At first glance, the plan to give income taxing powers back to the states so they can fund their own hospitals and schools looks like a disaster for Tasmania. Our economic output ‒ and therefore our capacity to pay for things ‒ is less than almost anywhere else in the country. Only about a third of the state government’s budget is derived from within Tasmania.
So in the absence of any other mechanism, we would have two options ‒ to pay far more tax than anyone else, further weakening the private economy, or settling for even worse health and education systems than we have now.
But it’s not like that. Such a mechanism of redistribution exists and has for many years. It’s called the GST.
The Commonwealth Grants Commission assesses the capacity of each state and territory to raise the money needed to provide services at an average standard across the nation. They then dole out the money from the GST pool accordingly. Poor states (like us) get more. Rich states get less.
One of the main things the Commission’ looks at is what it calls ‘taxation severity’. It assesses, overall, whether each state is doing as much as the others to raise its own cash. Those with unduly high taxes have, in effect, the proceeds taken away through the GST equalisation system. But those with unduly low taxes don’t get a top-up from the GST.
So there’s little incentive for one state to set its tax rates either higher or lower than anyone else. If the Tasmanian government struck a higher income tax rate than other states, they wouldn’t get to keep that extra money.
So would that mean we would have to settle for worse health and education services than anyone else?
Well, no, because there’s something else in the mix. The Grants Commission also assesses each state’s health and education needs and adjusts GST distribution accordingly. This year, Tasmania gets an extra $266 million for its health needs and $106 million for schools.
So if we are unable to raise our own taxes far enough to pay for our services, we would get more GST so the Tasmanian government would have enough money to provide services at the same standard as everyone else.
That’s not to say dangers don’t exist. They do, but not the ones some politicians are talking about.
The states have a long-standing habit of racing each other to the bottom in taxation levels. When Joh Bjelke-Petersen got rid of inheritance tax in Queensland, all the other states followed in quick succession. If they didn’t, they reasoned, everyone will move to Queensland.
Further back, the McMahon government ceded payroll tax to the states, thinking it would provide an efficient growth tax to fund schools and hospitals. But once again, the states competed with one another to lower this tax too. In neither case was a replacement found for these lost income streams and services suffered. They still do.
But since the advent of the current GST redistribution system, that race to the bottom seems to have stopped. State politicians may not understand why there’s no advantage in having out-of-whack tax rates but their Treasury officials do.
A more cogent objection to Mr Turnbull’s proposal is that income tax is a relatively narrow base for funding health and education services that benefit the entire economy, not just their direct consumers.
Companies could not operate without a well-educated workforce. And if governments did not fund health, the pressure would be on employers to do so. That was the pattern in the United States before Obamacare. Companies provided health insurance for their workers and the cost was crippling. It sent General Motors to the wall.
So if the whole economy benefits from these services, it’s reasonable for the whole economy to pay for them. Not just wage earners.
An even bigger danger is that the Commonwealth will use the transfer of some limited taxation powers to get out of hospital and school funding altogether. But the Commonwealth will always find it much easier to raise money ‒ from a plethora of sources ‒ than the states. It is far from certain that a state share of income tax would be enough to fund health and education into the future.
If the federal government sees this proposal as a means of shuffling out of its responsibilities in these two key areas, it would be a seriously backward step for the nation ‒ and for all areas of the nation’s economy.
• John Biggs in Comments: Thank you Martyn for clarifying things. I tend to see this in political as much as in economic terms. Here is the agile and innovative Turnbull out Abbotting Abbott in retrogressivity. Back to the 40s! His logic is flawed. The Commonwealth taxes less, the State taxes take up the gap to bring the overall tax take the same as it was — and this is to increase funding to health and education? Where’s the magic pudding? Surely this ill conceived complex plan, needing much analysis and discussion, is bound to be unpopular and it is dumped on the table in an election campaign! I am sure Turnbull in his egocentricity thought this would upstage Shorten in bold new ideas (it’s a very old idea) but instead looks like a repeat of his Godwin Grech moment: impulsive, silly and entirely lacking judgement.