Posts in "Budget 2017/18"

Budget 2017/18: Should we repair the Budget? Or our Democracy?

Should the Government repair the Budget? Or should they repair our democracy?

Reading the 2017 Federal Budget papers may have led you to ask questions such as, ‘What does that mean?’ and ‘Are they kidding?’. One question it probably didn’t lead you to ask is: ‘Are democratic systems fundamentally flawed?’

Well, it turns out that the answer is: probably not. However, it is also probably the case that a country’s education level plays a vital role in the performance of their democracy.

Recently, Professor Bob Gregory delivered the Freebairn Lecture, a free guest lecture put on annually by the University of Melbourne and timed to coincide with the release of the Federal Budget. This year’s topic, fittingly, was federal fiscal policy in Australia – or, more specifically, the Federal Government’s alleged desire to ‘balance the budget’.

Professor Gregory reminded the audience that each Federal Treasurer since 2007 has valiantly pledged to achieve a budget surplus. But their plan was never to do it the easy way. They wouldn’t simply increase taxes, they would do the responsible thing and cut spending, while at the same time making the system fairer and more efficient.

We now know that none of them were able to achieve their goal, and it is unlikely that our current Treasurer will be around to claim credit for a future surplus either.

According to Professor Gregory, we should not be surprised.

A closer look at the Budget papers over this period reveals that while each Treasurer touted this plan to decrease spending rather than increase revenue, they intended to do the opposite. Over the past ten years, government spending has continued to increase, so any progress made on cutting down the deficit was brought about by increasing tax revenue.

The personal income tax system offers a convenient option for those in charge of fiscal policy. This is because of the slightly sinister-sounding phenomenon known as ‘bracket creep’, whereby tax revenue automatically increases as taxpayers move into higher brackets. Treasurers can take advantage of this to collect more revenue each year while claiming they haven’t increased taxes (because they haven’t increased the rates) and every now and then (usually before an election) they can even take credit for being the generous bloke who came along and ‘cut taxes’ by adjusting the brackets.

But while the increasing revenue from bracket creep helped their courageous cause, in each case the government hoped to further benefit from national income rising to an optimistically high rate of growth. Of course, governments don’t tell voters they are relying on hope and optimism to keep their promises. Instead they order public servants to calculate forecasts and then they show us a neat, official-looking graph. Tellingly, these forecasts are almost always wrong.  Whether you view this fact as the result of honest mistakes or as evidence of deliberate attempts to mislead the public depends on your own level of cynicism.

It would be unfair to put all the blame for these fiscal failures on the government. Forecasting is difficult to get right (although that is a reason to try and under-forecast, rather than over-forecast) and this is because there are many factors that influence fiscal outcomes besides the policy itself. Two notable problems the government has run into over this period are the worst global recession since the Depression, and the slowing economic growth of our most important trading partner, China. But this issue nonetheless throws up several interesting questions.

These include economic questions, such as whether it’s sustainable to rely so heavily on personal income tax, rather than other, more efficient (and therefore more predictable) taxes. Political questions, such as the question of what it might take for voters to accept an increase in the income tax rate – or, more to the point, an increase of the size that would allow governments to fund an apparently ever-increasing array of government services.

But perhaps the most interesting question is one a little more philosophical in nature: Is there something fundamentally wrong with democracy if politicians apparently feel the need to tell voters one thing while doing the exact opposite?

This question is part of a debate that is as old as Western civilisation. In the 4th century BCE, Plato argued that democracy is an unjust (and undesirable) system because it results in a society that is ruled by carnal desires. Democracy leads to a lack of authority which means that society isn’t organised according to rational design but is rather like an anarchic society where all that matters is what each person decides they want. This leads to Plato’s famous argument that society should be ruled by an elite group of ‘philosopher-kings’, who could be trusted to think things through before making decisions.

In a more contemporary work – a report called ‘The Crisis of Democracy: On the Governability of Democracies’ published in 1975 by a controversial organisation called the Trilateral Commission – a similar argument was put forth, this time with a modern context. The authors argued that as democratic decision-making became more prevalent during the 20th century, Western governments became increasingly overburdened with providing the services demanded by citizens, while at the same time their authority to use expert advice to make decisions was eroded.

Since the release of that report, the ‘crisis of democracy’ has been a popular topic in academia. But recently, it seems to have become popular outside of academia, as well.

Electoral results in the United States and parts of Europe have become a common source of worry, particularly among progressives and advocates of international trade. The well-publicised economic success of an authoritarian China has led some casual observers to question whether democracy is all it’s cracked up to be, as a relatively small group of technocrats appeared to lift 700 million people out of poverty. Then there was the shock of the ‘Brexit’ referendum result, while in Eastern Europe there was the democratically-sanctioned annexation of part of the Ukraine.

But when approaching this topic, it’s important to be clear about which question we are trying to answer. Two caveats are in order.

