Productivity Commission Releases Draft Report Into GST & Horizontal Fiscal Equalisation

• Productivity, efficiency and economic growth, including the movement of capital and labour across state borders;
• The incentives for the States to undertake fiscal (expenditure and revenue) reforms that improve the operation of their own jurisdictions; and
• The States’ abilities to prepare and deliver annual budgets.

• Reflect what States collectively do;
• Policy neutrality;
• Practicality; and
• Contemporaneity.

“State governments should receive funding from the pool of goods and services tax revenue such that, after allowing for material factors affecting revenues and expenditures, each would have the fiscal capacity to provide services and the associated infrastructure at the same standard, if each made the same effort to raise revenue from its own sources and operated at the same level of efficiency.”

1. States with relatively low fiscal capacities are raised to the average fiscal capacity of all States
2. All States are then raised to the capacity of the fiscally strongest
3. Any remaining revenue from the GST pool is distributed to all States on an equal per capita (EPC) basis

“Mineral and energy resources are very unevenly distributed across States. For example, over 98 per cent of all iron ore production is in Western Australia. […] Due to these outsized effects, some have argued that States have an incentive to under-tax mineral rents or extract rents through other means. Several participants strongly criticised the HFE system as a major disincentive to States developing their mineral and energy resources. Any State that developed contentious mining activity would bear the full political cost of the development, but only retain its population share of the royalties. And there are perennial concerns that the equalisation process does not fully account for industry development expenses, though this inquiry has not been presented with new or convincing evidence that changes are required.

[…]

The potential for HFE to distort State policy is therefore pronounced for mineral and energy resources. While there is no direct evidence that GST effects have influenced specific policy decisions, the incentive effects are large and have the potential to undermine State policy neutrality over time. Yet there is no obvious and workable alternative for equalising mining revenue in a way that would not affect policy incentives. The current lack of policy neutrality may be an inevitable consequence of pursing full and comprehensive equalisation with the data available.”

“Overall, the current HFE system goes too far in the pursuit of equalisation and much beyond what other federations do. Arguably it also goes beyond what a unitary government would do, which is providing a level of services to all residents that is relatively consistent from one year to the next, and which is likely closer to the average across the nation. In contrast, equalising to the strongest State — particularly when the strongest State is so much stronger — has meant equalising to a benchmark that is relatively volatile.”

“The primary objective of the HFE system should be to provide the States with the fiscal capacity to allow them to supply services and the associated infrastructure of a reasonable standard. This objective should be pursued to the greatest extent possible, provided that:

• it does not unduly influence the States’ own policies and choices beyond providing them with fiscal capacity;
• it does not unduly hinder efficient movement of capital and people between States;
• the process for determining the distribution of funds is transparent and based on reliable evidence.”

DRAFT RECOMMENDATION 2.1

The Commonwealth Government should clearly articulate the objective of HFE. This objective should aim for reasonable rather than full equalisation (as envisaged in draft finding 2.1). The objective should be established through a process led by the Commonwealth and involving consultation with the States, and should be reflected in the Intergovernmental Agreement on Federal Financial Relations. The objective should also be reflected in the terms of reference which the Commonwealth Government issues for the yearly update and five-yearly methodology review. The Commonwealth Grants Commission Act 1973 (Cwlth) should also be updated to reflect the adopted objective.

DRAFT RECOMMENDATION 7.1

The Commonwealth Government should direct the CGC, through the terms of reference it receives, to consider approaches to assessment that deliver significant simplification and ‘good enough’ equalisation outcomes. The use of more highly aggregated assessments should receive detailed consideration as part of the current CGC process.

DRAFT RECOMMENDATION 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 occur only in exceptional circumstances.

DRAFT RECOMMENDATION 9.1

The CGC — through its Chairperson and Commission members — should provide a strong neutral voice in the public discussion on the HFE system. The CGC should also enhance its formal interactions with the State and Commonwealth Governments. In particular, it could provide draft rulings to State Governments on the potential HFE implications of a policy change.

DRAFT RECOMMENDATION 9.2

The CGC should make the data provided by the States publicly available on its website, along with the CGC’s calculations on these data. Where there are risks identified with this approach, mitigating steps should be identified and taken.

DRAFT RECOMMENDATION 9.3

The Commonwealth and State Governments, through the Council on Federal Financial Relations, should develop a process that would work towards a longer term goal of reform to federal financial relations. In the first instance, it should assess how Commonwealth payments to the States — both general revenue assistance and payments for specific purposes — interact with each other today, given the significant reforms to payments for specific purposes that have occurred in recent years. The process should also work to a well-delineated division of responsibilities between the States and the Commonwealth, and establish clear lines and forms of accountability. Policies to address Indigenous disadvantage should be a priority in this regard.