A review of the Commonwealth Grants Commission arrangements for sharing
Commonwealth taxation with the states
is reportedly being arranged by three states (Bolt C. 'Three states lambaste
tax share system', Financial Review, 30/9/01)
The Case: NSW, Victoria and Western Australia are particularly
concerned about large financial transfers to
Queensland through the Grants Commission. Queensland has now developed
through the growth of mining and tourism industry, and can
expect future prosperity. Despite this Queensland receives over $2bn pa more than
its economy contributes to Commonwealth taxes and other revenues. This
allows Queensland to pay huge subsidies to attract industry. And, due to 60 years of
subsidies, Queensland has no debts. There appear to be uncertainties about
the adequacy of Grants Commission's methods (Egan M, Brumby J and Ripper E.
- Treasurers of NSW, Victoria and WA, 'Donor states carry an unfair burden',
Financial Review, 30/11/01)
Show: more information about review
Queensland's response: The Treasurers of NSW, Victoria and WA want to
overturn a core principle of Australia's federal system - which is that no
matter where people live they are entitled to equal access to government
services. This principle involves horizontal fiscal equalization. The
donor states are being simplistic in promoting efficiency at the expense of
equity. They are claiming that Queensland is being subsidized. However the
Commonwealth sets taxes so that people in similar circumstances pay equally. It
then provides GST and special purposes revenues to the states. The
fundamental flaw in the three Treasurers' analysis is that they ignore
distributions other than GST. In 2001-02 Commonwealth GST payments were $30.6bn
and Special Purpose Payments (SPP) were $15.1bn. Queensland gained $41m over its
population share on GST payments, and $66m less than its population share of SPP's. And in Balanced Budget Assistance Queensland received $213m below its
population share. Queensland supports the current Grants Commission process
because (a) the Commission is independent expert body (b) process is open an
consultative (c) Commission's judgments are backed by a high level of analytical
rigor (d) all Treasurers review Commission's methods and (e) terms of reference
are set in conjunction with other states (Mackenroth T. - Queensland Treasurer
'Queensland happy to stay horizontal', Financial Review, 5/12/01)
The Proposed Review: Two well-regarded economists, Ross Garnaut and
Vince Fitzgerald, have been appointed to review the basis of Commonwealth-state
funding. The system they have been asked to review reflects substantial changes
in the financial structure of the federation since 1901 - most particularly
Commonwealth domination of the national tax base and a state dependence on
financial grants which is much higher than in other federations such as US,
Canada and Germany. As states are responsible for most important service
delivery, their dependence on Commonwealth funding is a critical issue.
According to a background paper, this review will not explore the return of income
tax powers to the states (considered a politically dead option) but how to get
existing arrangements right. This is worth doing, because of the complexity of
existing arrangements - and the conflicting objectives. Grants to the states can
be for general or specific purposes, and amount to some $50bn pa (or which $30bn
are for general purposes, and are 90% derived from the GST). Allocation of these
grants are determined by the Commonwealth Grants Commission - to allow each
state enough money to provide services at the same standard as other states.
This requires redistributing tax revenues from NSW, Victoria and Western
Australia - because others have less revenue raising capacity (eg because of
smaller populations and economies, higher services costs or more school age
children). The process of determining grants is very detailed, results in 2000 pages of
annual documentation and involves specific assessments of state revenue and
spending needs across many areas. Grants provided for general purposes do not
need to be spent on any particular programs. The present system does not
adequately reward / punish states for good and bad policies (according to Ross Garnaut). At a press conference, the economists were also critical of special
purpose funding (eg for spending on hospitals with conditions attached). There
are many such programs - which can have conflicting requirements and assessments
applied. Also the Grants Commission effectively takes away specific purpose
funding by reducing general purpose grants (Woods A. 'A better balance for the
states', Australia, 18/12/01)
A web-site for
the Review presents a Background Paper - which includes Terms of Reference
and a discussion of the issues involved.
Show: Outline of Background Paper
Review of Commonwealth State Funding - An outline of the Background Paper
- (December 2001)
Message from the Committee: There is a need to review Australia's
federal arrangements. In particular States are responsible for much service
delivery, but the Commonwealth has most fiscal power which has led to both special
and general purpose grants. The arrangements which have evolved are not always
relevant today. When the GST was introduced it became the basis for a large pool
of funds available to the states. The review of Commonwealth / State funding
will consider efficiency (ie could more economic growth, income or employment be
generated); equity; and simplicity / transparency.