The question should not be, ‘Do we need to improve democracy in Australia (or any other democratic country)?’. In the real world, no system is perfect, so there are always ways to improve the mechanisms that determine how well a system works. In the case of democracy these mechanisms are institutions – the rules that prevent things such as corruption, lobbying and media manipulation from adversely affecting outcomes. That we can and should improve these institutions goes without saying.

Another question we might ask is if democracy is the most ethical system. An argument can be made that authoritarian systems are more efficient at improving a society’s wellbeing, but that democracy is the superior system because the ability of citizens to participate in decision-making is more important than the outcomes. Where one stands on this issue depends on their moral values.

Both of those questions are important, but the question that Plato and the Trilateral Commission report were addressing is arguably more important. From a practical point of view, why would we choose a democratic system over an authoritarian system?

The most obvious reason is that democracies are better able to prevent corruption. Provided that the aforementioned institutions are doing their job, democracy creates a level of accountability that doesn’t exist in authoritarian systems.

There are factors that provide some accountability in authoritarian systems: it’s possible that poor performance by a dictatorship will lead to a revolution, and a dictator’s own ego and desire for a positive legacy could drive them to at least appear to be doing a good job. But a well-functioning democracy will certainly be better at incentivising leaders to improve the wellbeing of their citizens (rather than focus on their own wellbeing, or the wellbeing of their friends and family).

A less obvious reason that democracies work better than authoritarian systems is that they can utilise a larger pool of cumulative knowledge.

Theoretically, a democratic government asks the opinion of an entire population before making any decision. But the information they receive amounts to more than just conventional knowledge (such as language and maths skills) and wisdom (knowledge gained from experience). Perhaps the most important information that democracies have at their disposal is local knowledge – a farmer in a rural town will likely have a better idea about the effect of a policy or the demand for a service in their town than a politician who spends most of their time in capital cities. This may explain why China, despite being authoritarian on-the-whole, holds direct elections at the local level.

The problem is that making the most of this informational advantage is not straightforward. Again, the role of institutions is clearly important, but a population’s education level also becomes crucial.

The level of education in this case refers to the rate of attainment, the level of attainment and the quality of the education received. When any of these attributes are lacking then a government is less able to rely on the information it gets, which means that the population is less able to rely on the government to make well-informed decisions.

The ability to read and perform basic statistical analysis is less likely to lead to worthwhile knowledge unless a voter knows how to ask the right research questions. Wisdom gained from experience is virtually useless if a voter is easily tricked by fallacies such as the ‘post hoc ergo propter hoc (correlation proves causation)’ fallacy. And local knowledge about the services a community requires is less useful unless a voter understands how to think about basic economic problems.

It follows, then, that the level of education is an important determinant of how well a democracy performs. This makes sense intuitively but it is worth investigating empirically, as well.

The Economist Intelligence Unit (EIU) releases a report each year which includes an index containing 167 countries called the ‘Democracy Index’. It rates countries according to a score based on answers to 60 questions covering five categories: electoral process and pluralism, civil liberties, functioning of government, political participation and political culture. If a country scores between 8 and 10 they are categorised as a ‘full democracy’, if they score between 6 and 8 they are a ‘flawed democracy’. A score below 6 indicates the country is either ‘authoritarian’ or a ‘hybrid regime’. (To learn more about how the index is compiled, check out this article.)

Finding a standardised measure for the education level of a population is more difficult. The best statistic to use is arguably tertiary (post-secondary) education attainment rate. This is certainly an imperfect measure, partly because each country measures this slightly differently, but also because there is likely a large difference between the education levels of, for example, someone with a Doctorate in Theoretical Physics and the holder of an Associate Degree in Business.

However, students who complete post-secondary education were likely required to demonstrate a greater ability to perform research and analysis than the average secondary school graduate. Furthermore, to complete the qualification, they require not only the ability to learn but also a certain amount of inquisitiveness.

The following graph plots 2016 Democracy Index scores for X countries against attainment rate data from the Organisation for Economic Cooperation and Development (OECD). As expected, it shows a positive relationship, indicating that a higher attainment rate is correlated with a higher level of ‘democratic performance’. (Note: the graph only includes countries that scored above 6 on the Democracy Index, so each of the countries included is categorised as a democracy.)

Democracy Graph

This graph doesn’t allow us to conclude that a higher attainment rate leads to better democratic performance. However, it does throw up some more interesting questions. For example, why is the United States categorised as a ‘flawed democracy’ by the Index despite having one of the highest attainment rates?

One explanation for this is that the Americans’ institutions are letting them down. Indeed, political scientist Francis Fukuyama has argued that the United States is an example of a country suffering from what he coined as ‘institutional decay’.

Another explanation is that the high attainment rate of the United States doesn’t reflect a high level of quality in the education Americans receive. It has been argued that the quality of American universities – long considered the world’s benchmark – has been declining in recent years. But it may also be the case that the quality at lower education levels is lacking. Surveys indicating that American literacy rates are below the OECD average suggests this is the case. (While a large immigrant population explains part of these results, a low rate for Black Americans is evidence that poor educational outcomes are also a significant part of the story.)

