ESSAY 8: FEDERATION REFORM # 3.1
REVENUE OPTIONS FOR STATE GOVERNMENT ACCOUNTABILITY
It is common sense that any federal system of government should adhere (so far as practicable) to two principles:
First, subsidiarity: Government services are best delivered via principles of subsidiarity (localised decision making).
Second, responsibility: Each level of government must be accountable to voters, for raising the money it spends.
Both principles are among Common Sense for Australia Inc’s Core Beliefs.
We have split the nuts and bolts of federation reform between consecutive essays. Delivery of services (spending the money) was addressed in Essay 7. This essay is the first in a series (Essays 8 to 10) looking at funding (raising the money). Conclusions on funding appear in Essay 10.
Background
The Federal Government’s draft Reform of the Federation – Discussion Paper, 2015 (Note 2) identified future options to resolve funding of Health and Education to be (broadly):
1. Federal government taking over the states’ delivery of services;
2. Federal government giving appropriate revenue capacity to the states; and/or
3. Federal government ending ‘tied’ grants (ceasing to dictate how states spend money).
No reports on Federation Reform have been published by the Federal Government since 2015.
The most recent government report on federation reform is the New South Wales Government’s Review of Federal Relations, 2020 (Note 3). This report identifies various reform options which include (i) broadening the GST base and/or increasing its rate; (ii) harmonising state payroll taxes; (iii) replacing stamp duties with land taxes; (iv) individual states ‘opting in’ to receive a share of income tax raised by federal government in their state, in lieu of ‘tied’ (conditional) federal grants (like GST, the income tax received by the states, would be an ‘untied’ federal grant).
Proposals – Part 1 – Balancing of State Budgets
We propose that the federal government add fiscal discipline to State Budget Responsibilities, by exercising its rarely discussed Section 51(iv) power in the Australian Constitution, to force states to balance their budgets.
This proposal does not preclude the federal government from deploying “section 96 tied grants sparingly for genuine purposes of assisting smaller states” (Note 4).
Proposals which appear later in this essay, are consistent with eliminating the inherent major volatilities in some states’ major revenues.
These revenue volatilities make it difficult for voters (in states which are heavily dependent on stamp duties or mineral royalties) to have any accurate perception as to the real (as opposed to apparent) fiscal prudence, of their particular state government’s political leadership.
In our view the inherent role of the states – delivering services – mitigates toward their revenue needs, being relatively consistent over time. In contrast we see the federal government’s revenue needs, as being more subject to the ebb and flow of economic cycles (whether of a national or a global nature).
These factors are consistent with our state and territory governments being required (unlike our federal government) to regularly balance their annual revenues and expenditures.
Finally, unlike federal debt ceilings (or federal balanced budgets) which are set by federal politicians and can be varied by them at any time, it is not possible for state politicians to lawfully vary a debt ceiling (and corresponding need to balance budgets) which has been imposed upon them, by federal parliament.
We see discipline in ‘balanced state budgets’ as a fundamental contribution, toward Common Sense for Australia Inc’s Core Principle of Smaller Government.
Proposals – Part 2 – Funding of Services (State Revenues)
For reasons set out in Comments further below, we favour State Revenue being selected from a mix of only these sources (without need to select all of them):
(a) GST (whether or not with expanded base and/or increased rate);
(b) Land tax (rates determined by each state);
(c) Personal Income tax (a low flat rate determined by each state);
(d) A single federal government grant, to ‘equalise’ inherent per capita variations between states, in their capacity to raise revenue from (b) and/or (c);
(e) Tied grants strictly compliant with Section 96 of the Australian Constitution (Note 3);
(f) Specific Purpose Taxes and User Charges (unrelated to revenue purposes).
We propose cessation of these sources of state government revenue:
(x) Payroll taxes;
(y) Stamp duties;
(z) Mineral and resource royalties.
GST distributions
A key feature of this mix, is our proposal that annual distributions (if any) by federal government of GST to the states, should be on a simple per capita basis.
Voters today have little insight into how federal government GST receipts are apportioned each year between the states.
At best our understanding is that there is a formula, which somehow takes into account variations in:
(a) the capacities of the different states, to raise their own revenue; and
(b) the costs of the different states, in delivering the same services.
A major differential in the states’ relative capacity to raise revenue pertains to natural resource revenues. This differential is avoided if our federal government, instead of our states, raises all natural resource revenues. The politics of this (realistic) proposal are addressed in our Comments further below.
The policy of taking into account, in GST distributions, variations in the costs of service delivery in different states is questionable, as it undermines incentive for states to address costs. In our view, advances in communication technologies (since introduction of GST in 1999) have made a solid case, for dumping of ‘relative costs’ from GST calculations.
