Fixing the federation: sharing income tax with the states

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Australia’s federation is broken. Power has been excessively centralised. States cannot fund their services. And the blame game between the states and the Commonwealth is never ending.

In very exciting news, Prime Minister Malcolm Turnbull has confirmed that the federal government will be pursuing a policy of sharing income tax revenue with the states:

Under existing laws the Federal Government is the sole recipient of income tax. The Prime Minister wants to reach agreement with the states to lower the percentage of tax collected federally, allowing the states to collect a portion of income tax funds directly.

“We would withdraw from a certain amount of income tax that would be available to the states and we would agree that that would be the maximum they would levy for a period,” he said.

Mr Turnbull went on to acknowledge he would not be able to control whether the states increased the percentage of tax collected in the long term.

This proposal spurs from the ongoing debate over how to most effectively fund health, as well as education, in the long run.

Let’s go back to first principles.

The idea of dividing powers between a central government and regional governments is one of practical good governance.

Central governments should only undertake roles that cannot be more effectively completed at a lower level—by those with the most knowledge and relevance to the policy.

The federal government should not be directing the picking up of rubbish, local councils should not be interfering in foreign policy.

However, governments can only be accountable and responsive to local needs if they are collecting their own revenue—a feature seriously lacking in Australia’s federation.

In 1901 the states collected 87 per cent of government revenue. One hundred years later this has decreased to below 20 per cent. Nevertheless, the states are still largely responsible for delivering substantial services, including schools, hospitals and public transport.

To address this imbalance the federal government provides over $100 billion in payments to the states every year. This represents about a quarter of the federal budget, and around half of state budgets. By comparison, American states receive about 22 per cent of their revenue from the federal government, and Canadian provinces around 17 per cent.

The centralisation of revenue has led to the loss of many of the benefits of a federal system. Our states, tied to federal government dictations, are increasingly unable to be innovative or be responsive to local needs.

There is an ongoing blame game between the federal government and the states — the Commonwealth blames the states for lacklustre service delivery, states blame the federal government for lack of revenue.

There is excessive duplication, overlap and high administrative costs.

If successfully implemented, giving the states a share of income tax could seriously improve our federation.

It would finally allow the states to fund their own services, allowing voters to assess where their money is going and hold the respective level of government to account. It would enable beneficial competition between states to provide the most services at the lowest tax rate.

A state income tax will help us once again receive the benefits of a federal system that our constitutional framers envisaged.

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