Fiscal Equalization in Australian Federalism: Managing Diversity of Size Among Subnational Jurisdictions

Abstract

The Federal Commonwealth of Australia was established in 1901 by six self-governing British colonies of very different sizes. With lucrative customs and excise duties transferred to the Commonwealth, a politics of fiscal equalization quickly emerged among the six Australian States. The less populous States feared economic and fiscal domination. Managed politically for three decades, these fears became the focus of an independent, expert, economic body from the 1930s: the Commonwealth Grants Commission. Principles and methods developed by this body focused on comparative fiscal needs and capacities. In the 1980s, two more subnational jurisdictions joined Australia’s fiscal equalization system, two territories of the Commonwealth granted self-government. This increased the diversity of size among constituent units and led to methodological developments in assessing comparative fiscal capacities, or “relativities.” Two case studies from this recent era show contrasting developments in Australian fiscal equalization. The Northern Territory has maintained a high relativity for over three decades based on its dispersed Indigenous population, reflecting low-revenue capacity and high expenditure needs. Western Australia has developed high revenue capacity, based on royalties from iron ore mining. This has led Western Australia to argue against full fiscal equalization, winning significant concessions in this direction since 2018. Australian fiscal equalization is well institutionalized, but not beyond political challenge and change.

Introduction

Fiscal equalization between subnational jurisdictions has been an important part of Australian politics and public policy since its establishment as a federation in 1901, growing stronger over the decades through developments in the 1930s and 1980s. In recent years, Australia has been recognized internationally as having one of the strongest systems of fiscal equalization among federations worldwide (Brenton, 2020; Dougherty & Forman, 2021). However, this may now be changing. Following legislation in 2018, Australia’s system of full fiscal equalization between subnational jurisdictions, which has lasted four decades, is transitioning to one of partial equalization over a six-year period to 2027. These changes are discussed in the penultimate section. Earlier sections provide an historical account spanning 130 years before the current changes.

Historically, Australian fiscal equalization has managed the diverse sizes of the subnational jurisdictions, primarily in population, but also in economy and land area. Of concern has been the relative financial needs and capacities of different jurisdictions, both to raise revenue and to spend on services in a way that sustains some sense of commonality across the Australian polity. How this concern has been overtaken by the current change is suggested in the last two sections.

This chapter begins with the six self-governing British colonies that came together at the end of the nineteenth century to constitute Australia as “one indissoluble federal Commonwealth.”¹ It progresses through the early twentieth century to the formation of the Commonwealth Grants Commission (CGC) in 1933, which then advised on six-way division of revenues between the states for the next 50 years. A subsequent section notes the addition of two new subnational jurisdictions in the 1980s, two territories of the Commonwealth granted local self-government. This increase from six to eight constituent units also increased the diversity among subnational jurisdictions and coincided with the CGC’s development of a more generalized method for achieving fiscal equalization among them.

Late in the chapter, two divergent cases are explored that have emerged during this period of eight-way fiscal equalization, shaping Australian fiscal federalism into the twenty-first century. The first case concerns the least populous of the Australian subnational jurisdictions, the Northern Territory, with 1% of the national population spread across 17.5% of the national land area. With over a quarter of its population being Indigenous, the Northern Territory has raised questions for Australian federal finances that have not loomed so large in other subnational jurisdictions. The second case explores how a jurisdiction that was once regarded as “small,” Western Australia, has become financially “big” and has used this new status to challenge the established system of full fiscal equalization between subnational jurisdictions.

Constitutional Origins: Foundations for Commonwealth Financial Dominance

In the 1850s, five British colonies in the east and south of the Australian continent were granted self-government: New South Wales, Victoria, Queensland, Tasmania, and South Australia. This self-government was still overseen by Britain however, and by the 1880s a federation movement had emerged focused on the idea of replacing continuing British authority with a central Australian parliament. By 1890, this Australian federation movement had developed to the point of holding conventions of colonial politicians who developed and debated drafts of a constitution for the proposed new Australian parliament. Additionally in 1890 a sixth British colony on the Australian continent, Western Australia, was also granted self-government and began sending representatives to these federation conventions.

As early as the first convention in 1890, it was agreed that the “basic principle” for “distributing powers” between the two levels of Australian government would be that a limited set of specified functions would be assigned to the new central parliament and that “residual powers” would remain with the self-governing colonies that would become states (Norris, 1975, p. 4).² This was seen as following the model of the United States of America and rejecting the centralist model of Canada “which delegated powers to the Provinces and left the residue to the national parliament” (Norris, 1975, p. 4).

Many of the specified powers of the new Commonwealth Parliament came to be set out in 39 sub-sections of Section 51 (s. 51) of the proposed Australian Constitution.³ Some of these specified powers, like defense, immigration, and external affairs, were clearly intended to take over authority from Great Britain.⁴ Others were designed to manage issues that had emerged among the self-governing colonies. Primary among these was inter-jurisdictional trade and commerce, which had become contentious through different customs duties being imposed by and between colonies. Hence the first sub-section of s. 51 of the Australian Constitution gave the new central parliament power to make laws with respect to:

• (i) trade and commerce with other countries, and among the states:

In support of this first power in s. 51, s. 90 gave the new parliament an “exclusive” power to “impose duties of customs and of excise,” while s. 88 stated that these would be imposed “within two years after the establishment of the Commonwealth.” More substantively, s. 92 insisted that “On the imposition of uniform duties of customs, trade, commerce, and intercourse among the States ... shall be absolutely free.”

Together, these four constitutional provisions set the scene not only for free trade and commerce within Australia, but also for the potential financial dominance of the Commonwealth. This potential was reinforced by the second sub-section of s. 51, which gave the new parliament power to make laws with respect to:

• (ii) taxation; but so as not to discriminate between states or parts of states:

The qualifier of this second head of concurrent Commonwealth power in s. 51 expressed an egalitarian ethos which would become a hallmark of Australian fiscal federalism in the years ahead.⁵

Customs and excise duties accounted for three quarters of tax revenue in the self-governing colonies at the end of the 1890s, and the import of giving this power to the Commonwealth was “fully appreciated by the drafters of the Constitution” (Groenwegen, 1983, p. 174). One metaphor used in the 1890s was that a “common tariff’” was the “lion in the way” of Australian federation, which would either kill federation or be killed in achieving it. Writing about the constitutional origins of Australian federalism a century later, Galligan (1995) argued that the lion of common customs was surprisingly easily slain, but that “dividing up its carcass was fiendishly difficult.” He saw the “troubled founders” as wavering between “distribution on a per capita basis and distribution on a contribution basis,” each of which would have “major impact on the financial positions” of some “colonies-cum States” because of “substantial differences in the structure” of their budgets (pp. 216–221). The “outcome was a compromise” blending “contribution and per capita formulas” in the short term, while in the longer term “leaving fiscal distribution ... for the parliament to determine” (Galligan, 1995, pp. 220–222).

For a period of 10 years after federation, s. 87 of the Constitution obliged the new Commonwealth to retain for its own annual expenditure only “one fourth” of “net revenue … from duties of customs and of excise,” with the “balance” to be paid to the several states, or applied toward the payment of interest on debts of the several states taken over by the Commonwealth.

For five years after uniform duties (and thereafter until the Commonwealth Parliament provides otherwise), s. 93 prescribed that customs duties would be “taken to have been collected” in the state of “consumption” of a good and credited to “the several States” accordingly. After those five years, under s. 94, the new central parliament could provide for “the monthly payment to the several states of all surplus revenue of the Commonwealth” on “such basis as it deems fair.”

