I would like to start by thanking the organisers for the invitation to talk to you today. It is always a pleasure to speak to a group of people such as yourselves who share a passion for public policy. Today I want to talk about the subject of tax reform and fiscal federalism – an area that is attracting a lot of attention in the Australia's Future Tax System (AFTS) review.
One reason why fiscal federalism is so important to this review is that, notwithstanding the fact that the well-being of taxpayers is affected by the entire federation's tax-transfer system, past tax reviews tended to focus on improving the taxes only of the government that commissioned the review1.
An example you may find interesting is that although the Review of Business Taxation (the Ralph Review) was asked to report on, among other things, "… the Australian business taxation system as a whole compared with international experience…", its final report mentioned payroll tax just three times and no reforms were actually recommended.
This is not to criticise the Ralph Review, which was a first-rate exercise. It simply makes the point that past reviews have tended to confine themselves to matters that are the responsibility of the commissioning jurisdiction.
The AFTS review is therefore unique. As you are probably aware, it has been tasked with considering the taxes levied by the States along with those levied by the Commonwealth. And it has been tasked with reviewing large aspects of the Commonwealth transfer system. The terms of reference also ask us to consider how to simplify the tax system, including considering the appropriate administrative arrangements across the Australian federation.
And, to be frank, it is about time such an integrated approach to tax-transfer reform was undertaken. While it is nearly 20 years since the National Competition Policy reform agenda recognised Australia as a single market, rather than a series of state-based markets, no overarching attempt has been made to integrate the federation's tax-transfer system into a single national system. While the GST replaced some highly inefficient taxes at both the Commonwealth and State levels, those reforms did not attempt to integrate the federation's tax system.
My fellow panellists and I are well aware of the significant opportunity that the review provides to articulate a truly integrated, coherent tax-transfer system within the federation. Having said that, we are under no illusion that such a task will be easy. But if Australia is to meet the challenges and make the most of the opportunities of the 21st Century, then the federation's tax-transfer system also needs a 21st Century architecture.
An integrated tax-transfer system for our federation
So what does this mean for the panel's deliberations? As a first step, the panel is considering taxes and transfers on their individual merits, how they sit within the overall architecture of the tax-transfer system, and how they will meet the opportunities and challenges of the future. Importantly, this assessment is being undertaken without regard to the level of government which currently administers that particular tax or transfer.
The Panel's concern is to ensure that our tax-transfer system is calibrated to emerging challenges and opportunities that arise from things like population ageing, the re-emergence of China and India and continuing technological change.
As part of its enquiry, the panel is assessing how different taxes and transfers rate against the standard policy assessment criteria – fairness, efficiency, simplicity, sustainability and coherence. These criteria will enable us to identify taxes which should be levied, taxes that are so irredeemingly poor that they should be abolished, and taxes that are reformable – the good, the bad and the ugly.
In this regard, I would note that there is almost unanimous agreement from submissions that stamp duties are 'bad'. They can lock people into places they should not be; they tax those without the resources to avoid them with no regard to other social equity norms; they reduce liquidity; and they are volatile sources of revenue.
Similar comments were made on numerous occasions at the AFTS tax-transfer conference in June this year. However, abolishing all stamp duties – on conveyances, insurance premiums and other transactions – would result in a loss of revenue for State governments in the order of $20 billion2 a year. This is a significant amount of revenue that would need to be replaced by some other revenue source. Some delegates at the AFTS tax-transfer conference suggested that the revenue could be made up from the 'ugly' land or payroll taxes, provided they were broadened sufficiently to become good taxes.
Once the Panel has considered each tax on its merits, only then are we considering the level of government to which different taxes and transfers should be assigned, taking into account the long-term financial needs of each level of government.
The Panel will be particularly mindful of the incentives that the federation's institutional arrangements place on State governments. There would be little point in reforming state taxes if unproductive competition between the States simply leads us back to the inefficient taxes and bases we have today. This mistake has been made in the past. In 1971 the States were given payroll tax on a single standard base but, for reasons unknowable to anyone, a mere 30 years later, there were base inconsistencies no one can provide a good reason for – such as several different definitions of a taxable 'person' and several different payment dates. Despite recent harmonisation efforts, the base is not what it should be.
The Panel will also be mindful of how raising tax revenue affects incentives on the spending side. In particular, how can the balance between a simpler tax system administered centrally be squared with the need for the States to be accountable by having to raise their own revenue to finance their marginal spending?3
As I noted earlier this year, there are mechanisms to minimise the effects of this trade off, particularly in relation to taxation.4 For example, the States could be allowed to vary rates of centrally administered and secured tax bases. The Panel is considering the benefits and costs of such an arrangement.
Centralisation would also make it transparent that Australian governments use many taxes to raise revenue from the same tax base. For example, tax is levied on labour income through the personal income tax ($126 billion), payroll tax ($16 billion), fringe benefits tax ($4 billion) and superannuation funds ($12 billion). And there are eight different governments levying payroll tax. It is questionable whether such arrangements are the best way to levy taxes on labour income.
The expenditure side
I mentioned earlier that the revenue assignment of each level of government is dependent on how we view respective long-term financial needs. And this, in turn, depends on what we think is the appropriate role of each level of government in improving the well-being of Australians. Which government is best placed to be the financier of government services? Should a particular government be the sole provider of the service, or one provider amongst many?
I do not anticipate that the Panel will be recommending that the Commonwealth take over the delivery of any particular services currently provided by the States, nor vice versa. However, we shouldn't assume that the present allocation of roles and responsibilities is optimal. Much of the fiscal federalism architecture reflects past thinking about the appropriate role of government and the available means of addr
essing disadvantage. This often involved the States receiving grants from the Australian Government to help fund State provision of essential services; for example public hospitals, education and housing. The States built hospitals because people needed health care; they built state schools because people needed an education; and they provided public housing as a safety net for people unable to afford private housing services. That these arrangements still persist relatively unchanged today – despite waves of reforms in other product and labour markets – speaks to their success.
