11 May 2010

Funding the Social Democratic Project (and the Federal Structure)- comments on the Henry Review

The Report on Australia’s Future Tax System (the Henry Report) has finally been released by the Government.

As expected from his various speeches, the Review canvasses a number of different policy areas.

It will be a smorgasbord of policy options that will be dined on over the years as was the 1975 Asprey Report.

We will satisfy ourselves with two observations.

The first is what constitutes a ‘super profit’. It would appear the starting point of what constitutes a ‘super profit’ is the ten year government bond rate (currently averaging 5.7%) – the figure identified as the ‘risk free return benchmark’.[1]

We would hope that any return above the risk free return benchmark would not become the standard benchmark for ‘super’ profits made in the (insert here the industry to be picked off) whenever government requires extra revenue.

By definition it would discourage risk taking – the very thing that keeps the economy advancing.

The second relates to the fiscal federal structure.

Economists tend to think that a federal structure is an anathema to their guide star of allocative efficiency.

Whilst begrudgingly acknowledging that Australia will have three levels of government ‘at least for the foreseeable future’[2], the Review nevertheless acknowledged that as long as State governments have significant expenditure responsibilities they should have access to significant and sustainable tax revenue with a residual own source taxation capacity to finance marginal expenditure decisions.[3]

However, the Review nevertheless recommended on efficiency grounds that a resource rent tax (RRT) replace state based royalties as the way to bring mineral extraction to taxation - with the Australian and State Governments to ‘negotiate an appropriate allocation of the revenues and risks from the resource rent tax’.[4]

The report also suggests the abolition of a slew of State based taxes.[5]

In particular, payroll tax would be replaced in favour of a broad based ‘cash flow tax’ imposed at a uniform rate across Australia (and thus deprive states the further capacity to change the rate to suit the needs of the jurisdiction).[6]

It also suggests that the States and Australian Government could share, in particular, the income tax base.[7]

It is clear that for these reforms to work, the Commonwealth would have to allow the states some access to income tax and a reasonable flow of resource rent tax revenues.

It ain’t going to happen.

The Review adopted the standard view that as the national government is better placed to coordinate actions, taxes used to redistribute income should be levied by the national government.[8]

The fact is the federal government requires a lot of money to fund the broad ‘social democratic project’ established by pl.51(xxiii) and (xxiiiA) of the Constitution –income transfer payments, health, hospitals and (undoubtedly in the immediate future) disability support and will need more money (and not less) as an increasing number of worthy needs are identified as requiring support in a country with an aging population and an atomising society.

It is also the fact (undoubtedly assisted by taking in 82 per cent of total tax revenue[9]) that the Feds are assuming more and more state government responsibilities.

A simple illustration: an portion of the proposed RRT is to help ‘build the roads, rail, ports, electricity and water supply, and other facilities needed to unlock Australia’s resource wealth’.

Like housing, health and education, these are subject matters formally considered to be largely state responsibilities increasingly falling under Commonwealth control.

The Feds will increasingly need tax revenues to fund their projects in these areas on their terms.

Then there is the ‘seamless economy’ and the wish to remove duplication. Currently, the Government proposes that miners pay both royalties and the RRT, with royalty payments a claimable tax rebate.

But it won’t be too long before calls are made that this is an inefficient way of doing things – only one tax should be levied (in this case) on the extraction of minerals. There isn’t much doubt which tax will go.

Finally, there is the history of Australian federation.

As the report itself says:

Tax sharing of income tax operated in Australia before the Second World War, although there was little coordination between the two levels of government. In 1976, the Australian Government introduced the possibility of the States levying a personal income tax surcharge to replace financial assistance grants. No State took up the option. A key reason for this was that the Australian Government did not reduce its own tax rates to make room for the States.[10]
As the report itself admits, the States are more likely to be tied to the Deakin’s ‘chariot wheels of central government’ tighter than ever before:

The implementation of a number of recommendations related to state taxes would require cooperation between the Australian government and the states. Further, some recommendations related to Australian government taxes would also impact on State taxes……... Depending on when some of the recommendations are implemented, the states may also be subject to losses in revenue that could not easily be made up from other revenue sources (our comment – ask WA about the loss of royalties!) funding from the Australian government may at times be necessary to ensure that the financial position of a state is not adversely affected.[11]

As we have recently said, it is time to decide

1. which level of government should have responsibility for particular public policy areas;

2. what taxation bases should be assigned to the states and territories; and

3. where it is appropriate for the Commonwealth to be the level of government determining policy outcomes but is an area where it has no clear constitutional capacity to act, whether it is appropriate to confer Commonwealth power either:

(a) indirectly, through an agreement made under section 96 of the Constitution; or

(b) through a reference of power by the states to the Commonwealth or directly by constitutional amendment.

The Henry Review advances the discussion.

However, following the firestorm arising from the introduction of the RRT this is a matter that should form part of the discussion at the next election.

[1] See Part C1-1 of Volume 2 of the Report (esp.p.223 and footnote 2 of page 332 of volume 1)
[2] Page 570 of Volume 2
[3] Page 574 of Volume 2
[4] Page 680 of Volume 2
[5] See table on page 680 of Volume 2
[6] Page 681 of Volume 2
[7] Page 682 of Volume 2. The Commonwealth would retain control over the tax base.
[8] Page 673 of Volume 2
[9] Page 676 of Volume 2
[10] Page 682 of Volume 2
[11] Page 684 of Volume 2

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