EFFICIENCY EFFECTS OF CHANGES IN COMMONWEALTH GRANTS TO THE STATES: A CGE ANALYSIS *

This paper describes CSF, a general equilibrium model encompassing factors of relevance to economic efficiency in Federal/State funding including: interstate differences in tax bases and unit costs of State-provided goods; factor mobility; congestion; State-government behaviour incorporating the possibility that governments in subsidised States embark on expenditures with low benefit/cost ratios (flypaper effects); fiscal externalities; and non-discretionary expenditures in each State associated with special national responsibilities. The model is applied to Australia where Federal/State funding is a major political and economic issue. Welfare effects of moving from the present Australian funding system based on fiscal equalisation to a system of equal-per-capita grants are calculated. CSF implies that the welfare gain from this move would be small. The most important source of potential welfare gain is a reduction in flypaper effects. The recognition of congestion externalities can eliminate the small welfare gain, but only under seemingly extreme assumptions. The results are not very sensitive to variations in assumptions concerning population mobility and fiscal externalities. Copyright Blackwell Publishing Ltd/ University of Adelaide and Flinders University 2005..