Opinion & Commentary
States' tax system is deficient
The recent focus of Commonwealth-state relations on policy coordination in pursuit of improved productivity and labour force participation does not negate the case for further reform of fiscal federalism, notwithstanding the GST-based reforms that have already taken place.
The GST reforms delivered the states 100 percent of the revenue from the new tax in return for giving up some of their worst taxes and the old financial assistance grants from the Commonwealth. States’ finances are (or will be) more robust and the national economy will benefit from the demise of inefficient, distorting financial transaction taxes.
These are worthwhile benefits. But the GST reforms don’t really fix the long-standing basic flaws in Australia’s federal fiscal structure.
Decentralization is supposed to make government more responsive, efficient and competitive. But Australian federalism lost its anchor to these ideals decades ago and the GST reforms have done nothing to restore it.
Claims that the states receive more revenue as a result of the GST miss the point that the essence of federalism isn’t more or less revenue, but autonomy, responsibility and accountability. The states do not – and constitutionally cannot – determine GST policy on their own. Meanwhile tied grants (specific purpose payments) from the Commonwealth to the states are carrying the central government’s influence more widely and deeply into state service delivery, blurring responsibility and accountability.
What remains of the states’ own tax system is deficient. Even after the GST-related program of state tax repeal is completed in 2012, stamp duties on property transfers, insurance and motor vehicles will remain as important revenue sources. Their retention has more to do with the amount of revenue at stake than their merits as taxes.
The design of payroll tax and land tax could be greatly improved. Misguided policies have effectively turned them into distortionary selective taxes instead of the efficient broad-based taxes they could be.
What, then, should be done?
The best way within existing constitutional constraints to restore the states’ fiscal autonomy is for the Commonwealth to re-admit the states to the personal income tax base from which they have been excluded since 1942. This need not be a recipe for higher overall income tax or a greater administrative burden, provided the Commonwealth makes a large cut in its own income tax rates to make room for the states, the ATO provides the administration for both, and the states use the same definition of taxable income as the Commonwealth.
Let’s say the Commonwealth cuts its personal income tax take by one-third, offset by a state personal income tax rate of around 10 percent (initially uniform but later subject to change by each state). This would leave a large hole in the federal budget and an equivalent gain to the states, which could be neutralized in two ways. First, the Commonwealth should retain 5 percentage points of the GST for its own purposes. Second, the Commonwealth should eliminate most tied grants to the states, based on a thorough review of the roles and responsibilities of each tier of government.
To complete the package, the states should be required to scrap all remaining stamp duties, not just those the states are already committed to phasing out. But it is fanciful to think the states could do this out of existing and projected GST revenue. An increase in the GST rate to 12.5 percent would be needed, with 7.5 percentage points earmarked for the states.
This package would make the tax system more benign in its effects on the economy and would restore the substance of federalism by making the states more self-reliant in carrying out a clear set of responsibilities.
Robert Carling is a Visiting Fellow at The Centre for Independent Studies. This article is based on his report State Taxation and Fiscal Federalism: A Blueprint for Further Reform, released by the Centre for Independent Studies.
