Commonwealth Assistance to the States Since 1976


Index

Background Paper 5 1997-98

Denis James
Economics, Commerce and Industrial Relations Group
20 October 1997

Contents

Major Issues Summary

Introduction

General Revenue Assistance
Tax Sharing/Financial Assistance Grants
The Fraser Years
The Hawke/Keating Years
The Howard Years Special Grants
Special Revenue Assistance
Identified Health and Roads Grants
Special Assistance to the Northern Territory and the ACT
National Competition Payments

Specific Purpose Assistance

General Purpose Capital Assistance

Repayments

Trends in Commonwealth Assistance

Endnotes

Glossary of Terms

Appendix A. Charts - Real Per Capita Commonwealth Assistance to the States and Territories

Appendix B. Commonwealth Assistance to the States and Territories

Appendix C. Commonwealth Assistance to the States and Territories (Adjusted for Loan Council Borrowings)

Major Issues Summary

  • Australia is characterised by the largest degree of vertical fiscal imbalance between its tiers of government of any federal nation. In 1996-97, the Commonwealth raised $130.7 billion in revenue, representing 76 per cent of total Commonwealth and State general government revenues. On the other hand, Commonwealth outlays for its own purposes were only 58 per cent of total general government outlays. As a result, in the same year the Commonwealth provided the States with grants amounting to $34.6 billion ($15.9 billion in general purpose assistance and $18.7 billion in specific purpose funding).
  • The States are very dependent upon Commonwealth assistance as a source of revenue. Overall, in 1995-96, Commonwealth assistance comprised 45.8 per cent of State and Territory revenues. There is, however, quite a variation in the degree of dependency of the individual States upon Commonwealth assistance. In 1995-96, Victoria was the least dependent State, with Commonwealth assistance comprising 41.9 per cent of general government revenue. The Northern Territory was most dependent, with Commonwealth assistance representing 74.2 per cent of that Territory's revenue (see Table 1).
  • In real per capita terms, general revenue assistance (excluding untied health and roads grants) rose quickly over the period 1976-77 to 1987-88, with most of this rise occurring during the tax sharing period 1976-77 to 1984-85. Not only did the States appear to benefit from the tax sharing arrangements, they also benefited in the period to 1979-80 from the operation of generous guarantee arrangements negotiated in the last year of the Whitlam Government. Per capita real general revenue assistance fell over the late 1980s as the Commonwealth began to squeeze the States in order to meet its own budgetary targets. Throughout the 1990s these payments have stabilised in real per capita terms at around the same level as that obtaining in 1976-77 (see Table B4). However, the proportion of total assistance provided in the form of general revenue grants has declined from 55.5 per cent in 1976-77 to 47.7 per cent in 1997-98 (see Table B5).
  • Specific purpose payments to the States (that is, assistance for programs largely administered by the States, such as hospitals and government schools) have remained reasonably constant in real per capita terms over the period 1976-77 to 1997-98 (after allowing for the untying of health grants between 1981-82 and 1987-88 and roads grants after 1992). Such payments have also remained a fairly constant proportion of total Commonwealth assistance, increasing only slightly from 29.6 per cent of total assistance in 1976-77 to 31.3 per cent in 1997-98 (see Table B5).
  • However, real per capita specific purpose payments through the States (that is, assistance for those programs such as higher education and non-government schools where the States essentially act only as agents for the Commonwealth) have increased, especially throughout the 1990s. Furthermore, as a proportion of total assistance, these payments have increased from 14.9 per cent in 1976-77 to 21 per cent by 1997-98.
  • Moreover, even though the States have often argued for the untying of Commonwealth grants to provide them with greater budgetary flexibility, since 1990-91, specific purpose payments have exceeded general revenue assistance.
  • Overall, in real per capita terms gross Commonwealth assistance provided to the States has declined over the period studied, from $2129.49 per head in 1976-77 to an estimated $1804.81 per head in 1997-98 (see Table B4).(1) However, these figures may be somewhat misleading, since the main component involved in this decline in assistance is the reduction in general purpose capital assistance. This decline in turn reflects the fact that the Commonwealth, which used to borrow on behalf of the States prior to 1987-88 and provided the monies so raised in the form of general capital assistance, allowed the States from 1987-88 onwards to undertake all their own borrowing. Even allowing for this effect, the States are slightly worse off in real per capita terms than they were in 1976-77 and they have certainly lost the gains which they had made by the mid 1980s (see Table C4).
  • Finally, it might be noted that the Commonwealth has increased its own outlays at a greater rate than its assistance to the States. Whereas in 1976-77 gross assistance to the States represented 37.7 per cent of Commonwealth budget outlays, this proportion has steadily declined over time, having fallen to 27 per cent by 1997-98 (see Table B3). This result is still found if an adjustment is made to remove the impact of the borrowing arrangements prior to 1987-88. On this adjusted basis, gross assistance to the States has declined from 34 per cent in 1976-77 to 27 per cent in 1997-98. This declining share of assistance reflects both the attempt by the Commonwealth to achieve savings by reducing grants to the States, as well as the difficulty the Commonwealth has had in restraining its own expenditures due to the 'open ended' nature of many of its programs, especially in the social welfare area.
  • Levels of Commonwealth assistance to the States are shown in Appendices B and C. However, real per capita trends in the major components of such assistance are more easily discernible from the charts in Appendix A.

Note: Throughout this paper the term 'States' should be read as including the six States and two Territories unless otherwise indicated.

Introduction

Australia is characterised by the largest degree of vertical fiscal imbalance between its tiers of government of any federal nation. In 1996-97, the Commonwealth raised $130.7 billion in revenue, representing 76 per cent of total Commonwealth and State general government revenues. On the other hand, Commonwealth outlays for its own purposes were only 58 per cent of total general government outlays. As a result, in the same year the Commonwealth provided the States with grants amounting to $34.6 billion ($15.9 billion in general purpose assistance and $18.7 billion in specific purpose funding(2)). These grants represented 45.8 per cent of State and Territory general government revenue.

To a large extent, the source of this vertical imbalance lies in the Constitution. The Commonwealth's power to tax is found in section 51(ii) of the Constitution. Such power is certainly concurrent with the taxing power of the States, except in relation to the imposition of duties of customs and excise which, by virtue of section 90 of the Constitution, is a power exclusive to the Commonwealth.

Despite the apparent scope that the Constitution grants to the States to impose tax on a great variety of tax bases, in reality, the Commonwealth has been able to rely on High Court interpretations of powers bestowed upon it by certain sections of the Constitution, most notably sections 96 and 90, to effectively prevent the States from fully exploiting their taxing potential. Section 96 of the Constitution permits the Commonwealth to grant financial assistance to any State on such terms and conditions as the Parliament thinks fit.

Perhaps the greatest source of the current vertical fiscal imbalance was the takeover of personal income tax by the Commonwealth during World War 2. A number of the States had been levying small amounts of income tax even before Federation, although the main source of taxation revenue available to them at that time were duties of customs and excise. When the power to levy customs and excise became the exclusive preserve of the Commonwealth upon Federation, the States began to develop their income tax base. Even so, the Commonwealth began to compete for this base by commencing to levy income tax in 1915. Nevertheless, prior to World War 2, the States and the Commonwealth shared the income tax base in such a way that the States were reasonably fiscally self sufficient.

However, in 1942, the Treasurer appointed a Committee to consider the question of the Commonwealth becoming the sole income taxing authority for the duration of the War, and for tax reimbursement payments to be made, using section 96 powers, to the States upon their retirement from the income taxing field. The Committee's report recommended that, for the duration of the War and one year afterwards, the Commonwealth government should be the sole authority to impose taxes on income and that the States should be duly compensated. In May 1942, legislation was introduced in the Federal Parliament to give effect to this recommendation and a uniform income tax scheme came into operation on 1 July 1942.

At a Premiers' Conference in January 1946, the States were informed that the Commonwealth proposed to continue uniform taxation indefinitely. A formula approach was adopted to the distribution of tax reimbursement grants which continued to be provided on condition that the States made no attempt to re-enter the income taxing field. This left the States with little alternative other than to devise new forms of taxation.

However, the States' ability to devise new taxes was constrained by High Court interpretation of section 90 of the Constitution. Section 90 states:

'On the imposition of uniform duties of customs the power of the Parliament to impose duties of customs and of excise, and to grant bounties on the production or export of goods, shall become exclusive...'

In its early decisions on section 90, the High Court adopted a narrow definition of an excise, declaring an excise to be a tax only upon domestic production. However, in later cases, the Court widened its definition of an excise to be any tax on goods applied anywhere in the production and distribution chain. It is this broader definition of an 'excise' which has effectively prevented the States from applying any form of tax on the production or distribution of goods. This has seriously eroded the financial independence of the Australian States. In most other federations, either direct access to, or formula-based sharing of, the sales tax base is an important source of State revenue.