One other section of the Australian Constitution which laid financial foundations for the years ahead was s. 96, which gave the Commonwealth power to “grant financial assistance to any state on such terms and conditions as the parliament thinks fit.” This set in train claim-making by the less populous states in the early years of the twentieth century because they felt vulnerable to the economic dominance of New South Wales and Victoria. It also led to a later process of Commonwealth intervention in policy areas in which the national parliament had no clearly specified power. These two distinct stories arising from s. 96 are explored in later sections. For now, s. 96 can simply be seen as another constitutional contributor to the potential financial dominance of the new central Commonwealth Parliament and government.

Early Economic Positions, Small State Claims, and Commonwealth Growth

During 1898 and 1899 all six Australian colonies voted at referendums in favor of federation. Majority support was clear, but not overwhelming. The less populous colonies faced a conundrum, which was summarized 75 later as follows:

The small colonies in fact were in a dangerous position. On the one hand should federation not come about, then New South Wales could well go protectionist under William Lyne and thereby deprive them of the one remaining free market on the continent. On the other hand, should a small colony reject the Bill and the others accept, then under the federal tariff the self-isolated colony would be treated as a ’foreign’ state and thereby rendered destitute. Hence the vital question for the small colonies became not could they afford to federate, but rather could they afford not to. (Norris, 1975, pp. 27–28)

In the event, all six colonies joined, avoiding both these scenarios. But the concerns of the small colonies then played out within the new federation, as claim-making under s. 93 then s. 96 of the Constitution.

Table 1 gives some idea of the demographic and economic positions of the six Australian states at the time of federation. New South Wales and Victoria together then accounted for about two-thirds of Australia’s population and production value, particularly in manufacturing. These central more populous states were deeply divided, however, between protectionist Victoria, which derived revenue from a broad range of tariffs, and free-trading New South Wales, which relied on a narrower range of tariffs on intoxicants and “abundant revenue from the sale of public lands” (Galligan, 1995, p. 220). The other four states had populations ranging from 13% (Queensland), through 10% (South Australia), to just under 5% (Tasmania and Western Australia). Among these four, the two outlying states with large land areas, Queensland and Western Australia, contributed more to national production than their population shares, in Western Australia’s case about double. Conversely, Tasmania and South Australia (along with Victoria) contributed slightly less to national production than their population shares (see Table 1).

Table 1 Population and economic “disparities between the colonies at federation,” 1900–1901

While in demographic terms, Tasmania and Western Australia occupied similar positions at federation, in economic terms they were very different. Western Australia had experienced a mining boom in the 1890s and had “revenue and expenditure per capita nearly three times the national average,” based on high tariffs. Tasmania, in contrast, had “a restricted tax base and modest public expenditures,” considerably less than the national average (Galligan, 1995, p. 220). In order to maintain anything like their pre-federation financial positions, both Western Australia and Tasmania needed more than a per capita share in the distribution of Commonwealth revenue from customs and excise, but for very different reasons economically.⁶

Tasmania complained as early as 1903 that it was “not receiving the full share of revenue due to it” under the s. 93 “consumption” state provision for customs duties, due to the “book-keeping system,” and that the uniform Commonwealth tariff was having adverse effects on both “Tasmanian industry and the government’s finances” (May, 1971, p. 3). Western Australia also complained about effects on its finances, and that some of its imports (like sugar) were made unnecessarily expensive by tariffs protecting producers in eastern Australia (May, 1971, p. 3).

By 1906, at annual heads-of-government meetings known as the Premiers’ Conference, the four less populous states were lobbying together for a “system of per capita payments” to come into effect on the expiration of s. 87 in 1910 (May, 1971, p. 4). The Commonwealth agreed to this demand in 1909, with payments of 25 shillings per capita for the next 10 years specified in the Surplus Revenue Act 1910 (May, 1971, p. 5).⁷ Western Australia wanted more however, and immediately negotiated an annual special grant under s. 96, slowly declining over the 10 years.⁸ Tasmania’s ongoing complaints were rewarded in 1910 with a Royal Commission, which a year later “confirmed Tasmania’s losses under federation” and recommended a special grant under s. 96 over the next 10 years (May, 1971, p. 5).⁹ May summarized the situation by 1912 as follows (Fig. 1):

Within the first dozen years of federation, therefore, the governments of both Western Australia and Tasmania were receiving special grants on account of the adverse economic and fiscal effects of federation on their finances. But the declining scales of payment suggest that it was still thought that these states’ financial difficulties were transitory. (May, 1971, pp. 5–6)

Fig. 1

Map: Australia’s six states and two self-governing Commonwealth territories, showing boundaries and capital cities

The other big development during these early years of federation was growth in Commonwealth expenditure, to a level unexpected by the Constitution’s drafters a decade earlier. The new Federal government was now spending all its revenue from customs and excise, and in 1910 ventured into land taxation. Expenditure growth was partly due to Commonwealth expansion into social policy, like invalid and old-age pensions from 1908, but was also due to defense expenditure that was larger than expected, including the development of a standing army. This last expenditure item grew even faster during the second decade of federation, with Australia’s commitment of troops to World War I. Groenewegen has summarized Commonwealth finances of this second decade as follows:

In 1914, a progressive estate duty was introduced and the potential yield of the Federal land tax was increased by widening the base and raising the rates. In 1915, the Commonwealth introduced a progressive income tax, in 1916 an entertainment tax, and in 1916-17 a war-time profits tax. As a result of the war, Commonwealth expenditure rose from $40 million to $200 million which, despite the introduction of new taxes, was substantially financed by borrowing and resulted in the national debt in 1918-19 being $600 million. The enduring legacy of the war was an annual interest bill of approximately $40 million and a liability for repatriation payments which settled down to about $16 million after peaking at $60 million. The war substantially increased the relative size of the Commonwealth budget. (Groenewegen, 1977, pp. 174–175)

This growth of direct Commonwealth expenditure in the second decade of federation did not reduce the grievances of the small states against emerging Commonwealth policy. Tariff increases in 1921, 1926, and 1928 fed the idea that secondary industries developing in New South Wales and Victoria were being protected, along with the finances of those states. The Navigation Act 1921 aimed to “promote the growth of an Australian mercantile marine,” which again the small states feared would be primarily in New South Wales and Victoria. The 1910 legislation for annual per capita grants only lasted until 1920, after which these payments became discretionary for the Commonwealth. Premiers’ Conferences during the early 1920s saw proposals for future revenue sharing put by the states, but debated inconclusively. In 1926, the Commonwealth “lost patience and announced termination of the per capita subsidies” (Maxwell, 1967, p. 3). Rather than a final move, this announcement terminated years of haggling and precipitated finalization of a financial agreement in 1927, in which per capita payments to the states were retained and so too were special disadvantage grants. The main changes of 1927 were that “future Commonwealth and State borrowing was placed under a Loan Council” and “existing State debts were taken over by the Commonwealth” (Maxwell, 1967, p. 3). This increased the Commonwealth’s financial power over the states, even though state treasurers were members of the Loan Council alongside the Commonwealth.

Western Australia’s concerns about tariffs led in 1924 to the Commonwealth announcing a Royal Commission on the Finances of Western Australia as affected by Federation (May, 1971, p. 10). Tasmania sought a similar commission of inquiry focused on its finances in 1925 and, after positive indications from Prime Minister Bruce, prematurely established its own Disabilities Committee to prepare its case (May, 1971, p. 11). The Commonwealth pulled back from a second royal commission on the finances of a state, but the combination of inquiries in Western Australia and Tasmania in 1925–1926 was clearly potent (May, 1971, pp. 12–13). Then in 1927, South Australia appointed its own Royal Commission to examine its deteriorating finances. The Commission argued for a special disadvantage grant for South Australia and precipitated a Commonwealth Royal Commission on this topic in 1929 (May, 1971, pp. 18–19). As a result of this flurry of inquiries, Western Australia and Tasmania continued receiving annual disadvantage grants and South Australia received its first special disadvantage grant in 1929–1930, just as the Great Depression was starting.

