
rian
Gov
ernm
ent (
2001
b), (
2002
b), (
2003
b) a
nd (2
004)
N
ote:
Sha
ded
area
s ind
icat
e th
at th
is ti
me
perio
d is
prio
r to
adop
tion
of fi
scal
pol
icy
rule
s.
180
Chapter 6: Compliance and Public Capital Formation
The Commonwealth Government met its budgetary balance target of positive GFS
Net Lending/Borrowing in each year except 2001-02. The New South Wales
Government met its budgetary balance target of positive GFS Net Lending/Borrowing
from 1999-2000, failing to meet the target only in 1998-99. The Victorian
Government met its target of a GPFR Operating Surplus of at least $100 million per
annum from 2000-01 in every year. The Queensland Government attained its target
of positive GFS Net Operating Balance in 1999-2000, 2002-03 and 2003-04. It did
not attain positive GFS Net Operating Balance in 2000-01 and 2001-02. The South
Australian Government attained its target in 2002-03 and 2003-04 of positive GFS
Net Lending (excluding depreciation). The Western Australian Government met its
target of positive GFS Net Operating Balance from 2000-01 onwards.
Thus the Commonwealth and New South Wales Governments complied with their
budgetary balance fiscal policy rules in five of six years, both failing to comply once.
The Victorian and Western Australian Governments complied in each of four years.
The Queensland Government complied in three of five years, failing twice. The
South Australian Government complied in each of the two years examined.
The Commonwealth and New South Wales Governments each failed to meet their
targets in only one year and the Queensland Government failed to meet its target in
two consecutive years. This is a total of four failures, compared with 23 years of
being able to comply. The success rate of all governments is 23 of 27 or 85 per cent.
The success rate of State governments is 18 of 21 or 86 per cent. On balance,
governments have mostly, though not always, met the constraints self-imposed by
adoption of budgetary balance fiscal policy rules.
As stated in Section 3.2.1, no formal penalties attach to non-compliance with fiscal
181
Chapter 6: Compliance and Public Capital Formation
policy rules adopted by Australian governments although persistent failures to comply
would have the potential to generate criticism of the relevant government and could
contribute to a downgrading of their credit rating.
6.2.2 Net worth rules
Information contained in Chapters 3 and 4 is reproduced below in summary form,
since this forms a basis for comparison of ex-post fiscal outcomes in order to
determine the extent of compliance with net worth fiscal policy rules.
Table 6.3 summarises the measures used by governments to report their fiscal
outcomes relevant to net worth fiscal policy rules. The information is presented for
the Commonwealth, New South Wales, Victorian, Queensland and Western
Australian Governments. It is considered that the South Australian and Tasmanian
Governments did not adopt net worth fiscal policy rules, as defined for purposes of
this study (see Section 4.3), as neither adopted sufficiently authoritative means of
ensuring their longevity.
Table 6.4 provides the relevant fiscal outcomes. Again, the data are presented in
nominal terms, in accordance with terms in which the fiscal policy rules were
formulated. The exception is New South Wales, where the target was defined in real
terms (see Section 4.3.2). Accordingly, the New South Wales data have been deflated
by application of an implicit price deflator. The data again are accrual-based as only
accrual-based reporting frameworks can provide a comprehensive measure of net
worth (as described in Section 3.4.3).
182
Cha
pter
6: C
ompl
ianc
e an
d Pu
blic
Cap
ital F
orm
atio
n
Tab
le 6
.3 M
easu
rem
ent o
f net
wor
th fi
scal
pol
icy
rule
s
Juri
sdic
tion
Mea
sure
ado
pted
T
arge
t R
elev
ant S
ecto
r
Dat
e of
ado
ptio
n C
omm
onw
ealth
GFS
Net
Wor
th
Posi
tive
rate
of c
hang
e ov
er th
e m
ediu
m
to lo
ng te
rm
Gen
eral
gov
ernm
ent
1999
-200
0
NSW
G
PFR
Net
Ass
ets
Posi
tive
rate
of c
hang
e (in
real
term
s)
Gen
eral
gov
ernm
ent
1996
-97
Vic
toria
G
PFR
Net
Ass
ets
Incr
ease
of $
100M
per
ann
um
Gen
eral
gov
ernm
ent
2000
-01
Que
ensl
and
GFS
Net
Wor
th
Posi
tive
rate
of c
hang
e To
tal p
ublic
19
99-2
000
WA
G
FS N
et W
orth
Po
sitiv
e ra
te o
f cha
nge
Tota
l pub
lic
2000
-01
Tab
le 6
.4 N
et w
orth
fisc
al o
utco
mes
1996
-97
1997
-98
1998
-99
1999
-200
0 20
00-0
1 20
01-0
2 20
02-0
3 20
03-0
4 Ju
risd
ictio
n G
FS
Net
Wor
th (g
ener
al g
over
nmen
t) ($
m)
Com
mon
wea
lth
-31,
348
-40,
776
-42,
664
-44,
369
-47,
162
-30,
322
G
FS
Net
Wor
th (t
otal
pub
lic) (
$m)
Que
ensl
and
58,4
68
57,7
7557
,623
58,0
9264
,891
77,7
24W
A
31,6
9132
,197
35,9
9638
,016
43,7
47
GPF
R N
et A
sset
s (ge
nera
l gov
ernm
ent)
($m
) N
SW (n
omin
al)
22,9
5331
,288
34,8
9641
,204
43,8
2850
,337
54,6
5756
,601
NSW
(rea
l) 27
,390
36,8
0939
,121
45,7
8247
,484
53,2
1056
,059
56,6
01V
icto
ria
14
,619
16,5
7021
,845
23,6
0826
,279
Sour
ces:
AB
S C
atal
ogue
551
2.0
Gov
ernm
ent F
inan
ce S
tatis
tics 2
004-
05, V
icto
rian
Gov
ernm
ent (
2000
b), (
2001
b), (
2002
b), (
2003
b) a
nd (2
004)
, N
ew S
outh
Wal
es T
reas
ury
(199
9), N
ew S
outh
Wal
es G
over
nmen
t (19
97b)
, (19
97c)
, (1
999)
, (20
01b)
, (20
02b)
, (20
03) a
nd (2
004)
N
ote:
As t
arge
ts w
ere
defin
ed in
term
s of c
hang
e fr
om a
pre
viou
s per
iod,
whe
re a
vaila
ble,
the
rele
vant
mea
sure
for t
he p
erio
d im
med
iate
ly p
rior
to a
dopt
ion
of fi
scal
pol
icy
rule
s is m
ade
avai
labl
e (in
shad
ed se
ctio
ns) f
or c
ompa
rison
pur
pose
s. S
hade
d ar
eas t
hat d
o no
t con
tain
dat
a in
dica
te
that
this
tim
e pe
riod
prec
edes
the
rele
vant
per
iod.
183
Chapter 6: Compliance and Public Capital Formation
The data indicate that the Commonwealth Government attained its target of improving
GFS Net Worth, in the short to medium term, only in the last year of this period.
During the entire period, the Commonwealth Government’s net worth position was
negative. However, the absolute size of the negative net worth attained in the last
year was smaller than at the commencement of the period. The New South Wales
Government attained its target of improving GFS Net Worth in real terms throughout
the entire period. The Victorian Government attained its goal of increasing GPFR Net
Assets by at least $100M per annum for each year of the period. The Queensland
Government attained its goal of increasing GFS Net Worth only in the last three years
of the period studied. It did not attain this goal in 1999-2000 and 2000-01. The
Western Australian Government attained its target of maintenance or increase of GFS
Net Worth during each of the years since a net worth fiscal policy was adopted.
Thus the Commonwealth Government succeeded only in one of the five years
examined. The New South Government succeeded in each of the seven years for
which comparison is possible. The Victorian Government succeeded in each of four
years. The Queensland Government succeeded in three of five years. The Western
Australian Government succeeded in each of four years. In total, Australian
governments succeeded in meeting constraints imposed by net worth fiscal policy
rules in 19 of 25 instances, constituting a 76 per cent success rate. State governments
succeeded in 18 of 20 instances, constituting a 90 per cent success rate.
Overall, Australian governments enjoyed partial success in meeting net worth fiscal
policy rule targets. However, State governments on average enjoyed greater success.
184
Chapter 6: Compliance and Public Capital Formation
6.2.3 Net debt rules
Again, information provided in Chapters 3 and 4 is reproduced below as a basis for
comparison with ex-post fiscal outcomes. Table 6.5 summarises the measures used,
targets adopted, relevant sector and adoption dates for each government. The
Commonwealth, New South Wales, Victorian, Queensland and South Australian
Governments are included. It is not considered that the Western Australian or
Tasmanian Governments adopted a net debt fiscal policy rule (as described in Section
4.3). Table 6.6 provides the relevant fiscal outcomes.
185
Cha
pter
6: C
ompl
ianc
e an
d Pu
blic
Cap
ital F
orm
atio
n
Tab
le 6
.5 M
easu
rem
ent o
f net
deb
t fis
cal p
olic
y ru
les
Juri
sdic
tion
Mea
sure
ad
opte
d T
arge
t R
elev
ant S
ecto
r
Dat
e of
ado
ptio
n
Com
mon
wea
lthN
et D
ebt
1998
-99
to 1
999-
2000
red
uctio
n to
10
per c
ent G
DP
by 2
000-
01
Gen
eral
gov
ernm
ent
1998
-99
NSW
N
et D
ebt
Red
uctio
n
to a
‘sus
tain
able
leve
l’ by
200
4-05
and
elim
inat
ion
by 2
020
Gen
eral
gov
ernm
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1996
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Vic
toria
N
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Gen
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gov
ernm
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2000
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ensl
and
Net
Deb
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6.6
Net
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Net
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) 19
95-9
6 19
96-9
7 19
97-9
8 19
98-9
9 19
99-2
000
2000
-01
2001
-02
2002
-03
2003
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Com
mon
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82,9
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,928
54,4
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41,1
8935
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10
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,703
7,
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5,05
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toria
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2,16
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1,29
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399
Que
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512.