1. About the Review: Both general (GPP) and special (SPP) purpose
grants will be considered - and the relationship between these and state /
Commonwealth own outlays. The great financial significance of Commonwealth
grants is outlined. NSW / Victoria and WA receive less than the per capita
average of GST revenues. NSW, Victoria, Queensland and ACT receive less
than average share of SPPs. Also to be considered are budget balancing payments
(arising from GST) and the Commonwealth's own spending.
2. How to participate
3. How the system grew: The Commonwealth have had greater taxing
powers and the states had greater spending responsibilities. Special payments to
assist states emerged early in the 20th century. A Grants Commission (CGC) was
established in 1933. Commonwealth taxing powers were further increased as a
wartime measure in 1942 when it assumed sole income tax responsibility (though
states had previously raised 70% of income tax). From 1946 the CGC recommended
distribution of tax receipts on the basis of each state's population characteristics
(with WA and Tasmania free to apply for more). The Whitlam Government introduced
many tied SPP's in the 1970s. The Fraser Government's policy of phasing these
out came to little. In 1976 new tax sharing arrangements were introduced - and
revenue assistance was determined by the CGC (with no distinction for 'claimant
states'). Vertical fiscal imbalance increased greatly in 1997, when the GST was
introduced, and many state taxes were abolished. The CGC's role has
shifted from just recommending assistance to claimant states - to dealing with
large components of state funding generally. And the way it does this has
changed. In 1936 its goal was to allow all states to function at a similar
standard. In 1999 its goal was that "State Governments should receive
funding from the Commonwealth such that if each made the same effort to raise
revenue from its own sources and operated at the same level of efficiency, each
would have the capacity to provide services at the same standard". The GST
introduced a broad-based tax available to states - but there has been no change
in either SPP or GPP arrangements.
4. The Existing Approach: Most GPPs are now from GST - which is
allocated on the basis of horizontal fiscal equalisation. The impact of budget
balancing assistance varies widely - eg Queensland gains little as it gave up
little when the GST was introduced (having had no FID). The idea of horizontal
fiscal equalisation is to give each state the same capacity to provide services
if they make the same fiscal effort). A higher share of revenues is given to
states with a lower capacity to raise their own revenues. It also provides
compensation if their cost of providing services is higher. The aim of the CGC
is to be policy neutral - to be based on factors outside state control. Many
different factors influence assessments of relative expenditure requirements
(list quoted) and relative revenue capacity (wages and salaries, land values,
mining industry profits). Account is also taken of the differences in average
service standards to different groups in different locations. Issues related to
CGC process include: its complexity; the value judgements it embodies; and the
effect on equity and efficiency (of service delivery and resource allocation).
Policy neutrality aims to ensure that states can't influence grants through
their policies. But states can influence their population's need for services,
and the health of economies (and its capacity to provide taxation
revenues). There are unresolved complexities in policy neutrality (eg
should states be compensated for higher costs of services, if in fact they don't
provide them - and if they are not compensated would it not provide scope for grantsmanship). Compensation for differences in SPPs also causes controversy.
There have been substantial changes in relative state shares of GPPs - with
significant relative declines by WA and Queensland. SPP's are based on Section
96 of the Constitution. Issues related to this include: the great number of such
programs; the provision of SPPs in areas where states have sole constitutional
responsibility. The Commonwealth's own expenditures in various states vary
significantly from the population share. The Commonwealth receives
considerably less in Queensland than the national per capita average of its own
revenues (from companies and individuals).
5. Other Federations: discusses Germany, US and Canada
6. State Characteristics: compares budget balances, debts, revenues
and expenditure. Queensland's position in terms of net debt is better than other
states. Queensland also has a higher level of 'own source' revenue being income
on investments.
The Commonwealth's Condition: Federal Government will not support changes to Commonwealth / State funding
arrangements unless all states agree (Strutt S. and Allen L', Beattie Blocks
plan to overhaul state funding', Financial Review, 1-2/12/01)
CPDS
Comment on Review
CPDS Comments on the Grants
Commission's Treatment of Queensland
Introduction
The Queensland Treasurer has not answered the question being posed by the
'donor' states in the public debate that is outlined above. He spoke of the
desirability of horizontal equalisation. The 'donor' state are concerned (amongst other things) about the fact that, when funds are
allocated by the Grants Commission on the basis of horizontal equity, Queensland
receives significantly more funds from the Commonwealth than the revenues the
latter obtains in Queensland - and that this is at their expense [1].
However the reason that NSW, Victoria and WA were publicly reported as giving for reviewing the
Grants Commission arrangement may also need to be reconsidered.
