In his 1993 book Men At Arms, Terry Pratchett told the story of a man who, not being able to afford the cost of a decent pair of boots, had to buy a cheap pair that quickly needed replacing. He could only afford to replace that pair with another cheap pair, which in turn soon needed replacing. Pratchett wrote:

“But the thing was that good boots lasted for years and years. A man who could afford fifty dollars had a pair of boots that’d still be keeping his feet dry in ten
years’ time, while the poor man who could only afford cheap boots would have spent a hundred dollars on boots in the same time and would still have wet feet.”

This is a story about how it is cheaper to be rich than to be poor and how, because of this, the rich get richer while the poor get poorer. The rich also live more comfortably because higher upfront costs, which are a barrier to entry for the poor, also buy greater value – not just long-term savings, but dry feet.

This should not be a surprise to anyone. Installing solar and insulating your home will work out cheaper over time and generate other forms of value, such as comfort and reduced carbon emissions. Similarly, housing closer to cities is less affordable but comes with far lower transportation costs for residents. Only those who can already afford the upfront costs get the savings benefits.

For individuals, this is a problem that need to be addressed. But as a country, this could also be seen as an opportunity. Australia is a rich country: we can spend money on things that we value, even where they will not represent savings. And we are certainly rich enough to make the kind of upfront investments that work out much cheaper over time and generate better outcomes.

However, the budget rules for governments across the country currently make this much harder than it needs to be.

The real cost and benefits of policy: second round fiscal effects

Prevention is better than a cure. It is also cheaper. When we think about how much governments in Australia spend on treating acute need – through health, justice, emergency services, environmental clean-up and regeneration, unemployment and other benefits – it is clear that policies that reduce demand for these services by preventing acute needs from arising in the first place would deliver both wellbeing improvements and a level of savings.

For some programs, these savings may offset the entire cost of the intervention. For others, it will reduce the overall cost and make it more affordable. Victoria’s Journey to Social Inclusion (J2SI) homelessness early intervention program was funded in part because of the savings it was forecasted to generate through reduced demand for services such as hospital stays: keeping people out of homelessness significantly improves their health outcomes. Funded through Victoria’s Early Intervention Investment Framework (EIIF), J2SI has reduced homelessness by 90 per cent and hospital bed-stays by 60 per cent, saving the Victorian Government more than the program costs to run.

In a recent Centre for Policy Development paper, Banking the Benefits, Toby Phillips and I refer to the effect of a reduction or increase in demand for government services caused by a policy intervention as “Second Round Fiscal Effects” (SRFEs). The term “second round” is used because they are not the original target of the intervention (in the above case, the target was reducing homelessness, and the reduction in hospital bed stays followed from that first target being achieved). “Fiscal” because it relates to direct savings or costs to government. These are different from second round economic effects: costs or benefits to the economy of reduced or increased economic activity or effects on prices.

SRFEs can be savings, where for example policies reduce the need for long-term unemployment or mental health support. They can also be costs. A policy might, for example, have long-term second round health impacts: say a transport policy increasing the rates of road accidents or air pollution, or a cut in benefits increasing the number of children living in poverty that has long-term negative impacts on their health outcomes. These are going to result in higher demand for health services that hit the government’s bottom line.

Second round fiscal effects could be a powerful factor in policymaking

 Straightforward logic suggests that where a proposal will result in second round fiscal consequences, and those consequences can be determined (and secured) with a high degree of certainty, these should be included in formal budget costings. However, you might be surprised to learn that this happens in no Australian jurisdiction other than Victoria.

Factoring SRFEs into budget costings not only improves fiscal sustainability, it also achieves better outcomes. As we argue in Banking the Benefits, not counting SRFEs presents a barrier to better policymaking at federal, state and territory levels in various ways.

First, it acts as a barrier to departments developing and proposing programs that have higher upfront costs but lower costs over their lifespan (for example, those that focus on early intervention or prevention). This is because departments need to find the funding for new policy proposals out of their existing budget. When the full upfront cost of an initiative (and only this upfront cost) is competing with a department’s existing work to meet current need, it makes it very hard to justify investing in preventative initiatives – even though investment in such policies would reduce future need.

