Chapter 1

Chapter 1

Commonwealth-State Financial Relations

Background

1.1 From 1 July 2000, the Commonwealth proposes to abolish the current system of financial assistance grants and provide States with a stable and growing source of revenue by giving them all the revenue from the GST. This is conditional on the States abolishing inefficient existing taxes (such as the Financial Institution Duty, the debit tax and various stamp and conveyancing duties) and not re-introducing them.

1.2 The ANTS package states that bBy 2003-04 the States are projected to be $370 million better off than under existing arrangements. Reflecting the expected strength of GST collections relative to the existing system of Commonwealth grants and narrowly based State indirect taxes, the Budgets of the States are projected to improve by $1.25 billion in 2004-05, $2.25 billion in 2005-06, and commensurately larger amounts in subsequent years. [1]

1.3 The States will are expected to gain more revenue through the new tax system, and will take responsibility for the payments of general-purpose assistance to local government currently made by the Commonwealth. The enhanced revenue security of the States will ensure that they can provide a sustainable level of high quality services - such as hospitals, schools, roads and law enforcement – into the future.

1.4 The Commonwealth will make the payment of GST revenue conditional on the States making these payments in accordance with existing conditions. This will is designed to ensure that local government is not worse off in that respect. In fact, overall local government is expected to gain from the removal and reduction of Commonwealth and State taxes that currently increase their running costs. [2]

November 1998 Special Premiers' Conference

1.5 A Special Premiers' Conference was held in Canberra on 13 November 1998. At this meeting the States and Territories and the Commonwealth agreed that the ANTS package significantly underestimates the cost of reducing state gambling taxes.

1.6 The Commonwealth agreed to allow the States to retain stamp duty on business conveyancing transactions until their state budgets could repeal this duty and not be in a worse fiscal position.

1.7 The exact level of the underestimate by the ANTS package was not made public by the Commonwealth, but it is understood to be around $1 billion per year. That there is a significant underestimate is evidenced by the agreement in the Intergovernmental Agreement between the Commonwealth, the States and Territories where separate provision (specifically para (5)(viii)) is made for the repeal of the stamp duty on non-residential conveyances of real property.

Outcome of 1999 Premiers' Conference

1.8 On 9 April 1999, six State Premiers and two Chief Ministers reached an agreement on the future financial relations between themselves and the Commonwealth following the introduction of the GST on 1 July 2000. A document titled Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations was signed by all parties and is at Appendix II of this report.

1.9 Each party agreed to the following reform measures:

  • The Commonwealth will legislate to provide all the revenue from the GST to the States and Territories and will legislate to maintain the rate and base of the GST in accordance with the agreement;
  • The Commonwealth will cease to apply the Whole Sales Tax from 1 July 2000 and will not reintroduce it or a similar tax in the future;
  • The temporary arrangements for the taxation of petrol, liquor and tobacco under the safety net arrangements announced by the Commonwealth on 6 August 1997 will cease on 1 July 2000;
  • The payment of Financial Assistance Grants will cease on 1 July 2000;
  • The Commonwealth will continue to provide Specific Purpose Payments (SPPs) to the State and Territories and has no intention of cutting aggregate SPPs as part of the reform process set out in the Agreement, consistent with the objective of the State and Territory Governments being financially better off under the new arrangements;
  • The State and Territories will cease to apply the taxes referred to in Appendix A of the Agreement from the dates outlined below and will not reintroduce them or similar taxes in the future.
    • Bed taxes from 1 July 2000;
    • Financial Institutions Duty, from 1 January 2001;
    • Debit taxes, from 1 January 2001;
    • Stamp duties on a range of items, from 1 July 2001
  • Stamp duty on non-residential conveyances of real property will cease to apply by a date to be determined by the Ministerial Council on the basis that no State or Territory will be worse off in any year;
  • The State and Territories will adjust their gambling tax arrangements to take account of the impact of the GST on gambling operators; and
  • The State and Territories may introduce anti-avoidance measures that are reasonably necessary to protect its remaining tax base or liabilities accrued prior to the date the tax ceases to apply. [3]

1.10 Another outcome of the conference was the establishment of a Ministerial Council. The membership of the Council will include the Treasurer of the Commonwealth and the Treasurers of the State and Territories. The Councils main function will be to oversight the operation of the GST and coordinate the implementation of the Agreement.

Review of evidence received from the Queensland and Tasmanian Governments

1.11 Following the introduction of legislation relating to Commonwealth-State financial relations by the Government on 31 March 1999 the Committee contacted the Queensland and Tasmanian governments-the only states that made submissions and appeared before the Committee. The purpose of the Committee's approach was to seek any additional information to that which they had already provided at hearings and in submissions to the Committee prior to the introduction of the bills. No further information was received from either state government.