Faced with these Constitutional and political obstacles, the States have had difficulty in expanding their tax bases. Currently, the States raise tax revenue mainly through payroll tax and a range of other taxes which frequently tend to be economically distorting and involving significant administration and compliance costs. Such taxes include stamp duties, taxes on gambling, taxes on motoring, financial transactions taxes and land tax. They also raise revenue from interest and dividends paid by State enterprises, royalties, land rent and user charges. Nevertheless, the States have not been immune from the criticism that they could perhaps have made more effort in imposing taxes on services and in the levying of land tax and payroll tax.(3)

However, as mentioned previously, the States are very dependent upon grants from the Commonwealth. Furthermore, there is a considerable variation in the degree of dependence of individual States on the Commonwealth. Table 1 shows the degree of dependence of the States on Commonwealth financial assistance for the year 1995-96.

Table 1. Degree of State Dependency on Commonwealth Grants, 1995-96

State

State Taxation ($m)

Other State Own Revenue ($m)

Total State Own Revenue ($m)

C'wealth Assistance ($m)

Ratio of Assistance to Total Revenue (%)

Victoria

8 617

1 813

10 430

7 508

41.9

NSW

11 226

2 649

13 875

10 303

42.6

ACT

548

77

625

536

46.2

Queensland

4 214

2 616

6 830

6 110

47.2

W. Australia

2 777

920

3 697

3 663

49.8

S. Australia

2 100

1 018

3 118

3 182

50.5

Tasmania

657

301

958

1 188

55.4

Northern Territory

276

144

420

1 206

74.2

Total

30 415

9 538

39 953

33 696

45.8

Source: Australian Bureau of Statistics. Government Financial Estimates: Australia, 1996-97. (Cat. No. 5501.0)

General Revenue Assistance

General revenue assistance to the States since 1976 has fallen into six main categories. These are: (i) tax sharing grants, prior to 1985-86, and financial assistance grants (FAGs) since 1985-86; (ii) special grants; (iii) special revenue assistance; (iv) general revenue assistance provided in lieu of funding which had previously been provided for specific purposes (such as hospitals and roads); (v) special assistance to the Northern Territory and the ACT; and (vi) national competition payments.

Tax Sharing/Financial Assistance Grants

The Fraser Years

Upon gaining power at the end of 1975, the Fraser Government proceeded to implement its New Federalism policy. At Premiers' Conferences in February, April and June 1976, the details of the New Federalism arrangements were fleshed out. These new arrangements included the following initiatives:

  • financial assistance grants to the States were to be replaced by a system of income tax sharing grants. The States would receive a set proportion (just over one third) of net Commonwealth personal income tax collections. A guarantee was given by the Commonwealth that no State would receive an absolute fall in its grant from year to year and, for the first four years of the scheme (that is, from 1976-77 to 1979-80), no State would receive less than it would have received under the financial assistance grants formula that had been negotiated with the Whitlam Government at the June 1975 Premiers' Conference.
  • the existing relativities relating to the distribution of financial assistance grants would continue to apply to the tax sharing grants for the time being, but thorough, periodic reviews of all State relativities would be undertaken by the Commonwealth Grants Commission, with the first such review scheduled to be completed by the end of 1980-81.
  • under the so-called 'Stage 2' arrangements, each State would be able to legislate to impose a surcharge on personal income tax in that State additional to that imposed by the Commonwealth, or to give a rebate of such tax. The Commonwealth would be authorised to collect the surcharge or grant the rebate. The Commonwealth would legislate to make relevant provisions for this process to occur.

Some explanation of these new arrangements is required. For many years prior to 1976, the main form of general revenue assistance to the States had been financial assistance grants. These grants were determined under a formula whereby the grant paid to each State in the previous year would be increased by annual movements in each State's population and annual increases in the level of average wages for Australia as a whole. In addition, to enable the States to offer a higher standard and range of services, it was also agreed that a 'betterment factor' would be applied annually to further escalate the level of grants. The States were therefore receiving grants which were growing in real per capita terms. Between 1965 and 1970, the betterment factor was set at 1.2 per cent while between 1970 and 1975 it was 1.8 per cent.

In 1975, the Whitlam Government, in an attempt to appease the States in the face of considerable discontent, pledged to increase the betterment factor to 3 per cent. The Government lost office before this could be implemented and the financial assistance grants system was replaced by the Fraser Government's tax sharing arrangements. However, the States fully realised how generous the financial assistance grant formula was which had been offered to them by the Whitlam Government in June 1975. Only by offering them a guarantee that they would fare no worse under the tax sharing arrangements could the Fraser Government convince them to accept the new system.

Stage 2 of the New Federalism process did not come to fruition. The Income Tax (Arrangements with the States) Act 1978 was passed setting up the machinery for the Commonwealth to collect any surcharges (or grant rebates) applied by the States. The Commonwealth made no attempt to lower its own income tax rates to provide 'tax room' for the States to impose their surcharges. Any attempt by a State to impose a surcharge would have smacked of 'double taxation'. As a result, no State enacted legislation to levy such surcharges. The enabling legislation was ultimately repealed by the Hawke government in 1989. At the time, the Leader of the Opposition, Dr Hewson, had indicated that he might well be in favour of the introduction of a marginal State income tax. The Hawke Government wanted to make it quite clear that if such a policy should eventuate under a future Coalition government, that government would have to explicitly introduce legislation to that effect into Parliament, rather than simply being able to rely on the existing Income Tax (Arrangements with the States) Act 1978.

Stage 1 of the arrangements relating to the introduction of tax sharing entitlements was, of course, implemented, although the methods of determining the overall level of tax sharing funds and the distribution of those funds varied considerably in the years following 1976-77.

Initially, under Stage 1, it was decided that the States as a whole would receive 33.6 per cent of the current year's personal income tax receipts. This was attempted in 1976-77 but proved impractical since the actual tax receipts for the year were not known until after the end of the financial year. In fact, it was found that, based on income tax estimates for that year, the States had been overpaid and an adjustment had to be made to their 1977-78 entitlements. It was therefore decided that, in future, the States would receive 39.87 per cent of the previous year's personal income tax receipts.

The gross amount of the States' tax share then had to be distributed among the States. This was done on a weighted per capita basis, the weights being those that were derived from the allocation of grants among the States in 1975-76. Since the distribution of grants in
1975-76 reflected more the result of historical accident rather than any element of equalisation, the resulting weights were not particularly meaningful. Nevertheless, they were applied until the Commonwealth Grants Commission assessed new relativities, which it was required to do before the end of 1980-81.

Interestingly enough, however, most States benefited from the 'Whitlam guarantee' up until the end of 1979-80 and, as will be shown below, from various other guarantee arrangements negotiated to apply in succeeding years. As a result of these guarantee provisions, the actual tax sharing pool was boosted to a larger amount than that yielded by the tax sharing formula. Simultaneously, the guarantees meant that the actual distribution of funds amongst the States bore little relationship to the per capita weighted sums set out in the various pieces of tax sharing legislation. The importance of this influence throughout the entire period of tax sharing arrangements cannot be overstressed.

Between 1977-78 and 1979-80, the State personal income tax sharing entitlements were calculated as set out above. The situation altered slightly in 1980-81 since the Whitlam guarantee had expired. In its place, the States were guaranteed that, for 1980-81 only, no State would receive a lower grant in real terms than it had received in the previous year. In that year, Victoria, South Australia and Tasmania benefited from the new guarantee, while the remaining States received their normal income tax sharing entitlement.

Given the reviews of the tax sharing system that were completed in 1980-81, the method of calculating grants in 1981-82 became somewhat complicated. The Commonwealth and the States decided that tax sharing would be converted from a personal income tax base to a total tax base. The States were concerned at the impact that such Commonwealth initiatives as tax indexation might have on their grants, and besides, personal income tax collections were subject to significant fluctuations.

The year 1981-82 was thus to be a transitional year. Total grants to the States and the Northern Territory were increased by 9 per cent, with adjustments made to ensure that no State would receive less than an 8 per cent increase in its weighted per capita entitlement. The picture was further complicated by the payment of an additional $69.1 million to compensate the States for functions transferred to their control following the Review of Commonwealth Functions (the so-called 'Razor Gang' exercise).

In 1981, the Commonwealth Grants Commission produced its first report on tax sharing relativities. This report was rejected by the Premiers' Conference. This treatment of the Commission's report did, however, have implications for the size of the tax sharing pool assessed for 1981-82. In view of the fact that it was thought that the three larger States were being disadvantaged under the existing relativities, an additional sum of $60 million was shared among them in 1981-82, on condition that this would be regarded as a Commonwealth contribution towards adjusting to whatever new relativities might be assessed by the Commission.

From 1982-83 until 1984-85, the States were to receive 20.72 per cent of the Commonwealth's total tax receipts in each preceding year, with the whole tax sharing system to be re-examined by the end of that period. The Commonwealth Grants Commission completed its second review of relativities in May 1982. The new factors assessed by the Commission implied a smaller gain for NSW and Victoria, a larger gain for Queensland and smaller losses for Western Australia and South Australia. Tasmania's position remained virtually the same. At the June 1982 Premiers' Conference there was still not universal acceptance of the new relativities. The Commonwealth proposed that the Commission's relativities be adjusted such that the above average per capita health funding received by South Australia and Tasmania did not adversely affect those States' per capita relativities. Furthermore, in order to cushion the move to the relativities proposed by the Commonwealth, it was decided that adjustments to the new relativities should be phased-in over three years.

