Rangarajan FiscalTransfersAustralia 2004

Fiscal Transfers in Australia: Review and Relevance to India
Author(s): C. Rangarajan and D. K. Srivastava

Source: Economic and Political Weekly , Aug. 14-20, 2004, Vol. 39, No. 33 (Aug. 14-20,
2004), pp. 3709-3722
Published by: Economic and Political Weekly
Stable URL: https://www.jstor.org/stable/4415416
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Special articles
Fiscal Transfers in Australia

Review and Relevance to India
This paper examines the working of Australia's fiscal transfer system in the context
of its long-term evolution, paying particular attention to salient changes that have occurred
since the introduction of a comprehensive Goods and Services Tax (GST). The GST has
served to increase the vertical imbalance in the system, which was high even prior to this
change, by placing more revenue resources with the Commonwealth Government in
Australia. In spite of a high degree of expenditure centralisation, considerable emphasis is
placed in Australia on achieving horizontal fiscal equalisation through an
elaborate mechanism of equalisation transfers, which looks into both revenue and
expenditure sides of the state budgets and calculates revenue and expenditure 'disabilities'
that account for departures from a pure equal per capita distribution of the shareable
amounts. This paper looks at the equity and efficiency implications of the Australian
equalisation transfers and considers its relevance for the Indian system, which has many
comparable features. Apart from the need for making equalising features of the Indian
transfer system more transparent, there is need for emphasising some cost disabilities,
particularly those that are structural and exogenous in nature.
C RANGARAJAN, D K SRIVASTAVA
he working of fiscal federalism in Australia is now more a far-reaching influence on the vertical and horizontal sharing
than hundred years old. It was in 1901 that Australia of resources among the Commonwealth and state governments.
became a federation, when six separate British colonies The GST is collected by the Commonwealth government and
came together forming a Commonwealth and becoming as afully passed on to the states. This by itself accounts for almost
consequence its states. These states are Queensland, New South the entire untied transfers, and since it has come in replacement
Wales (NSW), Southern Australia (SA), Victoria, Western Aus- of several state level taxes, its distribution significantly affects
tralia (WA) and Tasmania. In addition, there are two territorial the availability of resources to the states. The Commonwealth
administrations, viz, the Northern Territories (NT) and the Aus- Grants Commission (CGC), which is the main institution that
tralian Capital Territory (ACT). Australia's federal fiscal struc- makes recommendations about the horizontal fiscal transfers, has
ture is characterised by a high level of vertical imbalance, an come out, in its 2004 Review, with a new set of recommendations
elaborate system of horizontal fiscal equalisation, and numerous for years covering the period after 2003-04. There is an extensive
special purpose payments. The centrepiece of the Australian contemporary debate in Australia about the relevance and im-
system of fiscal transfers is horizontal fiscal equalisation (HFE) plications of the manner in which the principle of horizontal fiscal
that looks into both revenue and expenditure sides of the state equalisation has been applied, particularly after the introduction
budgets and calculates revenue and expenditure 'disabilities' thatof the GST and the proliferation of the Special Purpose Payments.
account for departures from a pure equal per capita distribution It is some indication of the disenchantment of some of the states
of the shareable amounts. Australian equalisation calculations, that three states, viz, New South Wales, Victoria, and Western
cast in terms of 'disabilities', and state 'relativities' rather than Australia, i e, the so-called better off and 'donor states' jointly
the more usual term of state shares, are distinct in their presen-appointed a Review Committee comprising two eminent experts
tational scheme. The Australian fiscal transfers system is alsoRoss Garnaut and Vince FitZerald to assess the current system
unique in having developed an institutional framework for five- of transfers in terms of economic efficiency, equity, simplicity,
yearly reviews and annual updates of the relativities as also for and transparency. The disenchantment reached such a peak that
having developed techniques of micro assessments, particularly after the 2004 Review, New South Wales took out an advertise-
on the expenditure side. ment in the newspapers asking the citizens of the state to send
Currently, the Australian system of fiscal transfers is going telegrams to the prime minister expressing their dissatisfaction.
through a major transition with the introduction of a com- The Commonwealth Grants Commission itself observes in its
prehensive Goods and Services Tax (GST), which is in thereport containing the 2004 Review that the commission "is
nature of a Value Added Tax. The introduction of GST has had supportive of a far-reaching review of equalisation, including
Economic and Political Weekly August 14, 20043709

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its underlying purposes and objectives" and that the commission franchise fees and taxes on excisable goods converted into service
itself did not go into these questions because these were not part taxes for constitutional reasons. Local governments are given
of its terms of reference. The transfers system in India is facing taxes on immovable property at the municipal rates.
similar questions today. The IGA, finalised in 2000, was aimed at achieving a new
Australia's system of horizontal fiscal equalisation and the national tax system which is not distortionary and which also
related debates on equity and efficiency are relevant for other improves the financial position of the state governments. These
fiscal transfer systems including that of India. In this paper, we reforms have led to the implementation of GST, which is pres-
examine the working of the Australian system with a view to ently set at the uniform rate of 10 per cent. There is some
drawing comparisons with the corresponding Indian fiscal trans- ambiguity as to whether the GST should be considered a federal
fer system and deriving appropriate lessons. Section I looks at tax or a state tax. The Commonwealth itself has argued that the
the assignment of revenues and responsibilities in Australia. GST should be regarded as a state tax, which the Commonwealth
Section II summarises the institutional arrangements in Australia collects on behalf the state governments and fully returns to them.
that play a key role in the working of the federal fiscal arrange- The Australian Bureau of Statistics treats the GST as a Com-
ments. Section III looks at the state economies in Australia and monwealth tax. This seems appropriate because the Common-
their demographic features drawing appropriate comparisons wealth is not collecting the GST on behalf of the states and
with India. Section IV examines the extent of vertical imbalance returning it to them on the basis of derivation. The Common-
in Australia as well as India. Section V reviews the arrangements wealth has itself given up the wholesale sales tax and it is using
of horizontal fiscal equalisation, highlighting the use of revenue the GST revenues for distribution among states on equalisation
and cost disabilities in deriving states' shares in the overall untied principles. The GST revenue sharing arrangements do not have
transfers. Section VI examines same issues in assessment. Section constitutional force although these are based on the IGA.
VII provides a summary of the key features of the Australian Table 1 shows that the Commonwealth government collects
system of fiscal transfers focusing on practices that can be 76 per cent of all government revenues. About 20 per cent is
adopted with benefit in the Indian context. collected by the state governments and the remaining by the local
governments. This high degree of centralisation in raising rev-
enues arises primarily from the fact that more than 50 per cent
Assignment of Powers and Functions of all tax revenues are raised as income tax followed by the GST,
which contributes about 11 per cent of the total and excise and
In Australia, the functions of the Commonwealth government
relate to foreign affairs, foreign trade, defence, immigration, Table 1: Own Source Revenues by Governments, 2000-01
currency and banking. The states have responsibilities in respect Commonwealth State Local Govern- Multi-
of public safety, housing, transport, community and social ser- Government Government ments Jurisdictional
vices. The state governments also have jurisdiction over local
Total taxes of which 76.35 19.73 3.33 0.59
governments. Responsibilities such as maintaining the road Income taxes 50.59 0.00 0.00 0.00
system, recreational and cultural services and public services like Payroll taxes 1.50 3.98 0.00 0.00
water supply and sewerage have been delegated to the local Taxes on property 0.01 5.20 2.67 0.00
governments. Goods and services tax 10.81 0.00 0.00 0.00
Excise and levies 8.15 0.00 0.00 0.00
The central government has the power to levy all taxes and
Taxes on international trade 1.93 0.00 0.00 0.00
the states have concurrent powers except in the case of customs Income from government
and excise duty. At the inception of the federation, the Consti- business enterprises 1.23 2.24 0.00 0.01
tution was so framed as to give exclusive powers on the customs
Source: Australian Bureau of Statistics, Taxation R
and excise revenues to the Commonwealth. Further, starting in Finance Statistics.
1908, the high court has consistently interpreted these powers
more and more in favour of the central government by extending
Table 2: Australia: Inter-Jurisdictional Shares
the definition of excises. In particular, states have not been in Expenditures, 2000-01
permitted to levy sales taxes. The local bodies depend mainly (Per cent)
on property taxes.
Common- State Local Multi- Total all-
Prior to the taking over the income tax by the Commonwealth, wealth Govern- Govern- Jurisdic- Government
states were raising more than 70 per cent of the total income Govern- ment ments tional* Expenditure
tax revenue collected in Australia, way back in 1938-39. Ceding ment ($million)
access to this revenue source to the Commonwealth during the General public services 51 40 9 1 19046
war years completely reversed the relative position of the Com- Defence 100 0 0 0 11327
monwealth and state governments in revenue raising powers. Public order and safety 14 82 3 0 10745
Education 5 69 0 26 35777
With the Uniform Income Taxation Act of 1942 eliminating the
Health 46 53 1 0 41179
role of states in raising income tax, and subsequent court rulingsSocial security and welfare 91 8 1 0 72059
closing sales and excise taxation fields to the states, most of the Housing and community amenities 28 46 26 0 10583
important taxes on individuals, enterprises and non-residents Recreation and culture 31 41 29 0 6592
stand assigned to the Commonwealth. With the GST also being Fuel and energy 70 30 0 0 3760
collected by the Commonwealth as a result of the Inter-Govern- Agriculture, forestry, and fishing 45 55 0 0 3857
Mining, manuf and construction 55 33 12 0 1876
ment Agreement (IGA) in 2000, its domination of the tax field Transport and communications 15 67 18 0 15549
is near-complete. The states' most important own tax revenue Other economic affairs 46 50 3 0 6586
sources are the payroll tax that is levied on company payrolls, Total 52 39 5 4 238936
taxes on financial and capital transactions, taxes on gambling, Note: * This category includes
on insurances and on motor vehicles. The states also employ Source: Australian Bureau of S
3710 Economic and Political Weekly August 14, 2004

