01/10/2008 - 22:00

Divergence of tax theory, practice

01/10/2008 - 22:00


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NATIONALS WA's Royalties for Regions plan, which is now a key element of the new government's policy platform, is going to be a true test for Colin Barnett and his team as they manage the state's finances.

Divergence of tax theory, practice

NATIONALS WA's Royalties for Regions plan, which is now a key element of the new government's policy platform, is going to be a true test for Colin Barnett and his team as they manage the state's finances.

There was much said about this immediately after the election, when it became clear the Nationals were likely to have the balance of power and their policy of diverting 25 per cent of state royalties back to the regions was not negotiable when it came to power sharing.

The view was that the state is merely a tax collector in a giant money-go-round that converges with the Commonwealth Grants Commission's administration of the massive GST tax revenue distribution.

In other words, the more money we raise in royalties, the less money we get from the GST.

There is some truth in this, though it is not entirely as straight forward as that, at least on an annual basis, according to the numbers I've looked at.

It is true that the grants commission looks at each state's revenue before deciding what to dish out in terms of GST money. The commission's aim is to be equitable in its distribution, including how much money is raised by each state independently through their own taxes and changes, when it calculates what it needs.

At least that's the theory, though it doesn't necessarily work out that way in practice when each case is viewed in isolation.

For instance, the WA Treasury forecast a $353 million cut in the state's share of the GST pool in 2008-09 (the federal Treasury estimate is a $238 million cut in general revenue assistance, which includes GST), a year when WA expected royalty revenue to increase $898 million (not including the North West Shelf).

Over a four-year period looking ahead, though, forward estimates show general Commonwealth grants increasing by 2011-12 by more than $200 million from this financial year as royalties decline by almost $600 million due to anticipated falls in commodity prices.

Overall state revenue was expected to grow by a little over $1 billion to $19.87 billion this financial year, and then level out to $20.69 billion over the three following years, although these are state Treasury figures and they always seem to underestimate what happens in reality.

Going back to 2006-07 and projecting forward to 2011-12, the picture is much like the pundits warn. State revenue goes up, driven by numerous factors, but a clear growth area - mining royalties up $670 million - is largely netted off by a drop in GST revenue, which is down $690 million.

The key factors to observe are the GST revenue fall takes place despite rising population, so our per capita distribution falls more sharply that the 17.3 per cent fall in the unadjusted dollar amount, while royalties are largely driven by commodity prices and, to a lesser extent, output.

WA is not completely powerless to act here, though changes it could make may not be without consequences.

One area is to raise the royalty rate, as I discussed two weeks ago. Despite my basic calculations above, the Commonwealth grants system does allow the state some room to move in this respect.

In its deliberations the grants commission considers the revenue the state earns based on an average Australian royalty, rather than the actual earned. So having a royalty rate above average is advantageous in the revenue-raising stakes.

For instance, in 2006-07, WA earned $1.48 billion from royalties, whereas the grants commission calculated the state's royalty income at $1.39 billion. That's $100 million that wasn't counted in calculating WA's GST allocation, based on a period when iron ore prices were relatively low compared with today.

The reason is because WA's average royalty was 3.39 per cent while Australia's was 3.06 per cent. The latter is used to calculate GST allocations.

WA's value-based minerals production is roughly two thirds of the national output, so increasing the state's royalties will push the national average up but it will always be lower.

The suggestion has been to raise the royalty on iron ore fines - thought to be about 220 million tonnes in output this year - up from the 3.75 per cent currently charged. Iron ore is worth $2 billion in royalties, with about half of that coming from fines, so a 50 per cent increase in the royalty would generate a further $500 million.

Just how advantageous this would be in terms of netting off against the increased national average, is difficult to discern for an amateur economist like I am.

Some suggest this is a moot point anyway, with most new mines or expansions coming under higher royalty regimes than the initial elements of production.

A twisted tax system

HAVING gone through all that, I've really worth reminding ourselves how perverse the commonwealth grants system is, the one we signed up to with the GST.

Basically, from my view, it undermines one of the great strengths of our federal system - that of diversity.

While I know business hates different tax regimes and economists loathe distortions, markets work best when exposed to competition.

But under the system devised to allocate GST, much of the state's power is removed.

Worse, and here's the perverse bit, it actually encourages states to bid up their taxes and charges, because those that charge above the average are better off than those that charge below it.

Certainly, there remain arguments for reducing taxes to win business investment, therefore growing jobs and reducing anti-social issues like unemployment, but it's still at a cost from a pure grants perspective.

This doesn't make sense to me. The system should be designed to allow more flexibility.

For instance, this state pays a price for not having widespread gambling. While we may believe that's a social positive, it's a genuine cost because the grants commission calculates we could have a certain amount of revenue from that and adds that to its assumptions.

Furthermore, WA's non-participation reduces the gaming averages, ensuring other states can grab a little more GST; in effect, our foregone money.

This rewards those who learn to tax highest and clouts those who keep their taxes low. While there are good reasons for this - in the sense that it ensures all states make an effort to bear their weight - it means that competing taxes upwards is the natural direction, and that is not always in the nation's best interest.


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