Is ScoMo a “bastard” for cutting the Territory’s GST funding?

The NT News’ front page on Saturday is a vintage piece of Murdoch tabloid journalism – aggressively funny but without any meaningful regard for fact or fairness. Of course portraying any politicians as “bastards” is bound to meet with general public approval, especially when Messrs Turnbull, Morrison and Scullion are identified as the culprits who just unfairly robbed the Territory of $2 billion over the next four years. Moreover, the journos who write this stuff might even believe it; after all quite a few usually thoughtful local pundits have made similar noises.

The truth is that the national system for distributing GST revenue between the states and territories IS badly broken, but the decisions aren’t in a practical sense made by the federal government politicians so they aren’t “bastards” at least for that reason. More importantly, the system will be devilishly difficult to fix. However, explaining that in a way people can understand or be bothered reading is a tall order, because the system is also mind-blowingly complex. But I’ll have a go at it anyway.

The federal government has the lion’s share of tax-raising powers in the Australian federation, for a mix of constitutional and historical reasons we won’t go into right now. In econo-speak this is called “Vertical Fiscal Imbalance”.  The state governments’ revenue-raising powers are more limited than the Commonwealth’s, but they have the major constitutional responsibility for delivering most government services to their state. As a result there is a need for a fair, predictable and relatively non-partisan mechanism for determining the distribution of Commonwealth revenue to the states and territories.

How does the GST distribution system work?

The principles by which GST revenue (and before that general revenue or untied grants from the Commonwealth) are distributed are:

1. The proportionate carve-up or distribution is assessed by the independent Commonwealth Grants Commission (CGC) according to a very complex formula which measures each state/territory’s revenue-raising capabilities from its own potential sources of revenue (irrespective of the extent to which a given state actually chooses to tax a particular possible revenue source);
2. The CGC also assesses the revenue needs of each state and territory. It does this by the principle of Horizontal Fiscal Equalization, the objective of which is to achieve a situation whereby “each of Australia’s States has the same fiscal capacity, under average policies, to provide general government infrastructure and services.”

When Prime Minister John Howard introduced the GST in the late 1990s he was only able to win the support of the states (and the Australian people generally) by promising solemnly that the GST would not be changed without the unanimous consent of the state and territory governments. In relation to the rate of GST (currently 10%) and the base (what goods and services would be taxed, that was achieved by enshrining in federal legislation an inter-governmental agreement called the “Agreement on Principles for the Reform of Commonwealth-State Financial Relations endorsed at the Special Premiers’ Conference in Canberra on 13 November 1998” (“the GST Agreement”).  That Agreement provides that the GST base and rate can only be altered by unanimous agreement of the states and territories.  See section 1-3 of A New Tax System (Goods and Services Tax) Act 1999 (Cth) (“the GST Act”).

Now the GST Act is only ordinary federal legislation and so section 1-3 could be amended and repealed by any later federal Act, which could for example remove the requirement for unanimous state and territory agreement. But this form of limited entrenchment is actually much more powerful than it might sound, because federal governments almost never control the Senate and would have lots of defectors from their own ranks if they ever tried to increase the rate or base of GST without fairly broad consensus. That’s why Malcolm Turnbull briefly floated the idea of GST reform after he became Prime Minister in 2015 but rapidly backed away.

The principles for distribution of GST revenue between states and territories are also protected from change without unanimous state and territory agreement, but that requirement is not enshrined in legislation at all. Instead the principle of Horizontal Fiscal Equalisation is mentioned in general terms in the GST Agreement (1998) while the details of how it works are found in a later inter-governmental agreement called the Intergovernmental Agreement on Federal Financial Relations (“IAFFR”).  Like the GST Agreement, clause 4 of the IAFFR provides:

This Agreement will operate indefinitely from 1 January 2009 unless the Parties by unanimous agreement in writing revoke it.

The detailed arrangements for calculating and implementing distribution arrangements among the states and territories are found in Schedule D – Payment Arrangements.  The key principles for determining sharing/distribution of GST revenue are found at clauses D63-D67 inclusive.  They put the formal responsibility for distribution/relativity decisions on the Commonwealth Treasurer (currently Scott Morrison) but with this crucial proviso:

D65 The Commonwealth Treasurer will determine the GST revenue sharing relativities, which embody per capita financial needs based on recommendations of the Commonwealth Grants Commission, after consulting with each State and Territory.

Are Turnbull and Morrison “bastards” for allowing the Territory’s GST share to be reduced?

