ISSUES IN PUBLIC FINANCE

ISSUES IN PUBLIC FINANCE 2002-03 Budget Paper No. 6

TABLE OF CONTENTS 1. Commonwealth Grants Commission 2002 Update of Relativities 1 2. Commonwealth Grants Commission 2004 Review of Relativities 11 3. 2002 Ministerial Council Meeting 19 4. Specific Purpose Payments 35 5. Working for Outcomes 41 6. Public Private Partnerships 61 Appendix: Public Private Partnerships: Key Policy Issues 66 7. National Competition Policy 67 8. Government Owned Corporations 73 9. Insurance 81 10. Superannuation 87 11. Comparisons of Territory and State Taxes, Charges and Mining Revenue 93 Appendix: Northern Territory Tax Rates Compared with States 116 In this book, the term State or States includes the Australian Capital Territory and the Northern Territory, unless the context indicates otherwise. i

Chapter 1 COMMONWEALTH GRANTS COMMISSION 2002 UPDATE OF RELATIVITIES OVERVIEW The Commonwealth Grants Commission is a statutory authority and its primary role is to recommend the distribution of untied Commonwealth financial assistance between the States and Territories. Each State s Commonwealth financial assistance requirement is determined in accordance with the principles of horizontal fiscal equalisation and in line with the Commission s Terms of Reference which is agreed by Australian governments. The definition of horizontal fiscal equalisation, as applied in Australia, is that State and Territory Governments should receive funding from the Commonwealth such that, if each made the same effort to raise revenue from its own sources and operated at the same level of efficiency, each would have the capacity to provide services at the same standard. The Commission s recommendations are expressed in terms of per capita relativities (or per capita grant shares) for each State. The Terms of Reference for the 2002 Update required the Commission to assess two sets of relativities for all States; a set for use in distributing the pool of Goods and Services Tax (GST) revenue in 2002-03, and a second set for the distribution of a notional Financial Assistance Grant (FAG) pool that would have existed in 2002-03 had the Commonwealth s 2000 tax reform not occurred. The two sets of relativities are required in order to calculate the level of Budget Balancing Assistance necessary to ensure no jurisdiction is worse off as a result of the introduction of the GST and associated reforms. In the 2002 Update, both the Territory s FAG Relativity and GST Relativity increased substantially when compared to the respective 2001 relativities. If the 2002 Update FAG and GST Relativities had been applied to the respective 2001-02 pools, the Territory would have received the following funding increases: a $76.1 million increase in the Territory s share of the 2001-02 FAGs pool; and a $78.0 million increase in the Territory s share of the 2001-02 GST revenue pool. The increase in the Territory s share of the GST revenue pool is larger than the increase in its share of the notional FAGs pool, even though the Territory s GST Relativity is lower, due to the greater size of the GST revenue pool. The GST revenue pool is larger as it includes the capacity to: abolish revenue replacement payments; remove various State taxes (tourism marketing duty, financial institutions duty and stamp duty on quoted marketable securities); reduce gambling taxes; and finance increases in expenditure obligations (GST administration costs and first home owner assistance). As the size of the grant pool increases, relativities tend toward one; therefore the Territory s GST Relativity is lower than its assessed FAG Relativity. As the Territory will still be receiving Budget Balancing Assistance in 2002-03, this means its FAG Relativity (+$76.1 million) will apply to the Territory s funds in 2002-03. 1

Issues in Public Finance BACKGROUND The fiscal responsibilities of Australian governments under the national tax reforms are delineated in the Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations (Intergovernmental Agreement). The terms of the Intergovernmental Agreement require the Commonwealth to pass on all GST revenues to the States. GST revenues are to be distributed between States on the basis of horizontal fiscal equalisation. These provisions require the calculation of relativities by the Commonwealth Grants Commission. As required, in the 2002 Update the Commission prepared FAG Relativities for the distribution of a notional Financial Assistance Grants pool and GST Relativities for the distribution of the 2002-03 GST revenue pool. Both sets of relativities are assessed in line with the Intergovernmental Agreement. A key feature of the Intergovernmental Agreement was the Commonwealth s guarantee that no State would be worse off as a result of tax reform. This requires the provision of Budget Balancing Assistance by the Commonwealth where GST revenues are not sufficient to compensate the States for the loss of previously existing revenue sources in the initial years after the introduction of the tax reforms. Together, a State s share of the GST revenue pool plus its Budget Balancing Assistance equates to what is termed its Guaranteed Minimum Amount. Current Commonwealth estimates indicate that the GST revenue shares for all States will be less than their Guaranteed Minimum Amounts in 2002-03, that is, States would be worse off under tax reform without the Commonwealth s guarantee arrangements and Budget Balancing Assistance. As the Guaranteed Minimum Amount takes into consideration, amongst other things, revenues forgone including Financial Assistance Grants, it is FAG Relativities and not GST Relativities which determine the distribution of untied funding in 2002-03. As such, the 2002 Update Report primarily concentrates on FAG Relativities and the main factors affecting the FAG Relativities. The Commission calculates relativities by use of a five-year moving average process. Each annual update involves the progression of the assessment period forward one year. Therefore, the calculation of 2002 Update Relativities required the replacement of 1995-96 financial data with 2000-01 data. The assessment period for the 2002 Update is 1996-97 to 2000-01. In recent years, the Commission has derived financial data necessary to calculate relativities from the Australian Bureau of Statistics (ABS). Under national uniform reporting arrangements, Commonwealth and State financial data has been reported to the ABS on an accruals basis since 1998-99. Changes to ABS and State procedures and functional classification methods have made the compilation of reliable and comparable accruals data for the period 1998-99 to 2000-01 extremely difficult. As a result, the Commission has found it necessary to make substantial adjustments to the ABS accrual data to ensure the integrity of its assessments. 2002 UPDATE RELATIVITIES Following the July 2001 Heads of Treasuries meeting, all States agreed to support a protocol which established a best endeavour cut-off time for identifying technical issues in Update Reports. Accordingly, prior to the Commonwealth Treasurer endorsing the 2002 Update GST and FAG Relativities at Ministerial Council (see Chapter 3), technical issues (errors) were identified by two States as well as the Commission and revisions were subsequently made to States relativities. As such, the final relativities for the 2002 Update, detailed in Table 1.1, differ from the relativities published in the Commission s report. 2

