Other economics

How the west won

If you live east of Eucla you might look with envy on Western Australia. Its state budget, presented on May 9, allocates increased funding for housing, urban rail projects, and capital funding for state schools, while having enough left over for an operating surplus of $2.6 billion. That’s while other governments in our federation are struggling. Western Australia expects to run fiscal surpluses totalling $20 billion over the 8 years to 2026-27, while the other seven states and territories will run deficits totalling $300 billion.

Your envy might turn to anger if you realize that you’re paying for it, through a grossly imbalanced distribution of revenue from GST.

A little context. Compared with other federations such as the US, Canada and Germany, Australia has only minor disparities in living standards between states. One reason is that the Commonwealth collects about 80 percent of all taxes, provides almost all personal income transfer programs (age pensions and other social security), and distributes a segment of funding, specifically revenue from the GST, to state governments on the basis of their governments’ needs.

This redistributive process has been in place since 1933, when the Grants Commission was established. The Commission’s task is to use objective criteria to estimate how much each government has to spend in order to maintain the same level of government services as other states and territories, and similarly to estimate how much each government can raise in taxes without subjecting their citizens to higher taxes than in other states and territories.

Those calculations drive a process known as “horizontal fiscal equalization”. The Commission works out for each state and territory a per-capita distribution of general-purpose funds (the revenue from GST since 2001) in a way that compensates for states’ differences in need and taxation capacity. If you live in Victoria, for example, for every $1.00 you pay in GST, only 90 cents may come back to your state, the other 10 cents going to less-well-off states.

That deal worked well and quietly for many years. New South Wales and Victoria, being the states with the strongest economies, have almost always been subsidising the others. Up to about 1960 Western Australia was the main beneficiary, and from then on Tasmania has enjoyed the largest redistribution. That stood to reason – Western Australia is large, which makes it costly to provide transport infrastructure and to provide services to remote communities.

From the 1960s on that changed. More and more stuff that other countries wanted was being discovered in Western Australia. It’s the source of iron ore, gas, and more recently copper and lithium that will be in demand for the world’s energy transformation. The state government is now taking in more than $10 billion a year in mineral royalties.

So when the public servants in the Grants Commission ran the numbers through their computers, they discovered that Western Australia, with such massive revenue-raising capacity, should not get very much back at all in GST revenue.

That didn’t please the Western Australians. In a process described by Saul Eslake (a Tasmanian) as the “worst policy decision of the 21st century (so far)”, in 2019 the Morrison government, supported by the Labor opposition, put a floor under the amount of GST revenue Western Australia would receive. It will never get less than 70 percent of what it would receive if funds were to be distributed on an equal per-capita basis. You can find his speech at the National Press Club 8 May on his website, along with his accompanying slides.

Former Liberal Western Australian Premier Colin Burnett was the other speaker at that session. You can hear Eslake and Burnett present their own histories of horizontal fiscal equalization and their accounts of the 2019 deal, in the Press Club session. It’s a rich debate, intense, but non-partisan, raising a wide range of issues in tax policy and governance of a federation, and some of the problems in our established revenue-sharing arrangements. For example is a royalty a “tax” or a payment for minerals belonging to the people, and if the latter, are the people of one state or the whole Commonwealth the owners? That may sound like an abstract question, but as Barnett explains the answer has significant consequences for Western Australians.

Both Eslake and Barnett admit that there are some problems in the way the horizontal fiscal equalization has been working. Unsurprisingly, while Eslake argues for a return to the pre-2019 arrangements, Barnett is more in favour of a straight per-capita distribution, with a small reserve for dealing with interstate disparities.

Logic seems to be on Eslake’s side. He points out that “Never before has any one state’s revenue-raising capacity exceeded that of the others by as much as Western Australia’s has in the last 15 years.”

But party politics are on Barnett’s side. In the 2016 federal election the Coalition held on to office by one seat only because it won 12 of the state’s 15 seats, 3 of them on a margin less than 5 percent. In 2022 the Coalition lost 5 seats in Western Australia – 4 to Labor, 1 to an independent (Kate Chaney). The state has strong political leverage.

Also on Barnett’s side are the large states, particularly New South Wales, that have always been subsidizing smaller states. In his Policy Post Martyn Goddard (another Tasmanian) writes about what he calls The campaign to destroy the GST. That’s a bit of an overstatement, but Goddard’s main point is that “the problem with the GST is that it doesn’t raise enough”.  

One reason is that many if the items on which GST is paid have become cheaper in relation to items that are exempt, which means, mathematically, GST revenue is falling relative to GDP. The other is that states devote about 60 percent of their outlays to skilled labour-intensive services – school education, hospital care, and policing – for which it is difficult to achieve productivity gains.

Western Australia has always had a difficult relationship with the rest of Australia. It was the last state to hold a referendum to join the federation. In 1933, as the Great Depression took hold, it held another referendum, this time on whether it should leave the Commonwealth. Two thirds voted for seccession. The British government refused to accede to the request – not because they respected Australia’s sovereignty, but because they feared Western Australia’s secession woud energise separationist movements in other parts of the British Empire.

Canberra took the secession movement seriously: establishment of the Grants Commission that year was a response to the Western Australian secessionist movement.  Benjamin Wilson Mountford of Australian Catholic University and Robert Fletcher of the University of Missouri-Columbia remind us of this piece of Australian history in a Conversation contribution: “Westralia shall be free!” How Western Australia’s secessionists stoked British fears the Empire was at risk.

