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FINANCIAL ARRANGEMENTS IN AUSTRALIA FINANCIAL ARRANGEMENTS IN AUSTRALIA The Australian federation was formed in 1901 by a voluntary agreement among the then six British colonies, which became States of Australia. Self-government was given to the Northern Territory in 1978 and to the Australian Capital Territory in 1989. There are three levels of government in Australia (the Commonwealth, State and local governments). This paper concentrates on relations between the Commonwealth and the States. This paper provides: FEATURES OF THE AUSTRALIAN STATES Australia is a reasonably large and sparsely settled country of about 20 million people. The population is spread unevenly around the country with the vast majority of people living within a small distance of the coast and most people living in the sout Table 2 contains some demographic characteristics including: Figure 2 shows the differences between States in the proportion of their populations in the age ranges 0 to 18 years, 19 to 55 years and over 55 years. It indicates that Tasmania and South Australia have relatively older populations while the Northern T Figure 3 shows the per capita gross State product of each State relative to the Australian average in 1995-96 and 2000-01. Gross State product is above average in the ACT (reflecting the high contribution of the Commonwealth government to its economy) Figure 4 shows the per capita gross household income of each State relative to the Australian average in 1995-96 and 2000-01. Gross household income in the ACT is noticeably higher than elsewhere reflecting the high labour-force participation rate, low Overall there are some noticeable differences among the Australian States in their demographic and economic features. We have: However, the differences between the Australian States are small relative to those in some other federations. GOVERNANCE AND THE RESPONSIBILITIES OF THE COMMONWEALTH AND THE STATES Governance At the Commonwealth level, Australia has two houses of parliament: At the State level, most States have a two-house parliament, although some such as Queensland and the two territories have single houses. Interaction between the two levels of government takes place through a variety of means. Financial matters are dealt with in the Ministerial Council for Commonwealth-State Financial Relations, which is a meeting of the Commonwealth and State Treasurers. For other major matters where co-ordination of government actions is desirable, there is the Council of Australian Governments, consisting of the Prime Minister and the Premier or Chief Minister of each State and Territory. There are also many Ministerial Councils that are attended by the relevant Commonwealth and State functional ministers. These councils are responsible for establishing national policies and for co-ordinating Commonwealth and State actions in their relev Most of the ministerial councils have supporting meetings of officials. For example, Heads of Treasury meet at least three times a year to consider issues and initiate research in support of the Ministerial Council for Commonwealth-State Financial Relat Responsibilities of Each Level of Government Section 51 of the Australian Constitution specifies the powers of the Commonwealth. These include defence and external affairs, social welfare, international and interstate trade and commerce, immigration, and post and communications. All non-specified powers are the responsibility of the States. They have the major responsibilities for providing most of the services that affect the daily lives of people, such as education, health, law and order, transport, essential services (water The Constitution was intended to preserve the financial independence of the States. However, it has not prevented major shifts in the balance of powers nor has it prevented the Commonwealth assuming the dominant financial position. Within ten years of Federation, the Commonwealth Section 96 has been a major avenue through which Table 2 uses revenues and expenditures in 2000-01 to illustrate the current distribution of powers between the three levels of government. It shows that revenues are generally specific to one level of government, but expenditure is mixed. Economic development activities. The economic development function is a good example of the divided responsibilities. The latest comprehensive data relate to 1994-95 when the split of responsibilities was: The Commonwealth assistance is generally not regionally based, although its impact may not be equal across all regions. For example, in earlier years the tariff policies probably provided relatively more assistance to the economies of New South Wales an The assistance provided by States takes many forms, including: The 1996 inquiry by the Industry Commission largely stemmed from concerns that States were competing against each other for projects and major events with little or negative impact on national well-being. A survey conducted by the Industry Commission fo Other functions that have an impact on economic development, such as industrial relations and wage setting are also shared, although Commonwealth