The Problem
The main reason that the equalisation procedures which result in the Grant's Commission's
'generosity' to Queensland should be
reviewed is not that its economy is now strongly developed
so that it can afford to become a net contributor (because of
growth of the mining and tourism industries that the donor states referred to). In
point of fact, an examination of Queensland's budget suggests that it is facing
growing difficulties (see CPDS
Comments in About
Queensland's Budget).
Rather the main problem is
that Queensland has not needed (financially) to take the development of its economy very
seriously (and thus provides only a weak per-capita base for State and
Commonwealth government taxes and
charges). It could do this because it has been able to
rely on receiving a share of national tax revenues which provide
compensation for its own weak tax base. For this same reason Queensland
receives payments from the Commonwealth that substantially exceed the taxes and
charges the Commonwealth receives in Queensland.
How it works: The revenue which the Commonwealth receives in
Queensland depends on the strength of the state's tax base. Gross state product
per capita is a good proxy for this and has tended to be around 85% of
the national average in Queensland. Thus the Commonwealth's tax collections in
Queensland are limited.
However Queensland's share of this national revenue is then equalized - and
this equalization formula adds insult to injury by compensating Queensland for
the revenue disadvantages that its weak tax base impose on state taxation.
Clearly the Grants Commission's procedures have not been 'policy neutral' and have
resulted in significant economic inefficiencies.
Evidence
In the 1980s efforts (by the author and others) to develop a productive
modern economy in Queensland were constantly frustrated because:
preference was given to maximizing government's financial position. The
latter was seen (strangely) as the main indicator of Queensland's 'economic'
strength - so the goal of having a 'strong state' focused on public finance
rather than on the economy. At the same
time;
Australia's highly distorted Commonwealth / State financial
arrangements:
provided a share of Commonwealth revenues on a 'needs' basis without
regard for whether the state had a strong tax base; and
left only a narrow tax base to the states - in areas where revenues were
apparently dependent more on economic 'turnover' than on economic
value-added.
This encouraged Queensland
to favour industries with high economic 'turnover' - rather than those with high
value-added which might have done more to strengthen Commonwealth tax
receipts.
In the 1990s political rhetoric has endorsed the real development of
Queensland's economy - but for the reasons outlined above this has not needed to
achieve practical productive capabilities (and in fact does not appear likely to
do so). Queensland's
Economic Strategy suggests why both traditional and recent strategies
have not created a well developed economy.
Show: indicators of a lack of serious effort to develop Queensland's economy
Indicators of the lack of serious development of Queensland's economy
are also outlined in
Queensland's Economic Strategywhich includes referenceto:
a per-capita gross state product that is perpetually low relative to
national averages;
[An aside: Queensland's low per-capita GSP MAY also partly reflect
its branch office status - if earnings from branch offices in Queensland
are credited to to their interstate head offices. Though how such
earnings are counted in determining state product is unknown to this
author. The review's Background Paper (Section 4.3) notes that (a) the
Commonwealth receives much lower per capita revenue in Queensland than
in some states and that (b) this "reflect
the location of activities from which the revenues are derived (place of
residence for personal income tax, location of gross operating surplus
for company tax, location of production and sale respectively for
petroleum production revenues and excise, and location of consumption of
goods and services for GST)" - though whether this compensates for
the 'branch office' phenomenon is also unclear].
the poor quality (low value-added) of industries that have been
encouraged by a naive emphasis on growth rather than on development;
weaknesses in Queensland's institutional capability to develop its
economy;
the lack of any real prospect that current populist programs will improve
the situation.
Queensland's Financial Position
Moreover, it appears very likely that Queensland's financial position has
deteriorated in recent years - so that any expectation that other states might
now profit financially at Queensland's expense are uncertain (See About
Queensland's Budgets).
The core problem seems to be that the weak
tax base that has been created by defective economic strategies now makes it
difficult to fund a rapidly-growing decentralised state at a reasonable
standard. Furthermore any substantial increases in tax rates can be expected to
require economic adjustments. Thus the review of the Grant's Commission arrangement might
come to a different conclusion to that which the Treasurers of NSW,
Victoria and WA reportedly suggested (see the Case above).
In addition to the effect the Grants Commission rules have on the base a
state's economy provides for Commonwealth taxes, the implications for Australia current account
deficit might also be considered. Encouraging industries that involve large
turnover but produce little domestic income not only produces a weak
taxation base but must also have implications for
Australia's at-times-restrictive current account deficit (as the latter
reflects the difference between domestic expenditure and domestic income - see
The Current Account
Deficit Constraint, 1998).
