What would really happen if we gave more tax and spend power to the states?

I published this controversial piece a while ago: Four really awesome, quite left-wing ideas from the Commission of Audit.

I got a lot of thoughtful responses on the twitter.

The audit suggested giving ten percentage points of income taxation to the states to raise or lower as they pleased. I argued:

Putting more tax and spending power in the hands of a demonstrably more left-wing level of government will likely lead to more spending on – and better outcomes in – health and education.

ACTU economist Matt Cowgill wasn’t going to let that wash, and tweeted:

MattCowgillMay 02, 11:11am via Web

@jasemurphy I completely disagree that giving income tax powers to the states would be “left wing” or have progressive results.

A bunch of other comments followed.

This is what’s awesome about the information superhighway. You get to talk to super smart people who have done a lot of thinking, who compel you to think deeper and refine your views.

I concede my analysis was partial.

But today’s comments by Martin Parkinson, Treasury Secretary, have brought me back to this topic.

“the Budget flags that potentially significant changes in the distribution of responsibilities for schools and hospitals could arise from the forthcoming Federation and Tax White Papers.”

Is it a good idea to give more taxing and spending power to the states? Now I’ve thought more about it, I’m not going to die in a ditch for the idea. But I think it deserves to be considered, not dismissed out of hand.

Here’s a list of possible outcomes, arranged into pros and cons.

PROS

More tax and spend at state level

When I first wrote on this topic, nobody took issue with my point that letting states set taxes would lead to more tax and spend.

Just this week, My old boss Mat Dunckley published a piece about former premiers’ support for a higher GST. There’s mixed evidence, given Mr Napthine’s comments in the press about not raising the GST but it’s hard to imagine Labor state governments would not tax more – whether on income or goods and services – to spend more if they could.

If you believe publicly provided services are good, you may believe this would lift national living standards

Because Australia’s poor states are also small, I contend extra money for state schools in rich states would be more useful for the disadvantaged than extra money for state schools in poor states.

Sure, a smaller proportion of Victorians are very poor than Tasmanians. 15 per cent of Victorians rely on the government for 90 per cent of their income, compared to 21 per cent of Tasmanians.

But the absolute number of people in need in Victoria is seven times higher. (15 per cent of the population of Victoria is 750,000 people. 21 per cent of the population of Tasmania is 100,000 people.)

Keeping one’s focus trained on equalising between states may distract from equalising between people.

Self determination

Consider Europe. Would it really be a good idea to equalise funding between Sweden and Greece? You’d help Greece, but dim a beacon of quality in publicly-funded systems, and disenfranchise the people of Sweden.

I have in the past been accused of excessive parochialism, and I really do identify as a Victorian, but I think letting different states set different priorities can be good. Should not Victorians be able to set our taxing and spending policies without being compromised by Queenslanders?

Imagine if our federal government set health policy, but health funding came from ASEAN or the G20, along with a range of rules. Would that really be satisfactory?

More accountability for state governments.

State governments are a bit of a joke at the moment. A technocratic solution would be to kill them off and locate responsibility for everything with the federal government. Given that won’t happen, and we’re stuck paying state MPs salaries, can we not use them?

Politicians with big goals and deep skills play the game federally. Relatively little press attention is given to state governments. This is a shame because they have domain over much of what one thinks of as the role of government.

A system that really gave state governments power would simultaneously create an expectation for them to deliver.

More opportunity for innovation

State governments are bundled up inside the COAG system, and trussed with conditional grants. Their policy making freedom is curtailed, by decree of the level of government that holds the purse strings.

But smaller governments can excel. If this were not true, Malaysia would be a disaster compared to Vietnam, Switzerland a shambles compared to Germany.

Left alone to experiment, Australia’s states could model their education system on the Finnish system, the Korean system, a version of the Montessori method, or indeed become the next global model themselves. No doubt some would go backwards for a time, but neither is a the status quo an iron-clad defence against standards slipping.

