Michael Keating. Federalism (repost)

The Government’s Commission of Audit, which preceded this Budget, recommended that policy and service delivery should as far as practicable be the responsibility of the level of government closest to the people receiving those services, and that each level of government should be sovereign in its own sphere, with minimal duplication between the Commonwealth and the States. The Government for its part has insisted that it does not run schools or hospitals and that the States are ultimately responsible for them and what happens to them.

This conception of the Australian Federation with its emphasis on States’ rights and separate roles and responsibilities is of course not new. Malcolm Fraser enunciated it before he became Prime Minister, and its supporters insist that it was what the framers of our Constitution intended.

Furthermore, there is considerable intellectual attraction in separate roles and responsibilities for each sovereign government. It should enhance democratic accountability and help improve efficiency if the buck can no longer be passed backwards and forwards between the two levels of government. But why then has our Federation evolved in favour of greater national involvement in the provision of services that were originally the sole responsibilities of the States? The Commission of Audit seems to believe that centralism can and should be reversed, but I will argue below that there are good reasons why the national government has become more engaged in what were originally the prerogatives of the States.  Consequently, although there is probably some modest scope for redefining governments’ respective roles and responsibilities and reducing duplication, we will be best served by preserving the core features of our national system.

In my view there are three key reasons for the pre-eminence of the national government. First, a fundamental reason why the States agreed to federate was to remove tariffs as a first step towards the creation of a national market. But now that we have a national market and indeed are facing global competition, businesses want common standards and licensing across a wide variety of fields; for example, everything from rail gauges, regulation of heavy road transport, company law and national competition, to food standards and the recognition of qualifications.

Second, the responsibilities of government have grown. At the time of Federation pensions did not exist, but the Australian government now has constitutional responsibility for income support, including subsidising critical needs such as medical services, pharmaceuticals, and rental housing. Equally since World War II the Australian government has been expected to manage the macro-economy to ensure full employment and reasonable price stability.  Allied to this the Australian government also has responsibility for population policy, especially through migration, and for the growth in productivity and workforce participation which together determine the overall growth of the economy.

However, these various national functions and responsibilities are not self contained. Today the various functions of government are heavily inter-related in a way that was much less true one hundred years ago, when we were all much less closely connected. For example, productivity is heavily dependent on the skills of the workforce, but these skills are in turn dependent on the quality of the education and training systems of the States. It is simply not possible for the Australian government to meet its responsibilities while being unconcerned about the effectiveness of various State government services.

The third and final reason for national government pre-eminence is of course the national government’s domination of taxation, widely described as ‘vertical fiscal imbalance’ or VFI. Paul Keating called VFI the glue that holds our nation together, but for the States and the champions of States’ Rights, VFI is regularly trotted out as the root cause of centraliam. In the past the national government has passed payroll tax back to the States, and more recently they receive all the proceeds of the GST, but it seems unlikely that either of these taxes will ever be changed by so much as to make the States financially self-sufficient.

In that case the removal of VFI would require that the States have access to the income tax. Legally there is nothing to stop them doing that now, but they have never taken up the opportunity, and indeed there are very important efficiency gains in only one government being responsible for administering any particular tax.  So the alternative is for the Australian government to raise the income tax and then to share the proceeds with the States. But why would sharing a tax result in clearer lines of responsibility than sharing responsibility for other functions of government which require expenditures? There would still be the same arguments about who should get how much and whether the States have adequate revenue. Alternatively if the States were allowed to add a surcharge to the Commonwealth tax, then there is the risk that the Commonwealth’s independent use of taxation policy for macro-economic policy would be compromised.

In short it is not surprising that proposals to return to the past and increase State rights have got nowhere over a very long time. The truth is that a form of power sharing which we call ‘cooperative federalism’ is the only realistic way of managing inter-governmental relations. In Australia, for good or for ill, we have these two levels of government (plus local government), and power will inevitably need to be shared for a variety of functions where both have a legitimate interest. By contrast one cannot help being suspicious about the Commission of Audit proposals and whether their real intention is to provide a fig-leaf for the Commission’s smaller government agenda, with little or no concern for the impact on the availability and quality of publicly funded services.

Instead a more productive discussion, than endless repetition of State’s Rights, would be to formulate better arrangements to guide the necessary future power sharing between the Australian Government and the States. To their credit that was what the Hawke, Keating and Rudd Governments were attempting to do with some success through COAG.

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One Response to Michael Keating. Federalism (repost)

  1. Dr John CARMODY says:

    Michael Keating writes, “Legally there is nothing to stop them [the state governments] doing that now [imposing income-tax], but they have never taken up the opportunity”. That is incorrect. Until 1942 EVERY state imposed income-tax (in fact, my late father began his working life in the Queensland Taxation Department). It was the enormous demands on World War Ii which made the federal government realise that a co-ordinated national effort was necessary involved, which required uniform — and, as it happened, higher — levels of taxation. The sates were “compensated” with Commonwealth grants (and, by implication, given the assurance that — in part because it was far more efficient mechanism — those grants would be sufficient to allow the states to continue to provide all of their community services and discharge all of their responsibilities). There was, though, a sting in the tail. If any state administration were to decide that those grants DID NOT suffice for that duty to be fulfilled, it was free to continue to levy a state tax but it would be penalised for doing so by a pro rata (at least) reduction in its federal grant. Some states took legal action against this but lost their case in the High Court.
    I consider that the “theory’ (or”dry” economic philosophy which Mr Keating quotes at the beginning of his article [and which Malcolm Turnbull has also been promulgating] that somehow, by being “closer to the “raising” of its funds, a government will be more “responsible” or “accountable” for ts expenditure. That remains simply a pious assertion; I know no proof for it.
    The big problem has been the converse. There has been little good faith manifested on the part of most national governments since 1942: because, with sole and central power, good faith is required of federal governments: THEY must sustain the level of overall (but especially of individual and company) taxation for the states to be remunerated adequately. They have not done that. instead, for their own political purposes (or advantage) they have played with those tax rates with absolutely no concern for their co-operative (read: “federal”) responsibilities to the states. Yet, without that, we are not a fail and honourable –or, indeed, a REAL — “Federation”.
    Yet Malcolm Turnbull is at it again: with the sole purpose of trying to enhance his own political fortunes. It is as dishonourable as it is socially disruptive.

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