Sources: Government Financial Statistics Yearbooks; Advisory Committee on Intergovernmental Relations, Significant Features of Fiscal Federalism, Washington, 1993, Vol 2, p 12; Annuaire statistique de la Suisse; extracted in Ronald Watts, Comparing Federal Systems in the 1990s, Institute of Intergovernmental Relations, Queen’s University, Kingston, 1996, pp 42-3. Vertical fiscal imbalance is calculated as the ratio of the second column to the third column.
5.3 A federation’s rate of vertical fiscal imbalance is calculated as the ratio of the federal government’s revenue (measured as a percentage of total government revenue) to its expenditure (measured as a percentage of total government expenditure).1
5.4 In practical terms, vertical fiscal imbalance indicates a situation in which the allocation of revenue between the federal and state governments does not match those governments’ expenditure responsibilities. In a situation of vertical fiscal imbalance, the federal government must transfer a portion of the centrally raised revenues to the state governments, to make up for their revenue imbalance. These transfers have the potential to blur accountability for the raising of revenue and the funding of programs
5.5 Most federations have at least some degree of vertical fiscal imbalance. It makes fiscal and economic sense to centralise the collection of certain taxes. Major tax sources are often allocated to the federal government to ensure national economic harmonisation, contributing to a single national market.
5.6 This in-built vertical fiscal imbalance can become exacerbated when the original constitutional allocation of revenue and expenditure responsibilities becomes outdated with the growth and change over time of taxation practice and government programs, and federal and state spending responsibilities. This has been the case in Australia, which has the highest degree of vertical fiscal imbalance of any comparable federation in the world.2
5.7 Excess vertical fiscal imbalance has several undesirable consequences.
5.8 Vertical fiscal imbalance reduces the accountability of the Commonwealth to its electorate for the expenditure of its funds, because the States control a significant proportion of that expenditure.
5.9 At the same time, vertical fiscal imbalance reduces the accountability of the States to their electorates. This occurs in two ways.
5.10 First, the dependence of the States on transfers of Commonwealth funds leaves State activity hostage to Commonwealth taxation and expenditure decisions. If the Commonwealth does not transfer sufficient funds to the States, the States inadequate taxing powers leave them unable to raise sufficient revenue to meet the demands of their electorates. Australian Premiers and Chief Ministers expressed these concerns at a meeting in April 1992, prior to Keating’s first Heads of Government meeting:
Reform of Commonwealth/State financial relations is essential if Australia’s economic recovery is to be successful and the States and Territories are to avoid drastic cuts to services.
In considering the key issues proposed for discussion at the forthcoming Special Premiers’ Conference on the 11th May it was clear that the pace and success of economic recovery would be jeopardised if the problem of adequate funding for essential services delivered by the States was not satisfactorily resolved. This issue has always been the one of major concern to the States and which prompted the whole Special Premiers’ Conference process which has produced so many worthwhile reforms.
We are extremely concerned that without a meaningful increase in Commonwealth funding, the States and Territories face a combined budget deficit of approximately $7.3b in 1992/93 rising to $12.5b by 1995/96, not withstanding the expected recovery in the economy. These deficits are both long term and structural not primarily cyclical in nature and hence require a permanent not temporary solution. The current recession has exposed these deficits which had previously been masked by the buoyant levels of State revenues arising from the abnormal asset inflation of the 1980s. These deficits are due to a collapse of own-source revenues and a significant reduction of Commonwealth funding, not profligacy in spending.
Such a deterioration in State finances would require drastic remedial action, which could include higher borrowings adding to already burdensome debt levels, increases in State taxes and cuts in essential State services and facilities to levels that would be socially unacceptable. The increase in costs to businesses and the losses in jobs involved by such measures would jeopardise national economic recovery.
We believe that reform of Commonwealth-State financial relations must ensure that States and Territories are not only guaranteed certainty and maintenance of funding as already promised by the Prime Minister, but result in a real growth of Commonwealth funding to the States. Notwithstanding our preference for a national income tax another possible solution would be to set Commonwealth grants at a fixed share of Commonwealth revenues (as alluded to by Treasurer Dawkins) since these better reflect the level of economic activity than State tax proceeds. Any such arrangement would need to have a guaranteed minimum floor of grants to protect the States from unilateral cuts by the Commonwealth to its own tax base.3
5.11 Second, conditional transfers from the Commonwealth to the States oblige the States to spend their funds according to conditions that are laid down by the Commonwealth,4 rather than the citizens of the State.