0 G
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4-05
N
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As t
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ts w
ere
defin
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term
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pre
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whe
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the
rele
vant
mea
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or c
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dat
a in
dica
te
that
this
tim
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prec
edes
the
rele
vant
per
iod.
186
Chapter 6: Compliance and Public Capital Formation
The Commonwealth Government achieved the targeted reduction of the ratio of
general government Net Debt to GDP ($752,434 in nominal terms in 2000-01 (ABS
Catalogue 5204 Australian System of National Accounts 2004-05)) to 10 per cent by
2000-01. It has continued to reduce Net Debt in each year since. While sustaining an
increase in Net Debt in two years (1996-97 and 1998-99) after adoption of a target of
reduction and eventual elimination, the New South Wales Government achieved its
target of reduced general government Net Debt over the entire period under scrutiny.
Further, it met its target of elimination of Net Debt by 2020 some 16 years early in
2003-04. The Victorian Government achieved the targeted reduction of general
government Net Debt in the first two years (2000-01 and 2001-02). Though it did not
reduce Net Debt thereafter, it met its target of maintaining a AAA credit rating
throughout the period. The Queensland Government achieved in every year its target
of non-positive Net Debt levels in the general government sector since adoption of
that target in 1999-2000. The South Australian Government achieved its target of
reducing Net Debt in each year of the relatively short period since adoption of that
target.
Thus the Commonwealth Government can be said to have succeeded in meeting its
net debt fiscal policy rule in each of the six years scrutinised. The New South Wales
Government succeeded in six of the eight years examined. The Victorian
Government attained two successes of four. The Queensland and South Australian
Governments succeeded in each of five and two years respectively.
Overall, Australian governments succeeded in 21 of 25 instances. This is an 84 per
cent success rate on an aggregated basis. State governments succeeded 15 of 19 times,
constituting a 79 per cent success rate.
187
Chapter 6: Compliance and Public Capital Formation
Australian governments have enjoyed a slightly greater level of success in meeting net
debt fiscal policy rule targets than net worth fiscal policy rule targets. This may be
related to adoption of accrual accounting and its provision of an improved information
set which has enabled recognition of the extent of accruing net debt liabilities such as
employee entitlements including superannuation. Alternatively, greater emphasis on
debt as a result of its importance in determination of credit ratings could be an
explanatory factor. Either of these factors could have lead to accumulation of
financial assets at the expense of public capital formation.
6.2.4 Summary
This section set out to determine the extent of apparent compliance by governments
with constraints self-imposed by their adoption of fiscal policy rules. Targets,
identified in Chapters 3 and 4, were compared with ex-post fiscal outcomes to
determine the extent of compliance. As discussed in Section 3.2.2, this should not be
taken as an indication of intentionality.
It was found that there is some occurrence of non-compliance with constraints
imposed by adoption of fiscal policy rules. This is probably related to the absence of
penalties for non-compliance with fiscal policy rules adopted by Australian
governments (as described in Section 3.2.1). However, the incidence of compliance
was found to be much greater than the incidence of non-compliance.
The degree of compliance varied with the type of fiscal policy rule. Australian
governments enjoyed an 85 per cent success rate with respect to budgetary balance
fiscal policy rules, a 76 per cent success rate with respect to net worth fiscal policy
rules and an 84 per cent success rate with respect to net debt fiscal policy rules. State
governments enjoyed an 86 per cent success rate in meeting budgetary balance fiscal
188
Chapter 6: Compliance and Public Capital Formation
policy rule targets, a 90 per cent success rate in meeting net worth fiscal policy rule
targets and a 79 per cent success rate in meeting net debt fiscal policy rule targets.
Hence, Australian governments were more successful in meeting budgetary balance
and net debt targets than net worth targets. Possible explanations include greater
awareness of the need to accrue financial assets to meet accruing non-debt liabilities
as a result of adoption of accrual-based financial reporting frameworks and a focus on
credit ratings.
However, State governments were most successful in meeting net worth targets,
almost as successful with meeting budgetary balance targets and somewhat less
successful in meeting net debt targets. This may reflect the starting net debt levels of
State governments, which were generally lower than those of the Commonwealth
government.
6.3 TRENDS IN PUBLIC CAPITAL FORMATION
The ratios of GFCF to GDP/GSP over the study period are displayed in Figure 6.1.
189
Chapter 6: Compliance and Public Capital Formation
Figure 6.1 Trends in the ratio of GFCF to GDP/GSP, by jurisdiction
0.00200.00250.00300.00350.00400.00450.00500.0055
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
CW Linear (CW)
0.005
0.007
0.009
0.011
0.013
0.015
1985
-86
1987
-88
1989
-90
1991
-92
1993
-94
1995
-96
1997
-98
1999
-00
2001
-02
NSW Linear (NSW )
0.006
0.007
0.008
0.009
0.010
0.011
0.012
0.013
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
V IC Linear (VIC)
0.0100.0120.0140.0160.0180.0200.0220.0240.0260.028
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
QLD Linear (QLD)
0.0050.0070.0090.0110.0130.0150.0170.0190.021
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
WA Linear (WA)
Source: ABS Catalogue 5206.0 National Income, Expenditure and Product Dec 2005 Note: GFCF and GDP/GSP are expressed in real per capita terms.
190
Chapter 6: Compliance and Public Capital Formation
It can be seen that the ratio generally fell over the period 1984-85 to 2003-04 for all
jurisdictions. This indicates that public capital formation has not increased as quickly
as GDP/GSP. As discussed in Section 3.5, under certain assumptions, this may
indicate that government service levels have decreased over time.
The data series included a structural break at the time of the shift from a cash-based to
an accrual-based financial reporting methodology. (Techniques used to overcome this
difficulty were described in Section 5.3.1.) While comparison of levels across
jurisdictions is not strictly valid, the ratio of public capital formation to economic
activity is sufficiently lower for the Commonwealth Government than for each of the
four State governments to justify a conclusion that this is not an artefact of these
techniques. Further, the lower level of public capital formation by the
Commonwealth, compared with the States, is in accordance with the generally lower
level of public capital formation by the Commonwealth Government than State
governments in Australia’s model of federalism (discussed in Section 5.3.1).
For completeness, each part of the ratio is further examined below. Figure 6.2 plots
the levels of real GFCF per capita over time. It indicates that the Victorian and
Queensland Governments have increased public capital formation in real terms per
capita over time while the Commonwealth, New South Wales and Western Australian
Governments have generally reduced public capital formation in real terms per capita.
Figure 6.3 presents levels of real GDP/GSP per capita. As can be expected, real
GDP/GSP per capita in all jurisdictions tended to rise during this period.
191
Chapter 6: Compliance and Public Capital Formation
Figure 6.2 GFCF over time, by jurisdiction
100.00
110.00
120.00
130.00
140.00
150.00
160.00
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
$
CW Linear (CW)
250.00
300.00
350.00
400.00
450.00
500.00
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
$
NSW Linear (NSW)
200.00
250.00
300.00
350.00
400.00
450.0019
84-8
5
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03V IC Linear (VIC)
300.00
400.00
500.00
600.00
700.00
800.00
900.00
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
QLD Linear (QLD)
300.00
350.00
400.00
450.00
500.00
550.00
600.00
650.00
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
WA Linear (WA)
Source: ABS Catalogue 5206.0 National Income, Expenditure and Product Dec 2005, ABS Catalogue 3105.0 Australian Historical Population Statistics 2005 Note: GFCF is expressed in real per capita terms.
192
Chapter 6: Compliance and Public Capital Formation
Figure 6.3 Levels of GDP/GSP, by jurisdiction
25000.00
30000.00
35000.00
40000.00
45000.00
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
CW
25000.00
30000.00
35000.00
40000.00
45000.00
1984
-85
1987
-88
1990
-91
1993
-94
1996
-97
1999
-00
2002
-03
$
NSW
25000.00
30000.00
35000.00
40000.00
45000.00
1984
-85
1987
-88
1990
-91
1993
-94
1996
-97
1999
-00
2002
-03
$
VIC
22000.00
27000.00
32000.00
37000.00
42000.00
1984
-85
1987
-88
1990
-91
1993
-94
1996
-97
1999
-00
2002
-03
$
QLD
25000.00
30000.00
35000.00
40000.00
45000.00
50000.00
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
$
WA
Source: ABS Catalogue 5206.0 National Income, Expenditure and Product Dec 2005 Note: GDP/GSP is expressed in real per capita terms.
193
Chapter 6: Compliance and Public Capital Formation
A closer examination reveals that rates of growth were similar for all jurisdictions
with the exception of Western Australia which outperformed the other jurisdictions.
GSP levels for Queensland were below the national level. Victorian levels were close
to the national level. Levels of GSP for New South Wales and Western Australia
were above the national level.
Analysis with a finer temporal focus is carried out in the following sections, focusing
on whether the adoption of net worth fiscal policy rules coincides with changes in the
rate of growth of public capital formation, or in its relationship with economic activity.
6.4 NON-DEPENDENCE OF POSITIVE GROWTH IN PUBLIC CAPITAL
FORMATION AND NET WORTH FISCAL POLICY RULES
The Chi-square method is used to investigate whether the following two qualitative
variables are statistically related : (1) occurrence of positive rates of growth of GFCF;
and (2) existence of a fiscal policy rule requiring maintenance or increase of net worth.
