T H E GRANTS COMMISSION’S RELATIVITIES PROPOSALS: A COMMENT

RUSSELL MATHEWS

Centre for Research on Federal Financial Relations, The Austrulian National University

In their interesting paper (1983) on the effects on State economies of adopting the tax sharing relativities assessed by the Commonwealth Grants Commission in its recent reports (1981; 1982). J.R. Madden, D.W. Challen and A.J. Hagger reach a number of conclusions about the effects which acceptance of what they call the Commission’s recommendations would have had on output and employment in the six States. In particular, the authors suggest that if changes had been made in tax sharing relativit ies (so-called S t a t e factors) in response to the Commission’s ‘recommendations’, there would have been serious reductions in output and employment in Tasmania and, to a lesser extent, Western Australia and South Australia; and that although Queensland would have made significant gains in output and employment the effects in New South Wales and Victoria would have been minimal.

The first thing that should be said about the authors’study is that they are in error in asserting that the Grants Commission made recommendations about changes in State factors in either its 1981 or its 1982 report. In response to the specific reference whereby it was required to report on whether a change in the State factors was desirable, it concluded in both reports that a change was desirable. In each report, the Commission then presented assessments for State factors which it said would give effect to the principle of fiscal equalisation which, subject to some qualifications, was specified in the Commission’s terms of reference as the principle on which its assessments should be based. In neither report did the Commission make recommendations of any kind.

The Commission was not merely being coy or pedantic in presenting its conclusions in the form of assessments rather than as recommendations. This is because it recognised that any decisions which might be taken as a result of its inquiries and reports would necessarily be political decisions which governments would need to make, having regard to political and economic considerations and all the circumstances of federal financial arrangements including the Commission’s assessments as one element. After indicating why it had declined to incorporate political judgements in its assessments (as it had been urged to do by some States), the Commission in its 1981 report made the following statement: ‘The Commission wishes to add that the question whether its assessments are to be adopted, and if so the manner and timing of the implementation of the assessments, appear to it to be essentially political matters for decision by the Commonwealth after consultation with the States’ (1981, p. 293).

I w.5 G R A N T S (:OMMISSION - A <:OMMENT L' I 5

Nevertheless, the Commission referred in both reports to a number of proposals which had been made during the inquiries, whereby its assessments could be implemented. These included:

(a) increasing the total amount of tax sharing entitlements of the States so as to ensure that no State would receive less in money terms than under the previous relativities;

(b) providing a guarantee that no State would receive a smaller gran t in ensuing

(c) giving interim relief to States shown to be disadvantaged by a failure to adopt the

(d) phasing in the operation of the new factors over a period of time in anticipation of

years than in the year before new factors were adopted;

new factors:

further reviews:

(e) providing for a continuing examination of the matters which influenced the new factors, for example by making provision for annual reviews of State tax sharing relativities.

In its 1982 Report, the Commission said that, in the light of the 1981 decisions and a statement by the Commonwealth Government that it had no intention of funding the total cost of any adjustment to new relativities, it inferred that 'a gradual phasing in of the new equalisation factors in favour of New South Wales, Victoria and Queensland might be acceptable to Commonwealth and State Governments provided that there was to be no diminution in the existing grants for the other three States whose grants would otherwise be reduced"l982, p. 2111.

The Commission went on to suggest that such phasing in might take place during the three years 1982-83 to 1984-85, during which time a further major review, designed to overcome the time, da ta and methodological shortcomings of the review it had just completed, could be undertaken by the Commission.

The Commonwealth Government announced decisions at the June 1982 Premiers' Conference which purportedly were directed towards a phasing in of new relativities along the lines suggested by the Commission. However, the Commonwealth's failure to make new funds available and the perverse guarantee arrangements which it imposed, whereby the three States assessed as needing increased shares of the tax sharing grants were required to finance guaranteed increases in grants for the three States whose relativities had been assessed as being too favourable, meant that virtually no phasing in will occur over the three-year period'.

At no stage, however, did the Commission imply that increased grants to some States should be financed by reducing grants to other States, the course of action which is assumed by Madden, Challen and Hagger. This was not one of the options listed by the Commission because, politically as well as economically, it was clearly out of the question to expect States such as Tasmania to take cuts in their tax sharinggrants of

'For an elaboration of this point. see Mathems (1983).

216 AllSTRALIAN ECONOMIC PAPERS JIINE:

the order of 20 to 25 per cent, as would have been required if the Commission’s assessments of State factors had been adopted.