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
levies that contribute a little more than 8 per cent, all being with distributing the distributable pool of resources among the states
the Commonwealth government. and territories.
Table 2 shows the extent of centralisation in expenditures, i e, The commission was established in 1933 to assess claims made
the situation after transfers. About 52 per cent of expenditures by the states for financial assistance (special grants) under section
are incurred by the central government in total expenditures. 96 of the Constitution. At various times, Queensland, Western
There are several fields that the Commonwealth government co- Australia, South Australia, Tasmania and the Northern Territory
occupies with the state governments, particularly those relating had sought special grants.
to health, housing and community amenities, and some economic Various issues are referred to the CGC under sections 16, 16A
sectors like fuel and energy, agriculture, forestry, and fishing, and 16AA of the Commonwealth Grants Commission Act 1973.
mining, manufacturing, and construction, etc. Although references to the CGC are provided by the minister
Table 3 shows the corresponding picture for India using 2000-01 for finance and administration, their content is usually decided
data. Apart from defence, centre has a share higher than that of in negotiations between the Commonwealth and the states,
the states in housing, industries, and transport. In most of the conducted largely through their treasuries. While the resulting
social and economic services, it is the states that have the larger commission reports are provided formally to the Commonwealth
shares of expenditures. government, they are made available to the states immediately
thereafter. The relativities recommended in those reports are
considered at the annual treasurers' conference.
The Commonwealth Grants Commission defines its own role
Institutional Arrangements of Fiscal
Coordination as "an independent, impartial and authoritative arbiter in relation
to distributional aspects of fiscal federalism in Australia" [Com-
The framework of institutions dealing with financial and other monwealth Grants Commission 1983: 160]. The Commonwealth
matters between the centre and the sub-national governments is Grants Commission looks at the state budgets in a comprehensive
manner and looks at all needs, whether on current or capital
critical for the successful functioning of central-state financial
account. There is no fragmentation in approach as is the case
relations. In India, apart from the constitutional provision for a
Finance Commission, there are other institutions like the in India where expenditures are divided into revenue and capital
Planning Commission, the Interstate Council and the Nationalaccounts, and further into plan and non-plan categories, with two
Development Council. In Australia, there are five bodies thatbodies, viz, Finance and Planning Commissions looking after
play a key role in the management of the federal fiscal system. different segments of the expenditure requirements.
These are described below. Unlike in India, where the Finance Commission looks at both
the vertical and horizontal dimensions of transfers, the Common-
wealth Grants Commission does not look into the issue of vertical
(a) Council of Australian Governments
imbalance. With the introduction of GST, the vertical transfers
This council consists of the prime minister, state premiersareanddetermined by the amount of actual collections of the GST,
supplemented
chief ministers of the territories. This council has superseded the by the Health Care Grants (HCG). Prior to the GST,
the pool of transfer consisted of Financial Assistance Grants
premiers' conference that earlier decided about the vertical trans-
(FAG) and the HCG. In addition, the Commonwealth government
fers. Since now there is an agreement to transfer the full amount
pays special purpose payments (SPPs), which are conditional
of GST to the states, the volume of untied transfers to that extent
gets determined automatically. grants aimed at specific sectors. The SPPs are broadly comparable
to the centrally sponsored schemes in India.
For the 2004 Review, the terms of reference asked the CGC
(b) Ministerial Council for Commonwealth-State
Financial Relations to review the methods used to determine and report upon the
Table 3: Relative Share of Centre and States in India:
This council, which is also known as the treasures' conference,
Selected Heads, 2000-01
provides a platform for an annual meeting of the treasurers
Share of Combined
(finance ministers) of the states and territories to discuss grant
Centre States (Amount
allocations to the states (until recently this was done at the
(PerCent) (Per Cent) in Rscrore)
premiers' conference).
Defence services 100.0 0.0 49622
Fiscal services 46.0 54.0 9015
(c) Special Purpose Ministerial Councils Administrative services 35.2 64.8 34897
Organs of state 37.6 62.4 4261
These councils consist of the Commonwealth and state min- Pension and other retirement benefits 36.6 63.4 38819
Education, art and culture 11.1 88.9 63756
isters of a particular portfolio. These councils look after a wide
Medical and public health, water supply
range of special purpose payments.
and sanitation 11.5 88.5 24360
Family welfare 23.5 76.5 2826
(d) Commonwealth Grants Commission Housing 56.6 43.4 4156
Agriculture and allied services 32.4 67.6 35140
Industry and minerals less DCUs 57.8 42.2 6762
The main body entrusted with the task of making recommen-
Power, irrigation and flood control 11.8 88.2 33799
dations regarding the horizontal transfers of shareable resources
Transport and communications 51.3 48.7 24492
in Australia is the Commonwealth Grants Commission (CGC).
Public works 17.6 82.4 4007
The Commonwealth Grants Commission is an advisory body that Total 44.6 55.4 553533
responds to its terms of reference. It does not have powers to
Note: Centre's expenditures
initiate and pursue inquiries on its own. In recent years, the main from the combined amount
references have sought advice on per capita relativities for
Source: Indian Public Finance
Economic and Political Weekly August 14, 2004 3711

