The tax forum as a platform for a grand bargain?

In his Challenges of Federation speech we referred to in a previous article, Prime Minister’s Department Secretary Terry Moran said:

There are business leaders who hold the view that Australia can’t work well unless states cede regulatory authority to the Commonwealth, and that as much as possible affairs should be run from the centre. Proponents of this view often see government as a giant corporation, where everything is subject to the power of the CEO. This is not an arrangement for stable and effective democratic government. It is a recipe for authoritarianism, and would be a long way from the liberal democratic ethos we now enjoy.

Yet this is how the Australian federal model operates.

In an earlier article we referred to Peter Phelps’ maiden speech to the NSW Legislative Council.

In another part of the speech he said:

The problem (with the Australian federal structure) is compounded by vertical fiscal imbalance or, to put it in the language of humans rather than economists, the States have the attitude of teenagers:

"Come on, dad, give us some more money.""Why don't you just get a job, son?""Aw, dad, now you're just being mean".

This puts the situation well.

The Intergovernmental Agreement on Federal Financial Relations provides:

The Commonwealth will provide National Partnership payments to the States and Territories to support the delivery of specified outputs or projects, to facilitate reforms or to reward those jurisdictions that deliver on nationally significant reforms or service delivery improvements.

The National Policy and Reform Objectives underwriting the Federal Financial Relations IGA reads:

National Partnership incentive payments will be provided to reward the States and Territories which deliver reform progress or continuous improvement in service delivery.

These payments will be structured in a way that encourages the achievement of ambitious milestones or performance benchmarks.

Graduated benchmarks may be specified in National Partnership agreements to provide that States receive some proportion of funding for activity that has not fully achieved the reform or service delivery objectives but has resulted in partial attainment of the agreed outcomes.

The achievement of milestones and performance benchmarks will be assessed by the independent COAG Reform Council, in order to provide transparency and enhance accountability in the performance assessment process.

National Partnerships should set out clear, mutually agreed and ambitious performance benchmarks that can be assessed by the COAG Reform Council. These should be structured in a way that encourages the achievement of ambitious reform targets and continuous improvement in service delivery, and provide better outcomes than would otherwise be expected.

A practical example of a ‘reward payment is clause 32 of the National Partnership Agreement to Deliver a Seamless National Economy which provides:

32. The Commonwealth will provide reward payments to the States and Territories following CRC advice as to the achievement of key milestones, as set out in the Implementation Plan for the 27 deregulation priorities. The maximum distribution of funds to be paid is set out in Table 1 above.

And as we referred to in an earlier article, the NSW Parliament passed reforms relating to directors liability because they were reforms as they were COAG reforms for which reward payments were payable for ‘meeting key milestones’ - and the NSW Government was keen to secure passage to win ‘brownie points’ for making the necessary changes to the law.

If the state’s play up the Feds won’t pay up.

And, despite the wishes of Terry Moran the Commonwealth is hardly slowing down the areas of public administration in which it wishes to become involved.

The last article discussed the grand bargain that never was.

It was a pity a succession struggle within the federal ALP derailed an attempt of a grand bargain.

We remain of the view there should be a grand bargain establishing:

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.

Clearly, the proposed tax forum to discuss the Henry Tax Review to be held on 4 and 5 October 2011 would be the perfect opportunity

Except it won’t happen.

The forum will apparently:

....continue the decade-long conversation we started with the release of Australia's Future Tax System (AFTS) Review last year. It will focus on the broad sweep of topics in the Review, with sessions to discuss personal tax, transfer payments, business tax, state taxes, environmental and social taxes, and system governance.

But won’t discuss the GST, areas of the Henry Review the Government has already indicated it won’t implement and most importantly what elements of the federation will perform which function.

This is a wasted opportunity.

The Challenges of Federalism

As a broad policy issue federalism is bubbling away.

One bubble about the burst is the decision of the Government to impose a minerals mining resource tax.

The tension arises because one element of the scheme is the provision of a full credit for state royalties paid by a miner.

To limit this exposure, the Feds have been stepping up the pressure on states not to increase royalty rates payable on the extraction of minerals – one of the few ‘own source’ revenues remaining to state level governments.

This is irksome to Western Australia, which relies heavily on royalties revenue.

