on which the States provide feedback to the CGC. Many participants to the inquiry expressed concern with the complexity of the system (box 3.3), suggesting it leads to inconsistencies, unpredictable budget outcomes and barriers to accountability (for example, WA Government, sub. 15; the Association of Mining and Exploration Companies, sub. 23; Business Council of Australia, sub. 47). It also conveys a false sense of precision — an issue that was picked up in the 2012 GST Distribution Review (Brumby, Carter and Greiner 2012a, p. 43). Despite the recommendations of that Review, State relativities are still reported to five decimal places, even though the relativities are in many cases dependent upon the judgment and assumptions made by the CGC. Complexity is discussed further in chapter 3. 2.4 A revised objective The focus remains on equity In the Productivity Commission’s view, horizontal fiscal equity should remain the core objective of HFE. This is a view shared by most participants in the inquiry (box 2.2). What this means in practice is more contested, and inquiry participants expressed a range of views around equity and fairness (box 2.3). In particular, several participants to the inquiry have expressed the view that Western Australia’s allocation is not ‘fair’ (Put Western Australia First, sub. 12; WA Government, sub. 15; Parliamentary Liberal Party of WA, sub. 22). These concerns are not invalid, as the concepts of fairness and equity can have several interpretations. For example, participants have interpreted ‘fairness’ to mean that: every State should be treated the same — entailing funding being distributed equally per person, regardless of their personal circumstances every State should receive the funding it deserves — based on the amount of GST that is ‘raised’ in that State every State should be treated on the basis of need — those States that are fiscally stronger should assist those that are less able.
in size, as well as create an impression that the system is unfair. The Victorian Government (sub. 53, p. 6) submitted: There may be legitimate reasons for such exclusions. For example, where there is no reliable, policy-neutral approach to objectively assess cost differences between States, or where reliable data is unavailable … such exclusions should be independently and consistently administered by the CGC … to prevent political decisions from interfering with the independent process. However, some other exclusions in the past have not been based on any obvious policy rationale. For example, inconsistencies are created through the differential treatment between funding for road and rail infrastructure … (sub. 53, p. 6) To reduce the ad hoc element introduced to the GST distribution system by the quarantining of Commonwealth payments, clear guidelines outlining principles of governance for quarantining should be developed. As noted by the 2012 GST Distribution Review, the establishment and publication of such guidelines would aid transparency and may also improve predictability for the States, by making it clear when a payment would or would not be quarantined (Brumby, Carter and Greiner 2012a, p. 70). This recommendation, like most made in that review, has not been subject to a government response. Similar to Brumby, Carter and Greiner (2012a), the Commission considers that the principles on which the guidelines should be based would be that Commonwealth payments are to be quarantined only in exceptional circumstances that are in the national interest, as quarantining undermines the objective of HFE. Commonwealth payments should also only be quarantined for reasons that would not already be considered by the CGC, in order to avoid duplication and additional complexity. 7.2 The Commonwealth needs to develop clear guidelines detailing the basis on which Commonwealth payments are to be quarantined from HFE by the Commonwealth Treasurer, so that they do not unnecessarily erode the efficacy of the CGC’s relativities. The guidelines should be based on the principle that quarantining of payments ought to only occur in exceptional circumstances. The Commission seeks further views on the principles that should apply with respect to considering which (if any) Commonwealth payments should be quarantined by the Commonwealth Treasurer, and hence would not affect the distribution of GST revenue.
What does this mean for Australia? OECD experience provides some lessons on ‘dos and don’ts’ for how to operate Australia’s HFE scheme. Many of the lessons from overseas experience are already embodied in Australia’s system of HFE. Avoid the use of a narrow representative tax base in assessing revenue raising capacity. Moving averages are valuable in reducing volatility in the level of transfers and, as a result, providing budget stability for subcentral governments. Avoid tied equalisation payments. Take account of broader conditional transfers. An independent grants commission provides less room for political manipulation of fiscal transfers. Other lessons suggest Australia’s system could be improved. Avoid where possible high ‘equalisation tax rates’, as they can create incentives for subcentral governments to ‘game’ the system and can create development traps. As shown in chapter 4, Australia’s system can result in high equalisation tax rates in some circumstances (for example, increases in a tax base or changes to mineral royalty rates). Changes to equalisation arrangements must be accompanied by building political buyin by subcentral governments to ensure that those changes are enduring. Building societal understanding and consensus is vital in setting and adhering to whatever standard of equalisation is chosen to be at the heart of any HFE arrangement. Some of these lessons are picked up in chapter 9, which brings together the threads of earlier chapters in a discussion of how Australia’s system of HFE might be improved to better achieve its objectives. 8.1 Fiscal equalisation to address disparities in the fiscal capacity of subcentral governments is common among OECD countries. But other countries’ approaches to fiscal equalisation are inextricably linked to their unique institutional frameworks — this limits those schemes’ applicability to Australia. Despite this, overseas experience provides lessons that can inform the elements of our system in order to better meet the objectives of our fiscal equalisation scheme. Australia is the only OECD country with a federal government that totally eliminates disparities in fiscal capacity between subcentral governments.
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