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
question of the per capita relativities for distribution of GST borrowing to ease these pressures. The Commonwealth's
revenue grants and health care grants which the commission influence over the Loan Council was strengthened by the
would regard as appropriate to apply after 2003-04.l The com- fact that the Commonwealth undertook to provide funds to
mission was also asked to continue to prepare its assessments the states if the states were unable to raise, through the issue
on the basis that Specific Purpose Payments quarantined, i e, of securities, any borrowing that the Loan Council had ap-
excluded in the previous terms of reference should continue not proved. In effect, the Commonwealth agreed to underwrite
to affect the per capita relativities.2 state borrowing.
In preparing its assessment, the commission was asked to have The Gentlemen's Agreement was also bypassed when some
regard for the need to observe policy neutrality in relation to a states used 'unconventional' financing techniques such as finan-
reduction in the level of a Specific Purpose Payment resulting cial leases to circumvent its restrictions. The states also estab-
from non-compliance by a state or territory with the conditions lished borrowing authorities like the New South Wales Treasury
of the payment. Any such reductions should not directly influence Corporation, which was used to circumvent the Loan Council
the commission's assessments of the per capita relativities. The borrowing limits. In 1984, the Loan Council suspended the
commission was asked to prepare its assessments on a basis Gentlemen's Agreement and replaced it with Global Borrowing
consistent with the Commonwealth's intention that specified Limits. This 'global approach', among other things, limited the
components3 of the Australian Health Care Agreements between level of all new borrowings, conventional and unconventional,
the Commonwealth and a state should not directly influence the by Commonwealth and state authorities.
per capita relativities. However, the global approach also broke down. A major reason
was the increasing use of sophisticated financing techniques that
(e) Australian Loan Council eroded the Loan Council's effectiveness. In December 1992, the
Loan Council meeting adopted new arrangements for monitoring
Australia is unique among federations in that it has a mecha- and reporting. Under these arrangements which came into effect
nism in the form of the Australian Loan Council to coordinate in 1993-94, each jurisdiction nominated a Loan Council Allo-
borrowing by the Commonwealth and state governments. Effec- cation, which was based on its net borrowings as indicated by
tive control of public sector borrowings is a major concern forits deficit/surplus. The arrangements also changed the way in
all federations as government borrowing is linked with monetarywhich borrowings were allocated among the states. Previously,
policy and macroeconomic demand management. Unrestrained the global limit was allocated by a formula based on state
borrowing can compromise fiscal discipline by softening the
population. But this formula did not take account of a state's
particular fiscal circumstances. The Loan Council therefore
budget constraints to governments at all levels. The Loan Council
was set up by the Financial Agreement of 1927, as ratified by considered the nominations having regard to each jurisdiction's
a constitutional amendment in 1928, to provide an effectivefiscal position and 'reasonable' infrastructure needs as well as
control of borrowings by the state governments and state business
the macroeconomic implications of the total nominations.
enterprises. The Financial Agreement Act 1994 came into effect on July i,
The Loan Council's origins lie in the 1920s when the Com-1995. The financial agreement includes changes agreed at the
monwealth and states competed for funds on the capital markets.June 1992 Loan Council meeting. These changes (i) removed
The Commonwealth wanted to refinance war debt while the statesthe requirement for Commonwealth and state borrowings to be
wanted to fund infrastructure programmes. To resolve this and approved under the agreement; (ii) removed the Commonwealth's
other conflicts, the May 1923 Premiers' Conference agreed to explicit power to borrow on the states' behalf; (iii) abolished
form a voluntary Loan Council. The Loan Council is formally the restriction on state's borrowing through the issue of securities
a Commonwealth-State Ministerial Council comprising the Com- in their own names, and (iv) included the Australian Capital
monwealth Treasurer as chairman, and state and territory trea- Territory and Northern Territory as members (they previously
surers. The Financial Agreement Act 1928 provided among other had observer status).
things for (i) The Loan Council to regulate borrowing by the These changes, particularly the removal of the requirement for
Commonwealth and states; (ii) the Commonwealth to borrow approval of borrowing, constitute a major restructuring of the
on the states' behalf; (iii) limits on the states' borrowing powers;
Loan Council powers. Current arrangements seek to emphasise
(iv) the Commonwealth and the states to contribute to the Nationaltransparency of public sector finances, through financial
Debt Sinking Fund to redeem debt; and (v) the Commonwealth
market scrutiny of proposed borrowing to restrict borrowing
to provide grants to the states to help them meet interest payments
to prudent levels. The Loan Council meets once a year to
and sinking fund contributions.
The 1028 financial agreement has been altered on a number
Table 4: Australia: Mean Resident Population, 1997-98 to 2002-03
of occasions to take account of new developments. The 1928 (Per cent)
agreement did not encompass borrowing by Commonwealth and Share of States and Total Population
state semi-governmental and local authorities. As the Loan 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03
Council's restrictions became stringent, the states found ways
New South Wales 33.89 33.88 33.87 33.87 33.84 33.71
of circumventing the council by using statutory authorities for
Victoria 24.81 24.78 24.76 24.76 24.74 24.74
borrowing. In 1936 a voluntary 'Gentleman's Agreement' was Queensland 18.38 18.46 18.55 18.64 18.79 19.00
Western Australia 9.72 9.76 9.78 9.79 9.80 9.81
negotiated to bring such borrowing under the supervision of the
Loan Council. Southern Australia 7.98 7.94 7.89 7.82 7.76 7.71
Tasmania 2.54 2.51 2.48 2.45 2.42 2.40
A major change in the role of the Loan Council took place
Australian Capital Territory 1.66 1.65 1.65 1.64 1.64 1.63
in the 1950s when the Commonwealth increasingly saw Northern
it as Territories 1.01 1.02 1.02 1.02 1.01 1.00
Australia 100 100 100 100 100 100
an instrument of macroeconomic policy. Early in the 1950s,
Australia had faced strong inflationary pressures, andAustralia
the (million) 18.61 18.82 19.04 19.28 19.53 19.76
Commonwealth Treasurer advocated reducing council-approved
Source: Commonwealth Grants Commission, 2004 Review, Supporting Informatio

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
consider the nominations having regard to each jurisdiction's The main states, which serve as 'donor' states, i e, t
fiscal position. get less than per capita entitlement in the exercise of re
The Loan Council's allocations are not binding in a legal sense. through the fiscal transfer mechanism, are New Sout
According to its own statement the Loan Council has moved Victoria (Table 9). Such redistribution is relativel
from an approach based on rigid compliance to that of a handle as most of the population is concentrated in
credible and transparent framework for the allocation of net states. In contrast, the recipient states have lower
borrowings. To ensure that borrowings are consistent with the Such redistribution is far more difficult in India wh
states fiscal and debt positions and the nations overall macro- proportion of population is concentrated in the low fis
economic strategy, the Loan Council has implemented a joint states. Recognising this feature in Australia, Mathews
Commonwealth/state forecasting exercise. The National Fiscal observed "Fiscal equalisation is achieved more easily if
Outlook contained nationally agreed debt targets and states' with low fiscal capacity also have relatively small p
nominations were considered in that light. This arrangement because transfers involving small per capita payment
continued until 1998. Since then each government's own fore- federal (or other granting) government are translated
casts are used to set their targets. Governments are required to per capita grants for the recipient governments".
present three-year forward estimates as well as actual outcomes
within a uniform presentation framework. Discipline is now IV
exercised by ratings by international rating agencies, and Vertical Transfers and Vertical Imbalance
majority of states have got very good ratings. Most states are now
in budget surplus. Unconditional general revenue assistance as well as specific
purpose grants is given to the states according to section 96 of
1ll the Constitution. General revenue assistance is given for recurrent
Australian States: Population and Incomes as well as forcapital purposes. Specific purpose payments (SPPs)
in the form of recurrent or capital grants are given for specific
Australia is world's smallest continent but the sixth largest state functions like social services including health, education,
country, with population concentrated along the eastern and social security and welfare, economic services (roads, transport,
south-eastern coasts. Its arable land is only 6.88 per cent of total industry assistance, water resources) and other services (housing
area. Australia is rich in several minerals, particularly, bauxite, and urban renewal, regional development, disaster relief and debt
coal, and iron ore. In terms of 2001 figures, the share of agriculture charges). Three types ofpayments can be distinguished (i) payments
in the economy was only 3 per cent, with industry having a share to states for funding direct state outlays; (ii) payments through
of 26 per cent, and services having a share of about 71 per cent. the states to be passed on to other bodies or individuals; and
As shown by Table 4, New South Wales and Victoria are the (iii) direct payments to local governments.
two biggest states in terms of population. The total population The evolution of the extent and shape of vertical transfers in
of Australia is about 20 million. In contrast, India has 28 states Australia in more recent years can be seen in terms of four distinct
and seven union territories and its population size is more than phases, viz, prior to 1976 when general revenue assistance was
50 times as large as that of Australia. given to states, 1976 to 1985 when revenue sharing arrangements
In terms of per capita gross state product (GSP), the richest were put in place, 1986 to 1997 when the system of financial
states, leaving the territories are Western Australia followed by assistance grants was reintroduced, and after the intergovernmen-
New South Wales and Victoria. While economic activities are tal agreement in 2000, which provides for the sharing of the GST
more concentrated in NSW and Victoria, Western Australia is
revenues.
richer in mineral resources. The relatively less well-off states are

Phase 1: Up to 1976: general revenue assistanc
South Australia, Queensland, and Tasmania. Table 5 shows the
general revenue assistance in the form of Fin
statewise per capita gross state products. The ratio of the highest
Grants (FAG) was given to each state, determ
per capita GSP to lowest per capita GSP among states (Western formula subject to variation through Common
Australia/Tasmania) is only 1.5. This ratio, when the territoriesgotiations. Financial assistance grants were in
are included is 1.6. The corresponding ratios in India's case are
(from 1959 to 1976) by a formula stressing for
far higher, showing that difference in fiscal capacities is muchfactors, viz, population changes, average wag
lower in Australia compared to that in India. so-called betterment factor designed to allow the
their relative level of services.
Table 5: Australia: Gross State Product at Current Prices Phase 2: 1976-1985. revenue sharing arrange
as part of the Fraser government's 'New Feder
1997-98 2002-03 1997-98 2002-03
$ per capita $ per capita Relative tountied
average financial assistance grants were replaced
New South Wales 31837 40127 105.65 105.18 entitlements', whereby the states received a fix
Victoria 30433 39058 100.99 102.38 Commonwealth personal income tax receipts, d
Queensland 26623 33782 88.35 88.55 basis of existing per capita relativities. Access t
Western Australia 33939 42269 112.63 110.79 taxation was reopened to the states. However, t
Southern Australia 26297 32294 87.27 84.65
to impose personal income taxes of their own a
Tasmania 22467 27100 74.56 71.03
Australian Capital Territory 36389 47438 120.76 124.34 wealth did not make room for them by reducin
Northern Territories 32208 45870 106.88 120.23 personal income tax. A state that took up the o
Australia 30134 38151 100.00 100.00 had to impose an additional tax or surcharge
Ratio of Max pcGSP to minimum
Among states only 1.51 1.56 Sharing was first adopted for the income tax
Among states and territories 1.62 1.75 was formed by applying first a fixed propor
increasing proportion of the tax proceeds collec
Source:Commonwealth Grants Commission, 2004 Review, Supporting Information.
This lead to the states' revenues being determ
Economic and Political Weekly August 14, 20043713

