GST carve-up formula may dampen reform, says Productivity Commission

The formula used to decide how much GST revenue each state is given is acting as a potential barrier to reform, thinks the Productivity Commission.

A new draft report on horizontal fiscal equalisation — ensuring the states have the capacity to provide services to the same level regardless of their own revenue — finds that while it would not impact on states’ spending decisions, changes to how revenue is gathered could affect how much GST that state is entitled to, undermining the case for otherwise important reforms.

The decision to switch stamp duty for land tax, even if designed to be revenue neutral, could end up costing New South Wales or Victoria $1 billion, for example. A congestion tax hypothecated to public transport would not be quite as expensive, but there would be “considerable uncertainty” what impact it would have on GST allocation.

While it’s hard to say how much such considerations impact state governments’ choices, in aggregate such decisions may have a significant negative impact on the economy, the commission thinks.

“The system is beyond comprehension by the public, and poorly understood by most within government — lending itself to a myriad of myths and confused accountability,” says the report.

Australia addresses disparities between different states through horizontal fiscal equalisation to a much greater extent than other countries, and is the only federation in the OECD to eliminate fiscal inequalities between subnational governments.

While the commission thinks the process works well in general, this combination of complexity, limited recognition of efficiency and de-incentivisation of some reforms mean government should take another look at horizontal fiscal equalisation — as indeed political pressure from Western Australia is pushing it to do.

While the general idea of horizontal fiscal equalisation has widespread support, the system has come under pressure as the large amount of money going to the state from mining boom caused Western Australia’s portion of GST to shrink rapidly.

But, as tends to occur with resources booms, mining royalties have dropped away again, but because the horizontal fiscal equalisation formula takes into account the past three years, WA is entitled to very low GST payments.

Although it was known this would occur, WA government expenditure increased with the jump in mining revenue, leaving the state in deficit — though the report notes only part of the increase in ongoing spending was discretionary, as public sector wages and other costs had to increase due to mining boom wage inflation.

The commission thinks that changing the equalisation process from bringing all other states up to the same level as the highest state to matching the second highest state may help to deal with extreme swings in a single state.

Whatever the Productivity Commission eventually recommends, and whichever path the government chooses, it will be controversial: more for one state means less for the others — and you know what they say about premiers and buckets of money.

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