The Henry Review and the Federation - a Constitutionalist's View

The previous article set out parts of a speech given by Ken Henry, the Secretary to the Australian Treasury and chairman of the Future Tax System Review.

Henry looked at the issue of fiscal federalism through the prism of Australia as a single market, with taxes and allocation of responsibilities ‘assigned’ to the appropriate level of government through the operation of an intergovernmental agreement.

Kenneth Wiltshire from the University of Queensland Business School responded to the contents of the speech in the Australian on 24 August.

He said:

If Australia had a unitary system of government, some of (the observations of Henry) might be appropriate. Even then, a tax review ought to begin with the time-honoured principles of taxation, including that taxes should be fair and equitable, efficient, appropriate, certain, non-distorting, easy to administer and transparent. It would also begin by acknowledging that Australia is generally too dependent on direct taxes, which are often higher than our competitors', and that the tax system has too much vertical imbalance in its federal-financial relations.

But Australia is not unitary; it is a federation and any tax review of this kind should begin from the premise that states are sovereign partners. They do not need to be "empowered"; they already have sovereign powers, including in taxation, and they had them before the commonwealth was created.

He went on to say that the units of a federation can have different tax bases that can give rise to diversity, choice and competition – and also different tax rates in different jurisdictions.

Wiltshire then noted:

Henry is correct about two things: (a) the present state tax bases serve to distort economic behaviour by industry and individuals, and (b) the blame game is all about dollars. But both these features are caused by the commonwealth's intrusion into the states' constitutional powers, and the conditions it attaches to the majority of funding it gives to the states. Henry's proposals would exacerbate this situation. Clearly, asking the head of the federal Treasury to design a fiscal framework for the federation is like putting a fox in charge of the chicken coop.

Wiltshire suggests that the States should surrender their rights to the GST and instead recommence levying income tax, with the role of the Commonwealth Grants Commission of ensuring horizontal fiscal equity between the states ‘to ensure that no state is penalised for financial circumstances over which it has no control’ continuing.

He finally said:

Contrary to Henry's recently stated views, this is meant to be a tax review, not an expenditure review. If there is to be any decision about realignment of government functions in the light of the tax arrangements, that should be done by elected representatives of the states, not by bureaucrats. If he is not careful, he will certainly end the blame game between the commonwealth and the states, because all of them will blame him for the ensuing mess.

This all sets up an economist vs. constitutionalist debate on the structure of the Australian federation. My observations are set out in the next article.

The Henry Review and the Australian Federation - an Economist's View

As we said in a previous article:

….the debate that will follow 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.

The debate has begun.

The head of the Future Tax System Review (Treasury Secretary Ken Henry) gave a speech on taxation reform and fiscal federalism in Sydney on 19 August.

It reveals that the Treasury Secretary is very much an economist as he said:

While it is nearly 20 years since the National Competition Policy reform agenda recognised Australia as a single market, rather than a series of state-based markets, no overarching attempt has been made to integrate the federation’s tax-transfer system into a single national system. While the GST replaced some highly inefficient taxes at both the Commonwealth and State levels, those reforms did not attempt to integrate the federation’s tax system.

My fellow panellists and I are well aware of the significant opportunity that the review provides to articulate a truly integrated, coherent tax-transfer system within the federation. Having said that, we are under no illusion that such a task will be easy. But if Australia is to meet the challenges and make the most of the opportunities of the 21st Century, then the federation’s tax-transfer system also needs a 21st Century architecture.

He is clearly of the view that tax revenue should be centrally collected….

Centralisation would also make it transparent that Australian governments use many taxes to raise revenue from the same tax base. For example, tax is levied on labour income through the personal income tax ($126 billion), payroll tax ($16 billion), fringe benefits tax ($4 billion) and superannuation funds ($12 billion). And there are eight different governments levying payroll tax. It is questionable whether such arrangements are the best way to levy taxes on labour income.

….although this does pose problems in a federation:

The Panel will also be mindful of how raising tax revenue affects incentives on the spending side. In particular, how can the balance between a simpler tax system administered centrally be squared with the need for the States to be accountable by having to raise their own revenue to finance their marginal spending?

One way to deal with the issue is to change the structure of the federation:

I mentioned earlier that the revenue assignment of each level of government is dependent on how we view respective long-term financial needs. And this, in turn, depends on what we think is the appropriate role of each level of government in improving the well-being of Australians. Which government is best
placed to be the financier of government services? Should a particular government be the sole provider of the service, or one provider amongst many?

I do not anticipate that the Panel will be recommending that the
Commonwealth take over the delivery of any particular services currently provided by the States, nor vice versa. However, we shouldn’t assume that the present allocation of roles and responsibilities is optimal. Much of the fiscal federalism architecture reflects past thinking about the appropriate role of
government and the available means of addressing disadvantage.

He goes on to say:

This highlights that the nature of fiscal federalism is changing. The financial, informational and institutional advantages of the Commonwealth have seen it assume an increasing role in addressing perceptions of horizontal inequity and as a social insurer against disadvantage. On the other hand, there appears to be at least a tenuous consensus that the States have distinct advantages over the Commonwealth in supplying front line services. They are closer to their own communities and have been doing it for years. Recently, other providers of such
services have emerged; especially in the not-for-profit sector. Social housing services are a case in point. This seems to be a form of ‘good’ competition.