Australia enjoys a privileged position in the top 10 of the Index at number 6. However, the distance between our score and that of the impressively-rated number 1 Norway, which has a similar attainment rate, tells us that there is room for improvement.

One of the spending reduction measures in the 2017 Budget is a cut in university funding. If this cut leads to a lower attainment rate or a reduction in the quality of Australian universities then it would be a poor policy. However, the fact that the cut will be largely neutralised by an increase in tuition fees, which can be covered by the HECS-HELP loan scheme, means that both of those outcomes are unlikely (or at least that the effect will be minimal).

Alongside this policy is a proposal to direct more funding to disadvantaged secondary schools. There is a strong argument to be made that education funding at the secondary or early education level is more likely to increase the tertiary education attainment rate – particularly in Australia. Due to a largely merit-based system, access to university in Australia depends almost entirely on educational outcomes at the secondary level.

Furthermore, if a student enters university with a higher quality secondary-level education, then they are more likely to complete the degree, and they will probably get more out of the degree, as well. This would mean the end-result is not only a larger university-educated population, but also a smarter one.

If this occurs then it may be that as our tertiary education attainment rate increases, the quality of our democracy will move closer to Norway, rather than towards the United States.

Astronomer Carl Sagan is perhaps most famous for his efforts to popularise science. He believed that being human means living in a ‘demon-haunted world’, where our own irrationality makes us vulnerable to becoming a victim of potentially harmful things such as pseudoscience and superstition. In a brilliant interview recorded shortly before his death, he summed up his view on the importance of education with the following words:

“If we are not able to ask sceptical questions, to interrogate those who tell us that something is true, to be sceptical of those in authority, then we’re up for grabs for the next charlatan, political or religious, who comes ambling along … People [have] to be educated, and they [have] to practice their scepticism and their education. Otherwise, we don’t run the government, the government runs us.”

Budget 17/18: ScoMo’s Gift to the Retail Sector

There’s plenty in the 2017 budget for the struggling retail sector to be happy about.

The retail industry met Scott Morrison’s 2017 budget with a shrug and a lingering pout.

Retailers weren’t expecting much, which explains the shrug, but they were also hoping for something, hence the pout. Employer group aficionado Russell Zimmerman mustered the term “mixed bag” to described the apparent malaise, which is essentially the lobbyist equivalent of ‘move on… nothing to see here’. Myer CEO Richard Umbers was slightly more pointed, declaring that there is little in the papers to bolster ailing consumer fundamentals.

Perhaps the most entertaining part of ScoMo’s toils for retailers were the Treasury estimates for the domestic economy, which likely led to several extended laughing fits in Boardrooms. After all the idea that spending would pick up amid continuing wage stagnation and historic levels of household debt is a herculean effort of economic gymnastics that only Treasury could stick.

Nevertheless, it’s hard to blame retailers for wanting a bone, especially after retail figures for March left analysts warning that the sector is on the verge of recession. To top it all off international brands – which have been the subject of much taxation related discussion- are biting into the pie at record rates. That’s to say nothing of Amazon, the impending arrival of which has sent investment banks and their analysts into a frenzy, with several downgrades this month moving share prices into an even steeper downward spiral than is the trend.

But while it’s true that the retail sob story has merit, complaining about how a 0.5 per cent Medicare levy and hand-balled bank tax will hit consumer hip pockets is the type of short sighted quarter-to-quarter earnings nonsense that’s been leading retail’s downhill charge. Citi analyst Craig Woolford’s numbers peg the average benefit of the budget to households at $55 by 2018-19, which is nothing to write home about. But what’s harder to model and ultimately of greatest possible impact to retailers is the sizeable fiscal cannon the government has aimed at the country.

Under new plans the federal government will spend $75 billion over the decade on large scale infrastructure projects, including the long awaited inland rail and western Sydney airport developments. Aside from just turning over the macroeconomic engine, these projects will provide retailers with new trade opportunities in the medium to long term, particularly for large format retailers who have found it difficult to secure floor space in inner-urban areas.

Compounding that are housing affordability measures and their likely effect on dwelling starts, a key metric for anyone selling something that goes in a home, as well as investment in Melbourne’s northeastern and Sydney’s western suburbs.

To his credit Zimmerman welcomed the measures, alongside plans to return the budget to surplus -ever the optimist- but Umbers’ subsequent assertion is an ostensible admission that he doesn’t believe in animal spirits.

It’s no secret that developed economies, including Australia, are currently falling prey to economic stagnation, and irrespective of whether you’re willing to attach the term secular, it’s fairly rich to turn around and partly blame the “subdued” economic environment for a sales slide while saying that tens of billions in fiscal stimulus won’t help.

Those maintaining hope that the RBA will pull economic growth out of thin-air, even as record low interest rates continue to battle against persistently low inflation, are pining for the days of full employment and mining sourced returns. Indeed, retailers seem to enjoy maintaining hope for days long passed, having been slow to adapt to rapidly changing consumers in the last decade they are now paying the price of disruption. But, aside from taking a good look at taxation reform, there’s not much the government can do about continually compressing retail margins.

