Weekend Musing: Direct Democracy and Australia

Guest blogger Steven Spadijer, of Australian National University, completes his series on Direct Democracy. Part One is available here, and Part Two here.

In this final post, we will be looking at how Direct Democracy protects federalism and how it might minimise the costs of a federal system. In the broader policy debate of “should we abolish the states?” I contend that Direct Democracy could fix many of the excesses of our currently dysfunctional federal regime.

Now, firstly, what is so darn good about federalism?

In theory, the economic benefits of federalism are expected to give rise to competition between constituent governments while its costs are based in the necessity of cooperating on some issues. Hayek argues that competition between governments will reveal information on efficient ways to provide public goods. Assuming that governments have incentives to react to that information (a reasonable assumption given DD itself makes governments more alert and responsive to the people by highlighting to the representatives’ infrastructure bottlenecks or their preference for decentralized taxation), government efficiency should be higher in federations.

Furthermore, federalism brings with it other benefits:

• Persson and Tabellini (2003: 73) find that the federalism has a effect in explaining differences in both labour and total factor productivity, with robust federations (like Switzerland) having dramatically higher levels of each.
• Barankaya (2007) reveals greater decentralization is associated with higher educational attainment, with these gains leading to particularly for male students benefited more from educational decentralization closing the Swiss gender education gap.
• Obinger (1998) finds federalism and direct democracy have proved to be stumbling blocks for the expansion of the Swiss welfare state, with major services being provided locally or through privatization – such as compulsory private health insurance rather than the cost being incurred federally. Dreher also shows decentralization – measured as the share of sub-national employment, revenues or, respectively, expenditures – improves governance.
• studies cited in our first post also show in the US (at a local level) and in Switzerland (at a federal level) direct democracy leads to decentralization: it empowers lower levels of government to compete for taxpaying citizens, thus giving lower levels of governments an incentive to cater to these citizens’ preferences.

Unsurprisingly, we are now seeing Google and a number of IT companies setting up shop, not in the “representative government” which dominates the EU, but in the Swiss canton of Zug (which has no income tax).

Secondly, is there evidence Direct Democracy as opposed to some other institution protects federalism?:

Blankart compares the development of two federally organized states over time, namely Switzerland and Germany and asks whether the so called law of the attracting power of the highest budget is a law in the sense of natural sciences, or whether it is a consequence of constitutional choices. He conjectures that centralization is a function of the cartelization tendencies between federal and state government levels, which, in turn, would be a function of constitutional rules. He then shows that the competence of the federal level to appropriate tax competence from the state level is crucial for explaining differences in the centralizing tendencies of different federations.

For example, in Switzerland the Swiss people have explicitly limited the power of the Federal Government to tax in the Swiss constitution: the corporations’ tax cannot exceed 7% (Australia’s corporate tax rate is 30%) and the income tax cannot exceed 11%. All the rest is served to the cantons or to the people. Roughly 70% of Swiss government expenditure occurs at either the cantonal or local government.

By contrast, in the US or Germany there is no comparable democratic check on the economic powers of the federal government.

Similarly, Philip Grossman deals with the effects of fiscal decentralization on public sector size, showing that governments have an incentive to circumvent the pressures of competitive federalism by colluding. He hypothesizes that they will use intergovernmental grants toward this end. These grants, in turn, expand overall government size of the federal government. He finds evidence in support of his thesis for the United States (Grossman 1989a, 1989b), Australia (Grossman 1992), and Canada (Grossman and West 1994).

Indeed, in Australia this should not be a surprise given the High Court has held referendums are irrelevant in interpreting the Australian Constitution (Workchoices), despite the Australian people constantly saying ‘no’ to Commonwealth attempts to centralize power in Canberra under s128 of the Constitution.

Likewise the High Court held the Commonwealth can condition a grant on a State exercising or refraining from exercising its legislative powers – here states could not impose income taxes, forcing them to surrender the tax to the Federal Government. In other tax cases the court also said the Commonwealth could use the States as mere conduits or agents to distribute grants to others, and identify who those others are and how much they are to be paid.

From the above, we can see Federal Parliament is not going to defend the states. Nor is the High Court, who of course is appointed by the Federal Executive! In short, most centralized power proceeds undemocratically (EU, cough, cough).

But does Direct Democracy promote federalism and decentralization? In our first post, we saw how Direct Democracy leads to greater decentralization on a state level. But what about the state versus federal level?

Vaubel analyzes the process of centralization in federal states empirically showing that federal states are indeed less prone to centralization than states with a non-federal constitution. Centralization is measured as the share of central government expenditure in total government spending. The most powerful single explanatory variable is the age of the constitutional court or the independence of the constitutional court from the organs of central government.

If you take into account the degree of control that the lower-level governments have over changing the federal constitution and whether tax increases require a popular referendum, the explanatory power can be raised even further. It thus seems that some constitutional provisions – especially referendums – can make a difference in constraining centralization.

But what effect would Direct Democracy have on Australian federalism?