5.12 Mr Gary Sturgess, formerly Director-General of the Cabinet Office of New South Wales, argued before the Committee that conditional funding is not objectionable:
There is, I know, quite a bit of antipathy by the States towards Specific Purpose Payments. But in fact, a Specific Purpose Payment, or SPP, is really a contract from the Commonwealth Government to the States to buy a percentage of health services to meet their policy needs. We now live in an age of contract government. This is the Federal government saying, ‘We have a specific set of interests in education that are important to us politically, and we would like to buy from you, the States, just those services, which we will pay for. We do not want to set up an alternative education system.’ That is arguably efficient.
If the States have bought into arrangements they do not like, it seems to me that that is because they lacked the courage to conduct vigorous enough negotiations and make it clear to the electorate that it was Commonwealth policy and that the Commonwealth ought to put the money up to buy the services they required. Again, there is the sort of matching-grants problem, the dollar-for-dollar problem. There is a body of literature that argues that matching funds are not an irrational design and that they may well be a rational way of giving the States the best incentives to act in the Commonwealth’s interest.
Having said that, the major problem is that the States have not seen it as a contract and have not sat down and negotiated toughly enough with the Commonwealth to say, ‘You are just purchasing services from us. Now let’s talk turkey on it’. The States fell over far too quickly. It came from a view that if they did conduct vigorous negotiations and did not immediately embrace it, that somehow they would be punished by the electorate.5
5.13 However, the conceptualisation of conditional grants as contracts by the Commonwealth for the purchase of services only serves to emphasise the impact such funding has on the policy autonomy of the States. This point was made before the Committee by Mr Ken Baxter, formerly Director-General of the New South Wales Premier’s Department and Secretary to the Department of Premier and Cabinet in Victoria:
I commence with the issue of the financing arrangements and taxation. In my view they are key elements in the discussion of the overlap and duplication of roles and responsibilities. The Financial Assistance Grants to the States, the Special Purpose Payments and, of course, more recently the innovation of the funder-provider approach which was attractive to the previous Keating government is certainly being looked at favourably in a number of areas such as housing, health and parts of education involving the funding of Commonwealth activities or services which are supplied to Australian users.
Although the discussion has centred around the greater importance that Financial Assistance Grants have played and the fact that there has been an attempt to wind down the SPPs, in effect that has not happened. There has been effectively tighter control placed over the Special Purpose Payments and greater scrutiny by the Commonwealth. It is my assessment that the development will be that the Commonwealth will use the SPPs for funder-provider splits. Over the next five to six years it may be that instead of the States having greater security over their revenue base, there will be lesser security and we may well find that Local Government and private institutions are competing with State-based institutions for the provision of services.6
In terms of SPPs I think it is possible that one of two things will happen: either the Commonwealth will fulfil its rhetoric and diminish them, agree that they be rolled into FAGs and that the States be given the funds with less ties; or the Commonwealth will do a pea-and-thimble trick, change their name and roll them into FAGs, but then go to the funder-provider model. It will say that the sum total of cookies in the biscuit jar has not changed, but with the previous proportion of SPPs - which I think is 30-odd per cent or 35 per cent, but do not hold me to that figure - it will turn around and say it will call for bids for the delivery of services, whether it is the State Government, the private sector or Local Government.
Of course, housing, health, community services, and education - quite a few of those - start to fall into that category. So what you could see is the Commonwealth rejigging SPPs but effectively retaining control and influencing the policy. Under the terms of reference of the Committee, my view would be that that is a sleeper to which some thought has been given but that not a great deal of intelligent debate has been given to its consequences.7
Mr Sturgess also acknowledged this point:
That generally raises a problem for the States, which State officials have certainly talked about. If, as seems to be the case, there is a move to the purchaser-provider model of government, the contractual state, and the State Governments get out of service delivery and increasingly into purchasing, it is unclear whether the States have a particularly bright future. One of the threats on the horizon for States is that if you move down that road of States getting out of electricity and housing, the question then becomes what is it that the States actually do? I think there is an answer for that question, but the housing policy was a good example of where the roles left to the States were essentially planning functions or decisions about the design of certain communities and whether or not to choose to have people marbled through the rest of the community or located in particular states and so on. So yes, there is a whole range of questions in there that I do not think have been seriously addressed. I suspect that if the States were to pause to think about it they might like to rethink their enthusiasm.8
5.14 In addition to state government programs being less accountable, vertical fiscal imbalance undermines the virtues of federalism, as it reduces the budgetary flexibility of state governments to tailor programs to individual state needs. Professor Glyn Davis, of the Centre for Australian Public Sector Management at Griffith University, and a former Director-General of the Queensland Cabinet Office, expressed to the Committee the overall consequences of vertical fiscal imbalance for the policy autonomy of the States:
There are economists who argue about vertical fiscal imbalance, and you have probably had that case put to you at various times, but it does not matter. That is fine provided you are happy to have the Commonwealth make the policy choices, provided you are willing to say it is a good thing for the Commonwealth to decide how wide the corridors are in our schools because they are better at making those decisions. However, you may think it would be better that local communities made those decisions. You have to make the value judgment.