Like it or not international retail is here to stay and the relatively healthy margins Australians have enjoyed from our previously isolated pacific island are long gone, never to return.

The best the government can do is to act in the interests of Australia’s long term economic prosperity, which is what this infrastructure focused budget is shooting for. Prosperous consumers make for prosperous retailers, but which brands will enjoy that success is overwhelmingly a question for the Boardroom – not parliament house.

Fiscal Policy and Pickles for the Economic Potato


Budget talk can be nauseating but it is important. Understanding what all the fuss is about is even more important.

Some of you may not care for politics. Some of you may not care for economics. Naturally a lot of you don’t care about the Government’s yearly budget announced last week. Even if you’re the kind of person who would rather spend their Monday evening removing their own kidney with a blunt piece of cutlery than have to listen to a politician justify themselves on ABC’s Q&A; even if you’re the kind of person who thinks to negative gear has something to do with a car’s reverse function; politics, economics, and the budget affect you. It effects the type of society you live in, what you collectively choose to value, who deserves what, and what means are justified to achieve said ends. So, if this paragraph has got you walking toward the cutlery drawer, tracing an outline to locate your kidney whilst also kinda sorta making you want to know more, then this article is for you.

Politics is about conflicts in ideology. Economics is about the allocation of resources. Neither are black and white or good and bad. It’s very rare that people agree in all things politics and all things economics.This is why you will so often find yourself rolling your eyes at some of the pointless argy bargy in popular debate while you continue scrolling in the eternal search for the next fresh meme.

The truth is the world is in a bit of an economic pickle. What we’re experiencing is a sluggish hangover from the excessive largesse that came to a grinding halt around ten years ago. The most notable halt being the Global Financial Crisis (GFC) that revealed itself in the financial system as a result of excessive lending. The ripple effects are still showing themselves today. Europe is grappling with government debt issues that make ours look about as scary as a miniature dachshund puppy. While even China is staring down the Y-axis of slowing economic growth.

Australia itself avoided such a debt crisis in 2007-09 thanks to a healthy government surplus to the tune of $20 billion. This is no thanks to the oft-touted ‘fiscally conservative’ Howard-Costello era (the short one with the eyebrows and his tall mate). It instead had everything to do with Chinese demand for the stuff we dig up out of the ground. The International Monetary Fund have since pointed out that of the periods of excessive spending by Australian government 2003-07 take home the meat platter for fiscal profligacy. Feel free to use that the next time your conservative Liberal Party hack uncle tries to tell you “Howard was the best thing to ever happen to this country”.

As income earners we keep the economy ticking through our consumption habits and our saving habits. Large chunks of household saving is put back into the economy in the form of investment that naturally then goes to the pocket of someone else who in turn consumes, saves and/or invests. During economic pickles however the certainty that we can consume and invest in the same way we did previously goes out the window. Households and businesses tighten their belts and incidentally the pickle becomes even more ominous.

Enter fiscal policy. Fiscal policy is the tool of government that allows it to adjust its spending levels and tax rates so as to monitor and influence the nation’s economy. The role of fiscal policy during a time like we are currently seeing is to bring the economy back to producing at its optimum level.

In times of economic downturn fiscal policy is the hero that steps in to replace loss of economic activity. The government should not be tightening it’s belt as Abbott and Hockey circa 2013-14 would have us believe. Job creation through infrastructure spending like Turnbull’s $20 billion pledge for an inland railway in last week’s budget is fiscal stimulus designed to make us humble consumers feel more comfortable waving our credit cards around.

Overdo fiscal policy however and the public spending crowds out potential investment from the business sector. The Howard era did not necessarily overdo fiscal policy but they did rely too heavily on consumption trends that came from an increase in household debt. They most definitely relied too heavily on the possibility of the mining boom continuing on forever and ever.

Enter politics. It is very difficult politically to wind back spending. Even with amazing brains such as Ross Garnaut warning us that the economy would soon be entering the ‘Dog Days’, Howard had elections to win. It is even more difficult to wind back tax breaks given to wealthy people during times of economic largesse as they are often the source of political power. Instead it is easier to pretend the future looks bright.

In 2010 Julia Gillard was facing the beginning of the government ‘debt emergency’ narrative you might remember. Labor governments had spent the surplus inherited from the Howard government on fiscal stimulus and the opposition were out for blood. The mining boom was predictably coming to a grinding halt so the worst days were yet to come. And yet, Wayne Swan as treasurer in 2010 claimed a government surplus was just three years away.

At the time Swan had incorporated a new assumption into the budgetary estimates. It’s a built-in optimism generator that assumes a period of below-trend growth will always be followed by a period of above-trend growth. The idea was not so crazy at the time as it was based on real figures of the 1990s. Rainbows, sunshine, lollipops and a surplus-riding treasurer beaming with pride was only a few years away. Turnbull himself has branded this years budget as “Better days ahead”. This assumption, along with a plethora of other overly optimistic truth avoiding predictions has remained each year since and each year it has been wrong.

