Foundation for National Renewal     The "Model Constitution" Activity

Federal Election October 2004: Which Candidates Trust the People?

Introduction

One of the most controversial issues in any federation is the question of Fiscal Arrangements. That is, the method of collecting and distributing the revenue needed by governments, at various levels, to undertake their allotted responsibilities.

The system of collecting and spending funds must be organised in a fair, equitable and transparent way. Furthermore, in a federal system it is most important each level of government have control of the mechanisms generating that revenue. Otherwise there develops what is called ‘Fiscal Imbalance’. That is, there is a disparity between what is collected by one level of government and what that level of government is required to spend to fulfil its responsibilities.

The System in Australia

Currently, Australia suffers from ‘fiscal imbalance’. The Federal Government collects more than enough revenue to fulfil its responsibilities and the State Governments can’t collect enough to fulfil their responsibilities. The Federal Government must therefore dispense money to the States and the States have too little control over that distribution.

One of the causes of this imbalance is that the Federal Government collects all income tax, a major source of revenue. Although not specified in the Constitution, the federal government has enjoyed a monopoly in the collection of income taxes since an agreement was reached between the States and the Federal Governments during WW2. Under that agreement, the Federal Government became the sole collector of income tax. Thus, the Federal Gov’t now collects approximately 70% of total revenue and the States, 30%.

A proportion of that revenue collected by the Federal Government was ‘returned ‘ to the States by means of general-purpose grants (RRG) and special purpose grants (SPP). As the terms imply, the States can spend general-purpose grants as they please; but special purpose grants can only be spent as dictated by the Federal Government. Prior to the introduction of the GST, this reallocation of funds was the subject of acrimonious annual meetings at what was called ‘Premiers Conferences’ at which the States would fight the Feds (and amongst themselves) for a ‘fairer’ share of the cake.

This redistribution was not simply done on the basis of population. A complicated formula was used to ensure that each of the States received revenue to enable them to deliver the same standard of services if they made the same effort to raise their own revenue and operated with comparable efficiency. Thus, in 2000, NSW received .9 of a crude per capita entitlement, Tasmania 1.51 and the Northern Territory 4.16.

(For these and other data used throughout this paper, I have relied heavily on a book written by Dr Bede Harris in 2002, “A New Constitution for Australia”.)

The introduction of the GST has resulted in a more automatic reallocation of revenue to the States and they no longer receive general-purpose grants. However, the Commonwealth Grants Commission conducts the distribution of GST revenue to the States still using the same formula as before and still relying on Federal legislation (that could be changed at any time by subsequent Federal Governments).

The result of all this is that Australian State Governments have to rely on funds from the Federal Government for approximately 45% of their expenditure and therein lies the problem. Whenever a State Government is accused of not spending enough on any particular service, the standard response is, “Don’t blame us. The Federal Government has not given us enough money”. Thus accountability is destroyed and the People lose faith in the system. Furthermore, this dependence on the Federal Government for funds; destroys State autonomy, undermines their integrity and hampers future planning.

The Problem

The popular wisdom for resolving this problem is to say, “He who spends the revenue should collect the taxes”. This simplistic solution, however, fails to address the problems and costs of duplication of effort, the inevitable disparities between States, and complications in the laws that would adversely effect both individuals and corporations (Personal and corporate income taxes currently represent approximately 60% of total Federal revenue.)

On the one hand, we would like to see government services delivered by organisations ‘close to the people’. Consequently, you have expressed a clear preference for Regional Governments being responsible for the delivery of a wide range of services in conformity with Australia-wide policies disseminated by the National Government. The problem to be tackled in this Task is to determine the best way Regional Governments can be provided with the necessary funds to deliver those services and to fulfil the responsibilities decided as a result of Task 8 - Delivery of Government Services.

The Systems in Other Countries

An examination of the systems employed in other countries reveals a wide variety of ideas heavily influenced by the history of the country and the evolution of their constitutions. Most reflect the fact that their constitutions are more a compact between state and federal governments rather than a compact between the People and their governments as we are trying to achieve with our ‘Model Constitution’. Expressed in a broad, general way, the systems of some other countries are as follows.

The Swiss Constitution specifies the maximum rate of personal income tax at 11.5% and corporate income tax at 9.8%. These taxes are assessed and collected by the Cantons (States) and distributed as follows. ‘Three tenths of the gross tax yield shall fall to the Cantons; at least one sixth of this amount shall be used for financial equalisation among the Cantons.’ Presumably, the remaining seven tenths goes to the Federal Government.

The Swiss Constitution further specifies a maximum rate of 6.5% value added tax (GST) and that 5% of this revenue shall be used in favour of low-income groups. Other taxes, excises and duties may also be levied by the Federal Government and anything so affected may not be also affected by Cantonal taxation.

The Swiss Constitution is quite prescriptive and specific in terms of collection, disbursement and even expenditure of tax revenue. For example, ‘One tenth of the net yield of the tax on distilled spirits shall be credited to the Cantons. These funds shall be used to fight the causes and the effects of addiction.’

All revenue legislation and activity in Switzerland is predicated with a requirement for fiscal equalisation.

In the USA, the States collect their own taxes but also receive approx 18% of their revenue in tied grants from the Federal Government.

In Canada, the Federal Government collects most tax revenue on behalf of the Provinces (States) (except for Quebec) even though the rate of these taxes varies between Provinces. In addition, the Provinces receive (usually) untied grants from the Federal Government with the size of these grants calculated to overcome disparity between the richer and poorer Provinces.