When you work for the State Government you put that hat on and you say, “It is an outrage that the Commonwealth does not allow us to make our own choices.” Indeed, the local supervision by the Commonwealth is quite an issue in some areas, particularly in health, which is where most of the States’ budgets go. All of the States’ political problems reside in health, yet so many of the choices are not open to them.9
5.15 The Commonwealth Budget argues that vertical fiscal imbalance is not a serious impediment to accountability:
The extent of VFI has often been criticised on the grounds that it reduces government accountability. Accountability is considered to be best served when the level of government responsible for expenditure is also responsible for funding that expenditure through taxes. However, in practice, State governments are accountable for their budgetary decisions at the margin. The States raise around 58 per cent of their total revenue, and increases in State expenditures have to be financed largely through increased State taxation. Financial market scrutiny also has a bearing on a government’s accountability for its spending decisions.10
5.16 A similar view was put to the Committee by Professor John Freebairn of Melbourne University:
My argument is essentially the following: for the most part the dollars you get from the Commonwealth you spend first. Then you decide whether you are going to spend another $100 million on education, health or transport? How are you going to fund that? By raising another $100 million yourself from your own taxes. If that is true, the last $100 million you spend is also the last $100 million you raise from your own tax revenue. At the margin you are making a decision: will I get as much of a kick for a dollar as it will cost me to collect it? I think we tend to think too much about averages - that you collect 50 cents for each dollar you spend. My guess is you are really making decisions on the margin, so I am not all that hung up about vertical fiscal imbalance.11
5.17 However, these arguments, that conditional funding is not economically inefficient, do not address the impact of conditional funding on the States’ policy autonomy. Nor do they address the effect of vertical fiscal imbalance on the ability of the States to raise revenue to meet their citizens’ demands, when that vertical fiscal imbalance is a consequence of Commonwealth dominance of efficient and equitable sources of revenue.
5.18 The constraints that Australian fiscal federal arrangements place on State revenue-raising capacity also undermine attempts to change Australia’s federal arrangements in the interests of microeconomic liberalisation and associated public sector efficiency. As the States lack access to the most efficient sources of taxation, they cannot increase their own revenue without further exacerbating a dysfunctional tax system, thereby contributing to lower levels of business competitiveness. States thus have an incentive to resist or to seek to offset any change that reduces their existing revenue base (such as privatisation) or that increases their expenditure responsibilities (such as transfers of program responsibilities from the Commonwealth).
5.19 Conditional transfers create a need for sState officers to report back to Commonwealth supervisors. This additional bureaucracy, at each level duplicating the activity of the other level, leads to governments facing additional administrative costs.
5.20 Greater openness to international capital markets in the 1980s and 1990s increased the pressure on Australian governments for balanced budgets and debt reduction. By 1990, this fiscal tightening has led governments to become more concerned about the effectiveness of the ‘division of labour’ between Commonwealth and State programs. There was a widespread perception that significant overlap and duplication existed.12
5.21 The 1990s saw these concerns about overlap and duplication in service provision feed into the broader push for regulatory harmonisation and increased public sector efficiency, in tune with the competitive pressures on the private sector. Most controversially, the extension to the entire public sector of this push for microeconomic liberalisation has led to a questioning of the very ‘business’ of government, which has in turn resulted in a reduction of the role of government, and a paring back of the entitlements of the welfare state.
5.22 Many observers argued, and continue to argue, that a more decentralised fiscal federalism would result in greater state flexibility and accountability, and ultimately in more effective, efficient and responsive government programs. State Governments in particular expressed a desire to:
- reduce chronic vertical fiscal imbalance;
- ease acute fiscal squeeze on the States;
- reduce overlap and duplication in Commonwealth and State programs
.
5.23 Some commentators doubt that there is strong evidence of excess duplication between levels of government. They argue instead that duplication of government activity can allow healthy competition among governments, resulting in better public policy.13 This is known as competitive federalism.