As Ken Wilshire said in a recent opinion piece:

This is no way to run a federation. Ask the Canadians, who have long faced the challenge of maintaining balance between their resource-rich western provinces and Ottawa. The difference there is that the provinces have a clear and appropriate taxation base. In Canada, as in every federation in the world except Australia, the states have full income taxation powers. (Resource-rich Alberta, home of Prime Minister Stephen Harper, has often had the lowest income taxes made possible by resources taxes.) And progressive federations such as Germany have tax sharing arrangements of a rational nature.

All this points to the way forward for Australia. The forthcoming tax summit must discuss federal finances and especially the hopeless vertical financial imbalance because of the dominance of the national government in taxation. This will forever divide the nation if not corrected. It is badly distorting the accountability of all governments to their electors.

Henry Ergas has said similar things:

The states' abject financial dependence on the commonwealth causes constant conflicts and inefficiencies, while the redistribution of tax revenues from richer to poorer states has reduced the states' incentive and ability to adjust to changing circumstances.

On 8 June 2011 the Secretary of the Prime Minister’s Department (Terry Moran) gave a speech called the Challenges of Federalism.

He largely lauded the 2008 Intergovernmental Agreement on Federal Financial Relations which established an institutional framework as the basis to establish jurisdictional cooperation.

He then listed three things the States could do:

First, the states should continue to work with the Commonwealth to ensure the Intergovernmental Agreement achieves its goal of focused, incentive-based program delivery.

This is especially important in health, education, skills and workforce development, disability services, affordable housing and indigenous reform.

Second, the states should engage seriously with the review of Horizontal Fiscal Equalisation, and ensure the incentives in the arrangements are consistent with good governance and continuing reform.

And, third, the states should deliver on the promise they made when the GST was introduced, to reform their own tax bases in return for the stability of funding it provides.

Unless the states can rise to these challenges, there is a risk that the public will expect the Commonwealth to be more assertive in dealing with them – and that poses the risks of weakening the connection between government and citizens at the local level.

He then listed three things the Feds could do:

First, the Commonwealth must continue to restrain its tendency to control an excessive number of inputs on national Specific Purpose Payments.

Second, the Commonwealth should allow for and support localised approaches to reform, and rely less on all-embracing boilerplate policies and programs once the basic system architecture is agreed.

And, third, the Commonwealth should move towards strategic partnerships with the states and territories where it makes sense to share accountability for outcomes.

Moran finally mentioned a concept of the ‘grand deal’.

The concept of a grand bargain has an interesting history. In 1976, Malcolm Fraser sought to counter what he saw as the excesses of the Whitlam years with a proposal to share the income tax base, providing the states with a more reliable source of revenue. Bob Hawke tried again in 1990 and 1991 with a different proposal: taxation powers would be reallocated in return for the states taking clear responsibility for particular areas of policy, including some areas within the Commonwealth’s authority. That proposal was fateful – or should I say fatal, at least for Bob Hawke, after Paul Keating used it as a weapon in his fight with Hawke for the prime ministership.

There is indeed a history to the ‘grand bargain’. It is reviewed in the next article, followed by an article that proposes how the federalism debate can advance.

OHS and NOLS - a rockier passage for seamless economy national schemes?

As we have previously discussed, the COAG process is an exercise in ‘executive federalism’.

When it comes to 'seamless economy' national schemes, the relevant Ministerial Council signs off on legislation that is then usually rubber stamped by state parliaments with nary a change, because ‘COAG said’.

However there have been some signs that state parliaments may be less inclined to acquiese.

States and territories are introducing legislation that broadly introduces the model Work Health and Safety Act agreed by the Workplace Relations Ministerial Council (the WMRC).

We have previously noted the relevant intergovernmental agreement permitted some variation from the model legislation provided it doesn't ‘materially affect the operation of the model legislation’.

A major commitment of the incoming NSW Government was to implement the model law as agreed.

This meant not re-enacting some current NSW provisions, including the ability of unions commencing OHS prosecutions, hearing OHS cases in specialist industrial courts rather than courts of general jurisdiction, the reversal of the onus of proof and the effective imposition of absolute liability on employers.

However, the Shooters and Fishers Party were successful in moving some amendments in the Legislative Council.

