Australian Capital Territory

Submission to the GST Distribution Review’s Supplementary Issues Paper of December 2011

March 2012

Table of Contents
1	Overview
2	Introduction
3	Key Question 1 – HFE and tax reform
4	Key Question 2 – Alternative form of GST distribution
5	Key Question 3 – Broader indicators
6	Key Questions 4 and 5 – GST distribution design and policy decisions to be targeted
7	Key Question 6 – Appropriate institutional arrangements
8	Key Questions 7 to 9 - States Incentives in terms of MRRT and PRRT; Position regarding State incentives of MRRT and PRRT; and Factors that influence States’ royalty regimes.

1	Overview
The supplementary Terms of Reference ask the Panel to examine and make recommendations on the possible changes to the form of equalisation to achieve the following objectives:
•	Ensure that HFE does not provide a disincentive to State tax reform;
•	Utilise HFE to provide incentives and disincentives to promote future State policy decisions which improve the efficiency of State taxes and mineral royalties; and
•	Examine the incentives for States to reduce Mineral Resource Rent Tax (MRRT) or Petroleum Resource Rent Tax (PRRT) revenue through increasing State mineral royalties.
The ACT welcomes the opportunity to provide input to Panel’s considerations.
The ACT supports the objective of improving the efficiency of State taxes.  State tax reform, however, will be best pursued through multilateral and bilateral engagements between the Commonwealth and States.  GST distribution formulae are not the appropriate mechanisms to provide incentives for reform and/or disincentives for inefficient taxes.
If pursued jointly through national agreements, Horizontal Fiscal Equalisation (HFE) should not be a disincentive to State tax reform.  In some circumstances, and where a State improves the efficiency of its taxes, HFE could be a disincentive.  This is not a criticism of equalisation as a principle, or how it is implemented in practice; the system achieves its objective.
The ACT considers that the principles of HFE are paramount, and should not be compromised in achieving other desirable objectives, such as removing disincentives for reform.  However, consideration could be given to making some adjustments to assessment methods that involve different measures of tax bases which are less sensitive to policy changes.
2	Introduction
1	This submission responds to the key questions in the Panel’s Supplementary Issues Paper.  
2	The ACT’s position on the original ToR was provided in the Territory’s submission in response to the GST Distribution Review Issues Paper of July 2011 and is available on the GST Distribution Review’s website.  A number of issues raised in that submission are also relevant to this submission.  It is noted that the Supplementary Issues Paper of December 2011 states that these comments, where pertinent to the supplementary ToR, will be considered by the Review Panel.
3	Accordingly, the ACT has not sought to reiterate these views at length unless it has been important to reaffirm certain aspects of our position.  
3	Key Question 1 – HFE and tax reform

Q1. Does HFE provide a disincentive for States to undertake State tax reform?

4	In general, major State tax reform is likely to be pursued through national agreements and common time frames across States and Territories.  In such circumstances, HFE would not be a disincentive for tax reform.
5	It is, however, possible that HFE provides a disincentive if a State/Territory sought to pursue major reform of its own accord in some circumstances.  This could occur through a redistribution of the revenue gains; or a higher revenue raising capacity assessment due to improvement in economic efficiency following reducing or abolishing an inefficient tax.
6	For example:
•	a policy action by a State to significantly reduce the tax rate for conveyancing would lead to an increase in the number of property transactions.  Since the measure of revenue raising capacity (RRC) is the total value of property transferred, a reduction in conveyance duty rates would result in a higher measure of RRC and consequently a reduced GST share; or
•	if a State were to unilaterally abolish conveyance duty in favour of a broad based land tax, for example, and the State had an above average RRC for conveyance duty, the State would be negatively affected by the HFE process.  This is because the State would still be assessed to have an above average capacity to raise conveyance duty, as it would be standard policy for the States to collect conveyance duty, with the State not receiving its actual revenue (as if the tax was no longer assessed by the CGC).
7	Taxation reform invariably involves winners and losers.  In practice economic/revenue benefits of reform provide capacity to cushion the impact of reform.  Sharing of those benefits with other States, while consistent with the HFE principle, may cause reluctance to pursue reform.

4	Key Question 2 – Alternative form of GST distribution

Q2. If so, how could an alternative form of GST distribution be designed that would remove (or at least reduce) this effect? Would this alternative arrangement be desirable overall?

8	It is possible to adjust the Commonwealth Grants Commission’s assessments where a revenue base is highly influenced by the policy actions of a State in order to remove any potential disincentives to undertake reform.  This could be achieved by:
•	using more indirect measures for revenue bases that would be less sensitive to the policy choices made by States; and
•	capturing tax elasticity effects within the measures of the RRC.
9	However, there are issues with the practical application of this approach.  The significant risk is the added complexity.
10	The desirability of any adjustments to assessment methods would depend on the extent to which such changes preserve the fundamental principles of HFE.  The ACT considers that while it is useful and important to remove any disincentives to tax reform, the principles of HFE are paramount.  If the specific assessments cannot be adjusted without compromising those principles, then other avenues outside the CGC framework could be pursued to support state tax reform.
5	Key Question 3 – Broader indicators

Q3. Several submissions have suggested the use of broader indicators to assess revenue raising capacity.  If this was to be done, what indicators should be used?  

