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How we can reinvigorate the Australian Federation

There have been instances of successful federalism - how do we return to these? Flickr/, CC BY

When our two major levels of government work in partnership, our Federation can function well. The standout period for cooperative federalism was the Hawke/Keating term of government, producing the National Competition Policy, the east coast power grid, a national rail agreement, harmonised regulation and consumer standards, and mutual recognition of many policies and occupations.

More recent examples are the Intergovernmental Agreement on Reform of Commonwealth–State Financial Relations (1999), the National Reform Agenda (2008), the Intergovernmental Agreement on Federal Financial Relations (2011), and the National Disability Insurance Scheme.

Notwithstanding those successes, the post-World War II drive to centralise power in Canberra has made the Federation increasingly unbalanced. The division of roles and responsibilities has blurred and much overlap and duplication has been created. Political and administrative accountability has become unclear and significant inefficiency and shortcomings in service delivery have resulted.

Pushing from both sides

Despite its far greater command over revenues, the Commonwealth tends to push its financial problems onto the States – as it seeks to do in the recent budget. And the States, too, are not above a little cost-shifting to the Commonwealth.

The direct consequence has been proliferation of Commonwealth payments and involvement in areas of State responsibility. Ten years ago, there were fewer than 100 of these partnership agreements (as they are now known) – still too many - but since then (as noted by the Commission of Audit) the number has grown to 144. Each ties payments to priorities and conditions set by the Commonwealth, and most involve excessive red tape and reporting requirements.

The Commonwealth has tended to push its financial problems onto the States. AAP/Alan Porritt

While there are some legitimate grounds for a (limited) Commonwealth role in ensuring nationally consistent services, politics - not just policy - is a driver. There is an increasing desire by Commonwealth politicians to “tag” benefits to particular groups in the community as federally provided.

In the best cases, national partnership agreements delivering extra dollars to core service areas like health and education can lead policy without imposing uniform delivery mechanisms, spurring enough competition among the States to provide innovation in service delivery.

But the Commonwealth, particularly the Commonwealth bureaucracies involved, have increasingly sought to control, prescribe and micro-manage, often down to very detailed operational levels.

These burdensome compliance demands often create tension between levels of government rather than promoting cooperation, bloating bureaucracy at both levels. They typically lack incentives or frameworks for pursuing efficiency, and they blur political and administrative accountability.

Ingredients for successful reform

Yet there have been periods of successful cooperative federalism in the past - as noted earlier, during Hawke/Keating term of government. So what can we learn?

Firstly, we should forget the occasionally heard proposals that we should get rid of the States and adopt a unitary form of government (with some kind of regional underlay). It won’t happen.

Federal funding can spur innovation among State-provided services as long as it isn’t accompanied by onerous compliance. AAP/Dan Himbrechts

Hence, the starting point for negotiating roles and responsibilities is that the states must be treated as the sovereigns that they are, with clearly defined sovereign areas of jurisdiction.

Other ingredients required for successful reform are:

  • commitment to rational, evidence-based policy in the national interest, with purely political considerations marginalised;
  • leadership and demonstration of trust;
  • open communication, and
  • commitment to sharing of resources, including revenues, responsibilities and expertise, to achieve efficient outcomes.

Reforms to the Federation (presumably via a new Intergovernmental Agreement rather than constitutional amendment) must be based on:

  • Mutual recognition of sovereignty
  • National interest
  • Subsidiarity
  • Efficiency
  • Accountability.

Working together

There is substantial scope to reduce overlap and duplication, identify the areas where both major levels of government do need to be involved and to cooperate, and clearly define respective roles and responsibilities.

There are a number of areas where joint involvement of both levels of government appears inevitable, and desirable. The most obvious are: health; transport and transport infrastructure (at least on inter-state or national routes); other major infrastructure (e.g. power grids, rail networks, broadband), and the environment, including climate related issues, major river systems.

There are instructive models overseas for determining respective roles in these areas, in the US, Canada, post-war Germany and in the suggestions in the report of the Australian Advisory Committee on Intergovernmental Relations.

How should agreement on roles in shared areas be approached? A reformed Federation would incorporate a new model of partnership agreements embodying agreed outcome objectives and arrangements designed as a true partnership model, with mutually balanced obligations and contributions. There should be sharp clarity around which each role is exercised, who is responsible and accountable for what.

There should be an emphasis on efficiency, flexibility, and minimising administrative burdens, a major focus on dynamic improvement, stimulated by diversity and a degree of competition across states in policy design and in delivery solutions.

Ideally, the Commonwealth should provide leadership on broad national policy directions, minimum national standards, national consistency where important (especially in business regulation) and the provision of funding.

States should tailor services to local needs, coordinate delivery and drive policy and delivery innovation. Local government should also concentrate on delivery of services and delivery innovation.

Have the tax debate

But no reform will last without tackling the cause of the march to centralism: the vertical fiscal imbalance (VFI). The 2014 Commonwealth Budget’s squeeze on future Commonwealth contributions to health (especially hospital) and education funding via the states is apparently designed to encourage the states to press for an increase in the GST.

I think that is inevitable, whether it comes from the states or, more likely, the Commonwealth and whether it involves broadening the GST base or increasing the rate, or ideally both. (Compensation to those most affected such as pensioners and low income working families is critical.)

An increase or expansion of the GST is inevitable. AAP/Dan Peled

The National Commission of Audit’s proposal for the States to again share the personal income tax base is not new, but it is in my view a very good one. It is the only constitutionally (relatively) secure way to reduce the VFI substantially and to protect the new balance for the future.

It should be in the GST debate. Either extending or raising the rate of the GST will help resource the States (if the additional proceeds go to them), although it will again increase the VFI ‒ whose adverse effects are exacerbated by the distortions of our extreme horizontal fiscal equalisation (HFE) system (but that is a topic for another day).

There are various ways for the States to share the income tax base so total income tax doesn’t rise, and that the ATO still administers a single income tax return and collection system. Each State or Territory would receive:

  • a flat percentage (say 10%) of each resident’s above-threshold income, or
  • simply a given percentage of total income tax paid by each resident,
  • plus scope for the State or Territory to surcharge/discount on its own responsibility.

State politicians would thus have to take responsibility and political accountability for raising their own revenue (at the margin). And States should also agree to better manage and improve yield from their own existing tax bases, notably the best one they still control alone: payrolls.

The Commonwealth would reduce grants (and the extent of its involvement in many areas) ‒ and even take back some (or perhaps even all?) of the GST proceeds, to the extent of net additional funds that States and Territories achieve from the income tax (ignoring surcharges or discounts).

It is to be hoped that the present Commonwealth Government’s White Paper review of the Federation approaches its task on the basis of key reform principles implied by those lessons from past successes.

This is an edited extract of a paper presented at the Melbourne Institute’s 2014 Economic and Social Outlook Conference.

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