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WA’s $40 billion fraud on the rest of us.

Jim Chalmers has just added $11 billion to the cost of Western Australia’s dodgy GST deal. It’s an extraordinary case of political extortion. But is it even legal? And will WA have to give the money back?

This is a long, sad story.

It’s a story of how cynical politicians in one state were able to manipulate the selfishness of their own people, the ignorance of other Australians and the stupidity of national leaders to make off with $40 billion – and counting – of the nation’s money.

It all starts with the failure of politicians and journalists to understand how the system underpinning state and territory finances – the GST – works. It continues with the determination of one set of state politicians to blackmail the whole nation to pay for their administrative incompetence. And it ends with successive federal governments bowing to naked financial and electoral extortion.

This story is about the corruption of the notion of fairness: of the ideal that all Australians deserve the same benefits of the economy, no matter which state they live in. It traduces the principle that we are Australians first and Victorians, Tasmanians – or West Australians – second.

Let’s begin at the beginning.

We’re all in this together. Or are we?

First, we need to understand the way the Goods and Services Tax works to promote the highest ideals of the federation.

Ever since 1901, the Commonwealth’s taxation powers have grown and the states’ have shrunk. The result is called vertical fiscal imbalance – the feds have the money but the states deliver the services.

There’s another problem. Some states are rich, some relatively poor. It’s called horizontal fiscal imbalance. And if nothing was done, all state government services – public hospitals, roads, schools and so on – would be excellent in the rich states and deficient in the others.

Attempts to redress these twin imbalances began in 1910, with grants paid by the Commonwealth to Western Australia. (Until fairly recently, WA received top-up payments at the expense of other states. Only in the last few years has its revenue from minerals royalties reversed the relationship.)

The system finally developed into what we have now. The GST – a tax of 10% on most retail purchases – is distributed to all states and territories on the basis of how much they can raise themselves and on the particular needs of each population. Poor states with greater social needs get a bigger share; the rich ones get less.

Or it did.

Colin Barnett’s big budget problem

The Commonwealth Grants Commission, which distributes money from the GST pool, tries to smooth out volatility by averaging each state’s entitlement over three years. And there’s a further delay of a year while they wait for the figures to come in.

So when a state’s economic circumstances change, there’s a lag before its GST allocations catch up. Every state government knows about this and the wiser ones manage their budgets with this in mind.

Not Colin Barnett’s WA Liberals.

When iron ore prices – and royalties – took off during the mining boom, WA’s GST allocations still reflected the recent past, when minerals earnings were lower. So they were simultaneously getting high flows of GST money and huge royalties.

More sensible governments would have known that wouldn’t last and banked the apparent windfall. Barnett, though, spent up big.

Barnett ... improvident
His government was running a profligate budget with high spending on inefficient public services. Its hospitals, for instance, were the least cost-efficient and most wasteful in the country. Rather than reform, they spent.

The crunch was inevitable and hard. When the GST system caught up, the budget was in financial trouble – and Barnett was in political trouble. And he found a way of blaming the rest of the country for his own problems.

Because so much royalty money was flowing into the WA Treasury, its need for financial help from the GST was sharply reduced. In 2015-16, the state received only 30 cents of each dollar of per capita GST revenue. That was because they didn’t need it to provide a national-standard level of services. The principle that all states should have a similar capacity to provide public services was being upheld.

But few people understand how the GST works, so Barnett found an easy political solution: blame the Grants Commission and the equalisation system. It was a simple line: give us our fair share. But the fact that they were already getting their fair share was complicated to explain.

In the west, the idea quickly became mainstream opinion. Almost every news outlet, pundit and politician drank deeply of Barnett’s Kool-Aid. So did the senior WA Liberal ministers in the Turnbull and Morrison governments – Mathias Cormann, the finance minister; Julie Bishop, the foreign affairs minister; Christian Porter, the attorney-general; Michaelea Cash, employment minister.

Cormann, now the Paris-based head of the Organisation for Economic Cooperation and Development, was the key driver.

“The proposition that in a federation stronger states should support other states so that all have the capacity to provide similar outcomes for their populations is a good and important principle which we must continue to protect and preserve,” he said in an opinion piece.

“However, an arrangement which puts any one state into the position, as it has WA in the past, where it receives less than 30 per cent of its share of the GST back as a result of fiscal equalisation cannot possibly be sustained.

“All WA’s federal Liberal members and senators have long argued that this unacceptable situation for our home state must be fixed.”

So it was.

What they got, and what it cost

The Western Australians were given a guarantee that their per capita share of the GST pool would never fall below 70 cents in the dollar (rising to 75 cents from 2024-25) and that the basis of redistribution would be changed. Instead of the benchmark being worked out on the basis of the fiscally strongest state (WA) it would be on the second strongest – New South Wales or Victoria. Essentially, WA would be carved out of the system. The changes would be phased in over six years.

The WA budget windfall escalated dramatically and quickly. The Grants Commission reported that between 2021-22 and 2022-23, WA’s per capita share of the GST pool would rise from 4.4% to 7.3%: in dollar terms, it went from $3.199 billion to $5.682 billion in a single year. And that wasn’t the end.