5.24 Advocates of this view before the Committee included Professor Cliff Walsh, Director of the South Australian Centre for Economic Studies at the University of Adelaide:
As an economist, government competition encourages different sorts of feelings than competition in the business and market worlds. On many occasions I have used an example which has often caused apoplexy. I cannot think of any good reason why having a public education system competing with a private education system is not a bad idea. Having a public education system where it is possible to send kids to schools run by a federal government service, a state government service, or schools organised and run by a regional government, as long as you do not force me to send my kids to three of the schools simultaneously. In that sense we have an overlap, but I will not call it duplication. We have three spheres of government as well as the private sector competing in the one policy service space. I see it in the same sense as having three or five bread makers competing in a particular service space.14
Mr Doug Brown, formerly Director and now Fellow of the Institute of Intergovernmental Relations and Adjunct Professor of the School of Policy Studies at Queen’s University in Canada:
I think what happens is that terms get used, and they are confusing, and Brian referred to competitive federalism, and I think that concept is really just the following - it is that instead of one government, you have multiple governments. So that Victoria will have an education system that will differ from South Australia’s. The citizens of South Australia will see the extent to which Victoria has a better or a worse system. There is information that goes from the citizens of one state to another and acts on their governments and produces better public policy as a result.
This happens all the time in federal countries. One state will innovate and do something and then the others will copy, and in fact maybe the last one will learn from the mistakes of the others and so forth;15
and Mr Sturgess:
While to some extent we want to avoid inefficient and silly outcomes, competitive markets are full of overlap and duplication. Coles Myer and Woolworths both exist in the marketplace, and that is a classic example of overlap and duplication, but the theory is that we get better results if there is not a monopoly, and arguably the same applies with levels of government. If you have competition you get a better result that is better tailored to Australian values than if you have an all-wise group of people in Canberra saying, ‘We are going to have this but we are going to delegate this part to some region which is at our bidding.’16
5.25 However, horizontal competition between the States is not possible in a context of central dominance in major program areas. Commonwealth-State competition in service provision is also impossible, so long as the Commonwealth determines the extent of, and conditions governing, the States’ expenditure.
Finding 9:
A significant reason for State Governments entering the 1990s New Federalism negotiations was the possibility of achieving fiscal security and policy autonomy, through reform of vertical fiscal imbalance, and reduction of overlap and duplication.
5.26 In November 1991, State and Territorial leaders agreed to a statement of principles they felt ought to govern the reform of program roles and responsibilities. These principles provided a far-reaching framework for realignment.17 As the Commonwealth did not attend the meeting at which they were released, it is unclear that all parties to the intergovernmental negotiations endorsed them. It seems apparent, however, that the Commonwealth Government under Hawke had been ready to accept them.
5.27 A generalised approach to roles and responsibilities reform has not been pursued since the change in Commonwealth leadership in 1991. These principles have not been applied comprehensively, and attempts to renegotiate the boundaries of Commonwealth and State roles and responsibilities have been largely unsuccessful. Efforts to delineate new roles and responsibilities in the area of environmental protection (discussed in the previous chapter) appear to have succeeded because environmental protection involves regulation rather than expenditure. Training and disabilities services are the only expenditure policy areas in which there have been substantial realignments of Commonwealth and State roles and responsibilities. Health, housing and education continue to be sites of disagreement between Commonwealth and State Governments, impeding effective delivery of these services.
5.28 Developments that have taken place in the areas of disabilities services, training, housing and health will each be considered separately.
5.29 One of the earliest outcomes of the Special Premiers Conferences was the 1991 agreement to transfer full responsibility to the States for accommodation and employment-related services to the disabled. The Commonwealth agreed to pay all net additional costs to the States. In doing this it stipulated that these arrangements should not be viewed as a precedent for reform in other areas.
5.30 The arrangement called for the States to pass legislation complementary to the Commonwealth Disabilities Services Act 1991, which sets out conditions to be met by providers of disability services receiving public funding. In Victoria this is the Disabilities Services Act 1991.
5.31 The arrangements in training were designed essentially to ameliorate the Commonwealth’s centralisation policy, which culminated in the takeover by the Commonwealth of Technical and Further Education funding. Management and administrative responsibility in this area continues to be retained by the States.
5.32 Formal agreement to establish the Australian National Training Authority in 1992 resulted in its establishment under the Commonwealth Australian National Training Authority Act in the same year. The Australian National Training Authority authorises the allocation of direct funding to the Technical and Further Education institutions from a pool of Commonwealth and State funds. It is supervised by the Ministerial Council on the Australian National Training Authority, which appoints its members,18 and establishes guidelines for its operation.19
5.33 The establishment of this new national body provides an ongoing role for the States despite the Commonwealth’s control of the funding of Technical and Further Education.20 The Victorian Vocational Education and Training Act 1990 confers a number of functions and powers on the Authority.21
5.34 A commitment was made in 1990 to have this field reviewed by a working group.22 The focus of the working group was on urban renewal, and its report resulted in the Building Better Cities program being announced in 1991.23
5.35 In 1992 a revised Commonwealth-State Housing Agreement was entered into, and a new senior officials committee was created, with the aim of providing a framework for the proper integration of housing with urban development.24 In 1994 there was some discussion of the co-ordination and financing of urban infrastructure.