As the party’s leader said:

If politics is the art of the achievable this is the best that we believe could be achieved in terms of a middle ground between both starting positions, that is, what the Government, farmers and business wanted and what the unions wanted. A number of issues raised with us have been considered by our party in coming to our position.

The Shooters and Fishers Party supports the concept of harmonising occupational health and safety laws in New South Wales with those in the rest of Australia. This gives effect to a Council of Australian Governments [COAG] agreement signed on 3 July 2008, when each State and Territory agreed to develop and implement uniform national occupational health and safety laws by December 2011.

At the same time we recognise that there will be minor differences between States and Territories. I believe that most members of this House and the Legislative Assembly would acknowledge the unique position of the New South Wales economy in the Commonwealth, and it is imperative for all of us to maintain and develop the competitive position of New South Wales in respect of other States and Territories.

In the event, unions will be able to prosecute in some circumstances (but not claim a moiety or bounty) and some prosecutions will still be heard in the Industrial Court rather than the Local and District courts.

In South Australia, the model bill was introduced and then withdrawn by the Government in the Legislative Council.

This was because there was some dissention about the ambit of the primary duty of care imposed by the legislation.

The model bill imposes a general duty on people conducting a business or undertaking to take all reasonable steps to ensure health and safety.

However, some argue this duty should be restricted to duty holders who have ‘control' over the relevant workplace.

It is understood the Government may not have got the bill as introduced through the Council.

However, an unamended bill was reintroduced into the House of Assembly on 19 May 2011.

So it will be interesting to see if the opposition to the terms of the model law will be sustained.

Western Australia is considering the Occupational National Law Bill 2011.

This is an ‘applied’ law - where one jurisdiction passes a 'template’ law (in this case, Victoria), and the others adopt that law as a law of the jurisdiction.

Sadly, the WA Legislative Council Uniform Legislation and Statutes Review Committee hated the law, saying:

1.2 The Bill does not introduce national occupational licensing. It proposes a process for developing a national licensing system. Other than that, it largely consists of a list of matters about which regulations may be made. It is not uncommon for uniform legislative schemes to leave detail to regulations. However, the Bill goes beyond this. It requires the substance of the licensing scheme to be in regulations.

1.3 Given this, it is particularly important that the Bill meet minimum standards for good legislation. It should provide a reasonable degree of certainty and coherence as to the legislative framework , to which the regulation-making powers relate. The Bill does not meet this standard. It lacks clarity. Too often the Bill is silent. Too much is still to be developed. Too many options are left open. Too much is left to regulations. The Bill is not clear on what is permitted and what is not, what is to occur and what is not.

1.4 As a result, it is not clear whether the Bill asks Parliament to delegate its legislation making power (to a Ministerial Council) in respect of the proposed licensing system or abrogate it.

Other jurisdictions have passed the law, although in most the law has yet to be proclaimed – that is, it is not in operation.

Proposed draft occupational licensing regulations for the occupations regulated by the so-called NOLS scheme (ranging from real estate agents to refrigeration mechanics) are about to be released.

It will be interesting to see that whether, following consideration of the regulations stakeholders and governments will be happy to see NOLS continue as proposed.

It is finally noted the South Australian House of Assembly has been given notice to consider providing the parliament’s Legislative Review Committee a reference to develop a process to consider ‘the issue of sovereignty separate to any other debate on a bill, thereby avoiding unnecessary debate on this issue in parliament and instead enabling the debate to focus on the purposes and content of a bill.’

This is because:

(o)n many an occasion when a bill has sought to apply a law scheme from another jurisdiction—the most recent example I am aware of is the Controlled Substances (Therapeutic Goods and Other Matters) Amendment Bill—the issue of sovereignty is raised and an unnecessary amount of time is spent debating constitutional law issues instead of debating the purposes and content of the bill.

During the debate on that piece of legislation, and one other, I said to the member for Morphett—because I understand the issues being raised by the opposition in terms of sovereignty—'How about we refer the matter to the Legislative Review Committee to see if it can come up with an appropriate way of dealing with these types of measures so that we can reach some consensus about how to do it?' So, that is what I seek to do. The I advice I have is that, given the nature of what I am asking the Legislative Review Committee to do, it has to go through both houses of parliament, so I commend this motion to the house.

Unfortuately the reference lacks clarity.

The issue of whether a state should yield (or if a European Union fanatic, 'pool') sovereignty with other jurisdictions is a threshold issue when considering whether a particular Bill has merit. It is difficult ot divorce this consideration from others.