Currently, Australia has all the excesses of a federal state (if you can call it that) and none of its benefits. On the cost side, state governments are the source of destructive “bidding wars” (for federal government grants) and “buck-passing”, creating waste in their duplication and an enormous cost burden generally which Australia can ill afford in an increasingly competitive world.

On the benefit side, well, there is no canton of Zug in Australia to compete with Singapore or China to give manufacturing companies a hefty tax break; there is no “rural” state that readily embodies rural Australia. There seems to be little appreciation of the various cultures in Australia, between say North Queensland and the rest of Queensland. Australian federalism simply depends on arbitrary lines, rather than any self-evident economic or cultural rationale.

That said, I do not support “regional government”. Instead, I support the creation of new, far smaller states (akin to highly decentralised Swiss cantons). Why? In a federation:

“the individual States should possess an independent and uncontrollable authority to raise their own revenues for the supply of their own wants” (Federalist Papers)

A regional government supposes that government is financially subservient to the central government, and thus does little to improve on the straight jacket currently imposed on the states—such as resorting to inefficient taxes to fund themselves and allowing little room for innovation or competition. As Justice Brandeis puts it, federalism allows:

..a single courageous state may, if its citizens choose, serve as a laboratory, and try novel social and economic experiments without risk to the rest of the country.

So, how might Direct Democracy protect the benefits of federalism while minimising its costs?

Firstly, we should consider importing Article 29 of the German Constitution. This allows a simple petition (say 10% of voters in a region with at least one million people) to hold a referendum to create a new state (or join or separate from an existing state). If both the voters in the drawn boundary support the change as well as the voters who they are splitting from also support also support the new state, a new state is created.

Naturally, some have argued for the creation of Aboriginal States, which would involve cantons being created for linguistic and cultural grounds. But in Australia, similar provisions are unlikely to be used to keep diverse ethnic and linguistic groups from killing each other. Instead, they are more likely to create new states which have been proposed from time to time mitigate economic conflict. Examples would Capricornia (far North Queensland), New England and Riverina (along the Murray Darling basis), all of whom feel their government does not represent their interests.

Moreover, Article 29 provisions might rekindle other long-lost proposals. For example, in the 1860s a petition was presented to Queen Victoria for the creation of the Australian State of Princeland, but it that was rejected – the government refused to adopt it as it could no longer tax that regions lucrative mineral resources! The State of Illawarra (around the industrial base of Wollongong) might very well invoke enterprise zones to rebuild its manufacturing sector, which has slowly but surely been decimated over the last few years.

Equally, the State of Auralia (on the Nullarbor Plain) might create its own city state to trial a “single tax” on land; Sydney itself – if voters so decide – could even be split up into cantons; and so forth. Each “state” would set its tax and investment policies to suit its demand and desires. This is how Liechtenstein, Zug, Nidwald, Glarus and Zurich have been doing it for decades and interestingly, all have very high GDP per capita, despite having no natural resources.

Secondly, while creating new states which compete amongst themselves is all very good, a federal constitutional amendment would be needed to stop the Commonwealth from intruding into the affairs and policies of the “states”. Direct Democracy might result in any of the following:

• clearly defined limits of the taxation powers of the Federal Government being written into the Federal Constitution and the rest being reserved to the states.
• clearly defined delineation of federal power to avoid duplication i.e. declaring who exactly will be conducting education, healthcare, the Murray Darling basis and so forth. This avoids the “blurring of accountability” and “buck passing”. Any inappropriate interpretations by the High Court on the federal power would be put to the people.
• standardization where appropriate: some might favour a national curriculum up to year 10, while leaving the building of schools to the local level as well the appointment of teachers Other might favour the power of parents to appoint, dismiss and evaluate the performance of a principal. My hunch is that most people prefer education be funded locally (through local taxes), so one can see the direct cause and effect between tax and expenditure.
• Indirect effects: if the Central Bank won’t intervene in our currency market to save our manufacturing sector, I tell you who will…

Conclusion
If the preferences of a majority of voters is to keep key issues as close as possible to them, that is, to decentralize the ‘big’ decisions which affect their lives – transport, education and taxation, then Direct Democracy would readily transmit those preferences federally.

References:

Ben Geyes, ‘Voter involvement, fiscal autonomy and public sector efficiency: Evidence from German municipalities’
Persson and Tabellini, The Economic Effects of Constitutions.
Friedrich Hayek, ‘Economic conditions of inter-state federalism’
Herbert Obinger, ‘Federalism, Direct Democracy, and Welfare State Development in Switzerland’
Philip Grossman, ‘Fiscal decentralization and government size: an extension’ , ‘Federalism and the growth of government revisited’, ‘Fiscal decentralization and public sector size in Australia’, ‘Federalism and the growth of government revisited’
Iwan Barankaya and Ben Lockwood, ‘Decentralization and the productive efficiency of government: Evidence from Swiss cantons’
Ronald Vaubel, ‘Constitutional safeguards against centralization in federal states: an independent crosssection analysis’.