Approach to Disaggregation

Transcription

1 Response to the Commonwealth Grants Commission Issues Paper 2006/02 Approach to Disaggregation Department of Treasury and Finance April 2006

2 2 INTRODUCTION 1. Tasmania supports the simplification of the Commission s methodology, including more aggregated assessment categories, where this is consistent with maintaining the integrity of horizontal fiscal equalisation (HFE) The proposed top-down approach by the Commission for review of its assessment methodology seems a sensible and logical approach and will provide the best opportunity for delivering HFE in a simpler and more transparent form. 3. While the Commission will continue to be informed by existing assessments and its current knowledge base, a top-down approach recognises that simplification will require change. It is this change, where consistent with the current equalisation outcome, which will assist in ensuring the long-term sustainability of the assessment process. 4. The development of an appropriate assessment structure will require decisions on how much disaggregation is warranted by conceptual argument, materiality and data availability and quality. 5. Tasmania appreciates the interactive approach adopted by the Commission for developing the assessment category structure for the 2010 Review. Where and when it is judged useful, Tasmania is willing to participate in working groups of state and Commission staff to facilitate the development of an appropriate assessment structure. It is acknowledged that this initial structure will be subject to modification as work progresses throughout the Review. 6. Tasmania is comfortable with the indicative timetable proposed for developing the category structure for the 2010 Review. DISAGGREGATION IN CONTEXT 7. With the objective of simplification, the structure of the revenue and expense categories used in the assessments should reflect the minimum disaggregation that is consistent with achieving HFE. 8. Following a top-down approach, Tasmania supports, in-principle, the structuring of expense and revenue categories starting with large aggregates and disaggregating only where it materially improves the HFE outcome. 9. A top-down approach requires a case to be made for greater detail, rather than the other way around. The onus of proof will be on demonstrating that capturing the main differences between states requires greater disaggregation and greater detail than on demonstrating that similarities between states facilitates aggregation. 10. It is considered that materiality thresholds will be important to implementing a top-down approach. With a top-down approach to disaggregation, it will be 1 Tasmania notes that, in drafting CGC Issues Paper (2006/02), it has been assumed that the current interpretation of equalisation will apply for the 2010 Review.

3 3 necessary to have some concept of where this will end. This is where materiality thresholds will provide guidance. 11. Nevertheless, there is a possibility that, at the end of the Review, many of the existing categories may remain relatively unchanged or that only small amounts of aggregation are made. A radical overhaul or restructure of the assessments should not, therefore, be an end in itself. Ending up with a similar structure to the current one would not be a failure it would simply be confirmation that the existing structure, with adjustments, is found to be, after considerable effort and analysis, the best and simplest one to achieve HFE. 12. That said, Tasmania is not resistant to higher levels of aggregation. The primary concern is that the factors that drive differences in states capacities to deliver services continue to be recognised where those differences are material to the equalisation outcome. As long as a new structure, with higher levels of aggregation, achieves this, then the aim of simplifying the Commission s methodology, while upholding the HFE outcome, will go a long way to being achieved. Tasmania would welcome such a result. 13. Tasmania supports the Commission s intention to continue with an expense and revenue category approach in building assessment methods. While a disability approach should conceptually produce the same assessment results, a category approach is likely to result in assessments that are more transparent and simpler to explain. A category approach will allow the explicit identification of disabilities that affect each service and each tax. Tasmania agrees that it is easier to understand the effects of disabilities when they are presented within the context of the specific services they affect. 14. Notwithstanding, it will be useful to continue to provide an alternative presentation of the results to show the aggregate effect of each disability across all categories. 15. In terms of the creation of categories, Tasmania supports: expense categories continuing to be generally based on state functions (such as education and health); and revenue categories based on the legal incidence of taxes using data collected directly from the states. 16. This represents the most sensible approach having regard to data quality and interstate comparability. For education, health and law and order, for example, being the largest and most important areas of state services, ABS GFS data are available at the two-digit level to support the derivation of average expenses. They also have distinctive users and costs. 17. A number of alternative approaches upon which expense and revenue categories could be based are outlined in paragraph 18 of CGC Issues Paper (2006/02). These include expense categories based on services provided to people and services provided to business; the types of expenses incurred (such as labourrelated services, purchase of goods and services, financial expenses); and/or

