Let states raise their own income taxes

Back in 2016, Prime Minister Malcolm Turnbull proposed allowing the states to levy their own income taxes so that they can pay for their own services, such as hospitals and education. However, the proposal was viewed with skepticism by the states, as noted by Fairfax’s Mark Kenny at the time:

While outwardly wanting to appear constructive, premiers are deeply sceptical about the idea, regarding its future implementation as highly problematic, and viewing its emergence onto the COAG agenda now as a deliberate pre-election distraction by the federal government designed to “throw a bone to the states” to keep them quiet…

One leader described it as “scrabbling about in the desperate search for an agenda”…

Now, there is growing support within the Coalition’s ranks for an overhaul of fiscal relations between the federal and state governments. Some Liberal MPs have proposed giving the states more power to raise their own revenue, whereby federal income tax rates would be reduced and the states would impose their own income tax to make up for the revenue shortfall:

The common view of the Liberal MPs, who include Tim Wilson and James Paterson, is that the states should be responsible for raising their own revenue because that would make them more accountable for how they spent it.

“Every time states lose tax powers, they lose the impetus for reform because the easier political argument is to simply blame Canberra for shortfalls, not drive reform that would actually create jobs. When all major tax powers reside with the Commonwealth, states simply become client councils of monopoly Canberra” [Tim Wilson said]…

“What our Federation really needs is for the governments who are spending the money to raise it so voters can see the nexus,” [Jason Falinski said].

This is an excellent idea. Australia’s federation is not working effectively largely because of the vertical fiscal imbalances (VFI) embedded in the system, whereby the Commonwealth raises 82% of total tax revenue, the states and territories 15%, and local government just 3%.

This has left the states as the primary providers of public services (e.g. public health, education, transport, and law and order) but not the practical scope to fund them. Accordingly, they are left heavily reliant on the Commonwealth for funding, with the Commonwealth redistributing around a quarter of its revenue to the states.

This system has also led to unnecessary duplication and cost-shifting between both tiers of government, along with a never-ending ‘blame game’, whereby they accuse each other of sabotaging health/education services to the public.

Any move to reduce VFIs should, therefore, be thoroughly examined. Provided there are mechanisms to protect smaller states with older demographic profiles (and therefore less workers and higher age-related costs), like South Australia and Tasmania, from being unduly disadvantaged, such as through balancing funding via the GST, then giving the states a share of income tax would probably work.

After all, it is the states that so often complain that their expenses are growing at a faster rate than tax revenue. What better way to address this issue than giving them a direct slice of the fastest growing source of taxation: income taxes? And why not make them directly accountable for this funding?

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

Leith van Onselen

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