The technique can also be interpreted as indicating whether differences exist between
the two populations of observations (before and after the adoption of rules). Rejection
of the hypothesis of independence would suggest that adoption of the net worth fiscal
policy rules may have been associated with some changes in the way public capital
formation grew over time.
The test is non-parametric. The only technical requirement is that the minimum value
in any cell be 5. Sufficient data exist to meet this requirement when observations
pertaining to all jurisdictions are aggregated. To achieve aggregation, timelines are
normalised where:
194
Chapter 6: Compliance and Public Capital Formation
tk is the year of adoption of fiscal policy rules; and
tk-1 is the year before adoption of fiscal policy rules etc.
Observations for years comprising the interregnum were removed from the series.
This means that, for different jurisdictions, different numbers of observations were
dropped from the analysis.
The critical value of Chi-Square at the five per cent level of significance is 3.84.
Testing State jurisdictions only, the calculated value of the test statistic is 0.72;
therefore one cannot reject the null hypothesis of independence. That is, occurrence
of a positive rate of growth of GFCF is independent of the existence of a net worth
fiscal policy rule. In other words, no evidence has been found of an association
between (a) adoption of a net worth fiscal policy rule by State governments in
Australia and (b) whether public investment by State governments was likely to
increase each year.
Testing all jurisdictions (including the Commonwealth Government) produces a
calculated value of 0.576 and a similar conclusion. That is, based on this analysis, the
conclusion is that positive rates of growth of GFCF are not dependent on adoption of
a net worth rule by the Commonwealth and State governments in Australia. Use of
Yates’ correction for continuity yields lower calculated values and no change in the
basic conclusions (Sheskin (2004) page 502)
As a check on the effect of the interregnum approach, a non-interregnum model was
constructed where tk denotes the date of adoption of fiscal policy rules and no data
points are omitted, for both the State jurisdictions only and for all jurisdictions. The
calculated values of the test statistic are 0.639 for State jurisdictions only and 0.304
195
Chapter 6: Compliance and Public Capital Formation
for all jurisdictions. Consequently, tests of both models produce conclusions
consistent with those based on interregnum models.
The above conclusions have to be considered in light of limitations associated with
this aggregated approach. First, the fact that the analysis is carried out on all
jurisdictions simultaneously means that it can only provide an aggregated finding.
For example, if one jurisdiction had a very weak or non-existent relationship between
adoption of fiscal policy rules and public capital formation, this could be sufficient to
influence the overall finding for the aggregated analysis, even if a significant
relationship existed for the majority of jurisdictions. In particular, the New South
Wales Government does not appear to have increased the rate of public capital
formation after adopting a net worth fiscal policy rule. In this case, the limitation is
quite significant because of the small number of jurisdictions involved.
Perhaps more importantly, the technique focuses only on the conditional probability
that a positive rate of growth of GFCF will occur and does not take into account the
magnitude of such growth. Consider, for example, the hypothetical case where a
jurisdiction had been undertaking increases in public capital formation in every year,
then adopted a fiscal policy rule and proceeded to increase public capital formation
even faster than before. Under those circumstances, the current method of analysis
will not capture the essence of the change, because it can only focus on the fact that
public investment grew in every year before the adoption of policy rules, as well as in
every year after that event. More discriminating techniques are required to distinguish
between a positive-but-lower rate of growth from a positive-and-higher rate. Such
methods are implemented in Section 6.6 below.
196
Chapter 6: Compliance and Public Capital Formation
6.5 PROBABILITY OF INCREASED PUBLIC CAPITAL FORMATION
AFTER ADOPTION OF FISCAL POLICY RULES
A test of differences between population proportions is then performed to ascertain
whether a different proportion of positive instances of growth of GFCF occurred
before and after adoption of a net worth fiscal policy rule. Required conditions, on
which to base the assumption of normal distribution of the population proportion, are
that there be a large number of trials and that these trials be independent. A large
number of trials is again achieved by combining data for all jurisdictions. The clear
distinction between reporting periods again provides for independence between trials.
Again, due to differing adoption dates between jurisdictions, timelines are
standardised.
Using an interregnum model and examining State jurisdictions only, the calculated
value of the test statistic equals -0.86. Thus, one cannot reject the null hypothesis that
the proportion of “successes” after adoption of a net worth fiscal policy rule is the
same as the proportion of “successes” prior to adoption of this rule. That is, positive
rates of growth of GFCF occurred with essentially the same frequency before and
after existence of a fiscal policy rule requiring maintenance or increase of net worth.
Testing all jurisdictions produces a calculated test statistic of -0.759 and a similar
conclusion.
These results accord with the finding of the Chi-square test of independence carried
out in Section 6.4. The implication of these results is that, using these criteria, one
cannot find evidence that adoption of fiscal policy rules affected the likelihood that
public capital formation increased each year.
197
Chapter 6: Compliance and Public Capital Formation
However, the results must again be qualified by reference to the possibility that the
finding reached using aggregated data may not apply to some (or possibly many)
individual jurisdictions. The analysis in the next section will be carried out on a
jurisdiction-by-jurisdiction basis, providing findings for each government in turn and
a view of Commonwealth/ State differences. Another caveat is that the analytical
techniques used in this section view public capital formation and fiscal policy rules as
qualitative variables whose values can only be either Yes or No. Such an analysis
loses much of the information contained in available quantitative data, which can be
captured by the more sophisticated techniques to be employed next.
6.6 PARAMETRIC ESTIMATION OF FISCAL POLICY RULES
6.6.1 Fiscal policy rules and the relationship between public capital formation
and economic activity
Overview
To complement the qualitative-variable approach adopted in Sections 6.4 and 6.5, in
this section we turn to an approach that emphasises the numerical aspect of the
growth in public investment. Specifically, ordinary least squares methodology will be
carried out to ascertain the degree to which variations in economic activity and the
adoption of net worth fiscal policy rules explain variations in public capital formation.
This technique can potentially capture more details than the previous non-parametric
techniques. For example, suppose a government had increased public capital
formation by $1 million per annum prior to adoption of fiscal policy rules and by $1
billion per annum after adoption. While neither non-parametric technique would
recognise the difference, the regression technique described in the current section may
be able to do so.
198
Chapter 6: Compliance and Public Capital Formation
The current method involves regressing the natural log of GFCF on the natural log of
Gross Domestic/State Product, an intercept dummy variable and a slope dummy
variable. The economic variables are logged, as the investigation focuses on rates of
change. Transformation by taking natural logs provides a convenient measure of
these. Further, the relevant coefficient (β2) can be interpreted as an elasticity.
The underlying model is:
Y = A.Xβ1 (1a)
or
y = β0 + β1x (1b)
where:
y = the natural log of GFCF real per capita and
x = the natural log of real GDP/GSP per capita.
In regression (log-linear) format, and allowing for a structural break, this may be
expressed as follows:
y = β0 + β1x + β2FPR + β3M + ε (2)
where:
FPR = an intercept dummy variable, with a value of 1 when a fiscal policy
rule is in place and a value of 0 otherwise and
M = a slope dummy variable, being the product of FPR and x, and having
a value of 0 when no fiscal policy rule exists and the natural log of
real GDP/GSP per capita when a fiscal policy rule exists.
Τhus, β0 is the original intercept term, while β1 measures the elasticity of public
capital formation with respect to economic activity. Further, β2 measures the
proportional impact on the level of public capital formation of the imposition of a net
199
Chapter 6: Compliance and Public Capital Formation
worth fiscal policy rule. It indicates whether the level of GFCF increases at date of
adoption of rules and, if so, by how much. By contrast, β3 measures whether the
elasticity of public capital formation with respect to economic activity increases at
this date.
When a fiscal policy rule exists, Equation 2 becomes:
y = βo + β1x + β2 + β3x + ε = (βo + β2) + (β1 + β3)x + ε
in which the intercept term equals (β0 + β2) and the slope equals (β1 + β3).
When no fiscal policy rule exists, Equation 2 is simply:
y = β0 + β1x + ε
in which the intercept term equals β0 and the slope equals β1.
Following Pindyck and Rubinfeld (1992) and Seddighi et al (2000), such a
specification allows detection of changes in both the slope and intercept of the
regression line following adoption of net worth fiscal policy rules. In practice,
however, it is not useful to include all three regressors in one calculation due to the
presence of multicollinearity. High levels of correlation exist between the
multiplicative dummy and GDP/GSP (correlation coefficients in the order of .99 are
common). This can lead to spurious results of exceedingly high coefficients of
determination but low and unreliable t-statistics.
To address this problem, two separate regressions are carried out, thereby reducing
the severity of multicollinearity. The two models are:
y = (β0 + β2FPR) + β1x + ε (3)
y = β0 + (β1 + β3FPR)x + e (4)
200
Chapter 6: Compliance and Public Capital Formation
The key hypothesis to be tested using the first model is that β2 ≠ 0, that is, the level of
GFCF changes at adoption of a net worth fiscal policy rule. The hypothesis to be
tested using the second model is that β3 ≠ 0, that is, the elasticity of GFCF with
respect to GDP/GSP changes at adoption of a net worth fiscal policy rule. Tables 6.7
to 6.11 inclusive provide results for each jurisdiction.
Commonwealth Government results
Table 6.7 Commonwealth Government results
According to standard statistical tests, explanatory power of the models for the
Commonwealth Government is satisfactory (adjusted R2 is 0.79 for each) and the
models are deemed to be useful (p-value of the F-statistic is very close to zero for
each). Each independent variable is significant at the five per cent level of
significance (p-values are 0.00 and 0.01 for x, 0.04 for the level dummy variable and
0.04 for the slope dummy variable).
