GST is collected by businesses at the point of consumption on behalf of the Commonwealth Government, for redistribution to the states and territories (states). GST is an important revenue source for states as it is untied and not linked to the delivery of any specific services or targets, unlike other Commonwealth grants. As such, it provides budgetary flexibility for states. GST makes up a significant proportion of each state’s revenue. In 2020–21, GST comprised 25 per cent of total general government sector revenue for Victoria.
The system for distributing GST among the states is complex. The total GST collected, referred to as the ‘GST pool’, is divided between the states by the Commonwealth, based on advice provided by the Commonwealth Grants Commission (CGC), an independent advisory agency.
Since the introduction of GST, the CGC has been directed to follow the principle of horizontal fiscal equalisation (HFE) to make its annual recommendations on how GST should be distributed to the states. The principle of HFE seeks to balance the differences in each state’s demographic profiles, expense requirements and revenue raising capacities to enable each state to provide a similar standard of services and infrastructure to its residents. Following the principle of HFE, states with the ability to generate higher revenue relative to their expenses should receive less GST, while those that have a limited ability to raise revenue and have higher expenditure needs should receive more GST (CGC 2020).
To determine how much GST each state receives, the CGC assesses each state’s ability to raise its own revenue and its expenditure burden as if each state broadly followed the same policy as all the states. This assessment, based on the average of what all states do, ensures individual states do not alter their policies to gain more GST by, for example, spending more or raising less revenue. In assessing a state’s fiscal capacity, the CGC considers the state’s ability to raise revenue, such as tax and royalty revenues, as well as expenditures on services such as health, justice and school education. The CGC considers eight categories of states’ revenue, eleven expense categories and two capital categories, as well as a further eight disabilities and other assessments.
All categories are then considered together through a complex GST formula, arriving at a ‘GST relativity’ for each jurisdiction. Relativities represent the assessed GST needs of each state compared to the national average. A relativity value of 1.0 indicates a state has the average revenue raising capacity and expenditure burden and will receive its population share of the GST pool. A relativity value greater than 1.0 indicates that a state has a lower fiscal capacity and requires more than its population share of GST income. A relativity value lower than 1.0 indicates that a state has a greater fiscal capacity and requires less than its population share of GST income. The final GST share received by a state is a function of its relativity, population, the total GST pool and specific purpose payments provided by the Commonwealth (CGC 2020).
1.1 The new system of GST
In 2018, the Commonwealth legislated changes to the GST distribution system through the Treasury Laws Amendment (Making Sure Every State and Territory Gets Their Fair Share of GST) Act 2018. The new system revised the equalisation standard for states’ fiscal capacities achieved through the distribution of GST. Prior to this legislation, ‘full’ equalisation was achieved because each state’s fiscal capacity was lifted to the that of the strongest state. This means that states with lower fiscal capacities, greater expenditure needs and lower revenue raising capacity were allocated more GST so that they could provide government services to the same level as the state with the strongest fiscal capacity.
In contrast, the 2018 legislation aims for ‘partial’ equalisation. Specifically, it raises states’ fiscal capacities to the level of the stronger of New South Wales (NSW) or Victoria, regardless of whether another state has a higher fiscal capacity. If NSW or Victoria do not have the greatest fiscal capacity, any other state with a greater fiscal capacity is treated as effectively having a lower capacity and requiring more GST. Currently only Western Australia (WA) benefits from the new system.
The 2018 legislation also introduced a relativity floor – a minimum GST relativity for all states. It starts in 2022–23 at 0.7 and will increase to 0.75 by 2024–25. The floor insulates all states from receiving GST below a certain threshold, meaning that those with a strong fiscal capacity will continue to receive a minimum GST share. As the GST pool is divided among the states, maintaining this minimum GST share comes at the cost of other, fiscally weaker states.
To determine whether Victoria or NSW is the basis of the new equalisation standard and which states need to be lifted to the minimum relativity floor, the CGC still conducts its assessments of states’ fiscal capacities as under the former system and ‘full’ HFE. It publishes GST relativities reflecting this, referred to as assessed relativities. Relativities that form the basis of GST payments, after adjustments are made for the new system, are now simply referred to as GST relativities.
When the new system was introduced in 2018, the Commonwealth introduced a ‘no-worse-off guarantee’ which compensates states for any losses under the new system compared to the former system, funded from outside the GST pool. The new system will be phased in from 2021–22 to 2026–27, with the no-worse-off guarantee legislated until the end of that transition period. As a result, states are exposed to potential financial impacts of the new system compared to the former system once this guarantee expires.
1.2 Overview of this paper
This paper aims to deepen the understanding of the potential effects of the new GST system on Victoria’s GST revenue. We employ scenario modelling to demonstrate the size and range of impacts the new system may have on Victoria’s GST share, supported by a systematic analysis of the key variables that influence the GST distribution. The modelling includes:
- simple scenarios – changing one underlying variable at a time
- complex scenarios – shifting several variables simultaneously.
Our results show that across a range of feasible scenarios, Victoria is estimated to be between $3.5 billion and $6.5 billion worse off from 2021–22 to 2026–27.
Section 2 provides an overview of existing research and literature on the new GST system. Section 3 introduces the empirical methodology for this paper, including the selection of key variables. Section 4 discusses the modelling results and quantifies the potential costs of the new system of GST to Victoria. Section 5 concludes the paper and summarises the key results and findings.
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