Victoria pins budget on property recovery

The Victorian Government yesterday released the State Budget for 2013-14, which included the following headlines:

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Operating surplus of $225 million in 2013-14.
Government infrastructure investment program of $6.1 billion in 2013‑14, including transformational investments in East West Link – Stage 1, the Port of Hastings, road, freight and public transport.
Delivering the new Bendigo, Monash Children’s and redeveloped Royal Victorian Eye and Ear Hospitals with $197 million in 2013-14 and more than $1 billion in total.
Additional $426 million in 2013-14 to Victoria’s hospitals and health system – $11.2 billion in total for acute health in 2013‑14.
Allocates $580 million in asset and output funding for the future of Victoria’s education system – $11.6 billion in total towards education in 2013‑14.
Gross State Product to grow by 2.25 per cent in 2013‑14, rising to 2.75 per cent over the medium term.
Net debt of 6.4 per cent of GSP in 2013‑14, falling to 5.4 per cent by the end of the forward estimates.

Reading the Budget Papers gives the impression that the Government is on the one hand making excuses for the state’s recent weakening financial performance, but at the same time providing assurances that the future will be better if re-elected.

For example, the Revenue chapter includes the below chart showing just how fortunate the previous Labor government was and how unlucky the incumbent Coalition Government has been. Whereas tax revenues grew at a higher rate than gross state product (GSP) in the five years to 2007-08, they have grown at a slower rate since.

A key reason for the divergence between tax revenues and GSP relates primarily to the previous boom in stamp duty receipts on the back of rising prices and turnover, and the more recent decline as both housing turnover and prices fell across Victoria. As shown in the next chart, the Victorian Government is heavily dependent on stamp duties, collecting a higher proportion relative to its population than any other state. As such, it is disproportionately affected by swings in property prices and volumes:

Going forward, however, the Victorian Treasury expects tax revenues to recover and grow at a faster rate than GSP (see next table).

A key driver of the projected growth in tax revenues is property-related taxes – namely stamp duties and land taxes – which are expected to grow strongly on the back of rising prices and transaction volumes:

The property market remains an important driver of Victoria’s taxation base, and the forecasts incorporate the expectation that it will recover from historically weak outcomes in recent years. There are signs that the market has begun to improve with sales volumes, auction clearance rates and house prices increasing since the end of 2012. Given the inherent uncertainty around turning points, the recovery is forecast to be relatively modest compared with previous cycles.

land tax revenue is expected to fall by 1.4 per cent in 2013‑14 following growth of 13.3 per cent in 2012‑13. This uneven pattern reflects the biennial land tax revaluation cycle and the disaggregation of land holdings. Growth is expected to average 8.2 per cent a year over the forward estimates;

land transfer duty is expected to grow by 9.1 per cent in 2013‑14. This follows two successive years of decline and captures improvements seen in Victoria’s property market since the end of 2012. Growth is expected to average 6.4 per cent a year over the forward estimates, in line with a return to trend economic growth.

Higher property prices have an immediate impact on the net result from transactions through increased collections of land transfer duty. At the same time, the value of the superannuation liability decreases, due to the increased value of property holdings in superannuation funds’ investment portfolios. In later years, higher property prices continue to raise land transfer duty and land tax revenues, while the previous reduction in superannuation liability reduces ongoing superannuation expenses. All of these increase the net result from transactions. Higher property transaction volumes increases land transfer duty receipts, leading to a rise in the net result from transactions.

Indeed, turning to the projections, you can see that stamp duty revenues are expected to grow solidly each and every year until 2016-17 (see next chart).

Land taxes are also expected to grow strongly on the back of rising values (note also the greater inherent stability of land taxes):

Personally, I think the Victorian Government is being overly optimistic about a housing-led recovery in tax receipts. As shown below, Department of Sustainability and Environment (DSE) data shows that housing transfers are still trending down, tracking at decade lows as at March 2013:

It’s also difficult to see prices and transaction volumes rising significantly with the number of mortgages across Victoria in decline, according to DSE data:

That said, the Budget does warn that the finances are highly exposed to the property market, with a 1% increase in property prices adding $45-$69 million to budget revenue over the forward estimates, and a 1% increase in transaction volumes adding $37-$50 million to the Budget revenue:

The analysis confirms that the fiscal impact of variations in economic variables can be significantly greater than indicated by the sum of each variable’s individual impact. This highlights the point that the relationship between economic parameters and fiscal aggregates is complex and heavily influenced by the specific nature and characteristics of a given economic shock. Such shocks affect Victoria’s fiscal position to varying degrees, but given the composition of Victoria’s revenue base, property‑related shocks are likely to have the largest impact on the fiscal situation.

As an aside, one wonders why the Victorian Government is not looking to move away from stamp duties on housing transfers to a broad-based land tax. Apart from their greater efficiency and equity, land taxes are inherently more stable (see above). They would also make infrastructure investments, like the East-West Link, self-funding, since any land value uplift brought about through increased infrastructure investment would be partly captured by the government via increased land tax receipts.

Elsewhere, the other main driver of the rebound in budget revenues is payroll taxes, which are expected grow steadily into the future, in line with past performance (see next chart).

The Treasury has based its Payroll Tax projections on the heroic assumption that the unemployment rate will trend downwards from 5.75% in 2012-13 to 5.0% in 2015-16. How it can make such an assumption as the broader economy heads over the mining investment cliff, commodity prices decline, and households continue to disleverage, is beyond me.

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