One of the four themes in next week’s National Reform Summit, hosted by KPMG, is ‘tax reform in a modern federation’. The federal issue, while not exclusive to Australia, represents a particular challenge here and infuses many aspects of the tax system. In neither the US, Germany or Canada, our nearest equivalents, does the centre raise so much revenue which is then distributed to the states. So in the absence of a significant change in the function and responsibilities of states and federal governments the problem of so-called vertical fiscal imbalance (VFI) is likely to be with us for some time yet.
There are ways VFI could be reduced – such as allocating personal income tax rights to the states. But this raise issues of equity and complexity. For a start, states with lower wages would need to levy heavier taxes to raise the same per capita revenue. This would in turn drive people from higher-taxed states to other states. We see this in the US where people artificially move their tax domicile outside high-tax New York City.
Concessions also become an issue, as we have seen with payroll tax. Within three years of its introduction in 1971, the rate had doubled and for the next 20 years the base was halved by states competing and introducing concessions. Additional complexity would also be seen in the interaction of the tax and transfer systems. All-round, state income taxes would create additional complexity for the Australian tax system and is not where we need to look for answers.
As well as VFI, we also have the issue of HFE – Horizontal Fiscal Equalisation. Western Australia is currently complaining about the seemingly unfair distribution of GST revenue and is presently very much a donor state. But for much of its history it was a recipient state, and it may well become one again.
There are now calls for GST to be allocated on a per capita basis – but it was never intended to be so. GST was intended to secure HFE, i.e. to even out the imbalance caused by the varying revenue-raising and expenditure needs of differing states. We could certainly review the Commonwealth Grants Commission’s current system where a 3-year average is used and seek to introduce a more forward-looking mechanism, but it seems hard to justify ripping up the entire framework.
These are all difficult issues – federation has an inherent tension. On the one hand there is a desire for local autonomy but on the other in the modern era there is an inevitable shift to greater centralisation. And in several key ways we believe this trend can improve the efficiency of the Australian tax system for the benefit of all our people and states.
For a start, think how inefficient it is for foreign investors into Australia to have to deal with up to eight tax collectors. So over the course of the next 8 years let’s abolish them and give all tax collection powers to the Australian Tax Office. The IMF and World Bank rate Australia about moderately well on the ease of doing business yet poorly in relation to tax collection. In an era where we need to attract more international capital, our federation inefficiencies are a luxury we can no longer afford.
Let’s also conflate inefficient state taxes such as insurance taxes and stamp duty together with rates and land tax into a new property services tax, levied on progressive rates and administered by the ATO. We have seen in the recent Council of Australian Governments (COAG) meeting that some states are starting to lead the debate on tax changes.
This at least is encouraging as it shows an understanding that the peculiarly Australian issues of tax reform and federation have reached the point where they can be ignored no longer.