4 4 revenue categories based on where and how taxes are imposed. While these alternatives may have some conceptual appeal, they do not represent practical alternatives, because data availability and interstate comparability are likely to remain major limitations. 18. The current approach is also relatively transparent in that there is a direct link between the categories and what states do. Tasmania doubts whether a different presentation would materially improve the transparency of the Commission s assessments to the general public. BROADER INDICATORS 19. Tasmania acknowledges that the use of broader indicators could be considered as consistent with the adoption of more aggregated assessment categories, where this is consistent with the principle of HFE. Therefore, an approach similar to that used for disaggregating categories should be applied in deciding whether to use a broader or narrower indicator. This could include a materiality test similar in concept to the one proposed in the Issues Paper for deciding whether to further disaggregate categories. Tasmania believes, however, that the use of broad indicators will be more applicable to the expenditure assessments rather than revenue assessments. 20. To ensure that the process of calculating relativities remains transparent, Tasmania believes that the correlation between any indicator and the revenue base or quantity of required service it is attempting to describe should be clearly demonstrated. This is an important conceptual consideration when determining how broad an indicator to use and is analogous to the conceptual case that must be made when disaggregating an expense or revenue category. HOW DISAGGREGATION MIGHT WORK IN PRACTICE 21. Tasmania supports the Commission s proposed approach to disaggregation as an appropriate way of applying the principle of a top-down approach. The practical steps outlined in paragraphs 28 to 33 in the Issues Paper are likely to achieve the aim of simplifying assessments. 22. Tasmania agrees with the Commission s position that it will not apply the interim assessment guidelines in a mechanical fashion and that it is appropriate to first examine the conceptual case for disaggregation. Considering the case for disaggregation principally on a conceptual basis will also assist in maintaining a clean-slate approach to category formation, since it will force all parties to look at potential new categories with fresh eyes. 23. In practice, Tasmania believes the Commission will need to use a significant degree of judgement to determine if it expects HFE outcomes to be improved by further disaggregation. This may require testing around what might be considered an appropriate level of disaggregation to achieve a sound HFE outcome. This type of approach was identified by the Commission Chairman at the November 2005 CGC Conference:

5 5 We acknowledge that in order to implement this in a sensible, coherent and consistent fashion, we will actually have to do a lot of work at high levels of disaggregation to establish whether categories can remain highly aggregated or how far they need to be disaggregated to determine the extent to which disabilities apply. So we ll actually have to work from the top and the bottom within the Commission 24. Paragraph 35 of the Issues Paper also seems to support this type of approach. 25. The practical difficulty with aggregation rests with the interaction between categories and factors. The Commission s proposed approaches to disaggregating categories and factors cannot be considered in isolation. For example, it is possible that there may be a case for disaggregating a global indicator of a disability into smaller sub-global indicators to ensure that material differences between states are captured. However, this may necessitate the disaggregation of a category to which the disability applies into lower level categories than would otherwise be justified according to the proposed materiality, reliability and conceptual tests. It is not clear from the Commission s proposals whether the materiality of factors takes precedence over the materiality of the redistribution of GST revenue when considering possible category structures. 26. In these situations, Tasmania is of the strong view that the materiality of factors should take precedence over the materiality of categories. Factors recognise the key drivers of difference between states and this is at the centre of the equalisation principle. 27. In stating this view, Tasmania is of the belief that this problem should be avoidable in many instances because the compatibility of categories and factors at particular levels of aggregation should be strong. This will, of course, depend on how well designed the approach to disaggregation is when it is put into practice. The future work of the Commission will bear the evidence of this. 28. In practice all states will sanity check proposed aggregated categories from a bottom up perspective. This is because, notwithstanding the need for simplification and removing immaterial assessments, many assessments reflect well-established and recognised differences that affect states in their service delivery efforts. 29. In principle, Tasmania is comfortable with the proposed additional threshold to determine whether there is a material difference between one level of aggregation and the next level down. However, the suggested quantum of $30 per capita is untested and it is difficult to agree at this stage whether this threshold is a fair and reasonable measure of materiality between potential levels of disaggregation. Tasmania is open to further discussion about the threshold once the effect of a top-down approach can be more accurately quantified.

