Pape and Fiscal Federalism

Having the ability to do things is great if you have the money to do them.

And the States don’t have the dosh to do much.

As Bob Carr has observed, as a result of High Court decisions State Governments have lost the power to (effectively) tax petrol and alcohol – a lot of the capacity for states to raise ‘own source revenue’ has been lost.

The Australian reported a recent appearance of Queensland Treasurer Andrew Fraser at the Toowoomba Chamber of Commerce thusly:

"Without fiscal sovereignty, state sovereignty is illusory," Fraser said, in his unique style. "The sheer imbalance of the fiscal capacities of the states vis-a-vis the commonwealth invites a form of implicit fiscal bullying and tacit mendicancy. It is this dynamic that pervades commonwealth-state financial relations."
……………….

In his speech, Fraser pointed out that, with 45 per cent of all revenues across the states and territories coming from commonwealth grants, his own revenue streams were limited.

"The nature of the state revenue base - dominated as it is by transfer duty, payroll taxes and royalties - is narrow and sectoral," he said. "On the principles of tax design, this is undesirable. The effects of a sectoral decline can quickly tip a state budget in a manner disproportionate to the broader changes in the economic environment."

When all three sectors tip, as has occurred of late in the mining sector, property market, and in employment generally, a state such as Queensland finds itself in huge trouble, now contemplating a budget deficit of more than $3 billion.

The next pivotal part of the play will be the Henry Review of the tax system.

In a speech given on 26 March 2009 review chairman Ken Henry noted that improving the federal structure of the tax transfer system was an one of the important elements of the review.

He said there were three dimensions to this assignment exercise – the level of government responsible for the design of the tax; the level of government responsible for administration and collection of the tax; and the level of government that receives the revenue raised by the tax.

After noting that state and territory level governments should ‘avoid tax bases with high interjurisdictional mobility’ he said:

It is usually the case that whoever controls the policy and administration will also receive the revenue – and it is important that governments have some capacity to alter revenue consistent with their marginal expenditure choices.

But it is also usually the case in federal systems that there is an imbalance between the revenue that each level of government raises and its expenditure requirements. For some taxes, therefore, part or all of the revenue may be given to another level of government.

Then there is the question of how this revenue is distributed among governments at the same level and with what conditions.

There are trade-offs to be made in this three-dimensional assignment task. The more the policy and administration of the tax system is centralised at the national level, the greater the opportunity to develop a less complex and more efficient tax system.

However, centralisation obviously also means that sub-national governments have a greater reliance on revenue from the national government. And this may influence their spending decisions.

So the issue could ultimately boil down to:

1. Should taxes be levied by:

(a) the entity responsible for the expenditure; or

(b) the entity that can most conveniently and efficiently collect the revenue.

And, if the answer is (usually) the feds:

2. How much of a policy say should they have over the way in which the money they have collected is spent.

Following the High Court decision in Pape, the debate that will follow release of the Henry Review is probably the right time to realign who does what within the Australian federation, and then determine how those functions should be funded.