Pearls and Irritations

And it’s no less shameful that this ‘dirty deal’ has been supported in this by the Labor Party, who have promised to uphold these changes should they form government after the election on 21st May.

Australia has a federal system of government, in which state (and, since 1978, territory) governments typically play an important role in shaping and implementing public policies with regard to education, health, housing, transport, the maintenance of law and order, and other functions, which in turn have a key influence on the well-being of and life opportunities available to their citizens.

Reflecting the relative importance of the functions for which they are responsible, state and territory governments have over the past twenty years accounted for 40% of total ‘operating’ spending by all levels of government in Australia, and for almost 50% of all ‘investment’ spending by governments (or 58% of all ‘investment’ spending if public enterprises are included).

However, because of the way in which revenue-raising powers were allocated as between the Commonwealth and the States in the Australian Constitution (and the way in which those provisions in the Constitution have been interpreted by the High Court of Australia over many years), the states and territories have on average raised only 16% of the taxation revenue collected by all levels of government over the past twenty years. Even allowing for other sources of revenue available to state and territory governments (such as mineral royalties, fees and charges for government services), the states and territories typically finance only about half of their total expenditures from their own resources, and are reliant on grants and subsidies from the Commonwealth for the remainder.

As Australia’s second Prime Minister, Alfred Deakin, foresaw, the Constitution left the states “legally free, but financially bound to the chariot wheels of the Commonwealth”.

As a result, Australia’s federal system has historically been characterized by a much higher degree of ‘vertical fiscal imbalance’ than other federations (such as the United States, Canada, Germany and Switzerland) – that is, Australian state and territory governments have been more reliant on ‘fiscal transfers’ from the national government than their counterparts in other federations). This ‘vertical fiscal imbalance’ was greatly increased by the Commonwealth’s assumption of a monopoly of income taxing powers in 1942 – ostensibly as a ‘temporary war time measure’, but one which has remained in place ever since, despite occasional attempts to ‘hand back’ income-taxing powers to the states.

The fact that Australia’s state and territory governments are so unusually dependent on transfers from the national government gives Australia’s national government the potential to exercise considerably greater influence over the spatial distribution of revenue (and hence spending) than occurs in other federations where sub-national governments are more reliant on their own ability to raise revenues.

And this is an influence which Australian Commonwealth governments have chosen to exercise, from the earliest days of the Australian federation.

Since its establishment in 1933 – as a response to a referendum in which two out of three Western Australians voted to secede from the Commonwealth (to be told subsequently by the Privy Council, who in those days had the final say on constitutional questions, that they couldn’t) – the Commonwealth Grants Commission has recommended that ‘untied’ grants flowing from the Federal Government to the states (that is, money which they can spend as they see fit, as distinct from ‘specific purpose grants’ which must be spent on the purpose for which they are provided) should be distributed in such a way as to make it possible for the citizens of each state (and more recently territory) to have access to a similar range and standard of public services without facing vastly different burdens of state taxation.

In order to arrive at its recommendations, the Grants Commission each year undertakes a detailed assessment of each state and territory’s capacity to raise revenue from its own sources, and of the demand for and cost of providing, state public services such as education, health, housing and policing. Those states whose ‘fiscal capacity’ is stronger than average – because they have a greater capacity to raise revenue from state taxes or mineral royalties, or because the demand for particular types of services is lower, or the cost of providing them is less – will receive a smaller share of the revenue from the GST than their share of Australia’s total population; while those whose ‘fiscal capacity’ is weaker than average will receive a larger share of the revenue from the GST than they would have done under an ‘equal per capita’ distribution of that revenue.

Of course, whether states choose to use the money which they receive from their shares of GST revenue in order to provide similar standards of public services whilst imposing similar levels of state taxes is a matter for them, and their voters. Successive Queensland State Governments, for example, have long chosen to provide below-average state public services so as to be able to levy lower-than-average state taxes (although that choice has become more difficult to sustain in recent decades as a result of the growing proportion of its population who have moved there from southern states and who have different expectations of state public services from ‘native’ Queenslanders); while South Australian State Governments have traditionally made the opposite choice.

This approach to divvying up federal grants to the states and territories – formally known as ‘horizontal fiscal equalization’ – is one of the principal reasons why the differences in material living standards among Australia’s states and territories are much smaller than those richest and poorest states or provinces of other federations such as the United States of America, Canada, or Germany.