6 6 30. Regarding this new threshold, the Issues Paper states (in paragraph 32, page 6): The Commission is proposing that an aggregated category would be disaggregated only if the effect on the distribution of the GST pool resulting from the use of the disaggregated assessment instead of the aggregated assessment exceeds $30 per capita for any one State 31. This explanation is somewhat ambiguous and it is not clear how the Commission intends to implement this proposal in practice. When a category is disaggregated it will presumably form at least two new categories. It is not clear from the Commission s description whether, in order to be considered material: all of the lower level categories would need to exceed the $30 per capita threshold; only one category would need to exceed the threshold; or the test would be applied to the net effect of all the lower level categories taken together. EXPENSE ASSESSMENTS 32. Tasmania supports the Commission s proposed approach to disaggregation with regard to expenditure categories. The approach is consistent with that which the Commission flagged with states in its Draft Assessments Guidelines paper in December 2005 and with which Tasmania responded that it was, in general, comfortable. 33. From a top-down perspective, the three major blocks of services identified by the Commission (education, health and law and order) are a logical starting point to disaggregating expenditure categories. 34. The fourth other block of services is less logical and the Commission acknowledges that there is no unifying theme to it. Tasmania agrees with the Commission s tentative conclusion that it is likely that some disaggregation of this other block will be required to capture differences between states that affect their relative financial capacities. 35. Similarly, Tasmania s assessment is that further disaggregation of the three major blocks of education, health and law and order will also be justified and required to ensure the assessments are consistent with HFE. 36. The Commission s proposed starting points are a considerable distance from the current assessment structure and further disaggregation will require reasoned and logical arguments and evidence in accordance with the interim assessment guidelines. 37. Tasmania believes there is a strong conceptual case for further disaggregation of these initial high-level categories and that there are material differences to justify making assessments at lower levels. However, given materiality

7 7 thresholds, the only way movement away from the current assessment structure can occur is if current services that are immaterial are grouped with other services where there will not always be a strong functional fit. The use of broad indicators may improve functional fit from a practical perspective. 38. Given the broad nature of the Issues Paper and the timeframe for response, it is not possible to consider each block of services in detail to provide a firm view on further disaggregation. Tasmania understands that further, more meaningful analysis of potential assessment structures is the next step in this part of the Review process. 39. Nevertheless, Tasmania has developed preliminary considerations of how the major service blocks might be disaggregated. They have been developed within the context of the top-down approach and are based primarily on where Tasmania believes reasonable functional fits can potentially be made (ie the suggestions reasonably reflect what states do ). The preliminary considerations are also based on experience with the current assessment structure to inform considerations of potential materiality and differences between states that affect relative fiscal capacities. 40. No account has been made for the proposed $30 per capita disaggregation threshold, given that there has not been proper debate and agreement over whether this test and the quantum of the threshold is appropriate and, notwithstanding this, it is not possible to conduct the test until the Commission commences work on possible aggregation structures. 41. The preliminary consideration of potential disaggregation is discussed below. Education 42. Tasmania s preliminary consideration is that Education could be disaggregated as follows: Schools Education (recognising functions such as Government Primary, Non-government Primary, Government Secondary and Non-government Secondary education) VET Other (recognising functions such as Higher Education, Transport of Rural School Children and Pre-School Education) 43. The case study provided by the Commission is a good starting point for the disaggregation of education services. Tasmania agrees that there is a strong case for VET services to be maintained as a separate category because of its clear differences to other school education services and its materiality. 44. Tasmania is of the view that the there is likely to be a conceptual case to further disaggregate the suggested All Other Education category into a category to recognise primary and secondary education (ie Schools Education) and a category to recognise other education services.

