Federal-state reform should not mean more tax

When Tony Abbott said recently that the Goods and Services Tax (GST) should be “looked at”, the public response was to focus on that remark at the expense of everything else in a wide-ranging speech. Such a response may have been inevitable but was not a good start to the “mature debate” the Prime Minister called for.

The topic of his speech was review and reform of the federal system of government. Increasing the GST in itself does not constitute reform of anything. Nor is it an essential part of a federalism reform package. To suggest otherwise is to poison the debate before it even gets started.

The GST may have a part in overall tax reform, the subject of (yet another) review being run in parallel with the review of federalism. The tax system relies too heavily on income tax and relatively little on indirect taxes. But tax reviews have been saying that for at least 40 years, and sensibly structured trade-offs are very difficult to achieve, particularly in a Senate such as the current one. Also, there is never any guarantee that trade-offs will be sustained over time. In fact, they are very likely to lead to net tax increases over time.

Federalism and taxation are inextricably linked, but the starting point for the review of federalism should not be the GST or taxation in general, but identifying the most sensible allocation of spending responsibilities between the states and the Commonwealth. Funding issues then flow from the allocation of responsibilities. States’ spending responsibilities far exceed revenue from their own sources and the gap is closed by around $100 billion a year of Commonwealth untied (GST) and tied grants in roughly equal magnitudes.

This mismatch is the source of the dysfunctional aspects of our federation – the lack of accountability, the buck-passing and blame games, the duplication and overlap – and should be the focus of the white paper review.

Tied grants to the states are of particular concern as they give the Commonwealth a say in a wide range of state functions such as education, health, public housing and roads. As such they represent a de facto reallocation or sharing of responsibility from the states to the Commonwealth, a process that has been going on for decades.

As there has been much reflection on the Whitlam government, it is worth noting that tied grants grew explosively as that government sought to expand Commonwealth policy influence in an array of hitherto state functions. The Whitlam government re-set the base of tied grants from a low level to a much higher level which has been sustained and even built upon by subsequent governments.

As Abbott said in his recent speech, there are two ways to solve the mismatch problem: shift spending responsibility from the states to the Commonwealth; or shift revenue from the Commonwealth to the states. While theoretically these are the broad choices, it is inconceivable that an allocation of spending responsibility based on the principle of subsidiarity would lead to much or any of the former. In any case, it is difficult to see how such a shift could be achieved under the current constitution.

To the contrary, there is a strong case for the Commonwealth reducing its de facto power sharing with the states through tied grants in areas such as education and public housing. A key test of the Commonwealth’s reform bona fides will be its willingness to withdraw completely from at least some areas in which it currently influences state policies through tied grants.

Withdrawing tied grants and doing nothing else would effectively transfer funding from the states to the Commonwealth. There would need to be additional general revenue for the states, while the Commonwealth would be left with surplus funds. It is here that reform of the federation intersects with tax reform. There are various ways in which the states could receive more general revenue, one of which is a higher and/or broader GST, offset by a reduction in Commonwealth taxation (subject to the above reservations about tax trade-offs).

Another option is for the Commonwealth to begin sharing existing income tax revenue with the states. This, like a GST increase, would give the states a greater degree of revenue security but would not give them greater power to control their own revenues. A further option that would give the states such power is for the Commonwealth to enable them to levy their own personal income taxes, and to lower Commonwealth income tax to make room for the states.

There are, of course, other issues for tax reform such as company income tax and states’ existing inefficient taxes.

The key point for both the tax review and the review of federalism is not to start from the premise that overall taxation needs to be increased or that an increase in the GST is inevitable.

Robert Carling is a Senior Fellow at the Centre for Independent Studies