Saturday, April 02, 2016

Saturday Morning Musings - Mr Turnbull and the the future of the Australian Federation

The brief dispute over the possible return to the States of the power to levy income taxes illustrates the difficulties involved in changing Australian taxation structures, something I discussed in Wednesday's post, Problems with "tax reform" - dealing with an ever more complicated palimpsest.

At the time I wrote the post, the suggestion that Prime Minister Turnbull might float the idea of returning income tax powers to the states was just that, a suggestion. The suggestion became a reality during the day in a short Prime Ministerial statement entitled Statement on Federation. The key part read:
Currently, Canberra collects taxes and provides the states and territories almost $50 billion a year in tied grants each year to fund services and build infrastructure. This results in ongoing arguments, negotiations and duplication in administration. 
In many areas responsibility is far from clear and the only thing in ample supply is finger pointing and blame. 
We’re all sick of it. 
A way to solve this problem would be to give the states and territories a proportion of personal income tax - rather than demanding money from Canberra they would be raising money themselves and be accountable to their own voters. 
The focus of governments should be about delivering better services – not arguing over funding. 
The key principles will be that this is not about increasing the total tax take - any income tax surrendered by the Commonwealth to the States would be offset by a reduction in Commonwealth grants to the states. 
Taxpayers would not notice any administrative change - the Australian Tax Office would continue to manage the collection of income tax. 
So, clearer lines of responsibility, less duplication, more open accountability.

I know that I am something of a broken record in constantly stressing the importance of clarity, of the importance of clear definitions, of the need to untangle issues, in discussions on public policy. However, the response to Mr Turnbull's suggestion is a classic illustration of the difficulties I alluded to in Wednesday's post.

On Wednesday, I said that a third question related to the nature of Australia's Federation and especially the question of fiscal imbalance. I went on to suggest that everyone accepted that the current system was out of kilter. However, the solutions were not clear. I would add now that lack of clarity in solutions is largely political.

As Wikipedia notes, the term fiscal imbalance refers to the disparity between the revenue generation ability of different governments in a federation relative to their spending obligations. The term covers both horizontal imbalance, differences between states, and vertical imbalance, the differences between levels of Government. In Australia, the focus is on vertical imbalance because we have a process for managing horizontal imbalance through the operations of the Commonwealth Grants Commission. This process has its own problems, the debate over GST shares is an example, but has delivered a more uniform pattern of services and indeed income levels than is found in many other Federations.

Vertical imbalance arises because the Commonwealth now has much greater access to taxation of all types than do the states, yet the states are constitutionally responsible for major spending areas.This disparity between the two levels has grown with time. Balance was provided by Commonwealth general purpose grants, leaving the states free to set priorities in terms of their own needs. Increasingly, however, the Commonwealth come to use tied grants, giving money to be spent on specific things with specific conditions attached.

The original intent of tied grants was to encourage the states to do things that the Commonwealth Government of the time considered to be important. It was an incentive system targeting specific priorities. With time, tied grants changed their form, becoming a means for enforcement and control across all areas of spending, a process justified on the grounds such as the need for national uniformity and the obligation by the Commonwealth to get best value for tax payer dollars. 

The growing problems associated with the current system have been well documented. They include growing bureaucracy,  increasingly complicated and cumbersome decision processes, rising administrative overhead and a reduction in the capacity of the states to respond independently to meet the needs of their own citizens and to spend the dollars they collect from those citizens to best meet their needs.  

Various measures have been taken to address these problems including the rise of the concept of cooperative Federalism and the development of COAG, the Council of Australian Governments. 

In practice, these have just continued the process of complication as anyone who has been involved at a policy level  in Commonwealth-State matters would know. Perhaps most importantly, they have done nothing to address the mendicant process, the creation of a welfare mentality. Today the states are just like a welfare recipient, dependent upon welfare payments made under an increasingly complex regime with limited political or policy incentive to break out. After all, you can always blame the Commonwealth. In all this, it has become extremely difficult for the states to do any meaningful form of long term planning since their revenue streams are now so dependent on payments subject to the political whim of another administration. 

The GST was meant to provide the states with their own growth tax. Even then, it came with strings. One was the requirement that they do away with certain other taxes. A second and more important one was  the inclusion of the GST in the Commonwealth Grants Commission process. As Western Australia in particular has found, this took away the most important element, the possibility that the GST might provide an independent and stable source of revenue as compared to revenue dependent on decisions made by others.