policies arguably have a more widespread influence. For example, in wage setting the current Commonwealth g Summary. Australian Commonwealth-State financial arrangements, including the equalisation arrangements, have developed in a context where: COMMONWEALTH-STATE FINANCIAL ARRANGEMENTS Vertical Fiscal Imbalance Figure 6 (which summarises the material in Tabl Commonwealth Transfers to the States In these circumstances where the Commonwealth has the dominant financial capacity, Australia has developed an extensive system of payments from the Commonwealth to the States. These payments take two main forms. There is also a growing tendency for Commonwealth agencies to directly spend money on State-type Services. In these cases the Commonwealth funds statutory bodies established to oversee services or non-government bodies that supplement services provided In total, the payments to States are large and represent about half the revenue of the general government sector of the States. The levels of untied and specific purpose payments in 2000-01 and 2001-02 are shown in Table 3. Figure 7 shows the make-up o Untied Assistance For most of the time since federation, untied assistance has been the main form of Commonwealth transfers. Its importance has declined in the last thirty years, and as Figure 7 shows, in some years it has been less than half the total assistance. Over the years, Australia has had many different ways of determining the total amount of untied assistance to be provided to the States and of distributing it among them. The processes have included the following. An equalisation process has operated in Australia since the 1930s to even out the financial capacities of the State governments through the distribution of the untied assistance. Initially small supplementary grants were paid to the financially weaker S Figure 8 shows the per capita distribution of untied assistance among the States in 2000-01 and compares it with the equal per capita distribution. It shows the very high per capita amounts paid to the Northern Territory, largely because the equalisatio  Specific Purpose Payments SPPs are a large and important element of the Commonwealth payments to the States in Australia. They are currently about 40 per cent of the transfers from the Commonwealth to the States. This contrasts with their importance in other countries. For exa In Australia, SPPs are used for many reasons including: The conditions attached to SPPs take many forms, including: Determining the Size and Distribution of SPPs. The Commonwealth determines the total value of SPPs. The size of individual SPPs is influenced to some extent by the outcome of negotiations between the relevant Commonwealth Ministers and their State coun The interstate distribution of SPPs is generally decided through inter-government negotiations. There are many distribution mechanisms varying from Commonwealth discretionary allocations, to population shares, to a variety of formulae which often attemp Figure 9 illustrates the interstate distribution of SPPs in 2000-01 and compares it with an equal per capita distribution. The interstate pattern in the distribution of the Summary Australia has an extensive system of transfers from the Commonwealth to the States. About half the funds States have to spend are transfers from the Commonwealth. The transfers take the form of both untied funds A wide variety of approaches have been used to determine the amount of untied assistance over the years including a per capita entitlement, various formulae and a percentage of Commonwealth tax collections. Currently the amount is primarily determined a The total amount of SPPs is not so strongly contr EQUALISATION IN AUSTRALIA As noted previously, for about the last 25 years the main form of untied assistance has been distributed among the States on the basis of horizontal equalisation principles. A principle intended to equalise the financial capacities of the State governme Administrative and Procedural Arrangements The main features of the Australian processes are as follows. In general, the process is independent of political pressures, as objective as possible and conducted in an open manner. Commission decisions and the basis of them can be scrutinised by the States and interested commentators. The recommendations of the Equalisation Concepts and Methods in Australia The Commission developed the equalisation principle used in Australia in 1936. The initial definition was that the distribution of funds among the States should: The concept has been refined since then reflecting input from the Commonwealth, the States and the Commission. Horizontal equalisation is currently defined as: The 1999 Intergovernmental Agreement is the most The most recent statement by the Commonwealth in support of the current approach to HFE is held in Commonwealth Budget Paper No. 3, Federal Financial Relations 2002-03. Among other things, that document says: The definition of equalisation is based on what t Equalisation is not about: Implementing Equalisation and the Equalisation Formula To implement equalisation, the Commission identifies and measures differences in per capita costs of providing services