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49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
similar to those used for financial assistance grants before. Later, Table 6 looks at the vertical fiscal imbalance at the level of
revenue sharing was extended to federal tax receipts as a whole, raising resources in Australia. The Commonwealth raised nearly
which somewhat lowered the rate of growth of the states' revenue 29 per cent more revenues than what it required to spend in 1993-
pool. 94. This vertical imbalance in raising revenues increased after
Phase 3:1986-1997: reintroduction offinancial assistance grants: the introduction of GST. In 2000-01, the Commonwealth
Financial assistance grants were reintroduced in 1986. The size government raised nearly 40 per cent more revenue than it re-
of pool was determined by the percentage growth rate set to reflectquired to spend on its own. This vertical imbalance has been
specified real changes in assistance, which could be negative accompanied by high degree of centralisation in expenditures
when fiscal restraint was called for. From 1990 the Common- with the Commonwealth government spending about 56-57
wealth had agreed to maintain the real value of such grants per in
cent of total expenditure up to 1999-00, and 52 per cent after
order to provide greater certainty in the funding of the state the introduction of GST. The share of Commonwealth
budgets. expenditure in total expenditure has come down in 2000-01 to
The extent of vertical fiscal imbalance between revenue powers 52 per cent.
and expenditure responsibilities in the federation increased In contrast, as indicated in Table 7, in India, nearly 60 per cent
substantially in 1997, when the states lost the capacity to impose of total revenues are raised by the central government and its
business franchise fees on liquor, tobacco and petroleum prod- share in the combined total expenditure of the centre and states
ucts. This resulted from the high court decision, which held that is about 43 per cent. Thus, both in raising revenues and incurring
such fees are in the nature of excises and reserved for the
expenditures India is less centralised than Australia.
Commonwealth. The Commonwealth compensated the states for
their lost revenue by increasing its own excise on those products V
and returning the revenue to the states in the form of a new
Horizontal Transfers: System of Fiscal
component of untied grants.
Phase 4: GST sharing and the intergovernmental agreement,
Equalisation
1999: The Intergovernmental Reform Agreement on the Reform The main task of the commission is to advise the Common-
of Commonwealth-State Financial Relations (IGA) was signed
wealth government on the distribution among the states and
in April 1999. It dealt with the GST-based reforms in theterritories
tax of the revenue from the GST and Commonwealth
system. This agreement was revised in May 1999 as a result of Grants. The commission operates such that a full review
Health
negotiations between the federal government and the Democrats.
of state shares including the methods used to calculate them is
The final agreement provided for the levy of GST at the uniform
undertaken every five years, and in the intermediate years shares
rate of 10 per cent. Concurrently, the federal government abol-
are updated annually, using the latest available figures and the
ished the wholesale sales tax and the state governments abolished
methods of the last Review. The Reviews have been done in 1981,
the financial institutions duty, bed taxes (in NSW and Northern
1982, 1985, 1988, 1993, 1999, and 2004. The review process
Territories), Stamp duty on quoted marketable securities, and the
is aimed at ensuring that the relativities reflect changes over time
debits tax. It was also agreed that several remaining stamp duties
in the circumstances of the states, developments in public ad-
would be taken up for review in 2005. ministration, and trends in service delivery.
The IGA also provided for the replacement of the Financial
The heart of horizontal transfers system is fiscal equalisation,
Assistance Grants (FAGs) by GST revenue sharing. The overall
which is defined by the CGC as follows "state governments
package of transfers now consists of the GST revenues to the
should receive funding from the pool of goods and services tax
extent of 100 per cent, healthcare grants (HCG), and special
purpose payments (SPPs). Table 6: Vertical Fiscal Imbalance in Australia, Selected Years
The GST and related arrangements have increased the vertical 1993-94 1995-96 1996-97 1997-98 1999-00 2000-01
imbalance in raising revenues because some state taxes have been
Own source revenue: relative shares
abolished while enlarging the scope of fiscal equalisation through
Commonwealth 72.6 73.6 73.1 73.1 74.8 76.4
larger overall amount of untied transfers. In order to smoothen
States and local
the transition, particularly for the states who lose more from the
governments 27.4 26.4 26.9 26.9 25.2 23.7
Own purpose expenditures: relative shares
abolished taxes than gain from the larger divisible pool, provision
Commonwealth 56.4 57.8 57.1 55.6 55 52.0
has been made for giving a Guaranteed Minimum Amount
States and local
(GMA) in the form of Budget Balancing Assistance (BBA) governments 43.6 42.2 42.9 44.4 45 48.0
consisting of interest free loans and grants to cover the difference
Source: Adapted from Collins (2000) for 1993-94 t
between the share in GST revenue and the GMA. Accordingly
1999-00 and Madden(2002) for 2000-01.
the CGC has been asked to calculate two sets of relativities, one
based on the sharing of the GST-HCG pool, and the other on
Table 7: Vertical Fiscal Imbalance in Ind
the earlier financial assistance grants on the assumption that the
old system continued. Appendix Al gives the difference between 1993-94 1995-96 1996-97 1997-98 1999-00 2000-01
FAG and GST relativities as assessed in the 2004 Review. Revenue
The receipts: relative share of centre and states in accrual
Centre 60.65 60.67 62.81 60.80 61.60 59.24
relativities differ because, among other things, states have given
up some resources as part of IGA and the amount under States dis- 39.35 39.33 37.19 39.20 38.40 40.76
Expenditures: relative share of centre and states after transf
tribution through GST is larger. Analysing the impact of the IGA,
Centre 42.52 42.80 42.47 43.49 43.17 41.67
in a recent analysis, Collins (2000) observes: "Since the new
States 57.48 57.20 57.53 56.51 56.83 58.33
arrangements will involve the application of newly-calculated
Source: (Basic data): Indian Public Finance Statistics.
GST relativities to a GST funds pool that will be in the order
In the case of receipts from the total interest receipts paid by
of 35 per cent higher than the FAG pool, any inequities in are
the netted out. The relative share of centre and the states in t
HFE process will tend to be magnified over time." is also influenced by their respective shares in borrowing.

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
revenue and health care grants such that, if each made the same A mathematical presentation of the equalisation methodology
effort to raise revenue from its own sources and operated at can be provided, using symbols defined as below:
the same level of efficiency, each would have the capacity to ei = standardised per capita expenditure of state i; yi = expen-
provide services at the same standard". The Australian equalisa- diture disability of state i
tion differs from the Canadian equalisation due to the reference ri = standardised per capita revenue of state i; pi = revenue
to efficiency and standard of services. The Canadian system disability of state i
makes reference only to equalisation in fiscal capacity. In oi = per capita special purpose payment of state i;
Australia, fiscal equalisation looks at both the revenue and ex- ds = per capita budget surplus; di = ds for all states
penditure sides. Ni = population of state i; E Ni = population of all states
The CGC makes reference to 'three pillars' supporting and Subscript's' indicates corresponding numbers for the all-state
guiding the application of equalisation. These are capacity equal- averages.
isation, internal service standards, and policy neutrality. Policy The per capita all-state average grant is given by
neutrality refers to the consideration that state's own policies or gs = es- rs + d - s (1)
choices about services should not directly influence the level of The per capita grant to state i
grants it receives. The CGC's calculations are based on all-state gi = e- ri + d - o ...(2)
averages so that these may reflect average efficiency. These are Here, ei and ri refer to standard
also treated as ensuring policy neutrality being the result of policy for state i, di is the standard bud
decisions of all states. There is a comprehensive coverage of the for all states and oi is the given
services provided by the states and the revenues raised by them. standardisations are made in relat
averages which provides the stand
diture and revenue terms can be written as
(a) Equalisation: From Disabilities to Relativities
ei = yi e, ri= Pi rs ...(3)
The CGC recognises that since states have differential fiscal For a given state the standardised
capacities and different demographic, economic, and physical be the summation of standardise
circumstances, there will be differences in their revenue raising categories and standardised revenue
capacities and relative costs of providing services. Relative SPPs are considered exogenously
differences that are beyond the control of individual state mines first the total grants and d
governments are called 'disabilities'. Standards of services as deducting the SPPs (oi) that are t
well as the disabilities are measured relative to the all-state inclusive of the SPPs may be writt
position. grants as g, where
The first step in the equalisation exercise is the preparation g*i =gi+?i (4)
of the standard budget. The standards are equal to all-state There are three wa
averages in expenditures as well as revenues. The Commission GST-HCG transfer
does not consider any exogenous targets or norms. Any departure version, the needs v
from the average per capita expenditure needs to be justified on this purpose, we f
account of cost disabilities. deducting the SPP
The equalisation budget brings together all expense and re- (i) Standardised Mo
venue categories of state budgets. The per capita expense for state-specific terms
each service that the state would incur if it were to provide the the terms in equat
Australian average standard of service is calculated. On the g*i = Yi es - i rs + d ...(5)
revenue side, the per capita revenue each state would raiseand if gi = g - oi ...(6)
it applied the average revenue effort to its revenue base is Thus, the financial assistance
calculated. Expenditure assessment adjusts the standard expenses ed expenditure over asses
to allow for the effects of disabilities. Disabilities are broadly fractions of the all-state ave
classified as use disabilities and cost disabilities, accordingis to common for all states, minu
whether they affect the rate of use or the cost of each unit by ofinclusion.
service. Use disabilities reflect differences between states in the
(ii) Needs Version: Substituting rs-es = ds in (5), we can write
use of services as a result of factors such as population char- what is known as the needs version of the grant equation. Thus,
g*= [(i - l)es + (l-i)rs](7)
acteristics and the availability of private services. Cost disabilities
are influences that affect the cost per unit of service provided
to particular groups or places, e g, large cities or remote areas.Table 8: Main Factors Affecting Revenue and Cost Disabil
Cultural and communication factors can increase the costs of Revenue Bases Factors Affecting Expenditures
providing some services to people from cultural and linguistically
GSP per capita Share of Australian Population
diverse backgrounds. Some cost disabilities arise due to variation
Payrolls of large businesses Proportion of population aged 65 years or over
in inter-state prices as also due to diseconomies of scale. Sales of real estate Proportion of population who are indigenous
On the revenue side, tax bases are generally measured using
Value of commercial/industrial Proportion of population resident in centres of
the value of transaction in each state that would be taxed land 50000 or more
Value of mining production Proportio
under the average tax policy. For example, the value of the payroll
Proportion of population
tax is the estimated annual value of payrolls above a threshold schools
level paid by the private sector businesses and most public' Proportion of population with low income
trading enterprises. Table 8 gives some of the major revenue Relative average weekly earnings
Relative length of arterial roads
and expenditure side factors taken into account in the assessment
of disabilities. Source: Commonwealth Grants Commission, 2004 Review.