8 8 45. There may also be a case to further disaggregate the Schools Education category into government and non-government education, as it may be difficult to reconcile the key drivers of these services in one category (ie the differing population groups according to government enrolments and non-government enrolments and the significantly different per unit costs associated with each sector). 46. A category for other education services might then contain services such as preschool education, higher education and transport of rural school children. How these services might be grouped in practice is difficult to determine as they do not have any strong functional fit with each other. 47. The other alternative is to group them with the other education categories. For example, it may be possible to capture pre-school education and transport of rural school children in a Schools Education category. Similarly, higher education and potentially the post compulsory years of secondary education could be combined with VET to create a Post Compulsory Education category. Health 48. Tasmania s preliminary consideration is that Health could be disaggregated as follows: Inpatient Services Other Health (recognising functions such as Non-inpatient and Community Health Services and Population and Preventative Health) Welfare (recognising functions such as Family and Child Services, Aged and Disabled Services, and Homeless and General Welfare) 49. Tasmania considers that there is a strong case for Inpatient Services to be maintained as a stand-alone category. There is a significantly different per unit cost associated with treating patients in hospitals than outside of hospitals. 50. However, there is potential for other health services (such as those currently captured in Non-inpatient and Community Health Services and Population and Preventative Health) to be recognised in one category as the key drivers of the costs for these services may be reasonably compatible. 51. The Commission s Issues Paper suggests that welfare type categories could be considered under the Other block of services. Tasmania is of the view that at least some of the currently recognised welfare needs of states might better fit under the health block (many of these services in Tasmania are the responsibility of the agency responsible for health services). One way of achieving this could be to create a welfare category under the umbrella of a health group of categories. Alternatively, there may be some scope for recognising them in the other health categories.

9 9 52. However, sanity checking this approach from a bottom up perspective, the main concern with these suggestions would be how the key drivers of the assessments (which are essentially the different population groups) could continue to be appropriately combined and recognised in any aggregated category or categories. 53. There is also the issue of how services currently recognised through the categories of Housing, First Home Ownership Scheme and Services to Indigenous Communities may continue to be recognised in higher levels of aggregation. While these could be considered under a welfare category, they do not necessarily share a strong functional fit with other welfare services. However, apart from Housing, the other services are unlikely to be material to consider for separate assessment. Law and Order 54. Tasmania s preliminary consideration is that Law and Order could be disaggregated as follows: Law and Order (recognising functions such as Police, Administration of Justice and Corrective Services) Public Safety 55. There is a conceptual case for an aggregated category that recognises services currently recognised in the categories of Police, Administration of Justice and Corrective Services. This is because there appears to be a reasonable level of commonality in the key drivers (primarily SDC) of the current assessments that could be reflected in an aggregated category. 56. However, services currently recognised in the Public Safety category appear more problematic as the key driver of this category is much different to the other law and order type of services (ie it is based more on physical characteristics rather than demographic ones). Other 57. Tasmania s preliminary consideration is that the Other block of services could be disaggregated as follows: Economic Activities Transport (recognising functions such as Roads, Non-urban Transport and Urban Transit) Other (recognising functions such as Electricity and Gas; Water, Sanitation and Protection of the Environment; Primary Industries; Mining, Fuel and Energy; Tourism; Manufacturing and Other Industry; and Subsidies)

