“Let’s Stick Together”, They Said. But At What Cost?

The Goods and Services Tax is one of those issues that we tend to look at in isolation. By this I mean that a lot has been said as to its design and reach, yet seldom do we seem to discuss the GST in context. That is, what the overarching objective of the GST is. There’s little point in talking about the GST’s technicalities if we don’t also talk about this.

Firstly, as a consumption-based tax, the GST has proven to be extremely lucrative over the years and thus a seemingly unwavering source of tax revenue. It was the rational legislative replacement for a plethora of other inefficient taxes. Revenue grants from the Federal government sourced from the funds raised by the GST are a key source of revenue for state and territory governments, and hence the GST’s economic and political importance.

This being true, however, the GST’s underlying objective must also be considered. The reality is that the covert objective is, in essence, to subsidize economically poorer performing states and territories (i.e. to achieve Horizontal Fiscal Equalization). It is an old redistribution mentality from the early days of our Federation of “sticking together”. We aim to ensure states and territories have the same revenue capacity to pay for its services in the hope that there will be some long-term benefit from it all and that in the end all states will be equally prosperous*. It is a flawed ideal in that it cannot guarantee an equal outcome as it tries to work against more profound economic changes across the nation.

The GST itself is the flawed means to this flawed end.

To understand how this is so, a brief overview of the current GST methodology is needed.

The Commonwealth Grants Commission, who formulates something called a “standard budget”, which then the actual state and territory budgets are compared against, determines this “equalization”. Specifically, there are five categories that are assessed: own-source revenue, expenditure, investment expenditure, net lending and Commonwealth payments. There are approximately 110 or so assessment criteria under these five broader categories, which are assigned “relativities” and are then weighted according to their importance to the “standard budget”. From all these specific weighted relativities, the relativities for the broader own-source revenue, expenditure, investment expenditure and net lending categories are then determined. With these relativities now calculated, they are now applied to the “standard budget” and a “relative budget” is produced for each jurisdiction. The Commonwealth payments category is then assessed and added to the budget (the current level of federal funding apportioned to that state to fund their expenditure). An “assessed GST funding requirement” figure will then determine how much a state will need in GST revenue in order to have the equivalent of the “standard budget”. This figure is divided by the states’ population, which is then divided by the Equal per Capita (EPC) level of GST funding for that jurisdiction to determine the overall relativity. The distribution of GST to or from that jurisdiction is the difference between the “assessed GST funding requirement” figure and the EPC.

Now, apart from the fact that the relativities calculated are submitted by the states themselves and receive little or no adjustments by the Commonwealth Grants Commission (meaning the incorporation of perverse incentives into the GST’s methodology, stifling reform because states are inclined to modify their expenditure so as to maximize their grant revenue), there are other serious issues surrounding the whole GST methodology.

It is fiddly and in many cases, purely arbitrary. A primary example of this is the own-source revenue category in the equalization process. States have varying revenue sources, some of which are not included in the equalization process, and some of which are. For example, gambling taxes, which are not included in the equalization process, make up to 8 per cent of own-source revenue in a number of jurisdictions, whereas it makes up only 2 or so percent for a state with gambling restrictions like Western Australia. Moreover, mining royalties are included in the process, meaning a state like Western Australia, where mining royalties make up a large portion of its revenue compared to other states, is effectively been penalized for stronger economic performance by receiving less money back from the Commonwealth.

There are also other issues with the assessment of the Investment category, such as the neglect of the specific and unique infrastructure needs of some states (e.g. large infrastructure demands in states like WA and Queensland). The assessment is also retrospective and can’t take into account the future economic prospects of a jurisdiction.

With its unequal considerations of varying revenue sources in different jurisdictions, as well as its rigid assessment of certain criteria, the current GST methodology is inequitable. Estimates have it that Western Australia’s relativities will fall to a low 0.33 in 2014-2015.

In light of the above stated problem-ridden GST distribution methodology, the GST, by its very design, is (as with all subsidies) having an unfair impact on those people paying for it. What is happening is that money is being redirected to some state governments to prop up their economies in the name of some vague, unrealistic ideal. As these state and territory governments become increasingly reliant on the inequitable GST grants from the Federal Government, the stronger performing states are having their potential wealth squandered.

The problem with this is that the people, the flesh and blood human beings, in places that prosper are being penalized for their productiveness.

The end result could be that the nation’s wealth as a whole, in the long run, will be lessened by the fact that money is being redistributed to places where it isn’t optimally adding to the nations productive capacity as much as it would if it were to stay in the better performing economic areas.

This is what we ought to keep in mind when having a discussion about the GST. Yes, there are be issues with its design and reach, and this constitutes sensible policy debate. But it also needs to be considered whether or not it is in Australia’s long-term economic interests to pursue the objective of subsidizing poorer performing states, and whether the net loss to our wealth caused as a result is just the price we have to pay if we are all to “stick together”.  The current GST methodology enshrines distributional inefficiencies and inequities, yet these issues need to be seen in context.

On the GST issue, rather than just asking “how?”, we should be asking, “why?”

* However, it should be noted that efforts of HFE merely means equalizing revenue capacity, which doesn’t necessarily translate into equal standard of services if this money is used wastefully by state and territory governments.