SA offers plan to fix vertical fiscal imbalances

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By Leith van Onselen

One of the key factors holding back state governments, and preventing good outcomes for taxpayers, are the vertical fiscal imbalances (VFI) embedded in the current federal system, whereby the states’ responsibilities are well in excess of their revenue bases.

The extent of the VFI were outlined clearly in the Government’s 121-page discussion (green) paper on the reform of Australia’s federation, released in June, which noted that the Commonwealth raises 82% of total tax revenue, the states and territories 15%, and local government just 3%.

The states and local governments, therefore, are left heavily reliant on Commonwealth funding, as illustrated in the next chart:

ScreenHunter_7950 Jun. 24 10.00
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Another related issue holding back the federation, and resulting in bad outcomes, is duplication, whereby there are multiple areas of shared responsibility for key policy areas (e.g. health and education) across the state and federal governments:

ScreenHunter_7951 Jun. 24 10.03

As the saying goes, “when everyone is responsible, no one is responsible”, and the shared responsibility between the commonwealth and states across many areas of public policy is creating sub-optimal outcomes for taxpayers and the nation at large, creating incentives for buck passing, cost shifting, and lack of accountability, not to mention the inefficient use of resources via excessive duplication between the various levels of government (e.g. state and federal health departments and agencies).

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In theory, ending such duplication could deliver billions of dollars of benefits to taxpayers and the economy, by slashing costs as well as delivering more efficient and accountable outcomes.

Today, South Australian Premier, Jay Weatherill, has proposed a plan to end the VFI dogging the federation, which would involve the Commonwealth collecting the 5% increase in the GST (to 15%) in return for the states receiving a fixed 17.5% share of income tax. The AFR’s Phil Coorey explains:

…the revenue from the GST does not grow at a rate fast enough to enable the states to keep covering the spiralling cost of health.

If the GST were increased to 15 per cent help cover the health funding gap, it “would provide the states with too much revenue in the short term and too little revenue in the long term to meet growing service delivery costs”…

Mr Weatherill argued that income tax grows at a faster rate than the GST and would enable the states to keep funding heath…

The Commonwealth would retain control of setting the income tax rate, including reducing it to target bracket creep, and collecting it.

In addition, all fixed payments now given to the states in the form of tied grants would be abolished. These would include Specific Purpose Payments and National Partnership Payments…

“Most important of all, it amounts to genuine Federation reforms – giving the states more fiscal autonomy to pursue productivity growth through policy innovation… [It] gives the Commonwealth the freedom it’s seeking to provide near-term tax relief” [Weatherill said]…

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Weatherill’s proposal certainly has merit. Anything that could end the continual buck passing, cost-shifting, and blame game between the two levels of government should be thoroughly examined.

Ultimately, a better functioning federation is about having clearly delineated responsibilities, along with revenue sources that are commensurate with the level of responsibility.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.