From 1929, submissions from Tasmania and South Australia to inquiries of the Commonwealth Parliament’s Joint Committee of Public Accounts began arguing for a permanent body of expert appointees to assess all state claims for special financial assistance. Reports of this Joint Committee on Tasmania in 1930 and 1931 and South Australia in 1931 endorsed this idea (May, 1971, pp. 35, 201). The elevation of Tasmanian Joe Lyons to Prime Minister in January 1932 gave the idea another boost, and by early 1933 a bill was before the parliament for the establishment of a Commonwealth Grants Commission. This was despite lack of enthusiasm from Western Australia, where Lyons had traveled to promote the idea, but had received a hostile reception (May, 1971, p. 37). The Western Australian parliament and people were focused on the idea of secession and held a referendum on this issue in April 1933. Despite a strong pro-secession vote, this came to naught when a British parliamentary committee during 1934 ruled invalid a petition from the Western Australian parliament requesting that the referendum result be given effect.¹⁰ In the meantime Western Australian politicians, along with others, had to consider the Bill before the Australian Commonwealth Parliament in May 1933.

May (1971) has described debate on the Commonwealth Grants Commission Bill as “uninspired,” with many parliamentarians speaking to pet topics and failing “to grasp what the bill was all about” (pp. 37–38). He has argued that despite “widespread concern in the small states, intelligent appreciation of their basic problem was confined to an expert few” and that it was these experts “who provided the real pressure for the creation of the Grants Commission” (May, 1971, p. 38). Nevertheless, the Bill was passed into law without substantial opposition, though the number of Commissioners was reduced from five to three, as too was their term of appointment in years (May, 1971, p. 38).

Table 2 presents population shares of Australia’s subnational jurisdictions each three decades since federation. Focusing on changes from 1901 to 1931, Tasmania and South Australia seem justified in their fears of industrial and population centralization. As Australia’s population grew from 3.8 million to 6.6 million in these three decades, Tasmania’s population share fell from 4.6% to 3.5%, while South Australia’s fell from 9.5% to 8.8%. Conversely, New South Wales’s population share increased from 36.0% to 39.2%, at the expense not only of Tasmania and South Australia, but also of Victoria, whose population share fell most of all in these three decades from 31.6% to 27.5%. There was certainly some justification for thinking that New South Wales was dominating population growth (and hence economic growth) in the southeast of Australia during these first three decades of federation. The situation was somewhat different, however, in the more outlying, large-land-area jurisdictions of Queensland and Western Australia, which both increased their shares of the Australian population significantly in these three decades to 14.2% and 6.6%, respectively. No Australian state was in population decline during these decades, but they were growing at very different rates.

Table 2 Populations of Australian states and territories at 30-year intervals since federation, plus land areas

Later discussion will return to the population numbers for more recent years in Table 2. But for now, changes from 1901 to 1931 set the scene for discussing the role of the new Commonwealth Grants Commission (CGC) from 1933.

Advising on Six-Way General Revenue Sharing: The First 50 Years of the CGC

The first three members of the CGC, appointed in July 1933 for three years, were:

• a Tasmanian economist and former government statistician, L.F. Giblin, who by 1933 had become the Professor of Economics at Melbourne University,

• a Victorian lawyer, former parliamentarian and minister with an interest in public finance, F.W. Eggleston, and

• a South Australian merchant, J.W. Sandford.¹¹

Among these, Giblin was probably the most deeply informed, having been Tasmanian government statistician during the 1920s and part of the Disability Committee preparing that state’s submission to the Commonwealth Parliament’s Joint Committee of Public Accounts during 1930 (May, 1971, p. 21).

Having received submissions from the states in late 1933, these original members produced the CGC’s first report in July 1934. They tried to establish “the principles upon which grants were to be allocated” and a method for annually calculating their amounts. They rejected the common idea that grants should be related to “disabilities” of states flowing from federation and Commonwealth policies, opting instead for “a method of assessment based on budgetary needs relative to certain ‘normal’ standards of expenditure and revenue raising” among the six states (May, 1971, pp. 58–59). Despite adverse reactions, this first report led to larger grants to the three claimant states in 1934–1935 than in the previous year, and the CGC members persisted with their approach in a second report in 1935 (May, 1971, p. 61). By their third report in 1936, these original members of the CGC had consolidated their comparative “needs approach” arguing that “special grants” under s. 96:

are justified when a state through financial stress from any cause is unable efficiently to discharge its functions as a member of the federation and should be determined by the amount of help found necessary to make it possible for that state by reasonable effort to function at a standard not apparently below that of other states. (May, 1971, p. 63)

While this statement of the CGC’s approach was becoming clearer, there was still some opposition, partly because it led to smaller grants for South Australia and Western Australia in 1936–1937 than in the previous year, but partly also because Western Australia was still attracted to the federal disabilities approach and the Commonwealth Treasury had reservations about the comparative fiscal needs approach even though no longer arguing against it. Tasmania also showed in 1936–1937 that, even when accepting the fiscal needs approach, it could produce quite different calculations from those of the CGC (May, 1971, pp. 63–68).

The “outstanding feature” of the CGC’s work during these “formative years,” May (1971) argued four decades later, was that:

it quickly gained the general, if not unqualified, support of states and Commonwealth and was successful in establishing a set of principles and methods as the basis of a system of special grants, which has been received with only minor modification by subsequent Commissioners. (pp. 68–69)

The explanation for this, according to May (1971), was partly the CGC’s status as an “expert and politically independent body,” partly its “reasoned argument,” but also that its “statement of principles” had “something to please everyone” and enabled it “to combine flexibility and broad judgement with at least some appearance of objective scientific analysis” (pp. 69–70). The dominant figure in achieving all this was L.F. Giblin, whose “impressive influence” was “the most outstanding single feature” of these early years (May, 1971, p. 65).

Neither Giblin nor Sandford sought reappointment to the CGC when their terms expired in 1936. They were replaced by G.L. Wood, an Associate Professor of Commerce at Melbourne University, and G.L. Creasey, a Tasmanian accountant. Eggleston remained chair until 1941, at which point he was succeeded by R.C. Mills, Professor of Economics at the University of Sydney. Summarizing membership of the CGC up to 1970, May noted that there had always been “at least one … academic economist” and that appointments implicitly and de facto “have recognized a need to appoint members from the claimant states” (May, 1971, p. 44). Together with a procedure which took submissions from claimant states annually, this pattern of appointments led to the CGC being seen as an expert economic body that was sympathetic to the financial challenges of small states but would take a measured approach.

The CGC turned the raw politics of small state claim-making into a more technical exercise in which state and Commonwealth treasury officials argued fine points of public expenditure, revenue raising, and accounting. Looking back from 1970, May argued that while “the states have generally been in broad agreement” with the CGC’s “principles and methods,” they have “shown little hesitation in pressing their own views against the interests of the other claimant states” when the “interests of individual states have clashed.” He also noted that, while the position of the claimant states appearing before the GCC had been “roughly that of a plaintiff, seeking to establish a case for grants as large as possible, the Commonwealth Treasury cannot be correspondingly regarded as a defendant” (May, 1971, p. 80). He observed that the Commonwealth Treasury had not always been that active in annual discussions, had not always sought to reduce the size of grants, and had “been concerned more with the broader questions of the Commission’s basic approach than with the details of calculations.” One example, which emerged with economic recovery from the late 1930s, was how calculation of  the financial needs of claimant states related to “a budget standard of the non-claimant States” that was in surplus (May, 1971, p. 81). The Commonwealth Treasury argued that a “balanced budget” should set “the upper limit to assistance” and the CGC decided in favor of this approach in 1942, while also noting that the surplus in the non-claimant states was due to “abnormal wartime expenditure and policies” (May, 1971, pp. 81–82). The claimant states argued against this decision, but reluctantly accepted it over the next few years. By 1947, the non-claimant states were back in deficit, and the arguments of the claimant states were now more supportive of a balanced budget standard. By 1957, with the non-claimant states in ongoing deficit, the CGC “reverted to a deficit standard,” as in its early years (May, 1971, pp. 84–85). But Commonwealth Treasury continued into the 1960s to argue for a balanced budget standard.

