Canary in the mine

by Richard Eccleston

ON 18 JANUARY 1788, Captain Arthur Phillip and his small fleet finally entered Botany Bay, before making their short voyage around South Head to establish a settlement at Sydney Cove a week later. This not only marked the beginning of European settlement in Australia, but the very date of the First Fleet's arrival in Botany Bay coincided with the publication of Federalist 39, James Madison's inspired and revolutionary essay on federalism which had an enduring influence on the structure and scope of Australian Government.[i]

The American model of federalism, described by Madison more than two centuries ago, was a major influence on the founders of our Constitution, who were determined to 'preserve national unity, while allowing free scope for diversities, and free play to members of the federation'.[ii]

Protecting the political independence and diversity of the smaller colonies was a particular concern, championed by influential Tasmanians such as Andrew Inglis Clark and premier Edward Braddon during the constitutional conventions of the 1890s. Yet despite their determination and the Constitutional provisions they secured, Australian federalism has evolved such that current practice falls well short of this ideal.

It is increasingly apparent that Australian practice does not meet this basic objective of providing states with the political and financial independence required to respond to the distinctive needs of their residents. Instead Australian states are dependent on the Commonwealth and, in the absence of functioning political mechanisms for promoting effective intergovernmental cooperation, we are left with a parochial and partisan 'blame game'.

 

THE DEMISE OF Australian federalism has been a long time in the making. It dates back to Canberra assuming the exclusive power to levy income taxes at the height of World War II. The consequences of the gradual centralisation of financial and political power have been subtle, the symptoms obscured by brief bouts of co-operation – Malcolm Fraser's New Federalism and the creation of the Council of Australian Governments in 1992. The extent of state financial dependence and political subservience to Canberra has also varied as a consequence of reforms – the introduction of the goods and services tax in 2000, and subsequent property and mining booms that have provided some state treasuries with temporary respite.[iii]

Beneath this ebb and flow the prevailing undercurrent is clear. Australian federalism is increasingly dysfunctional and unsustainable and the community will increasingly suffer as a consequence. This fact has been laid bare in the aftermath of the global financial crisis, and is most apparent in Australia's smallest state.

Tasmania's current financial predicament is of national significance. Not because the island state's fate matters to the nation as a whole, but because Tasmania is displaying the most acute symptoms of a broader malaise. There is a need to analyse and address Tasmania's plight as the first step towards repairing an increasingly fractious and dysfunctional federation. If this is not addressed we will be burdened with more intergovernmental conflict and an increasingly disillusioned citizenry, as governments fail to deliver nationally significant reform agendas ranging from education funding to disability insurance and beyond. There is a clear need to revitalise and renew federal institutions to successfully address the many political, social, environmental and economic challenges of the twenty-first century.

 

IN THE ABSENCE of deep linguistic, cultural and economic conflict, Australians have generally been complacent about our federation. Indeed from the very first constitutional conventions fiscal affairs and the divisions of financial powers have been the only enduring source of political conflict. Significantly, it was Braddon as Tasmanian premier who brokered the original compromise allowing the Commonwealth to introduce a national customs duty (then the most important source of revenue) on the condition that three quarters be returned to the states. This important provision prevailed despite strident opposition from NSW premier George Reid and ensured free trade within the new Commonwealth.[iv]

By 2007, after a decade of petty partisan conflict between the Howard Government and Labor-controlled states, federalism came onto the national political agenda. Kevin Rudd tapped this nerve, not by arguing that reforming the institutions of federalism was an end unto itself (the failed Republican push a decade earlier suggested Australians had little interest in abstract goals). Instead, Rudd argued that the perennial 'blame game' between the states and Canberra was the real barrier to the delivery of effective and sustainable services, most notably in health.

Like much of the 'Kevin 07' platform, Rudd's aspirations for health reform morphed beyond recognition as a consequence of the global financial crisis, stoic state resistance and a fair share of maladministration.

This essay is not about the subsequent health reforms, but addresses the underlying structural cause of the blame game, which has characterised recent years.

There are few absolutes in politics and this is certainly true of the design of federal systems. However, there is a growing consensus that Australia's system is failing across three fundamentally important dimensions: adequacy, accountability and equity. These failures are clearly apparent in Tasmania.