Perhaps the question is whether the South Australian Parliament should either create, or clothe the Legislative Review Committee with responsibility for, the functions discharged by the WA Legislative Council’s Uniform Legislation and Statutes Review Committee.

It would be appropriate to have the matter clarified, as this reference could play an important national role as a mechanism that can assess the appropriateness of the model law and applied law models of implementing ‘seamless economy’ national legislative schemes.

Is harmonisation a euphemism for subjugation of the states?

Peter Phelps is a new member of the NSW Legislative Council.

As is the wont of maiden (or, as they are now grandly called, so as not to offend maidens, inaugural) speeches, the new member canvassed a number of different issues.

Perhaps unusually for a state MP making his first speech, he wondered about the point of maintaining the concept of provincial government, making some of the usual observations:

What relevance do the States then have? Not much by any assessment. They are too small to encompass the cultural and too large to encompass genuine communities of interest. To that end, Alex Hawke, who is in the public gallery today, kindly faxed me a copy of Jack Lang's 1930 Abolition Bill, with the suggestion that it would be an excellent first private member's bill for me to introduce. I doubt whether I will be taking him up on that offer at this time.

But if we are just going to be a way station for the Federal Government and its dictat, then why not? Why not abolish the Legislative Council and the Legislative Assembly. Why not abolish the State Government entirely? What purpose do we serve if we are straight-jacketed within federally mandated systems of education, water, land use, fishing, and environmentalism? Since the engineers case, the High Court has permitted a gradual accretion of power and interference in State matters.

Harmonisation has become a euphemism for subjugation. What is the use of this? Are we simply an imperial bauble perched atop a colonial anachronism, the errand boys of the Federal Government? If States are to remain relevant we must fight for real competitive federalism—not cooperative federalism—with genuine competition between the States, not this collectivist begging bowl approach. If you want to be a pot smoking Mullumbimby hippie, fine—but do not expect me to subsidise your lifestyle. Similarly, if a State has resources that are left unused, why should it expect us to subsidise a lifestyle for which it is unwilling to pay? If the distribution of revenue to the States was done on the basis of direct parity with its collection, then fine. It is not perfect but at least it would be a just outcome. But at this time horizontal fiscal equalisation, as it is called, is just an excuse to rob the productive to pay the lazy.

Whether through grand design or humorous coincidence the very next business in the Council was the thrillingly named Miscellaneous Acts Amendment (Director’s Liability) Bill 2011

The reason for introducing the legislation was because:

(t)hese amendments will ensure that New South Wales legislation imposing this type of liability accords with the set of principles agreed by the Council of Australian Governments [COAG] to guide the reform and harmonisation of directors' liability across Australian law.

As the Attorney-General said in the Legislative Assembly:

I thank honourable members for their contributions to the debate. In particular I thank the member for Liverpool, who said the Opposition does not oppose the legislation, which we are pleased about because it is important Council of Australian Governments [COAG] legislation. In response to the member for Liverpool, these reforms are part of a COAG National Partnership Agreement under which there are reward payments to the States for achieving key milestones.

One of these key milestones was for legislation implementing these reforms by December 2010. The Liberal-Nationals Government was not in office at that time. However, perhaps we can get some brownie points, because these milestones may be reviewed by COAG and there may be a second tranche of reforms at a later stage.....

Somewhat proves Phelps’ point, really.

There have been some developments in the federalism debate recently. They are discussed in the next couple of articles.

The Mugging of Bruce Baird (and the Carbon Tax) Shows Why a Tax Summit is Needed Now

It is a shame that political reality has forced NSW Shadow Treasurer Mike Baird stop thinking about imposing a profits based tax on mining, rather than the current royalties system of taxing an amount for each tonne of mineral extracted.

It probably is a more efficient way to bring mining to taxation.

We hope Baird isn't forced to drop the other parts of his observations made to The Australian:

A NSW Coalition government would push for radical reform of federal-state relations at the looming tax summit by demanding the states directly receive a greater share of overall taxes. NSW opposition Treasury spokesman Mike Baird said that, if elected on March 26, he would use the federal government's promised summit to address the imbalance in state and federal taxation powers and spending needs.