One of the most significant developments in the history of Australian fiscal federalism was the Commonwealth’s uniform income tax scheme of 1942. One piece of legislation imposed a Commonwealth income tax which had priority over state income taxes. In compensation, another piece of Commonwealth legislation, the State Grants (Income Tax Reimbursement) Act 1942, provided that states who levied no income tax would receive a grant from the Commonwealth equal to their average income tax revenue in 1939–1940 and 1940–1941. Under s. 6 of this Act, a Treasurer of a state could apply to the CGC if they felt that grant was “insufficient to meet the revenue requirements of the state” (CGC, 1995, p. 53). Over the next three years, first Tasmania, then Western Australia, then South Australia, all made such applications, in addition to their more usual annual submissions to the CGC as claimant states under the 1933 legislation. These applications ended in 1946, when the Commonwealth’s uniform income tax scheme transitioned from a temporary wartime measure to an ongoing peacetime feature of Australian federalism (CGC, 1995, p. 58).

The uniform income tax scheme increased the Commonwealth’s financial dominance within Australian federalism, making the states even more dependent on money shared with them by the Commonwealth.¹² Into the 1950s income tax reimbursement grants were the largest amount of money shared, and the formula for doing so was based on population with some adjustment “for sparsity of settlement and proportion of school children” (Prest, 1980, p. 474).¹³ Grants to claimant states based on the annual calculations of the CGC were for smaller amounts. For example, in 1958–1959 the income tax reimbursement pool was £175 million, while the CGC-recommended grants to the three claimant states totaled £20.75 million (Prest, 1980, pp. 474–476).¹⁴ But these smaller amounts determined by CGC calculations were still seen by states as worth pursuing. Indeed, in 1958 both Victoria and Queensland lodged applications (with the Prime Minister) to become claimant states before the CGC (1995, p. 64). These applications were not referred to the CGC, but rather precipitated a special Premiers’ Conference in March 1959 to discuss federal financial relations more generally (CGC, 1995, p. 65; Maxwell, 1967, pp. 13–16).

During the 1950s, the non-claimant states were becoming dissatisfied with their income tax reimbursement grants based on adjusted population, and New South Wales and Victoria even belatedly challenged the Commonwealth’s uniform tax scheme in the High Court in 1957 (CGC, 1995, p. 64; Holmes & Sharman, 1977, p. 140). While these two big-population states lost their High Court challenge, Victoria’s 1958 application to become a claimant state, along with Queensland, was a continuation of the battle. The non-claimant states wanted significant revision of revenue sharing back toward them.¹⁵

While the special Premiers’ Conference in March 1959 was “inconclusive,” it was agreed that the Commonwealth “should develop proposals” for the regular Premiers’ Conference in June that year (CGC, 1995, p. 65). Those proposals sought to expand the large general revenue sharing grants based on an adjusted population formula, and to “reduce to two the number of states which would in future regularly apply for special grants recommended by the Grants Commission” (CGC, 1995, p. 65; Maxwell, 1967, p. 14). The proposals were accepted by the Premiers of the six states, with “minor modifications” and some haggling over grants for that year. The large general revenue sharing amounts would henceforth be called “financial assistance grants rather than tax reimbursement grants” (CGC, 1995, p. 65). South Australia agreed to cease being a claimant state, partly due to the success of its industrial development during the 1950s.¹⁶ This left just Western Australia and Tasmania as claimant states before the CGC during the 1960s.

A consequence of these changes from 1959 was that the special grants recommended by the CGC declined in importance compared to the larger Commonwealth financial assistance grants distributed on the adjusted population formula. The non-claimant states pressed claims for additions to their financial assistance grants through the annual Premiers’ Conferences, while the claimant states focused their special pleading on annual CGC submissions. By 1968 the budgetary significance of Western Australia’s special grant had declined to around 5% of its recurrent revenues, and it decided to withdraw from claimancy status before the CGC in return for a $15.5 million addition to its financial assistance grant for each of the next two years (CGC, 1995, p. 68).¹⁷

With five of six states by 1970 taking their chances with political bargaining over Commonwealth financial assistance grants at annual Premiers’ Conferences, and only Tasmania focused on its annual submission to the CGC arguing for a special grant, the CGC seemed to be fading in significance and possibly destined for abolition (CGC, 1995, p. 69). But in fact, during the 1970s, the CGC had something of a renaissance. In 1970, the Commonwealth decided that “all four less populous States” could in principle be claimants before the CGC, and in 1971 that they would be assessed against a two-state standard averaging New South Wales and Victoria (CGC, 1995, p. 90).¹⁸ Queensland immediately took the opportunity to become a claimant state and remained so throughout the 1970s, receiving substantial special grants (Groenwegen, 1983, p. 178).

In 1973, the Whitlam Labor government passed a new Grants Commission Act which defined the purpose of calculations as “making it possible for a State, by reasonable effort, to function at a standard not appreciably below the standards of other States” (CGC, 1995, pp. 82–83). In addition, Labor moved the Commission out of the Prime Minister’s portfolio into a new portfolio of Special Minister of State, to reinforce its independence. Over the next few years, a new member of the Commission, ANU Professor of Accounting and Public Finance R.L. Mathews, played a major role in moving its calculations to a “direct assessment method,” compared to the previous “modified budget result comparison method” (CGC, 1995, p. 96). This also reflected a broadening of the Commission’s role during the Whitlam years to look at local government financing, in which a modified budget result method was not feasible (CGC, 1995, p. 115).

Under the Fraser Coalition government in 1976, the word “Commonwealth” was restored to the Commission’s name and its role in local government funding was restricted to advising on state-level division of funds (CGC, 1995, pp. 107, 122).¹⁹ More importantly, in 1978 the CGC was tasked, in legislation, with undertaking a general review of “tax sharing relativities” among the states. This led to four reports published over the next decade, which effectively set the foundations for a new era in which CGC “relativities” calculations would be used to determine the distribution of all general revenue, between not only the six states but also the two Commonwealth territories which moved to self-government in the late 1970s (Northern Territory) and late 1980s (Australian Capital Territory). The story of this era of eight-way sharing of general revenue is told in a later section, but first there is a complementary story to be told from the 1920s to the 1970s about Commonwealth use of s. 96 to grant financial assistance to the states for specific purposes.

Specific Purpose Payments: Another S. 96 Story

From 1923 the Commonwealth started making grants to the states specifically for the development of roads. Five percent of money was reserved for Tasmania and the rest was divided among mainland states as described by Jay (1975, p. 67): “three-fifths in proportion to population, two-fifths in proportion to area, as a rough estimate of needs.” States were also asked to match these Commonwealth grants. The motivation for these arrangements was later summarized thus:

These grants represented a supplementation of state expenditures in an area of state responsibilities which was of special interest to the Country Party element in the national government, with some pressure on the states to contribute to priorities determined by the national government. (Jay, 1975, p. 67)

In 1926–1927 the Commonwealth imposed a customs duty on imported petrol and an excise duty on locally produced petrol. Road grants to the states were seen as an appropriate use of revenue from these two duties, now without the requirement of matching contributions from the states. As motoring expanded during the 1930s and 1940s, so too did these specific purpose payments to the states for roads, with a variety of conditions attached over the years (Jay, 1975, pp. 66–86).