But this long-standing system of ensuring that people living in different parts of Australia can have access to broadly similar standards of state-type public services without facing vastly different levels of state taxes has been undermined by the changes to the GST revenue-sharing arrangements imposed by the Morrison Government in 2018, and which are being ‘phased in’ over five years from 2021-22 to 2025-26.

These changes were made in response to more than fifteen years of complaints from Western Australia about how that state was being ‘unfairly’ treated by the long-standing system of ‘fiscal equalization’.

As noted earlier, that system was established nearly ninety years ago in response to Western Australia’s grievances about the way it had been affected by Federation in 1901. And for about seventy years, Western Australia had been a beneficiary of that system, which recognized that it was very expensive to provide schools, hospitals and other state public services to Western Australia’s relatively small population, thinly scattered across one-third of the Australian continent, at a time when Western Australia’s mining industry was much smaller and less profitable than it is today.

But, beginning in the early 2000s, China’s willingness to pay unprecedentedly high prices for unprecedentedly large volumes of the mineral and energy resources with which Western Australia, fortuitously, happens to have been so richly endowed, resulted in Western Australia becoming the richest state in Australia – by a much wider margin than New South Wales or Victoria had ever been during the 20^th century, when one or the other of them was the richest state in the country.

And the river of mining royalty revenue which this bonanza generated resulted in Western Australia’s ‘fiscal capacity’ coming to exceed that of the other states and territories by an unprecedented margin – which in turn resulted, as it should have, in Western Australia’s share of the revenue from the GST falling to, in some years, less than one-third of what it would notionally have received under an ‘equal per capita’ distribution.

All of a sudden, then, once Western Australia become so rich, relative to the rest of Australia, that it became required, in effect, to “put into the pot” from which it had been so happy to draw for the previous nearly seventy years, it wanted the rules changed. It was somehow “unfair” that Western Australia was no longer getting back “its” GST – even though nobody actually knows how much GST is collected from the residents of each state and territory.

And, eventually, it found a Federal Government which was willing to change the rules in order to suit Western Australia – the government in which Scott Morrison was Treasurer, and of which he later became Prime Minister.

As Treasurer, Scott Morrison commissioned a Productivity Commission enquiry into the system of GST revenue sharing which had been entrenched into the legislation establishing the GST by the Howard Government – and gave it terms of reference which more or less guaranteed that the Productivity Commission would come up with recommendations that acceded to Western Australia’s demands.

The Productivity Commission conducted that enquiry with a very un-PC like disregard for the evidence which was presented to it, or which it adduced through its own investigations.

In particular, despite being no more able to find any evidence for the assertion, long made by New South Wales and Victorian Governments and more recently by Western Australian Governments, that the long-standing methods of ‘horizontal fiscal equalization’ provided disincentives for states and territories to undertake productivity- or growth-enhancing reforms (for fear of adversely affecting their GST revenue shares) than Nick Greiner and John Brumby were in 2012 when they were given a similar task by then Treasurer Wayne Swan, the Productivity Commission concluded that “absence of evidence wasn’t evidence of absence” – the same logic used by George W Bush, Tony Blair and John Howard to ‘justify’ the 2004 invasion of Iraq despite the repeated inability of UN-sponsored investigators to find any evidence that Saddam Hussein’s regime possessed ‘weapons of mass destruction’.

Following the Productivity Commission’s enquiry, the Government of which Scott Morrison was by then Prime Minister, via the Orwellian-sounding Treasury Laws Amendment (Making Sure Every State and Territory Gets Their Fair Share of GST) Act 2018, changed the long-standing principles for determining the carve-up of GST revenues among the states and territories in two ways:

• first, from 2021-22 onwards, no state or territory can receive less than 70% (and from 2024-25, 75%) of what it would have received under a notional equal-per-capita distribution of GST revenues; and
• second, instead of recommending a distribution of revenues that would raise the ‘fiscal capacity’ of each state and territory to that of the fiscally strongest state (which in most of the past two decades has been WA), the Grants Commission is now required to recommend a distribution which raises the ‘fiscal capacity’ of each state and territory to the stronger of NSW or Victoria.