The estimate of β1 indicates that real public capital formation per capita increased by
about 1.4% when the level of economic activity increased by 1%. The coefficients of
both dummy variables are positive. It is not possible to determine whether it is more
accurate to say that the intercept or slope of the regression line increases. Instead, the
two separate regressions indicate that there is a significant and positive relationship
Independent variables Constant ln GDP
rpc FPR (level)
dummy Multiplicative (slope) dummy
Eqn
Adj R2
Prob (F-stat) Coef Prob Coef Prob Coef Prob Coef Prob
3 0.79 0.00 -9.90 0.04 1.39 0.00 0.30 0.04 4 0.79 0.00 -9.86 0.04 1.39 0.01 0.03 0.04
201
Chapter 6: Compliance and Public Capital Formation
between either the level or the output elasticity (or both) of public capital formation
and adoption of a net worth fiscal policy rule.
New South Wales Government results
Table 6.8 New South Wales Government results
For New South Wales, the explanatory power of the models is very poor (adjusted R2
equals 0.13 for each) and the models are not useful (p-value of the F-statistic is 0.14
for each). None of the independent variables are significant, even at the ten per cent
level of significance (p-values for x are 0.48 and 0.49, 0.99 for the level dummy
variable and 0.97 for the slope dummy variable).
As the results are of an interregnum model, the data series omits the anomalous
observation represented by the large negative value of GFCF for 1996-97. Thus the
data anomaly does not explain these results. Nor does the earlier analysis of
compliance provide an explanation. The New South Wales Government complied
with its net worth fiscal policy rule in each of the seven years examined, with its net
debt fiscal policy rule in six of eight years and with its budgetary balance fiscal policy
rule in five of six years. This compliance rate is not strikingly different from that of
any other jurisdiction. However, earlier discussion of net worth established that
increasing net worth does not necessarily imply increasing real assets. It is possible
that the New South Wales Government accumulated financial assets rather than real
assets. Such an outcome could explain both the New South Wales Government’s
Independent variables Constant ln GSP rpc FPR (level)
dummy Multiplicative (slope) dummy
Eqn
Adj R2
Prob (F-stat) Coef Prob Coef Prob Coef Prob Coef Prob
3 0.13 0.14 3.17 0.42 0.27 0.48 0.00 0.99 4 0.13 0.15 3.23 0.42 0.26 0.49 0.00 0.97
202
Chapter 6: Compliance and Public Capital Formation
success in compliance as well as these results.
Victorian Government results
Table 6.9 Victorian Government results
Independent variables Constant ln GSP rpc FPR (level)
dummy Multiplicative (slope) dummy
Eqn
Adj R2
Prob (F-stat)
Coef Prob Coef Prob Coef Prob Coef Prob
3 0.41 0.01 1.53 0.73 0.39 0.36 0.26 0.09 4 0.41 0.01 1.53 0.73 0.39 0.36 0.02 0.09
While explanatory power is not very high (adjusted R2 is 0.41 for each), the models
for the Victorian Government are considered sufficiently useful (p-value of the F-
statistic is 0.01 for each). The coefficients of both dummy variables are positive. At
the ten per cent level of significance, both the level and slope dummy variables are
significant with p-values of 0.09. These results support a conclusion that there is a
significant and positive relationship between either the level or the output elasticity
(or both) of public capital formation and adoption of a net worth fiscal policy rule by
the Victorian Government.
It does not appear, however, that there was a significant relationship between levels of
economic activity and public capital formation in Victoria. A possible explanation is
the financial arrangements adopted in Victoria where an infrastructure reserve was
established in 2000-01 as a source of funding for future capital acquisitions. This
would have negated the link between revenue-raising capacity arising from increased
economic activity and funding availability for capital acquisitions. Another possible
explanation is that GDP/GSP is merely standing in for a time trend, a possibility we
shall pursue in the next subsection.
Overall, the analysis supports a conclusion that real public capital formation per capita
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Chapter 6: Compliance and Public Capital Formation
either increased in level, or began to exhibit a positive relationship with GSP, or both,
when the Victorian Government adopted a net worth fiscal policy rule.
Queensland Government results
Table 6.10 Queensland Government results
Although the explanatory power of the models is not high (adjusted R2 is 0.36 for
both), the models are considered sufficiently useful (p-values of the F-statistic are
0.02 each). All independent variables are significant at the five per cent level of
significance (p-values are 0.02 and 0.03 for x, 0.01 for the level dummy variable and
0.01 for the slope dummy variable).
Surprisingly, the coefficient for x is negative (-1.37), suggesting that public capital
formation decreased when levels of economic activity increased. This unexpected
result warrants further investigation.
One possible explanation is a tendency by the Queensland Government to increase
accumulation of financial assets rather than real assets. Such a tendency could be
explained in terms of a decision to accumulate financial assets by which to meet
accruing non-debt liabilities such as employee entitlement (including superannuation)
liabilities. Both entitlement liabilities and GSP experienced rising trends during this
period. Thus, the negative coefficient might reflect a shift from real assets to
financial assets, at a time when the latter were growing rapidly to match growing
Independent variables Constant ln GSP rpc FPR (level)
dummy Multiplicative (slope) dummy
Eqn
Adj R2
Prob (F-stat) Coef Prob Coef Prob Coef Prob Coef Prob
3 0.36 0.02 20.09 0.00 -1.37 0.02 0.57 0.01 4 0.36 0.02 20.07 0.00 -1.37 0.03 0.05 0.01
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Chapter 6: Compliance and Public Capital Formation
liabilities. The unusually high level of negative net debt of the Queensland
Government (reported in Section 5.2.3) provides support for this line of thinking.
Coefficients for both dummy variables are positive. Again, the two regressions
indicate that there is a significant and positive relationship between either the level or
the output elasticity (or both) of public capital formation and adoption of a net worth
fiscal policy rule by the Queensland Government.
Western Australian Government results
Table 6.11 Western Australian Government results
Explanatory power is high (adjusted R2 is 0.65 and 0.64 respectively) and both models
for the Western Australian Government are useful (p-values of the F statistic are 0.00
in each case). All independent variables are strongly significant at the five per cent
level (p-values are 0.00 in all cases).
Similarly to the case of Queensland, the coefficient for x is negative (-1.32) indicating
that public capital formation and economic activity were inversely related in Western
Australia. A possible explanation for this, similarly to Queensland, is accumulation of
financial assets. While the Western Australian Government did not adopt a net debt
rule, it is possible that a focus on accumulation of financial assets to offset accruing
liabilities may have contributed to the negative relationship between public capital
Independent variables Constant ln GSP rpc FPR (level)
dummy Multiplicative (slope) dummy
Eqn
Adj R2
Prob (F-stat) Coef Prob Coef Prob Coef Prob Coef Prob
3 0.65 0.00 19.74 0.00 -1.32 0.00 0.48 0.00 4 0.64 0.00 19.75 0.00 -1.32 0.00 0.05 0.00
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Chapter 6: Compliance and Public Capital Formation
formation and economic activity. However, investigation of this is outside the scope
of this study.
The coefficients for both dummy variables are positive (0.48 for the level dummy and
0.05 for the slope dummy). Again, the two regressions indicate that there is a
significant, positive relationship between either the level or the output elasticity (or
both) of public capital formation and adoption of a net worth fiscal policy rule by the
Western Australian Government.
Summary of results and their significance
Most jurisdictions show a positive relationship between public capital formation and
adoption of net worth fiscal policy rule. Table 6.12 summarises these results.
Table 6.12 Summary of results
Relationship between ln GFCF rpc and Jurisdiction Constant Ln GDP/GSP Level dummy
variable Slope dummy variable
Commonwealth - + + + NSW Victoria + + Queensland + - + + WA + - + + Note: - indicates a significant, negative relationship, + indicates a significant, positive relationship, and a blank space indicates no significant relationship.
The models adopted are useful for all jurisdictions except New South Wales and were
particularly useful for the Commonwealth, Queensland and Western Australian
Governments. The investigated relationships between public capital formation and
adoption of net worth fiscal policy rules were significant at the five per cent level for
the Commonwealth, Queensland and Western Australian Governments and at the 10%
level for the Victorian Government. The only jurisdiction where this association was
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Chapter 6: Compliance and Public Capital Formation
not significant was New South Wales.
The relationship between economic growth and public capital formation was
significant and positive only for the Commonwealth Government. While significant,
the relationship was negative for the Queensland and Western Australian
Governments. The relationship was insignificant for the New South Wales and
Victorian Governments.
Overall, these results are consistent with the premise that adoption of fiscal policy
rules has coincided with changed governmental fiscal behaviour with respect to public
capital formation by a majority of the Australian governments examined. In particular,
public capital formation tended to increase, or became more responsive to changes in
GDP/GSP, after adoption of net worth fiscal policy rules.
These results could also be interpreted as providing support for the broader, implicit
assumption adopted in much of the literature (as described in Section 3.2.1) that fiscal
policy rules generally are effective in changing governmental behaviour. However, as
outlined in Section 3.2.2, intentionality or otherwise of compliance, where compliance
exists, with constraints imposed by fiscal policy rules, is not determinable in this
study.
Similar outcomes are found for the national and three sub-national jurisdictions
indicating that, when fiscal policy rules are adopted, level of government is not a good
predictor of outcomes. This implies that fiscal policy rules may be useful tools of
fiscal sustainability for all levels of government, including the local government level,
in the Australian and international contexts. However, the greater explanatory power
evident for the national level may indicate that a slightly different relationship exists
between public capital formation and levels of economic activity than exists at the
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Chapter 6: Compliance and Public Capital Formation
state level.
In addition, high levels of constant growth of public capital formation are found for
Queensland and Western Australia which are also the highest growth States. The
literature surveyed in Chapter 2, in particular Aschauer (1988) and (1989) and Otto
and Voss (1994), indicated correlation between high rates of public capital formation
and (lagged) economic growth.