A second set of specific purpose payments to the states emerged from 1927, with the Commonwealth agreeing to take on the servicing of state debts through the Loan Council. While these payments to the states were specifically to meet interest charges on loans, Jay has argued that they were more like general revenue sharing in that they “did not compel the states to meet expenditure which they would not otherwise have undertaken,” but rather freed “an equivalent amount of state revenue for expenditure as the states think fit” (Jay, 1975, p. 43). Despite this lack of “effect on State priorities,” these payments to meet interest on state loans were specific purpose payments and are included as such in figures given in Table 3.

Table 3 Commonwealth financial assistance to states, selected years 1942–1943 to 1980–1981

A third set of specific purpose payments from the Commonwealth to the states began in 1946, promoting the development of public housing for people with low incomes (Jay, 1975, pp. 102–105). From then on Commonwealth specific purpose payments to the states became common policy mechanisms, starting in the health field from 1949 (tuberculosis hospitals), in education from 1951 (universities), and spreading rapidly to other policy fields over the next two decades.

All grants of financial assistance from the Commonwealth to the states have occurred under s. 96 of the Constitution, so differentiation of grant types needs to refer to other characteristics. Following summary statistics compiled in the 1980s (Groenwegen 1983), three categories of financial assistance to the states are identified in Table 3, described as general revenue sharing using an adjusted population or tax reimbursement formula, special grants to claimant states based on CGC calculations, and specific purpose payments. Table 3 shows specific purpose payments growing from 23% of Commonwealth financial assistance to the states in 1942–1943, the first year of the uniform income tax scheme, to 35% in 1964–1965, and reaching 54% in 1975–1976 after the centralizing policies of the Whitlam Labor government (December 1972 to November 1975). Under the Fraser Coalition government’s new federalism policy in the late 1970s, state budgetary autonomy was more respected and specific purpose payments dropped back to 45% of Commonwealth financial assistance to the states by 1980. Table 3 also shows how claimant state grants using CGC calculations were only ever in the range 4–6% of total Commonwealth financial assistance to the states and fell well below this during the 1960s and 1970s. The largest category of Commonwealth financial assistance to the states throughout the four decades covered in Table 3, except for a couple of years in the mid-1970s, was “general revenue shared using either an adjusted population or tax reimbursement formula,” outside the CGC’s fiscal equalization calculations. It was the application of CGC methods to this larger pool of money from the 1980s that would confirm the CGC as a central institution of Australian fiscal federalism during in the decades ahead.

Advising on Eight-Way General Revenue Sharing: The CGC’s Relativities Approach Since the 1980s

Under the States (Personal Income Tax Sharing) Amendment Act 1978, the Fraser Coalition government asked the CGC to undertake a review in line with the “principle” that Commonwealth payments to the states:

should enable each state to provide, without imposing taxes and charges at levels appreciably different from the taxes and charges imposed by the other states, services at standards not appreciably different from the standards of the government services provided by the other states. (CGC, 1995, p. 139)

This principle of fiscal equalization between the states had great continuity back to Labor’s 1973 legislation and the first three reports of the CGC between 1934 and 1936. What was changing in the 1970s were the methods and procedures through which this principle was implemented. The direct assessment method suggested that various expenditure disability and revenue capacity factors could be measured in standardized state budgets and summed to give a total state factor, or relativity, compared to all other states. The idea was that these relativities could be applied to all Commonwealth general revenue sharing in all states, on a per capita basis, to produce annual financial assistance calculations which would effectively combine the first two columns of Table 3, the formula-based grants and claimant state grants. States would no longer be divided into claimants, who appeared before the CGC, and non-claimants, who generally did not. Rather all states could make submissions and argue points about expenditure and revenue capacity factors before the CGC, contributing to an annual set of relativity numbers.²⁰

These procedural and method changes were significant, and it took four review reports, published by the CGC in 1981, 1982, 1985, and 1988, to establish them as an acceptable future approach for the principle of fiscal equalization between the states. At each step, there were losers among the states, who had to be convinced that this approach was going to be fair in the longer term, and who argued for short-term adjustments to soften immediate losses (CGC, 1995, pp. 137–158). In addition, in the 1985 review the newly self-governing Northern Territory was added as a seventh self-governing subnational jurisdiction, and in 1988 the Australian Capital Territory was added in anticipation of self-government there from 1989 (CGC, 1995, pp. 158–175, 208–237).

As well as the fiscal equalization principle, which was now well entrenched in CGC legislation, Ministers would regularly add issues to the CGC terms of reference for consideration. In the early 1980s there was an attempt to roll specific purpose health grants back into general revenue sharing, so the CGC was tasked with developing a set of health relativities alongside the more general per capita relativities (CGC, 1995, p. 150). For its 1985 review, the CGC was instructed to “exclude from its assessments payments of financial assistance in 1983–84 ... received by Tasmania” because of the Commonwealth’s 1983 decision to intervene and stop construction of the proposed Gordon-below-Franklin dam (CGC, 1995, p. 159). Another issue which repeatedly emerged was the treatment of state “business undertakings” that were largely off-budget, but which sometimes had recurrent budget implications (CGC, 1995, p. 160).

The differential impact of the 1984 introduction of Medicare on state and territory health systems was a ministerial term of reference for the CGC’s calculations in 1988, requiring again health relativities alongside more general relativities (CGC, 1995, pp. 168, 172). Another ministerial term of reference for 1988 raised ideas of “the efficient allocation of resources across Australia” as a potential counterbalance to the principle of fiscal equalization, to which New South Wales, Victoria, and the Commonwealth Treasury all responded supportively (CGC, 1995, pp. 169, 172–173). The CGC’s response was to acknowledge that fiscal equalization did have “some consequences” for allocative efficiency, but that these were “not serious enough to warrant any significant changes in the manner in which the fiscal equalization process is carried out” (CGC, 1995, p. 173). It argued that it “must respond to its terms of reference by basing its assessments on fiscal equalization considerations alone,” and that it was the “responsibility of governments to resolve any conflict between equalization and efficiency” (CGC, 1995, p. 174).

The CGC’s response to ministerial terms of reference in the 1980s was to explore them while also adhering to the principle of fiscal equalization laid down in its legislation. Responding governments were respectful of the CGC’s focus on fiscal equalization, while also being willing to make short-term adjustments to the financial assistance for particular states. More mundanely, some problems of timing for the 1988 review led the CGC to suggest a five-year review program, with more basic annual updates in between (CGC, 1995, p. 174).

At the Premiers’ Conference in 1988, due to a worsening budget balance, the Hawke Labor Commonwealth government imposed a $650 million reduction in financial assistance grants to the states and territories. The CGC’s relativities from the 1988 review were accepted by all as the basis for distribution, but with the proviso that the “base level” of both “general revenue and hospital grants” for each jurisdiction would not fall below the previous year 1987–1988 (CGC, 1995, p. 175). This was the beginning of a five-year period of financial stringency during which general revenue sharing was constrained, while specific purpose payments to the states and territories returned to over half of Commonwealth financial assistance (Department of Finance, 1996, p. 3; Galligan, 1995, p. 229; Groenwegen, 1994, p. 171). This in turn led to a period in which the states and territories pushed for a guaranteed proportion of Commonwealth financial assistance to be directed to them as general revenue, which the Howard Coalition Commonwealth government delivered in 1999 as part of its introduction of a goods and services tax (GST).

All revenue from the GST would be committed to general revenue sharing with the states and territories in accord with CGC relativities. This was the first time Commonwealth legislation had guaranteed the size of the general revenue sharing pool (Summers, 2002, p. 101).²¹ This intergovernmental agreement on the use of GST revenue was questioned during the first year of the Rudd Labor Commonwealth government in 2008, but re-affirmed, thus making the agreement a more secure bipartisan commitment for the longer term.