Commonwealth Grants Commission 2002 Update of Relativities TABLE 1.1: 2002 UPDATE RELATIVITIES FAG Relativities GST Relativities New South Wales 0.86037 0.90631 Victoria 0.83401 0.86824 Queensland 1.04008 1.01174 Western Australia 0.92858 0.97592 South Australia 1.29035 1.19447 Tasmania 1.75186 1.55419 Australian Capital Territory 1.20906 1.15216 Northern Territory 5.22670 4.24484 Australia 1.00000 1.00000 Source: Addendum to the Commonwealth Grants Commission 2002 Update Report Why FAG and GST Relativities Differ The Commission applies the same methodology in assessing the FAG and GST Relativities. However, the two sets of relativities are not comparable because they are based on a different mix of expenditure and revenue responsibilities and apply to a different pool of funds for distribution. The FAG Relativities are applied to the hypothetical FAG pool and are used to derive the level of Commonwealth funding that would have existed in 2002-03 had tax reform not occurred. FAG Relativities are assessed on the basis of State revenue sources and expenditure responsibilities prior to tax reform. The GST Relativities are applied to the estimated 2002-03 GST revenue pool. These relativities are calculated on the basis of State revenue sources and expenditure responsibilities that apply in 2002-03 as determined by the terms of the Intergovernmental Agreement. In line with the guarantee arrangements of the Intergovernmental Agreement, FAG Relativities are used to derive the Guaranteed Minimum Amount that States are to receive during the transitional period of tax reform. Therefore, FAG Relativities are more relevant than GST Relativities while the Territory continues to receive transitional Budget Balancing Assistance. This will continue while the Territory s share of the GST revenue pool remains less than its Guaranteed Minimum Amount. Each State will move away from guarantee arrangements at different times. Current estimates indicate that the 2002-03 GST revenue pool will be approximately $1.74 billion less than the Guaranteed Minimum Amount for all States. Based on current estimates, the Territory will be better off under tax reform in 2003-04. This is because the Territory s share of the GST revenue pool is expected to exceed its Guaranteed Minimum Amount in 2003-04. As each State becomes better off under tax reform, focus will move to the GST Relativities and greater importance will be placed on having access to timely and accurate GST revenue estimates. For many States, Commonwealth untied funding, in particular GST revenues, represents the largest single source of revenue for State Budgets. Based on current estimates, GST revenue is likely to represent as much as 50 per cent of all revenue received by the Territory. In order for the Territory to make fully informed financial management decisions and prepare responsible and sound budget and forward estimates in the future, it will be critical for GST revenue estimates to be of a high level of integrity. The Commonwealth currently releases initial GST revenue estimates for the budget year when it hands down the Commonwealth Budget, generally in May. Revisions to these 3