In our view accountability of governments (in particular for Smaller Government), would be assisted, by ending voters’ lack of insight into how GST distributions are determined. In comparison, our own proposed ‘equalisation’ payments by federal governments to states, are relatively comprehensible:
Federal government ‘equalisation’ grants (re state land and/or personal income tax)
State income taxes involve perceptions of disadvantage for some states, relative to others, owing to variations in average-personal-incomes (or in average-personal-wealth) across the different states. One option for the federal government to easily and transparently mitigate, any such disadvantage, would be ‘revenue equalisation grants’ (to all states excepting the state whose population enjoys the highest-state-average-personal-incomes).
The grants would be based on the percentages, by which the highest-state-average-personal-incomes, exceeds average-personal-incomes in each other state. This (relevant) percentage is applied to total (personal income) tax which each other state is anticipated to raise from its own voters, to determine its simple ‘equalisation’ top-up from the federal government. For states that opt to forgo imposing income tax, the ‘top-up’ is naturally zero.
The same top-up formula (to address perceptions of disadvantage for some states, relative to others) could apply in respect of land taxes imposed by states.
The relevant percentage (again based on the percentages, by which the highest-state-average-personal-incomes, exceeds average-personal-incomes in each other state) could be applied to total (land) tax which each other state is anticipated to raise from its own voters, to determine its simple ‘equalisation’ top-up from federal government. For states that opt to forgo imposing land tax, the ‘top-up’ is again zero.
The ‘equalisation’ mechanics work as intended, regardless of which states opt to levy tax on personal incomes and/or land (and however they opt to do so).
Both are improvements, relative to current GST distributions, in simplicity and transparency (and capacity for comprehension and appreciation by voters).
Transition
Whilst consensus between federal and state governments for federation reform – including who raises the taxes to fund state services – is ideal, it is not essential.
Any federal government (with the will to do so, and/or co-operation of the opposition) could for example simply advise the states (and territories) of its determinations to:
(a) eliminate all ‘tied’ grants in respect of education and health services;
(b) vacate responsibility and involvement in education and (most) health services;
(c) impose debt ceilings (and balanced budgets) on state (and territory) government;
(d) reduce GST distributions on a full dollar-for-dollar basis for any budgeted state (i) stamp duties; (ii) payroll taxes; (iii) mineral and resource rents;
(e) otherwise distribute GST to the states on a per capita basis;
(f) flag options for (i) a state personal income tax levy; and (ii) federal ‘equalisation’ grants (for any state revenues from income tax and/or land tax).
Comments
We concur generally with the first recommendation of the Henry Review (2009, Note 5). It proposes that taxes which comprise Australian Commonwealth government revenue (ie both state and federal revenue) should be broad-based and concentrated on only four areas (in our words):
(i) personal income (inclusive of capital gains and fringe benefits);
(ii) business income (inclusive of capital gains);
(iii) private consumption (GST);
(iv) economic rents (taxes on land and natural resources).
The Henry Review proposes that other government revenues be limited to ‘user charges’ and taxes which ‘improve social outcomes or improve market efficiencies’.
Looking at (i) and (ii) above – income tax as an option for increasing state revenue:
We do not favour sharing of income tax between federal and states governments in the manner proposed in the NSW’s Review of Federal Relations (see further above). It involves no accountability for states, to their voters, for setting rates for personal income tax which they would receive from their voters.
In our view, a better alternative (if income taxes are to contribute directly to state revenue) would be for each state to nominate a ‘flat income tax levy’ for its individual taxpayers/voters (to be collected for that state, by the federal government).
As an idea of concept, we would envisage federal government offering, to collect state income tax levies of between 0% and 5% (nominated by each state).
Looking at (iii) above – GST as an option for increasing state revenues:
As noted further above, the New South Wales Government’s Review of Federal Relations has proposed that consideration be given to increasing ‘untied’ federal funding of the states, by broadening the GST base and/or increasing the GST rate.
The disadvantage of this option, is that it would consolidate the lack of accountability of the states to voters, for raising the money they spend on our behalf. This is particularly so for states relying for the bulk of their revenue upon (in addition to federal grants) payroll taxes and stamp duties. When voters have little day-to-day awareness of money states take from them, their propensity to be concerned by excessive state spending and/or debt, understandably diminishes.
It is not possible for any individual state to ask the federal government to collect a particular rate of GST on its behalf (for purchases within its boundaries), as the Australian Constitution precludes the federal government from charging different rates of GST in different states. It is also impractical for states to levy a GST of their own, without amendment to Section 90 of the Australian Constitution. Whilst former High Court Chief Justice Harry Gibbs has mooted exactly that change (to our constitution) we concur with his contemporaneous observation that all constitutional change “is difficult to achieve” (Note 6).
Looking further at (iii) above – GST as an option for increasing net federal revenues:
As noted further above, the New South Wales Government’s Review of Federal Relations has proposed that consideration be given to increasing ‘untied’ federal funding of the states, by broadening the GST base and/or increasing the GST rate.
Australia’s GST arrangements (our federal government raising tax which our state governments spend) represent (arguably) our national capitulation to the problems of ‘vertical-fiscal-imbalance’ which bedevil our federation (ie state governments not being accountable for raising the taxes which they spend).
