Changing the definition of Horizontal Fiscal Equalisation – by Robert Schwarz

The Commonwealth Treasurer and the Productivity Commission (PC) seem intent on providing a greater share of goods and services tax (GST) grants to Western Australia (WA).

But do you have to change the definition of horizontal fiscal equalization (HFE) to deliver a fiscal advantage to WA, being the outlier fiscally strongest State, at the expense of the other States as proposed in the draft PC inquiry report into HFE?

Answer: not really – only if you seek the cover of the Commonwealth Grants Commission for that; and for it to appear as if the Intergovernmental Agreement on Federal Financial Relations (IGAFFR) which specifies that GST grants will be distributed on the basis of HFE (i.e the principle of providing states with equal fiscal capacity), is being adhered to.

Under the Federal Financial Relations Act, the Commonwealth Treasurer has the power to set so called GST revenue sharing relativities. He needs only to have consulted with the States, and to ‘have regard to’ the IGAFFR under that Act. It is the IGAFFR which provides that the Ministerial Council for Federal Financial relations discuss the recommendations of the Grants Commission. The Treasurer doesn’t have to conform to those recommendations.

Of course that would be inconsistent with the spirit and letter of that Agreement with the States and Territories.

Changing the definition could potentially entrench arrangements favouring WA permanently. Given that prospect, the PC draft report contemplates that the ‘benchmark’ chosen under a loose and vague definition of HFE (‘reasonable standard’ rather than ‘materially the same’) might be re-specified annually having regard to changing circumstances.

Clearly this is a very poor governance arrangement.

If the PC and the Commonwealth Treasurer really want to bring in relativities favouring WA, while leaving open consideration of changing circumstances, the PC could recommend a specific override of HFE and the Treasurer seek to implement that with the powers he has for an appropriate period of time.

This does mean the longstanding definition of HFE would remain in place, but this is appropriate given that the PC proposals to equalize to a less than the strongest State benchmark:

  • have no systematic relationship with any analysis of theoretical (but unevidenced) concerns regarding adverse HFE incentive effects1; and
  • are inconsistent with achieving horizontal equity among Australian citizens.

Nobbling the Grants Commission by way of including a changed definition of HFE in the terms of reference issued by the Treasurer may be a problem in so far as the Commonwealth Grants Commission Act refers to the purpose of making it possible for a State by reasonable effort to function at a standard not appreciably below the standards of other states.

In the early years when the strongest states were clearly either New South Wales or Victoria, those states were adopted as the equalization standard, and WA (among other States) received special grants to bring it up to that strongest state standard. Later with the multi state approach introduced under Malcolm Fraser, WA continued to receive an above per capita share of grants to give it the same fiscal capacity as other states. Today with WA out and out the state with the strongest fiscal capacity, somewhat remarkably WA has been receiving special (infrastructure) grants again – this time to keep it better off than NSW and Vic – no justice there.2

If Grants Commission relativities were nobbled as per the PC proposal for equalization to a less than strongest state standard, NSW and Vic and (especially) the lesser capacity states would pay for the extra share of grants to WA, and states would be put in a position well below that of WA. Such relativities would breach the “not appreciably below” Grants Commission Act wording one would think.

This leaves the scenario of the Treasurer overriding Grants Commission recommendations with the legal powers that he has. (You can imagine him asking ‘Why do I have to keep funding a WA bail out – can’t I shift this cost to the States with my choice of relativities? Bugger the Grants Commission!’). This may have been the intent all along (with a PC report as part of the defence shield) since there is no way that changing the definition of HFE will gain the support of States generally, and the Senate (being the States’ House) should it come to amendments to legislation.3

Of course the nation may well oppose this scenario and the breach of Commonwealth-State agreement and good governance at the political level. The GST Distribution Review4 conducted by former NSW Premier Nick Greiner, former Victorian Premier and Senator John Brumby and SA businessman Bruce Carter specifically considered the proposals being advanced again by the PC, and similar such as a relativity floor5, and rejected them as having the potential to undermine confidence in the Federation. The Treasurer may have the legal power, but as they say these days he will lack the ‘social licence’.

Biographical note: Robert Schwarz is currently part time adviser in the SA Department of Premier and Cabinet. He was formerly Assistant Under Treasurer Revenue and Economics in the SA Treasury. Robert has many years of experience in the fields of tax policy, intergovernmental financial relations and horizontal fiscal equalisation. In 2017 he was awarded the PSM for leadership and innovation in public finance in the State and national arena. He holds a Bachelor of Economics (Honours) from the University of Adelaide. The views expressed here are personal views and are not attributable to the organisations mentioned.

1 Allegedly these apply to all States, and not particularly the stronger states; and indeed whether there is an outlier strong State or not.
2 The Grants Commission is instructed not to count those extra grants in its assessments.
3 Note that the determination of a GST relativity for a State by the Treasurer is a legislative instrument, but pursuant to the FFR Act is not subject to disallowance by Parliament.
4 October 2012 – the ink is barely dry.
5 The PC also rejects a relativity floor in transparent form.

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