Reforming the system of GST distribution among the states – horizontal fiscal equalisation, or HFE – is unlikely to be on Malcolm Turnbull’s or Scott Morrison’s lists of New Year resolutions, but it is an issue they will have to deal with in 2018.
HFE is a zero-sum game. GST revenue is a given amount. If some states get more, others must get less. This makes changing the distribution system a nightmare for any federal government. Given the current distribution, the federal government is wedged between Western Australia — screaming blue murder over being dudded — and all the other states, but particularly the ones that receive well above their population shares of GST (South Australia, Tasmania and Northern Territory).
So Turnbull and Morrison will be relieved that the Productivity Commission’s final report on HFE has been delayed by a few months to 15 May. Even if you know a can of worms has to be opened, there is some relief from putting off the opening for as long as possible. In fact, states have always bickered over the distribution of federal grants — and in that sense, the unopened HFE can has been kicked down the road for many years, not just months.
Peter Costello used to deal with the issue by asserting that if the states could agree on a change among themselves, he would implement it — knowing full well they would never agree. In the circus of intergovernmental relations, the federal government always has to act as ringmaster if anything is to be achieved.
The Gillard government commissioned a review by former premiers Nick Greiner and John Brumby, which led to nothing. Just commissioning a review that leads to nothing can act as a safety valve, but it seems unlikely to be sufficient this time. The great majority of people know very little about HFE, but the voters of WA — primed by their state politicians — are up in arms about receiving only 35 cents in the dollar of their population share of GST revenue. The Liberal Party could lose several federal seats in WA mainly over this issue. But assuaging WA voters would create problems for the Coalition in other states.
This is unfair to Turnbull because the HFE system is working as it was designed many years ago, but the current WA anomaly is an extreme one and voters are in no mood to be fair to politicians anyway. That is why the Costello formula won’t work in current circumstances.
The Productivity Commission’s draft report already gives us a taste of its approach. It has dismissed the solution Turnbull has promoted up to now — setting a floor of 70 cents in the dollar, to be activated once WA’s actual share rises above that level in several years’ time — as no more than a ‘band-aid’. The draft report also dismisses some of the HFE myths on which WA’s complaints are based, but still finds deficiencies in the system large enough to justify reform. This is the nub of the matter: leaving aside all the hot air over HFE, the system is deficient and needs repair, even if it is not the most important issue in the universe of possible economic reforms or even in the universe of reforms of federalism.
The solution flagged in the draft report is to shift from the current approach — distributing GST revenue so as to equalise all states up to the level of the strongest one — to distributing the revenue so as to equalise to the average of all states or to the level of the second strongest state. In other words, instead of all states being given the fiscal capacity to provide the same services as the strongest state, they would be given the capacity to provide services to a ‘reasonable’ standard.
This would be nowhere near as far-reaching as shifting to an equal-per-capita (or population shares) distribution, but it would still involve substantial redistributions among states compared with the current system and is unlikely ever to command unanimous agreement even if phased in over a long period.
HFE needs to be changed, but Turnbull and Morrison will need Houdini’s skills to emerge from this performance unscathed.
Robert Carling is a Senior Fellow at the Centre for Independent Studies.
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