Commonwealth state financial relationship

commonwealth state financial relationship

Jonathan Pincus 'Commonwealth–State Financial Relations: The Case for Competitive In Australia, it is competition between the Commonwealth Government. Three areas of Commonwealth-state financial relations warrant reform. The first is to broaden the GST base to provide adequate funds for. Commonwealth State Relations Division provides advice to the Treasurer on issues pertaining to financial relations between the Commonwealth, State and.

The second fundamental consideration is that intergovernmental competition can sometimes lead to a disastrous race to one extreme or the other: An example of the race to the top is the nuclear arms race. Tax illustrates the possibility of a race to the bottom. Under Premier Joh Bjelke-Petersen, Queensland sought to attract retired folk by abolishing its death duties.

Other states followed suit, and now Australia has no death duties. Death is unpopular, and so are death duties. However, most tax economists think that death duties are a relatively efficient form of taxation, and should be in the tax mix.

On a less dramatic scale, state governments have competed to attract or retain specific businesses in their states, often by the granting of special exemptions or reductions of payroll or land taxes. The states are, as it were, fishing in the same pond, and whoever casts the most bait, gets the most fish. The tax revenues of state governments are, collectively, worsened by this kind of competition and the efficiency of the tax system, damaged. The argument is detailed in my CEDA piece.

In particular, the Commonwealth has control of taxation of personal and company income and the GST, and has the main responsibility for social security payments; but the states retain their own significant tax sources and spending responsibilities. However, to signal what is coming, the benefits of assigning the income taxes to the Commonwealth come with significant costs. Thus there is a third consideration: Other forms of competition I say that Australians should think carefully before abolishing vertical competition from the federation.

I will argue that these are not enough and, in addition, the very same people who are sceptical about vertical competition in our federation are at least as sceptical of other forms of intergovernmental competition. In fact, more effort has been made to reduce or eliminate horizontal competition between the states, than has been made to prevent vertical competition between the states and the central government.

If both vertical and horizontal forms of intergovernmental competition are eliminated, then that leaves electoral competition alone to do the job supported, of course, by a free press. Whenever there is government, there will be competition to become the government.

This is true for all kinds of government, including tyranny, hereditary monarchy, and rule by theocrats, or by philosopher kings. As any reader of history knows, all of these involve competition, often bloody, to be tyrant or king, or to represent truth or the word of god on earth.

Undoubtedly, fair electoral competition is the foundation upon which decent democratic government is based.

commonwealth state financial relationship

Combined with short electoral cycles and party stability, this is one reason Australians have such confidence in government. There is competition to be preselected for your party, and then there is the competition to be elected as one of the temporary rulers. But there are many other forms of competition, even when there is only one government involved. For instance, there is competition to influence party platforms, competition to influence voter attitudes, competition to influence government decisions, and so on and on.

Commonwealth-State Financial Relations

But is this all the competition that we need: Imagine a periodic election for the right to be the monopoly supplier of groceries to all Australians. One year, Woolies wins. Next time around, Coles wins, maybe in alliance with IGA. And so on, through a series of temporarily monopolistic suppliers of groceries.

Most Australians would be uncomfortable with this arrangement, fearing, correctly, that periodical competition to become the temporary grocery monopoly is not enough to ensure good outcomes, is not enough to discipline the supplier, is not enough to prevent price gouging and poor service.

If you agree about groceries, then surely the argument applies more strongly to competition among governments? Surely the services of government are at least as important to Australians, as are the services of grocery stores. Why be content with monopoly control of public hospitals, or school curricula, or tax rates, or industrial relations, or business regulation and so on? Why work to make the states completely subservient to the Commonwealth, or abolish them altogether, and thereby abolish intergovernmental competition within Australia?

Australia is a federation, comprising sovereign states and a sovereign central government. An Australian is simultaneously a citizen of a state or territory, and a citizen of Australia. Only in a federation can a citizen look to two sovereign governments, each operating over the same piece of geography. If one level of government fails in some way, then the Australian citizen can stay at home and push the other level of government to provide what he or she wants.

Voting with the feet Or, there is another option. If one Australian state offers what a person or family or business wants, and wants it badly enough, then they can move interstate. For people, examples are education, and laws relating to personal choices—drugs, abortion, and euthanasia.

For businesses, examples tend to be financial, like taxes and charges, or the quality of infrastructure, or the nature of business regulation. This is the basis for horizontal competition. Until there is only one government in the world, horizontal competition between governments will occur.