1.12 A number of State and local governments accept tax reform as a legitimate and timely goal of the Commonwealth Government, and fully support the development of a tax system which is able to raise revenue fairly and equitablynew taxation arrangements. It was noted that the proposed reforms have some advantages over the current arrangements for Commonwealth State financial relations. These include :

  • the states gain access to revenue from a broad-based growth tax which offers the potential for greater future revenue growth;
  • subject to satisfactory arrangements to lock-in the proposed reforms, the Commonwealth's ability to reduce, unilaterally, State revenue is lessened.

1.13 Submissions received from the Queensland and Tasmania Governments highlight some fundamental deficiencies in the proposed reforms of Commonwealth-State financial arrangements which form part of the overall tax package. In the transition period, the Queensland Government claims that the Commonwealth proposals disadvantage Queensland taxpayers and penalise the Queensland Government for its long-standing policies of low taxation and responsible fiscal management. The Tasmania Government has highlighted the burden from significant transition costs which Tasmania will face because of its economic and socio-economic circumstances. While other more robust economies may be able to cope with these changes, the Tasmania Government claims that their economy is already vulnerable and has a limited, if any, capacity to deal with such impacts.

1.14 The Queensland Government estimates its loss at around $465 300 million over three the first two years. The Queensland Government maintains that the proposed compensation arrangements for loss of State revenues in the transition period are held to be grossly unfair and discriminatory on the basis that :

  • they contravene the widely accepted principle of horizontal fiscal equalisation (HFE) on which the distribution of Commonwealth grants has long been based;
  • they also produce an increase in the effective level of taxation in Queensland relative to other States, for which there is no compensation in the first three years. [4]

1.15 The proposed reforms also have several other disadvantages:

  • The package results in a marked increase in Vertical Fiscal Imbalance (VFI). While the resultant revenue will be distributed to the States, the GST will remain a Commonwealth tax to be varied only with the support of the Commonwealth Parliament. Rather than redress VFI, the proposed reforms would reduce significantly the revenue autonomy of individual States.
  • The package fails to guarantee that the Commonwealth will not make offsetting cuts in specific purpose payments in the future. This leaves funding levels for such services as health, education and roads at considerable risk.
  • The States will need a mechanism for ensuring that the Australian Taxation Office efficiently and effectively collects the GST on their behalf. [5]

Fair Distribution of GST Revenue

1.16 Distributions of Commonwealth general-purpose revenue grants among the States have traditionally been based on the recommendations of the Commonwealth Grants Commission. The effect of the Commission's methodology is based on the principle of horizontal fiscal equalisation (HFE) which permits all Australians to enjoy a comparable level of services, regardless of State of residence, provided that a comparable revenue raising effort is undertaken. The essence of the equalisation process is that financial assistance is distributed on a per capita basis adjusted only for differing expenditure needs and revenue-raising capacities, as assessed by the Commission.

1.17 For the transitional period, the Commonwealth Government has proposed to depart from the decision to distribute GST in accordance with HFE principles in the longer term. The Queensland Government asserts that :

This departure allows the Commonwealth to reduce the amount required to reimburse higher taxing States for abolishing taxes by imposing a higher indirect tax burden on Queenslander, exacerbating the inherent unfairness of the GST. The reforms to Commonwealth-State financial relations, as proposed at the Special Premiers' Conference, will particularly disadvantage Queenslanders. For these reasons, the Queensland Government did not endorse the Agreement on Principles concluded between the Commonwealth and other States at the SPC. [6]

1.18 The Commonwealth is generally proposing that budgetary gains by any State would be redistributed to other States for the first three years of the GST. On an HFE basis, Queensland would be entitled to receive an additional $465 million for the first three years of the GST. However, under the proposed transitional arrangements, the Queensland Government noted that Queensland's entitlement for years 1 and 2 will be redirected to reduce the Commonwealth's guarantee payments to the States so the States, in aggregate, are no worse off in each of the first three years of the GST. This estimated loss of State revenue to Queensland will result in an increase in the relative tax burden for Queensland taxpayers with no commensurate return to the State Budget for at least the same period.

1.19 The Queensland Government also stressed that although the same set of States taxes are proposed to be abolished, the application and impact of these taxes on taxpayers vary widely from State to State. Significant differences between the States arise specifically because of vastly different tax efforts by States in respect of the taxes to be abolished:

For example, in those States where the current tax effort is above average (in respect of taxes proposed to be abolished), imposition of a GST at an average rate will result in a decrease in the overall tax burden for taxpayers in those states. Conversely, in those States where the current tax effort is below average, the imposition of a GST means that the tax burden will increase for taxpayers in such States. Queensland is and example of the latter. [7]

1.20 Evidence provided to the Committee at its Brisbane hearing acknowledged that in the longer run, the GST will provide an additional $390 million for the Queensland state budget through higher tax revenue raised in the State. The Queensland Government have also acknowledged that this additional revenue will be used to help offset the additional tax burden in Queensland so that residents will be restored to the same relative position as existed before the package.