So it is clear that Henry sees some change in the federal structure – to be determined by (another) intergovernmental agreement:

Finally, designing an improved tax-transfer system for the federation is not enough. The Panel is also aware that the implementation and maintenance of a package of reforms is a difficult task in our federation. A new intergovernmental agreement (IGA) would be necessary.

A broad based reform agenda, rather than a series of stand alone reforms, increases the likelihood that the gains from wide ranging reforms can be enjoyed by the community at large – even if some changes might be portrayed as not being in the interests of particular groups of people. By setting out and agreeing these reforms in an IGA, governments will send a strong message to the public that all of the reforms will be delivered. This should provide additional comfort to those who will benefit from future reforms that they will actually be delivered.

As the next article shows, not everybody agrees with this view.

Putting the unions back into government

The Australian has reported the recent ALP National Conference decided that:

…unions will be appointed to federal government boards,, committees and advisory bodies in a move that will increase their influence over critical national policies.

The decision, negotiated as part of a workforce package by Julia Gillard and senior union leaders at the ALP national conference [on July 31] follows increasing anger at their exclusion from some of the Rudd Government’s key advisory bodies, including the Henry tax review.

The Review of the Corporate Governance of Statutory Authorities and Office Holders, usually called the Uhrig Review was published in 2003.

It is the template guiding how government boards and other administrative structures are established that has been broadly been followed by governments of both persuasions.

Whilst at page 93 of the Review suggests representational appointments are ‘entirely appropriate’ for advisory committees it says at pages 98 - 99:

The review does not support representational appointments to governing boards as representational appointments can fail to produce independent and objective view. There is the potential for these appointments to be primarily concerned with the interests of those they represent, rather than the success of the entity they are responsible for governing. While it is possible to manage conflicts of interest, the preferred position is to not create circumstances where they arise.

At page 100, Uhrig suggests that ‘better practice’ means that:

In getting the best from boards, appropriately experienced directors are critical to good governance

and

Representational appointments to boards have the potential to place the success of the entity at risk.

It would be unfortunate if government boards and committees of inquiry charged to investigate specific policy issues requiring technical expertise were again weighed down with people who are ‘the honourable member’ for a specific sectoral interest.

That runs the risk of decisions made by these bodies being captured by those interests.

The public interest is not served.

This is one decision of the ALP National Conference that requires review.

Tony Abbott sets the battlelines for the federalism debate

Tony Abbott has written an article in The Australian that confirms his preference for what is effectively unitary government for Australia.

He first expressed this view in his book Battlelines.

In his newspaper article Abbott says:

My proposal is not to abolish the states but a referendum to give the national parliament the same authority over them that it’s long had over the territories. It’s not a bid for more power to Canberra. Rather, it’s an attempt to establish clear lines of accountability and responsibility.

He wants constitutional change so as to permit the Australian Parliament to make laws for the ‘peace, order and good government of the country’ – that is, confer on the national parliament the plenary power to make laws on anything.

Despite what he says, it is a bid for more power to Canberra.

The structure of the Constitution means there are some areas where the Commonwealth cannot legislate. Allowing the Commonwealth Parliament to legislate over any given subject necessarily means the Commonwealth gains power.

A bit of honesty would help debate.

Moreover, even though the travails of the Defence Department chronicled by Malcolm Farr in the Daily Telegraph suggest that not every area of commonwealth administration is an example of perfection, the Australian article gives the clear impression that Abbott thinks that the Feds run things better because, well…. they’re the Feds.

He says:

Similarly, at least since Queensland abolished death duties in the 1970s, there are no discernable examples of good policy adopted by one state and then copied by the others that would render plausible the argument that ‘states area laboratory for policy change’.

Anyone comparing commonwealth government health programs (such as Medicare and the Pharmaceutical Benefits Scheme
delivered by private doctors and pharmacists) with state government ones (such as public hospitals run by giant bureaucracies) would have to conclude that Canberra understands the subsidiarity principle far better than the states.

Taking the last observation first, if you are going to compare things you should compare like with like.

Both Medicare and the PBS are designed from the ground up as subsidy schemes with the intention to reduce the cost of particular goods and services to consumers and no more.

Hospitals provide direct medical services.

It may well be better if public hospitals were privately owned, thus facilitating the creation of a real contestable market in the provision of hospital services.

But comparing the administration of subsidy schemes with the administration of institutions providing services is a false analogy.

That said, there is an absence of modern examples of how the federal system has developed a novel policy development slowly picked up by other jurisdictions.

The development of modern seat belt laws is the usual example trotted out – but that is now nearly 40 years old.

Moreover, as a recent intervention by Queensland Treasurer Andrew Fraser has recently suggested, without own source revenues there are limits to what a state can do as a ‘sovereign’ jurisdiction.

By implication, there is only limited capacity for a state to be a policy ‘laboratory’.

The debate will be assisted if a list of tangible policy initiatives developed in one state and adopted in others can be identified, so a final decision can be made as to whether in the 21st century there are advantages to a genuine federal system, or that in fact Canberra is always right after all.