The Commission’s role is to provide independent advice to the Australian Government on how Goods and Services Tax (GST) revenue should be distributed among the states. The distribution of GST revenue is governed by legislation and terms of reference issued by the Commonwealth Treasurer. Both the legislation and terms of reference require the Commission’s advice to be based on the objective of horizontal fiscal equalisation.
Under this objective, which has been a feature of Australia’s federal financial arrangements for many decades, as well as that of other federations, Commonwealth financial assistance to the states seeks to ensure that each state has the financial capacity to provide services and associated infrastructure at a comparable standard if each made the same effort to raise revenue.
Within the Australian federation, the Commonwealth has a greater capacity to raise revenue, while states remain responsible for providing many services (vertical fiscal imbalance). States’ fiscal capacities also differ from each other (horizontal fiscal imbalance). Providing GST revenue to the states, and allocating it in a way that brings their fiscal capacities closer together, mitigates both imbalances, while retaining the benefits of decentralised service delivery by the states.
Changes to the GST distribution arrangements legislated in 2018 include a new equalisation benchmark linked to the fiscally stronger of New South Wales or Victoria, a GST relativity floor, and transitional arrangements to phase in the new benchmark and give states a no-worse-off guarantee. Under these changes, the concept of horizontal fiscal equalisation remains relevant to the first step in determining states' GST distributions — calculating states' relative fiscal capacities. This first step is also necessary to identify the fiscally stronger of New South Wales and Victoria.
The Commission has consistently stated that pursuing horizontal fiscal equalisation is not an exact science — it depends on the availability of appropriate data and requires the Commission to undertake estimates, make trade-offs and apply judgements in its assessments. The Commission seeks to make its judgements as consistent, transparent and understandable as possible.
The work of the Commission depends heavily on reliable and fit-for-purpose data. Around every 5 years, the Commission is asked to undertake a methodology review to ensure its assessment methods are appropriate and utilising the best available data. In between reviews, the Commission retains the same assessment methods, but provides an update each year to incorporate the most recent state financial and other data (such as from the ABS).
To provide certainty and support the reliability of its assessments, the Commission bases its recommendations on historical data. Since the 2010 Review, the Commission has used a 3-year lagged moving average of data. This balances the objectives of contemporaneity, predictability and smoothing the impacts of annual changes in states’ fiscal circumstances. States have supported this approach through recent methodology reviews including the current review.
The Commission recognises that in many, but not all, instances, its assessment methods are complex. Complexity is often a result of ensuring the methods are policy neutral — that is, that they do not reward or penalise states for their individual policy choices. Further, in pursuing the primary objective of fiscal equalisation, complexity can arise from adopting methods that seek to best reflect states’ particular fiscal circumstances. The Commission adopts a materiality threshold as a guardrail against undue complexity and, again, states have generally supported this approach.
Since the 2020 Review, the Commission has introduced an Occasional and Research Paper series. The purpose of these papers is to help improve understanding of the Commission’s role and its approach to its work by explaining in non-technical terms how it conducts its assessments of states’ relative fiscal positions. These papers are available on the Commission’s website.
Close consultation with the states is a priority for the Commission. States are involved in reviewing assessment methods and in working though new issues in annual updates. States have a good understanding of the Commission’s assessment methods, and the Commission regularly supports the states through the provision of training. All the Commission’s calculations are made available to the states, except in some limited circumstances where states have imposed confidentiality restrictions on underlying data. The Commission is always open to assisting states to improve their understanding of its assessments and the implications for the distribution of GST revenue.
The Commission’s ‘practicality’ supporting principle incorporates an objective to determine GST shares in a way that supports the stability and predictability of state budget processes. The 3-year lagged moving average approach to data is consistent with this objective. While forecasting future year GST shares has been suggested, this would increase, rather than reduce uncertainty, given forecasts would necessarily involve uncertain state forecasts on revenues and expenses, and would not include contemporaneous data from other sources such as the ABS. The relative nature of the GST distribution arrangements, with distributions coming from a fixed pool, also means that forecasts would depend on assumptions about relative movements in state financial circumstances across all 8 states and territories. As the Commission only receives the most recent state financial data around 2 months prior to an annual update, it is not possible to provide some form of mid-year update to GST shares at an earlier time.