In this context Barnett’s case could be seen as a statement that the Grants Commission, having arisen in response to Western Australia’s needs, served its purpose in its time. It is now no longer needed. Or it might even be seen as a warning that secessionist sentiments could re-emerge.

Cooking with gas, even if we don’t want to

The Future gas strategy, released by Resources Minister Madeleine King, reads as if it was developed by a completely different government than the government that produced the Future Made in Australia. It’s about developing new sources of gas supply, solidifying Australia’s position as a global supplier of liquified natural gas, and ensuring households still have access to affordable gas for domestic needs. That’s in stark contrast to government policies designed to reduce the economy’s dependence on fossil fuels.

On ABC TV – Anthony Albanese faces criticism over gas strategy – Laura Tingle observes that “The new policy bears a striking resemblance to what the Morrison government touted as its gas-led recovery” – a policy sharply criticized by Energy Minister Chris Bowen when he was on the opposition shadow ministry. On the same program Rod Sims, now Chair of the Superpower Institute, says “I think it damages our credibility internationally. This basically says, no, we're going to keep relying on fossil fuels. It is going to be a gas-fired future.”

Writing in The Conversation Samantha Hepburn of Deakin University writes Australia can have a future for the gas industry, or meet its climate commitments – but not both. For some time we will need to rely on gas to firm our electricity network, but that demand is small and will diminish over time. It does not need an expanded supply as this policy envisages.

Sophie Vorrath, writing in Renew Economy, makes essentially the same point, quoting several critics of the policy: Labor caves in to fossil fuel cartel as it locks in gas beyond 2050 amid deepening climate crisis. Tim Buckley of Climate Energy Finance is quite direct about the politics of the policy. Appearing on ABC TV news, he says that the policy shows the political clout of the methane gas lobby. “It’s worth bearing in mind, the fossil fuel industry in 2022-23 exported $220 billion worth of LNG, coking coal and thermal coal. They made $150 billion gross profit on the back of that and they pay next to no corporate tax.” He goes on to say “they have $150 billion of gross profit to undermine democracy and to entrench the incumbent industry’s power”.

The electoral politics of this policy are clear. Labor wants to hold on to its gains in Western Australia: see the previous post How the west won. It has met with ire from the Greens, but Labor is too inclined to take for granted that Greens preferences will get them over the line, forgetting that in the 2022 election they lost 3 House of Representatives seats to the Greens, and that demographic trends, while spelling a slow death for the Liberal Party, are much more favourable to the Greens than they are to Labor.

Political football

Here’s a question for a student assignment: “Establish an argument for a government to fund construction of a sports stadium”.

That could be an assignment in a politics or creative fiction course, but not in a public finance course, because there is no conceivable economic logic for governments to fund stadiums for spectator sport. They are not public goods, because unlike public playing fields in parks, people can be charged admission (i.e. stadiums are “excludable”). There is a public health case for funding community sports, but not spectator sports: the nation’s waistline does not shrink when people spend their Saturday afternoons sitting down drinking beer while watching people kick a football. Some may argue that watching football is a “merit good”. “Merit goods” are goods and services that people won’t buy unless they are given a nudge or a subsidy to encourage consumption, but which people come to appreciate in time. Broccoli, Arthur Boyd’s paintings, and Wagner’s operas may fall into that category, but attraction to football seems to spread like a pre-schooler’s cold, without any encouragement.

Nevertheless, it looks like Hobart’s football stadium is going ahead, with $240 million from the Commonwealth and $375 million from the state government. This is in spite of acknowledged shortages in the building and construction industries and a shortage of new house construction, nationally and in Hobart.

The last chance to kill this project was dashed earlier this month, when Labor announced it would join with the state’s minority Liberal government to support it, ending any chance of a blocking coalition forming to defeat it. In announcing Labor’s support of the spending Labor leader Dean Winter defended his party’s decision on the basis of the number of jobs it would provide in the construction industry. That must come across strangely to building contractors desperate to find skilled workers, and to young people who cannot afford to buy into an under-supplied real-estate market.

Lest we think this is a particular case of Australian bi-partisan idiocy, Dan Moore, writing in The Atlantic, points out that the same thing is happening in the US: Taxpayers are about to subsidize a lot more sports stadiums. He writes “You would think that three decades’ worth of evidence would put an end to giving taxpayer money to wealthy sports owners. Unfortunately, you would be wrong”.

Moore cites the power of the sports lobby, and in Australia many refer to the power of the AFL. But lobbying alone does not secure $615 million from cash-strapped governments. Maybe part of the problem lies with the way the Commonwealth budget is divided among portfolios. This project fell into the Sport portfolio: had it been evaluated by Infrastructure Australia alongside economically-justifiable projects, such as rail lines and freeways, it would surely have been knocked back before it got anywhere near Commonwealth or state cabinets.

A more basic problem is that our bodies politic seem to lack a clear understanding of what governments should and should not fund. Staff in departments such as Treasury, Finance, Agriculture and Transport may have a sound understanding of market failure and the economic case for public funding and provision, but that understanding is not shared widely. To many, particularly on the right of the political spectrum, government is just a big reservoir of funds. It would be better if we didn’t have government at all, but if we must have government, it doesn’t matter how money is spent, because it’s all waste anyway, be it spent on a road, a hospital, an extension to the War Memorial, a commuter car park that no one has asked for, or a stadium.