The risk of political failure sees successive treasurers using such flimsy assumptions to encourage our trust and improve their popularity. The result is optimistic fiscal policy that is handed down on a false promise of fruitful returns. This in turn means the level of government debt is here to stay with a hefty net interest payment of $13.4 billion this year alone. To put this in context this year the government is spending more on the interest accrued from its debt than it is on the pharmaceutical benefits scheme at $12.4 billion. So you see like so many things in life fiscal policy and the resultant government debt is neither good nor bad but depends entirely on contexts and forecasts for the future.

Policies like the medicare levy that put an emphasis on healthy people and healthy workers have good returns. Funding students based on their level of disadvantage creates structural security with a long-term vision. These examples of Turnbull’s vision are promising. Demonising the unemployed through mandatory drug testing for the sake of political fodder is not promising (not to mention hugely costly). Consistently schizoid attempts at housing reform to protect the wealthy from losing precious tax breaks through negative gearing and the capital gains tax concessions are not promising. Ignoring the threat of climate change so as not to upset industry is not promising. Ironically a carbon tax that puts a price on the pollution that is set to be hugely costly to Australians in the future could in fact be the kind of policy that sets meaningful budget reform on track. When politics is involved the need for truth is bumped by the need to appease those with power. Our political leaders have asked us to trust them but why should we?

Betrayal erodes trust and for younger generations especially there is little cause for trust and a lot of evidence of betrayal. Australia in its current situation is not facing the economic trauma of other parts of the advanced economic world. We are relatively safe. To stay safe however we need to trust that our future is in good hands. This requires the truth from both sides of politics. It requires an educated and economically literate voting polity. It requires our political leaders to leave their differences at the door and make some attempt to co-ordinate and deliver the politically difficult outcomes needed.

The future lies in the hands of millennials. The most educated and connected generation yet, millennials face a future of uncertainty never experienced by their elders. In this uncertainty though is a chance to explore the future of ideas, economics and politics and do it better than predecessors. A future that is less divided and not dictated by bullshit argy bargy. A future that instead faces hard truths and political difficulty. A future where articles about potatoes and pickles can only be about potato salad and not the economic security of Australians.

Budget 2017/18: Birmingham goes for Emerson 2.0

Birmingham goes for Emerson 2.0 – Trading off higher education spending for schools

Voters will be forgiven for thinking the Federal 2017 budget looked more ALP than LNP as the ghosts of Labor budgets past have been conjured up. The Gonski needs-based schools funding appeared dead after the Coalition’s 2014 budget, but like the good Lord it has been resurrected again three budgets later – now as ‘Gonski 2.0’. Savings to fund Gonski over the next four years have been found in higher education, a strategy hauntingly reminiscent of the Labor Government and then Minister Craig Emerson in 2013.

The budget context

In 2013 Craig Emerson as Tertiary Education Minister announced a 2 per cent efficiency dividend on universities recurrent teaching funding – the Commonwealth Grant Scheme (CGS) – which, alongside changing a student start-up scholarship into a loan, equated to $2.3 billion of savings. Yet for Emerson and the Gillard Government, the cuts were carried out for the best of causes: to help fund needs based schools funding policy. Alongside the new National Disabilities Insurance Scheme (NDIS) Gonski was a large expenditure commitment which put further pressure on a deteriorating Government budget.

Yet over the last decade revenue has not kept pace with spending, leaving what the boffins at the Parliamentary Budget Office (PBO) call a ‘structural budget deficit’ . Where controlling for cyclical fluctuation reveals recurrent government expenditure exceeds recurrent revenue. The revenue gap was in part due to the lower price of iron ore and coal and the end of the construction phase of the mining boom which dampened company tax receipts. The big factor though was the long-term erosion in the income tax base caused by large income tax cuts handed out by John Howard and Kevin Rudd. According to the PBO, these tax cuts account for two-thirds of the reduction in revenue between 2002-03 and 2011-12. Yet Labor also neglected to make the necessary but difficult decisions to increase the revenue base after the ‘salad days’ of high iron ore prices were over.

When the Coalition came back into power their 2014 budget strategy was to declare a budget emergency, cut public spending, and deny insufficient revenue was even an issue. As we all know, this resulted in perhaps the most scorned budget in living history. After a few years in the wilderness with an intransigent Senate and a leadership change, the Coalition has both toned down the rhetoric of ‘deficit and debt disasters’. More surprisingly, they have tentatively embraced the social spending of Labor, and have consolidated the NDIS putting forward a viable funding plan for Gonski 2.0. At the same time, it is still a political aspiration of both major parties to bring the budget back into surplus. The 2017 budget engages in substantial revenue raising measures, most notably the levy on big banks.

