Last Tuesday night, I was announced as the winner of the inaugural Per Capita Young Writers' Prize. My essay, "A New Fiscal Federalism?" is reproduced in full below as it was submitted to Per Capita.
Federalism is hardly a hot-button issue in today's political debate, but it is the underlying basis for much of political exchange in Australia, whether we realise it or not.
Tax, services, health, education, infrastructure; all are vital issues premised on a functioning federal system.
Alas functioning, our federal system is not.
The basic premise is this: The states are responsible for delivering most of the nation's services, but it is the Commonwealth that raises the majority of the revenue. This leaves the states in a precarious financial position, constitutionally obliged to deliver vital services such as health and education, but having to beg the Canberra for the funds.
I'd like to offer a big thanks to Per Capita, one of the nation's leading progressive think-tanks. Organisations like Per Capita have a big few years ahead of them, helping to shape the national debate and offer an alternative vision for the country. I'd also like to single out Harold Levien for his generous sponsorship of this prize.
Anyway, have a read. Have a think.
A New Fiscal Federalism?
There could me no more vital task for a Federal Treasurer than fixing Australia’s broken federal fiscal structure. While oppositions and the commentariat are fixated on issues such as interest rates, net debt and cost of living pressures, the state governments of Australia are facing severe shortfalls in revenue. With states the primary service providers in the Australian federation, this should be a major concern for all citizens.
A federal structure, when implemented correctly, can be an extremely effective method of governance, more so than a unitary system.1 Although far from the only federation in the world, Australia has the highest degree of vertical fiscal imbalance between the state and federal governments of any comparable federation.2 While the states are responsible for delivering the majority of the nation’s services, it is the Commonwealth that raises the majority of the revenue, then distributing these funds to the states in the form of grants.3 This disparity in fiscal capacity often leaves the primary services providers – the states – in disputes with the federal government over the funding for services and major projects.4 Popularly known as the “blame game”, states are routinely denounced as “obstructionist” by media commentators and likened – by federal politicians – to “beggars” and “leeches”.5 Some commentators, such as former federal MP Lindsay Tanner have called for the abolition of the states,6 seemingly oblivious to the constitutional and political impossibility of such an undertaking.
While Australia’s federal structure may not be a trending topic in today’s media, an efficient and effective federation are vital to the long-term national interest. It is only with fair and equitable Commonwealth funding that the states can invest the capital required to provide the services and infrastructure for the citizens of Australia. For a Federal Treasurer, and in fact the entirety of the federal government, there are policy options that could be implemented to ensure a better outcome for all Australians.
Federalism: a brief overview
Federalism is a political organisational structure focused on vertical power-sharing across different levels of government and the integration of various territorial or cultural units into a single polity.7 By dispersing powers throughout different levels of authority, federalism avoids the concentration of power evident in unitary states, providing the ‘least undemocratic’ form of government.8 Although only 25 of the world’s 193 nations are federations, their citizens constitute 40 per cent of the world’s population and over 50 per cent of global GDP, including the United States, Canada and Germany.9
Australia’s attitudes toward federalism are generally out of step with international perspectives. While generally viewed by Australians as an outmoded, ineffective and cumbersome system of government, federalism is regarded internationally as a modern and flexible structure.10 Australia’s drift towards political centralisation stands in contrast to the international trends towards federalism and decentralisation.11
Federalism is a structure able to cater to local, national and international needs with efficiency and versatility. Its multiple levels of governance provide citizens with greater access to the political system and acts as a democratic check on power.12 While the many benefits of a federalist structure are recognised internationally, federalism is generally treated with disdain within Australia, both by its civic leaders and by its citizens.13
The Commonwealth of Australia
The six self-governing colonies of Australia were united into a federal state under the Commonwealth of Australia Constitution Act 1900 (Imp). The constitution established ‘one indissoluble’ Federal Commonwealth consisting of one Federal and six State Parliaments.14 Australian federation was premised on the principle that the “powers and privileges and territorial rights of the several existing colonies shall remain intact”15 unless such powers are agreed upon to be surrendered to the federal government. The constitution divided powers and responsibilities between the state and federal spheres through various sections. This division was intended to ensure a “strictly limited” central government,16 with the rights of the states to be protected by a “States’ Assembly” in the Federal Parliament (the Senate) and a High Court to arbitrate on federal-state disputes.
