ON TUESDAY the Baillieu government will greet Victorians with either the state's first budget deficit in a generation, or heavy cuts to government spending, or possibly both. That's not its fault: it's just part of what is happening throughout south-eastern Australia as the high dollar and high interest rates flatten the economy.
Juggling the conflicting demands of economic hardliners and Victorian voters will not be easy. While it will not help Treasurer Kim Wells this time, a report this week. however, offers a whiff of reforms in the wind that could give Victoria more revenue to meet future demands for better infrastructure and quality services, at the same time as running a healthy surplus.
Federal Treasurer Wayne Swan released the interim report by former Victorian Labor premier John Brumby, former New South Wales Liberal premier Nick Greiner and Adelaide director and company healer Bruce Carter on how to reform the distribution of the $50 billion a year that the federal government raises from the GST and hands over to the states.
Victorian and NSW premiers have railed against the system of redistributing money to weaker states since the Pharaohs wore nappies. But until now, they got nowhere, because to change it would be a zero-sum game, and the losers would make more waves than the winners. So federal governments just left it to the Commonwealth Grants Commission to be the umpire deciding how much each state will get.
Back in the 1890s, the framers of the constitution envisaged a Commonwealth with limited powers operating alongside self-sufficient states that ran most areas of government activity: education, health, transport, police etc. But they gave the states' main taxes, customs and excise duties to the Commonwealth, and authorised it to make payments to the states of ''financial assistance ? on such terms and conditions as the Parliament thinks fit''.
Gradually the Commonwealth has acquired more and more power, and more and more revenue. The system has kept changing, and the size of those payments has grown massively - as has the amount taken from the bigger states to give to the smaller ones. On average, 50 per cent of state government revenue now comes from the Commonwealth - half through the GST, half through payments for programs such as hospital and school funding.
The GST money is distributed by the Grants Commission, with the goal of giving each state and territory government the same fiscal capacity, regardless of the size of its revenue base or its spending needs. It calculates this by complex estimates of how much revenue a state could raise if it applied the average of all states' taxes, and how much it costs to deliver the average level of services in every state.
In Victoria, it estimates that the state's relatively small size and its people's concentration in Melbourne means government services are cheaper to deliver than in other states - and far cheaper than in the Northern Territory. So Victoria gets less money than its per capita share, and the NT gets far more. On revenue, Western Australia's $4 billion a year of mining royalties puts it in a far stronger position than anyone else, while Tasmania is the weakest.
Ironically, WA was the first state to line up for federal funds, in 1910. For almost a century, its government received more than its per capita share of Commonwealth payments, often far more. But now that mining royalties have made it the main source of funds to subsidise the weaker states, it has begun rocking the boat deliberately to force change to a system that takes its mineral royalties and shares them around with everyone else.
Now that WA and Queensland have joined Victoria and NSW as donor states - WA as a donor on an unprecedented scale - the political balance has changed. For the first time, reform has become possible: indeed, inevitable.
For 2012-13, the Grants Commission has awarded Victoria 8 per cent less GST money than it would get if the funds were distributed to states on a per capita basis. NSW got 5 per cent less than its share, Queensland 1.5 per cent less. But WA was given 45 per cent less, and it forecasts that by 2014-15 it will get only a third of its per capita share. That is politically challenging.
So the Gillard government appointed the first outside review of how the Commonwealth grants are awarded. The presence of Brumby and Greiner on the panel at first raised alarm in the smaller states: in 2002, as Victoria's treasurer, Brumby attacked one Grants Commission finding with the words: ''Victorians are sick of being ripped off by ramshackle, outdated and blatantly unfair funding arrangements.''
Their interim report, however, suggests they were put on the panel because, as smart politicians, they can judge where the best trade-offs lie, and how far reforms can go without forcing WA or the smaller states and territories to try to derail the whole process.
Their interim report is deliberately blurred, specifying directions rather than detail, ruling some options in and others out, and pointedly pressing states to come up with ideas for solving the drawbacks in what they propose. In broad terms, it gives every child a present, and looks for reforms that would smooth the sharp edges off the current system, rather than overthrow it. And that means it could well succeed in delivering real change.
On one hand, it rules out the ambit claim put by Victoria and NSW for the system to be replaced by per capita funding entitlements, with special needs in Tasmania or the NT , for example, to be met by special federal grants. That claim would have given Victoria an extra $1 billion in 2012-13, but cost South Australia a similar sum and cost the NT almost half its budget.
Instead, the panel expresses interest in returning to the former concept of providing each state with ''comparable'' fiscal capacities, rather than identical ones. It points out that no other federation attempts to provide its states with equal resources. In Canada and Germany, they try to roughly equalise revenue capacity, but not spending; in the US, poor states such as West Virginia and Mississippi are left to do their best with what they have. The report hints that it might be better to define an acceptable minimum standard of service, and equalise capacity only up to that level.
It also rejects WA's ambit claims that each state receive at least 75 per cent of its per capita share of GST revenues, and/or that mineral royalties be excluded from the GST calculations. But the panel does agree, if unconvincingly, with the WA/Queensland claim that the cost of providing mining infrastructure is not adequately recognised by the Grants Commission, and asks the states to suggest how to do it.
It also points the way to sensible reforms. Victoria is understandably ropeable that the Grants Commission is taking away almost half the money the federal government gave us to build the new railway through the outer western suburbs (the ''regional rail link''). The panel suggests that big grants for defined ''nationally important infrastructure'' should be either excluded from the process, or included over time, at a reduced rate.
The interim report has defined the contours within which reform is possible. The states will now weigh in with specific proposals for or against the changes suggested, with a final report to be handed to Swan in August or September.
The panel will also have to report back by then on a second reference Swan gave it: asking how he could use the threat of withholding GST money to force the states to accept the tax reforms he wants. Treasurer, that is not a good idea. But that's another issue, for another day.