However, again the Commonwealth agreed to certain guarantee arrangements. It was proposed that no State would receive less than a 2 per cent real increase in its grant for
1982-83, nor less than a 1 per cent real increase in the succeeding two years. The guarantee was to apply as follows: the tax-sharing pool would be divided into two components, one being 98.1 per cent of the pool and the other component being 1.9 per cent of the pool. The larger component would be allocated among the States on the basis of the agreed relativities. The smaller component would be used to meet any binding guarantee. If after guarantees had been met there remained funds in the smaller component, these would be redistributed to the other States. However, if the smaller component did not contain sufficient funds to meet the guarantees, the Commonwealth would provide whatever extra funds might be necessary. This the Commonwealth was required to do in both 1983-84 and 1984-85. In both years, all States except Queensland received the guarantee payment. This required the input of an additional $178.5 million in 1983-84 and an additional $70.6 million was required in
1984-85. Again, the existence of the guarantee affected, even if only slightly, the size of the tax sharing pool while, more significantly, affecting the per capita relativities applying among the States.

As can be seen, the object of these complicated funding arrangements were to ensure that the provision of grants was, as far as possible, a 'closed' system. Under the grants arrangements which had existed up to the early 1980s, any State which was assessed by the Commonwealth Grants Commission as facing fiscal disabilities received its general grant and a top-up 'special grant', paid at Commonwealth expense. One significant feature of the tax sharing relativities process put in place in 1982 was to ensure that once the overall level of grants had been determined, these would be distributed among the States in such a way that the principles of fiscal equalisation could be applied without the need for additional funds from the Commonwealth. Such thinking has generally applied to various guarantee and special revenue assistance arrangements ever since.

The Hawke/Keating Years

The Hawke Government essentially inherited the fiscal arrangements which had been put in place during the Fraser years and seemed content to allow these to run their course for a number of years. It was not until 1985 that the Fraser system began to be dismantled. The dismantling of these arrangements, however, appears to have been based more on the macro-economic concerns of the Commonwealth Government rather than upon any major ideological basis.

The provision of general revenue assistance in the form of tax sharing entitlements was abandoned at the May 1985 Premiers' Conference. The main reason for doing so was to enable the Commonwealth to rein in its budget outlays. The Hawke Government, especially through its 'trilogy' promises, had committed itself to restricting the growth of budget outlays and reducing the Federal budget deficit.(4) A prime candidate for funding cuts was tax sharing grants to the States. These alone accounted for around 15 per cent of total Commonwealth budget outlays. On the basis of the tax sharing formula, such grants would have increased by around 10 per cent in real terms in 1985-86, an increase which the Government claimed neither the economy nor the budget could bear. The Commonwealth also pointed to the year-to-year variability in the growth of general revenue funding under the tax sharing formula and argued that more stable arrangements would be beneficial both to itself and the States.

Consequently, the tax sharing approach was abandoned and a system of financial assistance grants was re-established. The Commonwealth proposed that, for 1985-86, the pool of financial assistance grants would remain the same in real terms as the States had received in tax sharing grants in the previous year. The Commonwealth further pledged that, in each of the years 1986-87 and 1987-88, financial assistance grants would be increased by 2 per cent in real terms.

At the May 1987 Premiers' Conference, however, the Commonwealth argued that in view of the need to reduce the call of the public sector on the nation's savings, restraint in public spending was required. Instead of granting the 2 per cent per annum real increase in funding, as agreed in 1985, the Commonwealth ensured that the pool of financial assistance grants and identified health grants for 1987-88 were maintained in real terms only. At the same time, the Commonwealth cut back substantially the general purpose capital assistance it was providing to the States.

For the three years following 1987-88, the treatment of financial assistance funding was arbitrary. The States were informed what their funding would be for the year in question and no indication was given as to future funding arrangements. This obviously made financial planning difficult for the States. In 1988-89, financial assistance grants were reduced by 2.8 per cent in real terms; in 1989-90 a further real cut of 2.9 per cent was imposed, while for 1990-91, a cut of 3.7 per cent in real terms was experienced. At the June 1990 Premiers' Conference, however, the Commonwealth pledged that in each of the three years from
1991-92 to 1993-94, general revenue grants would be maintained in real terms. This was the first guarantee that the Commonwealth had been prepared to give since 1985. No doubt mindful of the fact that it had felt compelled to renege on its 1985 pledge, the Commonwealth qualified its 1990 pledge by indicating that the real terms guarantee would only apply while ever Australia were not to experience a major deterioration in its economic circumstances.

The period 1988-89 to 1990-91 was also characterised by a number of 'technical' adjustments to the level of financial assistance grants. In 1988-89 and 1989-90, the amounts of $172.3 million and $34.6 million respectively were deducted from financial assistance grants (and from the FAGs base) as the Commonwealth 'clawed back' 90 per cent of the revenues gained by the States from the Commonwealth's decision to remove the exemption from State taxation of its public trading enterprises. In 1990-91, the Commonwealth also deducted $161.4 million, following its decision to hand over its bank accounts debits (BAD) tax to the States. The FAGs base was correspondingly reduced by $386.4 million, this being the full-year effect of the handover of the BAD tax. From time to time, very minor adjustments were also made for the transfer of certain functions between the States and the Commonwealth (for example, the transfer of responsibility for the Victorian College of Agriculture and Horticulture to the Commonwealth in 1991-92).

Unlike the Fraser Government, the Labor Government was prepared to substantially implement the per capita relativities assessed by the Commonwealth Grants Commission. Certainly, from time to time, special revenue assistance was made available to some of the smaller States, especially the Northern Territory, to assist them to adjust to these new relativities. This special revenue assistance was funded from within the pool of general revenue assistance, so the system still remained 'closed', with the better-off States having to assist the States facing difficulties, rather than the problem of adjustment being addressed by an input of additional Commonwealth funds. Of course, the impact of these adjustments was to bring about a slight discrepancy between the relativities as assessed by the Grants Commission and the actual relativities applying, but these discrepancies were certainly not as substantial as those which developed during the last years of the Fraser arrangements.

Prior to the 1992 Premiers' Conference, however, the two larger States complained vigorously about the impact that the Commission's fiscal equalisation approach was having on their per capita general revenue grants. At the Conference itself, the Commonwealth adhered to its real terms guarantee and initially offered to provide an additional $150 million to the pool of general revenue funds. The Commonwealth argued that the States should decide upon the ultimate distribution of these funds, which led to a considerable degree of acrimony amongst State Premiers. It was finally decided that the base level of general revenue grants would be distributed on the basis of the Grants Commission's recommendations.

However, in respect of the additional $150 million, it was agreed that the States and Territories would receive the higher of their share based on either the Commission's assessed relativities or an equal per capita share, which ever were the higher. The Commonwealth indicated that it was prepared to fund the higher equal per capita payment implied for NSW and Victoria. This raised the Commonwealth's initial offer from $150 million to $166 million. It was further agreed, however, that the additional $166 million would not be reflected in the base level of funding for 1993-94 and beyond.

At the 1994 Premiers' Conference, the Keating Government instituted a much more generous and reliable funding formula for the States. The financial assistance grants pool was to be increased by the rate of inflation and the rate of national population growth. In other words, the States received a real per capita guarantee. Furthermore, unlike previous guarantees which had 'sunset' provisions applied to them, the Keating formula allowed for the real terms guarantee to be applied each year on a rolling three-year basis. The States could thus always have at least a three year forward planning horizon. These arrangements commenced in 1994-95 and have been re-endorsed at each Premiers' Conference since that year.

However, despite the apparent generosity of these arrangements, the States have not been able to gain full benefit from them. Even though, in principle, the guarantee has always been met, the States have often found themselves facing various cuts to general purpose payments which have eroded the value of the guarantee. In 1994-95, the States received their guaranteed payments but had their general purpose capital funds, worth $330 million, abolished. The guarantee was met in 1995-96 with no offsetting reductions in funding.

The Howard Years

At the 1996 Premiers' Conference, the States found themselves dealing with a new Government which had expressed concern about a '$10 billion black hole' in its underlying budget aggregates. As has become usual, the States were required to play their part in assisting the Commonwealth meet its budgetary targets. However, the Commonwealth found itself in a quandary, since it was politically bound by the rolling three-year guarantee arrangements. Instead of reneging on these arrangements, the Treasurer, Mr Costello, proposed raising funds from the States by removing their exemption from Federal sales tax. This so incensed the States that they threatened to boycott the rest of the Conference as well as the associated Council of Australian Governments (COAG) meeting.