5.36 Commonwealth and State Governments pursued the renegotiation of the existing Commonwealth-State Housing Agreement under the auspices of the Council of Australian Governments after April 1995. The Commonwealth proposed a new approach, whereby it would take responsibility for income support and housing affordability, while the States would assume full responsibility for the management and delivery of public housing services.25 The proposal remained under negotiation at the June Council of Australian Governments meeting.26 Negotiations over these proposals have broken down, and a new agreement has not been concluded. Funding is proceeding under an interim agreement until June 1999.27
5.37 As with housing, this program area had been scheduled for early review. Since the end of 1991, no substantive realignment of health care responsibilities has taken place. In 1993 the States agreed with the Commonwealth on a renegotiation of the existing Medicare arrangements.
5.38 A renewed attempt at change was initiated at the April 1995 Council of Australian Governments meeting, with the endorsement of a ‘key decisions’ paper. This paper did not envisage a dramatic change in Commonwealth and State roles, but it did recommend a wide-ranging action plan for reform of the organisation, planning and funding of health care services. The 1996 Council of Australian Governments meeting endorsed a revised version of the action plan. Negotiations continued at the Ministerial Council on Health and Community Services.
5.39 Negotiations over a new Australian Health Care Agreement (Medicare Agreement) at the March 1998 Financial Premiers Conference broke down, resulting in the Premiers walking out of the meeting. By the end of July only Queensland and the Australian Capital Territory had entered into a new Agreement with the Commonwealth. The Commonwealth made a revised offer in August, which increased the funds to be made available while still not meeting all the demands of the States. Every State has signed the offer document except for Western Australia and Tasmania, which have both indicated an intention to sign.
Finding 10:
In the 1990s, there have been minor realignments of roles and responsibilities in those expenditure policy areas in which Commonwealth and State activity overlaps. However, the promise of a comprehensive realignment in these areas - particularly health and housing - remains unfulfilled.
5.40 The issue of federal fiscal relations was taken off the agenda with the change in Commonwealth leadership in 1991. This has ultimately reduced the scope of changes to program responsibilities. The removal of federal fiscal reform from the Heads of Government agenda in late 1991 ended serious consideration of heath and housing until 1995.
5.41 At the first Special Premiers Conference, the State and Commonwealth Governments made a commitment to review Specific Purpose Payments (tied grants) to the States by establishing a Working Group of senior officials. The Special Premiers Conference meeting in Sydney in July 1991 noted the progress of an interim report, and saw further progress as related to the overall review of roles and responsibilities.
5.42 Four major options for change were outlined:
- assumption by the States of full program responsibility in some fields with Commonwealth assistance in the form of Financial Assistance Grants;
- the ‘broad-banding’ of many of the existing Specific Purpose Payments;
- reduced conditions on the existing structure of payments;
- assumption by the Commonwealth of full financial and administrative responsibility in some areas
.
5.43 When the Commonwealth did not attend the planned November 1991 Special Premiers Conference, the Premiers and Chief Ministers themselves endorsed a policy of no new tied grants and the objective of reducing the overall proportion of Commonwealth-State transfers in tied form. (This included the tied grants in the proposed Building Better Cities program.) They noted that proposals were ready for such reduction in the fields of education, training, and labour market programs. No formal consensus with the Commonwealth was ever achieved on this issue.
5.44 Since 1990, few changes have been made to the system of Specific Purpose Payments, leaving the Commonwealth with a strong hand in most social program areas. There has been no systematic reduction or elimination of overlap and duplication in Commonwealth and State programs, in order to increase program effectiveness, and the accountability and transparency to the public of intergovernmental programs.
5.45 As with tied grants, the first Special Premiers Conference established a Working Group of senior officials to review Commonwealth-State taxing powers. The Working Group reported in late 1991. Its key recommendation was to guarantee to the States six points of the income tax scale (up to $10 billion of revenue). This guarantee would correspond to a decline in Financial Assistance Grants provided to the States for general purposes. Ultimately the States would be able to vary the rate on their guaranteed band of the income tax scale.
5.46 It was the Working Group’s view that such devolution would not adversely affect the Commonwealth’s overall management of the economy, nor its commitment to fiscal equalisation.
5.47 Although the States endorsed the Working Group’s recommendations, these recommendations did not get Commonwealth approval. Keating attacked the proposed diminution of the role for the Commonwealth in housing, health and education, and the devolution of taxing powers to the State. When Keating became Prime Minister in December of 1991, comprehensive negotiations over fiscal relations and program responsibilities came to an end. No further action has been taken on the Working Group’s report.