For Western Australia, this is what Chinese President Xi Jinping would call a “win-win outcome” – whether the iron ore price (the main source of WA’s wealth) goes up or down, WA wins. If the iron ore price goes down, WA’s share of GST revenues goes up (as it always would have done, under the ‘old rules’). But if the iron ore price (and hence its mining royalty revenue) goes up and stays up, WA gets to keep it.

For the other states and territories, however, this is a “lose-lose” outcome.

To forestall that – at least until after the forthcoming election – the Morrison Government also provided a ‘transitional guarantee’ that no state or territory would get less by way of revenue from the GST than it would have done had the ‘old rules’ not been changed.

In order to give effect to that ‘transitional guarantee’, the Morrison Government undertook to ‘top up’ the revenue from the GST with whatever amount was required to ensure that no other state or territory would be worse off. At the time, it estimated that this ‘transitional guarantee’ would cost federal taxpayers about $4.6 billion over the eight years 2020-21 through 2027-28.

But because the iron ore price has remained much higher than had been assumed when these initial estimates were made, the cost of the ‘transitional guarantee’, as revealed in the most recent Federal Budget Papers, has blown out to $18.6 billion (more than four times the original estimate) – and that’s only for the years up to 2025-26.

It’s utterly scandalous that at a time when it is already running unprecedentedly large budget deficits in order to counter the economic carnage wrought by Covid-19, the Federal Government has entered into a ‘dirty deal’ which will require it to borrow another almost $20 billion, in order to give that amount to the only Government in Australia – and indeed one of very few anywhere in the world – which is currently running, and forecasting, budget surpluses.

This is surely one of the worst policy decisions that any federal government has made in at least the past twenty years.

As the New South Wales Treasury acidly observed in that state’s 2021-22 Budget Papers, “these dollars could have been better spent on productivity-enhancing reforms that support the post-pandemic recovery”.

And it’s no less shameful that this ‘dirty deal’ has been supported in this by the Labor Party, who have promised to uphold these changes should they form government after the election on 21^st May – especially given its professed concern about rising inequality.

The other states and territories are, quite rightly, worried about the possible consequences of this ‘dirty deal’ for them after the expiry of the ‘transitional guarantee’ at the end of the 2026-27 financial year.

In its 2021-22 Budget Papers, Victoria’s Treasury modelled the possible impact on each state and territory’s GST revenue in 2027-28 (after the ‘no-worse-off’ transitional guarantee expires) under each of six different scenarios, compared with what might have been expected under the pre-2018 arrangements. Under every one of these scenarios, Victoria’s share of GST revenue declined, by between $67 million and almost $1,200 million. New South Wales and Queensland were also ‘losers’ under every scenario, while the smaller states and territories were also worse off under most scenarios other than one entailing a significant fall in WA’s mining royalty revenues.

Tasmania’s Treasury has estimated that, after the expiry of the Morrison Government’s ‘transitional guarantee’, the cost to Tasmania of the changes to the basis for sharing GST revenues could reach $100 million per annum by 2031-32. It goes on to say that this amount would be equivalent to 1.1 out of every 5 teachers, 1.2 out of every 5 nurses, or 4 out of every 5 police officers – 1,000 teachers, nurses or police officers in total – being ‘unfunded’.

It is bitterly disappointing to see the Prime Minister and his Treasurer, and the Opposition Leader and his Shadow Treasurer, travelling to Perth in order to fawn over the Western Australian State Government, solemnly promising them, and voters in the seats which the Coalition needs to hold and the Opposition needs to win in order to retain or win Government at the forthcoming election, that the Federal Government will further indebt itself for another four years, and after that the citizens of the rest of Australia will be made worse off, so that the richest state in Australia can enjoy better standards of public services and/or lower state taxes than those living in the eastern states.

The Governments of the eastern states and territories, and those seeking to represent the eastern states and territories in the national Parliament, should be calling on both major parties to:

• bring forward the scheduled Productivity Commission enquiry into the ‘new system’ from 2026 to next year;
• give the eastern states and territories a say in the terms of reference for that enquiry; and
• give the eastern states and territories a say in who conducts that enquiry.

And should independents happen to hold the ‘balance of power’ in the new Parliament, they should make similar demands on both major parties (among the others they are likely to make) in exchange for their support on matters of confidence and supply.

Otherwise, this ‘dirty deal’ will remain in place for another five years – something which should not be allowed to happen.