CONS

Differences in outcomes between jurisdictions.

Matt Cowgill tweeted a link to a terrific story he wrote about the US school system. He uses the HBO show The Wire to demonstrate how a poor area can be left behind under a system where small jurisdictions each fund their own education system.

This is a powerful point. But Matt’s argument –  People of equal means and need should have same access to services regardless of state – sets a bar we do not currently clear.

Poor states go into suffering spiral.

The reason we have “horizontal fiscal equalisation” is that without it smaller, poorer states will tend to get further and further behind the rest. Lacking both economies of scale and a wealthy population, they face a tough choice between high taxes and good services, or low taxes and bad services. Both options will hurt living standards and the outcome gap between a Hobarter and a Sydney-sider will grow even wider.

Sorting effect

After a few years of differential tax and spend settings, a possible “sorting” effect could emerge.

People who want more services move to left wing states (e.g. Victoria) and people who want less tax move to right wing states (e.g. Queensland). This could polarise the whole nation, a la Americana.

I’m not going to try to tally the pros and cons column here. But I hope you feel, as I do, that this has been a useful exercise. Feel free to engage in another round of debate!

 

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thomasthethinkengine

Thomas the Think Engine is the blog of a trained economist. It comes to you from Melbourne Australia.

3 thoughts on “What would really happen if we gave more tax and spend power to the states?”

  1. good article. While I do think a state and federal system provides some kind of check and balance system -always good to have- I literally do not understand in a country of australias size (population not geography) why on earth you have a state and federal system. It seemed to me to be at least half the reason for the problems over there-australia still has stamp duty because its one of the only ways for states to raise taxes. Who has stamp duty these days.??? Its archaic.

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  2. To address Hannah’s point first: states are a legacy of previous arrangements. But geography matters – and non-state system would need local offices. I suspect the benefits of scale are often over-stated: lower responsiveness and higher internal communication costs don’t make for better services. The states difficulty in raising revenue isn’t a necessary condition of federalism either, but we’ll get to that.

    Jason, I raised this on twitter, but the cons depend on what role (if any) you see for the Commonwealth Grants Commission. It exists (since the 1930s) to assess revenue raising capacity, and expenditure costs at state level, and balances GST distributions to reflect those differences. (As Federal tied grants are assessed by the CGC as revenue (barring a few exceptions), there is more scope to refuse grants and control existing taxation than state treasurers admit – it never hurts to shift responsibility). Assuming equalisation continued and income tax capacity was assessed in the same as other state taxes, the first two cons are not valid concerns.

    The third, I suspect, over-states the cultural differences between Australian states and under-estimates those in the USA. A race to the bottom is perhaps possible, but already exists to a degree – industry subsidies for example. It is likely to be a lesser issue with income tax. I can’t see any state electing a low tax-low services regime for any length of time. If we did want to maintain consistent income taxes between states, there would still be value in allowing states to ask for a particular income tax, then delivering the weighted average; rather than the accountability mess that grants create.

    The downside to equalisation is that efficiency is lost, as a state that succeeds in creating a policy that creates structural advantages is penalised in the next round of GST distributions. Some time ago, I argued that that the Federal government should, instead of enacting direct policies, adjust CGC GST distributions according to benchmarked outcomes for desired policy outcomes. The states would then be free to experiment with policy to achieve (hopefully desirable) ends; incentivised Federalism, you might call it.

    (apologies for the long comment)

    Liked by 1 person

    1. No need to apologise, I love to see people engaging with the ideas.

      I suspect you’re right that the CGC will endure. While I reckon the various tax and federation reviews will push for its abolition or transfromation, the way to make their ideas more palatable would be to keep it.

      AS for states being able to raise tax already, you’re right. Just the other day I was arguing with a state public servant that all Victoria had to do was follow the ACT’s lead and bring in a land tax, and all her funding problems would be over!

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