The snag was that if WA got all this extra GST money, all the other states and territories would lose. They objected, so a compromise was cobbled together by which the Commonwealth would bail the system out. WA would still win but the other states wouldn’t lose.

The first couple of years of the bailout would be direct payments from Canberra to Perth; after that, the federal government would put the extra money into the GST pool. The system would last until 2026-27, when – unless further action was taken – the other states would have to foot the bill.

That, the nation was assured, would never happen. The government’s official estimates assumed iron ore prices – and state royalties – would soon fall back to the point at which the guarantees became immaterial. By the fourth year, no further top-ups would be needed.

It would, we were told, cost $2.279 billion over the first four years and then nothing. That would be that.

That, of course, was not that.

The iron ore price did not fall as planned. It went up instead. In successive budgets, the Turnbull and Morrison governments predicted that the price would fall back to $US55 per tonne and stay there. This is what actually happened:

By mid-2021, the price peaked at over $US180/tonne, sometimes going well above $US200. It hasn’t been anywhere near $US55 for quite some time. The most recent budget, brought down by the Labor government in May, increased the forecast from $US55 to $US60/tonne. At the time of writing, it’s around $US130.

Iron ore wasn’t WA’s only boom mineral. The gold price was pretty bullish too.

By the time the May 2023 budget was released, when the scheme had been running for just five years, the cost to the Commonwealth federal budget had blown out to over $8 billion. That’s almost four times the amount the whole scheme was supposed to cost in its entire lifetime.

That, though, is just the beginning.

By the time the original scheme was scheduled to end, in 2027, the cost will be – on the basis of current estimates – $27.4 billion. In the recently released Mid-Year Economic and Fiscal Outlook (page 295, if you want to look) the government estimated the extra three years promised to the states would cost another $11.1 billion, or $3.7 billion for each of the three years. Overall, it brings the total to $38.4 billion.

But those estimates are already out of date. Reality has already mocked the Treasury’s $US60/tonne forecast for iron ore.

Forecasts from the Department of Industry, issued in September – even though they’re a little more realistic than the Treasury’s – also look decidedly shaky. According to them, it should be $US91/tonne, not $US130-plus. And, unlike almost any international analysts, they think it’s going to fall. The statistical group Trading Economics, citing a strong rebound in demand from China, forecasts that it will go close to $US150/tonne by this time next year. Not $US81. And not $US60.

No matter what the government says, the rest of Australia will be paying WA well over $40 billion, and probably closer to $45 billion, by 2030.

How long can the federal government go on with this charade?

Jim Chalmers agreed to that expensive extension because he had no choice. At the 2022 federal election there was a swing to Labor in WA of 10.5%, allowing them to take four crucial seats from the Liberals. Without that swing, the Albanese government would be in minority. The deal didn’t help the Liberals, who introduced it. But abandoning it could be fatal to Labor’s hold on power.

So, whichever party is in power, this massive exercise in political extortion will continue.

But is it legal?

Maybe not.

Most Australians have never heard of the Intergovernmental Agreement on Federal Financial Relations but it rules almost every aspect of our lives. It sets the rules on the way federal and state governments fund hospitals, schools, roads and almost everything else. As a defining document of the federation, it’s second only to the constitution.

Under this umbrella sit many complex, far-reaching accords on the way the federal and state governments work together. That includes the GST.

At the outset, it was stipulated that the base (the items covered by the GST) and the rate (the 10% on goods and services) could not be changed unless all parties agreed. According to the document any change would need:

  • The unanimous support of the state and territory governments;
  • The endorsement by the Commonwealth government of the day; and
  • The passage of relevant legislation by both houses of the Commonwealth parliament.

And it said:

  • “All questions arising regarding this agreement will be determined by the unanimous agreement of the Council of Federal Financial Relations [which comprises state and federal treasurers] unless otherwise specified in this agreement.”

As part of the deal, matching legislation was passed by all state and territory parliaments.

So there it was, or so we thought. WA’s demands could not be satisfied unless all parties agreed, and most parties – the other states and territories – made it clear that they would never agree.

So when Mathias Cormann and his colleagues wanted to appease their noisy state party  and the angry electorate, they had a problem. For a while it looked as if the agreement would stand. Senior ministers were among those who thought so.

“If there is to be a change in the GST, it has to be with the agreement of all states,” Julie Bishop said. “Now, one state can’t demand the federal government change the formula without all states agreeing.”

But then the suggestion was made that this agreement was made by a law of the Commonwealth parliament, and the parliament had the constitutional power to vary its own legislation. And that’s what happened.

If the Morrison government was to avoid electoral punishment in the other states, and a probable High Court challenge, the other five states and two territories had to be bought off. And so they were.

But the question of the constitutional validity of a unilateral move to abandon a key element of such an important agreement remained unresolved. Any state – or any person or organisation with standing in the case – could begin such an action.

This agreement is special. It’s not just another political fix.