Regarding special purpose payments from the Commonwealth it is noted that:
a review of special purpose grants which the author undertook for the
Queensland Coordinator General's Department in the mid 1970s (at the time
that the level
of these programs was being significantly increased) suggested that senior
management in Queensland agencies were then being forced to expend a lot of
time in seeking to obtain funds for (say) 10% of their budgets - and
consequently were significantly constrained in effectively planning and
managing their overall operations. Presumably this difficulty (which was
serious because of states' responsibility for most public service delivery)
has reduced to at least some extent over the years as these programs became
routine;
while special purpose grants are a way of achieving goals of national
significance, they may create administrative and political friction in
intergovernmental relations because Australia's constitution does not
include other arrangements which promote Commonwealth / State cooperation.
In particular it might be that a Federal system such as that in Germany
might improve the situation - ie where the Federal upper House is a true
'state's house' - ie members are appointed directly by state governments.
Thus:
the Federal Government is unable to move far away from policy options
acceptable to the states, so cooperation rather than confrontation
apparently characterises Federal / State relations; and
governments opposing constructive changes which have general national
support are subjected to considerable political pressure.
Any study of German practices, needs to take account of the implications
of its Roman (as compared with British) legal tradition.
More generally, it can be noted that the high level of state financial
dependence on the Commonwealth tends to give a higher than desirable level of internal
policy influence to state financial authorities - and this was
presumably one of the reasons for Queensland's primary emphasis on state
financial goals in the 1970s and 1980s - and the resulting lack of real interest
in developing a productive modern economy (as discussed above).
The final report of the review, Commonwealth State Relations for the 21st
Century, is available on the
Review website.
Media reports on the proposal stress the disunity amongst states which the
proposals have produced - and the Commonwealth's desire to avoid taking any
leadership role.
A push by NSW, Victoria and WA to gain a bigger share of federal funding has
outraged smaller states. Change advocates suggested that current arrangements
were costing $280m annually in economic inefficiencies. A cooperative
federalism model was proposed to simplify special purpose payments, and to
deliver a fairer distribution of $29bn GST revenues. Victoria, NSW and WA
believe they are subsidizing other states $3bn pa. SA Premier (Mike Rann)
accused bigger states of seeking to shirk their responsibilities. Tasmanian
Treasurer (David Crean) suggested this was an attempt to overturn the principle of
equity that had long underpinned federal state relationships. Queensland's
Treasurer said that NSW, Victoria and WA had got what they paid for, and that
Federal Treasurer had indicated that the issue would not be allowed to be
discussed at next years meeting. The Prime Minister said states should decide amongst
themselves how to divide federal funds (Lewis S, Emerson S and Plan T 'Fair go
proposal has states brawling', Australian, 31/8/02)
A report to be released by NSW, Victoria and WA claims that horizontal fiscal
equalization costs the economy hundreds of millions of $ pa. It says the system lacks
transparency and accountability and does little to promote regional equity - and is a
disincentive to states in promoting economic growth. The GST was supposed to give
states more revenue - but largest states claim disadvantage through having to cross
subsidize others. Report suggests new formula for sharing out $32bn GST and
streamlining of $21bn special purpose funding. Proposed new model would guarantee no
state received less than at present. NSW GST formula involves paying states to ensure
meeting cost of minimum level of government services. Special purpose grants would be
combined into a smaller number of general programs (Davis M and Drummond M 'Big
states scrap over $50bn taxes', Financial Review, 30/8/02)
A possible solution to this particular political impasse may be to consider
whether the Review was asked the wrong question - ie how to better organize
federal financial relationships. The Review was asked this question because its
architects believed that there had to be something wrong with Grants Commission
methods if other states had to
provide large fiscal transfers to Queensland which was perceived to be an
economic success story.
However Grants Commission arrangements were only a part of the problem. The
main problem (as outlined above) was the
defective economic strategies that Queensland adopted which resulted in a
weak tax base and a need for large fiscal subsidies from other states.
The issue that gave rise to the Review might have been better addressed
directly, rather than indirectly through questions of Grants Commission arrangements.
Furthermore there are many deficiencies in federal-state relationships that have
nothing to do with horizontal fiscal equalization which risk being buried if
this is seen as the major point of contention.
An aside: An interesting email observation by the Hon Dr David Crean,
Treasurer of Tasmania, on 28/10/02 was that the core problem lies in the
vertical imbalances in Australia's federal financial system [Clearly if those
vertical fiscal imbalances were eliminated, then the Commonwealth would not
have to try to achieve horizontal equalization, and states would directly gain
the benefits (or costs) of the effect which their economic strategies have on
their state's tax bases).