Despite some of the commentary, Mr Turnbull's suggestion that the return of some measure of income tax powers to the states is not new. It has been one recurring thread in discussions about reform of the Federation for decades. Further, it is a theme that has been gathering strength. Note, however, that Mr Turnbull wrapped the suggestion in with something different: "the key principles will be that this is not about increasing the total tax take - any income tax surrendered by the Commonwealth to the States would be offset by a reduction in Commonwealth grants to the states."

This qualification was intended to address two problems: it was consistent with the Government's commitment to reduce or at least not increase the overall size of the Government sector in Australia; and it attempted to address the fear that it might lead to an overall increase in income tax. However, it also meant that the proposal was dead in the water from the beginning. Mr Turnbull was asking the premiers and chief ministers to accept possible political opprobrium without any certainty that their states or territories would be better off in either money or freedom of decision terms.  Not surprisingly, only WA Premier Barnett was supportive.

This, however, is not the end of the matter. The decision by the Commonwealth in the 2014 Hockey budget to cut so much money from the states in health and education in breach of existing agreements was a major driver in the renewed discussion on reform because it showed just how vulnerable the states had become. Now the Commonwealth is pushing forward with other changes that will force the states to either cut services or find more money from other sources. 

I am not opposed to these moves. The Australian Federation is becoming increasingly unworkable. It is going to take a shock or a series of shocks to bring about change.

In all this, I am really over Mr Shorten. 

In response to Mr Turnbull, Mr Shorten is reported to have called the whole thing a "humiliating farce" for Mr Tumbull. He went on:
"Wednesday he had an idea which was going to be the best reform ever to Federation, the crazy idea of double taxation, allowing state income taxes to be levied on working Australians, only to drop it temporarily by Friday," he said. 
"Mr Turnbull wants to move on from the train wreck of this week, with his outlandish idea to have double taxation, but Australians won't let him move on so quickly. 
"The Prime Minister who says that this idea of allowing states to introduce income taxes on working Australians as the most important reform of Federation cannot be trusted when he says, 'Well, I don't want to talk about that idea anymore for the time being'." .
This is populist crap, dreamed up by staffers in Mr Shorten's office for immediate political response. Leave aside the double taxation issue, it's not, the response does nothing to address the key issue, what do we do to make the Federation work better?. .


Anonymous said...

I would support a careful transfer of taxing powers back to the States precisely because of vertical fiscal imbalance. The States have all the expensive financial obligations (healthcare, schooling, infrastructure) and limited taxing powers - particularly after the High Court has limited those taxing powers over the last 100 years. I am a supporter of greater devolution of power to the States (the Senate really doesn't work as a States House, either).

I also think that we should minimise vertical fiscal imbalance because otherwise it allows buck shifting between the Commonwealth and States - the States say "We don't have money, it's the Commonwealth's problem" and the Commonwealth replies, "We don't have the power to do anything about it, it's the States' problem."

The problem with Turnbull's proposal was that it wasn't carefully thought through - it was just a random which suddenly (within a day) became policy - it reminded me a bit of KRudd. If you're going to do these things, you have to make the decision easy for people - set it all out logically so that people can see how it works. I didn't see the proposal itself as an embarrassment, but the rush to implement it on the run was foolish.


Jim Belshaw said...

Agree with your comments, LE

2 tanners said...

I wasn't aware that the Commonwealth had literally taken the taxing powers, I always thought the States had surrendered them for convenience in WWII and never wanted the opprobrium back. Thanks for that.

Jim Belshaw said...

I have to revisit the history here myself, 2t. The Turnbull line at the moment is interesting. Essentially, I gave you (the states) the choice to take back a measure of control and independence. You declined. That is your right. Now you have to bear the consequent pain as we cut spending.

2 tanners said...

I'm also going to "defend" Mr Shorten for a second here Jim. There are many reasons to deplore his performance over the last few years but spouting populist crap is not one of them. Unless you are going to include the whole Government run 'tax reform' 'debate between adults' etc. He may not have covered himself in glory, but misrepresenting the other side in order to score cheap political points at the expense of good longer term policy does not make him Robinson Crusoe.

Singling him out is a bit silly. You're applying higher standards to the leader of the opposition than to the Federal Treasurer.

Hmm, I don't think he'll be hiring me as counsel for the defence any time soon :)

Rod said...

Like LE I too thought that the states had "surrendered" their income tax powers to the commonwealth. I thought is was especially the case since the low populated states(and big area states) during world war 2 could not afford the higher income taxes that would be required to sustain them. It was just a federal act and not a constitutional issue I think?