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
This indicates that the essence of the exercise is the departure to the Indian tax sharing formula, although the relat
of the disabilities yi and pi from 1. Further, total grants can be to different terms are determined and derived diffe
seen as the sum of expenditure disabilities and revenue disabili- (iv) Total Grants and Relativities: Deriving g from g
ties. This equation also makes clear the difference between the CGC grant for a state can be written as:
Australian and Canadian systems. In the Canadian system only Gi = N g ...(12)
the second term, that is, revenue disability is operative and no The per capita relativ
consideration is given to the expenditure side disability. This relative to the all state
implies that implicitly yi is put equal to 1. The revenue disability fi = gi / gs ...(13)
(pi) in Australia [p 350 of the CGC 2004 Review, Supporting The relativities can be converted into shares:
Information]is measured by the ratio of states i's revenue base si = Gi / ? Gi = gi Ni/gs ? Ni = fi [Ni/ ? Ni] ...(14)
A relativity of below one means that a state requires less than
(bi) and the average per capita revenue base (bs). Thus, pi = bi/bs.
Substituting this in equation 7 and setting yi =1, we have
an equal per capita share of the divisible pool. A relativity above
g = rs - i r = abs - a b ...(8) 1 means that a state requires more than equal per capita share.
where a = r,/ bs, i e, the average taxNorate.
state can have its relativity increased without the relativity
This describes the method of determining untied
of one or more transfers
states being inrelativities are based
reduced. The
Canada (see Rangarajan and Srivastava.
on the2004
averagefor
of theaassessments
discussion).for the five most recently
A third way in which the determination of grants
completed years. Eachcan be
state's written
relativity for a grant year is the
is what might be called the normative gap
average of itsversion. This would
per capita requirement for a share of the pool in
facilitate comparison with the Indianeach system also.
of the five most recently completed financial years. Table 9
(iii) Norniative Gap Version: The termgives
yi relativities
es can also be written
and corresponding shares as
with respect to the
e, yj = es + (yi - ,)e, ...(9) GST assessments in the 2004 review. It is clear that redistribution
From equation (5) is from NSW and Victoria to the other states in comparison to
g= e -P rs + (i - )es + ds ... (10) an equal per capita distribution. Table 10 describes how the
Substituting a.bi for Pi rs, we can write relativities have moved over time between the 1999 Review and
g, = es - a bi + Pj e, + d, [where Pi=(yi
the 2004- Review.
1)] Between the two Review years, the per capita
relativities
The term es can be written as az where z of New South
is a constant Wales and the northern territories have
[es/a=z]
g* = a[z-bi ]+ Pi es + d, ...(11) both gone down. There is a major change in the status of Western
Australia,
The first term is the term comparable to the distance whose share had remained below I until the 2003
criterion
used in the tax sharing formula in India. However, the
Update. It distance
has become a net recipient in the 2004 Review with
from which the revenue base of a state is measured is different
a relativity of more than 1.
in the Indian formulation. The expenditure term is An also compar-
interesting issue that arises is whether equalisation calcu-
able to the supplementary factors representing factors accounting
lations remain valid when the sum of total grants under the CGC
for more than average costs like area and infrastructure.
formula isThe term
different from the GST amount that is to be distributed.
d is a constant and therefore reflects the population term
According to in
the the
equalisation calculations, the total distributable
devolution formula. Thus, the Australian formula amount is,
is comparable
Table 9: Australian States, Population, Income, and 2004 Relativities

States PCGSP* Population# Share in Assessed Share in Excess of Share of
All-state GSP GST Relativity Transfers** Transfers over Share
New South Wales 36505 33.8 35.5 0.86750 29.322 -4.479
Victoria 35810 24.7 25.4 0.86534 21.374 -3.326
Queensland 30727 18.8 16.6 1.05504 19.835 1.035
Western Australia 38664 9.8 10.9 1.03054 10.099 0.299
Southern Australia 29286 7.8 6.6 1.20407 9.392 1.592
Tasmania 25024 2.4 1.7 1.55939 3.743 1.343
Australian Capital Territory 42549 1.6 2.0 1.12930 1.807 0.207
Northern Territories 41472 1.0 1.2 4.26538 4.265 3.265
Australia 34769 100.0 100.0 1.00000 99.836 -0.164
Notes: * Average of 1998-99 to 2002-03.
# 2001-02 based on data from 2001 Census.
** based on GST relativities (average over 1998-99 to 2002-03).
Source: Tables C-11, E-5 and E-8, Report on State Revenue Sharing Relativities, 20
Table 10: Australia, Per Capita Relativities - 1999 Revie
1999 2000 2001 2002 2003 2004

Review Update Update Update Update Review
New South Wales 0.89948 0.90913 0.92032 0.90631 0.89117 0.86750
Victoria 0.86184 0.87049 0.87539 0.86824 0.8701 0.86534
Queensland 1.00687 1.0183 1.00269 1.01174 1.01902 1.05504
Western Australia 0.94793 0.98365 0.97516 0.97592 0.96946 1.03054
Southern Australia 1.2068 1.18258 1.17941 1.19447 1.21215 1.20407
Tasmania 1.60905 1.51091 1.50095 1.55419 1.59948 1.55939
Australian Capital Territory 1.1027 1.11289 1.14633 1.15216 1.14979 1.12930
Northern Territories 4.84429 4.16385 4.02166 4.24484 4.38638 4.26538
Source: Report of Commonwealth Grants Commission, 2004 Review.

