The (temporary) fix in
Horizontal Fiscal Equalisation and GST distribution
by Jenny Menzies
With competing reports released on the distribution of the goods and services tax (GST) last week — the Productivity Commission’s Horizontal Fiscal Equalisation Inquiry Report and Treasurer Scott Morrison’s 32 page response, as well as competing solutions to the ‘problem’, Australians are probably no more advanced in their understanding of horizontal fiscal equalisation (HFE) than they were a week ago. The Treasurer’s response was heavy on the rhetoric of ‘fixing’ the system, while cherry picking some issues raised by the Productivity Commission and leaving many others alone.
Both reports recommitted to the concept of horizontal fiscal equalisation and acknowledged Australians’ continued devotion to ideas about fairness and equity and the belief that all Australians are entitled to a certain level of services no matter where they live.
What this level of services should be is the nub of the differences in the two reports. The current system applied by the Commonwealth Grants Commission (CGC) is to equalise States and territories to allow them to deliver services to the ‘same’ standard. The Productivity Commission believed the CGC pursued this ‘narrow interpretation of equity’ above all else and that the objective of HFE should be a ‘reasonable’ standard of services and this would be achieved by equalising to the fiscal capacity of all States. The Treasurer, through the Government’s response rejected this model because of the unacceptable transition costs to be borne by the States. The Government accepted the Productivity Commission’s recommendation to move to a ‘reasonable’ standard of services. But instead of equalising States to the average of all States, the Government’s model was to identify a ‘reasonable’ level through a benchmark that would ensure the fiscal capacity of all States is at least the equal of NSW or Victoria (whichever is higher).
To achieve this transition, the Federal Government will itself inject an additional $7.2 billion into the GST pool in the years of transition — from 2021–22 to 2028–29. This is an expensive fix for a problem that had pretty much fixed itself.
The Western Australia story
Western Australia (W.A.) has been a major beneficiary of HFE since Federation and the establishment of the Commonwealth Grants Commission was in direct response to their threat to secede from the federation in 1933. This all changed in the early 2000s, but exponentially since 2013–14 when W.A. was contributing rather than being a recipient State.
From 2007–08 W.A’s revenue raising capacity increased by ninety per cent and in the six years before 2015–16 they were also the beneficiary of the lag in the GST assessment. The Grants Commission calculates GST payments through a three year moving average to reduce the volatility that would come from relying on a single year. So, at the beginning of the mining boom, W.A. received an additional $7 billion above its assessed needs and as the system adjusted and started taking the money out the other side of the boom, the complaints started. States and territories know that equalisation happens over a run of years as the formula catches up with the changed circumstances of the jurisdictions.
During this time, Western Australia had a vastly increased capacity to raise revenue through mining royalties and for all their complaints that increased capacity still exists. They continue to have the highest assessed fiscal capacity due to its high revenue raising capacity.
W.A. argued that the CGCs formula could not deal with the volatility of the mining boom and the subsequent drop in mining revenue. As the Productivity Commission pointed out, the response to such revenue volatility lies with the States themselves ‘and with the necessity for State Treasuries to factor the assessment period and GST lag into their budget management processes This is why all the other States and territories have always remained thin lipped about W.A’s attempts to overthrow the system and their special pleading to Canberra.
Impact on Queensland
In its submission to the Productivity Commission, Queensland emphasised the challenges in delivering services to large state with a significant indigenous population, as well as a decentralised population with many regional and remote communities. It is these characteristics which the current GST formula compensates the State for. They reiterated their commitment to the concept of HFE underpinned by the principle that all Australians will receive similar standards of services regardless of where they live.
Though Queensland believed the system could be wound back from the ‘full’ equalisation undertaken by the CGC and promoted an objective ‘that seeks to equalise to similar levels’. However, they have concerns about the method put forward in the Government’s response which is to benchmark to the two largest economies of NSW and Victoria. As the Queensland submission put forward:
Equalising to less than the fiscally strongest State will mean that at least one State has a superior ability to deliver services compared to the other States.
Over time, such approaches may result in significant differences in GST revenue outcomes between the States, and therefore significantly different fiscal capacities. Using the PC’s methodology, Queensland estimates that, compared to the current system, equalising to the second strongest State over the 10 years between 2008 and 2017 would have resulted in an increase of $7,384 per capita to Western Australia while reducing all other States including Queensland by $898 per capita
The main concern from Queensland is that the new model would see a disproportionate funding for Western Australia, a loss of funding for Queensland and an increasing disparity in the level of services available between States. The additional $7.2 billion to be injected by the Federal government into the GST pool will mask these disparities during the transition period, however the underlying issues will emerge once the transition period is over.
Future issues
As Laura Tingle pointed out in her analysis on Saturday, the distribution of the GST is a self correcting system and as the lagged assessment catches up with the changed budgetary circumstances in W.A. their relativities will continue to rise. As many commentators have noted, the Treasurer’s response, though wrapped up in rhetoric about the technical issues of dividing up the GST, was really a political response to the concerns loudly expressed by Western Australia. So as those issues ease, the Federal government will be pouring even more into their coffers to ensure the political perception that the matter has been ‘fixed’ is entrenched.
With the transition payments, the detrimental impact of these changes will be pushed well into the future. Further reform of federal financial relations is still urgently required and the transition payments by the Federal Treasury remove the States and territories even further from that reform. It adds a ‘grace and favour’ element to the distribution of the GST and harks back to the old Loan Council days where States went cap in hand to the Commonwealth.
The Commonwealth Grants Commission has its critics, however, it did apply a methodology that was impartial and independent of the political winds of the day. Now that it has been shown that the ‘squeaky wheel’ approach to HFE can gain a State a massive windfall from the Commonwealth, the distance that the Federal government was previously able to maintain from distributing the GST has been breached. Always quick learners, more States are likely to apply political pressure federally for state-based budget failure and seek the top ups which have been offered to Western Australia over the past few years.
JENNIFER MENZIES
Jenny is Senior Adjunct in the Policy Innovation Hub at Griffith University, Australia. Jenny has over 25 years experience in policy and public administration in both the State and Commonwealth Governments.
As a senior executive within the Queensland Department of the Premier and Cabinet she developed the government’s strategic policy agenda including the Smart State Policy.
She was Cabinet Secretary from 2001 to 2004 and the inaugural Secretary for the Council for the Australian Federation from 2007 to 2009 and a member of the Commonwealth Grants Commission 201 -2016. Jenny publishes in the fields of caretaker conventions, federalism and intergovernmental relations.
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