I'm very much a "states rights" oriented person so I don't object to states having the flexibility to modify the rate of income tax in their states. Having a base federal tax rate as a minimum and then allowing the states to choose any variation to this rate seems fine... I guess that now that idea has been scuttled it is a moot point.

I agree in part that 2 Tanners thinks that the government "debate between adults" has a condescending tone about it. It is a bit silly attacking Shorten in such a way but the point being made is that Shorten is not being serious about such ideas of reform. However, Shorten has actually proven Turnbulls snide comments by trashing a reasonable idea by trying to discredit the person instead! Debates where the person is always the thing to be discredited rather than the idea is frustrating and what turns me completely off politicians.

2 tanners said...


My memory had been the same as yours but LE's post stimulated me to go to Wikipedia. The Commonwealth did indeed take taxation powers by virtue of sticking them on top of State taxes (such that people would have been paying huge taxes) and then promising some of the funding back to the states. It was challenged during the war, and after the war, with the Commonwealth winning both times. The States couldn't also tax the income (in principle they could have, but that would have led to a flight of capital and a loss of government) and with the loss in the high court, it was the "Premiers' Conferences" from then on.

Anonymous said...

2T, yes, that's what I had in mind. It's a Constitutional issue because s 90 empowers the Commonwealth alone to levy "customs and excise". The question has always been what "excise" means, and the definition of what taxes are excise has expanded. The most recent case I can think of (off the top of my head) is Ha v State of New South Wales (1997) 189 CLR 465, which invalidated a bunch of State taxes on tobacco on the basis that they were "excise".

Cheers, LE

Anonymous said...

2015 State accounts revenues (Billions):
Grants 3.03 Taxes 0.98 Services 0.36 Etcs... Total 4.96 Population 530k (approx)
Grants 29.01 Taxes 26.05 Services 6.35 Etcs.. Total 69.14 Population 7.6M (approx)

Land tax, stamp duty, payroll tax - you name it, the differences between the rates and exemptions are marginal. Except - who doubts that NSW wins hands down on underlying gross collections on geographically affected values?

Taxation statistics (via ATO for 2012-13 - representing the millions of returns as parts of 100)
"People sent returns to us from all over Australia: 32 from New South Wales, ...., 2 from Tasmania"


I live in NSW but mostly view myself as an Australian - not a New Englander, nor any other small geographic location. Although the problems of 'lockout laws', and indigenous health, and black lung disease, and coral degredation, and even bad internet access, may (or may not) affect me, I'm willing to pay 'my share' and wait for 'my turn' at the public trough.

This discussion of how best to carve up a seemingly decreasing pie is best left to a group of old, ineffective, would be but never did actually, economists. Much like a group of friends round a campfire, poking at the dying embers and wondering what to talk about next, their ruminations are mildly interesting, but that's really all that can be positively said. We spend more than we raise, but we are unwilling to forego such benefits as we have, so we will continue to spend more than we raise. Pretty simple, really.

Please let's not be diverted by a diverting discussion as to how to divide the last slice of the cake - or ffs when the cake was actually constituted as an 'Australian' cake.


Randy McDonald said...

"Vertical imbalance arises because the Commonwealth now has much greater access to taxation of all types than do the states, yet the states are constitutionally responsible for major spending areas."

This sounds like the situation in Ontario, where particularly since the 1990s municipalities have been charged with providing services without necessarily having much by way of revenue generation.

Anonymous said...

But I do agree with Jim's primary point that this issue needs addressing. After all, how will coming generations view our failure to act?

I'm thinking of this guy and his generation in particular:

And then the downloads began: 14 seasons of MythBusters; 24 seasons of The Simpsons; the entire Wikipedia database; Microsoft software for his job; updates for his Xbox games; and "a lot of random other stuff". He also synced all his Spotify playlists offline.

He needs to know we are working tirelessly on the problems associated with vertical fiscal imbalance :)


Anonymous said...

Just a further comment on the concept of 'returning' some part of the tax take to the states:

It was said that this would be a simple sectioning of the overall tax rate for at least two years, but then states might be able to vary their 'share' - for simplistic example let's say 20c in years 1 and 2 but then Qld might wish to attract business by lowering that to 18c and SA, in dire strats, might raise theirs to 23c.

How does that fit constitutionally?


Jim Belshaw said...

The problems of vertical fiscal imbalance do, indeed, pale against the problem for Telstra created by that rather magnificent download. But, and as I am sure that you realise, the Commonwealth is a bit like Telstra, the states like that chap.