Second, it makes it harder for governments to work in a joined-up way that encourages multi-agency policy development and avoids siloed decision-making. Better decisions are made when attention is paid to the broader impacts of policy proposals beyond portfolio areas, and the interconnected nature of many problems that governments face. For example, it is estimated that a third to over half of the difference in health outcomes is due to factors that lie outside of the healthcare sector, such as housing, socioeconomic status, education, social support networks and transportation.

However, the inability to “bank” SRFEs discourages departments from working together on cross-portfolio budget bids, particularly where the benefits from a policy enacted in one department would mostly accrue outside its direct portfolio. The department delivering the initiative will be hit with the full upfront cost, which it will have to find room for in their current budget, even though from a long-term whole-of-government point of view, the cost might be far less due to second round fiscal savings. A struggle over which department is responsible for funding initiatives with out-of-portfolio positive impacts will often kill initiatives, even where all the relevant departments agree on their value.

Third, failing to include second round fiscal costs under-represents the long-term expenses to government of some policy proposals. This is particularly the case when the costs generated by a policy enacted in one department would mostly accrue outside that portfolio. In addressing one problem, policies can sometimes generate negative wellbeing impacts in other areas. For example, cuts to child services can lead to increased demand for justice and unemployment services given that the negative impacts of growing up in disadvantage have effects across the lives of young people. Better representing the overall costs of policies provides governments with an accurate picture of how much a policy will actually cost over time, reducing the risk of unforeseen, under-weighted or un-costed second round fiscal outcomes. It will also incentivise actively looking for policies that produce fewer adverse second round outcomes.

Shifting to a long-term budgeting approach

Being cautious about changing budget rules is very reasonable. There is a risk in pre-banking savings that have not yet been realised. However, this practice is routine in business, and has also been shown to work within an Australian jurisdiction.

In 2021, the Victorian Department of Treasury and Finance (DTF) brought in EIIF. It was designed to use SRFEs to support investment in early intervention to stop problems from getting worse or becoming acute. For each proposed intervention, DTF represents the savings that the intervention will generate due to reduced demand for government services. These savings are then re-invested into EIIF, and each intervention is tracked to ensure that these projected savings are achieved. DTF applies a high level of caution to this process, only banking savings when it has high confidence that they will be realised. This has paid off: so far, only a single successful EIIF bid has not delivered its projected savings.

By focusing on fiscal effects, not economic effects, the rigour of estimating costs and savings in the long run is greater. Governments do try to capture economic effects where they can in business cases. And in advocating for policies of all sorts across the political spectrum, the practice of representing what a policy would mean in dollar terms for the economy is near ubiquitous. But economic effects are hard to estimate robustly. Causal connections between an intervention and an economic effect are difficult to make because there are so many things that influence the economy at any one time. Economic effects are not good candidates for inclusion in formal budget costings, and it is important to be clear on the distinction between these and SRFEs.

In “banking” fiscal effects, the guardrails must be high, particularly initially while the methodologies are established. There should be high evidence-based confidence that SRFEs will occur and can be calculated. Moreover, there should be mechanisms in place that enable SREFs to be tracked. Governments have a long way to go in improving the evaluation of policies once they have been funded (which is rare). Policy tracking would have the added benefit of building a greater evidence base of what works, and making sure that the initiatives our governments fund are effective.

A better approach is within our grasp

The case for banking second round fiscal effects is about what kind of government we want: a government that is built around the holistic, joined-up and long-term decision-making that effectively and efficiently delivers on what really matters to Australians – now and into the future.

The case is also simply a logical one. Governments are able to budget across a long horizon, and they should be taking advantage of the ability to invest now in order to save in the long term.

Where these calculations can be done well, our system should build them into the budget, and where they cannot yet be done well, we have a good reason to invest in building that capacity. We can afford the decent boots – let’s make sure the system is set up to buy them.

Dr Cressida Gaukroger is a writer, philosopher and moderator at the Cranlana Centre for Ethical Leadership, and Lead of the Wellbeing Government Initiative at the Centre for Policy Development (CPD). The initiative is focused on working with Australian governments at all levels to put wellbeing at the heart of government decision-making.

Cressida has a PhD in Philosophy, and was a Departmental Lecturer in Practical Ethics at Oxford University until 2019. She has also taught at University College London, New York University, and City University of New York. When not working on ethics or wellbeing, she writes picture books about naughty children who get their comeuppance.

Image credit: Gujas