5.48 However, Keating strongly supported microeconomic liberalisation, and promised the States a revenue guarantee in place of tax reform. In 1992 the Commonwealth offered the States a ‘real terms revenue guarantee’ of Financial Assistance Grants. As part of the 1995 Agreement on National Competition Policy and Related Reforms, the Commonwealth renewed its commitment to maintain the real per capita guarantee of Financial Assistance Grants on a rolling three year basis. This ‘real terms revenue guarantee’ of Financial Assistance Grants has dealt with the acute revenue problems of the States, but vertical fiscal imbalance has become worse, and the chronic problems remain unsolved.
Finding 11:
The States have not obtained the fiscal security which they sought at the beginning of the 1990s New Federalism negotiations. This lack of progress is in strong contrast to the pace of microeconomic liberalisation at both the Commonwealth and the State level.
5.49 Two developments in the second half of 1997 have lifted the issue of fiscal federalism once more into national prominence. First, since mid-1997, the Howard Government has placed tax reform, and with it a realignment of Commonwealth-State fiscal relations, back on the national political agenda. Second, in August the High Court declared State business franchise licence fees unconstitutional.
5.50 In a media release issued on August 13th 1997, Prime Minister Howard announced that the following principles would guide the Commonwealth Government’s tax initiative:
- there should be no increase in the overall tax burden;
- any new taxation system should involve major reductions in personal income tax with special regard for the taxation treatment of families;
- consideration should be given to a broad based, indirect tax to replace some or all of the existing indirect taxes;
- there should be appropriate compensation for those deserving of special consideration;
- reform of Commonwealth-State financial relations must be addressed.
28
5.51 In a radio interview on May 27th 1998, the Prime Minister said that:
[O]ne of things we would do is address some of the weaknesses in the Commonwealth - State financial relationship and the ones that you’ve mentioned are part of that . . . there are some other issues and I believe that at the end of the process that what we produce will be something that the States will see as a very significant advance on the present system. Now I’ve had some discussion with State Premiers and I certainly expect to have some more with them before the tax package is finalised. Because although at the end of the day, we have to take the decisions, we are keen to have the views of the States. We’re keen [for] their input. We’re very keen to discuss various options with them and that’s part and parcel of the process.29
5.52 At the Council of Australian Governments meeting in November of 1997, the Heads of Government made the following joint statement:
At our meeting today, it was unanimously agreed that Australia needed fundamental reform to its national taxation system as we go into the 21st Century.
Premiers, Chief Ministers and State Treasurers agreed with the Federal Treasurer and I that such reform should not involve any increase in the overall taxation burden.
We will meet again to further progress our discussion.30
5.53 Possibilities discussed by commentators have included: the States gaining a fixed share of Commonwealth-collected income tax; the allocation of tax room for the States to raise their own income tax; or, the States gaining a share of a general consumption tax in return for abandoning some of their ineffective tax instruments.31
5.54 On August 13th 1998 the Prime Minister announced the details of the Commonwealth initiative.32 The Commonwealth Government’s proposal concerning federal fiscal arrangements is for a number of Commonwealth and State taxes to be altered or abolished, and for Commonwealth grants to the States to be correspondingly changed. The Commonwealth would abolish Wholesale Sales Tax and introduce a broad-based consumption tax, to be called a Goods and Services Tax. A number of changes would also be made to the taxation of alcohol, tobacco, fuel and luxury cars. The Commonwealth would cease to make Financial Assistance Grants and Revenue Replacement Payments to the States, and it is proposed instead that the States receive the entire revenue raised by the Goods and Services Tax, on condition that they abolish a number of indirect taxes33 and take over full responsibility for the funding of Local Government. The distribution of the Goods and Services Tax revenue among the States would be decided by the Commonwealth Grants Commission according to the principles of Horizontal Fiscal Equalisation. This proposal is to be the subject of parliamentary scrutiny and debate.
5.55 The High Court decision in the Ha and Hammond cases34, handed down on August 5th, has contributed to increased calls for tax reform. The High Court ruled that the New South Wales’s business franchise licence fees taxing the sale of tobacco are unconstitutional. By implication, all State business franchise licence fees, by which the States collected revenue from the sale of petroleum products, liquor and tobacco, are unconstitutional. This immediately created a shortfall in State revenues of $5 billion (16 percent of total State revenues). The Victorian Treasury explained to the Committee the impact of this development on Victoria:
[B]y 1996–97, [business franchise licence fees amounted to] some 17 per cent of our total tax revenues.