Eventually, the sales tax proposal was abandoned and a compromise solution was negotiated.(5) The States would continue to receive their guaranteed payments but would provide a 'fiscal contribution' to the Commonwealth, totalling around $1.5 billion over the next three years. This contribution could be made by taking reduced financial assistance grants, by receiving full FAGs funding but making direct payments to the Commonwealth, by accepting lower specific purpose payments or some combination of these alternatives.(6) In 1996-97, the States' fiscal contributions amounted to $619 million. Their contributions will be $627 million in 1997-98 and $313 million in 1998-99. The liability for meeting these contributions are allocated amongst the States on an equal per capita basis.(7)

Special Grants

Ever since Federation, it has been apparent that certain States have had greater difficulties than the other States in meeting their public expenditure responsibilities from the revenue sources available to them, due to differing tax raising capacities and inherent cost disadvantages faced by them in the provision of services (eg. different demographic characteristics). The Commonwealth Grants Commission was established in 1933 to advise on the provision of special grants to those States facing inherent budgetary problems.

After investigating various approaches to the provision of special assistance, the Commission decided in 1936 to provided additional assistance whenever a State, through financial stress from any cause, was unable to efficiently discharge its functions as a member of the federation at a standard not appreciably below that of the other States, providing that the State in question was making a reasonable effort to raise revenues from the sources available to it. Any State requesting special financial assistance (a so-called 'claimant State') would have its revenue raising capacities and expenditure disabilities compared with other States in the federation (the so-called 'standard States').(8) Where a claimant State was assessed by the Commission as suffering a significant financial disadvantage, a special grant for that State would be recommended. It should be noted that, up until 1974, special grants recommended by the Commission were basically concerned with assessing a claimant State's minimum financial needs and not with bringing its fiscal capacity up to the level of the most prosperous States. Moreover, claimant States were generally required to make an above-average effort to raise revenue from their own sources before qualifying for special assistance.

In 1974, the Commission adopted a more sophisticated approach to the assessment of special assistance to the States. This reflected the Commission's philosophy of attempting to balance equality with diversity. Equality requires that any State should be able, if it so wishes, to provide services to its citizens at the same standard as other States yet without having to impose a higher burden of taxes and charges. On the other hand, diversity requires that each State should be free to choose the standard and range of services to be provided to its citizens, and the level and pattern of its charges, independently of what is done in the other States of the federation. This diversity in policy making is, of course, one of the principal arguments in favour of federation.

Putting this philosophy into practice, the Commission developed a methodology whereby special grants to claimant States were calculated so as to provide that level of assistance necessary to give a State the capacity to provide services at a standard comparable with those of the standard States but without requiring that State to impose a greater burden of taxation. In essence, the Commission decided that it would make its recommendations on the basis of equalising potential fiscal capacity, while ignoring as far as possible any policy differences between the States.

In simple terms, once a claimant State applied to the Commission for the assessment of a special grant, the Commission would attempt to ascertain the revenue raising capacity of that State compared with that of the standard States. Furthermore, the Commission also attempted to assess the extent to which a claimant State experienced particular expenditure disabilities, relative to the standard States, in the provision of public goods and services.

Up until 1982, when the Commission adopted a full fiscal equalisation methodology, the Commission was required to assess special grants only for those States which requested an assessment. This approach had two main flaws.

Firstly, since a special grant was only assessed when requested, no mechanism existed for periodic review of the appropriateness of the distribution of Federal general revenue grants amongst all States. Any State which considered that it was getting more than adequate funding would obviously not request the Commission to undertake an assessment. Throughout most of Australia's federal history, the distribution of the bulk of Federal general revenue assistance had been somewhat arbitrary and, by the 1970s, it was widely felt that a number of smaller States were now receiving quite generous funding. In fact, by the late 1970s, only Queensland and the Northern Territory were regular claimant States. It was argued that, if anything, it was the two populous States of New South Wales and Victoria which were being excessively called upon to financially support the rest of Australia, yet these two States, due to their 'standard State' status, were effectively excluded from the Commission's examination. Full fiscal equalisation was not being achieved.

Secondly, the special grants system was open-ended, in that such grants were paid by the Commonwealth as additional assistance to the States concerned. Such assistance was thus purely at Commonwealth expense. With growing Commonwealth concern with its own budgetary position, such a situation was seen as untenable.

It was in order to achieve more equity in the provision of general revenue grants and to 'close' the system to ensure that once a pool of general revenue assistance is determined it would not be augmented but merely appropriately distributed, the Fraser Government requested the Commission, in 1979, to undertake regular reviews of the appropriate general revenue sharing relativities which should apply to the allocation of such assistance amongst all the States. This is the approach which continues to apply to this day.

To achieve fiscal equalisation, the Commission compares the fiscal capacity of each State in turn with a 'standard' which comprises the State concerned plus all of the other States. In this way, the relative fiscal capacity of all States can be determined. The relative financial needs of the States are ultimately reduced to a set of per capita funding relativities which are used to weight the distribution of Commonwealth general revenue assistance to the States. With the adoption of this fiscal equalisation approach, the practice of providing special grants ceased.

Special Revenue Assistance

Special revenue assistance is usually once-off general revenue assistance paid to any State which can demonstrate a particular budgetary need or which may require special treatment from the Commonwealth. The main reason for designating a payment as special revenue assistance is to make it clear that this payment is essentially unique and will not be included in the general revenue base upon which later year grants might be determined. Whereas prior to the early 1980s when the Commonwealth usually bore the full cost of special revenue assistance, over the last two decades, apart from exceptional circumstances, special revenue assistance has normally been paid out of the overall pool of financial assistance funds available to the States prior to the distribution of that pool amongst the States. The cost of special revenue assistance has thus been borne by the States, not the Commonwealth.

Special revenue assistance has been provided for a range of reasons. Some of these have been 'once-off' issues such as payments to particular States affected by bushfires or assistance to offset the impact of a High Court decision (such as the High Court disallowance of Victoria's pipeline franchise fee in 1983). However, there have been a number of instances where special revenue assistance has been paid to various States due to changed Commonwealth petroleum taxation arrangements, due to the impact on States of changed hospital and medicare funding arrangements or to assist a State to adjust to changes in the Commonwealth Grants Commission's assessed relativities.

In recent years, the level of special revenue assistance has be quite high, since NSW and Victoria have been receiving medicare guarantee payments and these have been classified as special revenue assistance. Unlike most other special revenue assistance, the medicare payments to these States have been met partly from the FAGs pool and partly from additional payments from the Commonwealth.

In 1993, the Commonwealth negotiated new medicare arrangements with the States, that is, the financial compensation that the States would receive for treating public (medicare) patients in their hospitals. At the time, NSW and Victoria expressed concern that, under the new arrangements, they would be financially disadvantaged even though the other States would be better off. The Commonwealth thus guaranteed NSW and Victoria that they would receive additional funding if their fears were realised. The Commonwealth also indicated that it would be prepared to pay around one half of any guarantee payment in 1993-94, with the remainder being taken from the FAGs pool. However, the Commonwealth indicated that over successive years, its contribution would decline, with more of the guarantee being met from the pool. In 1994-95, for example, the Commonwealth contributed $111.6 million while the pool funded $223.2 million. By 1997-98, the Commonwealth will only be contributing $62.3 million towards the guarantees, with the remaining $182 million coming from the pool.

Identified Health and Roads Grants

One of the Points of Understanding agreed by the Commonwealth and the States as part of the Fraser Government's New Federalism was the desirability of reducing the amount of tied grants to the States. The Fraser Government was able to reduce such grants to some extent by dismantling various Whitlam programs, especially in relation to urban and regional development policies. The only major function for which previously specific purpose funding was absorbed into general purpose funding was health.

Originally the Commonwealth provided specific purpose assistance to the States to aid in meeting public hospital running costs, community health programs and the school dental program. Following consideration of the report of the Jamison Committee of Inquiry into Efficiency and Administration of Hospitals, however, the Commonwealth announced in April 1981 that specific purpose funding for the above purposes would be terminated and, after some adjustment, would be replaced by block grants (referred to as identified health grants) which, while being in lieu of health funding, could be utilised by the States in whatever manner they saw fit. This arrangement initially applied only to Victoria, NSW, Queensland, and Western Australia, but with the termination of their hospital funding agreements in 1984, South Australia and Tasmania also entered into these arrangements. The impact of absorbing health grants into general revenue had the effect of reducing the proportion of specific purpose assistance in 1981-82 to 32.7 per cent of total Commonwealth assistance.

This treatment of health grants was seen to be the first stage in the process of ultimately absorbing such grants fully into general revenue assistance grants. It is interesting to note that even the Hawke Government committed itself to continuing this process and decided to escalate identified health funds at the same rate as financial assistance grants in the expectation that the two would ultimately be amalgamated. However, in 1988-89, the Government did an about-turn and converted such health funding back to specific purpose funding. This was done mainly to isolate levels of health funding from the succession of cut-backs in financial assistance grants that the Treasurer imposed on the States, beginning in 1987-88.