States were responsible for 40 per cent of service delivery, but raised only 16 per cent of taxes, he said, adding that NSW would operate more efficiently if it had greater responsibility for raising revenue.

We have previously noted the recommendations contained in the Henry Review, and, like Baird hopes that the proposed summit will determine:

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 importance of getting the taxation mix right is now more important than ever should the the God Knows What It Will Look Like Carbon Tax ever get up, discussed in our previous post.

Efficient public administration deserves nothing less.

2011 - The Year Ahead

The 2011 political year is now beginning. Here are some of the issues that will influence how it pans out.

The upcoming NSW Drubbing

It will not be an issue of whether NSW Labor will lose government on 26 March.
Rather, given that that the ALP primary vote is as low as 24% the question will be by how far.

The Hunter and the Illawarra no longer have the industrial bases of times of yore, making it more receptive to the very small ‘c’ conservatism of the Coalition, whilst the inner city is turning Green.

The glue that bound the labour movement – a wish to express solidarity with the working class – has lost its power to bind.

This reality, together with the poor condition of ‘brand Labor’ means that this could be a ‘transformational election’ – where tribal voters irrevocably change allegiance.

This could have federal ramifications as the NSW model has been the model of governance has been the template for Federal Labor.

Massively reject NSW Labor, the question of ‘what does Labor mean in the 21st century mean?’ will more broadly resonate.

Then there is the next challenge:

The Greens

The new Senate is sworn in on 1 July. From that date the dynamics of the chamber changes. All it needs is for the Government and Greens to vote together to enable matters to pass.

How will Labor handle this? Will it be like Tasmania or the ACT in which the parties act more like a coalition presenting to the chamber pre-agreed outcomes, or will there be an attempt of product differentiation between them?

Following the Queensland floods, the Prime Minister has announced the abolition, deferral or capping of a number of carbon abatement schemes, including the Green Car Innovation Fund, Cleaner Car Rebate Scheme, the Carbon Capture and Storage Flagships and Solar Flagships, the Solar Hot Water Rebate, Green Start Program, Solar Homes and Communities Plan and the Global Carbon Capture and Storage Institute – policy outcomes that will clearly rile the Greens.

However, at the same time she proposes retaining a price on carbon, something to the Prime Minister apparently akin to the floating of the dollar (as she told the National Press Club) or a driver of ‘another technological revolution like Information Technology did in the 1980s and 90s’ (as she told a recent CEDA luncheon).

Two lessons flowed from the Victorian election.

The first was that in deciding not to provide the Greens any preferences, the Victorian Libs proved that you can take on the Greens without being seen as anti-environmentalist and suffer an electoral backlash.

The second lesson was that suburbia is feeling the pinch of high utility prices.

This will be an increasing factor to take into account when ‘putting a price on carbon’ is ultimately unambiguously translated as being ‘increasing electricity costs’ as the carbon debate comes to a climax during 2011.

The Government’s attempts to balance its environmental credentials will be interesting.

Then there is:

Dealing with the States

We have commented before about the need for the Government to fund the social democratic project.

And so the Commonwealth is seeking to claw back some GST payments to the states to pay for hospital reform, whilst the current minerals resource rent tax will be used to (ultimately) increase superannuation payments to employees and ‘build essential infrastructure’.

The Commonwealth also wants to impose ‘pre-commitment’ technology on poker machines, in an endeavour to reduce problem gambing – and to give effect to a major policy concern of Andrew Wilkie, one of those on whom the Government is relying to maintain government.

However, the states are most unhappy.

Queensland’s Anna Bligh was reported as saying that ‘we are very clear here in Queensland that constitutionally as a sovereign state in our own right, we reserve the right to set appropriate royalties which are returned to Queenslanders for the minerals that are taken out of our state’.

The Victorian Coalition government's Resources Minister, Michael O'Brien, said he would not allow his state's taxpayers to "fill the federal Labor government's budget black hole", insisting royalties had always been a state right.

Finally, WA Premier Colin Barnett said his state would not hand over GST revenues.

Then there is the gambling issue, with some states concerned of (amongst other things) impact on gambling revenues – one of the few own source revenue streams left to the states,

Given that it appears the ‘tax summit’ to discuss the proposals contained in the Henry review is intended to be not much more than a talkfest, COAG will be a forum where the issue of dealing with vertical fiscal imbalance and the role of the states in the 21st century Australia will be a major issue – particularly as there are two (and very shortly, probably three) states with non-Labor governments this year.