Issues in Public Finance estimates are subsequently published when the Commonwealth Treasurer presents the Mid-Year Economic and Fiscal Outlook. This is usually in November although it can be as early as October of the budget year. For those States that bring down their budgets at the same time or earlier in the year than the Commonwealth, not having access to budget year GST revenue estimates will severely inhibit the preparation of reliable budget and forward estimates. Ongoing monitoring of financial conditions will also be difficult if the frequency of revised GST revenue estimates does not improve. In addition, because the current tax regime is still in its infancy, uncertainty surrounding funding estimates from year to year will make it difficult for States to plan in the medium term. A paper is currently being prepared detailing States needs in relation to the provision of GST revenue data and access to this data. Accessibility to timely and accurate GST revenue estimates will become more important as the Territory exits the transitional period. FAG Relativities As with the 2001 Update, the Commission s Terms of Reference required it to consider relevant provisions of the Intergovernmental Agreement when calculating the 2002 Update Relativities. Table 1.2 contrasts 2001 and 2002 Update FAG Relativities and the associated redistribution of grants if 2002 Update Relativities were applied to the 2001-02 notional FAGs and Health Care Grants (HCG) pool. TABLE 1.2: 2002 UPDATE: FAG RELATIVITIES 2001 Update 2002 Update Redistribution ($M) New South Wales 0.88284 0.86037-193.2 Victoria 0.84543 0.83401-73.2 Queensland 1.01882 1.04008 99.9 Western Australia 0.92429 0.92858 10.5 South Australia 1.27328 1.29035 32.8 Tasmania 1.68695 1.75186 39.4 Australian Capital Territory 1.18924 1.20906 7.9 Northern Territory 4.93364 5.22670 76.1 Australia 1.00000 1.00000 0.0 Source: Commonwealth Grants Commission 2002 Update Report and Addendum to the 2002 Update Report As Table 1.2 illustrates, the Territory s share of the 2001-02 notional FAG/HCG pool would have increased by $76.1 million if 2002 Update Relativities had been applied. The reasons for this are explained below. Note: The analysis below is based on FAG Relativities presented in the 2002 Update Report and not those presented in the Addendum to the 2002 Report. Any differences are minor. EXPENDITURE NEEDS The principle of horizontal fiscal equalisation dictates that each State should be afforded the fiscal capacity to provide uniform service standards subject to certain provisions. Therefore, in calculating relativities, the Commission determines the per capita expenditure levels each State needs to incur in order to achieve a national average service level. The Commission s assessed expenditure levels diverge between States because of relative differences in expenditure needs. Expenditure needs are the result of factors that influence the costs of, and demand for, services. 4

Commonwealth Grants Commission 2002 Update of Relativities The Territory has considerable expenditure needs, primarily because of its small and widely dispersed population, the unique composition of its population, its harsh physical environment and its relative isolation from Australia s main population centres. The combined influence of these factors determines the Territory would incur overall expenditure 2.4 times the national average in order to achieve a national average service standard. In general, a decline in assessed expenditure needs results in a reduction in the Commonwealth financial assistance requirement and a decrease in a State s share of the FAGs pool. Main Changes in 2002 Update The Territory s assessed expenditure needs declined marginally for the 2002 Update resulting in a net $0.1 million decrease in the Territory s notional Financial Assistance Grants. Decreases in assessed Debt and Depreciation, Public Safety and Emergency Services and some Education category expenditure needs, together with a significant decrease in the Community Health assessment, were partially offset by increases in Administration of Justice and Hospital-related expenditure needs. Table 1.3 illustrates the expenditure functions that experienced the largest changes in assessed expenditure needs. It also shows the associated impact on the Territory s share of notional Financial Assistance Grants from replacing the 2001 Update FAG Relativities with those from the 2002 Update. TABLE 1.3: 2002 UPDATE: ASSESSED EXPENDITURE NEEDS Redistribution ($M) Debt Charges -1.8 Depreciation -1.0 Public Safety and Emergency Services -2.0 Education* -1.1 Community Health -5.9 Hospitals 2.2 Administration of Justice 12.6 Other -3.1 Total -0.1 * Includes Preschool Education, Government Secondary Education and Vocational Education and Training Source: Commonwealth Grants Commission 2002 Update Report The primary causes of variations to assessed expenditure needs are changes in demand patterns, service delivery costs and population characteristics within States. A discussion of the expenditure categories listed in Table 1.3 follows. Debt Charges In the 2002 Update, the Territory s need for debt was assessed to have decreased due to: changes in the depreciation disability factors, which are given a weight of 75 per cent within the disabilities for the Debt Charges category, in particular the construction cost factor which reflected a below average increase in construction costs in the Territory relative to the larger States; and changes in recurrent expenditure disability factors, which receive a weight of 25 per cent in the Debt Charges assessment. The cost of services in the Territory remained relatively constant. 5