The budget papers reveal the $2.8 billion cut to higher education as the single biggest savings measure for the Government, and not far off the extra money assigned to Gonski 2.0 over the next four years. It is perhaps not surprising that, as Michael Sercombe has argued, cutting higher education funding is politically safe for the Coalition with only 22.6 per cent of Australians under 30 with bachelor degrees voting for the Coalition in the 2016 election. There are certainly other areas the Government could have looked to for savings. Some include; abandoning the commitment to cut corporate tax, as well as plugging up tax expenditures such as negative gearing, the 50 per cent capital gains tax discount, and superannuation tax concessions. Yet the Government remains committed to the corporate tax cuts, and are keenly aware at the electoral damage removing tax expenditures would cause them. Simon Birmingham, the Minister responsible for both schools and universities, has both had to find savings and find a way to fund Gonski 2.0. In doing so, he has engaged in a budget strategy we will call ‘Emerson 2.0’.

Emerson 2.0

Universities, students, and graduates have been called on to help offset some of the new funding towards Gonski 2.0, which adds $2.2 billion more to schools funding compared to the 2016 budget. The case for university cuts is assisted by a recent Deloitte report that was commissioned by the Government. The report found that university teaching costs per student in most university disciplines were less than the sum of the Commonwealth and student contribution that the universities received in revenue. As a result, universities have been dealt out a 2.5 per cent cut to their base funding in each of 2018 and 2019, and the Government will concurrently also reduce tuition subsidies for students by 7.5 per cent over the next four years. Alongside other measures, this will save the Government budget about $2.8 billion over the next four years in underlying cash terms.

The Government will allow universities to make up part of this reduction in the CGS with a gradual 1.8 per cent per annum rise in the maximum student contribution universities can charge students, amounting to a 7.5 per cent rise overall by 2021. The fee increase will see students paying between $700 and $3,900 more for their degrees by 2021. Holders of HELP debt will also begin repaying earlier, with a new repayment threshold to be set at $42,000, and crucially a lower starting rate of 1 per cent. For a graduate earning just above $42,000, this amounts to about a $400 annual repayment. Crucially, the indexation of the threshold will be changed from average weekly earnings (AWE) to the consumer price index (CPI).

The Government has consolidated support for the demand driven system, which has been under fire over the last few years amidst problems of worsening student retention, completion, and graduate underemployment. Demand driven funding will be extended to approved diploma, advanced diploma, and associate degree courses. The opaque system of postgraduate Commonwealth Supported Places (CSP) allocation, which favours the Group of Eight institutions, will be replaced by a student centred voucher system which allows students to take their voucher to any university of their choice.

The Higher Education Participation and Partnership Program (HEPPP), designed to build aspiration for higher education among disadvantaged students to improve their university outcomes, will be reformed and importantly enshrined in legislation. Alongside the efficiency dividend, the Government will quarantine 7.5 per cent of each university’s base funding to be put into a performance based funding pool, beginning in 2018. By 2019 a set of so far undecided performance benchmarks will help determine how much cash each university will be able to draw from the pool.

Efficiency dividends can hurt efficiency and performance funding can hurt performance

The best thing that can be said about the efficiency dividend to university base funding is that it really could have been worse. This budget officially abandons the so-called ‘zombie measures’ from the 2014 budget, which would have seen a 20 per cent cut alongside uncapped fees which the universities could use to make up the Commonwealth shortfall. Relative to 2014 this cut is smaller, and the sector can absorb some of the cut through the full fee international and postgraduate student market. The international student market has improved solidly after a slump in 2011. International enrolments are now growing faster than domestic, and international tuition fees made up nearly a fifth of total revenue for the sector in 2015.

Figure 1: Net operating balance for Australian universities in 2015

Figure 1: Net Operating Balance for Universities in 2015
Notes: This includes a number of one-off payments, and so overstates the extent to which recurrent revenue contributes to the net operating balance. Once these one-off payments have been accounted for more universities would be in deficit. Sources: Higher Education Finance, 2015

Figure 1 shows the net operating balance for universities in 2015. A significant few universities that struggle to attract international and postgraduate students already have budgetary issues, and the cuts will really hurt. They are likely to result in cutting academic and student support programs, which will ultimately affect the student experience. The cuts may also threaten the long-term financial health of universities. For instance, in their most recent audit of the sector in Victoria, the Victorian Auditor-General’s Office advised that, despite strong revenue growth, university investment in buildings and equipment was not keeping pace with the rate that current stock was depreciating.

The cuts also come just as the National Tertiary Education Union (NTEU) has entered the next round of enterprise bargaining with university administrations. The NTEU began the round aiming for a 15 per cent pay rise over the next four years, but the immanent cut to university budgets alongside slow wage growth across the economy puts a great constraint on their claims.

It is likely that the cut will be a catalyst for further staff cuts across the sector, and aggravate a trend towards the greater casualisation of the academic workforce. Since 2012 in full-time equivalent terms, the share of academic casual staff as a proportion of all academic staff has continued to rise, from 21 per cent in 2011 to 23 per cent in 2015. In full-time equivalent terms, between 2012 and 2015 an additional 1,759 casuals are now employed compared to just 1,260 extra full-time and fractional full-time academics. Casual staff are cheaper, and they can be hired and fired more easily. This helps universities manage volatile student demand, as well as uncertainty around Government funding. University balance sheets reflect this, with academic staff costs as a proportion of total expenditure continually declining since the introduction of the demand driven scheme, from 29.7 per cent in 2012, to 28.7 per cent in 2015.

