Examining Horizontal Fiscal Equalisation in Australia

In 2010-11 over $45 billion GST monies, and about $24b of other grants, will be distributed between the States and Territories on the recommendation of the Commonwealth Grants Commission. The Commission is instructed to implement Horizontal Fiscal Equalisation (HFE); and not to be concerned with efficiency. The paper examines how the CGC pursues fiscal equality, and finds some systematic flaws. The adjustments made by the CGC for demography and mining, but not for wages, undoubtedly reduce inequality in fiscal capacities, from a short-run point of view. However, for payroll tax assessments, the CGC can mistakenly transfer moneys from equals to equals; and disturb an efficient pattern of interstate migration and settlement. The reason is that labour mobility tends to make working households indifferent between jobs in different jurisdictions, with the differences in wage rates compensating for locationally-specific differences in costs of living. In addition to equity flaws, I note some negative efficiency effects, as counterweights to the common claims that HFE improves economic efficiency. Interestingly, HFE in Australia strives for full equalisation of state budget capacities; in contrast, governments attempt only partial equalisation of private budget capacities. I present a framework for considering the trade-off between equality and efficiency, adapted from Brennan and Pincus (2004 and 2010). The main result is that little or no allowance should be made for interstate differences in unit costs of public provision of (public or private) goods and services. An alternative distribution of GST monies is estimated for 2010-11.