Australia's system of federalism presents a reform challenge

Federalism reform should remove the disincentives for states to clean up their economic act, as improvements in one will have flow-on benefits that help all Australian jurisdictions, writes Professor Anne Twomey.

Reforming federalism is like the labours of Hercules. There are plenty of Augean stables that need to be cleaned out, and every time you lop off a head of that conditional grant Hydra, more appear. But the times require a new heroism, and just as Hercules worked his way, one by one, through the labours set him, governments must gird their loins and confront what needs to be done. The Federal Financial Relations Review Panel, set up by NSW Treasury, has issued a report, which is a good guide for governments as to where to start.

So let’s begin with golden apples of Hesperides — the low-hanging fruit. In a time of pandemic, when people are financially stressed, rather than raising the tax burden, it makes sense to squeeze all the value possible out of the taxes collected. That means making the administration of taxes more efficient for both taxpayer and tax collector. This can be done, for example, by harmonising the tax bases of payroll taxes or reducing the complexity of the exemptions from the GST. More could be done to ensure the tax mix is efficient. Perverse incentives could be removed, along with the means for widespread tax avoidance.

The result, even if the overall tax burden remains neutral, would be increases in revenue, productivity and social wellbeing. For example, if the stamp duty disincentive to buying and selling the family home were removed, and people chose to move house as their circumstances changed rather than sticking with the same unsuitable dwelling to avoid a tax burden, there would be many benefits. These include less traffic congestion because people could live nearer their jobs, more available housing stock to suit changing needs, and greater social amenity as people would more readily move to be near loved ones to provide and receive care and support.

State vs Commonwealth

Next, if you endure the risk and effort of slaying the Nemean lion, you should get the benefit of keeping and wearing its skin. If a state takes responsibility for its economy and undertakes politically painful reforms that improve its economy, its reward at the moment is a reduction in its share of GST revenue. This is the case even though the state’s actions have resulted in increased employment, higher income tax revenue for the Commonwealth and higher GST collection within the state.

An essential aim of federalism reform should be to remove disincentives for states to clean up their own economic Augean stables. Improvements in the economy of one state have flow-on benefits in tax revenue that lift all Australian jurisdictions. We need to quarantine GST distributions so they do not discourage or punish successful economic reform in a state.

As for killing the Hydra, Hercules provides a useful modern role model, as he used a cloth mask to cover his nose and mouth to protect himself from its poisonous fumes, rather than complaining about his rights as a sovereign citizen. He discovered when you chop off the head of a Hydra, two grow back in its place.

Prime Minister Kevin Rudd also discovered this when in 2008, Commonwealth-State funding agreements were slashed from 92 down to five. It didn’t take long for new agreements to spring from the bloodied stumps of the old. The numbers now exceed those that existed before the 2008 reforms.

Why is this a problem? In some cases it takes many months or even years for the states to negotiate significant numbers of Commonwealth funding agreements for relatively small amounts of money, with the grants running over short periods. This is hardly efficient. It ties up bureaucratic time and energy over two levels of government for little apparent benefit. The administrative burdens in accounting for the payments and their use are hefty. Commonwealth bodies that have no experience in running schools or hospitals impose prescriptive conditions upon those that do — not a recipe for well-run institutions.

The bodies that receive the benefit of the funding through this process are plagued by uncertainty as to whether it will continue and what future conditions will be imposed. They don’t feel able to invest in permanent, well-trained staff and expensive equipment because they have no certainty about future funding.

There is also the perennial problem that because the Commonwealth picks pet projects for funding, some things end up overfunded, others underfunded and some lost altogether in the gaps. It is not a rational way to plan and efficiently allocate resources where they are most needed.

Hercules found that to kill a Hydra, you not only have to lop off its heads, but also scorch the stumps after decapitation to cauterise them. If funding to the states is to be reformed again to give the states necessary long-term stable funding not tied up with prescriptive conditions, more will need to be done to secure the reform in place. There will need to be scorching changes to culture and public expectations.

Commonwealth tax revenue needs to be treated as public money, to be spent for the public benefit, not political gain. The boundaries of federalism and the responsibilities of each level of government need to be recognised and respected, and each level held to the fire of accountability for the quality of its service to its people. This would be a truly Herculean and heroic federalism reform.

Anne Twomey is a professor of constitutional law at The University of Sydney and a member of the NSW Federal Financial Relations Review Panel.