Australian states reap billions from mining. This revenue is already at risk

Neither the voters, nor the parties, seem to care that some of those "problems" are actually the responsibility of state governments (and others are not properly the responsibility of government at all).

Despite not featuring in the recent election, one of the most important issues Australia faces is the poor state of our federal system.

We have seen serious declining outcomes in areas of state responsibility like education, while policymakers at both the state and federal level focus on shifting the blame and bickering over funding.

At least in part, the degradation of our federalism has come from the massive gap between states' extensive spending responsibilities and their limited revenue-raising capabilities compared with the Commonwealth.

Unfortunately, both the federal government and the states seem set to make things worse, not better.

One crucial area of concern is the potential impact of environmental policy on mining. Australian policymakers are increasingly hostile towards mining - largely stemming from environmental concerns and the urgent push for decarbonisation.

As the pressure to rapidly phase out fossil fuels increases, the states will face an unexpected fiscal risk. Mining royalties are one of the few substantial revenue sources that state governments utilise.

Australian states and territories are set to earn about $73 billion in mining royalties and more than $38 billion in fossil fuel royalties alone between 2024-25 and 2027-28.

In 2022-23, Queensland received a record $15.4 billion in coal royalties, while Western Australia is projected to earn nearly $24 billion from iron ore royalties over four years.

In fact, royalties account for almost 5 per cent of total general government revenue across all states and territories, supporting tens of thousands of teachers, nurses, and police officers.

This means mining royalties play a vital role in funding public services and infrastructure.

Losing this revenue would further entrench state dependence on federal funding. This would deepen the already problematic dynamic of states deflecting accountability for service delivery failures onto Canberra.

Hence, sustaining mining royalties is critical not only for state budgets but also for maintaining healthier federal-state financial relations.

There are also potentially adverse economic consequences if royalty revenue is replaced by other sources. If fossil fuel royalties were removed, states would likely have to raise taxes elsewhere - potentially increasing payroll taxes, property transfer duties or motor vehicle fees.

Such measures could harm investment, employment, and overall economic growth.

Increasing or broadening the GST would be another option, but there would be a strong expectation of compensation from the public which would eat away a substantial portion of the revenue raised.

States have also proven to be very resistant to measures like land tax.

While royalties have at times also been criticised as being economically inefficient, the alternatives proposed - particularly resource rent taxes - have not fared well in Australia.

Historical attempts at resource rent taxes, like the Petroleum Resource Rent Tax (PRRT) and the Rudd government's Resources Super Profits Tax, have consistently underperformed expectations due to complexity, volatility, and difficulties in implementation.

In contrast, royalties have reliably provided state governments with stable, predictable revenues, essential for managing budgetary priorities effectively.

Yet this revenue is already at risk.

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The Queensland government's 2022 decision to hike coal royalty rates has contributed to lost investor confidence in that state and the cancellation of Glencore's $2 billion Valeria coal mining project.

The change was criticised by the then Japanese ambassador to Australia, straining our relationship with a major trading partner.

The previous royalty rates should be restored for existing coal projects to rebuild investor confidence.

Furthermore, regulatory barriers must be reduced to accelerate the development of Australia's critical minerals sector.

Through streamlined regulations and competitive royalty and state tax settings, states must encourage investments in critical minerals to diversify their royalty base, ensuring ongoing fiscal resilience.

Of course this will not be enough on its own especially in a world transitioning to lower carbon emissions. State governments in particular must embrace greater fiscal discipline.

They will have to focus on moderating operating and capital spending, encouraging more cost recovery for public services, and being cautious about assuming continued high royalty revenue from fossil fuels.

As the states bear primary responsibility for service provision in many areas, it will be particularly important for them to focus on increasing productivity and efficiency in those sectors.

For too long, the answer to declining outcomes has been to go cap in hand to Canberra. Not only has this not improved matters, even where the funding has been granted, this situation would not be sustainable if state revenue declines even further.

This means mining royalties are the lifeblood of our state budgets for the foreseeable future. They allow governments to invest in hospitals, schools, roads, and emergency services without placing the full burden of taxation on households and businesses.

State governments should be careful not to sacrifice this revenue to satisfy the requirements of ideological purity.