8.4 Improving horizontal fiscal equalisation

It is usual for individual states within a federation to have different capacities to raise revenue or deliver services. The practice of equalising revenue capacities and/or expenditure capacities between the states in a federation is common.

Australia has had various forms of fiscal equalisation since 1901. The view was taken that, unless some type of intervention occurred, the Federation would be unsustainable, as States with weaker financial positions would have had to reduce services and/or raise additional revenue.

To enable these fiscally-weaker States to provide services to their residents at the same standard as the fiscally-stronger States, it was recognised that a mechanism was required to adjust their fiscal capacities.

Under the Intergovernmental Agreement on Federal Financial Relations, the States are entitled to receive payments from the Commonwealth equivalent to the revenue received from the GST. The amount of GST distributed to the States is in the order of $50 billion in 2013-14. The Commonwealth distributes GST among the States having regard to the recommendations of the Commonwealth Grants Commission.

The CGC takes into account differences in the States’ capacities to raise revenues and differences in the costs the States would incur in providing the same standard of government services, including through acquiring the infrastructure used to deliver those services (Commonwealth Grants Commission, 2013).

In 2013-14, around $4.7 billion (or 9.3 per cent) of the total $50 billion in GST payments will be redistributed among the States.

Table 8.4.1 below illustrates that GST relativities for each State generally change only slowly over time (with the exception of WA, where change has been driven, in the last decade, by the impact of mining revenues on States revenue raising capacities).

 

Table 8.4.1: Distribution of GST by State

 

2000-01

2013-14

 

Equal per capita
distribution
($ million)

Grants Commission
distribution
($ million)

Difference
($ million)

Equal per
capita
distribution
($ million)

Grants Commission
distribution
($ million)

Difference
($ million)

NSW

10,182

9,262

-920

16,053

15,558

-495

VIC

7,488

6,523

-965

12,479

11,320

-1,159

QLD

5,617

5,721

104

10,133

10,741

608

WA

2,977

2,930

-48

5,493

2,458

-3,036

SA

2,348

2,776

428

3,629

4,595

966

TAS

733

1,106

373

1,111

1,801

689

ACT

491

546

55

834

1,022

188

NT

308

1,280

972

517

2,756

2,239

Total

30,145

30,145

0

50,250

50,250

0

Amount redistributed:

   $ million

 

1,932

 

 

4,689

   per cent of pool

 

6%

 

 

9%

Source: Australian Government 2013a. Note: Budget Paper No. 3 does not take into account distribution of unquarantined health care grants

 

The 2012 report of the GST Distribution Review (Australian Government, 2012) found that:

While modern horizontal fiscal equalisation (HFE) theory provides a conceptual model for determining the financial transfers between States in order to be fair to all citizens and avoid inappropriate migration incentives, the model has its critics and there are practical issues with it. The preference of some States for an outcome consistent with this theory, whilst others seek a simpler model, lies behind many of the differences between the positions put to the Panel by the States. While South Australia, Tasmania, the Australian Capital Territory and the Northern Territory support the current equalisation system, New South Wales, Victoria, Queensland and Western Australia see major problems with it.

This split in the States’ opinions on the current HFE distribution broadly reflects the current distribution of GST revenues (see Table 8.4.2). States which lose out, or are broadly neutral, under the current distribution are seeking change, while States which gain from the current distribution are in favour of the status quo.

 

Table 8.4.2: Difference in States’ per capita distribution of GST revenues, 2013-14

State/Territory

GST distribution 2013-14 Budget
$ million

Equal per capita distribution of GST
$ million

Redistribution
$ million

Projected population
'000

Per capita redistribution
$

NSW

15,557.9

16,053.1

-495.2

7,426.0

-66.7

Vic

11,320.3

12,478.9

-1,158.6

5,773.0

-200.7

Qld

10,740.9

10,133.4

607.5

4,688.0

129.6

WA

2,457.5

5,493.2

-3,035.7

2,541.0

-1,194.6

SA

4,595.0

3,629.2

965.7

1,679.0

575.2

Tas

1,800.5

1,111.3

689.2

514.0

1,340.7

ACT

1,021.8

834.0

187.8

386.0

486.6

NT

2,756.0

516.8

2,239.2

239.0

9,366.3

Total

50,250.0

50,250.0

4,689.5

23,246.0

 

Source:  Australian Government, 2013a.

 

The GST Distribution Review presented a comprehensive series of recommendations, but did not recommend fundamental change to the HFE system over the short to medium term. It instead focused on recommendations to improve governance, transparency, stability and simplicity, which will have only minor impacts on any State’s GST share. The Review noted that ‘it is not possible to closely replicate the outcomes of the current system in a dramatically simpler way’.

However, the Review did say that if some of the current issues around vertical fiscal imbalance were addressed, with State revenue raising capacity better linked to service delivery responsibilities, then a substantially simplified form of HFE could apply (Australian Government, 2012).