The Madden, Challen and Hagger study was thus directed to an irrelevant question. I t would have been more productive, and more relevant to the task of achieving long- term stability in federal fiscal arrangements, if they had used their model to examine the effects of implementing one or more of the options which were actually listed by the Commission, in particular the suggestions that the total amount of tax sharing grants could be increased and that new relativities could be phased in over a period without making any State worse off in absolute terms. Since 1981 and 1982 were years of heavy unemployment and since the Commonwealth had arbitrarily reduced the increase in tax sharing grants in 1981-82 from the growth of over 16 per cent which would have applied under the old tax sharing arrangements to 9 per cent, the possibility wasopen for new relativities to be phased in without making either the Commonwealth or any State worse off in absolute terms.

Even if the authors’ analysis is accepted on the basis of the question they actually asked rather than the questions they should have asked, their results and conclusions must be regarded as highly suspect and subject to many qualifications and limitations, only some of which they recognise in their paper. This is only partly a reflection of the limitations which are inherent in the use of any econometric model as a result of the numerous asumptions which are built into the model: or of the data deficiencies which the authors have noted, in particular the use of the 1974-75 input - output table of the Australian Bureau of Statistics (as the most recent available) as the basis for determining the effects of changes in government expenditure on industry output and employment by States. The results of the analysis also depend heavily on the particular restrictive and unrealistic assumptions made by the authors for the purpose of their study. These include: first, an assumption that State governments would respond to changes in State factors and in tax sharing grants only by adjusting expenditures, without altering State taxes or State deficits: second, assumptions that there would be no change in government overseas current expenditure, State defence expenditure or expenditure on services involving amountsof $0.5million or less in 1974-75, but that 19 major categories of government services in 1982-83 would all be adjusted in proportion to 1981-82 expenditures; and third, a specification that no account need be taken of the extent to which expenditures in those categories (which included such categories as services to agriculture, education, health and welfare services) were financed by specific purpose grants rather than by tax sharing grants.

I t is simply not plausible to expect that State governments would have responded to reductions in general revenue grants only by reducing all major expenditures in a uniform manner. To suggest that they would do so is to ignore all the imperatives and constraints of State budgetary processes as well as the recent evidence of innovative State revenue measures and deficit financing. Yet the effects on a State’s output and employment would obviously differ substantially depending on whether it maintained its recurrent expenditures by increasing taxes? and charges, maintained recurrent

‘The three States for which the Commission assessed lower tax sharing relativities than were currently in force were all assessed as making tax efforts below the level of the six-state average as \veil as providing services about the level of the six-state average (Mathe\vs. 1WL 11. 32).

19x5 GRANTS COMMISSION - A COMMENT 217

expenditures by various devices for financing recurrent deficits which States have been using in recent years (including the use of capital funds and new forms of borrowing or leasing), or even varied the pattern of expenditures while reducing their level overall.

In this paper I have said nothing about efficiency aspects of fiscal equalisation arrangements. The authors properly point out that their results are short-run in character. However, if some States are to continue to be over-equalised and others under-equalised so as to maintain existing patterns of output and employment, the implications for the efficiency and growth of the Australian economy overall would seem to be similar to those that flow from the excessive use of tariffs and other forms of selective industry assistance.

While it is undoubtedly true, as the authors conclude, that agiven loss of jobs means a higher percentage change in unemployment for a small State than for a State with a larger work-force, it cannot be inferred from this that an unemployed person in a large State, say a steel-worker in Newcastle, is somehow better off than a person who loses his job in Tasmania. If Commonwealth grants are to be used to resolve problems of regional unemployment and recession, the appropriate instrument is the same whether those problems affect whole States or parts of States. The grants should take the form of specific purpose grants and not tax sharinggrants distributed in a manner which ignores the fiscal needs of different States as systematically determined by reference to their relative revenue-raising capacities and costs of providing comparable services.

In the face of all these limitations, it must be concluded that, interesting as the authors’ analysis may be, it does not provide a satisfactory basis for policy conclusions relating to the distribution of tax sharing grants. If, as the authors suggest, their study had a dramatic impact on the deliberations of the June 1982 Premiers’ Conference and was ‘an important factor (perhaps the decisive factor) in the considerably more favourable treatment received by the smaller States’, the Premiers seem to have been badly informed and they would have done well to consider the other options listed in the Commission’s reports.

First version received 20th June, 1984 Final version accepted 22nd October, 1985

[Edi tors]

REFERENCES Commonwealth Grants Commission, Report on State Tax Sharing Entitlements 1981, Volume I -

Commonwealth Grants Commission, Report on State Tax Sharing and Health Grants 1982,

J.R. Madden, D.W. Challen and A.J. Hagger, (1983) “The Grants Commission’s Relativities

Russell Mathews. (1983), “Federalism in Retreat: The Abandonment of Tax Sharing and Fiscal

Main Report, A.G.P.S., Canberra, 1981.

Volume I - Main Report, A.G.P.S., Canberra, 1982.

Proposals: Effects on the State Economies”, Australian Economic Papers, vol. 22.

Equalisation”, Economic Papers, vol. 2.