1.21 Initial estimates by the Tax Policy Unit of Queensland Treasury show that in 2002-03, for example, the Queensland taxes abolished would have reached $404 per capita. In the same year, the estimated level of GST (revenue) required to abolish State taxes nationally would impose a $560 burden on each Queenslanders. There will be a per capita increase of $156 in the tax burden for Queenslanders but a $88 per capita decrease in New South Wales. [8]

1.22 The Queensland Government believes that there are compelling reasons why the equalisation process should apply, including during the transitional period.

The equalisation process compensates and adjusts for relative tax capacity as between States, but not for tax effort. State Governments remain accountable for their fiscal policy decisions. While the equalisation process will adjust for changes in tax capacity that a State might experience, it is a basic tenet of this process that a State reducing its tax effort should and in fact does bear the full cost in terms of lower revenue. [9]

1.23 The Queensland Government adds :

The proposed transitional compensation arrangements overturn the entire logic and fairness of the equalisation process. Rather than equalising tax capacity, the arrangements effectively compensate for differential tax effort, thereby unfairly penalising Queensland in the first three years after the introduction of the GST.

Under the Commonwealth Grants Commission equalisation process, grants to the States will change due to the discontinuation of needs assessments in respect of the State taxes to be abolished. This is entirely appropriate as it reflects capacity adjustments to States' grants. To suggest departures from a HFE distribution of GST revenue to States to achieve Budget neutrality would imply adjustments on the basis of differential tax effort by States. This clearly would compromise the equal treatment of taxpayers, which is a fundamental tenet of HFE.

The above analysis demonstrates that a sole focus on the dollar impacts on States' Budgets is both partial and misleading. The correct point for analysis is the final impact on citizens and taxpayers.

A positive revenue outcome for a low-taxing jurisdiction is entirely reasonable, as it would allow a Government to restore its taxpayers to the same relative position that they held before national tax reform, or alternatively to use the additional taxation revenue accruing to provide additional services to these taxpayers. Similarly, a budget shortfall for a high-taxing jurisdiction is to be expected, as taxpayers in such a jurisdiction would experience a reduced tax effort. This would ensure that all taxpayers receive equal benefit from national tax reform, regardless of jurisdiction.

To do otherwise would be to variously penalise or benefit taxpayers in different States according to their current tax efforts. Any redistribution of GST revenue to States experiencing Budget shortfalls in the transition period effectively would mean that an increase in the tax burden in low-taxing States would be used to subsidise a reduction in the tax burden in high taxing States. [10]

1.24 In its Submission to the Committee, the Queensland Government noted that the Commonwealth has not addressed in ANTS the principle of HFE in the distribution of local government financial assistance. The States with the greater needs for local government services will not receive a relatively greater share of financial assistance. The Commonwealth proposal will continue to reflect the existing arrangements whereby each State receives an equal per capita share of the local government grants pool, regardless of the needs in each State.

1.25 The Queensland Government considers that this is a further major deficiency in the Commonwealth proposals.

On grounds of consistency alone, the principle of fiscal equalisation should be applied to the interstate distribution of financial assistance grants for local government. … the responsibility for the distribution of these grants should remain with the Commonwealth, rather than being transferred to the States as proposed in ANTS. [11]

1.26 The Tasmania Government in its submission to the Committee acknowledges that the ANTS package does provide the opportunity for a growing and more secure source of revenue in the longer term. On current estimates, this is not expected to occur until about year five of the reforms. In the interim, the State will be at best no worse off under the proposed reforms, but will be required to bear an additional burden arising from the distributional consequences of tax reform. [12]

Mechanisms to lock in commitments made by federal and state governments with regard to the new arrangements.

1.27 The Queensland Government recommended that :

The preferred mechanism to ensure that the proposed Commonwealth-State financial reforms deliver revenue security to the States is to entrench it in the Constitution. Without the protection of constitutional amendment, it is always open to future Commonwealth Governments to assert its control over the collection of the GST and its allocation to the States. [13]

1.28 It has been acknowledged, however, that because of the difficulties of implementing constitutional change in Australia, the best alternative approach is to enshrine the proposed arrangements in legislation.

Footnotes

[1] ANTS, p78

[2] ANTS, p25

[3] Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations, p 2-3.

[4] Submission No.1088

[5] Submission No.1088

[6] Submission No. 1088.

[7] Submission No. 1088.

[8] Submission No.1088.

[9] Submission No. 1088.

[10] Submission No. 1088.

[11] Submission No. 1088.

[12] Submission No. 1411.

[13] Submission No. 1088.