But the strains have been showing for a while. Communities expect higher standards of service than many States say they can deliver. Confused responsibilities make it difficult for governments to be held accountable, with impaired incentives to improve performance. It might be time to look at things from first principles. Perhaps a different tax-transfer architecture could assist meaningful reform in this area.
The structure of our federal relations – involving overlapping accountabilities and large fiscal transfers from the Commonwealth to the States – encourages an assumption that improvements in service delivery can only come from increases in government funding; the currency of the "blame game" is dollars. Yet while providing further funding into the current system might see an improvement in outcomes, fundamental reform of institutional arrangements might deliver much better value for money.
The recent report by the National Health and Hospitals Reform Commission provides an interesting example. As with the tax system, there have been repeated calls for health reform. And many of the players have ideas on how to make improvements to individual components of the system. What I find particularly remarkable is how closely the thinking of the Commission and the AFTS panel align.
The Commission's vision of reforming the health system so that it is better positioned to respond to emerging challenges is consistent with the Panel's view for tax-transfer reform. And the need to streamline the complexity and inefficiencies caused by over-lap and inconsistencies is the same for health and tax.
The Commission proposes that the Commonwealth eventually finance health and hospital care on an activity-basis, leaving the States and perhaps some non-government entities as health providers. The important point here is that the proposed reforms are designed with an initial focus on how health services are provided, not which level of government provides them. The Commission's health reform plan is obviously ambitious and obviously with a longer term view – again, two concepts that could be used to describe the AFTS review.
This highlights that the nature of fiscal federalism is changing. The financial, informational and institutional advantages of the Commonwealth have seen it assume an increasing role in addressing perceptions of horizontal inequity and as a social insurer against disadvantage. On the other hand, there appears to be at least a tenuous consensus that the States have distinct advantages over the Commonwealth in supplying front line services. They are closer to their own communities and have been doing it for years. Recently, other providers of such services have emerged; especially in the not-for-profit sector. Social housing services are a case in point. This seems to be a form of 'good' competition.
One of the questions the Panel has under consideration is whether further substantial gains, including from competition among providers, can be secured without quite specific reforms to our tax-transfer system.
Finally, designing an improved tax-transfer system for the federation is not enough. The Panel is also aware that the implementation and maintenance of a package of reforms is a difficult task in our federation. A new intergovernmental agreement (IGA) would be necessary.
A broad based reform agenda, rather than a series of stand alone reforms, increases the likelihood that the gains from wide ranging reforms can be enjoyed by the community at large – even if some changes might be portrayed as not being in the interests of particular groups of people. By setting out and agreeing these reforms in an IGA, governments will send a strong message to the public that all of the reforms will be delivered. This should provide additional comfort to those who will benefit from future reforms that they will actually be delivered.
An IGA will also need to have some specific timelines to ensure that the reform agenda is delivered but may also need to have some flexibility in relation to timing, especially if the reform package is an ambitious one. While some may think flexibility in timing simply allows governments to renege on their commitments, I believe, if designed properly, flexibility can enhance the reform process, not hinder it.
It is possible that part of the reform process will need to be contingent on certain events occurring. For example, the IGA may specify today reforms to road funding and transport taxes that will only be possible, sometime in the future, when technology is available and cost effective. Such flexibility may make a more ambitious reform program possible, as the parties can be sure that if conditions outlined in the IGA do not materialise, they will not be forced into unrealistic reforms. Further, this flexibility may result in earlier reforms than would arise if the IGA gave a specific date for follow on reforms. Under the latter approach, parties to the agreement might be unwilling to lock in a date for the delivery of more ambitious medium to long term reforms.
The IGA must also ensure that all the parties share in any gains of reforms, as well as any pain from not following through on the agreed reforms. This can be achieved directly or indirectly. A direct mechanism is to structure the reforms so each party has access to a tax base which will expand as the reforms are delivered. An indirect mechanism, which we saw used to progress the NCP agenda, is for the States to receive payments from the Commonwealth which are linked to the progress of reforms.
These are just some of the issues that any IGA will need to address. Perhaps we are lucky that I don't have the time to go into all of them today.
But I trust my speech has highlighted the importance that the Panel places on reforms to the federation's tax-transfer system, and the difficulty not just of designing an integrated whole of federation tax-transfer system but also of delivering and maintaining such a system. Yet I also trust that I have left you with the impression that – while a whole-of-federation approach is a big challenge, and one which has not been seriously attempted before – the chance to take such an approach gives the review panel an unprecedented opportunity to influence tax-transfer policy across the whole of Australia and its governments. This is not an opportunity that any of us can afford to waste. Thank you.
1 For example, "The Asprey Review" terms of reference were to inquire into the Commonwealth tax system. The Independent Pricing and Regulatory Tribunal's Review of State (NSW) Taxation which considered Commonwealth taxes, particularly in regard to financing state tax reform, does not suggest ways to improve these taxes or how to integrate these with state taxes.
2 Estimate is based on revenue for 2007-08.
3 For an excellent summary of these issues, see Bird and Smart (2009) Assigning State Taxes in a Federal Country, presented at the Australia Future Tax System Conference on 18 June 2009. The paper can be accessed from http://taxreview.treasury.gov.au/content/Content.aspx?doc=html/conference.htm
4 For more detail on such arrangements see Henry
(2009) The Future of State Revenue presented to the 2009 Commissioners' Conference. The speech can be found at http://taxreview.treasury.gov.au/content/Content.aspx?doc=html/speeches/04.htm
This speech was originally posted on the Australia's Future Tax System website.