and capacities to raise revenue. A State’s requirement for untied assistance to ac In these calculations: Calculations at this level require large amounts of data. That data is only available for past periods. So the Commission translates its calculated requirements into per capita relativity factors which can be applied to future amounts of available ass To provide some stability in the relativities and hence in State untied assistance, the calculations are done for the five most recently completed years and averaged. This averaging process implies that there can be a lag of up to seven years between th Figure 10 shows differences in the relative cost of providing services as assessed by the Commission. Apart from the special case of the Northern Territory (where costs are 134 per cent above average because its small population is scattered over a hu Figure 11 shows relative revenue raising capaciti The impact of equalisation on the distribution of untied assistance can be seen from a comparison of the assistance each State receives with what it would have received under an equal per capita distribution. Table 4 shows comparisons for 1992-93 and 20 It is interesting to note that over that period, the amount available for distribution has more than doubled, but the distribution away from the two financially strongest States (New South Wales and Victoria) has remained fairly constant. The strength Table 5 provides some insights into the influences that caused revenue and expenditure needs in 2000-01. It shows that the revenue and expenditure assessments have about the same influence on the level of redistribution. It shows that interstate differ Summary Some major features of equalisation in Australia are: THE CURRENT DEBATE ON COMMONWEALTH-STATE FINANCIAL ARRANGEMENTS In Australia an untied grant process, which provides the States with about 30 per cent of their total revenue, is used to reduce the vertical imbalance and to remove the horizontal inequality among States. There is also a large SPP system, representing There are some long-standing concerns about the overall system. In early 2001, a combination of the size of the assistance being dependent on independent movements in collections from a broad based tax, which has grown more slowly than expected, and red Some of the issues the more populous States have raised over the years and which are reflected in the deliberations of their inquiry are considered below. Are the Processes Inefficient? In recent years, Australian governments have emphasised efficiency, and many aspects of the processes have been said to be inefficient at one time or another. Consequently, there are many strands to the arguments about inefficiency. The impact of vertical imbalance. The high level of vertical imbalance is often cited as a source of inefficiency in that it results in each level of government taking insufficient account of the full consequences of their decisions. The usual example Conversely, it can be argued that at the margin additional expenditures are likely to be financed by additional State taxes, which the States will evaluate rigorously. In addition, if the Commonwealth controls the major taxes and thereby influences the The balance of opinion seems to be that, despite the conceptual possibilities, the extent of vertical imbalance is not a cause for major concern in practice. The impact of the equalisation process. Equalisation has been said to result in four types inefficiency. There may be some conceptual validity in each of these possibilities. But, it is not clear that they have any practical impact. It is also necessary to consider whether equalisation brings other more worthwhile benefits in terms of the relatively high The impact of SPPs. There is widespread acceptance of the need for SPPs to promote national standards and to set strategic directions in a federation, but the States and some others argue that they are inefficient because they result in: Governments often state their intentions of moving to an outcome focus and reducing the number of payments and conditions attached to them. But little has happened. Are the Processes Inequitable? Statements by the Premiers of New South Wales, Victoria and Western Australia announcing their Review of Commonwealth-State Funding claimed: These statements primarily reflect the fact that these three States receive less than an equal per capita share of the untied assistance and of the SPPs. This simple view of fairness has support and was the basis for the interstate distribution of hosp It is also notable that the New South Wales Government has itself received much criticism over a decision to increase tolls on the Sydney Harbour Bridge and use the proceeds to fund road works in rural areas. Politics aside, there have been conceptual arguments that equalisation, with its focus on the financial capacity of State governments, does not achieve fairness between individuals – it does not ensure people in different regions or different groups of p Do the Processes Cost Too Much? It is often claimed that the administrative costs A 1994 Australian National Audit Office examination of SPP arrangements found that they were