Blame Canberra? Why should we?

One of the biggest tensions in last week’s budget was that it includes huge cuts to essential services, because we can’t afford them, but then promises regular income tax cuts to maintain a ‘tax cap’ of 23.9 per cent of GDP.

The principle at stake is that raising the total tax take too far would risk a fiscal drag that could crimp growth -- so collecting too much tax eventually becomes counterproductive as it strangles the goose that lays the golden egg.

The budget papers state that 23.9 per cent is chosen as the cap because “this is the average tax-to-GDP ratio of the years following the introduction of the GST and prior to the global financial crisis”.

That allows welfare lobbies such as the Australian Council of Social Service to argue that “we are currently one of the lowest taxing countries in the OECD with one of the lowest debt levels. What we don’t have is the sustainable revenue base needed to deliver the services that a country in Australia’s economic position has the capacity to support.”

Well they have a point, sort of. 

As discussed previously, state taxes and local council rates, when added to federal tax receipts, bring the total to around 30 per cent of GDP -- a bit less than Canada at 32 per cent.

So ACOSS is correct to say there is wriggle room. If the government allowed ‘bracket creep’ to bring federal tax receipts up a little over the forward estimates (to 25 per cent of GDP, for instance -- a difference of around $15 billion a year), a whole lot of the lost hospital beds could be funded, and our schools would stand a chance of competing with the best in the world.

But there is a bigger point to be made. As discussed yesterday many have interpreted the funding cuts as a wedge to get state governments to ask for the GST rate to be raised, or the base widened.

Longer term, however, it is just as likely that Tony Abbott has his heart set on devolving some power to the states and re-invigorating ‘competitive federalism’ -- as recommended by the Tony Shepherd-led Commission of Audit.

That plan, which has received far too little attention to date, would still see the federal government collect income tax, but a set amount -- it recommends 10 percentage points -- would be given back to the state that raised it.

This would achieve several things.

Firstly, that large chunk of money would replace about half of the tied grants currently awarded to states through the Grants Commission.

Secondly, it would help offset some of the decline in state revenue caused by weak consumer confidence, and a consequent drop in GST revenues.

And thirdly, it would require the states to not only manage, but take full fiscal responsibility for things such as health and education.

When ‘competitive federalism’ is discussed, what is usually meant is that states that stuff things up will gradually lose residents to states where the economy is booming. A nice idea in theory.

There are grave dangers, however, in supposing that communities can flow like water between states -- many can’t, or won’t, and altering the distribution of federal taxes could leave large pockets of disadvantage in ‘mendicant’ states such as Tasmania and South Australia, which are currently propped up with GST revenue from the more prosperous states.

If a large chunk of income tax revenue were also handed back -- and the audit commission recommends making it on a strict hypothecated basis -- the mendicant states would shrivel and the social problems would magnify.

So empowering states with hypothecated income revenue is not a simple business. The Commonwealth does have a clear responsibility to equalise for obvious structural disadvantages.

For instance, the current formulas used to carve up the GST take account of both a state’s ability to raise revenue, and the cost it faces in delivering services.

For example, Western Australia needs to build longer roads (give it a bit more money), but has oodles of mining revenues raised as royalties (take a bit back).

Likewise, Victoria and New South Wales can raise a lot more money in payroll tax, because by convention it is only imposed on large businesses, and most big companies have their headquarters in Sydney and Melbourne.

Equalising for those kinds of advantages and disadvantages would be complex, but not unworkable if the Commission of Audit’s plan to devolve some power to the states went ahead.

The problem with making such a huge change to the federation is primarily political, but there are two important principles that could inform a grown-up debate on this topic.

The first is that such a change can be done by degrees -- when John Howard promised all the GST revenue to the states in 2000, he gave them a degree of control back (they lost most of it in 1942 when the Commonwealth took control of their income tax raising powers).

The Commission of Audit proposal also represents change by degrees -- it suggested giving 10 percentage points back. That 10 point slice, to be known as a state surcharge,  could then be lowered (“come to sunny WA where the state surcharge is only 9 per cent!”) or raised (“we’re putting a temporary 1 point extra on the Queensland state surcharge to fix the budget!") to cope with fiscal problems or to be more competitive in attracting Labor.

Hmm. It would be a brave state that tried to tell its denizens they had to pay an extra point of income tax.

But putting that too-clever provision to one side, the basic principle is that a debate over restoring the original power structures of the federation does not have to be ‘all or nothing’. If it was done by degrees, voters would have a chance to accept or resist the process.

The second important principle, which has so far been overlooked, is that ‘competitive’ does not have to mean Mike Baird vs Campbell Newman.

Rather, giving real control of health and education back to the states would create more competition between political parties!

For decades the states have played a ‘blame game’ with the Commonwealth, and blame for poor health and education provision is sometimes on one side, sometimes another. Often, the blame game is most intense between governments from the same side of politics -- Colin Barnett vs Tony Abbott, for instance.

Often, that is understood quite well by the chattering classes -- higher socio-economic groups who absorb and understand complex policy debates through high quality media.

But many voters don’t know who to blame. Often they look over the heads of their state governments and blame Canberra -- and not always justly.

While there are powerful examples of state governments being turfed out of power for specific reasons (Jeff Kennett, take a bow), state governments are just as likely to change through sheer boredom and indifference -- voters thinking “not sure what they did, but it’s time for a change”.

How sharply voters’ minds would by focused on Denis Napthine or Jay Weatherill, if they knew these men’s governments were 100 per cent responsible for the hospitals and schools, as well as for the money to run them.

The blame game would be over.

Revitalising the federation will become more of an issue when the government’s tax white paper is released, and there are many dangers in rushing back to the old style federation -- would there be anyone at all left in Tasmania, for instance?

But a mature debate about doing it by degrees, and about the political impacts of reinvigorating voters’ engagement with state governments, would be a wonderful thing.