The states continue to play an important role in the delivery of core public services in health, education, policing and many other social services. Yet despite the importance of these functions there is growing recognition that states lack the financial capacity to provide such services into the future. While I'm sure that services could be delivered more efficiently, this simply won't be enough. Productivity gains in the labour-intensive services sector are notoriously difficult to achieve because, try as you might, key health and social services cannot be automated or outsourced. Take the high-profile case of public hospitals. Both the demand for and the cost of providing hospital services is increasing and as a result health cost inflation is running at about 12 per cent a year, in Australia and abroad. Yet the rate of state revenue growth has halved from about 8 per cent in the four years since the global financial crisis (excluding Western Australia).[v]

In short, the level of government with the least capacity to pay is shouldering the burden of the growing public hospital bill.

The structural problem was clearly set out in the Commonwealth Treasury's 2010 Intergenerational Report that estimated by 2035 the cost of running public hospitals would consume the entire budgets of some states.[vi]

This is most obvious in Tasmania, where health costs could consume the entire health budget within a decade. As a result, Tasmania's ailing public hospital system is critically dependent on established Commonwealth funding, supplemented by ad hoc takeovers (the Mersey Regional Hospital) and federal handouts (the Commonwealth funding extracted by Andrew Wilkie).

The standard approach to addressing this imbalance, where states have responsibilities they cannot afford, is a system of transfers from the Commonwealth. Such transfers were always intended to be a part of the system, with Braddon, as noted above, insisting this mechanism be included in the Constitution. However, the scale of these transfers when combined with the increasingly fractious and adversarial nature of Commonwealth-State relations creates significant accountability issues. Indeed, Rudd's very effective 'blame game' narrative tapped into the political point scoring and conflict from these transfers.

 

THE ONSET OF the global financial crisis also highlighted a second problem with dependence on Commonwealth transfers: when national governments come under financial stress it is normal, and indeed politically rational, to cut discretionary transfers to the states early and hard, effectively passing the political burden of cutting services and increasing taxes and charges to state politicians. While this has been apparent in the United States and Spain (without weighing into the argument whether Spain is a federation), the dynamic is also playing out in Australia. While initially obscured by Canberra's stimulus spending being distributed by the states, the current state budget cuts prove that the rate of Commonwealth funding to the states over the next five years will be at historical lows. As George Megalogenis, one of the most astute commentators on Australian budget politics noted, 'The most politically significant feature of the federal 2012/13 budget is that the projected growth in funding to the states is as flat as the tarmac at Tullamarine.'

Given that Tasmania relies on Canberra for two-thirds of its funding, there is little wonder that this drought has been felt first and hardest in Tasmania. Although the fact that all states are now dealing with this structural decline in revenue provides support to the thesis that Tasmania's financial condition is symptomatic of a more fundamental problem.

The third and related issue confronting the federation is that the mechanisms that promote unity and equity are at breaking point. Just as the centralisation of financial power over the twentieth century has demanded systems for transferring funds to the states, they have also been subjected to equalisation regimes. The basic logic here is that transfers from the national governments to states should be, in part, based on need. With the exception of the United States, almost all federal systems have a form of equalisation payments to ensure that all citizens have access to comparable services, provide mutual insurance against extremes in regional economic activity and prevent excessive economic migration.

In Australia the first equalisation payments were made in 1910, the current and increasingly controversial equalisation regime came with the creation of the Commonwealth Grants Commission in 1933. This has served Australia well over the past eighty years, with the Commonwealth providing supplementary payments to smaller, less prosperous states – Tasmania, South Australia and Western Australia (ironically a claimant state for most of this period).

The most obvious cause of the current conflict over the distribution of GST is the resources boom and the radical divergence in economic performance and outlook between resource and non-resource states. Obviously this dynamic is most apparent in Western Australia, where total revenue is forecast to increase by about 50 per cent between 2008 and 2014 as the growth in mining royalties outstrip the decline in the GST received by a factor of three to one.[vii]

Yet to blame the resources boom for the problems facing federation is to confuse context with cause. The resources boom has merely highlighted structural problems with the existing Grants Commission system. The most distinctive feature of the system of allocating general purpose payments (generated by the GST) is what public finance types call 'comprehensive equalisation', which was introduced in the 1990s. This involves the Commonwealth Grants Commission carving up a fixed pool of money over which Canberra has no direct control, after a detailed assessment of each state's revenue-raising capacity and cost of service delivery. This is good in theory but a political nightmare in practice, especially when the economic fortunes of states diverge.

The current system has created a zero-sum game in which gains from one state come at the expense of others. This institutionalises conflict and is the root of the acrimony poisoning intergovernmental relations. Tasmania is particularly vulnerable in the current debate concerning the carve-up of the GST, not only because it can be branded the undeserving beneficiary of Western Australia's prosperity, but because along with the Northern Territory, Tasmania is an outlier and can't form a viable coalition of claimant states to counter the current attack on equalisation in the same way as the poorer Atlantic Provinces have been able to do in Canada.

