EQUALISATION IN AUSTRALIA 41 In a federation comprising a national government and a number of States, services can be delivered in two broad ways. Services can be provided by the national government on a uniform basis across the federation. For example, old age pensions are provided across Australia in the one way so that similar people receive the same benefit. States also deliver services, but because they have different fiscal capacities and make different choices, only similar residents in a State receive the same standard of services. 42 In the same way, national taxes fall equally on similar residents across the federation while policy choice means even similar taxes are levied at different rates among States. 43 The aim of fiscal equalisation in Australia is to create the capacity/opportunity for similar residents across the federation to receive similar State services as well as face the same tax burden. However, preserving State choice, which gives them control over the best mix of services and revenues for their residents, is maintained as a key part of the equalisation process. Equalisation creates the capacity/opportunity for equal outcomes, rather than necessarily creating equal outcomes. 44 If States adopted the same policies, with equalisation, State services could be provided as if they were national services, without a role for the national government, and without it meaning some States bear a disproportionate fiscal burden. If States applied a national approach for service delivery without equalisation, some would incur a greater fiscal burden than others. For example, for services to homeless persons, the State with the largest concentration of homeless persons in its population would bear the largest per capita cost in its budget. 45 What equalisation overcomes is that if States were to provide the same standard of services to similar residents and raise revenue in the same way, their budget outcomes per person would vary widely. For example, those with a high concentration of high cost residents, say older persons for health care, or with a small Chapter 1 Achieving horizontal fiscal equalisation 32 The Equalisation system reflects the average policy of States. revenue base, say little or no mining royalties, would have a higher than average budget deficit per person. Equalisation offsets these innate differences creating a more balanced fiscal setting across the federation in which State policy makers can set spending and revenue policy. It does this by giving equalising grants to the States (different levels of general purpose grants) depending on their varying fiscal equalisation needs. 46 Equalisation complements the automatic redistribution across the federation inherent in national policies, where service standards in different States are not tied to the national revenues raised in those States. 47 The equalisation process could be implemented in several ways. For example, it could be based on a package of notional or hypothetical State service standards and some idealised State revenue system. While this might, because of its stylised nature, be easier to implement, it would differ from what the experience of States reveals about the relative importance of different services to residents, the desired standard of those services and the appropriate mix of revenues to fund them. Rather than base equalisation on an idealised or hypothetical standard, the Australian system is built on the foundation of the actual average service delivery and revenue policy of the States. It distributes revenue so that each has the capacity to deliver the observed average service delivery standard, if each applied the observed average tax rates. 48 The Australian equalisation system also recognises that grants paid by the Commonwealth to States for specific purposes such as schools or hospitals provide States with financial capacity to deliver services. This revenue is taken into account when determining the size of the equalising grant each State should receive to give it the capacity to provide the average level of services. 49 Because the equalisation system is founded on the observed experience of the States, and that experience is updated on an annual basis as new statistics are released, the pattern of equalising grants changes over time to reflect the evolution of individual State fiscal circumstances. For example, the buoyancy of State real estate markets changes over time, as does the capacity of States to raise revenue from the stamp duty on real estate transactions. As a State’s capacity rises, relative to other States, its equalising grant falls. If States on average choose to spend more on providing services to a particular group of their residents, for example, those living in remote communities, then those States with a high proportion of residents in remote communities would have to spend disproportionately more on providing the higher average service level, increasing their equalising payment. If a State were to receive an increase in their share of The Equalisation system adapts to reflect State experience. Chapter 1 Achieving horizontal fiscal equalisation 33 payments from the Commonwealth then, with no other changes, its equalising grant would decline. 50 To capture the material differences in State fiscal capacities the equalisation system comprehensively covers the service delivery, investment and revenue activities of States. While each part of the assessment of fiscal capacities is of itself relatively simple, when considered as a system, it is as complex as the State Governments which are its subject matter. To provide the greatest transparency, our methodology is developed in consultation with States. Most of this material, apart from confidential information provided by States, is also on the Commission’s website (https://www.cgc.gov.au/) to enable replication of results and is open to public scrutiny. 51 The methodology is also based on the best available data capturing the average service delivery and revenue policies of the States. Most often, this comes from national data collections which detail, for example, the average State spending on persons with different socio-demographic characteristics, supplemented by specific purpose data collected from the States and then averaged. The available data are often incomplete and so from time to time the Commission has to use informed judgment where we consider, based on the evidence before us, that a better equalisation outcome is achieved by adjusting the way that available data are used in our calculations. Those decisions are documented in our reports. 52 Equalisation in Australia has a single objective, to give all States the same fiscal capacity to deliver services to individuals as in other States, as evidenced by the average service States provide to those individuals. This is not the same as giving all individuals within States the same services because that is not what States do. Typically, States choose to spend different amounts on providing services to residents across their States (for example, service levels tend to vary between remote and non-remote regions) and the fiscal implications of this are captured in the equalisation process. 53 The equalisation system operates together with other Commonwealth programs and related funding to shape the environment in which States operate. The Commission is asked to recommend an equalising distribution, including by taking other Commonwealth support into account. While this can cut across the distribution of that funding and so might appear to undermine other policies, nothing equalisation does affects those other policies in other than their bottom line financial impact on States. For example, agreements to fund programs and matching arrangements are not affected. In making our recommendations, the Commission is not required by our terms of reference to adjudicate between equalisation and other policy objectives. In some particular cases, where the financial effects on States of other policies are The Equalisation system is comprehensive and transparent, not a ‘black box’. Chapter 1 Achieving horizontal fiscal equalisation 34 required to be preserved, the Commission is asked in terms of reference to ensure that outcome is achieved. 54 It has been suggested the Commission should adjust the equalisation system to create incentives to support other policy outcomes, for example, State tax reform. However, the Commission restricts its activities to the directions in our terms of reference which instruct us to take account of only one policy – that is, equalisation. We do not consider we have the role of weighing competing policy outcomes when that choice could compromise the achievement of equalisation. We do, however, consider that within equalisation the methods we adopt should create the minimum incentive for States to distort policy choice. 55 The equalisation process does not create incentives to adopt a particular form of Commonwealth-State interaction. For example, it operates equally well with competitive as well as co-operative federalism. Because it endows States with the same fiscal capacity, it facilitates a greater range of choice for States in their service delivery and revenue policies. Because it preserves State policy flexibility, while giving them equal capacity, it lets them choose service delivery levels and mechanisms as well as revenue policies which best suit their State. 56 There are critics of the aim of fiscal equalisation. The Commission considers that the policy discussion about the place and form of equalisation is important, but sees our role only to ensure there is appropriate information and clear understanding of the equalisation arrangements. Any debate on the aim of equalisation belongs in the wider community and in the agreements made between governments in the federation. 57 Managing an equalisation process is challenging.