An important point to appreciate is the link between issues around vertical fiscal imbalance and the HFE. If steps are taken to address vertical fiscal imbalance, States’ revenue raising capacities would be better linked to their service delivery responsibilities and a substantially simplified form of HFE could apply.

If a substantial reduction in vertical fiscal imbalance was achieved, then it would be possible to move to a model where there was minimal redistribution between the fiscally-stronger States (New South Wales, Victoria, Queensland and Western Australia), but more targeted distribution between the fiscally-weaker States (South Australia, Tasmania, the Australian Capital Territory and the Northern Territory).

Historically, the fiscally-stronger States have consistently collectively received around 80 per cent of the GST pool, while the fiscally-weaker States have received around 20 per cent of the GST pool (about twice their population share).

One option would be for all States to receive an equal per capita distribution of GST collected. Such a distribution would leave the fiscally-stronger States better off compared to existing arrangements. So as to preserve the current share of the fiscally-weaker States and allow them to maintain standards of services, it would be necessary for the Commonwealth Government to make payments out of its own revenue base. The CGC would retain a role in determining the basis for the allocation of this additional amount. A similar approach is currently used in Canada.

An indicative representation of how an alternative arrangement might work is shown in Table 8.4.3 below. The fiscally-stronger States would receive their per capita shares of GDP revenue; while the fiscally-weaker States would continue to receive the share as currently determined by the CGC.

 

Table 8.4.3: Impact of alternative approach to horizontal fiscal equity

State

 Current
Distribution
($ million)

 Equal per capita Distribution
($ million)

 Illustrative new distribution
($ million)

NSW

15,558

16,053

16,053

VIC

11,320

12,479

12,479

QLD

10,741

10,133

10,741

WA

2,458

5,493

5,493

SA

4,595

3,629

4,595

TAS

1,801

1,111

1,801

ACT

1,022

834

1,202

NT

2,756

517

2,756

Total

50,250

50,250

55,119

Source: Australian Government, 2013a.

 

Under these arrangements, the Commonwealth would need to fund an additional $4.9 billion in equalisation payments if the goal was to ensure that no State was worse off than they are today. That is, as well as providing the States with the full amount of GST collected, the Commonwealth would provide an additional $4.9 billion that would be sourced from elsewhere in the Commonwealth’s existing revenue base.

Reducing administrative burden 

A key objective of the Intergovernmental Agreement on Federal Financial Relations (IGA FFR) was a reduction in administration and compliance overheads. With its introduction in 2009, the IGA FFR saw a rationalisation of the number of payments to the States, along with an increase in the overall quantum of funding.

Since then, there has been gradual growth in the number of Commonwealth-State agreements, as seen in Chart 8.4.1.

  • As at 1 July 2013 there were 144 agreements in place under the IGA FFR.
  • Queensland has identified 19 intergovernmental agreements which are active, under development or recently expired, which together total only $33.4 million in funding (Queensland Government, 2013).

 

Chart 8.4.1: Total number of Commonwealth-State agreements from 2008 to 2013

This chart shows the increase in the number of Commonwealth agreements in each year from 2008 to 2013.

Source: Department of the Treasury.

Along with the administrative cost of developing the number of agreements, there is a growing reporting burden. The growth in the number of agreements has contributed to a significant growth in reporting and administrative expenses.

Furthermore, the Commonwealth has progressively moved back towards more detailed reporting arrangements in order that Commonwealth ministers, and the broader public, can have certainty that taxpayers’ money was being spent efficiently and in the areas required.

An additional bureaucracy is required to develop, report on, review and assess the agreements, which takes resources away from service delivery.

As part of the Reform of Federation White Paper, there should be a review of all national partnerships with a view to rationalising the number. This would reduce the administrative burden for both Commonwealth and State Governments.

At the same time, it would be useful to re-examine performance reporting requirements, along with broader data and transparency requirements. This could incorporate a review of the current role of the COAG Reform Council (CRC).

The CRC has responsibility for reporting on the performance of governments against National Agreements and National Partnerships.

The CRC is the independent monitor of performance of jurisdictions in fulfilling their responsibilities under the IGA FFR. However, the CRC is one of a growing number of national performance reporting bodies.

COAG itself has often been criticised as being slow and unnecessarily bureaucratic, slowing down rather than facilitating reform processes. It has also been seen as politically driven and focussed on short-term ‘announceables’ rather than longer-term reform goals.

There needs to be a balance between setting an appropriate level of reporting to achieve the accountability desired to assess outcomes, and maintaining the flexibility and efficiency required for service delivery.

A more streamlined system built around a single, integrated, national reporting system would reduce data collection costs and confusion in interpreting performance. Governments need to better consolidate data, streamline and simplify systems and reporting to improve clarity and make government decision-making more transparent.

If a substantial rationalisation of National Agreements and National Partnerships could be achieved, alongside a streamlining of reporting and data requirements, then the role of the CRC would be substantially diminished.