 

OUR FEDERATION FACES two foundational challenges which must be resolved if the system is to meet the needs and expectations of Australians. I am not denying the states could be better managed, but it is increasingly apparent the states do not have sufficient resources to meet their constitutionally defined obligations. While I believe most Australians continue to support the idea of equalisation, it is equally apparent the current system stifles efficiency-enhancing reforms and promotes intergovernmental conflict. As a result, the Tasmanian government's view that the current regime for allocating the GST should remain unchanged is both complacent and dangerous.

What is required is a system that addresses some of the concerns of the most powerful states while retaining the principle of equalisation.

Given the nature of these challenges, the debate about the future of federation needs to be elevated above the tedious and technical questions central to the current GST Distribution Review and related proposals to reform the multitude of intergovernmental councils and committees.[viii] The practice of Australian federalism is so totally removed from the vision described by Madison, or the model designed by our founders, that we desperately need a national debate about the rationale and structure of federation. This could go two ways.

If we move back to the Madisonian model of 'dual' federalism, in which states have a clear and uncompromised mandate to govern in relation to ascribed policy areas, then the Commonwealth needs to provide the financial resources to fund these obligations. By necessity this would mean transferring growth taxes to the states, by sharing the income tax base, or through broadening or increasing the GST. Another option would be to transfer the responsibility for funding high-cost services, such as health, to the Commonwealth. This would give the states more political autonomy in a smaller number of policy areas. Significantly, both strategies would end dependence on tied Commonwealth funding and the 'blame game' it fuels.

On the other hand, if we decide that high levels of Commonwealth control and co-ordination are necessary to respond to the demands of the twenty-first century we need to explore the German model of 'integrated' federalism. This system features high levels of co-operation between national and sub-national governments, made possible by direct regional representation at the national level. In Germany, members of the Bundesrat, the upper house of the national parliament, are direct delegates of the Länder(states) ensuring strong regional representation in the national parliament. In contrast, the Australian Senate, which like its American cousin was conceived as a states' house, became a playground of party politics in the early twentieth century and has remained so since.

Without a constitutional crisis of unprecedented scale, a national debate about the structure of our federation seems unlikely. I am pessimistic of even incremental change as a result of the current GST Distribution Review.

 

THE FUNDAMENTAL POLITICAL problem with the current Grants Commission regime is that it creates a zero-sum game in which one jurisdiction's gain is another's loss – an institutional system that breeds conflict and acrimony. This need not be so. It is an unusual and perverse design feature, peculiar to Australia. In most federal systems, needs-based equalisation payments have a vertical component coming from the national government to ensure states can meet minimum standards of service provision.

To use a Canadian example, the poor Atlantic Provinces receive billions of dollars from Ottawa, funded federally rather than from rich provinces such as Alberta. Another important element of the regime is that equalisation ensures funding up to an agreed national average but does not 'punish' provinces that have resources to spend more. While the Canadian system of partial equalisation is not without controversy, it has proven viable and sustainable despite a history of significant cultural and economic variation across the country.

There is a lot to learn from the Canadian model, but it remains virtually invisible here despite many similarities, including a common history of managing resource-driven variations in regional economic performance (Alberta's first oil rush was in 1914). The short answer to this myopia in Australia's case is a lack of national leadership from either political party. Despite the growing evidence of dysfunction and conflict, Canberra remains firmly on the sidelines for political and financial reasons. Politically, it is difficult for the states to blame Canberra for under-funded services and public sector sackings, and the Commonwealth has a short-term interest in maintaining the current GST distribution regime because it largely avoids responsibility for funding the poorest states and territories.

Comparative research clearly demonstrates that national leadership is essential to reform federal systems. In the Australian context, Canberra needs to actively broker compromises on the significant challenges facing the federation.[ix]

For example, in terms of the GST Distribution Review Canberra should consider allowing Western Australia to keep more of the proceeds of the resources boom in return for ending the ludicrous and destructive fight over which tier of government has the right to tax mining profits. On the other hand, poorer states such as Tasmania need to be guaranteed a minimum share of Commonwealth funding so they have some financial security.

Even more importantly, all jurisdictions should be rewarded rather than punished (as is sometimes the case) for becoming more self-sufficient through tax reform or delivering services more efficiently.

Beyond Canberra's moral obligation to provide leadership in such nationally significant reforms, recent modelling by my colleague Neil Warren clearly demonstrates that the Commonwealth would be the main financial beneficiary of such reforms: more efficient state taxation and service provision would increase national productivity, boost economic growth and increase the revenue raised through federal income and corporate taxes.[x] A short-term investment in reforming the federal system should return a long-term dividend to the nation as a whole.

