The basic premise of Horizontal Fiscal Equalisation — fiscal equality in the Australian federation — has broad support from all levels of government.
The current practice of HFE seeks to give all States the same fiscal capacity to deliver public services. To do this, all States are brought up to the fiscal capacity of the fiscally strongest State (currently, as assessed by the Commonwealth Grants Commission (CGC), Western Australia).
This approach to HFE is under intense scrutiny at present as Western Australia’s share of the GST has fallen to a record low. Even so, the current system of HFE has strengths.
It compensates States for their structural disadvantages and achieves an almost complete degree of fiscal equalisation — unique among OECD countries.
The independent and expert CGC is well placed to recommend GST relativities. It has well-established processes that involve consultation and regular methodology reviews.
But the current approach also has significant weaknesses. Reform and development opportunities are likely being missed at the expense of community wellbeing over time.
There is much scope for the system to discourage State policy for major tax reform and desirable mineral and energy policies (royalties and development).
Full fiscal equalisation does not systematically allow States to retain the dividends of their policy efforts. This raises concerns about the fairness of equalisation outcomes and corrodes public confidence in the system.
The system is very poorly understood by the public and indeed by most within government — lending itself to a myriad of myths and confused accountability.
While equity should remain at the heart of HFE, there is a need for a better balance between equity and efficiency.