6.4 Reforming financial arrangements – the quid pro quo

If the Commission’s recommendations to address vertical fiscal imbalance and adopt a new approach to horizontal fiscal equalisation were pursued it is possible that the States would get access to a considerable amount of additional revenue.

On the illustrative basis outlined above, the additional revenue could equate to some $30 billion per year (comprising $25 billion of income taxation revenue and $4.9 billion in top up payments as additional equalisation funding).

With no other changes, the Commonwealth would be out of pocket by this additional amount. The purpose of these changes, however, would not be 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 that provide them with a greater share of untied funding.

As part of any agreement to move to new financial arrangements within the Federation, it would be necessary to negotiate a transfer of responsibilities for areas of spending where the Commonwealth currently makes tied grants.

The Commission notes that total grants provided to the States in 2013-14 are around $45.1 billion. Of this total, around $13.9 billion is for National Health Reform Funding, $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 6.2 below provides an illustrative comparison of the current arrangements and potential arrangements that could prevail should the approach of addressing vertical fiscal imbalance through income tax sharing occur along with the revised approach to horizontal fiscal equalisation.

In the example outlined, the additional $30 billion in revenue received by the States from the Commonwealth would be offset by lower tied grant payments.

One possibility would be for responsibility for schools funding to be transferred from the Commonwealth to the States. The $13.2 billion that the Commonwealth current provides through the National Schools specific purpose payment would no longer be paid, with the States instead using the proceeds from having access to the personal income tax base available to more than fund this area of activity. A discussion of aspects of this option is outlined in Section 7.7 below.

Other existing tied grants including many of the National Partnership Agreements could also be abolished.

Under the illustrative arrangements outlined below, the amount of tied funding received by the States from the Commonwealth would reduce from $45.1 billion to $15.2 billion.

It would be possible for the Commonwealth and States to negotiate different ways of reallocating the responsibilities that would open up under the greater untied funding amounts provided.

Some of these issues are discussed in Section 6.5 below.

Table 6.2: Illustrative impact of changes to the architecture of federal financial arrangements

($ 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: Mid-Year Economic and Fiscal Outlook 2013-14 and National Commission of Audit.

Recommendation 10: Reforming the Federation – reduced tied grants to the States

Proposed changes to financial arrangements within the Federation should involve a transfer of responsibilities for areas of spending where the Commonwealth currently makes tied grants.

The Commission recommends that, should reforms be made to address vertical fiscal imbalance and horizontal fiscal equalisation as outlined above, existing tied grants from the Commonwealth to the States should be reduced by an amount equivalent to the additional untied revenue received by the States. Determining which grants would be reduced would be a matter for negotiation.