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
G* = [(e, - r- + d, - S*) . Ni] ... -15) factors like wages, administrative scale, socio demograph
This amount can be less than or more than the actual GST composition, etc, are common for several components in differe
collections. Suppose that GST is a proportion X of G*, wherecategories of expenditures, and general methodologies have be
X can be equal to or different from 1. developed for treating these disabilities. For disability factors t
GST = X. G* ...(16) are specific to an expenditure component, separate detai
If X = 1, the equalisation calculations
analysis is undertaken. remain va
unless it can be established that standardised
revenues, and budget outcomes would fall or ri
(d) Common Disability Factors
proportion in which actual GST is lower or hig
estimated G*, actual grants may
A discussion not factors
of the disability be consisten
also makes it clear th
equalisation entitlements. the CGC has In a recession,
to resort when
tojudgments at various places, particula
salaries and other cost elements in regard to weights are not
of different likely
factors to
affecting expenditu
proportion as the fall inlevels revenues.
where expenditures Itareis implicit
considered net of userincharg
formula as it is applied that
(i) Wages it Wages
input costs: is and homogeneous
salaries are major costs incurr
In practice, such a condition may
by the states, which rarely
differ significantly be
between me
states. In t
1999 Review, this disability was measured by considering
(b) Features of inter-state differences
Revenue in average weekly earnings in the
Assessment non-sta
sector. This was considered relevant as these differences wer
The main revenue categories analysed
not likely to be affected are
by state policies. payr
The commissi
revenue, stamp duty on averaged
conveyances, financial
the assessments over 10 tran
years and halved the interst
stamp duties
shares and
differences on
on marketable
the basis of judgment. In thesecuri
2004 Review
taxation, insurance taxation, heavy
also, the commission vehicle
found that regist
there are significant wa
taxes, light vehicle registration fees
differentials between states. and taxes,
The underlying wages were w
motor vehicle registrations
above averageand
in New transfers,
South Wales and below otheaverage
Queensland, South Australia and Tasmania.
mining revenue, and contributions by The commission
trading en
each category, the relevant
undertook anrevenue base
analysis of the underlying causesfor each
of the wage
up. The actual revenuesdifferential
from on the basis
allof an states
econometric modelare but considered
adde
these revenues by the aggregate revenue
that the analysis did not 'provide base
a fully adequate basis of
to estimate
the average tax rate. disabilities for the smaller states' [2004 Review: 40]. Specific
Thus, the average tax adjustments
rate were then made
for any to the model results on the basis
revenue hea
a = r/bs ...(17) of judgment.
where r, [= E (ii)
Ri/I Nil
Socio-demographic composition: and
Factors like age, sex, in- bs
state per capita come,revenue
and location account for differences inand
per capita expen- exp
category. ditures. The commission in its 1999 Review assessed socio-
The standardised per capita revenue of a state for a given demographic composition disabilities by applying the Australian
category is given by average use and unit cost weights to the number of people in
= aj* bK. ...(18)
each state in different groups characterised by age, sex, income,
where i refers to the state
location, non-English and
background, j refers
and indigenous status. Use t
Summation of all such terms
and cost weights were over
calculated from national data sets, wher-the r
per capita standardised
ever possible. Judgmenttotal
was used when data revenue
were not available,
ri = pi r, = a bi ...(19) particularly in regard to cost weights for indigenous people living
where a is a weighted average inof
remotethe individual
locations and for people havingall-state average
low English ability.
tax rates.
Similar method was applied in the 2004 Review also except that
additional costs were provided on account of cultural and
(c) Features of Expenditure Assessment linguistic diversity.
(iii) Administrative scale: Some fixed costs are incurred in all
On the expenditure side also assessment is undertaken statesinfor
a providing basic services regardless of the size of
disaggregate way. Techniques of expenditure assessment are In per capita terms, these costs are higher for less
population.
recognised to be the unique part of the CGC methodology populous of
states. The administrative scale factors therefore result
determination of relativities. It is also that componentintoof the relativities for less populous states and lower rela-
higher
methodology that is often criticised for its complexity tivities
and lackfor the more populous states. Here again, the commission
of transparency. had to resort to some judgment. The commission observes "Some
The overall methodology can be seen in three steps. Aggregate
data for fixed costs are available for most expense categories
expenditures are the sum of category expenditures. Each category
or groups of categories but comprehensive estimates call for the
of expenditure consists of a weighted sum of components. Each
use of judgment" [Commonwealth Review 2004: 45].
component is a function of one or more disability factors, i e,
variables relating to which disabilities are associated. The main
expenditure categories that are separately assessed relate to
(e) Adjusting for Specific Purpose Payments
education, health and community services, law, order andThe
public
Specific Purpose Payments (SPPs) are grants from the
safety, culture and recreation, and economic activities. Expen-
Commonwealth to the states for specified services, such as health,
ditures are considered net of user charges. The expenditure
education, roads and the environment. Section 96 of the Con-
relativity [yi] therefore gives a weighted average of the relativities
stitution provides the legal basis for SPPs and other Common-
of the individual expenditures categories. Many of the disability
wealth grants. It stipulates that 'the (Commonwealth) parliament

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
may grant financial assistance to any state on such terms and exercise, SPPs treated by exclusion, and SPPs treated by inclusion
conditions as the parliament thinks fit." in the assessment exercise. Most of the major SPPs are considered
The Commonwealth uses SPPs for a number of reasons. In by inclusion. The effect of the CGC's method of inclusion is
particular, SPPs are given to: to neutralise allocation priorities of the SPPs as higher SPP
(i) Introduce programmes reflecting Commonwealth wishes in allocations would result in lower untied grants and vice versa.
areas of state constitutionals responsibility (the majority of SPPs); Garnaut and FitzGerald (2002) observe in their Review [Final
(ii) impose or encourage national standards (e g, free public Report 2002: 11]: "The CGC effectively overrides the assess-
health and vocational training standards); ments that underlie most SPP allocations, which are determined
(iii) pay states for the delivery of Commonwealth programmes under direct legislative and ministerial authority."
(there are only a few examples of this sort, e g, funding legal
aid for federal law cases); VI
(iv) compensate states for the cost of Commonwealth initia-
Some Issues in Assessment
tives (such as the cost of the states of increased access to pensioner
concessions); and
The outcome of such a comprehensive equalisation exercise
(v) comply with international obligations (e g, payments in
to Australia is to reduce horizontal imbalance in the state ex-
help manage World Heritage areas). penditures. Table 11 shows that this objective is successfully
The SPPs were introduced in the 1920s to provide assistance
achieved. If the Territories are excluded, the actual expenditures
for road construction and debt costs. These remained limitedare
in within a narrow range from the all-state mean. The difference
scope until after the second world war. Following second world
between the minimum and maximum per capita expenditure
war there was a gradual increase in the number of tied grantsrelative to the all-state average is in the range of 19 to 22
programmes, including those for housing, education, agriculture,
percentage points. The per capita expenditure in the Northern
some health programmes and infrastructure development. The territories is however more than double of the all-state average.
SPPs increased markedly in the mid-1970s under the Whitlam This is the outcome primarily of the additional costs of providing
government, with comprehensive funding for education and public
services in this region. The coefficient of variation of the ex-
hospitals and the provision of general purpose grants for local
penditures relative to the average is limited in the range of 7
governments. Since then, SPPs have continued to increase slowly
to 10 per cent if the Territories are excluded. In contrast, the
as a proportion of total Commonwealth funding to the states. outcome of the overall transfer process in India still leaves
The specific purpose grants are administered by the Statutory
considerable horizontal imbalance in the system. It is also clear
Commissions appointed by the Commonwealth government. that states which receive larger grants have larger per capita
These constitute about 20 per cent of the total expenditureexpenditures
of implying larger public sectors in these states.
the states. The distribution of specific purpose payments hingesIn the context of CGC's assessment procedures regarding
on several factors, including the historical distribution, which
horizontal fiscal equalisation, several issues, particularly those
was often arbitrary or reflected Commonwealth's policy priori- related to its impact on efficiency, have been raised from
ties. In applying the equalisation principle, the CGC takes into
time to time. These issues have become even more important
account all operating revenues available including the SPPs, in the context of the transition from sharing the FAG pool
except those quarantined, that is excluded, before calculating its
to sharing a GST-HCG pool. Some of these issues are discussed
relative need for revenue from the GST-HCG pool. below.
The SPPs are subject to individual agreements. which include
a variety of terms and conditions to the grants. They are also
(a) Extent of Redistribution
usually classified as either: payments to the states for programmes
administered by the states or payments 'through' the states, whichThe main outcome of the exercise of horizontal fiscal equalisation
are payments to be passed on to other bodies, principally non
is redistribution of revenue resources among states. The CGC
government schools and local governments. calculates the extent of redistribution compared to a situation
The SPPs have grown substantially in importance over time,
of equal per capita allocations. Table 12 shows that the extent
increasing from 22 per cent of total Commonwealth payment in
1942-43 to 51 per cent of total Commonwealth payments inTable 11: Australia: Horizontal Fiscal Imbalance Per Capita
2001-02. Over time the SPPs have also proliferated in number. Expenditure Relative to All-State Average
(Per cent)
The Commonwealth identified over 120 separate SPPs, many of
which consist of a number of sub-programmes. Questions have 1999-00 2000-01 2001-02
often been raised about the efficiency of maintaining a large number
New South Wales 98.27 95.39 96.30
of small SPP programmes. Since many of the SPPs are in areas
Victoria 90.85 91.01 88.93
Queensland 90.79 98.22 104.44
in which the states have sole responsibility under the Constitution,
Western Australia 113.01 111.91 107.17
questions arise as to whether it is efficient and appropriate for the
Commonwealth to be determining priorities in such areas. Com-
Southern Australia 112.68 106.67 106.29
Tasmania 111.10 112.19 108.31
monwealth conditions on SPPs show substantial variation. Some
Australian capital territory 119.56 126.62 115.38
of the largest SPP programmes (e g, funding for government Northern territories 265.84 266.36 249.00
schools and hospitals) have a limited set of conditions andAustralia 100.00 100.00 100.00
Minimum 90.79 91.01 88.93
provide the states with a relatively high degree of flexibility to
Maximum exc territories 113.01 112.19 108.31
provide services consistent with the general objectives of these
Range 22.22 21.18 19.38
SPPs, whereas small SPP programmes can involve substantial
Coefficient of Variation(exc territories) 10.5 8.7 8.5
Commonwealth oversight and micro management.
Note: Expenditures are compiled from the equalisation budget.
In its assessment exercise, the CGC divides the SPPs into three
Source: Commonwealth Grants Commission, Review 2004, Supporting
main categories: SPPs considered out of scope for the assessment Information.