This about-turn has had an interesting implication for the calculation of the financial assistance grants to the States. When the Grants Commission undertook a major review of relativities, it formulated its recommendations on the assumption that identified health grants would be merged with financial assistance grants. The changed treatment of health grants means that the pool of financial assistance grants plus the specific purpose hospital funding grants is allocated on the basis of the Commission's recommendations. The amount of hospital grants agreed to be paid to each State is then deducted from the resulting allocations, leaving the financial assistance grants as a residual.

The other major source of untied funding has been in the area of roads. At the Special Premiers' Conferences in the early 1990s, the States again requested that some of the specific purpose assistance provided by the Commonwealth should be untied and provided in the form of general revenue assistance. Very little progress was made in this endeavour, but it was agreed, in 1992, that, as from 1 January 1994, Commonwealth assistance for State arterial roads (around $350 million in a full year) should be untied and provided as general revenue assistance.(9) As such, the money provided to the States in lieu of arterial road funding could be used by them as they wished.

Initially, the FAGs pool and the identified road funding pool were kept as separate pools, with the FAGs pool being allocated on the basis of Commonwealth Grants Commission recommendations while the identified road funds pool was allocated amongst the States on a purely historical share basis. However, it was always accepted that the two pools would be combined by 1997-98.

To achieve the absorption of the identified road funding pool into the FAGs pool, in
1995-96 one-third of the roads pool was allocated on the basis of Grants Commission relativities and two thirds on historical share. In 1996-97, two-thirds of the pool were allocated on the Commission's relativities and only one-third on historical shares. In 1997-98, the roads pool has been absorbed into FAGs and this total pool has been allocated on the basis of Commission relativities.

Special Assistance to the Northern Territory and the ACT

The Northern Territory was granted self-government from 1 July 1978 while the ACT began to be funded by the Commonwealth on a State-like basis from 1 July 1988. Both Territories required special financial treatment in their first years of self-government. This assistance took the form of various transitional grants to ease the adjustment to State-like operations, payments to assist with the transfer of Commonwealth functions to the Territories and, in the case of the Northern Territory, compensation for uranium royalties which were denied to the Territory since the Commonwealth retained territorial rights over this particular mineral.

The Northern Territory received tax sharing grants from 1979-80 to 1984-85, this latter year seeing tax sharing arrangements terminated for all States. Even though general revenue assistance to the six States had been determined on the basis of the Grants Commission methodology since 1982, the Northern Territory was not fully included into the relativities process until 1988-89. As a result, between 1985-86 and 1987-88, the Northern Territory received general revenue grants in lieu of financial assistance grants.

Similarly, even though the Commonwealth Grants Commission was required to undertake specific reviews of the Australian Capital Territory's finances using its fiscal equalisation model, the ACT continued to receive funding under transitional arrangements until 1993-94, when it began to be treated similarly to the other States in the relativities process. Prior to 1993-94, therefore, the ACT received general revenue grants in lieu of financial assistance grants. It might be noted, however, that due to difficulties faced by the ACT Government in fully accepting responsibility for certain functions, such as education and hospital services, the ACT has still continued to receive transitional allowances and payments to meet special fiscal needs which are not available to the other States.

National Competition Payments

Throughout this decade, the Commonwealth government has given considerable emphasis to microeconomic reform. The Commonwealth was able to implement certain reforms during the 1980s where it had legal powers, but considerable reform was also required at the State level, requiring State government action. The main vehicle for identifying and monitoring the implementation of these reforms has been the Council of Australian Governments (COAG).

However, the States expressed concerns that they often bore the cost of microeconomic reform within their States (especially as it impacted upon public utilities and authorities) while the Commonwealth would benefit financially from additional tax generated by privatised authorities and from improvements in national productivity. They therefore requested some share of these financial benefits.

At the 1995 COAG meeting, it was agreed that the States would receive 'national competition payments' from the Commonwealth. These payments are to occur in three tranches, providing that the States reach certain milestones in implementing microeconomic reform objectives. The National Competition Council has been given the task of independently assessing whether a State has met the required reform targets in order to be eligible for funding.

Under the terms of the National Competition Payments Agreement negotiated in 1995, national competition payments would commence to be paid in 1997-98. Under the first tranche (from 1997-98 to 1998-99) the States would receive between them, annually, $200 million in 1994-95 prices. In the second tranche (from 1999-00 to 2000-01), these payments would rise to $400 million while from July 2001 annual payments of $600 million would be paid, again with all amounts expressed in 1994-95 prices. National competition payments are paid to the States quarterly and distributed amongst the States on an equal per capita basis (assuming that all States meet their microeconomic reform targets).

Even though the National Competition Council, in its first report(10), identified certain deficiencies in the implementation of microeconomic policies in the States, the Treasurer has nevertheless agreed to pay the full amount of the national competition payments in 1997-98. It is therefore estimated that in 1997-98 the States will receive $215.1 million.

Specific Purpose Assistance

Section 96 of the Constitution provides the Commonwealth with the power to grant financial assistance to any State on such terms and conditions as the Parliament sees fit. As a result, the Commonwealth provides a range of grants and/or advances to the States for both recurrent and capital purposes, subject to conditions specified by the Commonwealth. Generally, specific purpose payments carry the requirement that the funds provided should be expended for a particular purpose, although the States may be given varying degrees of discretion in the use of such funds. In some instances, there will be very broad agreement as to the principles and program delivery mechanisms associated with the grant, while other grants will be subject to very detailed conditions relating to project approval and reporting requirements. Some Commonwealth grants are subject to matching requirements on the part of the States.

Section 96 grants have frequently been used by the Commonwealth to impose its priorities on the States, especially if the Constitution does not give the Commonwealth the power to act directly in particular areas of concern. Often such grants have been used to ensure that national objectives can be attained or national standards set. National highway funding is a good example of funding with a national dimension, while payments for higher education ensure that certain national education standards are maintained.

Even though some specific purpose funding for roads and agricultural programs had been paid for many years, the period from 1942 onwards saw a real burgeoning of specific purpose assistance from the Commonwealth to the States. Between 1942 and 1972 the first Commonwealth-State Housing Agreement was negotiated, some assistance began to be provided to universities, secondary schools, Colleges of Advanced Education and Technical and Further Education colleges and specific purpose funding was instituted for mental health institutions, blood transfusion services and tuberculosis control. Reasonably large amounts of money were also provided to the States in the post-war period to enable railway standardisation and upgrading projects to proceed. Assistance was also given for shipping and harbours, water supply and electricity infrastructure and agricultural programs.

The provision of specific purpose assistance escalated during the Whitlam period. Between 1972-73 and 1975-76, the value of specific purpose assistance quadrupled and increased from 25.8 per cent of total assistance in 1972-73 to 48.5 per cent of assistance in 1975-76. Specific purpose assistance programs were commenced in such areas as pre-schools and child care, hospitals, community health, urban and regional development, urban public transport and local government. It was also in 1974 that the Commonwealth began to fully fund higher education.

After gaining power, the Fraser government began dismantling some of the Whitlam programs, especially those in the area of urban and regional development which had most raised the ire of the States. However, the reduction in specific purpose payments was not great in the first few years of the Fraser period. Specific purpose assistance to the States rose from $4152 million in 1975-76 to $5481 million in 1980-81. It is true that the proportion of specific purpose assistance fell from 48.5 per cent in 1975-76 to 41.5 per cent in 1980-81, but this is probably due more to the rapid increase in general revenue funding as a result of the operation of the Whitlam guarantee than to any really marked decline in specific purpose assistance. Certainly the proportion in 1980-81 was still much higher than the proportion of 25.8 per cent which had obtained in 1972-73. It should also be realised, however, that general revenue assistance to local government is, in the first instance, paid to State government as a specific purpose payment. The provision of local government assistance since 1974 and especially the rapid growth of such assistance in the late 1970s certainly boosted specific purpose payments.(11)

As mentioned previously, one very major change to specific purpose funding occurred in 1981-82 when the Fraser Government untied health funding. This arrangement initially applied only to Victoria, NSW, Queensland, and Western Australia, but with the termination of their hospital funding agreements in 1984, South Australia and Tasmania also entered into these arrangements. The impact of absorbing health grants into general revenue had the effect of reducing the proportion of specific purpose assistance in 1981-82 to 32.7 per cent of total assistance.

While the Fraser Government reduced the significance of specific purpose grants to some extent, such grants again grew significantly under the Hawke/Keating Governments. Whereas in 1982-83, specific purpose payments represented 36 per cent of total payments, by 1995-96, such payments comprised 52.8 per cent.

A significant reason for this growth was the about-turn by the Hawke Government on the absorption of health funds into general revenue funds. Although it was initially the intention of the Hawke Government to follow through with the Fraser policy of achieving full absorption of such funds, this process was abandoned in 1988-89 when health grants were again treated as specific purpose grants. Apart from the obvious political advantages to the Commonwealth in being seen to be funding health in the States, at a practical level, the link between health funding and financial assistance grants had to be broken to protect health funding levels from the real erosion of general revenue assistance. The formula for setting hospital funding grants, based on changes in award wages, the CPI and an age/sex weighted population factor, has ensured that such grants have fared better than financial assistance grants.

