Federalism Is the Key

By Nahan, Mike | IPA Review, January 1, 1996 | Go to article overview

Federalism Is the Key


Nahan, Mike, IPA Review


TAX REFORM SHOULD FOCUS ON THE STATES.

How do we get a more efficient, fairer and simpler tax system without getting fleeced by it? This is the taxing question, regularly asked but seldom satisfactorily answered.

We have known for the better part of 20 years - since the Asprey Report of 1975 that our tax system is deeply flawed. We rely overly on income tax, and we tax savings and productive activity too heavily. We also need to replace our hotchpotch indirect taxes with a broader-based consumption tax.

Since 1975 there have been numerous serious attempts at tax reform at the national level. All of them have been unsuccessful. There has been a parallel, albeit less public and less committed, process of projected reform at the State level, which has been even less successful.

Clearly there have been many reasons for the failure of tax reform, but one important explanation has been the failure of reform to adequately deal with governmental cupidity. Models for better tax design -- proposing simpler, more efficient, more equitable tax - have without exception assumed that the Commonwealth could be trusted to tax and spend with benevolence and restraint.

Of course the taxpayers know better than this and have wisely decided that it's better to have the decrepit and debilitating tax system that we know than risk being fleeced by a new one. In a sense, taxpayers have imposed limits on government by rejecting tax reform.

This is, of course, a mug's outcome. It would be far better to have an efficient, fair and simple tax system with built-in limits.

LIMITING GOVERNMENT: The question then is how can we limit a government's ability to fleece us? One option would be to anoint a benevolent ruler, such as Lee Kwan Yew, who taxes and spends with restraint. The problem with this route is that we might end up with the opposite without any way out - for example, we might get a King Gough. Democracy and individual choice are a better option and the best known way to harness these is though a well-balanced federal system.

Government by its very nature displays all the characteristics of monopoly behaviour: it spends excessively, 'goldplates' and rarely undergoes the pruning that it needs. And it has an advantage over commercial monopolies in that its decisions are sanctioned by law.

But once choice is introduced, competition follows. Federalism provides choice. People and firms within a federal nation have a choice of jurisdictions in which to live, work or invest. If taxes are too high or spending poorly targeted in one jurisdiction people and jobs will either leave or threaten to leave for another. Indeed the ability to place a check and balance on government was the main reason federalism was invented in America over 220 years ago.

Seen in this light, federalism is a kind of competition policy for government.

A federal system of government has many other things going for it, It not only allows better targeting of the diverse needs and wishes of voters but it also provides an insurance mechanism against `putting all our eggs in the one basket'.

IMBALANCE: Australia is already a federation, so we do not need to undergo the trauma of constitutional change. However, the Australian federal system is seriously unbalanced with limited competition and choice.

The centralization of taxing and spending powers has been one of the defining characteristics of the Australian settlement. Since 1901, the Commonwealth's share of taxing powers has increased from 58 per cent to 75 per cent. Its control over spending powers has expanded even more, from 13 per cent to 54 per cent over this period.

Some centralization was inevitable. The world and the demands on the public sector have changed dramatically over the last 90 years. We have had the Keynesian revolution, the creation of the welfare state and the task of building a nation, all leading to more powers for Canberra. …

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