The Australian Financial Review has published an op-ed from me on the changes to the arrangements for distributing the revenue from the GST among the states and territories imposed by the Morrison Government in 2018 (with the support of the then Labor Opposition) – something which I regard as one of the worst public policy decisions of the last 25 years.

Good luck to State Treasurers in their quest to have the ‘no-worse-off’ guarantee extended beyond its currently-scheduled expiry in 2026-27 , at their meeting with Jim Chalmers on Friday. But that of course would mean that Federal taxpayers will continue to be on the hook for ensuring that the citizens of Australia’s richest state, with a per capita gross state product 60% above the national average, enjoy lower state taxes and better public services than their fellow Australians living in the eastern states and territories.

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The appointment of former Grattan Institute CEO Danielle Wood as chairwoman of the Productivity Commission is an inspired choice. In her new role, Wood can help undo what I regard as one of the worst public policy decisions of the 21st century.

This is the changes to the GST revenue-sharing arrangements imposed by the Morrison government in 2019 to bolster its chances of retaining House of Representatives seats from Western Australia, and which Labor supported to bolster its chances of forming government after last year’s election.

Danielle Wood is on the record as supporting an end to WA’s GST deal.  Alex Ellinghausen

Those changes involved trashing the horizontal fiscal equalisation (HFE) principle which had underpinned the allocation of “general purpose” (that is, “untied”) moneys flowing from the federal government to the states and territories since 1936.

The principle is that such moneys should be distributed among the states and territories to enable each of them to provide the same range and quality of public services if they made a similar effort to raise revenues from their own sources.

This long-standing principle is, together with Australia’s national income tax and social security systems, an important reason why the differences in material living standards between the richest and poorest states are considerably smaller than those between the richest and poorest states, provinces, Länder or cantons in other federations.

These changes followed a PC inquiry into the long-standing system of HFE commissioned by Scott Morrison, with terms of reference which appeared as if they had been drafted by the WA Treasury.

This inquiry was conducted in a very un-PC-like fashion, with scant regard paid to the evidence presented to it before and after the publication of its preliminary report.

In particular, like the previous inquiry into HFE conducted by Nick Greiner and John Brumby, it was unable to find any evidence to support the assertion that the long-standing arrangements acted as a disincentive for states and territories to pursue productivity-enhancing reforms (for fear that to do so might adversely affect their GST shares).

But whereas Greiner and Brumby had the intellectual integrity to acknowledge that the argument they had both put while serving as premiers of NSW and Victoria, respectively, had no evidentiary basis, the PC asserted that “absence of evidence does not imply evidence of absence”.

This was the same logic that George W. Bush, Tony Blair and John Howard used to justify the 2004 invasion of Iraq, despite the repeated inability of UN weapons inspectors to find any evidence that Saddam Hussein possessed weapons of mass destruction (as, it turned out, he didn’t).

As a result of the changes to the GST revenue-sharing arrangements, the “fiscal capacity” of the fiscally weaker states and territories will no longer be raised (by the distribution of GST revenues) to that of the fiscally strongest state (which for most of the past 15 years has been WA), but rather to the fiscally stronger of NSW and Victoria (which now, and for the foreseeable future, is NSW).

Additionally, the distribution arrangements are subject to a “floor”, which provides that no state can receive less than 70 per cent (in 2022-23 and 2023-24) and from 2024-25, 75 per cent of what it would have received under a hypothetical equal per capita distribution of GST revenues.

WA wins regardless

What these changes mean in practice is that if iron ore prices remain high, as they have done since these changes were imposed, contrary to the forecasts made at the time, Western Australia gets to keep them. But if iron ore prices to fall back to somewhere between $US50 and $US70 a tonne (as the federal and WA treasuries keep forecasting), WA’s share of GST revenues will rise just as it would have done under the now-superseded revenue-sharing arrangements.

In other words: heads WA wins, tails, the eastern states and the federal government lose.

Why does the federal government lose? Because the carve-up of the revenue from the GST is, in principle, a zero-sum game – that is, an increase in any one state or territory’s share can only be at the expense of one or more of the other states’ and territories’ shares.

To cajole the eastern states and territories into agreeing to something that was so obviously disadvantageous to them, the Morrison government provided what it called a “transitional guarantee” that it would “top up” the “GST revenue pool” by whatever amount was necessary to ensure that no state or territory was worse off than it would have been under the now-superseded arrangements, until 2026-27.

At the time, federal Treasury projected that this transitional guarantee would cost the budget $6.6 billion over the eight years to 2027-28, on the assumption that iron ore prices would come down to, and remain at, about $US55 a tonne.

But largely because iron ore prices have for the most part remained well above $US100 a tonne (while the Australian dollar has fallen, further boosting WA’s mineral royalty revenues), the cost of the transitional guarantee to the federal budget has blown out to a projected $28.4 billion. That number will probably be revised up again in the forthcoming MYEFO, given the trajectory of iron ore prices since the budget.

How federal Labor reconciles that with its professed beliefs in fairness and equity, let alone its claims to fiscal prudence, is beyond me.

That’s $28.4 billion that the federal government is borrowing (in every year except 2022-23, when it ran a surplus) and handing over to the only government in Australia – and one of few in the world – that has run and expects to continue running budget surpluses.

Moreover, it is going to the government of the richest state in the country.

How federal Labor reconciles that with its professed beliefs in fairness and equity, let alone its claims to fiscal prudence, is beyond me.

What’s all this got to do with Danielle Wood?

First, the Productivity Commission is required to undertake a review of the new GST revenue-sharing arrangements before the expiry of the transitional guarantee at the end of 2026-27. Hopefully, Wood will insist on less blatantly biased terms of reference for this review than those that Morrison as treasurer issued in 2017.

Second, Wood is already on the record, in a report she co-authored for the Grattan Institute titled Back in black? A menu of measures to repair the budget published in April this year, as identifying “winding back the WA GST deal” as an option that would “make a worthwhile dent in spending”. She noted that “in effect, the federal government is spending almost $5 billion a year to support superior government services in the only state that is running a strong surplus”.

So, Wood has an opportunity to help reverse one of the most ill-advised
public policy decisions of this century. Here’s hoping she takes it.