Issues in Public Finance Depreciation The Territory was assessed as having a reduced cost of service provision in the Depreciation assessment due to the updating of construction cost factors for buildings, other construction and housing components. This resulted in an increase in grants for NSW and Victoria and a decrease for other jurisdictions, reflecting the continuation of above average increases in cons truction costs in NSW and Victoria as well as increased demand for capital expenditure in these States. Public Safety and Emergency Services Revisions were made to the fire insurance claims data, which is used by the Commission as an indication of the level of fire damage in each State in assessing fire brigade expenditure. The Territory was assessed as having a below average incidence of fire damage leading to a decline in its assessed cost of service provision for public safety and emergency services. This resulted in a reduction to the Territory s notional grant share. Education The Territory s cost of service provision for the Preschool Education, Government Secondary Education, Vocational Education and Training, and Higher Education assessments declined due to changes in the input costs and isolation factors and declining share of interstate students, particularly for vocational education and training. Smaller input costs and isolation factors and a declining share of interstate students, particularly for vocational education and training, all contributed to a decrease in the Territory s assessed expenditure need for each of these categories. Community Health The Territory s cost of service provision for the Community Health assessment decreased resulting in a redistribution of notional grants away from the Territory. This occurred primarily due to the updating of General Practitioner (GP) data used in the calculation of the economic environment factor. The number of GPs in different Regional, Remote and Metropolitan Area (RRMA) classified regions is used as a proxy for private health services in these regions. The updated data reflected an increase in private health services in rural and remote areas while such services in capital cities and metropolitan centres remained constant. The increase in rural and remote area services resulted in a relatively lower weighting being applied to those population areas in the economic environment factor. As the Territory has an above average proportion of its population living in rural and remote areas, it was negatively affected by this change. Expenditure needs were assessed as being lower due to the implied improvement in private health services in the rural and remote areas. Hospitals The negative impact of the Community Health assessment (refer above) on the Territory s share of notional grants was partially offset by an increase in the cost of service provision for the Hospital assessment. This resulted in an increase in the Territory s notional grant share. The increased expenditure needs in the Territory for hospitals was mainly due to a shift in the patterns of use of hospital services across Australia. This shift gave an emphasis to population sub-groups that are higher users of hospital services or cost more to treat, such as the old, young or those residing in non-metropolitan areas. As a result, the Territory experienced an above average increase in demand for inpatient hospital services while most other States experienced a fall in demand leading to an increase in assessed expenditure needs. 6

Commonwealth Grants Commission 2002 Update of Relativities Administration of Justice Revisions made to the Administration of Justice assessment in the 2002 Update also led to a significant increase in the Territory s notional grant share. The revisions came about due to the correction of an error in the calculation of one of the category s main factors (socio-demographic composition). Due to this error, the use of court services by Indigenous people in remote areas was underestimated. As the Territory has a relatively higher Indigenous population, with an above average proportion of this population residing in remote areas, this correction benefited the Territory more than any other State. REVENUE NEEDS The Commission calculates relativities on the basis that each State makes an average effort to derive revenues from State tax bases. However, assessed per capita revenue collections vary between the States because of differences in revenue needs. Revenue needs are a result of factors that influence each State s capacity to generate revenue from its own sources. These factors include differences between States in natural resource endowments and the divergent structure of State economies. Revenue capacity refers to potential revenue collections the Commission considers a State could achieve if national average tax rates are applied to available revenue bases. Revenue capacity and effort are discussed in detail in Chapter 11, Territory Own-Source Revenue. States with a greater capacity to generate revenue from its own sources have less of a revenue need than those with a lower capacity to generate own-source revenues and, as such, are assessed as having relatively higher per capita revenue collections. States with relatively higher per capita revenue collections require less Commonwealth assistance. The Territory experienced robust population growth and strong economic performance in the late 1990s generating significant growth in employment, investment and property market values. This resulted in a reduction of the Territory s grant share in earlier Updates. In recent years, however, the Territory s performance has been less robust, particularly when compared with other jurisdictions, such that the Territory s own-source revenue needs have increased. Table 1.4 indicates the revenue sources, assessed for the 2002 Update, that have resulted in significant changes to the Territory s share of the 2002-03 notional FAGs pool. TABLE 1.4: 2002 UPDATE: ASSESSED REVENUE NEEDS Redistribution ($M) Mining Revenue 9.0 Stamp Duty on Conveyances 2.4 Financial Transaction Taxes 1.7 Pay-roll Tax -7.5 Land Revenue -1.0 Other -2.9 Total 1.7 Source: Commonwealth Grants Commission 2002 Update Report Following is a discussion of the revenue assessment categories and factors that have led to a slight increase in the Territory s share of notional Financial Assistance Grants in the 2002 Update. Mining Revenue The main contributor to the Territory s increased revenue needs assessment, in the 2002 Update, related to mining. Due to the rapid growth of offshore petroleum production in 7

