A very good point Saul. But one aspect of this GST carve up that does not appear to have been considered is whether the richer states are adequately discharging their obligations to their own regional communities.

We know that neither Bracks nor Carr ever recognised the legitimacy of this distribution and one must wonder if this perceived lack of legitimacy extended to the needs of regional NSW and Victoria? Beattie is clearly spending most of his windfall on infrastructure in SE Qld.

And this raises three very interesting consequences of the formation of new regional states in a rejuvenated federalism.

1 The metropolitan states will gain certainty that the money allocated to the new regional states by the Commonwealth will actually be spent there.

2 The delivery of services to the regions from new state capitals will eliminate many of the costs that are currently incurred by trying to deliver the same services from a distant metropolitan capital.

3 The overheads and congestion based inefficiencies involved with service delivery from greenfield sites in the regional state capitals will be much lower than the overheads and congestion costs currently incurred in metropolitan based service delivery.

Consequently, many of the additional costs of service delivey in the regions will be eliminated so the total amount of equalisation tranfers will diminish over time. The regional economies will consolidate around their new capital and maximise the improved purchasing power of their share of GST funds.

The cost of the diseconomies of scale in our major cities are all growing to the point where each additional resident costs more than the average $6,000 per head of state outlays on services. Each new metropolitan resident now generates $6,000 in new GST and other revenue, $6,000 in new expenditure on services and, according to the Bureau of Transport and Communications Economics, another $6,000 cost to the community in congestion costs or infrastructure costs to avoid that congestion.

So there is now a significant national interest in forming new regional states to increase the proportion of service delivery from lower cost regional capitals.

Both article and first respondent make good points and Horizontal Fiscal Equalisation is an important geographical equaliser in the Australian Federation. But it is not without its many, complicated nuances that often serve to stimulate new forms of inequality. One is that the redistribution formula aggragates the taxation tolerance of states' populations but doesn't account for individuals. On average, NSW anc Victorian citizens are able to tolerate higher levels of taxation because of greater income generation capacity across the state compared with poorer jurisdictions.

However, an equity problem of generalising the average income generating capacity of businesses and earning capacity of individuals in states is that it doesn't take account of the individual position. In other words, poor people and low income generating businesses in NSW and Victoria are assessed as having an equal capacity to pay tax as high income earners and generators.

This means that poor people and businesses in NSW and Victoria pay proportionately more tax than rich people and businesses in the, on average, poorer states. So while HFE achieves geographically averaged equality, it also produces greater individual inequality across states.

This equation then perpetuates the problem over time by encouraging low margin businesses and low income people (often retirees) to flee to the poorer states which then enhances the income inequality between the states, makes the flow of taxation even greater and makes the position of the poor individuals in rich states even worse.

Saul Eslakes example of indigenous people - given the relative income poverty of indigenous Australians - provides a wonderful illustration of how this affects the individual. While the Northern Territory (a subsidised jurisdiction) has the highest proportion of indigenous (read poor) people, New South Wales (a donor state) has the highest overall number of indigenous (read poor) people. Thus a very large number of poor indigenous people in NSW effectively subsidise infrastructure for a moderately wealthy population in SEQld via paying higher petrol and gambling taxes, public transport and registration costs, etc, - even if they're not buying houses and paying higher stamp duties.

Not the simple story that Eslake tells.

There are some circular arguments raised in Saul Eslake's article. If NSW & Vic have the highest income from property taxes, high property prices also have a negative effect on state budgets when there is a need to acquire land to build infrastructure such as roads, schools, hospitals etc. This is the reason road & rail tunnels are commonplace now in Sydney when they are not seen much in other cities. As for reliance on payroll taxes, is there any argument for keeping them apart from the financial dependence of the states? If everybody agrees that payroll taxes should be reduced and phased out, it cannot be argued that their greater value in NSW & Vic is an excuse to offset that by redistributing GST revenue to the smaller states.

I think you have missed the point a little. State governments do not need to worry about Australia as a whole as this is the role of the Federal government. State governments are only responsible for what is best for their state and giving money away to other states when there is no surplus for what they want to spend in their state, is not in the best interest for their state.

I don't have sufficient knowledge to comment on the 'fairness' or otherwise of the distribution of NSW State Government expenditures between metropolitan and rural areas in that State. However in Victoria the Bracks Government has been assiduous in attending to the interests of regional Victoria, not least because of the role that regional Victoria played in delivering Labor's unexpected election victory in 1999.

The Australian constitution does provide for the formation of 'new States', and there has been on some occasions since Federation strong support for the creation of new States in northern NSW, the Riverina and far North Queensland. In the end, however these have come to naught.

In response to the points made by 'Shell' and 'PK' I would re-iterate that the Grants Commission's assessments are not solely based on the capacities of the different States and Territories to raise revenue, but also on the relative demand for, and costs of providing, public services. Thus, the Commission recognizes that salaries and land costs are higher in NSW than in other States, and takes that into account in determining NSW's share of GST revenues - however these 'disabilities' on the expenditure side in NSW are outweighed by NSW's 'advantages' on the revenue side.

I doubt that 'poor' Indigenous people in NSW pay much, if anything, by way of State taxes since they typically don't own businesses which pay payroll tax, don't buy or own properties which attract stamp duty and land tax, and probably don't pay a lot of petrol tax either. Hence I don't accept that they are 'subsidizing' relatively affluent people in SE Queensland or elsewhere.

NSW has a higher incidence of tolls on its roadways because the NSW State Government has chosen to provide this type of infrastructure through 'private-public partnerships' and the like rather than by borrowing on its own account. That's a political choice on the part of successive NSW Governments, not something that's been forced on them by the Grants Commission.

My concern with horizontal equalisation is its effects on incentives for economic and fiscal management. Under this process, a state which implements sound economic policies that promote economic growth and expand the tax base loses almost all of the fiscal benefits through a reduced share of the GST pool. Such a state would gain far more revenue by exploiting its tax bases harder than trying to grow the tax base.

A state that implements dumb economic policies that cause its economy to stagnate (think Tassie in the 1990s) does not suffer the full consequences of its incompetence, because its share of the GST pool increases to offset its losses in own-source revenue.

Sauls says:

“At the federal level, no one seriously suggests that those who pay the top marginal income tax rate are entitled to have their tax payments returned to them in the form of an equal amount of federal government spending on them or their families.”

This is quite true, but no serious economist would advocate setting the marginal tax rate at 100% for incomes above the average, and redistributing all the revenues to those on below-average incomes - the effects on incentives would be too perverse. Yet this is pretty much what horizontal fiscal equalisation does to the States.