Divvying out the GST

The supercharged Queensland economy passed another milestone last week, although it’s one that Queenslanders may not want to celebrate. For the first time ever, the Sunshine State will join New South Wales, Victoria and Western Australia in subsidising the smaller states and territories in the way GST revenue is carved up.

It would be hypocritical of the state government to complain, because Queensland governments of all political colours have always supported the arcane “horizontal fiscal equalisation” system that has produced this result. The system is working as it was designed to work. But the latest turn of events should cause the state government to rethink whether the system is in its, and the nation’s, best interests in the longer term.

The hit to the state budget is the result of the Commonwealth Grants Commission’s annual review of the shares of GST revenue going to each state and territory. The subsidy comes about as one group of states receive less than their population share so that the others can receive more. In the past, New South Wales, Victoria and sometimes Western Australia have been the only states in the first group - the so-called “donor” states.

If the Grants Commission’s recommendations are accepted (and there is no reason to think they won’t be) then Queensland will receive about $300 million less than its population share in 2008-09. This will be its contribution to the subsidy pool for the smaller states. It is likely to be larger still in 2009-10.

Whatever its size, any contribution to the subsidy represents a significant change in status because Queensland, up to now, has always been one of the subsidised states, much to the chagrin of New South Wales and Victoria. As recently as 2004-05, Queensland was receiving almost $500 million more than its population share.

The change is a result of the surge in the state’s economic development over the past five years or so, which has made Queensland more like the big southern states in its revenue raising capacity.

For example, average real estate values and average wages are now closer to those of Sydney and Melbourne, which means that Queensland’s revenue base is stronger relative to the other states and therefore the state does not need to be supported by the southerners.

Queensland has also enjoyed a surge in mineral royalties. As a resource and export based economy, it has been a major beneficiary of the world economic boom. Some of its gains could be reversed if the world economy sours, restoring Queensland to subsidised status, but much of the change is likely to prove permanent and Queensland is never likely to go back to being a chronic dependent on the bigger states.

New South Wales and Victoria have always been vocal critics of the equalisation system that has made them pay the lion’s share of the subsidy to smaller states. Queensland is unlikely to convert to their cause overnight, but over time it will be in its interests to do so. This is not just a matter of expediency, for there are sound reasons in principle to question the current system.

Its mind-boggling complexity is one reason, and this is being addressed by a major review to be completed by the Grants Commission in two years’ time. But that review does not look into whether the principle of equalisation is best for the Australian economy or gives states the right incentives to be efficient.

That question was investigated in 2002 by the eminent economists Ross Garnaut (who is currently in the news for his work for the Rudd Government on the economics of climate change) and Vince FitzGerald. They identified ten ways in which the current system is inefficient, and advocated a major revamp. Queensland at the time joined other subsidised states in seeking to discredit the report, notwithstanding its respected authorship, because it had been commissioned by New South Wales, Victoria and Western Australia.

If Queensland were now to join those states in demanding a fundamental rethink of the idea that some states should subsidise others, it would be harder for the Commonwealth to ignore them and harder for the other states to block it. Such a rethink should be a part of Kevin Rudd’s revamp of federalism.