Document Index Budget Paper 3

Chapter II: Overview of Federal Financial Relations

• Composition of Public Sector Revenues and Outlays
  • Composition of Commonwealth Payments to State/Local Sector
• Revenue Collected by the Commonwealth on Behalf of the States and Territories
• Horizontal Fiscal Equalisation
• Effects of Horizontal Fiscal Equalisation
• Fiscal Equalisation and Specific Purpose Payments

COMPOSITION OF PUBLIC SECTOR REVENUES AND OUTLAYS

Federal fiscal arrangements in Australia are characterised by a significant difference between the relative revenue and expenditure responsibilities of the Commonwealth and the States, often referred to as vertical fiscal imbalance (VFI). The amount of own-source revenue raised by the Commonwealth is considerably larger than its own-purpose outlays. In contrast, the States' own-purpose outlays outweigh the amount which they raise in own-source revenue, with Commonwealth grants to the States forming a considerable portion of total State revenues. Chart 3 shows the estimated composition of general government own-source revenue and own-purpose outlays in Australia in 1998-99. Own-purpose outlays have been adjusted to include Commonwealth grants `through' the States (other than for local government purposes) and grants to the multi-jurisdictional sector and to exclude net advances.

Chart 3: Composition of General Government Own-Source Revenue and Adjusted Own-Purpose Outlays, 1998-99 (estimated)

1. Own-source revenue excludes the receipt of payments from other levels of government.
   
2. The ABS measure of general government own-purpose outlays excludes payments to other levels of government, public trading enterprises (PTEs) and public financial enterprises (PFEs), such as general revenue assistance, Specific Purpose Payments and advances and subsidies, and interest payments on borrowings for other governments and PTEs. The adjusted measure adds back in to Commonwealth outlays Specific Purpose Payments `through' the States (other than those for local government purposes) and includes grants to the multi-jurisdictional sector. A corresponding adjustment is made to the State/local series. The adjusted measures for both Commonwealth and State levels of government abstract from all net advances.
   Source: ABS, Government Finance Statistics, unpublished data.
   
   

Chart 4: Impact of Commonwealth General Government Payments
to Other Levels of Government, 1998-99 (estimated)^(a)

1. Commonwealth payments comprise general purpose payments and Specific Purpose Payments.
   
2. Excludes grants `through' the States.
   
3. Comprises grants made `through' the States to local government and direct payments to local government.
   
4. Commonwealth grants `through' the States, except grants for local government purposes, and grants to the multi-jurisdictional sector have been treated as Commonwealth government own-purpose outlays.
   Source: ABS, Government Finance Statistics, unpublished data.
   
   

Composition of Commonwealth Payments to State/Local Sector

Chart 5 shows the composition of Commonwealth payments to the State/local sector in 1999-2000. Chapter III discusses these payments in detail.

Chart 5: Payments to the State/Local Sector in 1999-2000 (estimated)
Total Gross Payments $35.1 billion

REVENUE COLLECTED BY THE COMMONWEALTH ON BEHALF OF THE STATES AND TERRITORIES

The Commonwealth collects a range of taxes on behalf of State and Territory Governments. These include revenues collected under the Section 90 `safety net' arrangements (following the 5 August 1997 High Court decision on Business Franchise Fees in the case of Ha and Lim v. New South Wales), mirror taxes at Commonwealth places (following the 14 November 1996 High Court decision in the Allders case), and from 2000-01, the GST.

Table 3 provides estimates of the taxes to be collected on an agency basis by the Commonwealth for the States and Territories between 1998-99 and 2002-03. The estimates of revenues for the GST are based on the proposed tax arrangements set out in A New Tax System, and take account of proposed technical and other amendments introduced in the Senate prior to the 1999-2000 Budget.

Table 3: Revenue Collected by the Commonwealth on Behalf of the States, 1998-99 to 2002-03 ($million, estimated)

1. These collections (less administration costs) are paid to the States and Territories as Revenue Replacement Payments.

HORIZONTAL FISCAL EQUALISATION

The general revenue assistance provided to the States by the Commonwealth is largely distributed on the basis of the horizontal fiscal equalisation (HFE) principles which are embodied in the per capita relativities recommended by the Commonwealth Grants Commission (CGC). The CGC is an independent statutory authority established by the Commonwealth Grants Commission Act 1973. The objective of HFE is to improve equity for all Australian residents.

In its assessments, the CGC uses a complex methodology that takes account of differences in the per capita capacities of the States to raise revenues and differences in the per capita amounts required to be spent by the States in providing an average standard of government services. A State's actual per capita expenditure or revenue generally differs from the average of all States for two reasons:

• influences that are beyond a State's control (referred to as `disabilities') affect the cost at which it can provide services and its capacity for raising revenue; and
• a State's policies, practices and operating efficiency differ from those of other States.

HFE requires that only those factors beyond a State's control be taken into account in determining a State's relative needs and hence the distribution of Commonwealth general revenue grants. The CGC's recommendations seek to ensure that each State has the capacity to provide the average standard of State-type public services if it makes the same effort to raise revenue as the States on average and operates at an average level of efficiency.

An update of the relativities is conducted annually by the CGC in response to terms of reference provided to it each year by the Commonwealth Government. The CGC also conducts broader methodology reviews every five years and completed its most recent review in February 1999 (see Box 1). The resulting changes to the CGC's methodology were incorporated into the CGC's recommended relativities for 1999-2000. As noted in Chapter I, the 1999 Premiers' Conference agreed that the per capita relativities to be applied in 1999-2000 would continue to be based on the five year assessment period which has been used since 1990-91. Accordingly, the assessment period for the per capita relativities to be applied in 1999-2000 spans the years 1993-94 to 1997-98.

