6.3 Improving horizontal fiscal equalisation

As outlined in Chapter Three, it is usual for individual states within a federation to have different capacities to raise revenue or deliver services. The practice of equalising capacities through various forms of fiscal equalisation has occurred in Australia since 1901.

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 allocation of GST revenue between States is currently set in accordance with the recommendations of the Commonwealth Grants Commission.

This is a well established process, but it is nonetheless contentious.

The 2012 GST Distribution Review into this matter found that the ‘recipient’ States support the existing equalisation system while the ‘donor’ States see many problems with it. The second group of States represent some 90 per cent of Australia’s population.

The GST Distribution Review presented a comprehensive series of recommendations, but did not recommend fundamental change to the equalisation system over the short to medium term. It noted that ‘it is not possible to closely replicate the outcomes of the current system in a dramatically simpler way’.

It is important to appreciate the link between vertical fiscal imbalance and horizontal fiscal equalisation. If steps are taken to reduce vertical fiscal imbalance, as proposed in the previous section, States’ revenue raising capacities would be better linked to their service delivery responsibilities, and a substantially simplified form of horizontal fiscal equalisation could apply.

In reducing vertical fiscal imbalance it would be possible to move to a model where there was minimal redistribution between the current donor States (New South Wales, Victoria and Western Australia) as well as Queensland, but with targeted distribution towards the current recipient States (South Australia, Tasmania, the Australian Capital Territory and the Northern Territory).

Since the introduction of the GST, the fiscally-stronger States have consistently received around 80 per cent of the pool collectively, while the recipient 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 donor States better off compared to existing arrangements.

To preserve the current share of the fiscally-weaker States, responsibility for ensuring these States’ fiscal wellbeing could be addressed by the Commonwealth Government. That is the Commonwealth would make ‘top up’ payments out of its own revenue base.

The GST Distribution Review noted that in this situation the question would be what level of funding should be provided by the Commonwealth to the smaller States for the purpose of horizontal fiscal equalisation.

The current 20 per cent of GST pool share or a set proportion of GDP could be used as the basis for determining this additional amount. The Commonwealth Grants Commission would retain a role in determining the basis for the allocation of this additional amount among the smaller States. A similar approach is currently used in Canada.

An indicative representation of how an alternative arrangement might work is shown in table 6.1 below.

Table 6.1: Impact of alternative approach to Horizontal Fiscal Equity

($ million)

Equal per capita
($ million)

Illustrative new
($ 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: Budget Paper No. 3, 2013-14 and National Commission of Audit.

Under these arrangements, the Commonwealth Government 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 and 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.

Such an approach offers substantial gains in efficiency and reduced complexity, which could also be taken further by a more general approach to reduce reporting burdens.

Recommendation 9: Reforming the Federation – arrangements for addressing horizontal fiscal equalisation

The practice of fiscal equalisation between the States is a central and longstanding feature of our Federation. The Commission recommends that, as part of a reformed approach to addressing vertical fiscal imbalance, new arrangements also be implemented to address issues with horizontal fiscal equalisation. This would involve:

  1. sharing all GST revenue on an equal per capita basis;
  2. the Commonwealth providing an additional grant to current recipient States to ensure that no State is worse off compared to the existing equalisation process; and
  3. distribution of the additional equalisation grant from the Commonwealth being determined by the Commonwealth Grants Commission.