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
of redistribution has ranged from 11.4 per cent in 1981-82 to (ii) It is possible for the states to adjust their calculated taxabl
a low level of 6 per cent in 2001-02. It is also shown that the capacities by varying tax mixes and tax policies.
extent of redistribution has come down over the years. The extent (iii) Partial measures are not policy neutral - for example,
of redistribution can also be measured in terms of what the donor improvement in rail network of a state might reduce its moto
states would have received on a per capita basis. For example, vehicle tax capacity; on the other hand, improvement of suburban
in 2002-03, on per capita basis, New South Wales and Victoriatransport facilities might lead, through higher land prices, t
together would have received $ 21,951 million, and the amounthigher land tax capacity.
redistributed is 11.3 per cent of this. (iv) Federal tax policies can affect states' taxable capacities
- for example, reduction in capital gains tax rate may through
(b) Revenue and Expenditure Equalisations: raising property prices and property turnover increase revenue
Relative Roles from land taxes and stamp duties.
Collins argues that significant data problems exist in Australi
in measuring global tax bases. He observes [Collins 2000: 53]
The distinguishing feature of the Australian fiscal equalisation
exercise is the importance that is given to expenditure thatside
there are serious data difficulties with state national account
statistics. The narrow tax bases left with the Australian states
equalisation. Revenue side equalisation is practised, for example,
in Canada also, and the two systems in their mechanics are arequite
also an issue as they are poorly correlated with global measure
similar. While in Canada, in the general purpose grant calculation
of fiscal capacity. Favouring the adoption of global measure
only revenue side equalisation is done, Australia undertakes of both
fiscal capacity in the longer run, he observes (p 53): "While
revenue side and expenditure side equalisation. Interestingly, as
the balance of the argument might lie with the use, in the lon
Table 13 indicates, expenditure equalisation is the stronger run, of global rather than partial measures of states' taxabl
influence since the redistribution through expenditure require-
capacities, it does not appear possible at this stage to mount
ment at $ 2,521.4 million is greater than that due to revenueconclusive arguments in favour of either approach." Given the
raising capacity at $ 1,880.7 million. It can also be seen that New tax base of the states in Australia, a tax by tax approac
narrow
South Wales loses more because of its higher revenue raising may have more relevance. The Indian situation is quite differen
as the tax base of the states is much wider.
capacity than on account of assessment of expenditure require-
ments. On the other hand, Victoria suffers only because of
expenditure equalisation.
(d) Equity Issues
(c) Macro Approach in Revenue Equalisation While the CGC methodology has successfully equalised access
to resources to the states provided they make comparable revenue
As far as the revenue-side equalisation is concerned, the the effect of the scheme of transfers on equity objectives
effort,
approaches in Canada and Australia are quite similar. In both
has often been questioned. Horizontal equity refers to 'equal
cases, a tax by tax approach is followed with the average all-
treatment of individuals in equal circumstances'. Garnaut and
state tax rate being applied to the actual tax base of each state.
The difference is in the nature of taxes themselves. WhileTable
in 12: Total Pool over Years and Extent of Redistribution
Canada, most of the major taxes are used by the provinces
Year Based on Total Pool Amount Proportion
including income and corporate taxes as also the GST, in Australia, Review/ Update of ($ million) Redistributed Redistri
states are left with a very limited and specialised set of taxes. ($ million) (Per Cent)
This also has a bearing on the issue whether a macro approach

1981-82 1981 Review 8202.9 932.4 11.37
1982-83 1982 Review 9217.9 1023.5 11.10
rather than a tax by tax approach would be better. In the Canadian
1985-86 1985Review 11826.3 1205.7 10.20
case, the individual tax bases are more likely to be highly correlated
1988-89 1988 Review 16019.9 1265 7.90
to a macro base than in Australia where the taxes under con-
1993-94 1993 Review 17315.7 1632 9.42
1999-00
sideration are small and specialised. Nevertheless, the issue of 1999 Review 23064.6 1692.1 7.34
2000-01 2000 Update 30506.3 1961 6.43
substituting a macro base for the tax by tax approach has been
2001-02 2001 Update 33209.7 1988.5 5.99
discussed in Australia also. In the macro or global approach each
2002-03 2002 Update 37555.7 2472.4 6.58
2003-04
state is free to choose any combination of utilisation of the tax 2003 Update 38825.2 2747.5 7.08
2004-05 2004 Update 41594.1 3213.7 7.73
bases available to it as long as it produces the same overall revenue
result. The CGC recognises the importance of the global approach
Source: Commonwealth Grants Commission, Review
when it observes: "A global approach assumes that, whatever
Table 13: Relative Contribution of Reven
the legal incidence of a particular form of revenue, its ultimate and SPP Disabilities in the 2004 Review
effective incidence would fall on income or be reflected in the ($ million)
value of production...The type of tax base adopted has impli-
Revenue Raising Expense SPPs Total
cations for the nature of equalisation. The use of global (and Capacity Requirements Redistributed
sub-global) bases tends to imply that equalisation is about the
New South Wales -1159.6 -625.5 69.6 -1715.50
capacity of state to pay tax. The use of tax bases tends to Victoria
imply 488.6 -1871.9 97.9 -1285.40
that equalisation is about the capacity of state governments to
Queensland 262.6 132.4 21.2 416.20
raise revenues" [CGC 1999]. Western Australia -721.2 840.8 0.6 120.20
Southern Australia 668.8 -9.4 -49.9 609.50
Collins (2000: 49-54) shows that use of a global approach leads
Tasmania 327.5 226.3 -37.8 516.00
to results that are quite different from those of a tax by tax approach.
Australian Capital Territory 102.1 -13.7 -6.0 82.40
Northern Territories 31.1 1321.9 -95.6 1257.40
He lists the following arguments against using partial measures,
i e, tax by tax approach in measuring fiscal capacity: All States* 1880.7 2521.4 4 189.4 4591.50
(i) Individual tax bases are not necessarily related directly
Note:to* sum of positive amounts.
state taxpayers' ability to pay. Source: Report of Commonwealth Grants Commission,

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
FitGerald (2002) in their Review note that "There are well known out of high cost locations." They also note that states that are
systematic regional differences in the quality of service available larger recipients of equalisation grants have noticeably larger
to Australians (e g, between metropolitan, provincial, rural and public sectors. Thus, they observe: "there are signs that the
remote areas). Some differences are inevitable, reflecting differ- exceptionally large role of the public sector and exceptionally
ences in costs of provision of services, while others are amenable small role of the private sector in some states that are large
to policy change". They argue that "the CGC's approach has recipients of transfers, notably Tasmania and South Australia,
equalised states' capacity to provide services, not service pro- have changed the political orientation in ways that are unfavourable
vision". In particular they argue that it is possible to base an HFE to growth."
distribution on monitoring and evaluating outcomes without The theoretical literature on equalisation, particularly the
prescribing them. contributions by Buchanan (1950), Scott (1950), Buchanan and
In theory, equalisation has always been about equalising fiscal Wagner (1971), Graham(1964), Gramlich (1985), and Mathews
capacities. Actual outcomes may yet differ because of differences (1993) has looked at the issue of the implications of equalisation,
in policies and preferences as well as efficiency in different states. especially expenditure side equalisation on efficiency in detail.
There is however some evidence of convergence in the provision While Scott had argued way back in 1950 that equalisation is
of services as the proportion of redistribution of the total pool detrimental to efficiency because it impedes mobility of factors
of distribution (Table 12) has steadily come down. of production to locations where they would be most productive,
Buchanan and Wagner have argued that efficiency would be
(e) Efficiency Issues impeded if migration is fiscally induced by states providing more
public goods at lower tax costs. They argued that rich states could
The issue of efficiency in federal arrangements can be con- induce migration by providing higher net fiscal benefit but,
sidered in terms of whether decentralisation of expenditure is eventually due to the existence of congestible goods, the net fiscal
efficiency augmenting, and if that is so, whether equalisation benefit would fall. As too many people migrate to the richer states,
transfers help promote efficiency of the sub-national govern- there would be a loss of efficiency in the economy as a whole.
ments. In the general literature on efficiency implications of This incentive towards excessive migration in their view ought
decentralisation [e g, Oates 1972], the source of efficiency is to be neutralised through fiscal equalisation. Under these cir-
traced mainly either to the possibility of non-uniform pro- cumstances, equalisation is consistent with equity and efficiency.
vision of local public goods based on lower signaling costs of Gramlich (1985) particularly questioned expenditure side
local preferences or to greater competition among juris- equalisation by arguing that this removes any disincentives for
dictions [Breton 1996]. In both cases, however, a variety of people to move from high cost areas to low cost areas and
decentralisation failures [Prud'homme 1995: Breton 2002] therefore raises the overall costs of service provision. He favoured
may constrain the efficiency-augmenting effects. Some of the that no allowance should be made for expenditure disabilities.
cases of decentralisation failure listed, for example, in Breton In response Mathews (1985) had argued that expenditure side
(2002) relate to costs of information, political participation equalisation was an essential ingredient of overall equalisation.
costs, coordination costs, diminishing supply costs, and Grewal and Mathews (1983) also showed that locational choice
dynamic instability arising from unhealthy 'race to bottom' type is usually influenced by private production and consumption
competition. activities rather than by fiscal and other activities of the govern-
In their Review of Commonwealth-state Funding, Garnaut and ments. While there may be a case for making transfers taking
FitzGerald (2002) have summarised in their Final Report several into account cost disabilities due to structural and exogenous
types of efficiency-reducing effects of the transfer arrangements factors, policy-induced disabilities should not be neutralised.
in Australia. They argue that equalising transfers tend to: However, in practice, it is often difficult to separate one from
(i) reduce the incentives for resources to locate in higher the other and measure their impact.
productivity locations:
(ii) reduce the capacity for investment in human resource VII
development in low productivity regions to enhance national
economic potential;
Summary and Conclusions
(iii) increase the overhead and transactions costs of managing As compared to Australia, India has not only a larger number
the system; of states and a larger population but also greater concentration
(iv) discourages the attraction and retention of high-value of population in low fiscal capacity states. Fiscal transfers aimed
mobile resources in an international market; at horizontal equalisation therefore call for larger redistribution
(v) leads to duplication, lack of co-ordination and game play- in India. The differences in the size, heterogeneity and the scale
ing by officials; of problems notwithstanding, the conceptual basis of the transfer
(vi) unduly enlarges the role of the public sector; system in Australia has much relevance for India. At the same
(vii) encourages grant-seeking behaviour, particularly where time, serious difficulties have been noted with the Australian
states have the capacity to influence the CGC's assessed standard system also. Some of the important differences, similarities, and
budget; essential lessons in respect of the vertical and horizontal dimen-
(viii) dilutes incentives for cost reducing reforms; and sions of transfers are summarised below.
(ix) discourages growth promoting policies if the benefits of
(1) The Australian system is characterised by a high degree
growth are mostly transferred to others; of vertical imbalance and centralisation of expenditure. In raising
Garnaut and FitzGerald observe that most of these efficiency revenues, the Indian system is also characterised by high vertical
reducing effects arise from the expenditure side of equalisation: imbalance but somewhat lower than that in Australia. Also,
"It is common to perceive the efficiency costs as arising prin- centralisation of expenditure after transfers in Australia is higher
cipally from compensation for disabilities on the expenditure than that in India. In the context of Australian vertical imbalance,
side, through their tendency to discourage movement of people Mathews(1993) had observed: "It is a paradox that Australia