All Australian governments are competing with governments in other countries for population. I would rather live in a country into which many people wish to immigrate, like Australia, than to live in a country from which many people want to leave, like Zimbabwe and the former East Germany.

Bad government is the major problem for a long list of countries. Good government is one of the major sources of the attraction of Australia. There are many reasons for such migrations, but sometimes an element of attraction is a better fiscal deal: It undoubtedly helps puts competitive pressure on states to perform better. Competition has its own costs, and I am not arguing that competition always delivers the best of all possible worlds.

But I am arguing against the opposite extreme position, that interstate competition is always detrimental to good government. Competitive federalism asserts that there is a national interest in fostering sub-national decision making in respect of things that are of national importance.

So, is competitive federalism the reason why nationally operated trains have to be equipped with eight different radios? Does competitive federalism explain why we have such a plethora of inconsistent state-based regulatory requirements for occupational licensing, occupational health and safety, road transport, water trading, and so on?

But there is a more likely explanation: But a proper accounting of its national economic consequences would be weighted heavily in the negative. But to me, there is a rather anti-democratic tone here: And in fact the states have not always stubbornly put the parochial ahead of national interests. In the s, far-ranging reforms of competition policy offered prospects of significant nationwide advantages from coordinated action. The states pushed for cooperative reform and then came to the party, in the form of the intergovernmental agreements on National Competition Policy.

More recently, the initial impetus for the New Reform Agenda, of coordinated efforts to improve the long-term economic and social prospects of Australians by reforms in health and education, came from Victoria. Tax powers and competition Competition works for the best when there is a close relationship between the costs and rewards of action; and competition is unlikely to further the social good when the relationship between costs and rewards is vague or broken.

In ordinary markets, prices should reflect full social costs and benefits. For example, businesses should pay for environmental damage they cause, and should pass those costs onto their customers. Similarly, for intergovernmental competition to be most beneficial, there should be a close relationship between the costs and the rewards of the government action.

Conversely, every time a state reduces its taxes and charges, then it should reduce its spending; every time it reduces its spending, then it can give tax relief.

commonwealth state financial relationship

This does not happen in Australia; and I am not sure that it can happen, unless the Commonwealth distributes all revenue grants to the states by a general formula, like that used to distribute the GST monies.

The states raise taxes and charges to cover about half of their spending, and receive the other half from the Commonwealth Government. But these payments by the Commonwealth are not independent of the actions of each state. Instead, the Commonwealth enters into arrangements with individual states that blur state incentives and accountability. Recently, these arrangements have been partly codified into a system of National Partnership Payments.

But this codification does not make it clear to the electors as to who is paying for what, and weakens fiscal discipline on the states. The evidence is that state governments are by and large content with the situation in which the Commonwealth collects much more tax revenue than it spends, and sends the surplus to the states. However, all this presents a bit of a puzzle: If the Commonwealth were only interested in the national interest, then maybe it should be content with the realisation that the assignment of taxes types is roughly in accord with good economic design—namely, assign to the states those taxes that are costly to escape by moving interstate and assign the other kinds to the Commonwealth.

Rather, it is in the political interests of the Commonwealth to claim credit for services or facilities that it has funded. This has deleterious effects, the chief of which are that voters are confused as to who is funding what; and that states have many ways to seek extra Commonwealth funding. And it has more subtle effects, mentioned earlier: Final remarks Today I have argued that intergovernmental competition, vertical and horizontal, brings benefits as well as costs.

Commonwealth-State Financial Relations

Critics easily see the costs, but tend to ignore or dismiss the benefits. In that context, I suggested that some forms of vertical competition, especially selective intervention, are unlikely to be socially beneficial.

More beneficial is competing using structurally different ways of doing things, with the institutions or instrumentalities fully controlled by and responsible to one government. There is a case for limiting tax competition, by assigning personal or company income tax exclusively to the Commonwealth, in order to improve the efficiency of the tax system. But the methods by which surplus Commonwealth funds are distributed to the states reduce the independence, autonomy, responsibility and capacity of the states.

Partly or mainly in consequence, the states have not performed well, and this has opened up scope for the Commonwealth.

commonwealth state financial relationship

What one must fear is that the nature and form of Commonwealth interventions will cause the states to become less competent and accountable, and less able to provide effective and productive intergovernmental competition. Question — A couple of centuries ago a textbook came across my bows which suggested that politics purges the system.

