Deconstructing Rudd’s health plan

I’m a bit conflicted about Rudd’s health plan.  On the one hand, it’s fairly clear that the States engage in a degree of cost-shifting and even cynical pork-barrelling over health.  I’m sure it isn’t a coincidence that the two NSW  hospitals most often in the news for their decrepit condition and major problems are Royal North Shore Hospital (where my sister works) and Hornsby Hospital.  Both are in blue ribbon Liberal electorates.

Moreover, Rudd’s plan wisely embraces the constitutional principle of subsidiarity with its structure of directly funding local regional hospital authorities.  It also adopts Victoria’s “activity-based” or “case mix” funding formula, which experts generally regard as successful and the best model in Australia.  It should mean that funding flows equitably to areas of greatest medical need rather than the greatest political need of the relevant state government.

However, Rudd’s plan won’t eliminate or probably even reduce “blame-shifting” because responsibility for hospitals would remain split between Commonwealth and States.  Funding would be 60/40 Commonwealth/State, and the Commonwealth would no doubt deliver its share by way of Special Purpose Grants (or “tied grants”) to the local regional hospital authorities, no doubt dictating to hospitals and regional authorities how they must operate and micro-managing down to ridiculous and inflexible levels of details in the same way the Commonwealth does with universities.  On the other hand those regional authorities will be established under State law and staffed by transferred State public servants.  The potential for evasion of responsibility by the (effectively) three tiers of government involved in Rudd’s plan should be obvious.

However, the largest single objection I have to Rudd’s plan, one that has hardly been mentioned in the public debate and certainly not seriously discussed, is that it represents a massive erosion of federalism and possibly the largest single transfer of power from States to Commonwealth since the Uniform Tax Scheme or “Great Big Commonwealth Tax” grab scam of the World War II years (the benefit of which the Commonwealth enjoys to this very day).

Rudd is relying on the fact that successive federal governments of both political persuasions going back decades have starved the States of funds and then cynically blamed them for failing adequately to discharge their responsibilities (inter alia) for health, when in fact their inability to do so flows directly from the Commonwealth’s starving them of funds.

Federal politicians of both political persuasions are fond of claiming that the States have plenty of money to discharge their responsibilities as a result of the “GST windfall”.  This is palpable nonsense.  My meagre contribution to this debate is to reproduce over the fold a substantial extract from an excellent paper by economist Glenn Withers and public law academic Anne Twomey titled Australia’s Federal Future and published in 2007.  I’ll guarantee you that it contains a lot more facts and commonsense than you’re going to hear from Kevin Rudd and Tony Abbott in tonight’s TV debate:

The argument is often made that the States, despite having been given financial security through the revenue from the GST, have failed to fulfil their responsibilities, so the Commonwealth is obliged to intervene and assume or oversee State responsibilities in the interests of the Australian people. The impression is often given that the GST funds were granted in addition to existing State funding, providing the States with a great windfall. In fact, the GST was designed to replace a range of existing State taxes plus the former general Financial Assistance Grants from the Commonwealth. The States remain reliant on the Commonwealth for substantial continuing funding through Specific Purpose Payments (SPPs). The ability of the States to raise their own revenue has been reduced by the requirement that States abolish certain types of State taxes. The Commonwealth remains in full and effective control of the amount of funding received by the States, because it can reduce the amount of new SPPs at its discretio  as the amount of GST transfers grow. Moreover, if one takes into account the abolition of State taxes required by the GST inter-governmental agreement, the grants received by the States from the Commonwealth in 2006 amount to 5.5 per cent of GDP – exactly the same percentage as in 1996. Indeed, the (net) payments to the States over the entire post-GST period remain at levels below the pre-GST average of 6 per cent of GDP for the whole period of the 1980s and 1990s. During the same period, the Commonwealth’s revenue rose by a further 2 per cent to 20 per cent of GDP. This is a $20 billion windfall for the Commonwealth well ahead of State and Territory gains both absolutely and proportionately.

Therefore, it cannot sensibly be argued that the States are now ‘financially independent’ because they receive funding from GST revenue. If the Commonwealth had been serious about giving the States fiscal autonomy, it would have ensured that the States had access to revenue that covered, and eventually exceeded, the loss of State taxes plus the combination of Financial Assistance Grants and the SPPs. It did not do so. Instead, it ensured that the States remained dependent upon Commonwealth funding. It is disingenuous to suggest that the States are failing in their responsibilities because they require Commonwealth funding and that the Commonwealth should therefore take over State policy functions, when this is the system that the Commonwealth deliberately created. …

Too often, Commonwealth arguments for taking over State responsibilities boil down to the fact that the Commonwealth has the money to fund necessary reforms while the States do not, rather than questions about which level of government has the greater expertise or skills or is most appropriate to fulfi l those responsibilities. For example, the Commonwealth’s claim to manage the Murray–Darling Basin seems to be based more on its ability to fund the buy-back of existing water rights than on any superior management capacity. The Commonwealth has been involved in the management of the Murray–Darling Basin since the negotiation of the first Murray–Darling Basin Agreement in 1914, and remains a party to the more recent 1993 Agreement. Commonwealth Ministers chair the Ministerial Council on the Murray–Darling Basin and the Commonwealth and the participating States each appoint representatives to the Murray–Darling Basin Commission, which manages the Basin and water allocations. Responsibility for any inadequacy in the management of the Murray–Darling Basin in the past must be borne by the Commonwealth as well as the participating States.

