The Commonwealth Government raises more revenue than the States and Territories (the States) so the Commonwealth transfers funds to the States to assist them to meet their expenditure responsibilities. In addition, there are differences between the States in both their revenue raising ability and their expenditure requirements. These interstate differences are taken into account in the allocation of Commonwealth payments to the States.

The current framework for Commonwealth-State financial relations in Australia is set out in the Intergovernmental Agreement (IGA) on Federal Financial Relations [Intergovernmental Agreement]. Legislative authority for payments made under the IGA is provided by the Federal Financial Relations Act 2009.

Under the current arrangement, the Commonwealth provides financial assistance to the States in the form of general revenue assistance and payments for specific purposes, accounting for around 50 per cent of total state revenue. General revenue assistance, mainly the Goods and Service Tax (GST) revenue, is available to the States to spend according to their own budget priorities. Payments for specific purposes are governed by:

Six agreements covering healthcare, schools, skills and workforce development, disability services, housing and Indigenous reform. National Payments for Specific Purpose are made from the Commonwealth to the States in each of these key service delivery sectors, with the aim of achieving outcomes agreed between the Commonwealth and the States. States have considerable flexibility as to how these funds may be spent, provided the agreed outcomes are achieved. 

Sixteen National Partnerships that are developed in the six areas covered by National agreements, as well as other service areas, including the environment, transport, and infrastructure. National Partnership Payments (NPPs) help the States to deliver large projects, and to facilitate and encourage reforms.All payments are made by the Commonwealth Treasury directly to State Treasuries which are responsible for distributing the funding to their line departments.

The IGA requires that the GST be distributed among the States on the basis of horizontal fiscal equalisation. The Commonwealth Grants Commission is assigned the task of recommending GST revenue sharing relativities according to this principle. The Commonwealth Treasurer, after consulting the States and Territories, gives the commission terms of reference asking for a report on appropriate relativities.

Terms of reference are provided to the commission for five-yearly reviews of methods to be used in calculating the GST revenue sharing relativities. Annual updates of those relativities are also required using the methods recommended in the previous review.

The Commonwealth Treasurer makes a formal determination of how GST revenues are to be shared after the Ministerial Council for Federal Financial Relations (MINCO) considers the commission's recommendations.