Give states revenue responsibility to improve efficiency


The Australian: 

Sitting alongside the Tax White Paper is the development of the Federation White Paper.  It may not get people as excited as tax changes, but federation reform could be equally far-reaching. This will be on the agenda for the COAG leaders meeting this week.

There is a general recognition that our federation isn’t working as well as it could. Over 80 percent have a negative view of its operation, according to the Australian Constitutional Values Survey.

The primary reason is that, perhaps more than any other federation, around the world, Australia’s different levels of government are involved and entangled across a whole range of important policy areas.

There are now very few state government responsibilities that have no federal engagement.

The result is that “everyone is in everything and no one is accountable” as the Committee for Economic Development of Australia points out. The states blame the Commonwealth for lack of money when things are not going well, and the Commonwealth points out that the states actually run the services.

Huge bureaucracies are created at both state and federal level for ostensibly the same services. The Commonwealth, for example, has over 1500 people in the education department but doesn’t run a single school, TAFE, or university.

There is almost no public policy problem that is not made more complicated by our federal arrangements.

The Federation White Paper aims to address some of these issues.  The objective is to shift the pendulum back to where governments are more sovereign in their own sphere. That is, a situation where a government delivers a service, raises the money for a service, and is held responsible for a service. 

We are far from there presently.

At the heart of the problem is the mismatch between revenue and expenditure. The states’ revenue is insufficient to meet their  expenditure responsibilities, while the federal government’s revenue exceeds its direct responsibilities.

If we fix this fiscal imbalance, much of the rest will follow.

At the moment, 45 percent of state and territory funding comes from the Commonwealth either via the GST or through specific purpose payments. This is one of the highest cases of 'vertical fiscal imbalance' in the world. In Canada, arguably the federation that is most like Australia, the figure is just 20 percent; in the United States, it’s around 25 percent.

As soon as the federal government becomes the primary revenue collector for all governments, a number of things happen.

First, it creates temptations for the Commonwealth to step into areas that are traditionally the domain of the states. At the beginning of the twentieth century, the Commonwealth had no involvement in schools; now it is seen by many as jointly responsible.

When the Commonwealth does get involved, it typically puts conditions upon the funds it provides. In 2010, this lead to 300 separate documents, including 6 National Agreements, 51 National Partnerships and 230 Implementation Plans.

These conditions are sometimes at odds with state governments’ own priorities that might be more reflective of local citizen preferences.

All this adds to blame shifting, lessens accountability, and adds to cost and complexity.

Expenditure restraint is also lessened when there is a cash supply from elsewhere. The International Monetary Fund notes that state governments have to be much more efficient and prudent with their spending when they have to tax their citizens and be accountable to them. A 10 percent shift from grants to taxing improves the fiscal balance by an average of 1 percent of GDP.

There are only two ways to address the fiscal misalignment. Either reduce the expenditure responsibilities of the states to match their revenues, or increase their revenue responsibilities.

The first would involve a transfer of responsibilities for some services to the Commonwealth.  It would not necessarily mean that the federal government has to run the services, but it would have the primary funding responsibility for them.

The second option is to give the states more revenue responsibility. The Abbott Government's aim is to reduce taxes overall on citizens, so any consideration of this objective would have to be offset by reduced Commonwealth taxes.

Premier Baird has already argued for the states to be able to levy their own income tax under a sharing arrangement with the federal government. This could follow the model suggested by the National Commission of Audit, or the Canadian model.

One proposal would be to quarantine a certain percentage of income tax and provide it directly to the states and territories, as own-source revenue, not as a grant. The Commonwealth would then commensurately reduce some of its payments for some of the core services that states and territories provide.

None of the options to reform the federation are straight-forward. Kevin Rudd made a lot of noise about "ending the blame game" but hundreds of agreements later and we are in no better place. 

For most Australians, who runs a service is of little relevance. They just want it run well and efficiently.  Our federation has generally done this, but we could do so much better.  Properly done, federation reform could unleash a new wave of productivity enhancements, service improvements and give state governments the enhanced sovereignty that they deserve.

Alan Tudge

Parliamentary Secretary to the Prime Minister

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