Even though the changed treatment of health grants explains the majority of the growth in specific purpose grants, there have also been significant increases in other Commonwealth programs, such as home and community care, legal aid, and housing assistance (reflecting in part the changed treatment of the States' Loan Council arrangements).(12) There has been some effort made by the Howard Government to reduce the proportion of specific purpose funding. In 1996-97, the Government imposed a 2.5 per cent cut (against the forward estimates) in specific purpose assistance while for 1997-98 the States were advised of a further reduction of up to 1.3 per cent (again, against the forward estimates). As a result, in 1997-98, such funding is expected to represent 52.3 per cent of total payments to the States, a slight decline from the 54.1 per cent which occurred in 1996-97 (see Table B5).

In recent years, there has also been a trend towards greater broadbanding of specific purpose assistance, that is, funds have been provided for broad functions rather than more specific activities. Associated with this has been a move towards 'outcome oriented' assistance, whereby the States can decide what means they will employ to meet required Commonwealth objectives rather than being instructed by the Commonwealth exactly how Federal funding should be used.

Specific purpose payments fall into two conceptual categories. There are a number of programs which are essentially Commonwealth Government programs but which, for constitutional reasons, the Commonwealth must fund via the States. In other words, the States are essentially acting as agents or 'mail drops' for the Commonwealth. In recent years, such payments have been designated as 'payments through the States'. These payments have consisted of funding for research at universities, higher education, non-government schools, coal mining industry long service leave provisions and general revenue assistance to local government. In 1997-98, these payments will total $7.2 billion, representing 39.8 per cent of total specific purpose payments.

Where the Commonwealth provides funding to the States for programs which are substantially administered at the State level, such payments are referred to as 'payments to the States'. These payments encompass a wide range of programs, including hospitals, government schools, aged and disability services, housing, highways and legal aid. In 1997-98 these payments amount to $10.9 billion or 60.2 per cent of total specific purpose payments.

Even though the States have often argued for the 'untying' of Commonwealth specific purpose assistance, the degree to which tied assistance actually reduces State budgetary flexibility is difficult to assess. If specific purpose assistance were to be untied, it is quite likely that a substantial proportion of the compensating general purpose funds would flow into the same functions anyway. Similarly, there is no doubt that 'grant substitution' occurs, whereby the States use monies 'released' by Commonwealth specific purpose payments for any particular function to fund other State functions as they see fit.

A corollary of this is the attempt occasionally made by the Commonwealth to claim that the value of specific purpose assistance for any function understates the Commonwealth's financial involvement in supporting that function, since part of the monies spent on that same function by the States would also have been provided by the Commonwealth in the form of general purpose assistance. Certain Commonwealth Ministers have thus tried to 'attribute' a certain amount of general revenue assistance towards particular functions. This has been done most recently in the case of Commonwealth education funding, but has also occurred at various times in the past in relation to other functions, such as road funding.

Table 2 outlines the pattern of specific purpose payments to the States in 1997-98.

Table 2. Specific Purpose Payments to the States, 1997-98 (Est.)

($'000)

Function

Recurrent

Capital

Total

Payments to the States:

     

Public order and safety

237 770

..

237 770

Education

1 284 616

223 895

1 508 511

Health

5 612 898

3 049

5 615 947

Social security and welfare

968 153

51 706

1 019 859

Housing and community amenities

16 566

955 534

972 100

Recreation and culture

7 333

5 536

12 869

Agriculture, forestry and fishing

120 750

22 151

142 901

Mining, manufacturing and construction

25 574

..

25 574

Transport

15 050

865 302

880 352

Employment and other economic affairs

7 552

4 554

12 106

Companies, royalties and other assistance

414 772

30 410

445 182

Total

8 711 034

2 162 137

10 873 171

Payments through the States:

     

Research at universities

405 111

..

405 111

Higher education

3 441 959

38 025

3 479 984

Non-government schools

2 025 019

86 996

2 112 015

Local government general revenue

1 205 208

..

1 205 208

Total

7 077 297

125 021

7 202 318

Source. Commonwealth Budget Paper No. 3. Federal Financial Relations, 1997-98.

General Purpose Capital Assistance

The Australian Loan Council, comprising the Prime Minister, Premiers and Chief Ministers (or their delegates), determines the aggregate borrowing program of the Commonwealth and the State governments and allocates the aggregate approved program amongst its members.(13) Prior to the early 1980s, virtually all borrowing was undertaken by the Commonwealth on behalf of the States and secured by the issuance of Commonwealth securities, although State governments could arrange their own borrowing from financial bodies constituted within their States. Commencing in the early 1980s, the States took advantage of this latter provision and established central borrowing authorities which progressively became the vehicle for State borrowing. The Commonwealth has not undertaken borrowings on behalf of the States since 1987-88.

Up until 1970, the States' Loan Council borrowing program consisted solely of loans undertaken by the Commonwealth and on-passed to the States. However, in 1970 the Commonwealth was required to take steps to alleviate the financial plight of the States. The Commonwealth rejected the States' plea for access to the income tax base but nevertheless agreed to assist them to overcome some of their financial difficulties. In addition to increasing financial assistance grants and handing payroll tax over to the States, the Commonwealth also agreed to take over the debt servicing on $1 billion of State debt. Furthermore, the Commonwealth agreed to provide a proportion (generally around one-third) of the States' agreed Loan Council borrowing program in the form of non-interest bearing, non-repayable grants.

By 1976-77, the Loan Council borrowing programs, including both the on-passed borrowing component and the general purpose capital grants, totalled some $1.3 billion, or 29 per cent of total general purpose assistance. From 1978 onwards, however, the importance of the State governments' Loan Council programs began to diminish in favour of increased borrowing entitlements by semi-governmental and local authorities. This was especially the case following the large increase in authority borrowing associated with the Infrastructure Borrowing Program, which commenced in 1978.

In the early 1980s, the Loan Council borrowing programs of the States were provided on even more concessional terms. In 1982-83, the States were given the option of nominating all or part of the 'borrowing' (as against the capital grant) component of their Loan Council borrowing program to be earmarked for public housing. Such nominated amounts were subject to the very generous conditions, in terms of the low interest rate and the long repayment period, which applied to Commonwealth advances to the States under the Commonwealth-State Housing Agreement.

From the outset two States, South Australia and Western Australia, nominated their entire borrowing component for public housing. Despite Commonwealth attempts to place limits on the proportion of the programs which could be devoted to this function, by 1987-88 all States were nominating their entire borrowing component for public housing. In 1989-90, the borrowing component of the States' Loan Council program was abolished, with the concessional loans being replaced by additional grants to the States under the Commonwealth-State Housing Agreement. Between 1989-90 and 1993-94, therefore, the so-called States' Loan Council program consisted only of general purpose capital grants.

However, the existence of these grants was somewhat anachronistic. They were an extremely small amount of funding, representing only 2.4 per cent of general purpose assistance to the six States and the Northern Territory in 1991-92. They were distributed amongst the States on an ad hoc, historical basis. They had been maintained essentially at the same level in nominal terms for several years, thus becoming even less significant in real terms. Furthermore, there was not even any requirement for these funds to be used for capital purposes. Ultimately, these grants were abolished by the Keating Government in 1994-95.

It might also be noted that, since 1991-92, capital grants to the States under the Building Better Cities program have been categorised as general purpose capital assistance rather than as specific purpose capital grants. With the abolition of the capital grant component of the States' Loan Council borrowing program, the only general purpose capital assistance to the States was their Building Better Cities funding. The abolition of this program was announced by the Howard Government in 1996. As from 1997-98, therefore, there is no longer any general purpose capital assistance paid to the States.

Repayments

Over the years, the Commonwealth has provided assistance to the States not only in the form of non-repayable grants but also in the form of advances (i.e. loans). As mentioned in the previous section, a major source of these advances was, until 1987-88, the 'borrowing' component of the States' Loan Council borrowing programs. However, the Commonwealth has, in the past, also provided specific purpose assistance in the form of advances rather than grants. For many years, for example, a significant component of Commonwealth housing assistance took the form of advances. Advances have also been used to provide natural disaster relief and rural adjustment assistance. With the decision to replace Commonwealth-State Housing Agreement advances with outright grants in
1989-90, the use of advances as a major form of Commonwealth assistance to the States has ceased. Currently, only a few minor programs, such as natural disaster relief, still receive assistance in the form of advances.

The States, of course, have been required to make regular repayments of both direct Commonwealth loans for particular purposes and loans raised on their behalf by the Commonwealth under the Loan Council borrowing programs. However, at the June 1990 Loan Council meeting, it was agreed that the States and Territories would progressively take over responsibility for outstanding debt issued on their behalf by the Commonwealth under the terms of the Financial Agreement. Although no debt has been raised on behalf of the States by the Commonwealth since 1987-88, outstanding debt had continued to be refinanced by the Commonwealth after that date. At 30 June 1991, around $16 billion of Commonwealth securities issued on behalf of the States was outstanding.

