The Commonwealth snatched income-tax power from the states in 1942 using some artful legal arguments and the war. The theory was that the Commonwealth would give the power back after the war, but it never did. Legally and constitutionally, it still possible for the states to levy income tax, if the Commwealth will let them.
This week Prime Minister Paul Keating said he would propose a referendum to change the Constitution to cement in an exclusive Commonwealth income-tax power so no future conservative government could give any income-tax power back to the states.
The Commonwealth shut the states out of income tax in 1942 with several Acts of Parliament which were upheld by the High Court. Essentially the Commonwealth demanded that the states hand over their income-tax records; that all state income-tax officials be transferred to the Commonwealth and that if any state dared raise an income tax the Commonwealth would impose a 100 per cent tax on that state’s citizens, thus excluding any room for a state tax. The Commonwealth would then return to the citizen any part of the income it did not need. The Commonwealth agreed to give back to the states a share of the tax collected in the form of grants.
The 1942 approach depended on strong political will. If the political will changes, it is fairly easy to unwind legally. On the Commonwealth’s part it could possibly be done without legislation (and therefore Senate approval).
Keating, an avowed centrist, does not like the idea of a state income tax. Hitherto, of course, neither have the states. But things are changing.
At present it suits Keating electorally to play up the spectre of a state income tax. He won the last election on a tax issue. The public resents any new form of taxation. It does not matter that the Australian economy, service delivery, government accountability and general well-being could be much improved with changes to the tax system. Those arguments _ on the 1993 record _ appear far to sophisticated for the public to understand. A new tax is a bad tax and any party that proposes it must be voted against. The fact that the total extra tax take now is greater than that proposed by the GST is lost in the hyperbole. But Keating does not like the idea of a state income tax for other reasons.
At present the Commonwealth raises about $100 billion a year in taxes and charges, half of it income tax. It is nearly 70 per cent of public-sector revenue. However, it spends only a tad over a half of public-sector spending. So the Commonwealth gives about a fifth of its revenue to the states to spend. Put the other way the states rely on the Commonwealth for about a third of their revenue.
This is not mucking about the edges with a bit of equalisation to help poorer states, as intended by the Constitution. They are large percentages of spending and revenue.
With the Commonwealth raising most of the money and dishing it out through the states, it can take much of the credit for spending programs, even if they are administered by the states. Federal politicians can be seen at the opening of all major road, railway, Better Cities, sport and other projects.
This revenue-spending imbalance has enabled the Commonwealth to justify setting up bureaucracies which are “”necessary” to supervise state spending of the “”Commonwealth’s” money.
Moreover, the Commonwealth gets a politically easier revenue path. Its revenues have increased naturally with inflation. They have also increased with the fairly politically acceptable broadening of income tax to include fringe benefits and capital gains. Whereas, the states have been confined to the politically nasties: petrol, booze, smokes, stamp duties (especially on the dream home), and over-charging for things over everyday concern like electricity, gas, sewerage and water.
If the states can get direct access to the income-tax stream, however, the gravy train of political credit would dry up for the Commonwealth. No federal politicians taking more train rides, joining up new highways, dishing out money for sport and Better Cities infrastructure _ all chosen completely on national merit, of course.
This is why Keating does not want the states to have income tax. Further the Commonwealth has large controls over state loan-raising.
The upshot has been that, in the past decade, the Commonwealth has squeezed the states, especially over the past four years. The overall Australian public-sector deficit has shrunk from 2.1 per cent of GDP to a surplus of 0.5 per cent of GDP and nearly all the burden has fallen on the states, while the Commonwealth has taken the political credit for fiscal responsibility.
To meet the shortfall the states have had to increase their own taxes. They have gone from 7.7 per cent to 11.7 per cent of GDP in the past decade.
The narrowness of the state income base means they have a few large taxes, rather than a lot of small ones. It means tax holidays to attract certain industries are easier to arrange _ knock off one tax and you knock off a lot of money. This is why we have had this ludicrous extreme of competitive federalism in the past couple of years, where states outbid each other to give away their tax base in order to attract industry.
There is further new pressure on the states to be more competitive with the delivery of utility services like water, electricity, sewerage and gas. This is both from other states and internationally. Those milch cows of de-facto tax through over-charging are drying up. Under this combined pressure, the states might well accept a Coalition offer to resume income tax.
The states are not innocent in all this, of course. They have shot themselves in the foot with competitive federalism and things like the abandonment of death duties. They have almost universally been guilty of foolishness, corruption, irresponsibility and over-spending. But this must partly be due to the tax system where they are not responsible and accountable for all of their own revenue. Borrow it, misspend it and blame the Commonwealth, has been the easy way out.
It is a popular conception that states rights and giving the states income-tax power are conservative causes. They need not be. My argument is one of efficiency, elimination of political cronyism (from left and right) and accountability. The result can just as easily result in better health, education and roads and cheaper electricity and water for the poor as freebies for the rich and higher profits. Indeed, the present tax system seems to headed more to the later than the former. The Commonwealth does not have a monopoly of social responsibility; the states are quite capable of providing money for these things, and would do so better in a more rational tax environment. Further the present system has resulted in socially irresponsible competitve federalism.
A lot of argument says that federations are inefficient duplicators. They need not be. OECD figures show federations do very well, provided the raisers of the money are the spenders of it and provided taxes are broadly based.
Broad-based low-rate taxes, which with computerisation are easier to collect, do not distort economic activity in the way narrow-based high-rate ones do. People avoid transactions that attract large taxes, and put their resources (less efficiently) in to other things. For example, at the margins, older people stay in large houses (inefficiently) because high stamp duty adds to moving costs.
The states should be made to raise and spend equal amounts so they are accountable for both. If there is to be a referendum it should be to restrict commonwealth transfers to the states to equalisation only, so that every year at least one state gets nothing from the Commonwealth.