Fixing the federation: sharing income tax with the states


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.


Harmonising state taxes upwards

Rather than “harmonising” state taxes, federal taxes such as the income tax should be returned to the states

The latest revenue raising plan to resolve Australia’s chronic over-spending:

A proposal to harmonise state and territory payroll taxes to raise an extra $13 billion a year and an overhaul of $16bn worth of levies on property will be put to the states as part of a commonwealth drive to fix old taxes rather than impose new ones.

The bid to unify tax rates could help fill a yawning gap in health and education funding, intensifying pressure on state and territory leaders to tackle their own challenges rather than turning to Canberra to raise taxes for them.

By all means, the states should have their own means of funding state government activities, rather than relying on federal funding. The vertical fiscal imbalance (the difference between a states’ spending commitments and its power to raise revenue) has crippled the Australian federation.

However, making taxes effectively uniform across Australia won’t mend the imbalance, but merely entrench those taxes across the jurisdictions. It would also undermine one of the great benefits of a federal system: jurisdictional competition.

Just imagine if the states were compelled to enact uniform inheritance taxes before the 1970’s. The Bjelke-Petersen Queensland government may never have kicked off a series of inheritance tax repeals across Australia by states seeking to keep pace with a tax-cutting jurisdiction, and today death would still be a taxable event.

The states need to retain the power to alter their own taxes to establish a relatively competitive regulatory environment. It would be much more preferable – and sensible – to see federal taxes returned to the states.


New gambling tax thought bubble would hurt more than help


A common complaint about gambling taxation levied by the states and territories is that by virtue of receiving over $5 billion per annum from these taxes, governments become addicted to gambling itself.

But with the federal government itself crippled by a persistent overspending problem, it was only a matter of time before someone in Canberra would float thought bubbles to take their slice of the gambling revenue pie.

And so it is with news Nationals senator Bridget McKenzie is suggesting a new federal gambling tax:

The guts of the proposal would see a uniform tax applied to the gaming industry, with revenue to be distributed across the states that currently regulate the industry. Some revenue would be reserved for regional development projects and for harm minimisation programs.

Based on the reporting, and a reading of her submission to the Tax Review in June this year, the proposal for additional taxes on gamblers seems predicated on a desire to quell online gaming – particularly the sports betting market – presently accessed by Australians.

Regardless of whether the betting games are being played in a hotel or a casino, or on somebody’s smartphone, the fact is that taxes on gambling tend to be regressive in their incidence.

When Prime Minister Malcolm Turnbull mentions that “fairness” ought to be a criterion when judging the efficacy of policy change, it becomes entirely appropriate to ask if a proposed new federal gambling tax is at all reasonable.

Senator McKenzie might decry the lack of a “national approach” to the gambling issues that concern her, but intimating that federal intervention in this area will come without cost remains very much an open question.


Federal government urged to push ahead with federation reforms


Positive news in The Australian this morning, with premiers and chief ministers from South Australia, Western Australia, Victoria, the ACT and the Northern Territory urging the Commonwealth government to seize a “rare consensus” and push ahead with federation reform.

Malcolm Turnbull is being urged to seize a “rare consensus” among states to speed up reform of the federation, as a panel ­cautions against a loss of momentum under the new Prime Minister.

… The states and territories are working on areas including health, education, housing and ­finance to develop a green paper on federation reform, which will then inform the government’s white paper.

The process is aimed at addressing the level of overlap and duplication in the federation, which is seen as excessive.

One of the advisers on the white paper review panel, former South Australian premier John Bannon, said he believed the process had been one of Mr Abbott’s “most successful endeavours”, and urged momentum continue.

A note of caution: politicians often cure “overlap and duplication” by giving the Commonwealth greater control and management of issues which should be managed at a state and local level. So while the Commonwealth should definitely pursue reforms, it should resist any temptation to make the federal-state imbalance, and Australian governance, even worse.


Victorian approach to creative industries should embrace competitive federalism


Jason Potts, the Professor of Economics at RMIT University, made a compelling argument in The Conversation this afternoon that the Creative Industries Taskforce formed by the Victorian government is not the worse idea. However, Potts also noted that state based arts policy should be accompanied by the complete abolition of federal income taxes, and replaced with state income taxes. As the author explains:

Government spending on arts, culture and creative industries is a public good that mostly benefits those who live in the region in which it is produced. If it is also paid for at that level with state-based taxes then each jurisdiction can propose its own level of public provision and taxes, and then Australian citizens (including creative producers) can sort themselves over the different state offerings based on their preferences and willingness to pay.

This is called “voting with your feet”, and it harnesses the mechanism of competition between states (called competitive federalism) to arrive at an overall efficient level of creative arts policy spending and taxes.

But for this to work, spending needs to be connected to the ability to raise revenue, which could best be met by shifting the income tax to the states. So state-based creative industries policy needs to be connected to a state-based funding model.

Continue reading here.


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