Issues in Public Finance recent years, the Commission concluded the estimation calculation for offshore petroleum and gas adjustments, used in previous Updates for determining each State s Mining revenue base, was inappropriate. A change in the way the Commission calculates the offshore petroleum and gas adjustments resulted in the Territory being assessed as having a lower mining revenue capacity. Pay-Roll Tax Conversely, the Commission assessed the Territory as having a higher capacity to raise revenues from pay-roll tax. This was due to: the Territory experiencing above average increases in wages and salaries paid between 1995-96 and 2000-01, particularly for medium to large employers in the private sector; the correction of 1997-98 data for gross earnings in the less than 20 employee range, leading to a reduction in the proportion of earnings paid by private employers with 20 or more employees for that year; and revisions to the ABS estimated compensation of employees data. The overall effect was an increase in the Territory s assessed revenue base and therefore a decrease in its notional grant share. Land Revenue Although the Territory does not levy land tax, land tax is considered a standard State revenue source by the Commission. The Territory is therefore assessed as having the capacity to generate revenue from land tax. Table 1.4 highlights the $1 million decrease in the Territory s grant share in 2002-03 due to the Land Revenue assessment. The reduced grant share is explained by the increase in th e Territory s assessed revenue capacity, resulting from its faster growing revenue base (that is, land values) relative to other States. SPECIFIC PURPOSE PAYMENTS (SPPS) Shifts in the distribution of SPPs over the assessment period (1995-96 to 2000-01) have had an impact on the Territory s relativities and resulted in an increase in its grant share of $7.4 million. The main reason for this increase is a reduction in the Territory s relative share of SPPs for Aboriginal Purposes which resulted in a lower SPP revenue assessment, leading to an increase in the Territory s grant share of $5.4 million. FINANCIAL STANDARDS Changes to the financial standards in the 2002 Update resulted in a significant increase in the Territory s share of the notional FAGs pool of $69.3 million. As previously stated, the Commission calculates relativities by use of a five-year moving average assessment period. This means the relativities applied to the FAGs pool in any given year are the average of the previous five annual update relativities. Therefore, the data used for the calculation of relativities is updated annually to include the most recent year s data and to exclude the earliest year s data. For the 2002 Update, this required the substitution of 2000-01 data for 1995-96 data (the assessment period for the 2002 Update is 1996-97 to 2000-01). In addition, the data used for the calculation of relativities may differ between updates due to revisions undertaken, when more accurate data becomes available or when actual data becomes available to replace previous estimates. 8

Commonwealth Grants Commission 2002 Update of Relativities Progression of the assessment period to include 2000-01 resulted in a $51.2 million increase in the Territory s share of the FAGs pool while revisions to financial data resulted in an increase of $18.1 million. The increase in the Territory s grant share as a result of the progression of the assessment period occurred in those categories for which expenditures and revenues have increased significantly since 1995-96 and in which the Territory has a relatively higher cost of service provision or a relatively lower revenue raising capacity. Categories where changes to financial standards have had a significant effect on the Territory s share of the estimated 2002-03 FAGs pool are illustrated in Table 1.5. TABLE 1.5: 2002 UPDATE: PROGRESSION OF REVIEW PERIOD Redistribution ($M) Superannuation 14.4 National Parks and Wildlife Services 6.3 Community Health 5.7 Other General Public Services 4.4 Aboriginal Community Services 4.2 Debt Charges -9.2 Other 25.5 Total 51.3 Source: Commonwealth Grants Commission 2002 Update Report The Superannuation standard has increased between 1995-96 and 2000-01 due to the shift to accrual-based standards and the inclusion of unfunded liabilities accumulated prior to 1998-99. As the Territory is assessed as having a relatively high cost of service provision in this category, the increase in the superannuation standard has resulted in an increase in the Territory s grant share of $14.4 million. Similarly, increases in the National Parks and Wildlife Services, Community Health and Aboriginal Community Services standards have resulted in an increase of $16.2 million in the Territory s share of the notional FAGs pool. These increases were partially offset by the reduction in the Debt Charges standard. Many States, particularly the larger ones, have actively repaid large amounts of debt leading to a fall in the Debt Charges standard. As the Territory is assessed as having a relatively higher cost of service provision for debt charges, the fall in the Debt Charges standard implies a lower expenditure need, leading to a reduction in the Territory s notional grant share. OVERALL OUTCOMES The net result for the Territory in the 2002 Update was an increase in its FAG Relativity when compared to 2001, increasing the Territory s dollar redistribution by $76.1 million. This increased grant share is a result of changes to financial standards ($69.3 million), SPPs ($7.4 million) and revenue capacities ($1.7 million) which more than offset the influence of the decline in assessed expenditure needs (-$0.1 million). The overall change in FAG Relativities and subsequent grant share effects for the other States are detailed in Table 1.2. 9

