9 October 2017
Media Release - #2017098, 2017

Productivity Commission releases draft report on horizontal fiscal equalisation

The Turnbull Government welcomes the Productivity Commission’s (PC) draft report on horizontal fiscal equalisation (HFE).

The draft report provides a comprehensive analysis of HFE and how GST revenue is distributed to the States and Territories, the impact of the current method on national productivity, efficiency and economic growth, and how this could be better achieved.

HFE is how we apply the ‘fair-go’ principle to the way the Commonwealth makes payments to States and Territories, in particular how we share around the $60 billion in annual GST revenue. The objective of HFE is to ensure that all our States and Territories have the fiscal capacity to provide Australians with services and infrastructure at the same standard across the country.

The draft report affirms the benefits of HFE and finds that Australia does better than any other comparable federal system in the world in how we seek to deliver HFE.

The Turnbull Government remains absolutely committed to HFE in determining how GST and other payments are made to the States and Territories.

However, the PC also finds that the system goes too far, creating significant weaknesses.

The PC finds that the way ‘same standard’ has been defined for HFE purpose has crept upwards over time, making the system less able to deal with economic shocks that have an uneven impact across the states, producing unforeseen and unfair outcomes, what they describe as ‘unfair equality’.

In more recent years the PC explains this has included Western Australia’s GST relativity falling to less than 30c in the dollar, post the mining boom.

While acknowledging the $1.2 billion provided in top up payments to WA by the Federal Coalition, effectively stopping the drop in WA’s relativity falling below 37c, top up payments and GST floors are not considered by the PC as viable longer term solutions.

This finding reinforces one of the core reasons I commissioned the PC to do this work back in May. We need to fix the system, not plaster over a part of it.

This is also true of the PC finding of our current HFE system holding our economy back, by creating disincentives for States and Territories to pursue ‘productivity enhancing reforms that are in the national interest’. These include making their tax systems more efficient and to realizing their own resource and minerals opportunities.

The report recommends that ‘revising the objective of HFE would be in the best interests of national productivity and wellbeing’.

As a result, the draft Report establishes a national interest case to address the weaknesses in our HFE system that the PC has identified. This problem is bigger than one state or territory. It’s in the national interest to fix it.

Rather than a major overhaul of the current system, the draft report outlines a number of draft recommendations aimed at improving the way Australia’s GST revenue is distributed to achieve our HFE goals.

This includes a draft recommendation that the Commonwealth Government reset the HFE objective from ‘full’ equalisation, currently interpreted by the Commonwealth Grants Commission (CGC) as bringing everyone up to the fiscal standard of the strongest state, to a more practical objective of ‘reasonable equalisation’. The PC argues such an approach would deliver on the flexibility the system needs, removes disincentives for tax reform and proactive resources policy, while continuing the equity demanded by HFE.

The draft report also includes draft recommendations aimed at improving simplicity and transparency in the current system. This includes retaining the system of lagged indicators, which the CGC indicated was a more reliable and accurate basis for making the necessary GST distribution calculations.

The PC has also suggested a system of rulings by the CGC on how decisions would impact on GST distribution to assist States and Territories with their budgeting.

The Government will issue a full response following receipt of the final report due early next year.

The Turnbull Government’s goal is to deliver a fairer, more durable and more efficient system for implementing HFE into the future.

But we also need to do this in a way that gives all states and territories time to adjust. While we must continue to act to provide fairer treatment for states like WA, we must similarly consider the potential impact on smaller recipient states like South Australia and Tasmania as we consider any transition plans.

Such transition plans must also appreciate that GST relativities are not static. So care should be taken in making assumptions about the specific point in time impacts on any one jurisdiction from alternative models. The Government will work to assess impacts over time to avoid any ‘policy cliffs and to smooth out impacts, wherever possible.

I therefore look forward to the PC doing the further work that must now be done, in close consultation with the States and Territories, to identify how we can not only make the system work better and fairer, but how we can transition to any such system.

The PC is undertaking a further round of consultation to gather stakeholder views on the draft report. States’ views on the draft recommendations and potential implementation and transition issues will be vital for the PC to finalise its recommendations.

The draft report will also be discussed with States and Territory Treasurers at the Council of Federal Financial Relations to be held later this month.

I urge all interested parties to participate in this important process. Written submissions can be made by Friday 10 November 2017 or stakeholders can attend one of the PC’s public hearings in Perth, Melbourne and Sydney during November.

The draft report is available on the Commission’s website