These results must be considered in light of a number of qualifications. First, it is
recognised that the number of observations available for analysis is very small, with
consequences for both the degrees of freedom underlying the various statistical tests
and for the power of the tests. Second, the specifications assume constant variance of
the error term in the prior and post adoption periods. This is a fundamental
qualification, applying to all of these regressions. A priori, it could be expected that
the variance of the error term would decrease in the period following adoption of a net
worth fiscal policy rule, when the incidence of negative public investment is less
likely to occur. However, as previously discussed with respect to net worth, negative
investment in real assets may be offset by positive investment in financial assets
resulting in an overall increase in net worth. Thus, the assumption is not unacceptable.
Further, the validity of ordinary least squares regression methods relies on correctness
of the classical assumptions. Following Hill, Griffiths and Judge (2001), these are (a)
the expected value of the random error term e is zero (stationarity of the economic
variables); (b) the variance of e is constant (no heteroskedasticity); (c) uncorrelated
values of the dependent variable y, which has zero covariance, based on statistical
independence between values of the dependent variables (no serial correlation); and
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Chapter 6: Compliance and Public Capital Formation
(d) the independent variable x is not random and takes at least two different values.
Under these assumptions, least squares estimators b1 and b2 have the smallest variance
of all linear and unbiased estimators of β1 and β2. An additional option assumption,
that e is normally distributed, is sometimes made.
As previously discussed, collinearity has been minimised, though not fully removed,
by model specification. Heteroskedasticity can be diagnosed by visual inspection of a
scatter diagram of the error term plotted against the explanatory variable. Some
evidence of heteroskedasticity exists for both equations for the Commonwealth
Government. This suggests that the model will be estimated more precisely for lower
levels of economic activity than for higher levels. Evidence of heteroskedasticity
exists for the Victorian Government, suggesting that the model will be estimated less
precisely for lower levels of economic activity than for higher levels (as GFCF varies
more at low levels of GSP). No evidence of heteroskedasticity exists for the New
South Wales, Queensland or Western Australian Governments.
Visual inspection of graphed errors indicates the presence of positive autocorrelation
for the Commonwealth, New South Wales, Victorian and Queensland Governments.
Autocorrelation of the errors was not evident for the Western Australian Government.
Similar consequences for the least squares estimators as for heteroskedasticity apply.
Additionally, the question of non-stationarity, common in time series data, must be
addressed. There is a strong likelihood that both the main economic variables (real
GDP/GSP per capita and real GFCF per capita), in either level or log forms, are non-
stationary i.e. exhibit deterministic trends. The fact that real GDP/GSP per capita
grew over time, and real GFCF per capita exhibited a downward trend over time,
lends weight to this expectation. Following Gujarati (2006), popular methods by
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Chapter 6: Compliance and Public Capital Formation
which to diagnose non-stationarity are the use of either (augmented or unaugmented)
Dickey-Fuller unit root tests or the Box-Jenkins approach, based on visual inspection
of the correlogram. Should non-stationarity be detected, a unit root test is usually
applied to the residuals of an ordinary least squares regression carried out using the
non-stationary variables. If the residuals of that regression are found to be stationary
i.e. integrated of order 0, this indicates the existence of cointegration between the
economic variables. The significance of this is that the coefficients estimated by the
regression are said to represent long term equilibrium relationships between the
dependent and explanatory economic variables. Where cointegration is not found,
first differences of the economic variables may be used to detrend the series and
relationships estimated. However, the brevity of the time series used in this study
indicates that unit root tests are not suitable.
6.6.2 Fiscal policy rules and the relationship between public capital formation
and the passage of time
Overview
In this section, attention is focussed on the effects of the passing of time. Ordinary
least squares methodology is again used and GFCF is regressed on time, an intercept
dummy variable (which has a value of 1 when a fiscal policy rule is in place and a
value of 0 otherwise) and a slope dummy variable, which is the product of the fiscal
policy rules dummy variable and time. In such an analysis, a non-interregnum
approach is conceptually most appropriate as such an approach uses uninterrupted
time series data, although results obtained using an interregnum approach are also
presented for completeness.
As previously, the underlying model is initially considered in nonlinear form:
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Chapter 6: Compliance and Public Capital Formation
Y = A.eβ1.t (5a)
or
y = β0 + β1t (5b)
where:
y = the natural log of GFCF real per capita and
t = years from 1984-85 to 2003-04, designated by sequential
numbers 1 to 20.
In regression (log-linear) format, and again allowing for a structural break, this may
be expressed:
y = β0 + β1t + β2FPR + β3M2 + ε (6)
where:
FPR = an intercept dummy variable, with a value of 1 when a fiscal policy
rule is in place and 0 otherwise and
M2 = a slope dummy variable, being the product of FPR and t, and therefore
having a value of 0 when no fiscal policy rule is in place and the
sequential number of the year when a fiscal policy rule is in place.
Again, β0 is the original intercept term. β 1 measures the growth rate of public capital
formation before the adoption of fiscal rules. β 2 measures whether the level of public
capital formation increases at date of adoption of rules. β 3 measures whether the rate
of increase of public capital formation increases at that date.
When a fiscal policy rule is in place, Equation 6 is:
y = β0 + β1t + β2 + β3t + ε = (β0 + β2) + (β1 + β3)t + ε
in which the intercept term equals (β0 + β2 ) and (β1 + β3) measures the slope.
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Chapter 6: Compliance and Public Capital Formation
When no fiscal policy rule is in place, Equation 6 is simply:
y = β0 + β1t + ε
where β0 is the intercept term and β1 is the slope parameter.
For reasons analogous to those applying to the analyses carried out in Section 6.6.1,
two models are used. The models are specified (in log-linear format) as follows:
y = (β0 + β2FPR) + β1t + ε (7)
y = β0 + (β1 + β3FPR)t + e (8)
The key hypothesis to be tested using the first model is that β2 ≠ 0, that is, the level of
GFCF changes at the date of adoption of a net worth fiscal policy rule. The key
hypothesis to be tested using the second model is that β3 ≠ 0, that is, the rate of
increase of GFCF changes at that date.
Results
Table 6.13 provides results for all jurisdictions. As in Section 6.6.1, results for New
South Wales differ from those of the other jurisdictions. Both models are useful at the
five per cent level of significance for all jurisdictions except New South Wales, for
which the second model is useful at the ten per cent level of significance.
212
Cha
pter
6: C
ompl
ianc
e an
d Pu
blic
Cap
ital F
orm
atio
n
Tab
le 6
.13
Res
ults
of t
rend
ana
lysi
s
Inde
pend
ent v
aria
bles
C
onst
ant
Tre
nd
FPR
M
2 Ju
risd
ictio
n
Eqn
A
dj
R2
Prob
(F
st
at)
Coe
f Pr
ob
Coe
f Pr
ob
Coe
f Pr
ob
Coe
f Pr
ob
7 0.
85
0.00
4.
26
0.00
0
.03
.00
0.27
0.
01
Com
mon
wea
lth
8 0.
86
0.00
4.
27
0.00
0
.03
.00
0.02
0.
00
7 0.
12
0.16
5.
93
0.00
0
.00
.57
0.04
0.
59
NSW
8
0.19
0.
07
5.96
0.
00
-0.0
0 .8
9
0.
01
0.26
7
0.25
0.
04
5.62
0.
00
0.0
0 .9
4 0.
27
0.06
V
icto
ria
8 0.
27
0.03
5.
62
0.00
-0
.00
.97
0.02
0.
04
7 0.
39
0.01
6.
29
0.00
-0
.02
.10
0.45
0.
00
Que
ensl
and
8 0.
31
0.02
6.
29
0.00
-0
.02
.14
0.03
0.
01
7 0.
29
0.02
6.
18
0.00
-0
.02
.01
0.30
0.
01
WA
8
0.51
0.
00
6.27
0.
00
-0.0
3 .0
0
0.
03
0.00
213
Chapter 6: Compliance and Public Capital Formation
For the Commonwealth and Western Australian jurisdictions, explanatory power of
the model is high, with adjusted R2 above 0.8 for the Commonwealth and 0.51
(second model) for Western Australia. The first model is less useful for the Western
Australia Government, with an adjusted R2 of 0.29. Explanatory power for the New
South Wales, Victorian and Queensland Governments is lower, varying between 0.12
and 0.39.
There is a significant positive relationship between public investment and the passing
of time at the five per cent level of significance for the Commonwealth Government.
No significant relationship exists between public investment and the passing of time
for the New South Wales or Victorian Governments. There is a significant negative
relationship between public investment and the passing of time at the five per cent
level of significance for the Western Australian Government and at the ten per cent
level of significance for the Queensland Government.
Again, it is not possible to determine whether the intercept or the slope of the
regression line increases. Instead, the two separate regressions indicate that there is a
significant and positive relationship between either the level or rate of growth (or both)
of public capital formation and adoption of a net worth fiscal policy rule for the
Commonwealth, Queensland and Western Australian Governments (five per cent
level of significance) and the Victorian Government (ten per cent level of
significance). Again, no such significant relationship exists for the New South Wales
Government. These findings generally are in accordance with findings of Section
6.6.1. This was to be expected given the correlation between the passing of time and
increases in GDP/GSP51.
51 An interregnum model was also used with similar results. The passing of time is significant to growth of public capital formation for the Commonwealth, Queensland and Western Australian Governments. In addition, growth of public capital formation increases at adoption of net worth fiscal
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Chapter 6: Compliance and Public Capital Formation
Comparison of relationships between public capital formation, fiscal policy rules,
economic activity and passage of time
Adjusted R2 are compared in order to determine whether economic activity or
passing of time, with fiscal policy rules adoption, has greater explanatory power.