Issues in Public Finance GST Relativities GST Relativities mirror the provisions of the Intergovernmental Agreement, thus reflecting changes in expenditure and revenue responsibilities as a result of tax reform. Table 1.6 contrasts the 2001 and 2002 Update GST Relativities. It also shows the associated redistribution of grants if the revised 2002 Update Relativities were applied to the notional 2001-02 GST revenue pool. TABLE 1.6: 2002 UPDATE: GST REL ATIVITIES 2001 Update 2002 Update Redistribution ($M) New South Wales 0.92032 0.90631-162.0 Victoria 0.87539 0.86824-61.6 Queensland 1.00269 1.01174 56.9 Western Australia 0.97516 0.97592 2.5 South Australia 1.17941 1.19447 39.1 Tasmania 1.50095 1.55419 43.6 Australian Capital Territory 1.14633 1.15216 3.4 Northern Territory 4.02166 4.24484 78.0 Australia 1.00000 1.00000 0.0 Source: Commonwealth Grants Commission 2002 Update Report and Addendum to the 2002 Update Report As Table 1.6 illustrates, the Territory s share of the notional 2001-02 GST revenue pool would have increased by approximately $78 million if 2002 Update GST Relativities had been applied. The reasons for the redistribution of grants to the Territory by applying the 2002 Update GST Relativities are essentially the same as for FAG Relativities, adjusting for the effects of tax reform. Overall Outcome As previously discussed, the application of the 2002 Update Relativities to their respective pools will determine: the distribution of the 2002-03 GST revenue pool; and the distribution of the notional FAG pool, which is required to determine the Guaranteed Minimum Amount of funding for each State in 2002-03. At the time of Ministerial Council it was estimated that the sum of revenues and expenditures that the Territory will forgo in 2002-03 (including Financial Assistance Grants) plus the additional expenditure requirements (for exa mple, GST administration costs and First Home Owner Scheme) will total $1 516.5 million. This is $23.8 million greater than the Territory s share of the estimated 2002-03 GST revenue pool ($1 492.7 million). Consequently, the Territory is estimated to receive $23.8 million in Budget Balancing Assistance from the Commonwealth in 2002-03 to guarantee that it is no worse off through the introduction of tax reform. The requirement for Budget Balancing Assistance is explained in detail in Chapter 3. 10

Chapter 2 COMMONWEALTH GRANTS COMMISSION 2004 REVIEW OF RELATIVITIES OVERVIEW The Commonwealth of Australia is regarded as one of the most successful federations in the world. To a very large degree, this success derives from effective intergovernmental financial arrangements, which provide equity and comparative certainty for sub-national governments, the States and Territories. At the centre of these arrangements is the principle of horizontal fiscal equalisation, which is the basis for the distribution of untied Commonwealth assistance to the States. The Commonwealth Grants Commission is a statutory authority and its primary role is to recommend the distribution of untied Commonwealth financial assistance between the States and Territories. Each State s Commonwealth financial assistance requirement is determined in accordance with the principles of horizontal fiscal equalisation and in line with the Commission s Terms of Reference as agreed by Australian governments. The definition of horizontal fiscal equalisation, as applied in Australia, is that State and Territory governments should receive funding from the Commonwealth such that, if each made the same effort to raise revenue from its own sources and operated at the same level of efficiency, each would have the capacity to provide services at the same standard. The Commission s recommendations are expressed in terms of per capita relativities (or per capita grant shares) for each State. The relativities recommended by the Commission are recalculated annually and are based on a five-year assessment period. These annual updates are based on the data for the latest available five years, with data used for the calculation of relativities being updated annually to include the most recent year s data and to exclude the earliest year s data. The methods used to calculate relativities are reviewed every five years, with the last review completed in February 1999 and the current review due for completion by February 2004. It is during a review that changes and/or adjustments can be made to the assessment methods used by the Commission, hence the 2004 Review provides each State with the opportunity to ensure the Commission s assessment methodology takes into account all the relevant issues. Changes made during a review may significantly affect a State s relativity and thus grant share, therefore it is important that the Commission is made aware of all the issues affecting the cost to States of providing the average level of service. 2004 REVIEW OF RELATIVITIES The 2004 Review of Relativities is perhaps the most important of the Commission s recent reviews. It is being undertaken at a time of substantial change in intergovernmental arrangements. The Goods and Services Tax (GST) was introduced on the basis that all GST revenues would be provided to the States, replacing arrangements that had been in existence for decades. One of the centrepieces of the Intergovernmental Agreement on the Reform of Commonwealth State Financial Relations (Intergovernmental Agreement) is that GST revenues are to be distributed according to the principle of fiscal equalisation, as recommended by the Commonwealth Grants Commission. Following that agreement, the Commission was required to produce a method of calculating both GST and Financial 11