A better approach to federal–State financial relations would be to ensure that the States either have the capacity to raise their own funds, or receive a sufficient share of overall tax revenue, to allow them to fulfil their responsibilities. Only then, if they failed to do so, ought a question arise as to whether the Commonwealth could do better. …

The revenue from the GST was intended to substitute for the lost franchise fees as well as replace Commonwealth Financial Assistance Grants to the States. However, the 1999 GST inter-governmental agreement required that certain State taxes also be abolished and that others be reviewed in the future. This further reduced the capacity of the States to raise their own taxes. The States now receive Commonwealth funding from two main sources. GST revenue is paid to the States according to a formula applied by the Commonwealth Grants Commission aimed at producing ‘horizontal fiscal equity’ across the jurisdictions. The intention is to ensure that the less-well-off States can provide services at an equivalent level to the more populous States. The other main source of revenue is Specific Purpose Payments (SPPs). These payments are tied to conditions imposed by the Commonwealth. In this way, the Commonwealth can dictate aspects of State policy. In 2006, SPPs amounted to approximately 42 per cent of the total payments made by the Commonwealth to the States.

The product of these changes is a fiscal system characterised by substantial imbalance in revenue collection between the Commonwealth and the States, plus substantial imbalance between the Commonwealth and the States in spending, which together are termed Vertical Fiscal Imbalance (VFI). There is, however, a substantial degree of equalisation across the jurisdictions in the distribution of Commonwealth grants, termed Horizontal Fiscal Equalisation (HFE). As explained in section 3.7, the GST has not diminished these characteristics; instead, it has accentuated them. …

The outcome in 2005, the last year for which offi cial ABS data has been published, is that the Commonwealth directly collects 82 per cent of taxes in Australia. The Commonwealth then transfers 27 percentage points of its collected taxes to the States and Territories, with 16 percentage points of this transfer being GST and 11 percentage points being SPPs.151 So, of the Commonwealth tax take of $11,336 per capita, $3,060 goes to States and Territories. Of this, $1,813 is GST and $1,247 are SPPs. The remaining $8,275 is retained by the Commonwealth. Another way of expressing this is to say that the States and Territories raise 19 per cent of government taxes themselves, but undertake 40 per cent of public spending in Australia. The difference between own-taxes and own-purpose spending is the measure of VFI, which represents some 5 per cent of Australia’s now trillion-dollar economy.

Strong sustained economic growth and Commonwealth control over income and corporate tax have combined to deliver a windfall gain for the Commonwealth in recent years. This has allowed the Commonwealth to adjust statutory tax rates down, while still growing its own revenue receipts faster than the States and claiming to be a benefactor for the States. The benefit to the Commonwealth is apparent in Figure 9, which shows past and projected growth in company tax receipts for the Commonwealth as opposed to the growth of the GST receipts provided for the States and Territories. Total company taxes have grown by 109 per cent over five years while the GST has grown by 48 per cent.
A problem with this situation is that the particular service delivery functions of the States and Territories mean that their costs are likely to rise faster than those of the Commonwealth for basic economic reasons beyond issues of good management.

This is because it is harder to enhance productivity in service functions provided by the States, which involve direct personal delivery, than it is in Commonwealth functions, such as tax collection and social service disbursement, which are IT-intensive rather than labour intensive.153 When this pressure on State unit costs is combined with growth in the scale of activity required in these service areas, the cost pressure on States and Territories is dramatic. For example: prison populations have been growing at 4 per cent per annum, acute-care hospital activity at 8 per cent per annum and children in care notifications at 15 per cent per annum over recent years.

Therefore, the States need a greater share of revenue over time to support their functions, but it is the Commonwealth’s revenue share of GDP that has been growing – allowing debt retirement and tax rate cuts, while still supporting Commonwealth expenditure obligations and new spending initiatives. This allows claims of good economic management to be made, although these claims owe much to the legacy of earlier bold economic reform, including co-operative reforms undertaken by the States, recent Chinese economic growth, and Reserve Bank independence and good judgement in interest rate determination.

Some VFI is not unusual in a federation. However, its extent in Australia is the most extreme of any federation in the industrial world. Figure 10 shows VFI across the 1990s in five major federations for which comparable data are available. Australia had the lowest share of State and local own-purpose spending, the lowest share of State and local own-revenue, and the largest relative gap between these two.