The performance funding measures are yet to be developed, but caution is required. Performance funding can be counterproductive if incentives are not properly aligned to the real outcomes policy makers seek to achieve (see Goodhart’s Law). Performance funding may also be punitive to universities that may have poor student outcomes, through no fault of their own. Regional universities, universities which serve greater proportions of disadvantaged groups, or universities in areas experiencing poor economic times, will have very different natural performance benchmarks based on their unique missions. If these factors aren’t taken into account, performance funding is likely to be a Procrustean bed – cutting the funding out from universities that most need them. Furthermore, it is not obvious as to why future members of a university community – students, academics, and administrators – should be funded according to the performance of their predecessors. It is a good sign the Government has flagged both a long consultation period and a more tailored approach to devising performance benchmarks. Still, in the worst case scenario after combining the efficiency dividend and the loss of performance funding, some universities could lose up to 10 per cent of their recurrent funding over the next few years.

Higher student contributions are fair

In his budget reply speech, Bill Shorten rejected the Government’s fee increase measures declaring that, ‘a university is an opportunity you earn – not a privilege you inherit’. Yes, quite. Yet the data shows the opposite tends to prevail – universities are still predominantly occupied by the beneficiaries of inherited privilege. Since 1989 the proportion of low SES students attending university has remained the same at around 15 per cent, although the move to a demand driven system in 2012 led to an increase that has persisted. In the first half of 2016, only 16.6 per cent of all higher education students were from low SES postcodes.

While nobody likes to have to pay more for university, there is little evidence that higher fees would deter disadvantaged students. Despite fee hikes both in the United Kingdom, and here in 2005, the proportion of low SES students continues to grow. One reason higher fees have little effect on disadvantaged students has to do with the nature of the student loan scheme, which removes any up-front cost to studying, and protect loan holders against downside risk. HELP loans are income contingent, meaning repayments are only required above a certain income threshold.

Another reason is that, even if the Government completely removed the tuition subsidy and replaced it with student contributions, a university degree would likely still have substantial net financial and non-financial benefits. Compared to someone who has only finished Year 12, the median male graduate earns about $1.4 million more over their lifetime, and for the median female graduate nearly $1 million. Graduates are also much less likely to be unemployed, more likely to experience better health outcomes over their life, and are more likely to be employed in meaningful and secure jobs. Low participation amongst disadvantaged students is more likely driven by sociocultural rather than financial factors. Students from disadvantaged backgrounds require no up-front money to pay their fees, yet universities will only offer places to students deemed academically prepared. In a 2009 study using longitudinal survey of Australian youth (LSAY) data, Buly Cardak and Chris Ryan found that, after controlling for a student’s university entrance scores, university participation rates were approximately equivalent between students from different socioeconomic background.

What matters for getting into university is prior learning opportunities. To support this claim, I have gathered index of community socio-educational advantage (ICSEA) scores for Victorian senior secondary schools from the My School website. ICSEA measures a school’s educational advantage based on parent’s education and occupation, geographical location, and proportion of Indigenous students. I matched this against data from the Victorian Government’s On Track survey, which tracks the 2016 activity of Year 12 completers in 2015.

Figure 2 shows the plot of university participation rates and ICSEA scores for Victorian secondary schools. There is a strong relationship between a school’s ICSEA value in 2015 and the proportion of 2015 Year 12 completers that enrolled in bachelor degree in 2016. In some of the most disadvantaged schools less than a third of the Year 12 cohort go on to university, whereas in the most advantaged schools nearly the entire cohort does.

Figure 2: Victorian schools by ICSEA scores in 2015, and the proportion of 2015 Year 12 completers enrolled in higher education in 2016
Higher Ed ICSEA Correlation
Notes: Includes 389 schools in the analysis. The proportion of students enrolled in higher education also counts those that deferred their place in 2016. Sources: My School website; On Track (2016)

Parental education and occupation is also important. According to the Australian Bureau of Statistics (ABS) 2014 General Social Survey, 57 per cent of all people aged 18 to 70 that had a male parent with a bachelor degree or above, had a bachelor degree or above themselves. In contrast, only 25 per cent of the same age-brackets, except with a male parent with no post-school qualifications, had a bachelor degree or above. As figure 2 shows, 57 percent of 20-24-year-old people with parents in managerial or professional positions either had, or were studying, a bachelor degree or higher. In contrast this was only true of 20 per cent of the sons and daughters of machinery operators, drivers, and labourers.

