“What happens if we don’t get our grant?” It’s the question that keeps CEOs and staff members of small arts organisations awake in the small hours.

Most arts organisations get by on the smell of an oily rag, and for the small-to-medium sector in particular, annual or triennial funding for operational expenses such as staff is the difference between being a voluntary organisation surviving on the goodwill of friends and family, and a going concern able to hire staff and plan for the future.

Similarly, once secured, the loss of operational funding can quickly mean the end for a small company. Most have little in the way of capital reserves and have limited ability to raise money in sponsorship or philanthropy, the proceeds of which overwhelmingly benefit the big and famous companies. Small companies generally have smaller supporter groups too, so the fuss over any loss of funding is muted.

This is the situation that innovative Newcastle arts and media festival This Is Not Art now finds itself in. After receiving ongoing funding from Newcastle City Council for a decade, it failed to win triennial funding in the council’s latest community assistance program. As a result, the festival fears for its future.

As is so often the case with arts funding, the dollars involved are tiny. This Is Not Art was seeking only $18,000, which would have covered the cost of part-time management staff and a small production budget for things such as lighting and sound.

This Is Not Art festival co-ordinator Eliza Adam told Crikey that “the festival for 2011 is under threat” and that “there is a very real possibility that the event will not be able to go ahead”.

Newcastle City Council is facing its own financial issues, with the current budget running a $9 million deficit. The council also plans to borrow $100 million over the next 10 years to fund infrastructure upgrades. Despite this, council is raising rates by nearly 8% next year and is spending $23.5 million on developing a Newcastle Museum.

Newcastle City Council’s manager of tourism and economic development, Simon McArthur, told Crikey that This Is Not Art’s application hadn’t scored highly enough in the competitive grants process.

“Funding is … awarded on the merit of an application, as assessed by a panel of seven, that includes the lord mayor, general manager, representatives from council’s strategic advisory committees and staff expertise covering the major applicant areas of sport and recreation, economic development, cultural development, environment and youth,” he wrote in an email.

Said Adam: “This is Not Art believes that the council’s decision does not reflect the contribution made by the festival to the Newcastle community.” She points out the festival “makes a significant contribution to a culturally diverse, rich, and sustainable arts sector in Newcastle”.

“Further, This is Not Art contributes significantly to the Newcastle economy through the generation of cultural tourism and local economic development,” she said. A previous study has found that the festival brings in about $1.5 million in economic benefits to the city annually.

When arts organisations are defunded, the excuse is generally made along the lines of “due process”, in which the failed application was not competitive enough. Sometimes this is indeed the case.

But competitive grants rounds are only a part of the story. In nearly every local, state and federal agency that provides arts and cultural funding, the majority of the grant dollars are not allocated competitively in the first place.

Take the Australia Council, the federal government’s arts funding agency. More than half of the Australia Council’s entire budget goes to 29 so-called major performing arts organisations, such as Opera Australia and the capital-city orchestras and theatre companies. These organisations do not have to apply for their funding competitively, and eligibility for funding from this part of the Australia Council is “by invitation”.

The pattern is replicated at state and local level. State governments typically devote the majority of their arts budgets to funding state cultural institutions such as state libraries, museums and performing arts centres; local councils do the same for their regional galleries and performing arts spaces. Because of this, grants for artists and small organisations represent only a few percentage points of their total funding. A recent Arts Queensland report found that “grants to individual artists to make work are estimated to be fewer than 5% of all arts funding”.

All this is worth remembering when governments and councils cry poor over arts funding. There is in fact quite a lot of cultural funding in Australia — however most of it is locked up in places struggling artists and grassroots organisations can’t access.

In particular, the tens of millions Newcastle is spending on its new museum makes the notion that the council can’t find $18,000 to support a nationally recognised festival that brings thousands of people to the city every year faintly ridiculous.