This is before dealing with policy changes necessary to bring the budget back to surplus by 2013.

2011 will be one of the more interesting political years.

COAG - Quo Vadis?

We have previously indicated 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, agreements made under section 96 of the Constitution; or

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

The political class really must come out one way or another and declare whether Australian States are either:

1. ‘incubators of innovation’ within a country where there is genuine ‘competitive federalism’ –where different jurisdictions will make different rules and regulations and have different levels of taxation, with each jurisdiction ultimately picking up what is ‘best practice’ or face the loss of people and investment; or

2. effectively English style County Councils providing a narrow range of services within an Australia with a single seamless economy with a centrally set of rules and taxation levels in force uniformly throughout the country.

The Senate has quietly formed a Select Committee on the Reform of the Australian Federation.

Only constitutional (and parliamentary) savants would have known that the Committee existed.

It would appear that some respondents are disposed towards something called a ‘Convention for the Federation’.

Others submissions are keen to ensure that the position of COAG within the federation is either formalised or, at the very least, clarified.

The Select Committee is currently to report by 17 November 2010.

In our view the work of:

(a) the Select Committee (and its submitters);

(b) the Henry Review on Taxation;

(c) the treasury heads report to be prepared for COAG; and

(d) a ‘Domesday Book’ which would look something like the List of Australian Government Bodies and Governance Relationships, and would assist in identifying what governments actually do and what duplications exist

would both form the basis of developing suitable terms of reference of a ‘Convention for the Federation’ as well as commence the conversation that would accompany the creation of such a body.

It will be interesting to see how reform of the federation will fare within Canberra’s ‘new political paradigm’.

Towards a constitutional convention

As we have said previously:

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.

This is because, as Henry Ergas recently observed in the Australian, the reality of vertical fiscal imbalance within the Australian federation means that to use the famous phrase of Deakin, whilst the states were ‘legally free’, fiscal imbalance left them ‘bound to the chariot wheels of central government’.

And as Ken Henry said in a March 2009 speech, one consideration to bear in mind when assigning taxes in a federal system:

……… concerns how the revenue from taxes is distributed between levels of government. 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.

It is the power of the purse that allows the feds to control policy – it has no capacity to simply legislate, or to spend money without constitutional support. As Justices Hayne and Kiefel said in Pape:

.…. it may be accepted that there is some implied legislative power in the Parliament that follows from the existence of the national polity. That power extends to laws putting down subversive activities and endeavours. But that implied legislative power does not extend so far as to encompass the general subject of the "national economy".

Ken Henry said in an August 2009 speech:

.…. I do not anticipate that the (Henry Review) 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.

This often involved the States receiving grants from the Australian Government to help fund State provision of essential services; for example public hospitals, education and housing. The States built hospitals because people needed health care; they built state schools because people needed an education; and they provided public housing as a safety net for people unable to afford private housing services. That these arrangements still persist relatively unchanged today – despite waves of reforms in other product and labour markets – speaks to their success.

But the strains have been showing for a while. Communities expect higher standards of service than many States say they can deliver. Confused responsibilities make it difficult for governments to be held accountable, with impaired incentives to improve performance. It might be time to look at things from first principles. Perhaps a different tax-transfer architecture could assist meaningful reform in this area.

It is finally noted that earlier in the speech, he said:

Once the Panel has considered each tax on its merits, only then are we considering the level of government to which different taxes and transfers should be assigned, taking into account the long-term financial needs of each level of government.

The Abbott ascendency may have put the federal structure as one of the issues in the upcoming federal election due during 2010.

There should be greater clarity of the roles and responsibilities of the various levels of government of the Australian federation.

This is one method of clarifying it.

Firstly, the report of the Australian Future Taxation System (the Henry Report) should be released right away. A report with its own website and trailed considerably in the media should be immediately released rather than released at a time of the Government’s choosing. The public has paid for it. They should be able to see it.

Secondly there should be a ‘Domesday Book’ published listing, for each Australian state and Territory and the Commonwealth:

1. the programmes that are run by each department and statutory authority;

2. the intention of each programme;

3. the benchmarks used to measure satisfactory progress; and

4. the source of funding for the programme.

