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Optimal fiscal equalisation and its application to Australia

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  • Chris Murphy

Abstract

The first part of this paper develops a theoretical model of fiscal equalisation and uses the model to derive an optimal equalisation formula that has general applicability for federations. If vertical equity is achieved by the central government and horizontal equity by interstate migration, the role of fiscal equalisation is to support an efficient distribution of different labour types across states. The theoretical model draws on Boadway and Flatters (1982) and Albouy (2012), with some Australian-oriented extensions. The resulting optimal formula implies that full equalisation should be applied for the fixed costs of state government and for source-based taxes on natural resources, land and capital. However, equalisation should only correct for difference in fiscal capacities arising from state demographic mixes when applied to the variable costs of state government, residence-based taxes on labour and consumption taxes. Simplifying assumptions of the model are discussed. The second part of this paper applies the optimal equalisation approach to Australia, using the Commonwealth Grants Commission (CGC) assessment for 2017/18 as a base. The effects on consumer welfare of moving from the current Australian full equalisation system to optimal equalisation, partial equalisation or no equalisation are estimated, along with the associated impacts on state populations.

Suggested Citation

  • Chris Murphy, 2017. "Optimal fiscal equalisation and its application to Australia," Departmental Working Papers 2017-12, The Australian National University, Arndt-Corden Department of Economics.
    • Handle: RePEc:pas:papers:2017-12
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    File URL: https://acde.crawford.anu.edu.au/sites/default/files/publication/acde_crawford_anu_edu_au/2017-09/2017-12_murphyc_fiscal_equalisation_of_australian_states_and_territories_wp3.pdf
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    References listed on IDEAS

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    1. James M. Buchanan, 1952. "Federal Grants and Resource Allocation: A Reply," Journal of Political Economy, University of Chicago Press, vol. 60(6), pages 536-536.
    2. Albouy, David, 2012. "Evaluating the efficiency and equity of federal fiscal equalization," Journal of Public Economics, Elsevier, vol. 96(9-10), pages 824-839.
    3. Jeffrey D. Petchey, 2011. "Fiscal Capacity Equalisation of the Australian States," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 44(2), pages 207-214, June.
    4. Robin W. Boadway & Frank R. Flatters, 1982. "Efficiency and Equalization Payments in a Federal System of Government: A Synthesis and Extension of Recent Results," Canadian Journal of Economics, Canadian Economics Association, vol. 15(4), pages 613-633, November.
    5. L. S. Wilson, 2003. "Equalization, Efficiency and Migration: Watson Revisited," Canadian Public Policy, University of Toronto Press, vol. 29(4), pages 385-395, December.
    6. James M. Buchanan, 1952. "Federal Grants and Resource Allocation," Journal of Political Economy, University of Chicago Press, vol. 60(3), pages 208-208.
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    More about this item

    Keywords

    fiscal equalisation; Federalism; Intergovernmental relations; Australia;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
    • J61 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Geographic Labor Mobility; Immigrant Workers

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