[Budget Forum 2022] For Social Infrastructure and Tax Reform, We Need a New Federal Fiscal Bargain

New South Wales Treasurer Matt Kean has been loudly calling out failures of expenditure by the Commonwealth, as we head into budget and election season for both levels of government. In January, Kean criticised the Commonwealth for not signing up to a financial scheme to support small businesses out of covid. In February, he argued that the Commonwealth failed to deliver enough to the nation’s growing health needs and his call for a 50-50 split in hospital funding has been picked up by all State Treasurers. In March, Kean called on the Commonwealth to lead on the crucial economic issue of universal affordable childcare, or NSW would do it for them.

The Commonwealth Government needs to step up and properly finance care for our children, elderly, disabled and sick. The States are on the front line and are the experts at service delivery: they should take the lead in delivering on childcare, education and health to national standards agreed by all governments. But the Commonwealth must deliver adequate and stable funding, through a new 50-50 deal.

A new deal for sharing the income tax and GST

We need a new 50-50 deal for sharing revenues from our two major national tax bases: the income tax and GST. Now in the second century of federation, the States have a clear entitlement to half our most important taxes, and the Commonwealth must deliver.

Today, State and Territory governments rely on grants of national revenues for 45 per cent of their budgets. In 2021-22 this totalled $149 billion. The Commonwealth raises 80 per cent of total taxes, especially through income tax – our most important tax by far – and the Goods and Services Tax (GST).

The 1999 bargain to deliver the GST to the States is creaking at the seams. Today, the GST supplies less than half of funds granted to the States. Its inadequacy was recognised by the decision in the last budget to permanently boost the GST pool by $600 million a year, rising to $850 million in 2024-25. This top up is not enough and is entirely at the discretion of the Commonwealth.

NSW and Victoria lose out on GST revenue, to the ire of their treasurers who have picked up most of the pandemic tab. Western Australia benefits from a boost that changed the original bargain because of past problems, although it is the only State in surplus after the pandemic. The balance of funds is delivered through conditional grants in a tiresome and politicised annual bargaining process. But the federal fiscal bargain should not be about States competing: The Commonwealth Government is not stepping up to the task of delivering.

Redesigning the federal-state fiscal bargain

By turning the thorny issue of federal financing on its head, we can design a new federal-state fiscal bargain.

The estimated revenue raised (MYEFO Table 3.5) in the 2021-22 year by the individual income tax is about $240 billion and GST is about $72 billion, in total $312 billion. Half of this is $156 billion, a little more than the total that is currently paid to the States. If more revenue was needed, we could allocate States a share of the company income tax, which raises $100 billion.

A 50-50 bargain for the income tax and the GST would guarantee a stable revenue source for the States and Territories, and would make it clear that this revenue source depends on achieving adequate revenues in those taxes.

The 50-50 approach has long been adopted in Germany, under their Constitution, as explained in this volume (Ch 10). Australia’s constitution is not explicit about the share of revenues, but it is clear that the States are required to deliver most government social services – this became very clear in the State and Territory leadership in response to the pandemic. The Commonwealth has a responsibility to deliver funding for this crucial task.

Supporting social infrastructure and tax reform

For States and Territories to be entitled to the extra revenues under this fiscal bargain, they would need to commit to economic reforms to boost long term Australian prosperity and fiscal sustainability. They would also need to sign up to national standards and partnership agreements to ensure delivery of high quality social infrastructure. The Commonwealth would remain responsible for delivery of our social security system that is the main equaliser of incomes across the country as a whole.

The Commonwealth would still levy and collect the income tax and GST, as this is the fairest and most efficient approach. Administrative costs would be shared with the States and Territories, as is currently done for the GST. The system for both income tax and the GST would be governed by a joint committee, as is currently done for the GST.

The States and Territories would have to sign up to tax reform of their antiquated tax systems. The additional revenues delivered to them would support the States to achieve crucial tax reforms, including a tax mix switch for land tax and stamp duty, that would make our whole system fairer and more efficient.

The 50-50 split would remove perverse incentives that are blocking tax reform at both levels of government. A Commonwealth government that actually relies on half of GST revenues would be more interested in ensuring its sustainability by broadening the base and perhaps raising the rate – reversing the decline in its revenue contribution to finance government. State and Territory governments with a direct stake in income tax revenues would have a voice in protecting that tax base, and could pressure the federal government to stop doing short term rate-cutting without real base reform in the income tax.

The NSW Treasurer is right. It’s time for a new federal fiscal bargain to finance essential social infrastructure in the federation. Since 1901, the Australian Federation has delivered a stable and fair democracy and significant economic prosperity shared among most Australians. Today it is failing to ensure the fiscal sustainability of State and Territory governments which have responsibility for delivering core government services. Financing this care must be shared by all of us, through a 50-50 split of Commonwealth tax revenues.

Other Budget Forum 2022 articles

A Free Lunch From Government Debt? It Certainly Looks That Way, by John Quiggin and Begoña Dominguez.

On the Limits of Fiscal Financing in Australia, by Chung Tran and Nabeeh Zakariyya.