5 July 2018

All better off from fairer way to share the GST


The Turnbull Government will fix problems in the system used to share the revenue from the GST leaving all states and territories better off.

This will be the first time real changes have been made to fix problems in how the GST is shared since the GST was introduced almost 20 years ago.

This problem has been kicked down the road for too long and it is time we now got on and fixed it.

The Turnbull Government's changes will reinforce and protect the 'fair go' system used to distribute the GST, called Horizontal Fiscal Equalisation or HFE, that supports the services all Australians rely on, especially in smaller states, while removing the volatility in how these funds are distributed by removing the impact of external shocks, like a mining boom.

The proposal will involve transitioning to a new HFE system over eight years from 2019-20 in a way that is fair, reasonable and sustainable, and that will ensure all State or Territories are left financially better off.

By proposing an update to the way the GST is distributed, the Turnbull Government is moving to protect the long term integrity of the HFE system, ensure it is fit for purpose and can continue delivering on its objectives now and into the future, for all States and Territories, for all Australians.

Our preferred model involves moving to a new benchmark that will ensure the fiscal capacity of all States and Territories is at least the equal of NSW or Victoria (whichever is higher). Benchmarking all States and Territories to the economies of the two largest states will remove the effects of extreme circumstances, like the mining boom, from Australia's GST distribution system.

In addition to moving to a new, more stable equalisation standard, the Government also proposes to commit to put in place a 'floor' on the relativity any State can receive. The Government will implement a floor of 70 cents per person, per dollar of GST, below which no State's relativity can fall, from 2022-23, rising to 75 cents from 2024-25. Given the formula is now based on a more stable benchmark, it is highly unlikely relativities would move below the new floor.

Last year, I asked the Productivity Commission to examine Australia's system of HFE – the system that has determined the allocation of GST since it was introduced in 2000. Along with the Government's interim response, today, I release the Commission's final report which helped to inform the Government's proposed changes.

While accepting all of the other recommendations put forward by the PC, subject to further consultation with the States and Territories, the Government has chosen not to proceed with the PC's recommendation to equalise to the standard of the average off all states and territories.

We also note that the PC themselves observed that this option was "was not unambiguously superior to any other."

The Government considers that implementing the PC's preferred model would move too far from the 'fair go' principle of HFE, and risk leaving smaller states behind.

We also consider that the PC's preferred option would create a level of unnecessary disruption and transition costs that most States, and the Commonwealth, would not be able to reasonably accept or absorb.

Not surprisingly however, the Commission did find that although the system functions well and achieves high levels of fiscal equity, it has resulted in perverse outcomes when there is a significant shock to our economy.

This occurred in Western Australia where the effect of the mining boom resulted in a fall in its relativity, which eventually reached 30 cents in the dollar per person of GST and saw that state receive less in distributions from the GST than much smaller jurisdictions, including the Northern Territory, Tasmania and South Australia.

The Northern Territory has also recently experienced extreme outcomes and the Commonwealth has stepped in to provide the additional funding necessary for essential services and infrastructure.

As broad-based, strong and large economies, the use of NSW or Victoria as the benchmark will ensure that all states continue to be equalised to a high standard, while also providing a stable benchmark to minimise volatility in states' annual payments.

For much of HFE's history in Australia, NSW and Victoria have been the fiscally strongest states. As a result, these States have historically served as the benchmarks for equalisation. It is only recently that the benchmark has shifted to WA as a result of the mining boom, which, with its reliance on one particular sector, has led to substantial volatility in the HFE system.

To assist with the transition to the new system, the Commonwealth would provide short-term funding over the three years from 2019-20 to 2021-22 to ensure that no State receives less than 70 cents per person per dollar of GST. This funding would be untied, meaning recipient State Governments would be able to spend it as they see fit to deliver services in their state, including schools, hospitals and infrastructure. WA is expected to be the only State with a relativity below 0.70 during this time.

Over the same period, the Government would also ensure that the NT keeps at least their current share of GST, as it did in this year's Budget in recognition of the unique circumstances faced by the NT in dealing with current GST distribution volatility given its small size, remoteness and relatively large Indigenous population. No state will be financially disadvantaged as a result of moving to this new benchmark. A fair and sustainable transition to a new equalisation standard will be ensured, through an additional, direct, and permanent Commonwealth boost to the pool of funds to be distributed among the states.

The first injection into the GST distribution will be worth $600 million in 2021-22, the first year of transition to the new equalisation standard. The Commonwealth's contributions in the following years would be equivalent to indexing this injection at the same rate of growth as GST collections in those years. This would be followed by a second injection of $250 million in 2024-25, at the same time the 0.75 cent floor would be introduced. The combined additional Commonwealth funding would then be indexed to grow in line with GST collections on a permanent basis.

A change of this scale will require significant consultation with all the states. In addition to visiting the states over the coming weeks, I will convene a special meeting of the Council on Federal Financial Relations by September, with a view to coming to a final agreement on transition arrangements by the end of this year. States will have the opportunity to interrogate the available data and propose alternative approaches during this time.

The PC also made a number of other recommendations to sensibly improve the HFE process and simplify the formula to distribute the GST. The Government is proposing to accept all these recommendations and will seek to implement them as soon as possible, following consultation with the States and Territories.

The PC report can be accessed at the Productivity Commission website and the Government's interim response is available at the Treasury website.