Issues in Public Finance Assistance Grants (FAG) Relativities in order to support the guarantee arrangements provided for in the Intergovernmental Agreement. There is considerable likelihood that, before the 2004 Review is complete, at least one State will have moved beyond the guarantee arrangements agreed in 1999. For further detail regarding the Intergovernmental Agreement and guarantee arrangements see Chapter 3. The 2004 Review provides the first opportunity for a comprehensive analysis of the Commission s method since the introduction of tax reform. This comes at a time when there is disquiet amongst some States about fiscal equalisation. It appears arrangements associated with GST revenues are contributing to this concern. However, such a debate is a matter for governments and it is important that in conducting the 2004 Review, the Commission is not placed under undue pressure to conduct its assessments in such a way as to appease those who promote alternatives to equalisation. That is not to say that changes to methods should not be countenanced but the objective of any changes should, first and foremost, be the improvement in equalisation outcomes. The Commission has undertaken considerable preparatory work for the 2004 Review in order to build on the method improvements gained in the 1999 Review, reduce the level of work required by all parties and enhance simplicity and transparency. The Territory supports the Commission in these objectives but has recorded its view that all these objectives should be secondary to the achievement of fiscal equalisation. Calculation of Relativities The starting point in the calculation of relativities is the determination of the scope of State activities to be included in the assessment and their placement into a common framework, known as the standard budget. The transactions included in the standard budget are currently classified into 41 expenditure categories and 18 revenue categories. The financial standard for each category, in each year, is the basis for all the comparisons. Standard revenues and expenditures are Australia-wide averages, that is, average per capita spending or revenue raised by all States in the assessment year. In determining the relative grant share required by each State, the Commission determines the per capita expenditure levels each State needs to incur in order to achieve a national average service level. These assessed expenditure levels diverge between States because of relative differences in expenditure needs. Expenditure needs are the result of factors that influence the costs of, and demands for, services. The primary factors contributing to the Territory s considerable expenditure needs are its small and widely dispersed population, unique population composition, harsh physical environment and relative isolation from Australia s main population centres. In determining relative grant requirements, the Commission also takes into account revenues States could raise from their own sources if they made an average effort to do so. The assessed per capita revenue capacities vary between the States due to differences in revenue needs. Revenue needs are a result of factors that influence each State s capacity to generate revenue from its own sources. These factors include differences between the States in natural resource endowments and the divergent structure of State economies. In addition to a State s capacity to raise revenue from its own sources, the Commission also takes into account the level of tied grant funding (Specific Purpose Payments, see Chapter 4) that each State receives from the Commonwealth. The Territory receives a larger per capita share of Specific Purpose Payments than other States, primarily due to its population demographics. 12

Commonwealth Grants Commission 2004 Review of Relatives MAIN SUBMISSIONS Scope and Structure The Main Submissions of States for the 2004 Review were due on 5 April 2002 and provided the primary opportunity for each State to put its case to the Commission. In the lead up to the Main Submissions, the Commission released a number of discussion papers detailing issues and/or problems with the current methods, identified by the Commission itself and subsequently proposing changes to these methods. The discussion papers were provided to the States to allow them to respond to the Commission s proposed changes, however, they in no way restricted the States from raising their own issues with the methods or proposing changes themselves. State submissions vary significantly in style and content, since the priorities of States differ and each is endeavouring to convince the Commission of the merits of its arguments. The Territory s Main Submission covered a range of factors and expenditure and revenue categories identified as requiring comment. In addition, the Territory made every effort to comment on the issues and proposals raised in the Commission s discussion papers. The key matters included in the Territory s Main Submission are summarised below. The Commission s Discussion Paper 2001/12 Scope and Structure of the Standard Budget outlined various issues and proposals relating to the standard budget, that is, the expenditure and revenue categories that make up the Commission s assessment. On the basis of administrative simplicity and improved transparency, the Territory supported, in principle, the Commission s proposed revisions to the structure of the standard budget to align more closely with data sourced from the Australian Bureau of Statistics Government Finance Statistics (GFS). However, in some critical expenditure areas, the Territory saw compelling reasons why the use of a GFS-based structure was not appropriate, particularly if its use would lead to a diminution of equalisation. Aboriginal Community Services is an expenditure category of considerable importance for the Territory. The Commission s proposal to rely on GFS-based categorisation for its assessment was strongly opposed by the Territory on the basis that needs could either be ignored or not properly captured by the proposed approach. As such, this important expenditure area would be relegated to a minor addition to mainstream assessments. Subject to its comments with respect to the Aboriginal Community Services category, the Territory concluded that the proposed changes to the Concessions and Other Payments categories provided the best opportunity for some time to provide an appropriate assessment of Community Service Obligations. The Territory was strongly supportive of the current level of disaggregation in the standard budget. It noted that while the Commission s move from a cash to an accrual GFS has presented various data problems for all States, these problems are transitional, albeit being experienced over a longer period than desirable or initially envisaged. Thus the Territory argued that the Commission should not consider any reduction in categories because of short-term data shortcomings. The Territory also argued that the standard budget should be as broad as possible to ensure equalisation is not compromised. Any restriction in the scope of equalisation in areas where differential needs exist will mean that States will have to redirect resources from areas which have been equalised, with a net effect of reduced overall capacity and below average services in these areas. As a result, the Territory agreed with the Commission that it might be necessary to broaden the standard budget to include an allowance for capital outlays. Further, it noted the Commission s proposal that the inclusion of expenditure associated with economic development be considered on a case by case basis. Due to its early stage of development 13