In Germany, most revenue (from personal and corporate income tax) is collected by the Federal Government despite there being constitutional provision for the States to collect taxes. The bulk of this revenue is distributed in accordance with a complicated set of rules specified in the Constitution. In essence, an agreed proportion of this revenue is allocated to communes (local government); the remainder is then distributed with equal shares going to the Federal and State Governments. Sales tax (also collected federally at uniform rates) is distributed by the Federal Government but under constitutionally mandated rules requiring the distribution does ensure uniform living standards across the country and that sufficient funds are available to each level of government so that they can meet their obligations.

Conclusion

It can be seen from the above that a constitution can be as broad or as prescriptive as we like without being outside the international norm. A study of other countries also reveals that the more detailed the constitution, the less complicated is the legislation covering the fiscal arrangements. These are both useful observations as we consider how best to finance our Regional Governments. It is also useful to note that, even though several Constitutions provide for sub-national governments to collect taxes, in many of these countries the practice has become for this to be done by the national government.

It is interesting to note that, despite a painstaking revue of this issue in his book, ‘A New Constitution for Australia’, Dr Bede Harris has opted for a system that simply gives the current system of collecting and distributing revenue, constitutional validity and authority. That is, of the revenue raised by the Federal Government, he advocates a distribution ratio of 68:32 (in which the States get the 32% of federally collected revenue).

Obviously, our current system or any of the above could be used as the basis for the fiscal arrangements in our Model Constitution. However, it seems to me we can do better. In the following paragraphs I will outline a system that could best fulfil our requirements.

A Proposition

The premises on which this proposition is based are as follows.

1. Simplicity is a virtue.
2. Parity in living standards is desirable and should be pursued.
3. The system should be detailed enough to ensure the wishes of the People are adhered to and not diverted from or diluted over time.
4. The system should incorporate sufficient flexibility to cope with changing conditions and unforseen developments.
5. The system must be framed in such a way as to be able to cope with extraordinary circumstances without having to revert to ad hoc arrangements.
6. The system must preserve and enhance the autonomy of the regions and eliminate any dependence on the whims of any other government.

In Task 8, we dealt with those aspects of governance that should be the responsibility of Regional Governments and those that should be the responsibility of the National Government. Consultation with learned colleagues (primarily Mark Drummond who is currently engaged in completing his Doctorate thesis on this very subject) has indicated the following. Those aspects of governance that we have allocated to the National Government currently absorb approximately 20% of total revenue.

The proposition then is that 20% of total revenue would be mandated to the National Government and 80% of total revenue would be mandated to Regional Governments by our Model Constitution. (These percentages could be fine-tuned as we refine our Constitution and the allocation of responsibilities.) This revenue would be ‘untied’. That is, the National Government would be able to spend that money as they saw fit and the regional parliaments would be able to spend their allocated money however they determined would best suit the requirements of their particular region. The only restraint would be that national policies, as determined by the National Parliament in the areas that Parliament had policy responsibility, would have to be met.

Distribution of revenue would be done on the basis of population. There would need to be a mechanism for special allocations to be made to specific regions to maintain equality in living standards but this would only be activated as a result of experience under this system. (Currently, subsidising of States is largely necessary because of perceived difficulties in some States of delivering government services because of distance, etc. I anticipate that the creation of 100 or so regions instead of eight States and Territories will significantly reduce this disparity. Furthermore, I anticipate the delivery of necessary government services in densely populated urban areas will be as costly as delivering necessary services in remote, sparsely populated regions.)

There would also need to be a mechanism to deal with extraordinary circumstances. For example, if Australia became embroiled in an expensive and prolonged war, this extra expenditure would need to be subtracted from national revenue before the 20%-80% allocation. Similarly, a natural disaster in one or more regions might require special funding and that too would have to be subtracted from total national revenue before the normal allocation.

Decisions on the issues raised in Paragraph 26 above would necessarily be made by the National Government. However, as the National Government we envisage would be made up of Members elected by and accountable to Regional Governments, due consideration to the needs of all Regions is assured.

Once the proportion of revenue to each level is determined, normal constitutional change mechanisms would be have to be activated to change that proportion.

It is considered that this system would ensure and entrench the autonomy of regions by giving them a constitutionally guaranteed funding. It would forever remove the requirement for sub-national governments to rely on the good graces of the national government for their funding and it would entrench responsibility and accountability at both levels of government. Furthermore, by having only one collector of taxes, the fairest and most efficient mechanisms can be employed for the collection of taxes.

 

Task 25 - Fiscal Arrangements

The task for this month is to determine the best arrangement for financing the National and Regional Governments.

The broad options are perceived as being as follows. The advantages and disadvantages of each should be obvious from the above. You are asked to rate them from 1 to 5 in order of your preference with ‘1’ being the option you most prefer and ‘5’ the option you least prefer.

1. The National Government and the Regional Governments each collect their own total revenue.
2. The National Government and the Regional Governments both collect revenue and equalising distributions are made as determined by the National Government (the current system).
3. Regional Governments collect all the necessary revenue and determine an allocation of some to the National Government. (This arrangement would certainly reinforce the concept of ‘government for the People by the People’.)
4. The National Government collects all the necessary revenue and allocates some to the Regions as decided by the National Parliament.
5. The National Government collects all the necessary revenue and allocates some to the Regions on a constitutionally mandated proportional basis (as outlined in the proposition above).

If you favour some other option, would you please outline it and grade the above options 2 to 6 according to your preference.

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Last updated: 3 May 2006