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?. .