It was an American textbook on federalism and it also made the observation that politics went well beyond the art of a possible to frankly who gets what, when and how.

Jonathan Pincus ‘Commonwealth–State Financial Relations: The Case for Competitive Federalism*’

Can you give us your definition of politics please? Jonathan Pincus — When I went to the University of Queensland, I was told that politics would be the authoritative distribution of goodies among people—exactly who gets what, when and how. Economics is a social science which studies the exchange of things in all its various manifestations.

That is, there is a lot of bargaining in exchange going on. I think that a lot of politics still has tremendous amounts of bargaining. Mention the national competition policy which was very beneficial on average to Australians.

There is a lot of bargaining that went on there. But there are some people who know who are in the audience who could give you a good answer. God bless them we need them, if only for the variety of their opinions? Jonathan Pincus — Which is exactly right, economics is not a religion or an insight into truth, economics is a way of arguing and if all economists came to the same answer I think something would be mad.

Question — I think I could understand your argument on horizontal competition between the states. After all, different states could establish different priorities: I have difficulty in understanding your concept of vertical competition and in particular your analogy with a market.

After all, where the central government is largely responsible for funding the state governments, how can you see this as a market with competition between the two? Let me just go over a little bit again the example I gave of vertical competition where the states might compete with the federals. The fact that the Commonwealth funds the states I think does have deleterious effects but the deleterious effects are on both sides.

Relations between the Union and the States

Now some time ago in putting in a submission to the Senate about how GST money should be redistributed, I suggested that the Commonwealth should hive off that portion of the GST moneys that the Commonwealth Grants Commission allocates differentially at this stage on account of remote Indigenous Aboriginal population and just deal with that. You may say they have done it badly, you may say they have done it well, but it is possible to have central funding and to still have untied money, as we call it in economics, not tied to specific performance.

Question — Your market analogy, which I think you have difficulty in persuading people. Jonathan Pincus — Sure, the market there is the customer. Customer markets are the thing that I am interested in. The market analogy is, there other suppliers of public hospital regulations, public hospital arrangements, the states—we do have those.

Most private hospitals are not-for-profit type hospitals, at least most hospital patients in non-government hospitals I think are in those. Question — Kerry Packer broke up a monopoly, a world monopoly: Jonathan Pincus — I regard that as a friendly question.

A higher per capita share goes to states with relatively high costs of providing services because of, for example, sparse populations and relatively lower capacity to raise their own taxes due to less mining activity or lower property values, for instance. The Commonwealth provides the other half of the transfers — on average about a quarter of state funds — as tied grants to the states for specified programs in health, education, housing, infrastructure and others. At the same time, the funding required to maintain current education, health and other programs is likely to rise faster than national income.

The relatively slow growth of GST revenue arises because the current GST tax base exemptions, particularly for health and education, are growing as a share of household expenditure. An additional short-term risk is that the household savings rate will increase as interest rates rise, reversing the recent rapid growth in household debt, to meet higher mortgage interest rates.

What can other countries teach us about GST reform? Reforming the GST by adopting a comprehensive tax base with minimal special exemptions, along the lines of the New Zealand model which has a broader base and a higher ratewould provide a larger and more robust supply of funds for growing state expenditures.

Some of the additional revenue raised will be required to increase social security rates and reduce income tax rates so that the overall tax burden remains roughly the same.

At the same time, a comprehensive GST base will contribute to national productivity by removing tax distortions to household spending decisions and by funding reductions in income and other more distorting taxes. For example, conveyance duties also known as stamp duties on property sales deter some households and businesses from selling and buying property when circumstances change — when they change jobs, family size etc.

Numerous reviews have identified state tax reforms to reduce these distortions. Examples include replacing conveyance duty with a broad-based property tax and broadening the payroll tax base.

Three areas to reform federal-state financial relations

An annual property tax would remove the disincentive to buy and sell property, but would collect roughly the same revenue. Other proposals require reform across both tiers of governance. These include replacing the Commonwealth fuel excise and state taxes on motor vehicleswith explicit charges for road use, congestion and pollution. These better signal the costs of travel to motorists and result in better use of the transport network.

Reforming GST is the key to productivity growth Effective reform of state taxes is more likely under the banner of cooperative Commonwealth and state negotiations than reliance on the initiative of individual states. As noted in the Productivity Commission draft reportif individual states replace conveyance duties with a broad-based property tax, this will likely reduce the share of GST allocated to the reforming state.