Issues in Public Finance and disabilities associated with isolation, small population size and economic environment, the Territory has high needs in this area. General Factors The Commission s expenditure framework involves breaking each category into discrete components, measuring the disabilities for each component, combining them and then adding the combined disabilities for each component to derive the category factor. Following is the Territory s response to arguments and suggestions regarding disability factors raised i n the 2004 Review. The Territory argued that changes in administrative practice including nationally agreed reforms such as National Competition Policy have provided greater benefits to the more populous States with more developed economies and as a result have increased the relative disadvantage of the smaller States, as is evidenced through an increase in scale disabilities. Efficiency measures adopted in the large States are reflected in the weighted standards used by the Commission. It was argued that, to the extent small States cannot take advantage of similar efficiencies, they are disadvantaged if this disability is not recognised. This again is evidenced in the scale factors. The main scale disabilities assessed by the Commission are at the administrative level and recognise that some States are required to expend resources disproportionate to the size of their population. The administrative scale factor consists of a fixed component, which recognises States face a fixed or minimum level of expenditure in providing a standard level of government services, regardless of population size, plus a variable component that includes costs in addition to fixed costs arising because of a State s social and environmental characteristics. As part of the 2004 Review, the Commission has proposed removing the variable component of this assessment. The Territory has strongly opposed this move. The Commission s preliminary position was that because these costs are difficult to measure and thus require judgment, they should not be included. The Territory contended such a position is completely inconsistent with the achievement of equalisation where the use of judgment is essential if small, diverse and dispersed States like the Territory are not to be seriously disadvantaged. The growth of information and communications technology has changed the provision of government services in all States. However, while it is resulting in greater efficiencies in the large, highly urbanised States (thus lowering standard expenditures), in the more remote parts of Australia, the growth of advanced communications technology has been comparatively limited, often requiring capital and operational contributions from State governments. The result is not savings but rather the potential (often not the reality) for standards of service to improve to levels approaching those in urban centres. The effect is a widening of disabilities between States, which must be taken into account if equalisation is to be achieved. The Territory also contended its socio-demographic disabilities are not properly captured in the Commission s methodology. While these issues are generally best considered within specific categories, it was argued the Territory s very different socio-demographic features must be taken into account in a consistent way throughout the assessment. Specific issues raised included: the Territory s population underestimation in intercensal estimates and in respect of the Indigenous population; high levels of intrastate mobility; alcohol and other substance abuse; violence; and poor outcomes for Indigenous Territorians in the key areas of health, education and justice. These disabilities are not always captured in indices, thus requiring the Commission s continued use of judgment. 14

Commonwealth Grants Commission 2004 Review of Relativities These features are far more prevalent in the Territory than in the other States and mean the Territory s priorities and related service delivery disabilities are quantitatively different from other States. The provision of services to people from non-english speaking backgrounds who are socio-economically disadvantaged is a mainstream issue in the Territory. As a result, service delivery and head office disabilities require different consideration in the Territory. Within the Commission s current framework, recognition of these disabilities only provides the capacity to address differential costs associated with the disabilities, not the capacity to provide equal outcomes. The economic environment factor is applied in a limited way but the Territory argued that the lack of private services, facilities and resources means more government services are required in virtually all areas, thus greater consideration of this disability is required. The Territory also recommended other general factors such as input costs, isolation and dispersion be continued but with some minor changes to current methodology. Social Services Categories In education, the Territory argued strongly for the retention of the four category structure (government, non-government, primary, secondary) on the basis that State policy has a negligible effect on the choice of school by parents and the relative proportions of government/non-government enrolments have not changed materially over time. In the health categories, the overwhelming burden of disease in the Indigenous population and the lack of private providers combine to make the Territory s disabilities far higher than other States. The Territory strongly argued that changes are required to the Commission s methods to ensure that these disabilities are reliably assessed. Specifically, it argued that the economic environment factor, premature ageing of Indigenous Territorians, emergence of chronic diseases and greater requirement for research and public health programs all need better recognition in the assessment. Another key issue for the Territory is the Commission s treatment of Primary Health Care Access Program (PHCAP) payments. These are Medical Benefits Scheme (MBS) and Pharmaceutical Benefits Scheme (PBS) replacement payments and the Territory asserted that they require very different consideration and treatment from other Commonwealth Aboriginal and Torres Strait Islander health programs. In fact, the Territory argued that because of the importance of the differential distribution of MBS and PBS payments across the States and the consequential effect on State responsibilities to provide primary health services, equalisation can only be achieved if all of these influences are taken into account. In law and order categories, the Territory raised its concern that, while use rates of Indigenous Territorians are reasonably assessed, the associated cost weights are not adequate and need to be increased. In addition, there has been a significant increase in the number of Commonwealth offenders imprisoned in the Territory and while their larger numbers are taken into account, albeit with a lag, the additional costs associated with this group need to be taken into account. In housing, the demand for public housing in urban and remote localities is growing at an alarming rate. Current levels of stock are inadequate, and overcrowding and social disorder are at levels that result in far higher maintenance costs. The Rawlinson s Index, which is used to identify differences in the cost of construction between the States, is inadequate for the purposes to which it is put by the Commission. The method requires revision with substantial adjustment to Indigenous cost weights. Revenue The Territory generally supported the Commission s revenue assessments. Minor changes were, however, proposed to the Pay-roll Tax, Gambling Taxes and the Financial 15