The CRC could then be abolished as a separate entity, with its reporting role assumed by the Productivity Commission (which already has a strong government reporting focus).

Reforming federal financial arrangements

These four components of reform (rationalising Commonwealth-State roles and responsibilities, addressing vertical fiscal imbalance, improving horizontal fiscal equity and reducing administrative burden) are all interdependent. Each of these components has the capacity to result in substantial changes in expenses and revenues for the Commonwealth and the States.

It is critical that all components be considered and implemented at the same time to ensure that neither the Commonwealth nor the States are worse off after the reform.

For instance, the illustrative example on vertical fiscal imbalance above would have the Commonwealth transferring $25 billion in income taxation revenue to the States; and the illustrative example on HFE would result in the Commonwealth transferring an additional $4.9 billion from consolidated revenue to the fiscally-weaker States. Without any compensating changes, the States would be $29.9 billion better off, at the expense of the Commonwealth.

The purpose of these changes, however, is not to provide the States with a windfall gain, but rather to provide them with access to revenue sources that grow in line with growth in the economy, and to provide them with a greater share of untied funding.

In order for the Commonwealth to not be any worse off in any such transaction, any gain in untied grants to the States would need to be offset by an equivalent decrease in tied grants.

Current tied grants to the States are around $45.1 billion per year. Of this total, around $13.9 billion is for National Health Reform Funding, and $13.2 billion for specific payments in education and $3.9 billion in other payments for specific purposes for skills, disability and housing. The remaining $14.0 billion is made up of payments under 144 different National Partnership Agreements.

Table 8.4.4 below shows an illustrative example of how these tied grants could be decreased by $29.9 billion to offset the $29.9 billion increase in untied funding.

 

Table 8.4.4: Impact of illustrative changes to the architecture of federal financial arrangements

 

Current
Architecture
($ billion)

Illustrative Architecture
($ billion)

GST Revenue and existing general revenue assistance

51.2

51.2

Commonwealth Grants to States

 

 

National Health Reform Funding

13.9

13.9

School Specific payments

13.2

0.0

Skills & Workforce Specific Payments

1.4

0.0

Disability Specific Payments

1.2

1.2

Affordable Housing Specific Payments

1.3

0.0

National Partnership Agreements

14.0

0.0

Total Grants

45.1

15.2

Access to personal income tax base

0.0

25.0

Additional equalisation payment

0.0

4.9

Total Commonwealth transfers to States

96.3

96.3

Tied transfers

45.1

15.2

Untied transfers

51.2

81.1

Source: Australian Government, 2013b.

 

Under this illustrative example, responsibility for schools funding would be transferred from the Commonwealth to the States and the $13.2 billion that the Commonwealth currently provides through Schools specific purpose payments would no longer be paid. All existing National Partnership Arrangements would also be removed, along with funding for skills and workforce specific payments and housing specific payments.

In practice, of course, determining which of the current tied grants would be reduced would be a matter for negotiation between the Commonwealth and the States.

References 

Australian Bureau of Statistics (ABS) 2012, Government Finance Statistics, Australia 2011, cat. no. 5512, ABS, Canberra.

Australian Capital Territory (ACT) Government 2013, Australian Capital Territory Submission to the National Commission of Audit 2013, ACT Government, Canberra.

Australian Government 1991, Taxation and the Fiscal Imbalance between Levels of Australian Government, Working Party on Tax Powers, Report to the Special Premiers’ Conference, Australian Government, Canberra.

Australian Government 2000, Budget Papers 2000-01, Australian Government, Canberra.

Australian Government 2010, Australia’s Future Tax System Review, (Henry Tax Review), Australian Government, Canberra.

Australian Government 2012, GST Distribution Review Final Report, Australian Government, Canberra.

Australian Government 2013a, Budget Papers 2013-14, Australian Government, Canberra.

Australian Government 2013b, Mid-Year Economic and Fiscal Outlook 2013-14, Australian Government, Canberra.

Commonwealth Grants Commission (CGC) 2013, Report on GST Revenue Sharing Relativities 2013 Update, CGC, Canberra.

Council of Australian Governments (COAG) 2011, Intergovernmental Agreement on Federal Financial Relations 2011, COAG, Canberra.

James, D 1997, Federal and State Taxation: A Comparison of the Australian, German and Canadian Systems, Issues Brief 5 (1997-98), Parliamentary Library, Canberra.

New South Wales (NSW) Government 2013, New South Wales Submission to the National Commission of Audit 2013, NSW Government, Sydney.

OECD 2014, Fiscal Federalism 2014 - Making Decentralisation Work, OECD Publishing, Paris.

Queensland Government 2013, Queensland Government Submission to the National Commission of Audit 2013, Brisbane.

Victorian Government 2013, Victorian Government Submission to the National Commission of Audit 2013, Melbourne.