Despite these compelling arguments the prospects of Commonwealth leadership seem more remote than ever. Analysis of the Henry Tax Review quickly disappeared from the national political radar while the policy of benign neglect of the system has bipartisan support. Under these circumstances leadership must come from the states. Tasmania, as the smallest and most vulnerable state, has the most to gain from promoting a mature debate about the future of federation. Tasmania's moment to drive this significant national reform has arrived.

Political representatives from all sides of politics, federal and state, need to promote reform of the federal system. In 2010, Tasmania's financial woes could easily be dismissed as the inevitable consequence of what is widely (if incorrectly) regarded as being a small, remote and uncompetitive economy. However, as states across the country experience budget crises it is becoming increasingly apparent that there are systemic problems with our federal settlement. Despite the national scale of the problem, Tasmania can play a critical role in framing the problem and developing solutions.

In terms of political strategy, Tasmania's political leaders can no longer afford to defend the status quo. The current regime for redistributing the GST has serious technical flaws and is politically unsustainable. The donor states are simply too populous and powerful to ignore. Instead, Tasmania needs to make a clear case for the principle of equalisation, while acknowledging that flourishing states such as Western Australia have legitimate concerns. Successful reform requires compromise and willingness to trade and bundle policies so that everyone can take something home.

In practical terms, this means working with other states to spur the Commonwealth into action, both in terms of brokering the national reform agenda and providing short-term compensation and incentives so no state is worse off. This may seem like a pipedream given the current animus of intergovernmental relations, but the National Competition Policy in the 1990s is the model which we need to follow – a model whereby innovative states demonstrate to Canberra what is possible.

Tasmania has a proud record of policy and political innovation, especially when confronting fundamental challenges. Tasmanians can no longer afford to be the passive victims of seismic shifts occurring in the federation.

Just as Edward Braddon and Andrew Inglis Clark played a vital role insuring that the Australian Constitution balanced national concerns with the interests of Tasmanians, our current leaders must once again play a leadership role in reforming our federal system, or Tasmanians will be forever relegated to being the poor, mendicant cousin.

 


References

[i]
Madison's Federalist No. 39 is available at http://www.constitution.org/fed/federa39.htm

[ii]This often cited statement of the federal ideal is from James Bryce'sThe American Commonwealth. 2nd edn, London, Macmillan. 1891. Bryce was a leading British liberal intellectual of the late 19th century.

[iii]See for example: Eccleston, R (2007) 'Righting Australia's Vertical Fiscal Imbalance: Transferring Public Hospital Funding as an Option for Reform', Agenda, 15(3) 2008; Eccleston, R., Warren, N, and Woolley, T. 'Beyond the Blame Game: Strategies for State Funding Reform' Australian Journal of Public Administration. Forthcoming 2013.

[iv]The provision is contained within Section 87 of the Constitution and widely referred to as the 'Braddon Clause'. In a compromise with Reid to win NSW support the Braddon Clause was limited to the first 10 years of federation.

[v]The most comprehensive data on health cost inflation is published by the Australian Institute of Health and Welfare. http://www.aihw.gov.au/publication-detail/?id=10737423009

[vi]The Australia to 2050: Future Challenges report is available at http://archive.treasury.gov.au/igr/igr2010/report/pdf/IGR_2010.pdf

[vii]For detailed analysis see GST Distribution Review: First Interim Report March 2012. Canberra: Commonwealth Department of Treasury.Available from http://www.gstdistributionreview.gov.au/content/Content.aspx?doc=reports.htm

[viii]GST Distribution Review: First Interim Report March 2012. Canberra: Commonwealth Department of Treasury.Available from http://www.gstdistributionreview.gov.au/content/Content.aspx?doc=reports.htm

[ix]Eccleston, R., Warren, N, and Woolley, T. 'Beyond the Blame Game: Strategies for State Funding Reform' Australian Journal of Public Administration. Forthcoming 2013; Blöchliger H. and Vammalle C. 2012. 'Going Beyond a Zero-sum Game: Reforming Fiscal Relations', eJournal of Tax Research, 10(1):49-64.

[x]Warren, N. A. 2010. 'Intergovernmental Fiscal Arrangements as a Constraint on State Tax Reform under Henry.' In C. E. Evans, J. G. Head, and R. Krever (eds). Australia'sFuture Tax System: A Post-Henry Review.Sydney: Thomson-Reuters:305-63.

From Griffith REVIEW Edition 39: TASMANIA – The Tipping Point? © Copyright Griffith University & the author.