By international standards, the extent of HFE in Australia is pronounced and the methodology is complex. The complexity of the CGC's processes has arisen in response to the requirements of the States and the Commonwealth over time for a comprehensive and rigorous approach to HFE. For its part, the CGC has sought to maximise the transparency of its methodology and to provide the opportunity for input and comment by the States and the Commonwealth.

Further information on HFE is provided in the CGC's Report on General Revenue Grant Relativities 1999.

EFFECTS OF HORIZONTAL FISCAL EQUALISATION

The distribution of the pool of FAGs and HCGs in accordance with the CGC's relativities means that New South Wales, Victoria and Western Australia receive less than an equal per capita share of the pool, and the other States (particularly the Northern Territory and Tasmania) receive more. This reflects the CGC's assessment that the `donor' States have greater relative revenue capacities and/or less significant expenditure disabilities than the other States.

Table 4 shows the amount of FAGs and HCGs received by each State under HFE relative to the amount that they would receive on the basis of an equal per capita distribution or a distribution based on personal income tax collections. The table shows that in 1999-2000, around $1,690 million (or 7.4 per cent) of the FAGs/HCGs pool is to be redistributed among the States as a result of the application of the CGC's relativities, compared with an equal per capita distribution.

Table 4: Impact of Horizontal Fiscal Equalisation on the Distribution of the Pool of Financial Assistance Grants and Health Care Grants in 1999-2000^(a)

1. The pool consists of $17,267.2 million in FAGs and $5,676.5 million in HCGs (see Table 12 in Chapter III).
   
2. Based on ABS population projections -- see Table 1.
   
3. Based on each State's contribution to personal income tax paid in 1996-97, sourced from Table 9 of Australian Taxation Office, Taxation Statistics 1996-97.

Table 5 shows the per capita relativities used to distribute the combined pool of FAGs and HCGs since 1994.

• Western Australia and Queensland have experienced the largest declines in per capita relativities, reflecting relatively strong economic growth in those States, which has contributed to an increase in their assessed fiscal capacities.
• The per capita relativities of the remaining States have increased, particularly those of the Australian Capital Territory and Tasmania.
• The Australian Capital Territory, became a `recipient' jurisdiction for the first time in 1999-2000.

Table 5: Commonwealth Grants Commission Relativities, 1994 to 1999

1. The 1996 Update relativities as amended by the CGC's subsequent alternative calculation of 29 May 1996 relating to the treatment of Section 130 payments to Western Australia by deduction.
   
2. The 1998 Update `equalisation' relativities.
   
3. Relativities based on a five year review period and the inclusion of a depreciation assessment, as provided by the CGC to the Commonwealth, States and Territories on 29 March 1999.

The estimated State distribution of general revenue assistance on a per capita basis for 1999-2000 is shown in Chart 6. It indicates that New South Wales, Victoria and Western Australia receive less than average per capita payments while Queensland receives just above the average level of per capita payments. The Northern Territory receives over five times the national average and Tasmania, the Australian Capital Territory and South Australia also benefit from above average per capita payments.

Chart 6: General Revenue Assistance, 1999-2000

FISCAL EQUALISATION AND SPECIFIC PURPOSE PAYMENTS

In determining per capita relativities for the distribution of general revenue assistance, the CGC takes account of the interstate distribution of most current Specific Purpose Payments (SPPs). Within the CGC's methodology there are three approaches to dealing with SPPs:

• Inclusion is used for SPPs which are considered to go towards meeting the States' expenditure needs as assessed by the CGC (for example, SPPs for funding government schools). In general, while the effect of the Inclusion method on the overall distribution of funding depends on a number of factors, a State receiving a higher (lower) share of an `included' SPP than the CGC considers appropriate to satisfy its relative `needs' in the area will be assessed as requiring a commensurately lower (higher) share of the FAGs/HCGs pool.
• Absorption is a variant of the Inclusion approach with the main difference being that SPPs treated by this method are added to the pool of FAGs and the CGC's recommended per capita relativities are determined with regard to the combined pool in that year. Unquarantined HCGs are treated in this manner.
• Exclusion is used where an SPP is considered to finance expenditure in addition to that which States would otherwise have undertaken or where an SPP is distributed in accordance with the CGC's assessment of State needs. Under this approach, the SPP does not enter into the CGC's calculation of needs -- only the State-funded portion of expenditure is taken into account in the CGC's assessments of expenditure needs.

As part of a process to improve the simplification and transparency of the HFE process, the CGC has changed the terminology in relation to the treatment of SPPs as used in the 1998 Update. Absorption and Inclusion remain the same as in the 1998 Update and Deduction has been renamed Exclusion. Previously, the CGC used the term Exclusion to define SPPs which were directed to areas in which the Commonwealth had largely accepted financial responsibility (for example, most SPPs `through' the States) or were outside the scope of the CGC's assessments of recurrent expenditures and revenues (such as most capital SPPs).

The distribution of SPPs treated by Inclusion or Absorption affects the distribution of FAGs. Concerns have been expressed that this may in some instances result in the Commonwealth's policy objectives with respect to SPPs being overridden. The Commonwealth attempts to balance the objectives of SPPs with the objectives of fiscal equalisation. Accordingly, the Commonwealth has sometimes instructed the CGC to treat certain SPPs in a different way from how the CGC may otherwise have treated them. For example, the financial assistance provided under the Natural Heritage Trust of Australia has been excluded from the CGC's assessments to ensure that the benefit of the assistance is not partly offset by a redistribution of FAGs amongst the States.

It is not necessarily the case that the Commonwealth's policy objectives will be forgone where an SPP's distribution may be overridden over time in a financial sense. The objective of an SPP may be achieved by the fulfillment of the related conditions which the Commonwealth has agreed with the State receiving the payment.