The document would look something like the List of Australian Government Bodies and Governance Relationships, and would assist in identifying what governments actually do and what duplications exist.

(A document like would have arguably have been better prepared prior to, or in conjunction with, the Henry Report. But there you go.)

Then, drawing on the Henry Review recommendations, the Domesday Book and the law as recently declared by the the High Court in a full constitutional convention (and NOT merely a COAG meeting called to consider an intergovernmental agreement prepared by bureaucrats) similar to those conducted during the 1980s should be called.

Its function would be to act as the forum to determine whether states and territories should be able to develop separate policy responses to particular issues (which could lead to them having different rules and regulations and have different levels of taxation) or whether the Australian Government should possess the general power to determine policy direction either generally or in particular areas of public policy.

From there, decisions should be made as to:

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.

This would be a discussion worth having.

The Henry Report Is In

The Government has apparently received the Henry Report.

Whilst perhaps not as radical as originally trailed, it still apparently:

….mix(es) relief for families and individuals and controversial measures covering the taxation of bank savings, superannuation, petrol, resources, companies and federal-state financial relations.

driven by:

……the challenges of an ageing population, the new baby boom, the rise of China and India, globalisation and the environment.

It will be interesting to see what it ultimately says. As we noted earlier, the Review dropped heavy hints suggesting an increased federal role.

As Henry himself indicated in a speech made during 2009 :

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 ofgovernment and the available means of addressing disadvantage.

Tony Abbott has now become Opposition Leader.

As we have previously remarked, he is a centralist. And we note his party is ‘thinking about’ whether there should be a referendum on who should run hospitals – an idea illustrating a centralist line of thinking.

Some would argue there is a case for the Feds to run hospitals, given the increase in costs in the sector.

As the then NSW Health Minister said on 1 August 2009:

In NSW, health consumes about 30 per cent of the state budget. Australia's Heads of Treasuries have estimated costs in every state are growing at just under 10 per cent. At that, rate the NSW Auditor-General has forecast our entire state budget will be consumed by health by 2033, leaving not a cent for education, roads, transport, police or disability.

And as the Queensland Chief Health Officer said in her 2008 Report:

The health system in Queensland and Australia is not sustainable under these current and growing pressures. Just 15 predominantly chronic diseases drove 56% of the increase in national healthcare expenditure between 1987 and 2000, with 10 of these diseases related to obesity. In fact, in South Australia it is projected that ‘… by 2042, without significant change to the health system the entire state budget could be consumed by the health care sector’. Similar analyses have not been done for Queensland, the overall magnitude of the outcome is likely to be the same.

There is an argument to say that the sector that effectively funds a particular service should have the political responsibility for it. However, others will disagree.

The current Prime Minister campaigned in the last election for ending the blame game between the states and the Commonwealth, whilst the current Opposition leader has said:

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.

The Australian federal structure should thus be a significant issue in the upcoming election contest.

The next article contains some ideas that could be adopted.

Fifield vs. Abbott: the confused state of the Liberal Party on federalism

In a recent article for The Punch, Mitch Fifield wrote a copperplate defence of Australia’s federal model.

The principles of Federalism are timeless. Liberals believe in the principle of subsidiarity: that power, where possible, should be located as close as possible to the people so that it is responsive to their demands. Liberals are wary of concentrating power in the hands of a small number of people. Liberals also believe in checks and balances – abolishing or rendering state governments impotent would leave a federal administration’s power virtually unchallenged.

Liberals also believe in competition. States competing for jobs, investment and talent should lead to lower taxes, lighter regulations and more attractive communities to live in.

He had better have a chat with Tony Abbott, who has different views about the issue:

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.

The Liberal Party is the erstwhile party of federalism: it certainly is no longer the ‘states rights’ party, as the Howard Government’s use of the corporations power to federalise Australia’s industrial relations laws illustrates.

The Fifield/Abbott discussion is a healthy one to have whilst a party is in opposition.

However, as we have previously discussed the Henry Review will raise the issue of whether Australia should be viewed as a federation or a single market, whilst in our previous article we noted the idea of whether state parliaments have a role in setting standards will be challenged as interested stakeholders challenge one size fits all legislation designed to bring about a ‘seamless economy’.