For the Commonwealth Government, the time trend model discussed in this section
provides larger adjusted R2 (0.85 and 0.86) than those (0.79 for each) for the
economic activity model, as discussed in Section 6.5. The opposite is found for the
Victorian and Western Australian Governments. Both models provide similar results
for the New South Wales and Queensland Governments. These results are not
surprising, given the fairly constant growth rates of real economic activity per capita
in all jurisdictions over time and the likely resulting strong correlation between the
trend and GDP/GSP.
6.7 VARIATION IN PUBLIC CAPITAL FORMATION AND FISCAL
POLICY RULES ADOPTION
This section discusses the flow of analysis of an event study, as described in Chapter
5, in the context of this study. Results are then presented.
6.7.1 Defining the event and outcome of interest
The event of interest is defined as the adoption of fiscal policy rules. The outcome
measured in this study is the fiscal measure specifically affected by adoption of a
policy rules in these jurisdictions. Passage of time is not significant for the New South Wales and Victorian Governments. Nor does growth of public capital formation increase at adoption of a net worth fiscal policy rule by the New South Wales Government. However, growth of public capital formation increases at adoption of a net worth fiscal policy rule by the Victorian Government.
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Chapter 6: Compliance and Public Capital Formation
fiscal policy rule. Hence, this event study measures the impact of adoption of a net
worth fiscal policy rule on public capital formation.
6.7.2 Identifying the period of examination
The period of examination is the period for which data is available. This is from
1984-85 to 2003-04. The period of examination includes examination of periods
surrounding the event and thus comprises three stages. These are the estimation
window, the event window and the post-event window. The estimation window and
post-event window are positioned in time by reference to the event window.
Following MacKinlay (1997), it is customary to define the event window to be larger
than the specific period in which fiscal policy rules were adopted. As discussed in
Section 5.3.2, the interregnum represents a transitional period between when
governmental behaviour may first have changed and the formal adoption of fiscal
policy rules. Thus the interregnum periods previously described are conceptually
consistent with the event window and are adopted for that purpose. Then the event
window is defined as extending from the beginning of the interregnum up to and
including the year of formal adoption of a net worth fiscal policy rule by each of the
jurisdictions examined. The estimation window is defined as the period prior to the
event window and is used to calculate normal outcomes. The post-event window
follows the event window and is used to calculate abnormal outcomes. Figure 6.4
diagrammatically presents the above timelines.
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Chapter 6: Compliance and Public Capital Formation
Figure 6.4 Event study timelines
(estimation window) (event window ) (post-event window)
T0 T1 T2 T3
Outcomes are indexed in event time using τ, with τ = T0 to τ = T1 indicating the
estimation window in normalised timelines, τ = T1 + 1 to τ = T2 representing the event
window and τ = T2 + 1 to τ = T3 describing the post-event window. While T0 and T3 are
the same for each jurisdiction, and represent 1984-85 and 2003-04 respectively, T1
and T2 vary between jurisdictions, in accordance with different commencement dates
and lengths of interregnum. The length of the estimation window is defined as L1 =
T1 – T0, the length of the event window is L2 = T2 – T1 and the length of the post-event
window is L3 = T3 – T2. Again, these lengths vary between jurisdictions.
6.7.3 Determining the selection criteria for inclusion in the study
This step is relevant to a study where measurement of abnormal outcomes relies on a
market return-type model and judgements have to be made as to the measure to be
used for market returns. As this study does not use this method of measuring
abnormal outcomes, the step is not necessary for this study.
6.7.4 Selecting a method for measuring normal and abnormal outcomes
Central to an event study is the measurement of normal and abnormal outcomes.
Again following MacKinlay, the normal outcome is defined as the expected outcome
without conditioning on the event taking place. In the context of an event study
measuring the impact on the price of a given security of an earnings announcement,
MacKinlay (1997) at page 15 states that:
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Chapter 6: Compliance and Public Capital Formation
“There are two common choices for modelling the normal return – the
constant mean return model where Xτ is a constant, and the market model
where Xτ is the market return. The constant mean return model … assumes
that the mean return of a given security is constant through time. The
market model assumes a stable linear relation between the market return
and the security return.”
An analogous constant mean model would assume that mean GFCF is constant over
time. However, this is not supported by perusal of the data series presented in
Section 6.3. While another analogue would be the rate of change in GFCF, this also
is not constant over time (see Section 6.3).
An analogous model to the market model is one in which a stable linear relationship is
assumed between public capital formation of a jurisdiction and the level of GDP/GSP.
This is also not supported by the empirical observation (presented in Section 6.3) that
public capital formation has comprised a decreasing proportion of GDP/GSP over
time. Nonetheless, a market-type model offers potential improvements over a
constant mean outcomes model by removing the portion of variation in GFCF related
to variation in levels of economic activity.
As a consequence, the model employed in this study is:
ln GFCF iτ = αi + β i ln GDP/GSPit + εit
E(εit) = 0
Var (εit) = σ2εi
where:
ln GFCFiτ is the period-t natural log of GFCF real per capita for jurisdiction i
218
Chapter 6: Compliance and Public Capital Formation
ln GD/SPiτ is the period-t natural log of GDP/GSP real per capita for
jurisdiction i
αi is the intercept term for jurisdiction i
βi is the slope parameter for jurisdiction i and
εit is the time period t disturbance term for jurisdiction i, with an expectation
of zero and variance σ2εi.
Under general conditions, ordinary least squares is used to produce consistent and
efficient estimators for the model parameters. This is based on assumptions that fiscal
outcomes are independent and normally distributed. MacKinlay (1997) notes that
while such an assumption is strong, it is empirically reasonable and therefore
generally does not lead to problems in practice, and that, in any case, the normal
outcome models are robust to deviations from the assumption. Estimation of the
market-type model is therefore based on ordinary least squares estimation of
parameters, for the ith jurisdiction in event time.
The abnormal return is the actual ex-post fiscal outcome (measured as the natural log
of real GFCF per capita) over the post-event window minus the normal or expected
outcome over the post-event window, estimated on an out-of-sample basis.
For jurisdiction i and event date τ, the abnormal return is:
ARiτ = Riτ – E(ln GFCF rpc iτ|Xτ)
where:
ARiτ is the abnormal return for time period τ for jurisdiction i,
Riτ is the actual ex-post return for time period τ for jurisdiction i,
E(ln GFCF rpc iτ|Xτ) is the expected, normal return for time period τ for
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Chapter 6: Compliance and Public Capital Formation
jurisdiction i, and
Xτ is the conditioning information (adoption of net worth fiscal policy rules)
for the normal return model.
6.7.5 Designing the testing framework for abnormal outcomes
The abnormal returns were tested using a framework of a null hypothesis that the
event has no impact on the distribution of fiscal outcomes and an alternative
hypothesis that this is untrue. Each abnormal outcome is thus a disturbance term of
the market model calculated on an out-of-sample basis. Given the assumptions, these
abnormal outcomes will be jointly normally distributed, with zero conditional mean
and conditional variance σ2(ARiτ).
This variance will constitute only disturbance variance and will not contain the usual
additional component of variance due to sampling error in αi and βi. Under H0, the
distribution of the sample abnormal outcome of a given observation in the event
window is ARiτ ~ (N(0, σ2(ARiτ))).
The abnormal outcome observations are considered separately. They are also
aggregated across time and jurisdictions in order to accommodate a multiple period
event window. Consideration on this basis enables overall inferences, regarding the
event of interest, to be drawn. Inferences about the cumulative abnormal outcomes
can also be drawn to test the null hypothesis. The sample variance measure from the
regression is an appropriate choice of estimator for the variance of the abnormal
returns. The null hypothesis is that abnormal returns are zero and the alternative
hypothesis is that this is not true. A finding that abnormal returns are zero would
indicate no change in growth of public capital formation following adoption of net
220
Chapter 6: Compliance and Public Capital Formation
worth fiscal policy rules.
Following MacKinlay (1997) and Patell (1976), the common approach is taken where
each abnormal return is standardized using an estimator of its standard deviation.
When standardised by division by the sample standard deviation, the resulting statistic
is approximately t-distributed, for degrees of freedom equal to the number of years in
the estimation period minus two. Due to the different dates of adoption of fiscal
policy rules and resulting different lengths of time series in the estimation window,
degrees of freedom differ between jurisdictions and for the individual and cumulative
tests, and thus are calculated separately for each jurisdiction and for each test. The
null hypothesis thus can be tested in the usual way, using a one-tailed (right-tailed)
test and decision rule to reject the null hypothesis when the calculated value of the test
statistic exceeds its critical value.
6.7.6 Results
Tables 6.14 and 6.15 respectively present calculated and critical values of the test
statistic, for both the interregnum and non-interregnum models.
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Chapter 6: Compliance and Public Capital Formation
Table 6.14 Calculated values of the test statistic used in event analyses
Table 6.15 Critical values of the test statistic used in event analyses
Interregnum model CW NSW VIC QLD WA
1997-98 68.36 1998-99 196.08
1999-2000 96.31 2000-01 3.53 103.43 13.61 8.00 2001-02 6.23 141.47 20.42 12.37 5.47 2002-03 10.77 180.61 25.82 5.54 4.31 2003-04 13.65 149.00 24.12 9.63 6.12
Cumulative value 17.09 353.49 40.62 20.57 11.95 Non-interregnum model
CW NSW VIC QLD WA 1994-95 42.06 1995-96 -11.12 1996-97 88.22 3.56 1997-98 37.10 5.59 3.68 1998-99 106.42 6.63 4.06
1999-2000 5.39 52.27 10.38 5.53 2000-01 3.34 56.13 -4.16 7.87 8.99 2001-02 5.90 76.78 16.51 7.15 6.15 2002-03 10.20 98.03 20.88 3.20 4.84 2003-04 12.92 80.87 19.50 5.57 6.88
Cumulative value 16.88 198.20 26.37 17.66 15.17
Interregnum model Item CW NSW VIC QLD WA
Degrees of freedom 13 8 14 10 11Individual abnormal returns Critical value of t 1.771 1.86 1.761 1.812 1.796
Degrees of freedom 73 98 62 94 89Cumulative abnormal returns Critical value of t 1.667 1.662 1.671 1.662 1.664
Non-interregnum model Item CW NSW VIC QLD WA
Degrees of freedom 13 10 14 13 13Individual abnormal returns Critical value of t 1.771 1.812 1.761 1.771 1.771
Degrees of freedom 73 118 62 118 103Cumulative abnormal returns Critical value of t 1.667 1.66 1.671 1.66 1.66
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Chapter 6: Compliance and Public Capital Formation
For the interregnum model, calculated values of the test statistic are higher than the
critical values for all cumulative abnormal returns and for all except two individual
abnormal returns. Thus, the interregnum model produces a decision to reject the null
hypothesis, implying that after adoption of fiscal policy rules the growth of public
capital formation was altered for all jurisdictions, both when measured by cumulative
returns and by individual returns.