The next slide traces the trends in four major tax bases over that time and illustrates how tax reliance on labour and property have declined over that period while at the same time reliance on transactions taxes and franchise fees has grown. The next slide shows that these trends have occurred against a backdrop of the States receiving a declining share of Commonwealth revenues. It shows that a decade ago Commonwealth payments to the States represented about 8 per cent of the economy. Today, they represent less than 6 per cent. State taxes have had to grow to fill in the gap and, as I have noted, franchise fees were the fastest growing of the States’ taxes which had evolved to fill that gap. Today they are gone.35
5.56 The Commonwealth Government has increased its own excise duties on tobacco and petroleum products, and its wholesale sales tax on liquor, effective from the 6th of August, in order to provide Revenue Replacement Payments to the States. As section 51 (ii) of the Constitution requires the Commonwealth to impose taxes at the same rate nationally, without discrimination between the States, the Commonwealth excise will be increased sufficiently to cover the rate of the highest-taxing States. To preserve the status quo, of the States having set their business franchise licence fees at various rates, Commonwealth money will be paid to the States with the expectation that any difference between the Commonwealth rate and the State rate be immediately passed on to wholesalers. The Australian Competition and Consumer Commission will monitor any effect of the rescue plan on prices.
5.57 Commentators predict that this scheme, distributing as it does the federal revenues according to past tax effort and thus unevenly across the States, is untenable over the long term.36 There is the possibility that the rescue plan will be challenged in the courts for being unconstitutional, with the Commonwealth’s real aim being to levy taxes at different rates in different states. Mr John Waugh, of Melbourne University, told the Committee:
Mr WAUGH - The whole question of the grants back to the States of the excess tax raises a Constitutional problem, too. It is possible that the rescue scheme will be challenged in the courts on the ground that it really does discriminate between states, that the overall intention of the Commonwealth is that rates of tax will vary between the States.
The CHAIRMAN - One could therefore put a constitutional argument that it is discriminatory, with the different states making different refunds.
Mr WAUGH - Seeing the enthusiasm of Mr Quilty, the solicitor for the challengers in New South Wales, I would not be surprised if the plaintiffs wanted to have another go at anything in this that can be challenged. The Commonwealth is very well aware of that danger, and that is reflected in the Commonwealth Treasurer’s comments. He has been very careful to say, “We are just giving money back to the States,” and I think he has said in as many words, “What the states do with the grants is up to them. It is their business.” However, he fully expects that they will refund the money to maintain previous rates.37
5.58 The Revenue Replacement plan involves some further anomalies. For example, State tobacco franchise licence fees have been levied with reference to the value of the tobacco sold, whereas the Commonwealth tax on tobacco (which has been implemented not by legislation, but by altering Commonwealth regulations prescribing rates of excise under Commonwealth law) is levied by weight.
5.59 The Commonwealth Budget Papers describes the Revenue Replacement Payments in the following way:
The States have acknowledged that these arrangements would represent State taxes imposed and collected by the Commonwealth at the request of and on behalf of the States.38
The current arrangements are clearly unsatisfactory. The Victorian Budget Papers predict that:
The business franchise fee safety net arrangements are temporary, pending the development of longer term revenue replacement options arising from national tax reform. It is expected that the safety net will remain in place at least until the end of the 1998-99 financial year.39
Some commentators have suggested the possibility of a Constitutional amendment to permit the States to levy taxes on sales.40
Finding 12:
There is a need to reform federal fiscal relations, in order to secure an appropriate policy role for the States.
RETURN TO TOP
1A simpler measure, of government own-purpose revenue to government own-purpose outlay, is sometimes used (see, for example, State of Victoria, Budget Statement 1998-99, 1998-99 Budget Paper No 2, p 198).
2R L Mathews & W R C Jay, Federal Finance: Intergovernmental Financial Relations in Australia Since Federation, Thomas Nelson, Sydney, 1972, reprinted Centre for Strategic Economic Studies, Victoria University, Melbourne, 1997; Richard A Bird, Federal Finance in Comparative Perspective, Canadian Tax Foundation, Toronto, 1986; Cliff Walsh, Reform of Commonwealth-State Relations: No Representation Without Taxation, Occasional Paper 2, Federalism Research Centre, Australian National University, Canberra, 1993; see also the table at p 107, above.
3Meeting of Premiers and Chief Ministers, Communique, April 26th 1992.
4Industry Commission, Annual Report 1993-94, Australian Government Publishing Service, Canberra, 1994, pp 93-114; National Commission of Audit, Report to the Commonwealth Government, Canberra, Australian Government Publishing Service, 1996, pp 43-44; Walsh, above n 2.
5Minutes of Evidence, FSRC, September 11th 1997, p 851 (per Mr G Sturgess).
