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What is fiscal equalisation?

Fiscal equalisation involves the transfer of payments or grants across jurisdictions with the aim of offsetting differences between a jurisdiction's revenue raising capacity and expenditure needs.

It can address both vertical fiscal imbalance and horizontal fiscal imbalance.

Vertical fiscal imbalance refers to the situation where the Commonwealth Government raises more revenue than it requires for its own direct expenditure responsibilities, while the State Governments are, on average, only able to raise about a half of the revenue they require for their expenditure responsibilities.

Horizontal fiscal imbalance refers to the situation where the States have differing abilities to provide comparable levels of services through the imposition of comparable tax burdens, because of demographic and economic disparities between them.

The equalisation which addresses horizontal fiscal imbalance is called horizontal fiscal equalisation (HFE), usually also referred to as fiscal equalisation in the Commission's publications.

The fiscal equalisation system in Australia (http://www.cgc.gov.au/fiscal_equalisation/commonwealth-state_financial_relations)

The Intergovernmental Agreement on Federal Financial Relations (IGA) provides the overarching framework for fiscal equalisation in Australia.

The vertical fiscal imbalance is addressed by the Commonwealth's on-going financial support for the States' service delivery efforts, through general revenue assistance and specific purpose assistance.

The IGA provides for:

• general revenue assistance, including the on-going provision of GST payments in accordance with the principle of HFE [http://www.cgc.gov.au/fiscal_equalisation/navigation/4], to be used by the States for any purpose;
  
  
• National Specific Purpose Payments (National SPPs) to be spent in the key service delivery sectors; and
  
  
• National Partnership Payments (NPPs) to support the delivery of specified outputs or projects, to facilitate reforms or to reward nationally significant reforms.
  
  
  

The current operational definition of HFE that the Commission has adopted is:

"State governments should receive funding from the pool of GST revenue such that, after allowing for material factors affecting revenues and expenditures, each would have the fiscal capacity to provide services and the associated infrastructure at the same standard, if each made the same effort to raise revenue from its own sources and operated at the same level of efficiency." [Each underline links to section later in this page]

Each of the key terms (underlined) in this definition is elaborated upon below.


The pool of GST revenue

Funds available for the equalisation of fiscal capacities between the States and Territories are equivalent to the revenue received from the GST. While some States will receive shares larger than their population shares of the pool, others will accordingly receive a lower than population share.


Material factors

State fiscal capacities are affected by a wide variety of factors. The Commission's recommendations take into account those factors which are outside the control of State governments.

A material factor is one whose influence on the Commission's calculation changes the GST distribution by more than a certain dollar amount per capita. That amount is determined by the Commission and is set out in the Commission's assessment guidelines [http://www.cgc.gov.au/__data/assets/file/0007/18349/2010_Review_final_report_vol_1.pdf#page=150].


Fiscal capacity

Fiscal capacity is a summary measure of the relative financial capacity of each State to provide general government services. Applying the same (average) set of policies to the varying circumstances of each State, it takes into account the resulting State expenses, revenues, assets and liabilities. Fiscal capacity is currently measured by reference to net financial assets per capita. States are said to have the same fiscal capacity, if after providing the same/average level of services and the associated infrastructure, and raising the same/average level of revenues, they can hold the same net financial assets per capita.


The same standard of services and the same effort to raise revenue at the same level of efficiency

The same standard of services (for example, for school or police services) and the same effort to raise revenue (for example, payroll tax rates and threshold) are defined as the average level of what States collectively do.

The level of service provided or the effort made to raise revenue is not distinguished from the efficiency with which the services are provided or the revenue raised. For example, we accept as the 'same' the expense per unit of target population, or revenue per dollar of revenue base. We are not concerned with whether a State achieves that rate through a low standard of service and an inefficient method of delivering the service or a high standard of service and an efficient method of delivering the service. We assume States operate at the 'same' level of efficiency.


Own source revenues

States' own source revenues include revenues raised by State governments other than grants from the Commonwealth government.


The average policies

The average polices are reflected in the practices of the States in the collection of revenue and the provision of services. These averages are usually weighted according to the size of the user or revenue bases in each State (for example, the average policy on school education is defined relative to the number of school-aged children).