In practice, these constitutional protections have not acted as intended. The rise of the mass political party, and with it, party discipline has turned the Senate into a “house of review”,17 usually bound to party lines rather than the states. The High Court has become less an arbiter of States’ rights, consistently adopting a wide interpretation of Commonwealth power under the constitution. Consequently, the legislative and fiscal position of the States has been eroded. This has resulted in the undesirable situation where the States are constitutionally responsible for the provision of most services, while the Commonwealth raises the majority of the revenue.
The constitutional preeminence of the states has been virtually ruined by 112 years of High Court precedents and surrendered powers, with the states now in a more dire financial and political position than at any point since Federation. With the ability of states to raise their own revenue severely restricted, they have become reliant on the whims of federal funding though Commonwealth Grants, including the distribution of the GST. It is these key areas that the Federal Treasurer has the ability to overhaul to strike a new fiscal deal for the states and their citizens.
The Elephant in the Room: The GST
Since the Goods and Services Tax was introduced by the Howard government almost thirteen years ago, it has become a political hand grenade passed from party to party in the hope it won’t yet detonate. As evidenced by the two recent attempts to introduce a GST prior to 2000, large tax reforms are arguably among the most difficult reforms for political parties to implement. The GST, while one of Australia’s most substantial tax reforms when introduced, needs to be adjusted to suit the present economic times. This should be a policy priority for any Federal Treasurer in the long-term interests of the nation.
The rate and base of the GST has remained unchanged since its introduction, with many goods including basic foods and education costs exempt from the tax. These exemptions constitute almost 40 per cent of all consumption.18 Presented to the states in 1999 as a growth tax, ever-increasing revenue from the GST was intended be distributed to the states in exchange for the abolition of various state taxes and duties. The theory being that the GST revenue would be a more robust tax base and would grow at approximately 6 per cent per year in the medium term.19 While the pool of GST funds has grown in line with forecasts over the past ten years, this figure masks sluggish growth in tax receipts since the global financial crisis. As noted by the GST Distribution Review, from the tax’s introduction through to 2007-08, GST revenues grew on average annually by 8.3 percent. Between 2009-09 and 2011-12, average annual growth has been a meagre 2.2 per cent.20 As a tax predicated on consumer spending, the global financial crisis has severely harmed revenues. Since 2010, the GST pool has failed to live up to its original promise as a growth tax, placing the states in a difficult fiscal situation.
With the states having abolished several inefficient taxes in exchange for GST funding, the state treasuries have few options to cover the revenue shortfall. In Victoria, for example, the policy options exercised to close this gap have included public-sector job losses and TAFE funding cuts. States are now finding it more difficult to respond financially to local needs, unless the state is in the fortunate position of earning a strong income from mining royalties. The same distribution formula that has seen GST funding to resource-rich Western Australia cut by some $549 million has seen resource-poor Victoria’s allocation cut by $207 million.21 While it is easy to criticise these changes in funding on party political grounds, as those states’ conservative premiers have, there exists a fundamental problem with the GST.