relatively expensive to administer. Considerable effort has been devoted to simplifying the arrangements. But they are still costly. Is the Equalisation Process Unrepresentative and Too Complex? The Premiers of New South Wales, Victoria and Western Australia: It is true that the Commission is not elected. (As noted previously, members are appointed by the Governor-General following selection procedures involving the Commonwealth and the States.) This criticism is contrary to the conventional wisdom that t The Commission is open with and accountable to its stakeholders (the Commonwealth and the States). While its assessments are not subject to a formal audit, the procedures for the conduct of inquiries provides many opportunities for States to provide i That the Commission’s assessments, as opposed to The Report of the Review of Commonwealth-State Funding Many of these issues have been echoed in the report of the inquiry set up by New South Wales, Victoria and Western Australia. That report concluded that the current Commonwealth-State financial arrangements (including the SPP arrangements) inhibit gr It also considered that both the equalisation and SPP arrangements lacked simplicity and transparency. The report recommended a new system under which: Debate on this report is just beginning. However, other States and interested observers dispute many of its findings. In particular, the conclusions regarding the incentive effects of equalisation are considered untested at best. For its part, the Commonwealth has adopted the attitude that issues surrounding the allocation of the GST revenues are ones for the States to resolve. It has stated a preparedness to change the allocation processes if there is unanimous agreement among Many aspects of Australian Commonwealth-State relations are not perfect and it is appropriate that we do stop to ask: are the equalisation and SPP arrangements achieving what governments think they are; what do we want them to achieve; can they be varie We shall have wait and see what unfolds. For its part, the Commission has indicated a preparedness to undertake its tasks in whatever way governments request. ATTACHMENT A EQUALISATION NEEDS FORMULA The average budget result of the Australian States. FINANCIAL ARRANGEMENTS IN AUSTRALIA A PAPER FOR THE CONFERENCE ON FISCAL EQUALISATION AND ECONOMIC DEVELOPMENT POLICY WITHIN FEDERATIONS Malcolm Nicholas Forum of Federations / Forum des federations FINANCIAL ARRANGEMENTS IN AUSTRALIA FEATURES OF THE AUSTRALIAN STATES Figure 1 POPULATION(a) DISTRIBUTION, AUSTRALIA – 2000 Table 1 55 & OverManufacturing and constructionFigure 2 Figure 3 Figure 4 Figure 5 GOVERNANCE AND THE RESPONSIBILITIES OF THE COMMONWEALTH AND THE STATES Governance Responsibilities of Each Level of Government Section 96 ‘….• • Table 2 REVENUE Total Revenue EXPENDITURE Total Expenditure , Taxation Revenue Australia, 1999-2000, 2001 Update Report Supplementary InformationGovernment Finance Statistics Australia, 1999-2000Economic development activities.Summary.COMMONWEALTH-STATE FINANCIAL ARRANGEMENTS Vertical Fiscal Imbalance Figure 6 Commonwealth Financial Relations with other levels of Government, 2000-01, Budget Paper No.3, p 15Commonwealth Transfers to the States Untied assistance,Specific Purpose Payments, Intergovernmental Agreement on the Reform of Commonwealth-State RelationsTable 3 Transfer 2000-01 2001-02 Untied Funds Tied Funds – Specific Purpose PaymentsTotal Commonwealth Financial Relations with Other Levels of Government 1999-2000, Budget Document No. 3, AGPS, Canberra, 1999Figure 7 – Untied Assistance • • • • Intergovernmental Agreement on the Reform of Commonwealth-State RelationsFigure 8 Specific Purpose Payments Determining the Size and Distribution of SPPs.Draft 2002 Division of Revenue Bill and Explanatory MemorandumFigure 9 Summary EQUALISATION IN AUSTRALIA Administrative and Procedural Arrangements Equal per capita grant ($1000) Equalisation Concepts and Methods in Australia Federal Financial Relations 2002-03Capacity equalisation. Internal standards.Policy neutrality.Implementing Equalisation and the Equalisation Formula Federal Financial Relations 2002-03, .Figure 10 Figure 11 Table 4 Commonwealth Financial Relations with Other Levels of Government 1992-93Federal Financial Relations 2001-02Table 5 Revenue Expenditure Summary • • THE CURRENT DEBATE ON COMMONWEALTH-STATE FINANCIAL ARRANGEMENTS Are the Processes Inefficient? The impact of vertical imbalance.The impact of the equalisation process.Background Paper: A review of the allocation of Commonwealth Grants to the States and TerritoriesFinancing the FederationThe Equity and Efficiency Implications of Fiscal Equalisation• • • The impact of SPPs.The Impact of Changes in Public AdministrationAre the Processes Inequitable? Donor States carry an unfair burdenDo the Processes Cost Too Much? Is the Equalisation Process Unrepresentative and Too Complex? The Report of the Review of Commonwealth-State Funding Bridge toll fury mounts as bus users get caught in the netDonor States carry an unfair burdenATTACHMENT A EQUALISATION NEEDS FORMULA Review of Commonwealth-State Funding, Final Report∑ίίί∑ίίίί∑ίίί402030Less Less Less ∑ίίί∑ίίί