Both these developments and the fact that Australia is slowly lurching towards a federal election means that the Liberal Party will need to have some view as to how they see the federation operating – perhaps far sooner than they imagine.

The Henry Review and the Australian Federation - Defining the Debate

The previous two articles illustrate the two different ways one can view how Australia, as a federation, should function.

As we said in an earlier article:

Many will say …. Australia is an integrated common market, with people and companies commonly undertaking activities across state borders.

Moreover, Australia exists in a globalised world, with the complication of different rules in different states a reason not to come to Australia.

Regulatory difference is nothing more than a mere compliance costs that distort allocative efficiency with no public benefit.

In this case, there to be only one set of rules (usually encapsulated in legislation), preferably made by one legislative body – in our case, the Australian Parliament.

The states would have the role of (effectively) an English county council, concentrating on service provision based on national standards. However, there are alternative arguments.

The (few) supporters of a federal system argue that citizens benefit where there is genuine "competitive federalism" –the idea that different jurisdictions will make different rules and regulations and have different levels of taxation, with each jurisdiction ultimately picking up what is "best practice" or face the loss of people and investment.

A similar argument is one holding that States are "incubators of innovation" –a place where different ideas can be tried, with the good ones taken up in the bad ones discarded - and if an idea is really bad, the entire nation doesn’t have to face the consequences.

The contents of the Henry Review means the time is now right for a full political discussion of whether the nation should be viewed as a federation or a single market.

However, the decisions should not be made through the Governor’s Club of COAG.

Whilst a bureaucrat like Henry may see some advantages in going down this route, these massive reforms should be discussed by the elected representatives reflecting the interests of all political interests represented in Australian parliaments – and not just the representatives of the executives that have been drawn from them.

Ideally, early in 2010 there should be a full constitutional convention, drawn from the Australian legislatures in a manner similar to the conventions convened in the 1980’s by the Hawke Government, to fully discuss the issue of what is the role of state government of the 21st century, to flesh out the issues of the structure of the Australian federation.

From there, each of the major political parties should then set out policies that set out the appropriate role of a state in a 21st century federation (including the role of a state parliament) and the role of COAG within the Australian federation.

The winner of the 2010 election should then put their preferred view to another constitutional convention, from which appropriate constitutional amendments (that may not go as far as Tony Abbott is advocating) could be prepared for the consideration of the Australian people.

The Henry Review will be an important reference document as this debate proceeds. It will be interesting to see how the argument will pan out.

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.

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.

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.

A win of sorts for Federalism - Pape v. Commissioner of Taxation

On 7 July the High Court handed down a decision called Pape v. Commissioner of Taxation.

In a narrow sense, it decided that the decision to pay the tax bonus to eligible Australians earlier in the year was constitutional.

However, it is a decision that could have significant ramifications on the federal structure.

The Australian Parliament has increasingly appropriated money to directly fund projects and schemes using the so-called executive power of the Commonwealth without regard to whether the thing being funded is relevant to one of the areas for which the Commonwealth has constitutional responsibility.

This proposition did not receive total High Court support.

The general direction of the Court is contained in this paragraph of the joint judgement of Justices Hayne and Kiefel:

In the end the Commonwealth's submissions about the executive and incidental powers came down to the proposition that the Commonwealth's power to spend is limited only by the need to obtain parliamentary approval for the proposed expenditure. That contention should be rejected. The matters of history
described earlier in these reasons do not require its acceptance. Its acceptance would not be consistent with what Mason J referred to as "the broad division of responsibilities between the Commonwealth and the States achieved by the distribution of legislative powers" and would, by "enabling the Commonwealth to carry out within Australia programmes standing outside the acknowledged heads of legislative power merely because these programmes can be conveniently formulated and administered by the national government", effect a radical transformation in what has hitherto been thought to be the constitutional structure of the nation. To hold that the Commonwealth power to spend does not extend so far is consistent with what was decided in the Pharmaceutical Benefits Case and, after the AAP Case, in Davis v The Commonwealth.

Sadly, it will require more litigation to work out with greater certainty what is ‘good’ direct Commonwealth expenditure and what is ‘bad’ direct expenditure, although it would appear that things that are clearly Commonwealth responsibilities will still be okay.

Leaving aside the mechanism of section 96 tied grants, the States could be liable to fund a greater range of activities. Could they even if they wanted to? This is discussed in the next article.