Explaining the GST distribution method

John Freebairn (Professor of Economics at the University of Melbourne) has written a useful short note on how the GST allocation process works and the context for WA’s small share. This article was originally published in The Conversation on 17 April 2015.

Why the GST distribution is “news” at the moment

Premiers, territory leaders and the federal government are meeting at the Council of Australian Governments (COAG) today in Canberra and high on the agenda is the re-distribution of GST revenues, particularly to Western Australia, which is facing a reduction in its allocation.

COAG will discuss the “GST carve-up” - that is, the proportion of GST allocated to individual states and territories. The GST is collected by the Commonwealth and then redistributed. The share of the GST sum allocated to each state is designed to meet a society-wide equity objective, specifically described as horizontal fiscal equalisation (HFE).

Basic facts about the GST

The GST is Australia’s general consumption tax introduced in 2000. It increases the price of about a half of the goods and services households purchase by 10%.

Estimated GST revenue for 2013-14 is A$50 billion. In aggregate, it provides a quarter of state government revenue.

Unlike other countries such as New Zealand, which charge GST across the board, our GST exempts fresh food, education, health, childcare, water and sewage.

Over the last decade or so, the growth rate of GST revenue has been slower than national income. In part the slow growth is a result of the household saving rate increasing in recent years from close to zero to around 10%. But also, some of the exempt items, and in particular health and education, are increasing in importance as a share of household expenditure.

Slow growth of a key state revenue source brings budget challenges.

Allocation of the GST

While the Commonwealth collects the GST, all of the revenue is reallocated to the states as an untied grant. (States also receive special purpose grants, or tied grants, from the Commonwealth.)

This means that rather than allocate revenue to each state according to revenue collected, or on an equal per capita basis, it is designed to meet a society equity objective - horizontal fiscal equalisation (HFE).

The general principle of HFE is:

“each of Australia’s States has the same fiscal capacity, under average policies, to provide general government infrastructure and services.”

This principle recognises states have different capacity to raise revenue from their own taxes, as well as differences in the costs of providing transport, health, education and other services.

For example, Western Australia, Queensland and the Northern Territory are considered better endowed from royalties collected on mineral resources; NSW and Victoria have higher property prices and collect more conveyance duty; and South Australia and Tasmania have lower employment rates and wages, which affects the level of payroll tax collected.

But states such as WA, Queensland and the NT face sparser populations and higher costs of providing transport, health and education in combination with lower employment rates and wages. These states also have a larger Indigenous population share and higher costs associated with natural disasters.

Importantly, distribution of the GST is a zero-sum game. Increasing the share for one state has to come at the expense of a smaller share for other states.

Role of the Commonwealth Grants Commission (CGC)

In practice, the CGC, an independent statutory authority, has the task of providing advice on the distribution of the GST revenue. The CGC gives its recommendations to the Commonwealth Treasurer.

The starting point is an equal grant per person. This has a significant redistributive element. States with a lower per capita income and consumption expenditure receive a transfer from states with a relatively high per capita income and expenditure.

Then, in a very comprehensive and rigorous manner, the CGC assesses the relative capacity of each state to raise revenue from each of the different state taxes, the relative costs to each state of providing the different state services and infrastructure, and relative levels of Commonwealth special purposes grants to each state.

These assessments are based on the average outcomes over the preceding three years. For example, the 2015-16 allocation is based on a three-year average over 2011-12, 2012-13 and 2013-14. The report for 2015 includes a 135-page Volume 1 and a 700-page Volume 2. Detailed relativities for each of the main taxes and expenditure categories are reported.

The WA story

For most of the 20th century, WA was allocated a higher share of Commonwealth untied revenue transfers to the states than an equal per capita grant. This outcome reflected primarily higher expenses of providing services of similar quantity and quality across the nation due to the large area, sparse population and large Indigenous share.

Development of the iron ore mining industry from 1970, and associated royalty revenue, reduced the net reallocation to WA. But this improved relative revenue position did not offset higher relative costs of providing comparable services.

The current mining boom initially brought a windfall boost to WA own-source revenue, from higher iron ore prices, increases in tonnage and higher royalty rates. Because of the data lags in calculating relativities by the CGC, most of the initial WA revenue gain went to WA.

With the progress of time, the above-average revenue-raising capacity of WA has led to a lower and lower calculated relativity factor. According to the CGC advice, in 2015-16, WA will receive less than 30% of a per capita allocation of the GST.

Late last year, Treasurer Joe Hockey asked the CGC to examine how to change the system to take better account of WA’s volatile mining royalties.

But looking further ahead, lower iron ore prices of the post-2011 period will feed into a lower estimate of the revenue-raising ability of WA compared with other states, and thus an increase in WA’s share of the GST.

Clarifying what the share represents

On the same subject, Michelle Grattan has noted (The Conversation, 17 April 2015) that Treasurer Joe Hockey set off a wave of inaccurate descriptions of the Grants Commission’s relativities formula when he referred last week to WA “receiving 30 cents in the dollar from the GST that is contributed by its citizens”.

The Grants Commission pre-emptively warned against such a slip, noting in its report that “some people have misinterpreted a relativity to be the proportion of the GST revenue raised in a state which is returned to that state. This would only be true if the GST collected per person were the same in every state, which given differences among the states is unlikely.”

Whether the difference for WA is big or small we don’t know – there are not figures for individual states.

In fact the Grants Commission calculation is based on a per capita average of the national GST pool. What the Grants Commission recommended is that WA receive about 30% of the per capita average of GST collected nationally (down from about 37%).

These articles are republished under Creative Commons license.