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.