10 10 Recreation (recognising functions such as Culture and Recreation and National Parks and Wildlife Services) Other (recognising functions such as Superannuation, GST Administration Costs, General Public Services, Debt Charges, Depreciation and User Charges). 58. It would seem logical to start with a block of services currently considered to fall under the broad heading of Economic Activities. The case for further disaggregation under this heading is then relatively strong for transport services to be separately identified (which would recognise services under the existing categories of Roads, Non-urban Transport and Urban Transit) from the more industry assistance/regulation type services. Again there are potential difficulties in how the key drivers of the existing categories would continue to be recognised in a combined broader category (ie the drivers of the Roads category are based more on physical factors compared to Non-urban Transport and Urban Transit which are based more on demographic factors). 59. Disaggregation of the suggested Other block of services could include a category to recognise the current assessments for Culture and Recreation and National Parks and Wildlife Services. It is difficult to see how these could fit with economic activities. 60. There would appear to be a need for a residual category to capture expenditure on items that reflect general administration costs. There could be a case for including recognition of some other assessments in this residual category, such as the First Home Ownership Scheme. How user charges might be aggregated into such a broad category is problematic, and they may have to remain separate. Alternatively, it may be possible to reflect the impact of user charges in the relevant expenditure category assessments (ie Hospital Patient Fees may be able to be reflected in Inpatient Services). REVENUE ASSESSMENTS 61. Tasmania endorses the proposed continuation of the category based tax-type approach to revenue assessments because of the ease of explanation and ready availability of data rationales noted by the Commission. However, Tasmania also considers that this approach is justified more fundamentally because it is closer to what states do. That is, to the extent that it is consistent with the way that tax revenues are actually raised it builds in some intrinsic reality checks. A measure of this is that, in general, revenue assessments are considered robust. 62. The Commission is proposing to start from an aggregate revenue structure and then break this down according to the general principles and steps as outlined for expenditure disaggregation. Pragmatically, however, Tasmania considers that it would not be surprising to find at the end of this process that many of the existing revenue categories remain relatively unchanged or that only small amounts of aggregation are made.

11 It is difficult to conceptualise mixes of pay-roll tax, land tax, gaming taxes, transactions taxes and mining revenue that could appropriately be combined and assessed using broader/sub-global indicators. This reflects the heterogeneity of these tax bases. In the absence of an appropriate broader indicator to apply to assessing a range of tax bases, the process is then likely to reduce to a choice between assessing individual taxes using targeted individual sub-global indicators or continuing to assess them on the existing basis (typically legal incidence) subject perhaps to some minor materiality adjustments (eg. determined using the proposed $3 adjustment materiality test). 64. This point is illustrated by reference to the possible disaggregation outlined in paragraph 61 of the Issues Paper. Under this proposal, land tax is categorised as a wealth tax, payroll tax as a tax on wages, mining revenue as a tax on economic rent and the various duties as taxes on transactions. That is, relative to the expenditure side, there are more limited functional starting points. Transactions taxes provide the clearest example, but even within this it may be problematic to derive a single appropriate broader indicator given the disparate nature of the transactions bases. Gaming tax is categorised as either a tax on wages or tax on economic rent. It is difficult to think of a sub global measure that will provide both an appropriate indicator of states relative capacities to raise revenue from their mineral bases (an essentially random result of natural physical endowments) and to raise revenue from gaming activity (more reflective of demographic characteristics). 65. At this point in time Tasmania has no alternative revenue disaggregation approach to put forward. CONCLUSION 66. It is likely that a number of potential category structures could be justified on conceptual, materiality and reliability grounds. Tasmania acknowledges this and, therefore, it is important to reiterate that Tasmania is not fixed to the above preliminary views on expense and revenue category structures. Rather, Tasmania is open to debate over whether, in the combined interests of simplicity and HFE, more or less aggregation is required, or other assessment structures provide a better outcome. 67. The final structure that is chosen will require the use of judgement by the Commission, with guidance from states, to determine the most logical and practical structure to use.