The effect of the GST guarantee on federal finances could be seen clearly by 2006–2007. The GCG summarized federal finances at that time as follows:

• The Commonwealth collected 81% of public sector revenue and was responsible for 61% of outlays;

• The states and territories collected 17% of public sector revenue and incurred 33% of outlays;

• The states and territories were, as a consequence, on average dependent on the Commonwealth for 55% of revenue;

• Of this 55%, 32% now came from GST general revenue sharing, while specific purpose payments had declined back below half to 23% (CGC, 2008, p. 8).

Averages, however, are deceptive when there is diversity of size among subnational jurisdictions. Later in the same publication, the CGC noted that around an Australian average of 45% own-source revenue, states and territories varied as shown in Table 4.

Table 4 States and territories, own-source revenue as proportion of total revenue, 1980–1981 to 2006–2007

Raising only 17% of its own revenue over the previous quarter century, the Northern Territory was highly dependent on Commonwealth systems of financial assistance, both through general revenue sharing and specific purpose payments. This is one reason this chapter concludes with a case study of the Northern Territory’s inclusion in the fiscal equalization system within Australian federalism. To do so, another set of figures are introduced, which are the relativities for the states and territories calculated by the CGC for selected years from 1993 to 2021, including all years in which CGC undertook a methods “review” (labelled with an R in Table 5) plus one “update” year ( labelled with a U) between each review. In the 1993 review, the CGC adopted a population-weighted average of all eight subnational jurisdictions as the relativity standard of 1.0 against which each jurisdiction was assessed.²² The CGC (1995) argued that this change in method would make it “easier to understand the model and to follow the changes in the position” of each subnational jurisdiction over time (p. 194). It has also meant that CGC publications since tend to start from 1993 as the base year, due to the complexity of comparisons before then (CGC, 2016).

Figures in Table 5 show stability of relativities over time in most instances, but also some significant changes that have emerged among the subnational jurisdictions over the last three decades. For population numbers at the beginning and end of this thirty-year period, refer to 1991 and 2021 figures in Table 2.

Table 5 Per capita relativities in eight subnational jurisdictions, select years 1993–2020

In the left two columns of Table 5 are the large-population jurisdictions of New South Wales and Victoria, with relativities consistently below (and fiscal capacities above) the weighted national average of 1.0. As a small-population jurisdiction within this heartland of the south-eastern Australian economy, the Australian Capital Territory (ACT) initially also had a relativity below 1.0 in the 1990s but has crept up in the two decades since to 1.1 and occasionally 1.2. The other two small-population, slightly more peripheral, south-eastern jurisdictions of Tasmania and South Australia have relativities consistently above (and fiscal capacities below) those of these three most central jurisdictions. Tasmania sits consistently between 1.5 and 1.9, with South Australia between 1.2 and 1.5.

In the right three columns of Table 5 are the three jurisdictions with land areas over a million square kilometers: Queensland, Western Australia, and the Northern Territory (see bottom line of Table 2 for land areas). Among these large-land-area jurisdictions, our two concluding case studies delve into one instance of stable relativities, Northern Territory, and one instance of significant change, Western Australia.

Northern Territory: Greater Indigenous Population Diversity Which Questioned General Revenue Sharing

It took six reports, from 1979 to 1986, for the CGC (1995) to integrate the Northern Territory into its methods and calculations for fiscal equalization (pp. 213–221). The issues raised were often procedural and administrative, about disentangling Northern Territory finances from the Commonwealth’s and standardizing the budget of the new self-governing jurisdiction in CGC calculations. But there were also more substantive issues to address, which reflected the Northern Territory’s greater demographic diversity compared to any of the six states. With just 1% of the Australian population, spread over 17.5% of the Australian land area, the Northern Territory increased markedly the diversity of size among subnational jurisdictions that was being managed through fiscal equalization (see Table 2). In addition, around a quarter of the Northern Territory’s population identified as Indigenous, which was roughly ten times the national average; plus, a significant portion of this Indigenous population lived outside urban areas in small “discrete Indigenous communities,” ranging in population from a couple of thousand down to under a hundred.

To cope with this greater degree of demographic diversity in the Northern Territory, the CGC developed new expenditure disability factors in its calculations. Among these were a population “dispersion” factor and a “service delivery scale” factor (CGC, 1993b, pp. 37, 55). Also in 1993, the CGC devoted a whole chapter of its main report on relativities to issues around “Funding for Aboriginals and Torres Strait Islanders” (CGC, 1993a, pp. 63–68). This latter noted that the two major Aboriginal land councils in the Northern Territory had made submissions to the CGC in 1993, along with some other Indigenous organizations and the national Aboriginal and Torres Strait Islander Commission (ATSIC).

ATSIC’s submission to the CGC in 1993 “expressed concern” about “inadequate accountability requirements” when subnational jurisdictions were, through CGC calculations, provided with additional funds to “meet identified needs in Aboriginal services programs” (CGC, 1993a, p. 64). The CGC’s response was to point out that it had “no charter … to monitor expenditures” of subnational jurisdictions, either “for Aboriginal-specific programs” or in any other service area (CGC, 1993a, p. 64). Its charter was to advise on general revenue sharing, following the principle of fiscal equalization laid down in its legislation, but not to direct or monitor expenditure in subnational jurisdictions. Another theme in the 1993 submissions from Indigenous organizations was whether the principle of fiscal equalization could be applied to Aboriginal and Torres Strait Islander communities, including in the distribution of ATSIC funds. On this the CGC was more positive, arguing that it was possible and that the CGC had expertise to contribute, but also noting that it “would require a reference from government; the Commission has no power to initiate such an inquiry (or any other) of its own volition” (CGC, 1993a, p. 67).

In 1999, the CGC was given terms of reference by the Commonwealth Minister for Finance to inquire into “the needs of groups of indigenous Australians relative to one another across government and government-type works and services,” and over the next two years it produced a substantial Report on Indigenous Funding (CGC, 2001). But not much came from this work, particularly once ATSIC was destined for abolition from April 2004 (Robbins, 2004).

A third theme in the 1993 submissions to the CGC from Indigenous organizations was that funding for “essential services to remote Aboriginal communities” should be provided “direct to Aboriginal local governing bodies,” rather than as “untied” general revenue to the Northern Territory government (CGC, 1993a, p. 67). This could be seen as a call for local Aboriginal self-government in remote areas. Alternatively, it could be seen as a call for greater use of specific purpose payments, which as part of their conditions would flow to Aboriginal community organizations through the Northern Territory government, rather than leaving decision-making discretion to the Territory (Sanders, 1995, pp. 6–8). Either way, the concern of Indigenous organizations was that general revenue received by the Northern Territory on account of its remote Aboriginal communities and population might not end up being spent on them, but rather on services for non-Indigenous residents in the capital city Darwin (Crough, 1993, pp. 93–99, also Westbury & Dillon, 2019, p. 52). But again, the CGC noted that these matters were “outside the scope” of its “responsibilities” and were for “governments to consider” (CGC, 1993a, p. 67).

What was in scope for the CGC in 1993, and has continued to be since, has been producing an annual relativity figure for the Northern Territory to sit alongside those for the other seven subnational jurisdictions, thereby determining the Territory’s share of general revenue from Commonwealth tax sources. Table 5 shows that the relativity produced for the Northern Territory has been consistently around five during the last quarter century, meaning that the Territory’s share of Commonwealth general revenue is five times what it would be on a per capita basis. In fiscal equalization, this is an order of magnitude bigger than in sharing among the states, either historically or currently. The addition of the Northern Territory since the 1980s has increased the diversity of size of Australia’s subnational jurisdictions and correspondingly increased the degree of horizontal fiscal equalization (HFE).²⁴

The CGC’s 2020 Review identified the main “drivers” of different fiscal capacities among the subnational jurisdictions. On the expenditure side of the ledger, the top two were “population dispersion” and “Indigenous status.” Together these two “socio-demographic characteristics” accounted for “redistribution” away from equal per capita shares of around $5.1 billion across the eight subnational jurisdictions, of which almost $2 billion went to the Northern Territory (CGC, 2020, p. 27). Overall CGC calculations boosted the Territory’s budget above equal per capita shares by about $2.4 billion in 2020–2021, or from $2,598 per capita to $12,410 (CGC, 2020, p. 40). This large Commonwealth contribution, following CGC calculations, means that Northern Territory own-source revenue continues to be under 20% and far below the national average (as seen for earlier years in Table 4).