For the Federal Treasurer, the policy priority should be to make the most effective use of the GST possible. A comprehensive and unrestricted review should be immediately undertaken to investigate the most effective configuration of the GST for the future. To this end, a great opportunity for true taxation reform was lost when the terms of reference for the review for Australia’s Future Tax System, chaired by Ken Henry, explicitly excluded the GST from scrutiny. To many interested parties, omitting the GST from the review was “plain stupid”22 and since retiring as Treasury secretary, Ken Henry has supported expanding the GST in order to “meet the future needs of government”.23 In the the current antagonistic political climate, it is unfortunate that one of the few areas of policy bipartisanship is the major parties’ refusal to even contemplate increasing the rate of the GST or widening its base. This is made all the more pressing, considering the general downward revision of tax receipts noted in the Mid-Year Economic and Fiscal Outlook 2012-13.24
Of all possible tax reforms, raising the rate or expanding the GST would be relatively simplest to undertake, with the structure of the GST already well entrenched in Australian financial and domestic life. Consumption taxes, such as the GST, are considered to be one of the more efficient classes of taxes and any alteration to the base or rate of GST could be used to fund the abolition of less efficient state taxes.25 Although an increase may not be politically palatable, Australia’s 10 per cent GST is among the lowest consumption tax rates in the world with Britain recently increasing its VAT to 20 per cent and New Zealand, its GST to 15 per cent. Extending the 10 per cent GST to the remaining 40 per cent of consumption currently exempt would increase GDP by $20 billion per year,26 affording state treasuries some certainty in budget forward estimates. Ultimately, the main beneficiaries of such a change to the composition of the GST would be the states and, in turn, the citizens of those states as government can provision better services and use less of the language of austerity when formulating budgets.
It is easy for Australians to look back at the infrastructure achievements of a previous era and ask why current governments cannot undertake the same forward-looking tasks. In Melbourne, for example, the underground City Loop was built without federal government funds over the course of ten years27; cities were ringed with freeways and were indeed ‘free’ to use. But times change. In a debt-averse globalised economy, governments are either unable or unwilling to fund large infrastructure through borrowing and budget deficits. In the case of state governments, revenues are severely constrained with a large reliance on grants from the Commonwealth and relatively inefficient state taxes such as land and property duties.28 For any major infrastructure project undertaken by states, Commonwealth funding is almost a necessity. A Federal Treasurer must ensure that these funds are available and subject to as little political wrangling as possible.
Unfortunately, some of the largest projects in recent times have been subject to conflict between the state and federal governments over funding and planning, often exacerbated by partisan differences. For example, federal funding has been withheld from Sydney’s North West Rail Link as the federal funds were originally designated for a different project the Commonwealth felt should be prioritised, the Epping to Parramatta rail link.29 Although it is beyond the scope of this essay to pass judgement over the intricacies of these major infrastructure projects, it is ultimately the people of Sydney who suffer with the constant funding rows between their state and federal governments. Ideally the local government, in this case the government of New South Wales, should have the autonomy to determine how best to spend their funds. It is the state members of parliament who, in theory, know their electorates and recognise which projects to prioritise. Increasing either the base or rate of the GST would go some way to restoring the fiscal autonomy of the states, especially in tough economic circumstances.
This is not to say the federal government has no role in funding large projects. As the principle revenue raiser in the Australian federation, it would be decidedly odd if the Commonwealth did not contribute to funding infrastructure. Through its statutory authority Infrastructure Australia, the Commonwealth can direct funding to infrastructure projects it considers vital to the national interest, but the existence of Infrastructure Australia should not preclude state governments from undertaking projects they consider to be in the state’s interest.
Towards a new fiscal federalism?
Today the states are a pale imitation of the jurisdictions their constitutional founders intended them to be. Although any return to the position the states enjoyed at the turn of the last century is not desirable or possible, the financial dependency the states have on the federal government is equally objectionable. The Federal Treasurer and the federal government should do all within their power to ensure the financial stability of the states. The simplest option presented here would be to look at the best possible use of the GST to secure its place as an effective growth tax.
Australia’s federal structure is something Australians should all be immensely proud of, as an instrument that united six different colonies under one flag, with no war or bloodshed. Federal systems are viewed around the world as a modern and flexible structures and this should be used to pursue Australia’s long-term interests. While federalism has the inherent problem of vertical fiscal imbalance, there is no reason why Australia’s problem should be worse than any other federation, especially if an effective tax regime can be established to improve the states’ financial position.