Under the June 1990 agreement, the States and the Northern Territory consented to make additional payments to the National Debt Sinking Fund so as to fully redeem the outstanding Commonwealth debt. Such debt should thus be fully taken over by the States and Territories by the year 2005-06. The Commonwealth has agreed to pay compensation to the States and the Territories to assist them to meet the increased burden of their interest payments and sinking fund contributions. It might be noted that, in 1995-96, both Queensland and Victoria made early repayments of previous Commonwealth advances.

Trends in Commonwealth Assistance

The charts in Appendix A and the tables in Appendices B and C show movements in Commonwealth assistance to the States since 1976-77. Data are provided for each of the States and for all States and Territories combined.

As shown in Table B4, real per capita tax sharing grants increased significantly over the period 1976-77 to 1979-80. However, this growth more reflects the impact of the Whitlam guarantee on these grants rather than the move to a tax sharing system per se. Nevertheless, the existence of tax sharing did enable the States' tax sharing grants to continue rising in real per capita terms until these arrangements were abolished in
1985-86. Even then, during the first three years of financial assistance grant funding, these grants maintained their level due to the existence of guarantees offered by the Hawke Government.

However, in order to rein in Commonwealth outlays, the Commonwealth cut financial assistance grants to the States in real terms in each of 1988-89, 1989-90 and 1990-91. Table B4 clearly shows the impact this had on reducing real per capita general revenue grants over this period. Since then, the existence of various real terms guarantees has stabilised the level of these grants. However, it might be noted that throughout the 1990s, such real per capita grants have generally hovered around their 1976-77 level.

The movement in total general revenue assistance reflects the abovementioned changes in tax sharing and financial assistance grants. However, the pattern is distorted somewhat by the untying of specific purpose funding at various times. Between 1981-82 and 1987-88, a significant amount of health funding was untied. This accounts for the large bulge in general revenue assistance during this period (and the concomitant reduction in specific purpose funding to the States). The impact of this measure was, of course, reversed in 1988-89 when health funds were again converted to specific purpose payments. A similar, if not so significant effect can be seen with the untying of State arterial roads grants in 1992.

In terms of total general revenue assistance, then, it can be seen from Table B4 that even though the States are no worse off in real per capita terms than they were in 1976-77, they have lost the gains which they had made by the mid 1980s.

The fall in real per capita total general purpose assistance (that is, in general revenue assistance plus general purpose capital assistance) over the period 1976-77 to 1997-98 portrayed in Table B4 might be somewhat misleading. Prior to 1987-88, the general purpose capital component included a significant amount of borrowing undertaken by the Commonwealth on behalf of the States under the Loan Council arrangements. Since
1987-88, this borrowing task has passed wholly to the States.

While the figures in Tables B1 to B5 are an accurate description of Commonwealth assistance to the States, a more meaningful analysis of overall trends in funding may be obtained by adjusting Commonwealth general purpose capital assistance to remove the impact of Commonwealth borrowing on the States' behalf prior to 1987-88. Tables C1 to C5 in Appendix C are adjusted in this fashion, so that only general purpose capital grants are shown. Commonwealth borrowing on behalf of the States is not included.

Whereas Table B4 shows real per capita general capital assistance declining from $315.69 in 1976-77 to zero in 1997-98, the adjusted figures in Table C4 show the decline to be only from $105.23 to zero. As a result, Table B4 shows real per capita general purpose assistance declining from $1182.33 to $886.10. This is quite a significant decline. Adjusting for borrowings, it can be seen from Table C4 that there is still a reduction in real per capita general purpose funding, but the decline is somewhat less - from $971.87 to $886.10.

Taking into account the changing treatment of health and road funding over the period studied, Table B4 shows that specific purpose payments to the States have remained fairly constant in real per capita terms between 1976-77 and 1997-98. Furthermore, as a proportion of total Commonwealth assistance, such grants have also remained fairly constant, increasing only slightly from 29.6 per cent of total assistance in 1976-77 to 31.3 per cent by 1997-98 (see Table B5).

Real per capita specific purpose payments through the States, on the other hand, have increased over the period in question and especially during the 1990s. As a proportion of total assistance, these grants have increased from 14.9 per cent in 1976-77 to 21 per cent by 1997-98.

Table B5 also shows the relative importance of specific purpose assistance and general purpose assistance. Whereas specific purpose assistance was only 44.5 per cent of gross assistance in 1976-77, in 1990-91 specific purpose payments actually surpassed the value of general purpose assistance. In 1997-98, specific purpose assistance is estimated to be 52.3 per cent of total assistance. Again, however, it might be instructive to compare these figures with those in Table C5 which is adjusted for on-passed borrowings. This table shows that, even in 1976-77 specific purpose payments virtually equalled the adjusted general purpose payments.

Overall, Table B4 shows a significant decline in real per capita gross Commonwealth assistance. From $2129.49 per head in 1976-79 (in 1996-97 prices), real per capita assistance has fallen to $1804.81 in 1997-98. The comparable figures from Table C4 do not show such a large decline, but nevertheless, even these statistics show a reduction from $1919.04 in 1976-77 to $1804.81 in 1997-98

Finally, it might be noted that the Commonwealth has increased its own outlays at a greater rate than its assistance to the States. Whereas in 1976-77 gross assistance to the States represented 37.7 per cent of Commonwealth budget outlays, this proportion has steadily declined over time, having fallen to 27 per cent by 1997-98 (see Table B3). Again, the decline is not quite as large if the borrowing-adjusted data is used. Table C3 shows gross assistance falling from 34 per cent of total budget outlays in 1976-77 to 27 per cent in 1997-98. This declining share of assistance reflects both the attempt by the Commonwealth to achieve savings by reducing grants to the States, as well as the difficulty the Commonwealth has had in restraining its own expenditures due to the 'open ended' nature of many of its programs, especially in the social welfare area.

Endnotes

  1. In 1996-97 prices, indexed by the Implicit Gross Non-farm Product Price Deflator.
  2. After adjusting general revenue funding and specific purpose payments for the payment of State fiscal contributions.
  3. The exclusion of the States from the taxation of goods would not preclude them from imposing sales taxes on services although, granted, there could be practical problems in taxing services where the price of the service includes the cost of goods used as inputs. Land tax is subject to exemptions relating to residential and agricultural property. It has also been argued that competition between the States in the field of payroll taxation has led to higher thresholds and lower tax rates than might otherwise have applied. Similar competition also led to the abolition of estate and gift duties in the late 1970s and early 1980s.
  4. During the campaign prior to the December 1984 election, Mr Hawke committed his Government to a trilogy of pledges. These were:
    • there will be no increase in tax revenue as a proportion of GDP in 1985-86 and over the life of the Parliament;
    • government expenditure will not increase as a proportion of GDP in 1985-86 and over the life of the Parliament; and
    • the budget deficit will be reduced in money terms in 1985-86 and reduced as a proportion of GDP over the life of the Parliament.
  5. Note, however, that the States did lose sales tax exemption on motor vehicles purchased for executive use.
  6. In 1996-97, Queensland and the ACT made their fiscal contributions totally in the form of offsets to funding under the Commonwealth-State Housing Agreement (CSHA). South Australia made its contribution partially as a direct payment ($31.6 million) and partially ($18 million) as an offset to CSHA funding. All other States either made direct payments or paid their contribution as an offset to financial assistance grants.
  7. In 1997-98, Tasmania and the ACT were permitted to defer one half of their allotted contribution until 1998-99. These States argued that they were facing difficult budgetary situations which would be exacerbated if they had to make their full contribution this year.
  8. The Commission, over time, used a number of definitions of what constituted the 'standard States'. At times, the claimant State may have been compared with all the other States, while at other times (especially in the 1970s), only New South Wales and Victoria together would have been regarded as the 'standard States'. Furthermore, over time, various States relinquished or regained their right of claimancy, usually as the result of some financial deal with the Commonwealth.
  9. It should be noted that funding for local roads had been untied as from 1990-91. Since virtually all such roads were the responsibility of local government, the Commonwealth began to pay identified roads grants to local government in addition to local government financial assistance grants. Unlike untied road grants to the States, there has not been any proposal to merge local government identified road funding with local government financial assistance grants.
  10. National Competition Council. Assessment of State and Territory Progress with Implementing National Competition Policy and Related Reforms. 30 June 1997.
  11. Local government assistance to the six States increased rapidly throughout the Fraser years, rising from $79.9 million in 1975-76 to $424.5 million in 1982-83, mainly due to local government tax sharing arrangements which saw the local government share of Commonwealth personal income tax collections increase from 1.52 per cent in 1976-77 to 2 per cent by
    1980-81.
  12. For a detailed compendium of all specific purpose payments to the States see Catalogue of Specific Purpose Payments to the States and Territories, 1996-97. Department of Finance. February 1997.
  13. For more information on the Australian Loan Council see James, Denis The Australian Loan Council. Parliamentary Research Service. Background Paper No. 29. November 1993.