On the revenue side of the ledger, the CGC’s 2020 Review identified royalties from mining production as the outstanding driver of different fiscal capacities among subnational jurisdictions, accounting for $7 billion of “redistribution” away from equal per capita shares (CGC, 2020, p. 27). This is a useful starting point for our second case study of recent developments in Western Australia.

Western Australia: Becoming Big and Challenging the System

Table 5 shows Western Australia’s relativity sitting close to 1.0 in the period from 1993 to 2004. However, from 2007, this figure fell rapidly, dipping below 0.3 in 2015, before rising back above 0.4 for the last two years presented, 2018 and 2020. The cause of these changes in Western Australia’s fiscal capacity was rapidly expanding iron ore mining, which was producing large, somewhat volatile flows of royalty payments to the Western Australian government.²⁵

Around 2010, the Coalition government in Western Australia started complaining that their state was losing its share of GST revenue due to increasing own-source revenue from mining royalties. This was argued to be unfair and a disincentive to further development based on natural resources (Porter, 2011). Attention to Western Australia’s complaint was initially limited, but by 2015 it was achieving more traction.²⁶ The argument in 2015 was that the iron ore mining boom in Western Australia had dipped, and that CGC calculations were not recognizing this as they relied on rolling financial averages from two to four years prior to the year for which relativities were being calculated. Western Australia ran significant budget deficits from 2015, arguing that it was being penalized for its higher income from mining royalties three to five years before.

In May 2017, Coalition Commonwealth Treasurer Scott Morrison directed the Productivity Commission to undertake an inquiry to “consider the effect of Australia’s system of HFE on productivity, economic growth and budget management for the states and Australia as a whole.” More specific terms of reference reflected Western Australia’s critique, as they mentioned “rolling three averages,” “states heavily reliant on large and volatile revenue streams,” “lagged fiscal impacts,” “the effect of producing a disincentive for a state to develop a potential industry,” and whether the “aim of comprehensively equalizing states fiscal capacities places too great a reliance on broad indicators” and insufficiently recognizes the “different circumstances” of states (Productivity Commission, 2018, v).

Reporting back to the Commonwealth Treasurer in May 2018, the Productivity Commission acknowledged the “strengths” of Australia’s established system of full fiscal equalization, compensating “states for their structural disadvantages,” but also pointed to three “significant weaknesses.” First, there was “scope for the system to discourage state policy” that was “desirable” in both mineral and energy development and tax reform. Second, the system did not “allow states to retain the dividends of their policy efforts,” which both “raises concerns about the fairness of equalisation” and “corrodes public confidence in the system.” And third, the system was “very poorly understood by the public and indeed by most within governments – lending itself to a myriad of myths and confused accountability” (Productivity Commission, 2018, p. 2). More prescriptively, the Productivity Commission recommended a “revised objective for HFE,” which would be to provide subnational jurisdictions with the “fiscal capacity to supply services and associated infrastructure of a reasonable (rather than the same) standard” (Productivity Commission, 2018, p. 18). This, the report argued, would acknowledge “the trade-off between full and comprehensive equalization on the one hand, and fairness and efficiency on the other” (Productivity Commission, 2018, p. 19).

With this critique of the CGC by another expert economic body, the Productivity Commission, the Coalition Treasurer, and Commonwealth Treasury seized the initiative. Although not drawing greatly on the specific reform suggestions of the Productivity Commission, new legislation was quickly devised to change the system presided over by the CGC away from full fiscal equalization. The Treasury Laws Amendment (making sure every state gets their fair share of GST) Act was passed by the Commonwealth Parliament in November 2018. This new law, in the short term, sets a level of GST per capita below which no subnational jurisdiction could fall. This would bring Western Australia’s relativity back up to 0.7 from 2022 (CGC, 2020, p. 1).²⁷ In the long term, the new standard against which jurisdictions would be assessed was to be the fiscally stronger of New Souths Wales or Victoria, plus there was to be a six-year graduated transition period extending to 2027 (CGC, 2022, pp. 1–2).

Table 6 shows the effect of these arrangements in 2022. The “assessed” relativities in the first line reflect the CGC’s full fiscal equalization methods developed over the last four decades. They are, in effect, the next line in Table 5, which could be labeled U2022. Under these full equalization calculations, Western Australia in 2022 had its lowest relativity ever, at 0.15784. This is because iron ore mining in Western Australia boomed again from 2017, and royalty revenue from it more than doubled over the next three years (CGC, 2022, p. 18).

Table 6 Relativities calculated by CGC in 2022 for financial year 2022–2023

The “standard state” relativities in the second line of Table 6 represent where Australia’s system of fiscal federalism is heading in 2027. Western Australia’s relativity is no longer a distinct figure, but rather is matched to the stronger of New South Wales and Victoria, being Victoria at 0.84245 in 2022. To compensate for Western Australia’s increase in relativity in 2022 of roughly 0.7 from the old (0.15784) to the new (0.84245) system, the relativities of all other jurisdictions decrease by about 0.1 (compare first and second lines of Table 6 for seven other jurisdictions). The third line of Table 6 blends the relativities in the first and second lines in a two-thirds/one-third sum as part of the six-year transition arrangements. As this blending produces a relativity for Western Australia in 2022 of 0.38608, this is then increased in the fourth line of Table 6 to the floor of 0.7 set in the 2018 legislation. With this increase in relativity for Western Australia between the third and fourth lines in Table 6, all other seven jurisdictions need to have their relativities pushed down slightly in order to compensate.

While it is the fourth line of Table 6 which gives the relativities that apply to the GST pool in financial year 2022–2023, it is the first two lines which give a clearer sense of the difference between the old system of full fiscal equalization until 2018 and the new system of partial fiscal equalization that Australia is working toward in 2027 because of the 2018 legislation. The CGC has calculated that Western Australia in 2022–2023 is $4.4 billion better off than it would have been under arrangements prior to the 2018 legislation, in a GST distribution pool of $77 billion. Conversely, New South Wales, Victoria, and Queensland are together roughly $3.3 billion worse off and the other four subnational jurisdictions together about $1 billion worse off (CGC, 2022, p. 28). It is reasonable to suggest that by the time the new system is fully implemented in 2027, Western Australia could be more than $10 billion better off, and the other seven jurisdictions similarly worse off than under the pre-2018 full fiscal equalization system.

How and why Western Australia could successfully challenge Australia’s long-established system of full fiscal equalization with relative ease between 2010 and 2018 is an important matter for analysis and debate. Part of the answer goes back to the Howard Coalition government’s 1999 dedication of all revenue from the GST to general revenue sharing between the eight subnational jurisdictions. A decade after its introduction, this allowed Western Australia to focus on how little it was receiving from this Commonwealth revenue pool, rather than analyzing fiscal capacity in more aggregate terms, as the CGC has done for many decades. This narrower focus on distribution of the GST allowed Western Australia to frame its revenue from mining royalties as its own concern, which should not disadvantage its share of the GST pool.²⁸

As substantial fiscal transfers to Western Australia occur over the next few years, with Australia’s transition from full to partial fiscal equalization, the responses of other subnational jurisdictions will also warrant analysis. Under the current legislation, the CGC’s annual calculations will still fully assess each jurisdiction’s fiscal capacity, producing the annual equivalent of the first line in Table 6 for the year ahead. Any jurisdiction which falls below Victoria and New South Wales in this calculation will then be brought up to the level of the fiscally stronger of these states (with a lower relativity), as occurs for Western Australia in comparison with Victoria between the first and second lines of Table 6. This is only likely to occur for a jurisdiction with a very strong own-revenue flow, like Western Australia with mining royalties.