As you can see, the Treasurer makes GST distribution decisions in a formal sense, and undoubtedly has a measure of discretion within the IAFFR framework, but decisions must be “based on recommendations of the Commonwealth Grants Commission”. However former Treasurer Joe Hockey specifically asked the CGC to review its GST distribution methodology in December 2014, in response to loud complaints from Western Australia that its funding and budgetary base were being completely smashed by the CGC’s existing GST distribution approach. Moreover, WA IS being smashed by the GST distribution formula, to a much greater extent than the NT is about to experience. As a result the CGC undertook a review of its methodology/approach.

However it concluded that its existing approach, which involves assessing states’ revenue-raising capabilities over a 3 year rolling average of historical data, while admittedly imperfect was nevertheless better than any of the available alternatives (which it discussed in detail). Consequently it declined to change its approach and has continued making similar recommendations to the Treasurer each year using the same approach about which WA had complained. Western Australia had complained (and still complains) that the effect of the 3 year rolling average approach is drastically unfair for it in a situation where it is being assessed as having the benefit of windfall revenue from iron ore and gas when in reality the Chinese Minerals Boom ended some years ago. Prices and therefore government revenue are now much lower.  Here’s what the CGC said about WA’s complaint:

The lagged average approach is less contemporaneous when dealing with larger scale variations in trends (relative to the trend growth rate of the GST pool). Where revenues are trending upwards at an unusually fast pace, as in a mining expansion, the lagged average approach routinely underestimates actual revenues in the application year. Conversely, the lagged average approach regularly overestimates actual revenues in the application year during a larger than average downward trend. However, to the extent that these developments are cyclical, rather than ongoing structural trends, the effects of the system in achieving HFE over time apply irrespective of the relative amplitude of the cycle.

The three year lagged average approach also assists States with budget management, in that any State’s GST revenue is not immediately subject to the volatile outcomes in other States. For example, while the equalisation system will see Queensland compensated by the other States for expenses incurred in addressing natural disasters, States do not bear this cost unexpectedly in the year in which the disasters occur. States can plan to absorb those costs through reductions in GST revenue as the relevant year moves through the equalisation system. States are well aware of this longstanding aspect of the HFE system and manage their budgets accordingly.

Given that the CGC continues making recommendations about GST revenue on the same basis it has employed for some years, there does not appear to be much if any practical scope for Treasurer Morrison to adopt some different approach which might satisfy the complaints of WA and now the Northern Territory as well. Such a determination would certainly be within the Treasurer’s executive authority under the Constitution, but equally certainly it would not be “based on recommendations of the Commonwealth Grants Commission”. Treasurer Morrison could only make such a decision by effectively tearing up the IAAFR. ^[1]Most expert commentators regard intergovernmental agreements like the GST Agreement and the IAFFR as political agreements that are not legally enforceable, even though breaching them may well have … Continue reading  Any move of that sort made unilaterally by Turnbull and Morrison would immediately trigger World War III between the Commonwealth and states.  The GST distribution system can only be changed in the real world of politics in a significant way through patient discussion and negotiation over a period of time. Agreement will not be easy to achieve.

Moreover, the CGC also sought feedback from the states and territories about whether and to what extent they favoured changes to the CGC’s existing approach. Although some said they were willing to discuss change in a careful and considered way over time, they were strongly opposed to rushing into anything. The fundamental reason for state reluctance to change is that GST distribution is a zero sum game; there is a specific pot of GST money (currently about $57 billion). If the formula is changed so that one or two states get a bigger share of the pot then the rest by definition get less. The Northern Territory Government’s feedback on WA’s complaint is especially interesting given that the new Gunner government (or at least the NT News on its behalf) is now crying foul about the operation of a system that has until now always operated very generously in the Territory’s favour:

The Northern Territory said that other States have previously experienced significant variation in revenue sources due to the inherent data lags under the current methodology. The Territory said these States were not afforded special treatment to smooth or lessen the impact on its fiscal capacity, and it does not consider that it is appropriate to do so for Western Australia.

In all the circumstances we can be very confident that the Territory’s current bleating about its forthcoming reduction in GST share will be given short shrift by the other states and the ACT, and quite possibly by the federal government as well. When you keep in mind that the Abbott and Turnbull governments were unable to get the GST distribution system changed to reduce the drastic adverse consequences being suffered by Western Australia, even though they knew very well that failing to do so was going to spell the end of the Barnett Liberal-National state government, the chances of it being willing to do so for the benefit of a Labor Territory government are somewhere between Buckley’s and zero.

The Territory has in recent times been getting 5.5 times the share of GST revenue to which it would be entitled on a per head of population basis. It has now been re-assessed and will next year be getting only 4.7 times more than its fair share on a population basis.

