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Review of Commonwealth-State funding.

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No. 22, 10 December 2002

Review of Commonwealth-State Funding

The Governments of New South Wales, Victoria and Western Australia argue that current Commonwealth-State funding arrangements disadvantage them. Late in 2001, these States commissioned Professor Ross Garnaut1 and Dr Vincent Fitzgerald2 to review these arrangements and recommend changes. The authors' proposals are contained in their final report (the Review), which was issued in August 2002.3 This Research Note examines the proposals and comments on them.


The Commonwealth provides grants to the States in the forms of specific purpose payments (SPPs) (also called 'tied grants') and general purpose payments (GPPs) ('untied grants'). SPPs are payments, generally under section 96 of the Constitution, for purposes such as health and education, on such terms and conditions that the Commonwealth may specify.

The States can spend GPPs as they wish. The main component of GPPs is GST revenue. This is distributed among the states on the basis of the per capita relativities that the Commonwealth Grants Commission (CGC) calculates. The relativities are based on the principle of horizontal fiscal equalisation (HFE), which seeks to ensure that each State has the capacity to provide services at national average levels and at average levels of efficiency.4 NSW, Victoria and WA, the so-called 'donor' States, receive less GST revenue than if it were distributed

on an equal per capita basis, whereas the other ('recipient') States receive more than their per capita share of GST revenue.

Under this model, Commonwealth and State ministers would jointly determine objectives that specify outcomes to be achieved for individuals and households across Australia, and corresponding performance measures. Funding would be allocated according to the distribution across the States of requirements for the services concerned (i.e. primarily demographic factors) …

Equitable Access

At a conceptual level, the Review proposes that the concept of equity among individuals or households should replace the HFE concept of equity of capacity to provide services:

Many SPPs outside health, education and indigenous community development would be discontinued, and the funds rolled into the two national programs administered by the States … SPPs covering cross-border programs such as national roads … would be unaffected.7

The central aim of Australia's system of Commonwealth-State funding should be equitable outcomes for Australian individuals or households.5

Equity among individuals means 'vertical' equity, that is, the redistribution of income from high to low-income individuals. The Review cites a study that indicates that the CGC's methods do not improve vertical equity but may make it worse.6

General Purpose Payments

The proposal with respect to GPPs has two elements. The first element is:

Each State would receive a flat amount calculated to cover the irreducible minimum overhead costs of government.

Specific Purpose Payments

The proposed changes to arrangements for SPPs are:

The second element is:

The centrepiece of the proposed reform is a new cooperative model for SPPs in the key merit areas of health and aged care, and education and training. SPPs in these areas would be broad-banded into two national programs in which the States have clear authority over service delivery, without micromanagement and input controls. A third national program would be established in indigenous community development. The Commonwealth would have primary control over services provided under this program …

Beyond that, the GST pool would be allocated on an equal per capita basis …8


The Review focuses on outcomes and the use of performance indicators to measure how well outcomes are met. The proposals are thus consistent with moves at the Commonwealth level to have agencies focus on outcomes. But it is often difficult to define outcomes and measure performance. For example, both the States and the Commonwealth fund health

services making it difficult to determine the contribution of each to health outcomes.9

The Commonwealth, because of its financial dominance is, to some extent, able to impose its priorities, on the States. By having Commonwealth and State ministers jointly determine priorities, the Review seeks to establish more 'cooperative' arrangements. But given that the Commonwealth has the financial whiphand in negotiations with the States, it is questionable how much would change. Parties of all political persuasions when in power at the Federal level have displayed little reluctance in using the Commonwealth's financial strength to assert their will over the States.

Political considerations may militate against the proposal to broadband education and health and aged care services. The Commonwealth funds a number of specific programs and political parties may wish to continue to be identified with these programs.

Responsibility for some functions, (for example, education and rail transport), is shared among the different tiers of government. This results in overlap of administration and blurred lines of accountability. The proposal that responsibility for service delivery reside with the one tier of government would reduce costs associated with 'buck passing' and the waste of resources associated with grant negotiations. The Review claims that annual administration costs for the CGC and SPPs exceed $150 million.10

Having one tier of government responsible for service delivery could improve accountability because that tier alone would be responsible for meeting outcomes. However, the other tiers of government may find it difficult to resist intervening if they believe that services are delivered inappropriately.

The proposal to allocate SPPs on a 'needs' basis would redistribute income. A question that arises is how need would be defined and measured. But a number of factors would limit redistribution. Trade-offs between equity and efficiency objectives in programs are inevitable. And the proposal to distribute most GST among the States on an equal per capita basis may conflict with the equity objective.

The two elements of the proposal for GPPs entail a trade-off with respect to the distribution of resources among the States. Under the 'minimum cost of government' element, all States would receive the same fixed amount (estimated at $98 million annually) to cover the cost of 'basic infrastructure' needed to operate government. The amount would cover the cost of 'merit goods'—goods and services whose consumption is deemed to be intrinsically desirable—such as law and order.11 This element would redistribute resources from the larger States—which arguably have a high minimum cost of government—to the smaller States. On the other hand, the second element—to distribute most GST revenue on an equal per capita basis—would favour NSW, Victoria and Western Australia.


The Review's proposals reflect the fact that it had to meet the objectives of the three governments that commissioned it. This is evident, for example, in the proposal to distribute most GST revenue on an equal per capita basis.

The proposals are unlikely to be implemented. The Government's position is that it will do nothing to change current arrangements unless the States agree, knowing full well that this is highly unlikely.

That said, the Review nonetheless contains proposals that may be worth consideration. For example,

the proposal to broadband health services has the potential to provide the States and Territories with greater flexibility in service provision.12

1. Ross Garnaut is Professor of Economics at the Australian National University.

2. Dr Fitzgerald is Co-Chairman of the Allen Consulting Group Pty Ltd.

3. Review of Commonwealth- State Funding. Final Report, 30 August 2002. 4. See Richard Webb, 'Horizontal

Fiscal Equalisation', Research Note no. 1, Department of the Parliamentary Library, 2002-03. 5. Review, op. cit., p. 3. 6. ibid., p. 2.

7. ibid., p. 3.

8. ibid., pp. 3-4. 9. See Richard Webb, 'The Commonwealth Budget: Process and Presentation', Research

Paper no. 10, Department of the Parliamentary Library, 2001-02. 10. Review, op. cit., p. 2. 11. The question also arises as to which merit goods to include. 12. Abby Bloom. ed., Health Reform in Australia and New Zealand. Vivian Lin and Cathy King, 2000, 'Intergovernmental Reforms in Public Health'.

Richard Webb Economics, Commerce and Industrial Relations Group Information and Research Services

Views expressed in this Research Note are those of the author and do not necessarily reflect those of the Information and Research Services and are not to be attributed to the Department of the Parliamentary Library. Research Notes provide concise analytical briefings on issues of interest to Senators and Members. As such they may not canvass all of the key issues. Advice on legislation or legal policy issues contained in this paper is provided for use in parliamentary debate and for related parliamentary purposes. This paper is not professional legal opinion.

 Commonwealth of Australia ISSN 1328-8016