For the non-interregnum cumulative returns model, the null hypothesis is rejected for
all jurisdictions. For the non-interregnum individual returns model, the null
hypothesis is rejected for all jurisdictions in all years except New South Wales in
1995-96 and Victoria in 2000-01.
These results illustrate a particular strength of the event study methodology (non-
interregnum model) in that the methodology enables identification of individual years
for which abnormal levels of GFCF occurred. These years were 1995-96 for the New
South Wales Government and 2000-01 for the Victorian Government. The New
South Wales Government in 1995-96 incurred a large negative value for GFCF due to
transfers of assets to local government authorities and devaluations, as discussed in
Section 4.3. Similarly, in 2000-01, the Victorian Government established a $1 billion
infrastructure reserve with the proceeds of a large budgetary surplus in the preceding
year and adopted fiscal policy rules prescribing the use of those funds. Each of these
occurrences could be expected to effect rates of public capital formation in an
abnormal manner. However, linear regressions carried out on an interregnum model
exclude these data points.
Overall, results of the event study methodology provide confirmation of the linear
regression results. These were that the regression models used were useful in
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explaining variations in growth of public capital formation by all jurisdictions except
the New South Wales Government and were of mixed usefulness in explaining
variations in growth of public capital formation by the Victorian Government.
Further, the event study methodology provides possible reasons for those findings.
The results imply that adoption of net worth fiscal policy rules has been associated
with a change in the growth of public capital formation by all jurisdictions in all years
except New South Wales in 1995-96 and Victoria in 2000-01.
6.8 CONCLUSION
6.8.1 Did governments comply with rules?
Perusal of fiscal aggregates indicates that governments have generally though not
always complied with fiscal constraints imposed on adoption of fiscal policy rules.
However, greater incidence of compliance was found than non-compliance.
Occurrence of non-compliance with constraints imposed by adoption of fiscal policy
rules is probably related to the absence of penalties for non-compliance with fiscal
policy rules adopted by Australian governments (as described in Section 3.2.1).
The degree of compliance varied with the type of fiscal policy rule, with constraints
imposed by net debt rules met more often than net worth and, in turn, budgetary
balance rules. Possible explanations for this include greater awareness of the need to
accrue financial assets to meet accruing non-debt liabilities after adoption of accrual-
based financial reporting frameworks. In the context of multiple influences on
governmental fiscal outcomes, intentionality is not ascertainable in this study.
6.8.2 Did public capital formation vary after adoption of rules?
Preliminary analyses in Sections 6.4 and 6.5 using cross-sectional time series data
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Chapter 6: Compliance and Public Capital Formation
indicate, firstly, that growth in public capital formation is independent of the existence
of a net worth fiscal policy rule. Secondly, analysis indicates that positive rates of
growth of GFCF occurred with the same frequency before and after existence of a net
worth fiscal policy rule.
More detailed analyses in Sections 6.6 and 6.7 provide an indication of individual
jurisdictional experiences, as well as numerical differences underlying the relevant
relationships. Regression analyses indicate that, at the time of adoption of fiscal
policy rules, there was an increase in the level, or growth rate, or output elasticity of
public capital formation (or a combination of these) in the Commonwealth, Victorian,
Queensland and Western Australian jurisdictions, but not in the New South Wales
jurisdiction.
For the Commonwealth Government, regression estimates indicate that real public
capital formation per capita increased by about 1.4% when the level of economic
activity increased by 1%. While it is not possible to determine whether it is more
accurate to say that the intercept or slope of the regression line increases, estimates
indicate that there is a significant and positive relationship between either the level or
the output elasticity (or both) of public capital formation and adoption of a net worth
fiscal policy rule.
These regression results contrast with those for the New South Wales Government.
For this jurisdiction, the explanatory power of the models is very poor and the models
are not useful, nore are any of the independent variables significant. This suggests
misspecification of some type, possibly because the New South Wales Government
accumulated financial rather than real assets during the period studied.
Victorian Government results support a conclusion that there is a significant and
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Chapter 6: Compliance and Public Capital Formation
positive relationship between either the level or the output elasticity (or both) of
public capital formation and adoption of a net worth fiscal policy rule. However,
results do not indicate a significant relationship between levels of economic activity
and public capital formation in Victoria. This may be due to differing infrastructure
financing arrangements adopted in Victoria.
For the Queensland Government, regression analysis indicates that there is a
significant and positive relationship between either the level or the output elasticity
(or both) of public capital formation and adoption of a net worth fiscal policy rule.
However, results indicate a significant, negative relationship between public capital
formation and economic activity, possibly because of a tendency by the Queensland
Government to increase accumulation of financial assets rather than real assets
(similarly to the case of the New South Wales Government).
Similarly to the case of Queensland, for the Western Australian Government, results
indicate that public capital formation and economic activity were inversely related,
again possibly because of greater accumulation of financial assets than real assets.
Results also indicate a significant, positive relationship between either the level or the
output elasticity (or both) of public capital formation and adoption of a net worth
fiscal policy rule by the Western Australian Government.
Comparison of relationships between public capital formation, fiscal policy rules,
economic activity and passage of time indicated that economic activity, with fiscal
policy rules adoption, has greater explanatory power or passing of time for the
Commonwealth Government. The opposite is found for the Victorian and Western
Australian Governments. Both models provide similar results for the New South
Wales and Queensland Governments. These results are not surprising in light of
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Chapter 6: Compliance and Public Capital Formation
observed fairly constant growth of real economic activity per capita in all jurisdictions
over time.
Event analysis confirms findings of the regression analysis, and further specifies the
years in which the New South Wales Government’s investment led to these results.
Event analysis also indicates why results for the Victorian Government require
acceptance of a higher level of significance for type II error than do other
governments, specifying a year in which results differed from all other years.
The finding of analyses at an individual jurisdictional level is that adoption of net
worth fiscal policy rules has coincided with changed rates of public capital formation.
The implication is that adoption of fiscal policy rules may have influenced
governmental decision-making pertaining to public capital formation. This is
significant when considered in the context of private production elasticities related to
public capital stocks and the resulting changes in levels of economic activity.
This chapter set out to ascertain what happened to public capital formation when
Australian governments adopted fiscal policy rules requiring maintenance or increase
of net worth. Scrutiny of fiscal measures provided conclusions that most
governments complied most of the time with the constraints imposed by those fiscal
policy rules. Application of inter-linking statistical inference and econometric
techniques provided further detail. Initial analyses indicated that when all
jurisdictions are considered together, there is limited evidence of changes in the rate
of public capital formation coinciding with adoption of net worth fiscal policy rules.
However, analysis of individual jurisdictions indicates that a main contributor to this
outcome may be the experience of the New South Wales, and to a lesser extent,
Victorian Governments. The New South Wales Government had a strikingly different
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Chapter 6: Compliance and Public Capital Formation
experience of public capital formation to that of the other governments. This was in
part due to its transfer of fixed capital to other levels of government and devaluation
of fixed capital. The Victorian Government had a slightly different experience, in
part due to arrangements adopted for financing infrastructure acquisitions. In general,
more sophisticated analysis indicated that rates of public capital formation increased
with adoption of net worth fiscal policy rules.
The findings differ by level and are generally stronger for the national jurisdiction
than for the state jurisdictions. It is possible that a more useful specification for state
governments would take into account the composition of those governments’ revenue
bases, specifically the extent to which state government revenues are sourced from
economic activity within the state and from the Commonwealth Government, revenue
for which in turn is linked with economic activity across all states.
These findings have some significance for the current state of understanding of the
usefulness of fiscal policy rules. Of further significance is the potential of these
findings for contribution to a new, more detailed treatment of government in
macroeconomic theory. An overarching theory of the effects of fiscal policy rules on
governmental fiscal behaviour is unavailable as mainstream macroeconomics does not
investigate determinants of government outlays in a detailed manner, the convention
being to treat them as exogenous. Analysis of public capital formation after adoption
of net worth fiscal policy rules therefore cannot draw upon an existing body of theory
and can neither validate nor invalidate such a body of theory.
This study attempts to mitigate the current treatment of government expenditures by
making findings regarding variations in public capital formation in the context of
fiscal policy rules adoption, without claiming causality between fiscal policy rules
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Chapter 6: Compliance and Public Capital Formation
adoption and those variations. The importance of pursuing such a line of
investigation can be inferred by reference to the developing literature on private
production elasticities to public capital formation, which is described in Chapter 2.
It is interesting to note that those jurisdictions experiencing increased growth of
public capital formation subsequent to adoption of fiscal policy rules also have
experienced higher growth rates than New South Wales. (While there is an obvious
problem of causation here, the very small (and declining) proportion of GDP/GSP
represented by GFCF means it is likely that this holds even with GFCF ‘stripped out’
of the GDP/GSP measures, though such analysis is beyond the scope of this study).
