The negligible impact of specific purpose payments and Australia's "New Federalism"

Abstract

The operational key to intergovernmental relations in Australia's federal system of governance is the nature of the financial relations between the different levels of government. Integral to these relations are Specific Purpose Payments (SPPs) transfers. This paper argues that, in most cases, SPPs have similar effects on the pattern of expenditure by States and Territories as have unconditional Financial Assistance Grants. The theory of intergovernmental grants suggests that tied grants with matching conditions attached, and non-matching tied grants that force recipient governments to provide the assisted function at a level above its preference, induce substitution effects upon the recipient government, and so should impinge on their spending options. In Australia, however, this constraint has been removed because of the role of the Commonwealth Grants Commission. The Commission is required to calculate the distributional relativities for the States and Territories according to the principle of fiscal equalisation. In deriving these relativities, the Commission treats SPPs by the so-called inclusion method. This ensures that any intended matching effects of SPPs (explicit or otherwise) are largely compensated for over the period being reviewed. Theoretical and statistical evidence is provided to support these arguments. Hence, with the exception of two special cases, there is no real benefit, and almost certainly real costs (because of the larger bureaucracies associated with the administration of SPPs), to the community in the Commonwealth generally retaining Specific Purpose Payments. Australia's intergovernmental fiscal arrangements, including the relatively high incidence of Specific Purpose Payments, prevent the community from fully enjoying the perceived benefits of the federal system of government. In particular, they fail to act as an effective constraint on the expansionist tendencies of government. Sustainable reform of fiscal imbalance, however, may be difficult to attain because of the effects caused by the interrelationships between Sections 51, 90 and 96 of the Constitution.