The next most generously treated state is little Tasmania, which gets 1.6 times its fair share on a population basis. Western Australia has just been given a tiny increase to just 0.34 times its fair share on a population basis, while the big states of NSW and Victoria are just under “even steven” at around 0.9 times their fair share on a population basis. Queensland, South Australia and ACT are all just above “even steven” at 1.1-1.3 times their fair share on a population basis.

Of course there are good and defendable reasons why the Territory gets so much than any other state or territory: we are very sparsely populated and need more or less that sort of money to provide a similar standard of public infrastructure, services and facilities as other Australians enjoy. Nevertheless the other states are unlikely to be very sympathetic to the Territory’s case that it really deserves to keep getting five times as much as everyone else despite the fact that the CGC has assessed that we don’t actually need that much.

The CGC’s GST formula needs fixing

Despite those observations, there really isn’t any doubt that the CGC formula really does need some serious tweaking.  As right wing economist Judith Sloan has observed:

Experienced economist and director of Deloitte Access Economics Chris Richardson has summed up the situation very well: “The calculations of the Commonwealth Grants Commission may be highly detailed but they often produce highly detailed humbug.”

In the Territory’s case it appears that the main reason our share of GST revenue is about to be reduced by $500 million per year is that the NT’s population has stopped growing rapidly. In fact it is hardly growing at all. Hence we don’t need as much GST revenue to build new roads, hospitals and other facilities for a growing population. The birth rate remains a bit higher than the national average but net interstate migration is now strongly negative with the huge Inpex project now well past its peak and almost finished. At its peak Darwin’s population was boosted by 5,000-8,000 additional workers, a few of whom brought their families with them where they were on longer contracts.  That is a boost of around 3% to the Territory’s resident population, which is now being progressively reversed. However, given that it appears we were previously receiving more GST funding (to the tune of 5.5 times our fair share on a population basis) in significant part because the formula assumed we needed to provide facilities for a rapidly growing population, that in itself shows that the CGC formula needs revision. In a larger state even a very large construction project would not make a huge proportionate difference to the total population. You could reasonably make an assumption that a population increase of 3% was likely to be long term and needed to be catered for in terms of public infrastructure and facilities.  However the Inpex workers were only ever going to be resident in Darwin for the duration of the construction project, and so the NTG’s need to provide extra infrastructure and facilities for them was very limited.

To the extent that the existing CGC formula resulted in the Territory getting a bigger share of GST to provide such facilities, that extra money was a free windfall gift resulting from a defective formula.  The money should have been jealously guarded and spent wisely, because funding at that level was never going to last. I have no doubt that both the NT Treasury and both the Giles and Gunner governments were well aware of all this.^[2]They were definitely aware of it to a significant extent. Page 40 of last year’s Budget Strategy and Outlook document forecasts a fall in the NT’s GST relativity to 5.1, and the Giles … Continue reading Although NT Treasurer Nicole Manison was at pains to emphasise the severe difficulties the federal funding cut would cause for the Territory’s budget and broader economy, she has so far refrained from the sort of colourful political abuse directed at Turnbull and Morrison to which the NT News immediately resorted. That may be because she has been told by NT Treasury that people in glass fiscal houses are unwise to throw stones.

The NT News will not succeed in bludgeoning the federal government into giving us a better GST deal, although it may well sell more newspapers by drumming up misplaced outrage against Turnbull and Morrison.  The Turnbull government has nothing to lose politically (in contrast to the situation in WA where it was also unable to do anything meaningful) because both NT House of Reps seats are held by Labor and the Coalition isn’t going to lose its NT Senate seat even in a landslide election defeat.

Moreover, although Judith Sloan’s fairly scathing and unsympathetic opinion about successive NT governments’ fiscal prudence is a little unfair, it is widely accepted interstate:

Research undertaken in the Northern Territory — relativity 5.66061 this financial year — has shown that a great deal of the GST money is spent in Darwin on government buildings and facilities and public servants, rather than providing government services of the same standard to the large number of indigenous citizens living in the Territory.

The distribution of the GST as determined by the grants commission involves the highest degree of horizontal fiscal equalisation in any federation in the world. It is fatally flawed. And the more complicated it becomes, the more erroneous are the results.

Most people “down south” view Territorians as pampered yokels who have been waxing fat on Australian taxpayers’ money for far too long.  The Territory’s best chance of surviving the coming federal funding famine is to keep our mouths shut, crank up deficit budgeting to keep the local economy going, keep pursuing viable ideas for growing our economy (including developing onshore gas) and try to convince the Turnbull government to give us some short term Special Purpose Grant funding to tide us over the shock of reduced GST funding (as Western Australia was given last year for a similar reason). Those efforts are not likely to be helped by calling them “bastards” or worse (even if it was true, which it isn’t).