How to get the states on board federal reform

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By Leith van Onselen

The AFR’s Alan Mitchell has written a solid piece prognosticating about the best tax reform options to reform Australia’s federation.

Predictably, Mitchell mentions raising/broadening the GST in exchange for lower income taxes, which according to the OECD could produce a long-term increase of almost 1% in Australia’s GDP in the event of a 1% shift in the tax mix. The OECD’s estimate is broadly supported by professor John Freebairn, who has previously noted that “changing the tax mix from (income taxes to indirect taxes) brings gains of 20c to 30c in the dollar and beats anything that a major corporation could do on productivity”.

Mitchell also argues for an increase in state land taxes, reductions in superannuation concessions, and compensation measures for the poor, in order to ensure that the overall tax reform package meets the goals of being both efficient and equitable:

A bigger GST will impact more heavily on the disposable incomes and savings of lower income earners. To the extent that this is not offset by the income tax cuts, there will have to be additional compensation.

More generally, a shift of the tax burden from personal income tax to a proportional consumption tax will reduce the nominal progressiveness of the tax and transfer system.
To pass the public’s fairness test, any change in the tax mix probably will have to be accompanied with reforms less favourable to higher income earners – like a land tax on expensive residences and a cut in their tax superannuation tax concessions.

To sweeten the pot there also should be reforms for lower income earners, such as a reduction in effective marginal tax rates for (mainly female) second-income earners, and increased subsidies for child care. Together these measures would amount to a powerful economic reform in their own right.

Mitchell’s proposals broadly mirror those of CEDA’s Terry Moran, who earlier in the week proposed increasing “the rate and coverage of the GST” and transferring “the extra revenue to the states to support growing demands on public hospitals”, along with developing “a land tax, or property charge, with a broader base of applicability but at a much lower rate than currently applies”, as well as extending “road-use charging to existing freeways, highways and major arterial roads within cities”, with any extra revenue used by the states to fund infrastructure investment, rather than being reliant on the commonwealth.

Both Mitchell’s and Moran’s proposals are sound, and would ensure that the states’ revenue sources are commensurate with their level of responsibility, while also shifting the nation’s tax burden away from inefficient personal income taxes to more efficient sources.

The key road block to reform, however, is state resistance. As highlighted by tax expert, professor John Freebairn, in his recent Henry George Commemorative Dinner speech, the state’s bear “most of the pain of tax reform” whereas “most of the benefits of state tax reform would be reaped by the Commonwealth [via] the larger and more productive economy [which produces] big gains in income tax, big gains in corporate tax”.

Accordingly, Freebairn proposes that the commonwealth provide incentive payments (compensation) to the states, much like it did under the 1990’s National Competition Reforms, which “essentially said to the states, “If you reform your state taxes in various ways, we the Commonwealth will pay you some compensation, that is a share of the net national gains”. This way, both the commonwealth and state governments can overcome the political problems inherent in reform:

The states can argue, “Hey electors, we didn’t really, really want to do that tax reform and hurt you, but because we’ve done it the Commonwealth has paid us these billions of dollars. You’re a winner”. And then the Commonwealth will say, “God, we had to shell some money out, but that was only to get those incompetent buggers in the states to get their act together, and we’re all winners”. And so while the pollies are blaming each other, you and I are confused that the economy’s better.

To me, Freebairn’s incentive payments to the states look like the only realistic way forward for federal reform. What gets paid gets done, and without such payments the bickering that often accompanies federal-state reform will remain, and the vertical fiscal imbalance and buck passing that has dogged policy making for generations will persist.

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https://prosper.org.au/2014/10/29/how-to-get-the-states-on-board-federal-reform/