From 2027, the equivalent move as from the first to the second lines in Table 6 will fully determine GST distribution. These calculations will be there for all subnational jurisdictions to see and argue over. A new politics of Australian fiscal federalism will surely emerge, but its terms will be different from the past four decades, in which CGC methods of comparing budget outcomes drove full fiscal equalization between the subnational jurisdictions (Mathews, 1994). Now, the terms of debate are likely to be about what degree of revenue equalization is reasonable, while leaving in place the CGC’s expenditure equalization assessment. Western Australia has already successfully argued that better revenue raising than the stronger of New South Wales or Victoria should be rewarded and supported, rather than diluted by full fiscal equalization.

Concluding Discussion

These developments in recent decades in the Northern Territory and Western Australia illustrate some deep continuities in Australian fiscal federalism, while also, in the latter case, driving the current change away from full fiscal equalization. Since the 1980s the Northern Territory has taken over Tasmania’s prior position as the most low-revenue jurisdiction with the highest expenditure needs. It has shown how strong claims for additional expenditure are sustainable over several decades, based on the demographic and socioeconomic characteristics of a population that diverges significantly from the Australian average. The Northern Territory’s disproportionate sparsely settled Indigenous population enables it to claim expenditure needs that are several multiples higher than any other jurisdiction. Yet, ironically, there has been no mechanism within Australia’s fiscal equalization system to ensure that this is how additional revenue from the Commonwealth is spent. This limitation has made Aboriginal land councils in the Northern Territory enduring critics of fiscal equalization, though they have struggled to find pressure points in the system for their concerns (Sanders, 2021, pp. 27–30). The Northern Territory has shown starkly how Australian fiscal equalization accommodates diversity between jurisdictions, but is less accomplished at managing diversity within a jurisdiction.

In the twenty-first century, Western Australia has resumed its historic role of being a high revenue jurisdiction demanding exceptional consideration within Australia’s fiscal federal system. It has shown how easily equalization of revenue can be argued against as a disincentive to resource-based regional development in a fast-growing subnational jurisdiction, as it did in the early years of federation. This disincentive applies primarily to jurisdictions with large land areas and potential resource endowments, with relatively small shares of national population. With resource development luck, it could one day also apply to the Northern Territory. However, in the timeframe examined here, the Northern Territory has joined the Australian fiscal equalization system more like a big Tasmania than a small Western Australia.

Western Australia and Tasmania are notable for being at opposite ends of a demographic and economic spectrum during the hundred and twenty years since federation. In 1901, both these jurisdictions had just under 5% of Australia’s population. But in the years since, Western Australia’s population share has more than doubled to 10.4%, while Tasmania’s has fallen to 2.1% (see 2021 population figures in Table 2). While discussed together as “small” states within Australian fiscal federalism by May in 1971, the reality was always that Western Australia and Tasmania were small in very different ways. Tasmania was established as an early British colony in 1803 and probably enjoyed its relative economic heyday over the next three decades. Once Victoria was established as a separate colony to its north in the 1830s, Tasmania was almost inevitably destined to struggle as a small peripheral island economy within south-eastern Australia. Western Australia, by contrast, was an outlying late starter among the British colonies. It was far enough away from the eastern colonies to grow as a distinct economic entity, developing its own international trading links.

Western Australia’s higher share of national production compared to population was evident in the 1890s (see Table 1). This lessened during the twentieth century but has re-emerged in the twenty-first. Table 7 gives Australian Gross Domestic Product (GDP) by state and territory at five-year intervals from 1991 to 2021. At the beginning of these three decades, Western Australia contributed 9.7% to Australia’s GDP, which was very close to its population share of 9.5% (see 1991 population figures in Table 2). However, by 2011 Western Australia’s contribution to GDP had risen to 15.6%, and by 2021 to 17.5% (see Table 7), which was well above its 2021 population share of 10.4% (see Table 2). In terms of dollars per capita per annum, Western Australia moved in these three decades from close to the national average GDP ($24,800 compared to $24,200) to almost 1.7 times the average ($135,500 compared to $80,500) (see Western Australia and Australia columns of Table 7). This is reminiscent of the economic position Western Australia occupied at federation after its mining boom of the 1890s. In the 2020s however, Western Australia has double its share of the national population compared to 1901, so its booming share of GDP is of far greater national significance.

Table 7 Australian gross domestic product by state and territory, 1991–2021, current prices

Table 7 shows Tasmania’s contribution to Australian GDP in the last three decades moving from 2.1% to 1.7%. Hence Tasmania is being confirmed as an enduringly “small” state within the Australian federation, both economically and demographically, while Western Australia is emerging in both these dimensions as a “big” jurisdiction, growing rapidly from a small, late starting base. Other patterns in GDP shares among states and territories emerging in Table 7 largely reflect Western Australia’s upward economic and demographic path. Three of the other south-eastern jurisdictions have fallen in their contribution to GDP over the three decades: South Australia from 7.7% to 5.7%, Victoria from 25.5% to 22.9%, and New South Wales from 37.3% to 31.1%. The two self-governing territories have roughly maintained their contributions to GDP over the three decades, at 2% for the Australian Capital Territory and 1% for the Northern Territory. Only Queensland, along with Western Australia, has increased its contribution to GDP in these last three decades. Most of Queensland’s growth in GDP share occurred in the first 15 years from 1991 (14.6%) to 2006 (18.5%), before Western Australia’s growth really began to dominate the national figures.

Putting together figures from Tables 2 and 7, it is clear that the long-term demographic and economic trends in Australia since federation have been away from the south-eastern jurisdictions and toward the north and western jurisdictions. The latter, in the right three columns of Table 2, accounted for almost a third of Australia’s population in 2021, having been less than 20% at the time of federation. In the right three columns of Table 7, Western Australia, Queensland, and the Northern Territory have grown from 25.4% (9.7 + 14.6 + 1.1) of GDP in 1991 to 36.4% (17.5 + 17.7 + 1.2) in 2021.

Analyzing state and territory shares of national population and GDP over time is, of course, a zero-sum game. It should be noted that as Australia’s population has grown from around 6 million in 1930 to 10 million around 1960, 17 million in 1990, and over 20 million in 2020, no state or territory has ever gone into sustained population decline (see Table 2). So, as important as these long-term shifts to the north and west are, they should not be seen as cause for alarm. Indeed to the extent that they lessen the demographic and economic dominance of New South Wales and Victoria, they can be seen as good. But if they are seen as at the expense of Tasmania and South Australia, they can be judged more adversely.

These significant demographic and economic shifts have all occurred under Australia’s strong system of full fiscal equalization, which has been comprehensively in place since the 1980s and was evident in its principles from the 1930s. What future demographic and economic trends may emerge under Australia’s currently emerging new system of partial fiscal equalization is open to speculation. The obvious suggestion is that shifts toward the north and western jurisdictions will likely increase, and that the south-eastern jurisdictions will continue to slowly lose their demographic and economic dominance. Within these two sets of jurisdictions, however, there will also continue to be winners and losers, which will animate the debate over Australian fiscal equalization in the years ahead. Tasmania and South Australia will surely continue to fight for their additional expenditure needs among the five south-eastern jurisdictions, while the Northern Territory will do likewise among the north and western three. Perhaps some lucky jurisdiction will happen upon a natural resource ripe for development and taxation, like Western Australia has with iron ore and mining royalties in recent years. But this will be a chance event if it occurs, and the more likely scenario is that Western Australia alone will remain the one truly “big” revenue jurisdiction within Australian fiscal federalism over the next decade or two.