11	The ACT has concerns with the general suggestions for the use of broader indicators to assess RRC to increase the simplicity of the current HFE system.  Adopting broad indicators involves an inherent trade-off between simplicity and precision.
12	The ACT considers that a high level of aggregation of assessments and the use of broad indicators would fail to achieve equalisation as they would not adequately or accurately reflect States’ circumstances.  It is acknowledged that there may be some specific assessments where simplification could be achieved without significant loss of differentiations between the various States and Territories’ circumstances.
13	Further discussion of the ACT’s view of broader indicators is provided at Attachment A.
6	Key Questions 4 and 5 – GST distribution design and policy decisions to be targeted 

Q4. How could the GST distribution be designed in order to provide incentives and disincentives for certain State policy decisions?
Q5. If the method of GST distribution was utilised to provide incentives to promote the efficiency of State taxes and mineral royalties, what specific policy decisions should be targeted?  

14	The ACT does not consider that GST distribution should be designed to provide incentives for State policy decisions.  Changes to State policy decisions in relation to taxation would be best pursued through the multilateral and bilateral engagements between the Commonwealth and the States.
15	GST revenue grants from the Commonwealth are untied and available for any purpose.  Utilising GST distribution formulae to actively provide incentives for tax reform, or disincentives for inefficient taxes is contrary to the principles of HFE and the Intergovernmental Agreement.
16	To incentivise the approach for certain State policy decisions implies that a system of HFE is no longer required in Australia or could be diluted.  Obvious issues also arise including what policies come into play; does it apply equally to both revenue initiatives and/or expenditure programs, and who draws the boundaries as to what is in and what should remain untouched.
7	Key Question 6 – Appropriate institutional arrangements

Q6. What would be the appropriate institutional arrangements for determining the State policy to which the incentives would be targeted and assessing States’ progress? 

17	The ACT notes that the supplementary ToR request that the Review be guided by the findings of the AFTS Review relating to existing State taxes and mineral royalties.  The AFTS Review envisaged State tax reform being pursued through national agreements. 
18	State tax reform should be promulgated through the established institutional arrangements, namely, the Council of Australian Governments (COAG) and the Standing Council on Federal Financial Relations (SCFFR).  These institutional arrangements allow jurisdictions to work together to ensure no one party unilaterally decides on the way forward.
19	The ACT Government remains open to progressing State tax reform and will consider any proposals offered, on the basis that the fundamental principles of HFE are not compromised.  
8	Key Questions 7 to 9 - States Incentives in terms of MRRT and PRRT; Position regarding State incentives of MRRT and PRRT; and Factors that influence States’ royalty regimes.

Q7. Do States have an incentive to reduce MRRT or PRRT revenue through increasing State mineral royalties?    
Q8. If there are such incentives, should they be removed, and if so, how?
Q9. What factors influence the structure of States’ royalty regimes? 

20	States’ decisions on mineral royalties will depend on a range of considerations which include their expenditure needs, the economic circumstances, and the extent to which the State would be able to retain the revenue in the context of the HFE.
21	In effect all States, and not just the States increasing mineral royalties, benefit from such increases.  A State that raises its royalties loses a proportion through the impact of equalisation to the other jurisdictions.
22	The ACT recognises the need to protect the MRRT revenue base.  The requirement to effectively place a cap on State mineral royalties, however, overrides State sovereignty, and potentially reduces the overall revenue available to States to deliver services:
23	It is suggested that the Federal Government continue to influence the policies of the mining States outside HFE, such as through direct Commonwealth payments and the use of infrastructure payments.  

 Attachment A 
Broader Indicators
1	As referred to in the CGC’s 2010 Review Report, the initial proposals for measuring revenue bases in the early part of the review process used broad measures without allowances for exemptions, thresholds or progressive tax rates premised on the belief that the assessments would be simpler and more reliable.  Many States opposed those proposals because they did not adequately reflect ‘what States do’.  In particular, it was noted that they did not take account of common features of State revenue raising policies (such as exempting small business from payroll tax and applying progressive tax rates in stamp duty on conveyances and land tax) which have materially different effects across the States. 
2	Instead the CGC measured the taxable part of potential revenue bases and allowed for progressive tax rates by applying an average of the exemptions, thresholds and rates in all States, if it materially affected the GST distribution, reliable data were available, and it was not unduly complex. 
3	The greatest contribution to simplification in the revenue assessments was made by combining several revenues in the other revenue category and not making differential assessments for them. 
4	As a result, the ACT stands by these findings.  
5	To illustrate the point further, real household disposable income (HDI) has been proffered as a suitable indicator.  However, it is noted that the use of HDI as a measure of RRC has a range of weaknesses, such as:
•	HDI is limited as a measure given that land tax is not applied to principal residences;
•	HDI is a global measure that does not capture differences in the propensity of individuals to engage in taxable activities;
•	HDI is a poor measure for taxes paid by corporations, such as, payroll tax, mining tax, commercial and industrial land tax etc; 
•	HDI does not capture the effects of States’ thresholds, exemptions and taxation structures on RRC, nor their differing industry structures and the headquartering of large companies in large cities such as Sydney and Melbourne and the Commonwealth Government’s presence in the ACT and the ACT Government’s inability to levy taxes on the Commonwealth; and
•	definitions of HDI are problematic.

6	It would also be inequitable to introduce sweeping changes via the use of broad indicators for revenue assessments whilst not balancing this with similarly broad indicators for the expenditure assessments.  This would result in asymmetry.