The left-leaning twitterverse went into predictable convulsions of outrage yesterday when it emerged that (equally predictably) the four Coalition States had declined to pony up dollars for the 4 year trial phase of the proposed national disability insurance scheme.
However the chorus of condemnation ignored several salient factors. First, the Gillard government’s own reports had apparently recommended that the Commonwealth should fund the whole scheme (presumably in part because the States simply don’t have the revenue base (see below).
Secondly, it’s only a trial anyway. Full implementation of the scheme is expected to cost an additional 8 billion dollars per year according to the Productivity Commission. It is arguably cruel to raise the expectations of carers for the disabled when there is no plausible proposal on the table as to how that cost is going to be met (except by the Commonwealth acting alone or almost alone).
When NSW Premier Barry O’Farrell not unreasonably pointed that out and suggested that it was just a part of a plot to pressure the States into long term funding they simply couldn’t afford, Prime Minister Gillard said that “funding arrangements for the trials would have no bearing on how the final scheme is funded.” Really? Try asking Ms Gillard whether the Commonwealth will commit to funding the whole $8 billion itself. We already know the answer.
Why can’t the States afford it?
At the risk (or rather certainty) of repeating points I made only yesterday((Apparently there is now a concept of self-plagiarism. It sounds a tad precious but I’d better avoid it anyway by posting this recycling warning. ~KP)), ALL states and territories are currently in significant budget deficit and most will stay that way until at least 2014-2015.
Moreover, the reason isn’t hard to identify either: the reduction in expected GST revenue in the wake of the Global Financial Crisis. Indeed, that recent reduction is just a re-emergence of a longstanding fundamental flaw in Australia’s federal system.
For the first few years after GST was introduced in 2000 it seemed as if it was a huge and unexpected windfall. GST revenue exceeded expectations every year, and both the states and territories (including the NT) were able to retire existing debt. But it turned out this was just a temporary and fairly short-lived phenomenon. Australians had gone on an orgy of borrowing and gearing up to buy real estate through the nineties and early noughties. After the Hawke/Keating government deregulated the exchange rate, interest rates and financial markets generally, banks and other lenders were queuing up to lend money to Australians at much cheaper rates than had previously been available and on easier terms. Many people took the opportunity to buy a new and larger home and to invest in residential rental properties. Property prices went up and up and up seemingly without end. People felt richer and richer as a result, and many decided they could afford to max out their credit cards on consumer spending as well.
That’s why GST revenue kept exceeding expectations. But it was never going to last, and it all came to a screaming halt after the GFC. Since then Australians by and large have been saving, reducing debt and living within their means. And that’s a very good thing too, although retailers like Gerry Harvey probably don’t agree. It also means that state and territory governments, which had become accustomed to receiving an ever-growing GST pot of money each year, are being forced to wean themselves off the habit by cutting back on often very basic services.
The longer term significance of these developments is that it has again thrown into sharp relief the complete inadequacy of federal-state financial relations. The states and territories are radically underfunded to allow them to discharge their basic responsibilities to provide health, education, roads and the like. Moreover they don’t have access to income tax revenue after the Commonwealth hijacked it in a dodgy scheme sanctified by the High Court during World War II. The phenomenon is known as Vertical Fiscal Imbalance and it is arguably the most urgent governance problem Australia faces. Yet neither Julia Gillard nor Tony Abbott is addressing it or even mentioning it in passing. Moreover, it’s hardly a breathtaking new insight. Constitutional Founder Alfred Deakin foresaw the fundamental flaw in our constitutional arrangements in a letter to a London newspaper in 1902:
“As the power of the purse in Great Britain established by degrees the authority of the Commons, it will ultimately establish in Australia the authority of the Commonwealth. The rights of self-government of the States have been fondly supposed to be safeguarded by the Constitution. It left them legally free, but financially bound to the chariot wheels of the Central Government. Their need will be its opportunity. The less populous will first succumb; those smitten by drought or similar misfortune will follow; and finally even the greatest and most prosperous will, however reluctantly, be brought to heel. Our Constitution may remain unaltered, but a vital change will have taken place in the relations between the States and the Commonwealth. The Commonwealth will have acquired a general control over the States, while every extension of political power will be made by its means and go to increase its relative superiority.”
I’m not meaning to suggest that Vertical Fiscal Imbalance in itself is necessarily a bad thing, just that the States by some means need to have assured access to the baseline funding they need to discharge their service delivery responsibilities. Until they do, it is disingenuous for Julia Gillard to accuse them of meannness for refusing to put themselves further around the fiscal s-bend by committing to a very expensive (if highly desirable) disability insurance scheme they cannot afford to fund.
In fact, in relation to VFI specifically, I actually think our evolved Australian solution, whereby the Commonwealth raises the taxes and they’re distributed to the States via an impartial body (Commonwealth Grants Commission) according to regularly reviewed formulae designed to provide all States with the funding they need to provide roughly equal levels of services to their citizens, is an excellent one. It’s one of the best aspects of evolved Australian federalism.
The problem is that the GST revenue pool itself isn’t big enough. I would support raising GST to 12 or even 15%, which I’m sure would solve the problem. If it was the higher rate then the Commonwealth might also require the States to abolish stamp duty as a condition (although I haven’t done the sums to see if that would be a fair trade). However in the world of realpolitik it probably won’t happen.
On the other hand, it’s greatly to Joe Hockey’s credit that he refused to rule out raising the GST rate the other day, while pointing out quite fairly that it was really up to the States to take the running:
After the Opposition Leader issued a “categorical no” to raising the GST two weeks ago, Mr Hockey canvassed the option and said it would be up to the states to press for the reform. “If you are going to have a discussion about changing the GST, the states have to lead the argument because they are the ones that need the revenue,” he said. “They have to take the community with them and they are not doing that.”
This week, former Treasury secretary Ken Henry warned that consumption taxes would have to rise to ease pressures on state budgets, while the Grattan Institute has called for the GST to be extended to food and education to fund income tax cuts that would lift economic growth.
By contrast, it’s greatly to Wayne Swan and Labor’s discredit that they have categorically ruled out raising the GST rate. Surely they could at least have fudged and changed the subject, because it’s a subject that will certainly have to be revisited soon.
Finally, given that the political probability of the States and Commonwealth agreeing to take the political heat of raising the GST rate in the foreseeable future is close to zero, what about a different approach? The Gillard government could legislate to set aside an assured (and adequate for State needs) share of income tax revenue for the States and Territories, perhaps in exchange for referral of State powers over the waters of the Murray-Darling basin. After all, the Commonwealth effectively stole income taxing power from the States in the first place. Gillard could leave a huge legacy of major positive reform of Australia’s federal system. Moreover, the political barriers to Tony Abbott unwinding such a scheme once it was in place would be massive.