That other white paper…

The federal government’s white paper review of taxation has attracted a great deal of attention and commentary of late, but there is another white paper review in the works that has been shunted to the sidelines – namely, the federation white paper. However, the federation review will be back in the spotlight at this week’s Council of Australian Governments (COAG) meeting.

The two white papers are closely related because taxation is central to fiscal federalism. The inter-relationships are complex, and COAG needs a starting point to structure its talks. New South Wales Premier Mike Baird put forward his plan before the last COAG meeting and South Australian Premier Jay Weatherill put his plan on the table more recently. The Weatherill plan, for those who missed it, is in two basic parts.

Part 1 involves the Commonwealth sharing 17.5% of personal income tax revenue with the states and territories. (At current collection rates, this is about $33 billion.) This would be neatly offset by the Commonwealth ceasing all specific purpose grants to the states and territories, except those for infrastructure and those that are passed on to non-government schools. This neat exchange makes Part 1 budget-neutral for both sides at the time of implementation, but over time the states and territories could expect to be better off at the expense of the Commonwealth to the extent personal income tax revenue grows faster than specific purpose grants.

Part 2 involves the states and territories agreeing to an increase in the GST from 10% to 15%, with the novel twist that the Commonwealth would retain the revenue from the incremental 5% to help fund personal and company income tax reforms after compensation for low income earners. Thus, the GST would become a revenue sharing scheme, with the state and territories receiving two-thirds and the Commonwealth receiving one-third. This has the advantage that the Commonwealth, which has legislative and administrative control of the GST, would have ‘skin in the game’ that it doesn’t currently have.

Although Weatherill puts the two parts together as a grand bargain involving gains and losses for both sides, in mechanical terms each part is self-contained and could be implemented without the other.

I don’t agree with every detail of Weatherill’s plan, but I find it to be the best starting point for discussion so far put forward – and certainly better than the Baird plan, which is a naked grab for more state revenue.

Part 1 of the Weatherill plan constitutes a much-needed reform of federal-state financial relations, reversing the decades-long trend of increasing federal entanglement in state responsibilities. Having advocated something very similar myself, I find Part 1 of Weatherill’s plan appealing. For example, it would see the Commonwealth withdraw from any funding or policy role in school and technical education, with the federal department of education becoming the department of higher education.

However, it is important to understand that on the income tax side, the Weatherill plan is a revenue sharing model, not a power sharing model, which would allow states and territories individually the freedom to impose and vary their own personal income tax rate as in the US and Canada. Thus while the Weatherill plan would give states greater spending autonomy, it would not give them greater revenue autonomy, which would require income tax power sharing. The more limited revenue sharing approach may be an essential first step along the way to the more far-reaching power sharing approach.

Part 2 raises the contentious issue of a GST increase. As I have written before for Business Spectator, there are many problems with this, such as the waste of revenue on likely over-compensation of social benefit recipients, and whether the trade-off between a higher GST and lower income tax would be sustained over time. The concern is that over time the GST increase would stay, but the offsetting income tax cuts would be eroded either through bracket creep or explicit action by future governments.

Neither part of the Weatherill plan addresses the pressing need for reform of existing state taxes such as stamp duties and land tax. Such reform can be undertaken unilaterally by any state – and the Weatherill government is giving an example by phasing out stamp duty on commercial property transfers. However, including state tax reform in the grand bargain would provide greater certainty and a more comprehensive approach.

For the Weatherill plan to work, the federal government needs to be willing to give up its monopoly of income tax and the extensive control it exercises over state functions through the web of tied grants – a willingness it has not displayed in the past. Tony Abbott launched the federation review on the basis that the states should be “sovereign in their own sphere”. We never got to find out exactly what he meant by that in practice, but the fact that he said it gave hope to those, such as myself, who have long wanted the Commonwealth to get out of state functions. Prime Minister Turnbull is yet to reveal much of his basic beliefs in how the federation should be structured, but we may find out more at this week’s COAG meeting.

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