Brave new tax world: devolution back on the COAG agenda

By Stephen Easton

Thursday March 31, 2016

Federation reform and its central issue — taxation — will dominate tomorrow’s Council of Australian Governments meeting, which will discuss a proposal to let states and territories directly receive some personal income tax.

The devolution plan would see the second tier of government take full responsibility for funding public schools beyond 2017 and need to provide a bigger share of hospital funding after a four-year interim federal funding package that will also be put on the table tomorrow.

The Opposition is strongly against the idea and will campaign hard against it up until the next election.

Prime Minister Malcolm Turnbull said the reform would deliver “clearer lines of responsibility, less duplication, more open accountability” and claimed there would be no administrative changes noticeable to taxpayers or compliance costs passed down the line, because the Australian Taxation Office would continue managing the system.

“We will clearly identify the areas of responsibility for the state and for the federal government and the state will have access to personal income tax, to enable them to raise that money, to fund that expenditure,” he told reporters in Sydney yesterday.

In a “statement on federation” issued after half a day of confusing speculation and commentary, Turnbull summed up his take on where the Commonwealth of Australia went wrong:

“The States’ lack of financial freedom, their constant begging to the Commonwealth, the constant blame game — this is what is wrong with our federation.”

Turnbull said he and his senior officials had concluded the proposal was “the only way that we can genuinely reform our federation” after finding widespread recognition of this supposed “failure at the heart of the federation” through various discussions.

According to the PM, the “core problem” is state and territory governments regularly demanding more money from the Commonwealth instead of having to ultimately make the case for tax increases to their own voters.

“In other words, they’re not accountable enough in the way a government should be,” Turnbull said.

The current situation with about $50 billion in tied grants from the federal government to fund infrastructure and services only leads to “ongoing arguments, negotiations and duplication in administration” in the PM’s view, whereas he proposed “clearly marked out lines of responsibility” to improve efficiency.

Standard for pundits, radical for a PM

The idea is being described as “radical” by some news reporters, commentators and the Opposition, but the broad prescription of letting more tax flow directly to the second tier of government has been suggested for years, as the PM noted. While money without strings attached is generally welcome, the responsibility of setting the tax rate and explaining when it has to go up is not.

Former top federal mandarin Terry Moran has long argued in favour of devolution. Setting out a way forward on federation and tax reform last October in his final speech as outgoing Institute for Public Administration Australia president, Moran argued:

“Generally, we would be better as a nation if, incrementally, the Commonwealth simply backed out of service delivery and either transferred funding to the states — or made payments available in different areas based on a standard funding basis per person or per transaction.”

In 2014, former Victorian premier Steve Bracks told The Mandarin he thought a share of income tax would help states deliver those services better. Both Bracks and Moran described the abolition of the COAG Reform Council by Tony Abbott as a “retrograde step” for efforts to reform the federation.

A more crucial piece of the tax reform puzzle is the need for states and territories to replace inefficient taxes — stamp duty and insurance levies — with land and payroll taxes.

Commonwealth Grants Commission chair Greg Smith, speaking as a contributor to the Henry Tax Review at the IPAA national conference last year, said he didn’t think vertical fiscal imbalance was necessarily a major issue. But if one did want to reduce VFI, Smith argued, states must shift their revenue streams to the more efficient taxes.

He added that if governments were serious about decreasing VFI, giving each state and territory a share of personal income tax collected by the Commonwealth would be the best option.

While putting more revenue directly into state coffers is far from radical for policy pundits, federation and tax reform have a lot of moving parts and could prove to be a minefield for the Prime Minister. As the head of Treasury’s Tax White Paper Taskforce Roger Brake commented at the same conference: “These reforms are much easier to say, of course, than to implement.”

Who wants to set the tax rate?

The sticking points for Turnbull are the spectre of states and territories increasing or lowering personal income tax rates in the future, and how demographic differences between jurisdictions would be managed.

In Turnbull’s proposal, COAG would agree that taxpayers pay the same amount as they do now, but only for a limited time.

“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,” Turnbull said. “But in future, of course, on the longer term, a state should be free to lower that amount or indeed raise it and then they are accountable to their own voters.”

Earlier in the day, his team were trying to assuage fears of second-tier governments fiddling with income tax rates in future. Treasurer Scott Morrison said the federal government had “no appetite” to see the rates change and the only certainty was that COAG would discuss the idea.

Depending on how it is implemented, such a change could also fragment the national economy by exacerbating existing economic disparities between states and territories.

Turnbull bluntly denies that his plan would disadvantage the less wealthy states and says there are “mechanisms within the federal finance arrangements to do that” which he has already begun discussing with the South Australian and Tasmanian premiers, who have indicated they do not support the idea.

States react

SA Premier Jay Weatherill supports a system where the federal government transfers a proportion of the revenue directly to state coffers, but only if it continues to take a standard rate of personal income tax across the nation.

Weatherill and his Tasmanian counterpart Will Hodgman argued that letting states set the rates would not result in them receiving more revenue to fund health and education but just the opposite, as jurisdictions would compete in a race to the bottom with their states vying for the wooden spoon.

New South Wales Premier Mike Baird would also prefer to get a share of income tax while letting the Commonwealth continue to set a single national rate. But the PM’s argument is clear: if more revenue is needed, then those who spend it should be the ones to explain that to the electorate.

Turnbull stressed that increasing the overall tax paid by Australians was not the federal government’s “intention” although he conceded it could be a result of the scheme. Asked if he was simply shifting the blame for inevitable future tax rises, Turnbull argued that “in an ideal world” every government would collect all of the tax they spent and be accountable to their voters for both spending and revenue.

“Seriously, the state governments are sovereign governments in their own right,” he said, setting himself apart from past prime ministers who had “sought to constantly expand federal power and have been quite happy to reduce the autonomy of the states” for decades.

Of course, many would argue the very purpose of the federation is to share the wealth of Australia around more evenly and reduce disparities in standards of living between different parts of the continent, for the collective good of its people.

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