Australia’s federation is failing

The Australian’s Judith Sloan has taken direct aim at Australia’s federation, arguing that states and territories have become increasingly reliant on the federal government for funds, while the federal government in turn is getting involved in areas that have been traditionally been the domain of the states and territories. Researchers have suggested that Australia’s GDP could be $4,500 higher per person (in 2006 figures) if its federation could operate in accordance with OECD best practice. However, the odds of that happening are slim at best:

This dilemma of our federal system was recognised as early as 1902 when future prime minister Alfred Deakin wrote: “The rights of the states have been fondly supposed to be safeguarded by the Constitution. It left them ­legally free, but financ­ially bound to the chariot wheels of the central government”…

Deakin’s point about the financial dependence of the states was well made, with a high proportion of state and territory revenue coming from the commonwealth. This proportion is now about 45 per cent. While this vertical fiscal imbalance is common in other federations, Australia has one of the highest rates of funding from the national government to the sub-national governments, with only Austria recording a higher proportion. In Germany the figure is 16 per cent; in Canada, 19 per cent; in the US, 24 per cent; and in Switzerland, 29 per cent.

What vertical fiscal imbalance means in practice is that while the states and territories may be technically assigned certain roles and responsibilities, these governments are not capable of financing them without the assistance of the commonwealth. This gives rise to the payments from the commonwealth, particularly specific purpose payments, mentioned above…

The failure to sort out the roles and responsibilities of the different levels of government as well as the inadequacy of our system of federal financial relations exact a ­potentially high economic cost on everyone. Anne Twomey and Glenn Withers, for example, estimated that GDP could be higher by $4500 a person (in 2006 prices) were Australia’s federation to operate along the best lines evident in OECD countries.

But the most likely outcome is a continued muddling through when it comes to federation matters. The blame game will flare up from time to time and voters will remain confused about which level of government should be held to account. There is always the possibility that politicians ­like it this way.

Australia’s federal system has created 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).

Moreover, as the Commonwealth raises 82% of total tax revenue, the states and local governments are left heavily reliant on Commonwealth funding, as illustrated in the next chart:

ScreenHunter_7950 Jun. 24 10.00

Possible options for improving the operation of the federation include:

  • Consolidating existing Commonwealth payments to the states into a single untied funding stream to be spent on areas such as hospitals and schools. This option would not reduce VFI, but would improve accountability and minimise the blame game.
  • Increasing states’ access to tax revenue, for example by allowing states to raise their own income tax and/or expanding the GST.
  • Shifting more responsibilities to the Commonwealth (e.g. healthcare).

Without addressing VFIs, there can be no meaningful reforms to the federation. Rather, the state’s and feds will continue to pass the buck, cost-shift, and blame each other, leading to sub-optimal outcomes for Australian taxpayers.

Unconventional Economist

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith is an economist and has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

Latest posts by Unconventional Economist (see all)

Comments are hidden for Membership Subscribers only.