If our Federal Government retained (almost) all the revenue which it raises (rather than distributing much of its revenue – including any GST – to the states), it would be possible for Federal Government to substantially reduce our nation’s heavy reliance (relative to other countries), on personal income taxes. The potential reduction in personal income tax rates is all the more material, if the Federal Government was to broaden and/or increase the GST rate (as has been proposed in the New South Wales Government’s Review of Federal Relations).
Looking at (iv) above – land tax as an option for increasing state revenue:
Whatever public attitudes to a broad-based land tax may be – as a source of state revenue – it offers benefits which are simply unmatchable by any alternative tax.
This includes option for mandatory disclosure – in every monthly, fortnightly or weekly residential tenancy invoice – of the portion of rent, which is the ‘tenant’s contribution’ to land tax (a tax on their home, forwarded to their state government, by their landlord). In this respect broad-based land taxes (including on family-owned-homes), are as ubiquitous for every voter on the state electoral role, as GST is for every voter on the federal electoral role.
One obvious disadvantage of land tax is that owner-occupied-land does not generate cash, to facilitate payment of the tax. This cashflow issue is particularly a problem for retirees (in terms of land tax payable on their home). The practical solution for the cashflow issue is giving homeowners (or categories of homeowners) the option, of letting unpaid land tax accrue as a charge (in favour of their state) against their property.
The proposal in NSW’s Review of Federal Relations (see further above), for states to adopt broad-based land taxes, are focussed on land taxes replacing stamp duties (on property transfers and insurance). In our view a better alternative is to give consideration, to the greatest possible extent to which state land taxes might displace all our existing taxes (including – indirectly but no less effectively – personal income taxes imposed by the federal government).
Looking further at (iv) above – natural resource tax as an option for increasing state revenue:
We concur with this element of Recommendation 45 of the Henry Review (2009, Note 5):
“The current resource charging arrangements imposed on non-renewable resources by the Australian and State governments should be replaced by a uniform resource rent tax imposed and administered by the Australian government.”
A takeover by our federal government of all mineral royalties (including all existing royalties arrangements collected by the states) would remove material differentials in the revenue-generating-capacities of individual states. These differentials are (in theory) taken into account, when our federal government determines each state’s annual share of GST. Such GST calculations become redundant, if states are no longer collecting any form of tax on natural resources.
There would be little capacity for the states to thwart a determination by federal government, to take over all taxes on minerals and other natural resources.
The Federal Government could simply propose to reduce each state’s individual GST receipts, on a full dollar-for-dollar basis, for all mineral royalties which are receivable by the state. The process would be similar, to how the federal government coerced the states to agree to its takeover of income taxes, in the 1940s. Whilst South Australia, Victoria, Queensland and Western Australia took joint legal action to oppose the federal government’s actions, the High Court ruled in favour of the federal government. Reasoning in that case (1942, Note 7) would caution the states against threatening a similar legal action now.
To win a corresponding case today, the states would have to ask the High Court judges to overturn the reasoning of their earlier High Court peers, in the very same case (1942, Note 7), which has now stopped the states from imposing income tax for 80 years.
We are of the view that natural resource royalties and taxes (of whatever nature) should be maximised and permanently invested in an Australian Sovereign Fund (with monies released from the Fund to be limited to income and realised net capital gains).
Other comments
Proposed changes are not intended ‘in isolation’. They are proposed as part of – huge – corresponding reforms.
Under the immediately preceding heading, this essay outlines the mechanism by which our federal government could force upon the states, a federal takeover of royalties and other taxes on natural resources. We anticipate that a similar mechanism could be deployed by federal government to:
(a) retain all GST revenues (rather than distributing same to the states); whilst
(b) coercing states to only raise such taxes, as are approved by federal government.
Counter arguments
Envisaged changes are not intended as ideological. They are envisaged as a compact of potential bipartisan political reform.
Changes of the massive scale envisaged in this essay cannot be achieved through the political line (lie) that ‘nobody will be worse off’.
Careful considerations of how to address concerns of potential individual disadvantage, arising from any such proposals, is imperative for their implementation. A start to such considerations will be included in Essay 10.
For and on behalf of Common Sense for Australia Inc
Authorised for publication, 23 December 2021
Note 1: References in this essay to ‘states’ are our shorthand for references to ‘states and territories’.
Note 2: https://apo.org.au/sites/default/files/resource-files/2015-06/apo-nid55457.pdf
Note 4: Part of Essay 6’s quotation of Brian Gallaghan, sourced from: https://theconversation.com/renewing-federalism-what-are-the-solutions-to-vertical-fiscal-imbalance-31422
Note 5: Australia’s Future Tax System (Henry Review), 2009, Final Report to the Treasurer
Note 6: Gibbs H, 1994. ‘The Decline of Federalism?’, University of Queensland Law Journal, 18(1): 1–8
Note 7: South Australia (et al) v Commonwealth (1942) 65 CLR 373