6Minutes of Evidence, FSRC, April 21st 1997, pp 408-9 (per Mr K Baxter).
7Ibid, p 424.
8Minutes of Evidence, FSRC, September 11th 1997, p 853 (per Mr G Sturgess).
9Minutes of Evidence, FSRC, June 26th 1997, p 469 (per Professor G Davis).
10Commonwealth of Australia, Federal Financial Relations 1998-99, 1998-99 Budget Paper No 3,
p 15.
11Minutes of Evidence, FSRC, February 23rd 1998, p 923 (per Professor J Freebairn).
12Economic Planning Advisory Council, Promoting Competition in Australia, Council Paper No 38, Australian Government Publishing Service, Canberra, 1989.
13Vincent Ostrom, The Political Theory of a Compound Republic: Designing the American Experiment (2nd ed), University of Nebraska Press, Lincoln, 1987; Christine Fletcher and Cliff Walsh, Intergovernmental Relations in Australia: Managerialist Reform and the Power of Federalism, Discussion Paper No 4, Federalism Research Centre, Australian National University, Canberra, 1991; Brian Galligan, A Federal Republic: Australia’s Constitutional System of Government, Cambridge University Press, Melbourne, 1995; D V Smiley, The Federal Condition in Canada, McGraw-Hill, Ryerson, Toronto, 1987.
14Minutes of Evidence, FSRC, July 3rd 1997, pp 683-4 (per Professor C Walsh).
15Minutes of Evidence, FSRC, April 15th 1997, p 398 (per Mr D Brown).
16Minutes of Evidence, FSRC, September 11th 1997, pp 852-3 (per Mr G Sturgess).
17See above, Chapter 3, para 3.29, p 59.
18Australian National Training Authority Act 1992 (Cth), s 25.
19Ibid, ss 6 (2) (e), (h), 8, 14 (2) (b), 40A (3), 45 (3), 49 (2) (a).
20Intergovernmental News, Centre for Comparative Constitutional Studies, University of Melbourne, Melbourne, April 1992.
21Sections 9A, 22A, 22B.
22Special Premiers Conference, Communique, October 30th-31st 1990, under the heading “Infrastructure”.
23Special Premiers Conference, Communique, July 30th-31st 1991.
24Council of Australian Governments, Communique, December 7th 1992.
25Council of Australian Governments, Communique, April 11th 1995.
26Council of Australian Governments, Communique, June 14th 1996.
27State of Victoria, Budget Estimates 1998-99, 1998-99 Budget Paper No 3, p 480.
28Prime Minister the Hon John Howard, Media Release, August 13th 1997.
29Prime Minister the Hon John Howard, interview with Howard Sattler, Radio 6PR, May 27th 1998.
30Council of Australian Governments, Communique, November 6th 1997.
31Michelle Grattan, “Mantras won’t mend imbalance”, Australian Financial Review, November 3rd 1997, p 16; L Taylor and L Dodson, “Fundamental nod on tax”, Australian Financial Review, November 7th 1997, p 7; L Taylor, “Howard’s uncertainties” - Perspective, Weekend Australian Financial Review, November 8th - 9th 1997, p 27.
32The Commonwealth Government’s proposal is set out in Commonwealth of Australia, Tax Reform: Not a new tax, a new tax system, Australian Government Publishing Service, Canberra, 1998. The proposed changes to federal fiscal arrangements are detailed at pp 79-89.
33Financial Institutions Duty, debits tax, bed taxes, conveyancing duties on business property and stamp duties on marketable securities, credit arrangements, instalment purchase arrangements, rental (hiring) agreements, leases, cheques, bills of exchange, promissory notes, mortgages, bonds, debentures and other loan securities.
34Ha v New South Wales; Hammond & Associates Pty Ltd v New South Wales (1997) 71 ALJR 1080; 146 ALR 355.
35Minutes of Evidence, FSRC, November 5th 1997, p 867 (per Ms C Thomas).
36Intergovernmental News, Centre for Comparative Constitutional Studies, University of Melbourne, Melbourne, October 1997.
37Minutes of Evidence, FSRC, August 12th 1997, p 768 (per Mr J Waugh).
38Commonwealth of Australia, Federal Financial Relations 1998-99, 1998-99 Budget Paper No 3, p 32.
39State of Victoria, Budget Statement 1998-99, 1998-99 Budget Paper No 2, p 105.
40Chris Merrit, “Fiscal federalism up for judgement”, Australian Financial Review, June 12th 1997; Paul Kelly, “Verdict upsets power balance”, The Australian, August 6th 1997; John Waugh, “Commonwealth left with the cards and the cash”, The Age, August 6th 1997.
Home