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
has combined the world's finest system of horizontal fiscal disabilities through incorporation of factors such as area and
equalisation with one of the most vertically unbalanced fiscal infrastructure in the devolution formula. The emphasis has to be
systems. The threat to horizontal fiscal equalisation in Australia on neutralising structural and exogenous cost disabilities. Correct-
arises not from any inherent defects in fiscal equalisation, but ing policy-induced cost disabilities may lead to a loss in efficiency.
from pressures which are being placed on it by continuing failure Separating one from the other is however a difficult task.
to restore vertical fiscal balance. It is the Commonwealth tax (5) The relativities in Australia and the shares in tax devolution
in India are determined using past data. In this, Australia may
monopoly that needs to be dismantled and not the system of fiscal
capacity equalisation". Since Mathews wrote, with the GST have an advantage since they use a rolling forward method
arrangement, vertical fiscal imbalance has gone up rather than for each update of the relativities. The time-lag is therefore
down. Large vertical imbalance may be justified in situations much less in their case than in India. However, in both countries,
the shares are applied to transfers, which are not known in
where horizontal imbalances are large requiring correction through
equalisation transfers. This does not appear to be the case advance.
in The Australian transfer system does not use any pro-
Australia. jections. It treats the grant entitlement emerging from the most
(2) In Australia, the determination of the vertical share of re- recent data as appropriate for the year for which the transfers are
sources to be transferred to the states is not in the hands of the made. In the Indian case, since transfers are to be determined
Commonwealth Grants Commission. It gets determined automati- for a period of five years ahead and since, in addition to tax
cally by the amount of revenues collected under the GST supple- sharing, grants are to be specified in absolute amounts, projec-
mented by the Special Purpose grants which are also in the hands tions are required.
of the Commonwealth government. In India, the Finance Commis- (6) The working of the Australian Loan Council has relevance
sion determines a large part of the transfers in the form of tax for India where consideration of sub-national borrowing in a
devolution under global sharing and grants, requiring it to determineframework of sustainability and macroeconomic stability is
in some way the vertical imbalance. The Finance Commission
desirable. There is need for an institutional arrangement for
transfers are supplemented by the Planning Commission grants and
keeping the growth of central and state debt within prudent
other discretionary grants determined by the central government.
limits and consistent with requirements of macroeconomic sta-
Global tax sharing may have some merits over the sharing of bility.
a In fact, as in Australia, states should be allowed to raise
single tax as in Australia where the collecting agency, namely, the loans in the market subject to agreed limits and there is no need
Commonwealth government has no revenue interest. Deciding for the central government to intermediate. Over time, such an
about vertical transfers facilitates horizontal equalisation and to that
arrangement can lead to better discipline.
extent India has an institutional advantage.
(3) Australia has one of the most elaborate systems of deter-
Appendix A1: Difference between GST
mining equalisation transfers. The Australian equalisation pay- and FAG Relativities
ments are based on explicit principles that aim at enabling states
to provide its citizens services at comparable standards if they Table Al provides a comparison between GST and FAG
are willing to make comparable revenue efforts and are able torelativities as assessed in the Review 2004. Although the CGC
operate at comparable levels of efficiency. The overall approach was not asked to provide estimates in the Review 2004 for the
FAG relativities, i e, relativities calculated with the assumption
to equalisation is with reference to entire transfers as most special
purpose payments are integrated into the equalisation calcula- that the old system of financial grants continued. A comparison
tions. The Australian system is sound in principle but thewith the 2004 GST relativities shows that New South Wales and
methodology adopted particularly with respect to equalisingVictoria gain in the GST relativities as compared to the FAG
expenditure disabilities has made the system unduly complex. relativities. Their FAG relativities have gone down considerably
compared to the corresponding relativities in 1999-00.[3
The system is still grappling with issues of efficiency. From the
Indian perspective, the major lesson to be drawn from the Australian
experience is the need for a clearer enunciation of the equalisationAddress for correspondence:
chrtfc@nic.in
objective and its translation in practice is called for. It may be
practical to consider a macro base for revenue side equalisation
and focus expenditure equalisation in respect of select services Notes
where mobility is limited.
[We had the benefit of discussions with several scholars during our visit
(4) An important feature of the Australian system is its emphasis
to Australia to study the system of fiscal transfers. We wish to thank the
on cost disabilities. In India, some consideration is given to cost
Indian High Commission in Australia, the Consulate General offices in
Table Al: Comparison of GST and FAG Relativities
GST Relativities FAG GST 2004- Share in Popul- Net Aggregate FAG Relativities 2004 FAG Relativities -
2004 Relativities 2004 FAG 2004 ation (2002-03) Loss(-)/Gain(+) Review 1999 Review 1999
(Per Cent Points) FAG Relativities
New South Wales 0.86750 0.80363 0.06387 33.71 2.153 0.89948 -0.09585
Victoria 0.86534 0.83480 0.03054 24.74 0.755 0.86184 -0.02704
Queensland 1.05504 1.10104 -0.04600 19.00 -0.874 1.00687 0.09417
Western Australia 1.03054 1.00781 0.02273 9.81 0.223 0.94793 0.05988
Southern Australia 1.20407 1.30402 -0.09995 7.71 -0.770 1.2068 0.09722
Tasmania 1.55939 1.74908 -0.18969 2.40 -0.456 1.60905 0.14003
Australian Capital Territory 1.12930 1.16529 -0.03599 1.63 -0.059 1.1027 0.06259
Northern Territories 4.26538 5.22706 -0.96168 1.00 -0.964 4.84429 0.38277
Source: Report of Commonwealth Grants Commission, 2004 Review (Tables 3-1,4-2,D-1 1).

49.36.181.184 on Mon, 04 Dec 2023 12:28:16 +00:00
Sydney and Melbourne and the Chancery at Canberra. We would also like - (2004): Report on State Revenue Sharing Relativities, Review 2004,
to thank officials of the Commonwealth Treasury in Canberra and state Canberra.
treasuries and finance departments at Sydney and Melbourne. We also wish - (2004): Report on State Revenue Sharing Relativities, Review 2004,
to thank A G Morris, chairman and M A Nicholas, acting secretary of Supporting Information, Canberra.
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Fiscal Transfers in Australia: Review and Relevance to India

Author(s): C. Rangarajan and D. K. Srivastava

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Fiscal Transfers in Australia

Economic and Political Weekly August 14, 20043709

3710 Economic and Political Weekly August 14, 2004

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richer in mineral resources. The relatively less well-off states are

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3714 Economic and Political Weekly August 14, 2004

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Table 9: Australian States, Population, Income, and 2004 Relativities

Table 10: Australia, Per Capita Relativities - 1999 Revie

1999 2000 2001 2002 2003 2004

3716 Economic and Political Weekly August 14, 2004

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3718 Economic and Political Weekly August 14, 2004

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This also has a bearing on the issue whether a macro approach

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3720 Economic and Political Weekly August 14, 2004

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Table Al: Comparison of GST and FAG Relativities

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National Competition Council (2001): Assessment of Governments' Progress

3722 Economic and Political Weekly August 14, 2004

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