Legally, two questions are involved. Was a clause in the GST Act of 1999 – that the rate and base of the GST could not be changed without all parties agreeing – actually binding on the federal government? Did it actually mean anything?

The second question is whether the Intergovernmental Agreement is binding, or whether it has the status of a mere deal of political convenience that can be abrogated at will?

On the first, the prospects for a successful court action are dim. Various eminent constitutional experts have been unanimous that this measure meant nothing at all. A law enacted by the Commonwealth parliament can be changed or repealed altogether by a second Commonwealth law. That’s in the constitution.

“The Commonwealth Parliament cannot abdicate its legislative power,” said Professor Anne Twomey. “The constitution gives the Commonwealth parliament its power to enact tax laws and only an amendment to the constitution could limit or take that power away.”

The second question – whether the Intergovernmental Agreement can be held to be binding – is far less clear. If there’s a reasonable basis for a challenge, it will probably be found here.

The NewsCorp papers commissioned an opinion from Bret Walker, a leading constitutional silk, and a Melbourne junior, Tony Lang. And their opinion was that the Intergovernmental Agreement was just a political deal and that the High Court would not become involved.

It was a bold call – the court had never ruled on anything directly relevant to the case – and the two lawyers based their case on a single paragraph in a paper by Professor Cheryl Saunders (pictured), a leading academic expert on constitutional law at Melbourne University. That paper was actually about something else, and only tangentially touched on the question at hand. There was, apparently, no other authority to draw on.

“These rules [on the exercise of executive power],” Saunders wrote, “do not clearly distinguish intergovernmental agreements from two other more familiar categories of executive instruments: treaties and contracts. Conceptually, an intergovernmental agreement usually falls between the two, bearing the hallmarks of a political agreement, but between parties who lack the sovereign status of treaty partners. An intergovernmental agreement may in some circumstances be able to be enforced as a contract. Usually, however, lack of precision in the terms of the agreement, or the political nature of the undertakings in it, dispel an intention to create binding legal relations and place it beyond the normal authority of courts to enforce.”

Walker .. could he be wrong?
So, Walker and Lang concluded, the Commonwealth had the power to do what it did and the apparently firm stipulations in the agreement had no force.

“The GST intergovernmental agreement would appear to be largely political in nature,” they said. “It is thus most unlikely in our view that a court would be prepared to enforce the GST intergovernmental agreement against the Commonwealth, should the Commonwealth decide to change the rate, base or basis of distribution of the GST without the consent of the states.”

And that seemed to be it. That opinion, Walker’s name and reputation, and such a forceful conclusion, ended all discussion.

But what if he was wrong?

Learned opinions on what the High Court will rule frequently seem to be wrong as often as they are right. It’s frequently said that trying to second-guess the court on complex constitutional matters is a mug’s game. Many governments, including the Albanese government in the recent migration detention case, have discovered that to their considerable embarrassment.

Any dealings between governments are, by their nature, political. So merely being political can’t be the deciding factor. If it was, no agreement could ever be enforceable.

And the deals cited by Saunders in her paper were small affairs, such as land transfer deals. It’s not surprising that the High Court didn’t want to become involved.

Walker and Lang also brushed aside the important question of whether the parties intended that the agreement would be enforceable. Let’s look again at what Saunders said about that:

“Usually, however, lack of precision in the terms of the agreement, or the political nature of the undertakings in it, dispel an intention to create binding legal relations and place it beyond the normal authority of courts to enforce.”

Bishop ... 'Can't happen', she said
There’s a good case that in this instance the parties did believe they were signing a legally binding deal. Otherwise, why would senior ministers, such as Julie Bishop, have said so firmly that it was?

And there was no lack of precision about it. The wording of all those documents – the GST Act, the text of the agreement, and the various state laws enacted under its terms – are quite precise. There is very little room for doubt on the question of intent.

There’s only one way to find out. Unless the High Court makes a finding on the matter, we will never know whether the $40 billion being transferred out of the Commonwealth Treasury to the benefit of a single state is legal or not. And we will never know where the limits are on the power of the federal parliament to make or unilaterally break agreements with other governments.

What if it’s illegal after all?

 If the High Court ruled that the Commonwealth parliament did not have the constitutional power to unilaterally overturn the agreement, all payments made under it would automatically be illegal. They would, in theory, have to be paid back.

The longer it’s left, the more money will be involved. By 2030, as we have seen, the bill will be somewhere above $40 billion.

If that judgement was made today, the bill would be somewhere around $9 billion. The Commonwealth could sue to get the cash back, withhold it from future payments or, as is more likely, forgive the debt.

In that event, the other states may have something to say. Of all Australian governments, only the Commonwealth and WA are running budget surpluses. The others are deep in deficit and falling ever further into debt. Essential services are being neglected.

If the West’s extortion of the rest of Australia is ended, there would be a very good case of redirecting that money into all states. Most Commonwealth payments (unlike the GST) are made on the basis of population share. If $40 billion was shared out that way, this is what each state would get:

Western Australia would keep $4.32 billion of the $40 billion windfall. But the treasurers of every other state and territory could be expected to pursue their share with vigour.

It would be fascinating to watch.



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