The states are adult sovereignties that have reverted to teenager status.

By Gary Scarrabelotti 

Let’s step back from the fray. Let present claims and counter claims over hospital funding pass us by – in particular, that tedious PM Gillard vs. Premier Baillieu debate.

Instead, let’s simply note that chronic federal-state discord has broken out all over again and pose ourselves a question: 

After we throw out Labor at the federal elections later this year, will we tolerate renewal by a Coalition government of the perennial battles fought over Commonwealth grants to the states and the conditions under which they might be spent? 

In a Federation like ours such debates should be limited — certainly not interminable — because hospitals, for instance, really are a state responsibility and, therefore, the states, and not the federal government, should fund them. 

The reason why the states do not today fund hospitals adequately is because the states are adult sovereignties that have reverted to teenager status.  

Sweet surrender 

Between Federation and 1942 the Australian states developed strong fiscal foundations — the Great Depression notwithstanding.  This was because they shared the levying of income taxes with the federal government.  

In 1942, however, in the name of wartime necessity, the states yielded to the Commonwealth their power to raise income tax.  Since then the Commonwealth has levied this tax exclusively.  

The states made this surrender, we now realise, without making proper provision to meet their future responsibilities.  The result is that, gradually, the states have become more and more dependent upon commonwealth grants to meet their obligations. 

Grants, in the form of transfer payments, are a necessary part of the glue that holds together the Australian federation. The creation of the Commonwealth Grants Commission was one of the works of genius that that went into Australia’s federation compact. 

One reason why the EU uses bureaucratic tyranny and the slavery of forced indebtedness to stop itself from flying apart is because it was founded, unlike Australia, without a mechanism of “equalising” transfer payments from the financially stronger to the weaker states. 

Our grants system was, however, never intended to undermine the sovereign power of the states to raise their own taxes.  But that is, indirectly, what has happened.  The state power to raise taxes has withered under the influence of two lamentable factors. 

Imperial pretensions 

One is the imperial pretentions of federal governments and their leaders who have extended the system of commonwealth grants so as to absorb, partially — though significantly — various state responsibilities.  

This has been done by the Commonwealth undertaking to “assist” the states to fund various of their obligations while, at the same time, setting the conditions under which federal monies might be spent – or, as in the case of state aid to non-government schools, by assuming to itself responsibilities which sectarian animus had induced the states to neglect. 

The other is the diminishing political courage of state politicians and their leaders for whom it has been more rewarding politically to haggle with – and to blame! – the Commonwealth over financial arrangements than it has been to front state electorates manfully with the need to levy adequate taxes upon them. 

The result is: 

• The Commonwealth presently raises 80 per cent of all taxes (federal, state and local) levied in Australia and the States only 16 per cent. (See: Taxation by level of Government in “Taxation Revenue, Australia, 2010 – 2011,” ABS, 5506.0 ). 

• The states make 42 per cent of all government outlays (federal, state and local), but their income (excluding Commonwealth grants and subsidies) represents only 25 per cent of all government income. 

• The difference is made up by $86 billion from the Commonwealth representing 45 per cent of total state income. Taxes account for only 29% of state income. (See:  All levels of Government operating statement in “Government Finance Statistics, Australia, 2010−11”, ABS, 55120DO001_201011). 

Conclusion? 

If the states were to eliminate their massive dependence upon the Commonwealth, they would need to raise an extra $86 billion in taxes – that is, they would have to lift their proportion of all taxes raised from 16 to 40 per cent: an astonishing figure which illustrates the herculean nature of the task. 

State premiers think it is more rewarding politically to blame the Commonwealth over financial arrangements than it is to front their electorates with the need to levy higher taxes.

Labor of Hercules 

This imbalance could be corrected, but it would call for vision and statesmanship of a high calibre on the part of a future Australian prime minister … but not of a prime minister alone.  He would need solid backing from at least three other state premiers – those of Western Australia, Queensland, and either that of New South Wales or Victoria. 

Given the preference since World War II of premiers to run pauper states dependent on Commonwealth handouts, it may be a forlorn hope to find three premiers willing to tell their electorates that the states will need to increase their tax raisings by 60 per cent. 

Still, it is not hard to see how it could be done. The Commonwealth would need to decrease the burden of its taxes by the amount required to fund $86 billion in grants to the states, while increased state taxes would make up for lost Commonwealth grant money. 

One option is for the Commonwealth to reduce the income tax it levies, while the states step into the “breach” and raise their own income taxes, just as they did until 1942. 

Obviously this could not be done overnight. It would need to be phased in over several years: itself a major barrier to reform because it would require a rare quality of statesmanship, and a rare unity at the highest political levels, to rebuff the corrosive force of “politics as usual” over a number of electoral cycles. 

But, you might ask, would not a switch back toward state income taxes have the same fiscal outcome as accepting billions in Commonwealth grants?  In which case, why change anything? 

Yes, the fiscal outcome would be the same.  The difference, however, is one of responsibility.  The states need to “own” – i.e. become politically responsible for — the tax raisings that must be undertaken to fund the services the states provide. This is what it means to be a federation. 

Some people say that the states should be granted a fixed share of federal income tax. I have a problem with this. There would have to be some formula to determine how the fixed share was “divvied up” between the states.  That would lead, however, only to more fruitless debates like the one we already have over GST allocations. 

The states, of course, actually prefer these kinds of disputes because premiers and state treasurers regard them as more advantageous politically, in the short term, than the painful business of having to increase taxes.  

Still, I would have no problem with the Commonwealth raising an income tax on the behalf of the states on this condition: that each state resolved in parliament to set the level of tax to be levied on its behalf upon its citizens. 

Land tax 

There is another option, however. That is to leave income tax to the Commonwealth and let the States raise the money they need through a broad-based, low-level, flat-rate land tax. 

This sounds like a revolutionary proposal. Actually, it is not as radical as it first appears. 

Land taxes are already levied by the states and the ACT, though they tend to be narrowly targeted and the rates are applied marginally to land value, sometimes with punishing effect.  

In a remarkable development, however, the ACT Labor government has taken a lead over the states by designing a new taxation system built around a broad-based land tax with an option to levy it at a low flat-rate.

In what has to be a model study of a taxation system and how to reform it, the ACT Taxation Review 2012 had this to say about a land tax: 

“A broad-based land tax is widely recognised as an efficient tax. It does not create distortions in production, consumption, and investment when applied at low levels because supply is fixed. Further, land is visible and immobile, making tax evasion difficult. Lastly, land tax is one of few taxes levied on foreigners that cannot be shifted to domestic factors of production.

“Its value as an instrument to reduce speculation has also been recognised. Land tax effectively reduces buyers’risk-adjusted return from land, all else being equal, and therefore they would only be willing to invest in land if the after-tax return is equalised with the return on other investments.” (ACT Taxation Review, p.88.) 

This report is a landmark because its implications reach far beyond the boundaries of the Australian Capital Territory. It’s just a pity that the ACT Labor government has been so modest about its nationally-relevant achievement. 

If the states were to build on this normative tax review and to draw out its meaning for themselves, then they could re-discover their fiscal adulthood and leave behind their old dependent, irresponsible “lifestyles” lived under the Commonwealth’s parental roof.  

Meantime, that Mum-and-Dad monster, the well-meaning but presumptuous Commonwealth, could get some wisdom too.  It could become a humbler servant of the country.  There is no need for the Commonwealth to be forever fussing over, intruding upon and manipulating the states to fit Mum-and-Dad’s ideal.  

Let them be.  Let them go free. 

That’s one thing we should demand of the next Coalition government.