Ultimately, the states will continue to act as the main service providers for all citizens of Australia. Mooted federal takeovers notwithstanding, the states are best placed to provide services and infrastructures to the local communities they serve. It should be the job of a “strictly limited” federal government to ensure states receive the funding they require to provide these services. Despite what prominent figures might say, the states are not going anywhere. They can not and will not be abolished, therefore the federal government, lead by the Treasurer and Prime Minister should do all within their powers to ensure every Australian has access to the highest quality services and infrastructure possible.
1 For an overview of the benefits a federal structure oﬀers see A Twomey and G Withers, Australia’s Federal Future, a report prepared for the Council for the Australian Federation (2007)
3 Australian Bureau of Statistics, Government Financial Estimates, Australia, 2011-12, 5501.0.55.001
<http://www.theage.com.au/news/national/540m-fear-in-freeway-funding-war/2005/09/24/1126982270095.html> and ‘Federal vs state funding fight escalates,’ 7.30, Australian Broadcasting Corporation, 25 February 2013
5 In media reports and commentary such as J Gordon, ‘What’s really behind Brumby’s stoush with Rudd,’ The Sunday Age, 25 April 2010, p. 19; and ‘Herald Sun Editorial,’ Herald Sun, 20 May 2005, p. 20; M Franklin, ‘Abbott slams state health ‘beggars’,’ Weekend Australian, 12 August 2006, p. 8; S Neales, ‘Federation under strain - State stands to be big loser as result of smaller GST revenues,’ Hobart Mercury, 27 November 2010, p. 26.
7 B Rittberger and J Bulpitt, ‘Federalism,’ in eds. Iain McLean and Alistair McMillan The Concise Oxford Dictionary of Politics, (Oxford Univer- sity Press: Oxford, 2009), pp. 194-195
9 The World Bank, World Development Indicators, <http://databank.worldbank.org/>
11 T Hueglin and A Fenna, ‘Relevance of Federalism in a Changing World,’ Comparative Federalism: A Systematic Inquiry (Broadview Press: Peterborough, 2006), p. 11.
13 I Gray and A.J. Brown, ‘The Political Viability of Federal Reform: Interpreting Public Attitudes,’ in eds. A.J. Brown and J.A. Bellamy Feder- alism and Regionalism in Australia: New Approaches, New Institutions? (ANU E Press: Canberra, 2006), pp. 34-36.
15 Oﬃcial Report of the National Australasian Convention Debates. Sydney, 2 March to 9 April, 1891 (Acting Government Printer: Sydney, 1891), p. 23.
16 G Craven, ‘The States’ in ed G Craven Australian Federation: Towards the Second Century, (Melbourne University Press: Melbourne, 1992), p. 51.
17 R Mulgan, ‘The Australian Senate as a ‘House of Review’,’ Australian Journal of Political Science 31, no. 2 (1996) p. 192. (pp. 191-204).
18 S Eslake, Australia’s Tax Reform Challenge, Australian Parliamentary Library Lecture, Parliament House, Canberra, September 21 2011
19 GST Distribution Review Interim Report March 2012, The Australian Government, Canberra, (2012) p.ix
21 Report on GST Revenue Sharing Relatives 2013 Update, The Australian Government, Canberra (2013), p. 5.
22 M Cuddihy, ‘Grenier: Not reviewing the GST is stupid,’ AM, Australian Broadcasting Corporation November 23, 2012.
23 C Yeates, ‘Henry takes swipe at leaders’ timidity over tax,’ The Sydney Morning Herald, July 16, 2012
26 J. Daley, Game-changers: Economic reform priorities for Australia, Grattan Institute, Melbourne (2012) p. 29.
27 S Dornan and R Henderson, Electric Railways of Victoria (Australian Electric Traction Company: Sydney, 1979) p. 92.
28 Victorian Budget 2012-13 Statement of Finances, The Victorian Government, Melbourne (2012) p. 146