Should GST shares be stable or reflect fiscal capacity?

Yesterday, the Commonwealth Grants Commission published its recommended relativities for sharing GST revenue in 2024-25. Western Australia's oversized share has received considerable attention. Equally prominent in many reports are complaints about large changes for other states, such as New South Wales.

The basis of these complaints is that shifts in GST payments from year to year make it difficult for states to prepare their budgets. I understand the basis of this thinking but aiming for predictable payments conflicts with the CGC's principal objective - fiscal equalisation.

The CGC's recommendations for 2024-25 are based on its assessment of state fiscal capacity in 2020-21, 2021-22 and 2022-23. Annual 'relativities' for these years are averaged to arrive at the recommendation. Averaging over three years smooth variations in the series of relativities. By providing its recommendations for 2024-25 before the start of that year, the CGC reduces uncertainty about how much each state will receive when they are preparing their budgets (the total amount of GST and the populations used for calculating pay aren't settled until the second half of 2025).

Combined these features result in recommendations that can poorly reflect the fiscal capacity of states in the year they apply. This can be seen in the chart above, Western Australia's strong fiscal capacity through 2020-21 and 2021-22 wasn't reflected in the relativities recommended (green dots) for those years, but would have taken effect in 2022-23 if a floor hadn't been introduced.

By making the GST payments more predictable in this way, the CGC is making them less effective in equalising fiscal capacity. State treasurer's may be more certain about the amount of GST they will receive, but overall they are less likely to have the fiscal capacity in that year to provide a similar level of services. For example, if a state's revenue raising capacity drops between the assessment period and the application year, they won't receive enough GST to cover this shortfall.

Fiscal equalisation could be improved if the CGC's recommendations:

• applied in the year they are provided - that is, yesterday's recommendations would apply to 2023-24 payments.
• were based on assessment of the most recent year only, rather than an average of three years.

The chart above shows the relativities based on this approach as pink dots. In general, they are a better reflection of the fiscal capacity when they would apply then the current recommendations. This can be seen in the chart below, where the assessed fiscal capacity for the prior year has generally been closer to actual fiscal capacity in any given year than the CGC's recommendations.

If I was a state treasurer, I would prefer this outcome to the certainty provided by the current approach. There are other options for states to smooth revenue over time (borrowing and saving) that don't detract from fiscal equalisation.

Headline chart reproduced below to allow rescaling.