Figure 3: Highest education attainment or enrolment of 20-24 year old’s by parent occupation 2014

HILDA Higher Ed

Notes: Original data taken from the 2015 HILDA survey. Sources: See Table 3 in Norton and Cakitaki (2016)

Lowering the repayment threshold

A lower repayment threshold makes the HELP system more sustainable over time, but it does throw into question the underlying philosophy behind the HELP scheme. One of the ticking time bombs in the budget is the HELP program. HELP loans have two main costs to the budget: first is an implicit subsidy on the borrowing costs students face, because HELP is indexed to CPI but the Government has to borrow the money it lends out at the market rate; second is debt not expected to be repaid (DNER). It was never intended in the design of the loan scheme that everyone would repay their HELP debt in full, yet as more people enter the HELP system the potential cost of HELP to the budget becomes much higher. According to recent Australian Tax Office figures, over 2.4 million people had nearly $48 billion in HELP loans remaining outstanding, and only 22 per cent of debtors made a repayment in 2013-14. The lower threshold will bring an estimated additional 183,000 HELP debt holders into the system. The architect of HELP, Bruce Chapman, has also argued that the lower threshold improves the case for expanding the demand driven system to include sub-bachelor places, the graduates of which typically earn much less than bachelor graduates.

Yet the new proposed threshold changes the philosophy of HELP as it is conventionally understood. HELP has traditionally been seen less as a loan, and more as an extra contribution graduates make once they begin earning incomes higher than the average Australian. The new threshold of $42,000 is nearly $5,000 below median earnings, which in 2014-15 was $46,854. While this is still substantially above the minimum wage, the policy discourse has changed to one of personal responsibility. Rather than insure graduates against the event of lower than average incomes, HELP is now being reimagined as insurance against financial hardship. Now it’s more a safety net than socioeconomic mobility insurance.

1.0 cheers for Emerson 2.0

As a strategy, Emerson 2.0 is probably the best of the worst options, or as the late Neville Wran would say, ‘a shit sandwich’. The cuts were probably expected by the sector, but they will still hurt, and are likely to affect the student experience over time. The shift to more performance based funding leaves room for concern on the specific details. Increasing the student contribution was probably the least damaging cut, and a better outcome may have been to increase the contribution further instead of an efficiency dividend. The lower repayment threshold will help the budget over the long run, but it also fundamentally changes the philosophy underlying HELP. In an ideal world there were better places to find savings to fund Gonski 2.0, including winding back corporate tax cuts, and removing tax expenditures. Yet given the political constraints Simon Birmingham faces, his Emerson 2.0 strategy deserves a single cheer.

Budget 17/18: Drug Testing Welfare, does it add up?

The federal government has announced, in their 2017 budget, plans to drug test welfare recipients and link payments to their test results. They plan to test 5,000 recipients as part of a trial. This includes the possibility of selecting areas for testing based on testing the sewerage of certain suburbs for traces of drugs.

A similar program in New Zealand over three years saw just 0.47% of tested welfare recipients failed the drug test. In 2015, New Zealand spent $1m testing 8001 people and 22 tested positive, a mere 0.27%. Similar programs have been run in various parts of the United States. In Missouri they spent $336,297USD in 2014 testing 446 of the 38,970 welfare applicants for drug use and 48 tested positive, a mere 1.1%. In 2015, 10 U.S. states spent a total of $850,909USD testing welfare recipients and found 321 positive cases out of 2,996, a total of 10.7% and one percentage point higher than the national drug use rate of 9.7% – although Kansas and North Carolina only apply tests to those under ‘reasonable suspicion’ of drug use and Maine tests those previously convicted of drug offences only. Utah, a state which does not base tests on suspicion or convictions, had only 18 of 460 test positively, less than half the national rate at 3.9%.

With positive results from drug testing payment recipients often turning out lower the national rate, it may be the case that those who are worse-off simply cannot afford to spend their incomes on much else besides necessities.The Prime Minister has stated that this policy is “doing them a favour”, and that “substance abuse and drug dependency have a high correlation with unemployment”. In his own words, “The lesson is: don’t do drugs”. While it is true that substance abuse and drug dependency have a high correlation with unemployment, it is not necessarily the case that drug use causes the user to be unemployed. It is perfectly believable that someone without work may be more likely to turn to substances due to their unhappy situation. As these programs have consistently cost more money than they have saved, as seen in both the United States and New Zealand, the question which arises is: why drug test welfare recipients at all?

If the government does not wish for people to engage in illegal activity such as using illicit drugs then perhaps they should randomly drug test all citizens and avoid targeting a particular, more vulnerable, group. If the government does not wish for people to use government support to engage in illegal activity then perhaps they ought to drug test and monitor pensioners, people who negatively gear, people in industries which receive subsidies or beneficial regulations, students and indeed politicians. Indeed, the government could test the sewerage of suburbs with high levels of pensioners or investment property owners. Of course these programs would also be likely to cost more to implement than they would save, so while they would be a net negative to the budget, perhaps they would enable the government to sleep more soundly at night knowing that less people are using government transfers to buy drugs.

When discussing his proposal and design for a negative income tax, economist Milton Friedman argued that the government should simply not waste administrative resources policing the activities of recipients of welfare. Ultimately targeting people on welfare may prove to be a popular move politically for the government, and although I believe it will be a net negative for the budget, they may push ahead with the program even as costs add up if what they are really paying for is votes.