Quietly, Chalmers moves on WA’s dodgy GST deal. Nobody is going to be happy.

A rather large time-bomb, bequeathed to Jim Chalmers by the previous government, is set to explode in just over three years from now.

Usually, when they announce an important inquiry, governments issue a media release. Hold a press conference. Answer questions, even.

Not this time. A few days ago, when the federal Treasurer directed the Commonwealth Grants Commission to review the GST deal struck between the Morrison government and Western Australia, it wasn’t mentioned by anyone. The inquiry’s terms of reference just appeared one day on the Commission’s website with no further explanation.

There are reasons for keeping it quiet. Many billions of dollars are at stake. Neither the Western Australians, the other states and territories, or the Commonwealth, can afford to let them go. This will be a nasty fight.

Barnett ... profligate, wasteful

The current deal, legislated in 2018, followed years of campaigning by the former Liberal Premier of WA, Colin Barnett, and his Treasurer, Christian Porter. They ran one of the most profligate and inefficient governments in the country and were – predictably – in budgetary trouble. They wanted someone else to pay.

Barnett’s campaign was based on the apparently low amount WA received per capita from the GST pool and he wanted more. It was a simple, easily sold case. It was also utterly dishonest.

The way the GST was distributed was based solely on the capacity of a state to raise its own money, and on the particular needs of each for government services – health, education, roads and so on. The idea was that every Australian, regardless of their state, had a right as citizens to services of an equal standard.

The process is called Horizontal Fiscal Equalisation, and it’s one of the most significant forces for fairness and cohesion in the Australian economy and society. It’s been in place since 1936 for a good reason: mucking about with this is dangerous.

Iron ore bonanza

Western Australia received a smaller proportion of the GST pool because its bonanza in mineral royalties gave it much greater capacity to raise its own money than, say, the non-mining states like Tasmania and South Australia. WA’s share of GST revenue sometimes sank to below 40% of the amount it would have got if there had been no needs-based redistribution.

This was thought to be locked in by the Intergovernmental Agreement on Federal Financial Relations. Most people haven’t heard of it but it’s second only to the Constitution as a defining document of the Australian federation. And it says it can’t be changed except by agreement of all the governments involved. There are laws enabling the agreement in all jurisdictions, including the Commonwealth.

Against all precedent, Morrison unilaterally changed the federal law, pushed by three senior WA Liberals, Finance Minister Mathias Corman, Foreign Minister Julie Bishop and his Attorney-General, Christian Porter, now transferred from Perth to Canberra.

From 2018 on, no state would get a GST share less than 70% of the equal-per-capita rate; that will rise to 75% in 2024.

The non-WA states squealed loudly but backed down without a High Court challenge when the federal government promised to make up what they’d lose – but that deal runs out at the end of June 2026. Unless something is done, the other states will find billions coming out of their own budgets and being sent west.

The alternative is for the federal budget to go on being hit with a bill that’s currently running at over $4 billion a year.

When the changes were put to the parliament in 2018, the top-ups to the states were expected to cost $2.8 billion and would only be needed for three years because iron ore prices were expected to come down. Those price assumptions – of around $US50 to $US70 a tonne – were radically (and perhaps deliberately) low. But it helped sell the package.

Reality, inevitably, intervened. Over the past decade, the average price has been $US95.65 a tonne. It dipped below $US50 only for a few months in 2016 but reached $US214.55 a tonne in June 2021.

These prices have brought massive royalties into the WA budget, most of which they now get to keep. And the cost of bailing out the other states has soared. In effect, the Commonwealth has been subsidising a single state at a substantial cost to its own capacity to fund services for everyone.

Paradoxically, Colin Barnett wasn’t around for long enough to benefit. By the time the new regime started, Labor’s Mark McGowan was in power.

By the time the bailout program stops in 2026, it will have cost the federal budget over $21 billion. If mineral prices don’t come down, it will be even more.

But what happens in 2026? The non-WA states cannot afford and will not accept a multi-billion-dollar annual hit on their own budgets. The premiers, including WA Premier Mark McGowan, are talking tough. And it’s getting personal.

“Mark McGowan is the Gollum of Australian politics,” said NSW premier Dominic Perrottet. “You can just picture him over there in his cave with his little precious – the GST.”

McGowan ... Gollum?

McGowan fired back: “He’s got an election coming so he’s just trying to divert attention away from the NSW government, which is a complete and utter basket case.

“We're still funding the other states to a massive degree. The deal was hard-fought. We won't surrender and we'll do everything to make sure we keep it in place.”

McGowan has had similar stoushes with the Labor premiers of Victoria, Daniel Andrews, and South Australia, Peter Malinauskas.

Jim Chalmers is in the middle of a very nasty fight that nobody can win and nobody can afford to lose. Including him.

Using the GST relativities that were in place in 2018-19, immediately before the new system took hold, we can get a good idea of how much each state would have lost if the federal government had not introduced its temporary bailout.

The three biggest states stood to lose well over a billion dollars a year each. Over the period, the cumulative losses would have amounted to over $6 billion in NSW and Victoria, and almost $5 billion in Queensland.

Jim Chalmers’s Terms of Reference to the Grants Commission leave no doubt at all that the Treasurer wants a new framework for the GST, and that he is determined to move away from the current Morrison-Frydenberg-Corman formula.

“The outcome of the review,” the document directs, “will be a revised methodology for calculating the GST revenue sharing relativies, which the Commission will apply to its assessments of GST relativities from 2025-26.”

The choice of the Grants Commission to undertake this review is also revealing. The former government relied on the Productivity Commission to design the system now in place. The economist Saul Eslake said this about that process:

“The terms of reference for the PC inquiry which led to the changes imposed in 2018 were deliberately written in such a way as to almost guarantee that the PC would recommend the sort of changes that WA wanted.

“And that PC inquiry was conducted in a very un-PC like way, with scant regard for the evidence, and with what staffers who worked on that inquiry have since told me was a pre-determined conclusion in mind.”

Chalmers will get a Productivity Commission report anyway – that’s in the legislation – but that won’t be ready until well after June 2026. And he clearly wants something that doesn’t carry the baggage that surrounds that organisation on this issue.

In contrast, the Grants Commission has been a staunch, and even outspoken, advocate for the system that had been in place since 1936. The Terms of Reference also say:

“In undertaking the review, the [Grants] Commission should also take into account the Intergovernmental Agreement … which provides that GST revenue will be distributed among the states is accordance with the principles of horizontal fiscal equalisation.”

This doesn’t mean Dr Chalmers is proposing to ditch the WA scheme altogether: he certainly doesn’t want McGowan to think that. But a scheme which was supposed to give them $2.8 billion has instead delivered over $21 billion.

Anthony Albanese has promised that WA will continue to get favoured treatment. But even Mark McGowan must realise that can’t go on as it is.

There’s a further twist. The High Court has never ruled on whether the federal parliament had the power to unilaterally renounce the terms of such an important agreement as the one defining financial relations of states with the Commonwealth and with each other.

In 2018, the states decided not to bring a case when the federal government promised to bail them out. Perhaps, this time, the court will get that chance. It may turn out to be the best way.

Chalmers has another budgetary headache looming at about the same time.

The Stage 3 tax cuts for the rich come in 2024-25, just a year before the GST bailout scheme is due to end. According to the Parliamentary Budget office, that will take $22.7 billion out of the federal budget in 2026-27, rising every year. In a decade from now, that’s expected to be $36.9 billion.

But Albanese has promised to keep that one too.