This is consistent with the findings of Aschauer (1988 and 1989) and Otto and Voss
(1994), described in Chapter 2, that public capital formation has a positive impact on
private sector production.
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Chapter 7: Conclusion
CHAPTER 7
CONCLUSION
7.1 INTRODUCTION
This study investigated whether public capital formation by five Australian
governments changed at the time of their adoption of net worth fiscal policy rules. In
order to investigate this, firstly the degree to which governments complied with the
constraints imposed on fiscal measures by adoption of fiscal policy rules was
ascertained (Chapter 6). Due to the simultaneous existence of multiple identifiable
influences on governmental fiscal outcomes, intentionality of compliance where
observed cannot be ascertained (see Chapter 3).
It was found that the examined governments experienced a high level of compliance
with fiscal constraints imposed by adoption of fiscal policy rules. Perusal of the
institutional arrangements surrounding rules adoption indicated that the absence of
penalties for non-compliance may have contributed to the occasional occurrences of
non-compliance.
The degree of compliance varied with the type of fiscal policy rule. Net debt rules
were more frequently met than were net worth rules and, in turn, budgetary balance
rules. This may be due to the significantly enhanced information set available to
governments after adoption of accrual-based financial reporting networks (described
in Chapter 4), allowing greater awareness of asset and liability aggregates at the time.
Another probable contributing factor was the significance attributed by governments
to their credit ratings and, in turn, the focus on net debt by credit ratings agencies in
assessing those ratings.
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Chapter 7: Conclusion
Attention was then focused on the experience of public capital formation and whether
it changed at the date of adoption of net worth fiscal policy rules. Preliminary non-
parametric analyses indicated that this was not so and that positive rates of growth of
public investment were not dependent on existence of a net worth fiscal policy rule.
Further, the frequency of occurrence of positive rates of growth of public investment
was unchanged in the periods before and after governments adopted a net worth fiscal
policy rule.
A variety of techniques, described in Chapter 5, were used to investigate the research
question. This strengthened the overall analysis by overlapping examination and
mitigated the weaknesses of individual tests. It also permitted different perspectives
to be brought to bear on the issue.
In Chapter 6, parametric techniques were used to provide a more detailed view,
providing an indication of individual jurisdictional experiences and estimating
numerical relationships. The Commonwealth, Victorian, Queensland and Western
Australian Governments increased the level, growth rate or output elasticity of their
investment when they adopted a fiscal policy rule requiring, at a minimum, that they
maintain their net worth. The New South Wales Government did not. Its investment
simply cannot be modeled in this way. This is in part because of its history of transfer
of fixed capital to other levels of government and of capital devaluations. The
Victorian Government’s results require acceptance of a higher level of significance
for type II error than do other governments. The Victorian Government’s investment
experience, while successfully modeled in this way, showed the effects of unique
infrastructure financing arrangements which weakened the relationship between
economic activity and investment. These findings are confirmed by event analysis
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Chapter 7: Conclusion
which also specifies the years in which the New South Wales and Victorian
Governments’ investment experiences led to these results.
Importantly, these findings imply that the usual macroeconomic assumption of
exogeneity of government expenditures may be too strong in circumstances where
governments have adopted such fiscal policy rules. Specifically, it becomes
necessary to review the general assumption, described in Chapter 2, that only certain
elements of government expenditures, those that are related to automatic stabilisers,
are business cycle dependent. The remainder of government expenditure, usually
considered to be independent of levels of economic activity, can no longer be
considered to be so when certain institutional arrangements, such as fiscal policy rules,
exist. Instead, constraints imposed by adoption of fiscal policy rules assume the
position of determining upper or lower bounds on certain fiscal measures. However,
Chapter 3 establishes that it is a complicating feature of reporting frameworks that
increases in net worth do not necessarily lead to increases in public investment but
can instead be achieved by increasing financial assets.
This is despite the absence of penalties of a financial or judicial nature. The examined
governments possibly incurred reputational penalties only. It is unclear whether these
penalties were sufficient to motivate the high rates of compliance that were observed.
This is of some significance to the ongoing exploration of the desirability of
discretionary versus rules-based fiscal policy regimes, since one of the assumed
detractions of fiscal policy regimes is their usual lack of enforceability. The findings
of this study provide an indication of the strength of reputational penalties alone.
These may not be limited to electoral effects but may also include credit market
effects via impacts on fiscal policy validity.
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Chapter 7: Conclusion
The level of government under consideration is also significant in the context of these
findings. The findings hold regardless of the level of government considered i.e.
whether it is a national or sub-national government under consideration. As
automatic stabilisers are generally seen to affect only national governments, because it
is generally the national level of government in a federal system that bears
responsibility for transfer payments and collects income-dependent taxes, it has
usually been considered that sub-national governments’ expenditures are less affected
by business cycle stages than are national governments. However, in Australia, there
is a strong correlation between State government revenues and the business cycle.
Thus it is shown that adoption of certain fiscal policy rules may in part generate a
transmission mechanism between levels of economic activity and levels of
governmental outlays. Further, this appears to be unrelated to the stringency of any
penalties incurred by non-compliance with adopted fiscal policy rules.
This is significant because it indicates the potential of institutional arrangements to
foster sustainable fiscal policymaking. It is possible that the potency of the potential
sanctions imposable by the credit markets in the form of risk premia on public debt, as
well as the potential electoral impact, are the key causes of the findings of this study.
Therefore, consideration of the totality of institutional conditions should be made
before any decision is taken to adopt fiscal policy rules. In particular, when
international agencies such as the International Monetary Fund recommend fiscal
policy rules adoption to governments who are potential recipients of financial aid,
consideration of such issues should be a part of any assessment of the likely
enforceability and thus efficacy of fiscal policy rules.
Further, consistent with the literature on supply-side effects of public capital
233
Chapter 7: Conclusion
formation, the jurisdictions experiencing increased growth of public capital formation
subsequent to adoption of fiscal policy rules are those which have experienced higher
growth rates than other jurisdictions. While this study does not extend to an
exploration of the existence and nature of a relationship between public capital
formation and economic growth, such further research is recommended in the
following section. This is because of the potential significance particularly for
governments of developing nations, which typically face continual constraints on
expenditure, placing a premium on optimising expenditure decisions as they attempt
to improve the living standards of their populations.
7.2 RESEARCH DIRECTIONS
This study suffers from data deficiencies. Due to the relatively recent adoption of
accrual-based reporting methodologies, it was necessary to transform accrual data into
cash-based equivalencies and splice the two datasets to create a series sufficiently
long to enable econometric analysis. As a result, the results must be interpreted with
caution. In particular, findings cannot be considered to represent e.g. levels of public
capital formation although trends and change are ascertainable. In addition, the
transformation introduces unavoidable difficulties, being reliant for its validity on the
proposition that certain elements of public capital formation, recognizable under an
accrual-based methodology, comprised a similarly negligible proportion of total
public capital formation before and after the dates of adoption of accrual-based
methodologies. A longer accrual-based data series would provide a greater level of
comfort with respect both to the transformation and for econometric analysis
generally. Hence, a study completed after the passage of some time would provide
greater analytical reliability than is possible to achieve in this study.
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Chapter 7: Conclusion
This study does not extend to an exploration of the impacts of increased public capital
formation on economic growth. However, the study identified that the high-growth
states (Queensland and Western Australia) experienced increases in the level or rate
of growth of public investment, while the low-growth state of New South Wales did
not, and the low-growth state of Victoria did but to a lesser extent. This is an
accordance with Aschauer (1988 and 1989) and Otto and Voss (1994) who
determined that public capital formation has a positive impact on private sector
production. In particular, Otto and Voss (1994) used Australian data, albeit at the
national level. No study has yet been carried out at the state level in Australia. An
obvious direction for subsequent research is to carry out such an analysis at the state
level for the above states.
In Chapter 6, it was pointed out that, due to the simultaneous existence of multiple
identifiable influences on governmental fiscal outcomes, it is not possible to
determine with certainty the cause of the observed changes in fiscal behaviour. For
example, an information effect may exist i.e. improved information made available by
adoption of accrual-based reporting methodologies may have influenced
governments’ decision-making. Exploration of this issue may produce useful
information by which to inform decisions of governments still using cash-based
reporting methodologies.
Therefore, it would be useful to examine the impact of fiscal policy rules adoption in
jurisdictions, having similar institutional arrangements and fiscal circumstances as
Australia, such as New Zealand and Canada. Such studies could cast further light on
the likely causes of the Australian experience as well as providing a basis for
international comparison. For example, the level of compliance experienced could be
235
Chapter 7: Conclusion
considered in the light of any penal arrangements in order to provide an indication of
the effectiveness of reputational or other penalties. If public capital formation were
found to increase at the time of adoption of accrual-based financial reporting
frameworks rather than at the time of adoption of fiscal policy rules that focused on
net worth, it could be concluded that the information effect may outweigh the
reputational and credit market effects. This would substantially extend the current
level of awareness of the effects of fiscal policy rules adoption on public fiscal
outcomes.
Further, the integrated nature of the financial reporting methodologies (by which are
measured the financial aggregates upon which fiscal policy rules impose constraints)
means that increases in net worth can be achieved by increasing financial assets rather
than by increasing capital formation. The high rate of compliance with net debt rules
and the emphasis that the examined jurisdictions placed upon achieving favourable
credit ratings indicates that a relationship may exist between adoption of net debt
rules and the rate of financial assets accumulation or of debt retirement. A fruitful
line of enquiry could include exploration of the existence and nature of this
relationship.
236
Chapter 7: Conclusion
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