Glossary of Terms

Advances:

Repayable, interest-bearing loans, often provided on concessional terms.

Broadbanded grants:

Grants provided by the Commonwealth to the States for very broadly defined purposes. While the States must use the grants for the purposes as broadly specified, they may exercise a considerable amount of autonomy as to how the funds are actually used.

Central borrowing authorities:

Agencies established by the States to undertake borrowing on behalf of State semi-governmental and local authorities. In recent years, the State governments have also tended to borrow from their central borrowing authorities. The NSW Treasury Corporation is an example of a central borrowing authority. The amount of borrowing by CBAs is regulated via the Australian Loan Council.

Claimant States:

Those States which, at various times in the past, have been eligible to apply to the Commonwealth Grants Commission for an assessment of their need for a special grant.

Council of Australian Governments (COAG):

The Council of Australian Governments comprises the Prime Minister, Premiers and Chief Ministers. A non-voting representative of local government is also a member. COAG was established in 1992 to facilitate the discussion of important Commonwealth-State issues at a heads-of-government level. It meets irregularly.

Equalisation grants:

See fiscal equalisation.

Financial assistance grants (FAGs):

Financial assistance grants were the main form of general revenue assistance provided to the States for many years prior to 1976-77, when they were replaced by tax sharing grants. They were re-introduced in 1985-86 and are currently the main component of general revenue assistance.

Fiscal equalisation:

The provision of financial assistance to the States which, as assessed by the Commonwealth Grants Commission, is designed to provide a State with the capacity to provide services at a standard comparable with those of the other States but without requiring that State to impose a greater burden of taxation.

Fiscal capacity:

The financial capacity of a State to meet its responsibilities. This will reflect the adequacy of the various tax bases available to that State, as well as the existence of any disabilities or advantages faced by that State in the provision of services.

General government sector:

All of the agencies of government not classified as public trading or financial enterprises. It includes all government departments and offices and other bodies engaged in providing services free of charge or at prices significantly below their cost of production.

General purpose capital assistance:

Prior to 1987-98, general purpose capital assistance comprised capital grants provided by the Commonwealth to the States along with borrowings by the Commonwealth on behalf of the States. After 1987-88, general purpose capital assistance consisted only of grants including, from 1991-92, grants under the Building Better Cities program. Such assistance could be used by the recipient as it saw fit. Despite its title, general purpose capital assistance did not need to be used by the States for capital purposes. This form of assistance was abolished as of 1997-98.

General revenue assistance:

Grants provided by the Commonwealth to the States (and local government), to be used for whatever purposes the recipients might choose. The main form of general revenue assistance currently provided to the States is financial assistance grants. Other forms of general revenue assistance to the States have included special revenue assistance, special grants, identified health grants, identified roads grants and national competition payments.

General revenue grant relativities:

To achieve fiscal equalisation, the Commonwealth Grants Commission compares the fiscal capacity of each State in turn with a 'standard' which comprises the State concerned plus all of the other States. The revenue needs and expenditure disabilities faced by each State are assessed and the amount of financial assistance required to offset these needs and disabilities is calculated. After subtracting the amount of eligible financial assistance received by each State, the equalisation assistance requirement of each State is determined. These requirements are then expressed as a set of per capita weights. The resulting set of per capita weights are referred to as the general revenue grant relativities.

Grants:

Non-repayable, non interest bearing assistance.

Horizontal fiscal equalisation:

See fiscal equalisation.

Identified road funding:

Since 1991-92, Commonwealth funding for local roads, which used to take the form of a specific purpose payment, has been provided as general revenue assistance to be used as the recipient sees fit. From 1 January 1994, funding for State arterial roads was also untied. Identified road funding to the States has been absorbed into financial assistance grants as from 1997-98.

Identified health grants:

Between 1981-82 and 1988-89, funding for hospital running costs, community health and the school dental program, which had been provided as specific purpose assistance, was converted to general revenue assistance, but separately identified. From 1988-89, such assistance has reverted to being a specific purpose payment.

National competition payments:

General revenue payments to the States, commencing in 1997-98, provided on condition that the States meet agreed 'milestones' in the implementation of micro economic reform objectives under the terms of the National Competition Agreement.

Payments:

Monies paid by the Commonwealth to the States or local government either in the form of grants or advances.

Public trading enterprises:

Public sector undertakings which aim at covering the bulk of their expenses by revenue from sales of goods and services.

Relativities:

See general revenue grant relativities.

Section 96 grants:

Grants provided to the States by the Commonwealth under section 96 of the Constitution, which permits the Commonwealth to provide financial assistance to the States on whatever terms and conditions the Commonwealth Parliament thinks fit. While most of these grants are for specific purposes, conditions have also from time to time been applied by the Commonwealth to the provision of general revenue assistance to the States.

Special revenue assistance:

Once-off general revenue assistance provided by the Commonwealth to a State which is suffering particular budgetary distress from any cause. Such assistance is meant to supplement the basic general revenue assistance provided to the State in the form of financial assistance grants.

Special grants:

Grants which were assessed by the Commonwealth Grants Commission to enable a State (a so-called claimant State) with a poor fiscal capacity to function at a comparable level as that of the other States. Usually, the fiscal position of the claimant State was compared with that of standard States. It was common for NSW and Victoria combined to be used as the standard States. With the implementation of the per capita relativities approach to fiscal equalisation, special grants have ceased to be provided.

Specific purpose payments:

Payments made to the States, generally under section 96 of the Constitution, for the purposes, and on such terms and conditions, as may be specified by the Commonwealth. All specific purpose assistance of a recurrent nature is in the form of grants, while a small amount of assistance of a capital nature takes the form of advances.

Specific purpose payments through the States:

Specific purpose payments provided to the States for programs for which the States essentially act only as agents for the Commonwealth (for example, higher education, non-government schools and payments to local government).

Specific purpose payments to the States:

Specific purpose payments to the States for programs largely administered by the States (for example, government schools and hospitals).

Standard States:

Those States which, at various times, were chosen against which to compare the budgetary positions of claimant states which had applied to the Commonwealth Grants Commission for an assessment of a special grant.

Tax base:

The object upon which taxation is levied. Common tax bases are income, value of production or sales of goods, payrolls, land, etc.

Tax sharing grants:

Tax sharing grants were the main general revenue grants paid to the States between 1976-77 and 1984-85. Between 1976-77 and 1980-81, such grants were expressed as a proportion of Commonwealth personal income tax collections. From 1982-83 to 1984-85, they were expressed as a proportion of total Commonwealth tax collections.

Tied grants:

See specific purpose payments.

Uniform taxation:

Under the Constitution, the Commonwealth is required to impose its taxation so as not to discriminate between any States or any parts of States. Prior to 1942, in addition to Commonwealth income taxation, the States also imposed their own income taxes, with quite different tax regimes applying. In 1942 the States vacated the income taxing field in favour of the Commonwealth, thus creating a uniform, national income tax system under the control of the Commonwealth.

Vertical fiscal imbalance:

An imbalance between the expenditure responsibilities of each tier of government and the own-source revenue resources available to that tier. Australia is characterised by significant vertical fiscal imbalance since the Commonwealth raises around 75 per cent of all general government revenues but is only responsible for around 60 per cent of all general government outlays.

APPENDIX A

CHARTS A1 to A10

REAL PER CAPITA COMMONWEALTH ASSISTANCE TO THE STATES AND TERRITORIES

Chart A.1 All States and Territories
Chart A.2 New South Wales
Chart A.3 Victoria
Chart A.4 Queensland
Chart A.5 Western Australia
Chart A.6 South Australia
Chart A.7 Tasmania
Chart A.8 Northern Territory
Chart A.9 Australian Capital Territory
Chart A.10 All States and Territories - Adjusted for Loan Council Borrowings

Source: Commonwealth Budget Papers, Various Years

Notes: All constant prices estimates are in 1996-97 prices, indexed by the Implicit Gross Non-farm Product Price Deflator

The figures for general purpose and specific purpose grants in 1996-97 are adjusted for the method of payment of fiscal contributions. Figures for 1997-98 are similarly adjusted on the assumption that the States will adopt the same method of paying fiscal contributions as they did in 1996-97.

APPENDIX B

TABLES B1 to B29

COMMONWEALTH ASSISTANCE TO THE STATES AND TERRITORIES

Source: Commonwealth Budget Papers, Various Years

Note: All constant prices estimates are in 1996-97 prices, indexed by the Implicit Gross Non-farm Product Price Deflator

APPENDIX C

TABLES C1 to C5

COMMONWEALTH ASSISTANCE TO THE STATES AND TERRITORIES

(Adjusted for Loan Council Borrowings)

Source: Commonwealth Budget Papers, Various Years

Note: All constant prices estimates are in 1996-97 prices, indexed by the Implicit Gross Non-farm Product Price Deflator


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