After this week’s High Court tax judgment what the economists call the vertical fiscal imbalance is now so great that the autonomy of the states is on the verge of toppling over.
Vertical fiscal imbalance is the technical term for states whingeing because the Feds don’t give them enough money and the Feds whingeing because the states misspend what money the Feds give them.
The Feds raise about 70 per cent of total federal-states revenue but directly spend only 50 percentage points of that; the other 20 percentage points they give to the states to spend.
This week’s High Court decision ruled that $5 billion worth of state taxes on tobacco, alcohol and petrol were invalid because the Constitution says in Section 90 that only the Federal Parliament can levy excise taxes. Hitherto, the states have disguised the taxes as licence fees, but as the licence fees were usually tied to the value or quantity of goods sold the court said they were invalid excises.
The Feds immediately volunteered to collect the taxes for the states. But the Constitution demands that federal taxes must not discriminate between the states; that is, they must be uniform. The states, on the other hand, had different rates of tax and different exemptions. These different rates and different exemptions reflected different policy positions of the states. Wide open, decentralised, farming Queensland, for example, does not have a petrol tax. Some states put less tax on low-alcohol beer for health and safety reasons, and so on.
Now the Commonwealth has taken over the taxes at a uniform level, the states can no longer use excise taxes as a means of initiating and enforcing policy.
True, the Commonwealth says it will hand money back to those states with lower tax regimes to maintain their present tax statuses, so that Queensland will get back the equivalent raised in petrol taxes and Western Australia will get back the equivalent raised in tax on low-alcohol beer.
But there are several things wrong with this. First, it freezes existing policy positions and will not let the states develop new policy positions later to be enforced by excise. Secondly, it may be unconstitutional. The Commonwealth says it will give the money back under Section 96 of the Constitution which says the Commonwealth may give financial help to the states on whatever terms the Parliament thinks fit. But it may well be that the High Court will not permit such an artifice to circumvent the intention of Section 90. Thirdly, it is fine to hand the money back to the states, but it then has to be remitted to the wholesalers and then to the consumers. Besides the administrative nightmare, money is bound to go missing before the consumer gets reimbursed.
Before long, the Commonwealth will inevitably rationalise the arrangements and levy the tax either upon delivery by the producer to the wholesaler or upon consumption, rather than through the complex licence system.
Ultimately it means more vertical fiscal imbalance. The Feds will now be raising 75 per cent of the federal-state revenue and a third of this will go to the states.
The states will have even less room to move. Before last week, the states relied on the Commonwealth for a tad under half their revenue; now they rely on the Commonwealth for a tad over a half of their revenue.
And bear in mind the Grants Commission closely scrutinises the states before determining the level of grants they should get from the Feds. If they are spending too much or too inefficiently they get less from the Feds. If they are not embracing maximum revenue effort they cannot seek more money from the Feds to meet the shortfall.
So any state policy decision to provide more services or to raise or reduce the business or household tax burden has a effect on that state’s revenue from the Commonwealth.
Further a state’s revenue action affect other states and is affected by other states. Once Queensland dropped death duties, others felt bound to follow. Only the Commonwealth was smart enough to seize the opportunity and breach the gap. It imposed a capital gains tax which is very similar to a death duty. Much capital gains tax is indeed levied upon death. And to the extent that it is paid by the living it reduces the capital base that would have been transferred on their death. The federal capital gains tax is, in effect, a death duty. This was a tax field once occupied by the states.
The states have also been stupid enough to relinquish a lot of stamp duty. As soon as one state cut stamp duty on share transfers, for example, the others had to follow.
Further, when the states get their grants from the Feds, the Feds feel obliged to ensure they spend it wisely by imposing conditions and bureaucratic scrutiny. Once again, state autonomy is eroded, however justified the scrutiny may be.
The essential problem, which this week’s case has made worse, is that the states do not have control over a large portion of their revenue raising and spending. In this environment it is too easy for them to blame the Commonwealth if they perform poorly.
The states have been forced or have forced themselves into an ever-narrowing tax base. It causes great economic inefficiency and social cost. Reliance on gambling taxes, for example, has caused the states to encourage gambling as a revenue raiser rather than impose gambling taxes purely to discourage it. The Victorian Government’s promotion of the casino is the extreme example. Greater reliance on housing stamp duty had resulted in stamp duties so high that they deter people from moving to more appropriate accommodation (socially and economically speaking).
The narrower the tax base the higher individual taxes have to be and the more distorting, inefficient and unfair the taxes become as people have such a great incentive to avoid the transactions being taxed or to avoid the tax by cheating, thereby imposing higher burdens on others.
The tax issue is much wider than a GST. The weakness of the states’ position is much more important.
In these circumstances you have to question whether it is worth having the states at all. They seem to be little more than inefficient, noisy conduits for spending Commonwealth money.
They should be scrapped, or we should go the other way and strengthen them in worthwhile, autonomous, accountable and responsible levels of government that respond to local conditions.
That can be done.
The states still have plenty of taxing powers. They could tax property every year rather than raising stamp duty when it is sold; they could reimpose death duties and raise a capital-gains tax; with Commonwealth permission they can raise income tax; they can tax services; they already tax payrolls and gambling and raise stamp duty (none of which are affected by this week’s decision). They can even impose licence fees on businesses, provided the fee is a flat one not based on turnover of goods. They could impose a flat licence fee on service industries or even one which is linked to turnover.
The trouble is the states do not want the political odium of raising taxes; it is far easier to whinge about the Commonwealth.
Internet:
crispin.hull@canberratimes.com.au