Australia's Future Tax System

Consultation Paper

Section 9: State and local taxes and transfers


A well functioning federal tax-transfer system is necessary if Australia is to meet the challenges of the coming century and make the most of future opportunities. Through a lack of coordination in policy and administration, the federation's tax-transfer system has become disjointed and complex, imposing unnecessary costs on all Australians.

Reforms which enhance the accountabilities, integration and efficiency of the federation's tax-transfer system can improve the functioning of the federation by reducing costs, removing complexity and improving resource allocation.

There are many issues that need to be taken into account when considering possible reforms to the way the tax-transfer system operates across the federation. Central to this is the trade-off that may occur in relation to the accountability (and other benefits) of State governments for raising their own revenue and the complexity and efficiency of the federal system. In addition, having different transfer policies in different States as well as multiple administering agencies for both taxes and transfers is a source of further complexity and possible inequities.

Consultation questions

Q9.1 Noting the overall structure of Australia's federal financial arrangements, what changes, if any, should be made to the assignment of revenue raising powers and intergovernmental transfers in Australia?

Q9.2 Given the widely held view in submissions that the current state tax arrangements need to be reformed, what changes should be made to state and local government own source revenue instruments? What scope is there for greater use of user charging to bring social, environmental or economic benefits?

Q9.3 What is the appropriate allocation of the roles of the Australian and state governments in income redistribution?

Q9.4 What opportunities could be pursued to deliver more seamless administrative arrangements of the tax-transfer system across the federation?

9.1 Funding expenditure responsibilities in the federation

Australia's fiscal relations between the Australian government and the states is characterised by a high level of vertical fiscal imbalance (VFI). That is, the States' own revenue sources are insufficient to fund their expenditure responsibilities, while the Australian government's revenue sources are greater than required to meet its expenditure responsibilities. This imbalance, and the mechanisms used to transfer funds to the states, can have implications for the fiscal accountability of the Australian government and the states, and the overall effectiveness of the tax-transfer system.

In 2006-07, the own source revenue of the states comprised around 55 per cent of their total revenue, with the remaining 45 per cent made up of specific purpose payments and distribution of GST revenue. Australia's level of VFI is higher than in comparable federations, such as Canada and the United States, although less than in some others.

The continuation of current federal financial arrangements is likely to have implications for the level of VFI in the future. For example, the Productivity Commission (2005) noted that in the context of an ageing population, under current taxing powers and expenditure responsibilities, the States' taxation sources would be relatively stable as a percentage of GDP, but expenditure pressures would increase. The States would therefore be more reliant on transfers from the Australian government.

Summary of key messages from submissions

Many submissions note the complexity that arises from multiple levels of government being involved in the tax system. They also note that the mix of taxes currently levied by the States (and, to a lesser extent, local government) is inefficient and inequitable.

A number of submissions recommend abolishing some state and local taxes and compensating the States and local government by increasing the level of grants from the Australian government, thereby increasing VFI.

Other submissions note that the current level of VFI leads to weakened accountability for spending decisions, particularly at the state level. There is a view that this could be addressed by a review of the existing distribution of expenditure functions between levels of government. That is, some functions could be transferred from the States to the Australian government.

Submissions that propose addressing VFI through increases in States' own source revenues note that any new revenue source needs to be of better quality than the existing taxes imposed by the States. Some submissions raise the possibility of the States having access to the income tax base (that is, sharing the base with the Australian government).

In terms of intergovernmental transfers, some submissions note that the current arrangements, including specific purpose payments and the distribution of GST revenue, are in need of reform to make payments between levels of government more transparent.

Submissions by local government note the importance of Australian government funding in equalising the fiscal capacities of local councils across the federation.

Implications of the structure of funding

For a given allocation of expenditure responsibilities in a federal system there are a number of different ways that the expenditure responsibilities of governments at each level can be funded. The two extreme approaches are:

  • one level of government (the national government) raises all revenue in the federation and distributes an appropriate amount to each sub-national government so they can meet their expenditure responsibilities (complete VFI); and
  • each level of government raises enough revenue to fund its own expenditure (zero VFI).

The first approach allows tax system centralisation with only one level of government involved in the policy, administration and collection of taxes. This provides the opportunity for a less complex and more efficient tax system. The main disadvantage of this approach is with accountability. Sub-national governments may be able to shift the blame for inadequate service provision to the national government, by claiming that insufficient funding is provided by the national government. Equally, the national government can blame poor outcomes on poor administration or a misallocation of funding by sub-national governments. The accountability issue can be further complicated if the national government imposes conditions on how the sub-national government spends its funding. This can reduce the transparency of revenue and expenditure decisions, thereby reducing the accountability of governments to their citizens.

The second approach reduces the opportunity for blame shifting to other levels of government. However, with governments at each level raising revenue independently, there is a greater risk of the tax system becoming more complex, particularly for individuals and businesses operating across more than one jurisdiction.

In practice, federations do not operate at either of the two extremes, but at some point in between. The Architecture paper showed how Australia's level of VFI compares to other federations and how the level of VFI in Australia has changed over time. It also outlined costs and benefits of VFI. The extent to which the current and future level of VFI is seen as a problem depends upon how these costs and benefits are viewed, in particular the trade-off between efficiency and accountability. Of those submissions that address VFI, most suggest there should be a better alignment of revenue raising capacity and expenditure responsibilities.

Alternative methods of funding sub-national governments

The level of VFI is not the only important issue for a federation. A further important issue is the way in which government's expenditure responsibilities are funded — that is, the type of taxes levied and the grants received. Chart 9.1 provides a summary of the alternative ways the expenditure responsibilities of sub-national governments can be financed.

Chart 9.1: Funding sub-national governments in a federal system

Chart 9.1: Funding sub-national governments in a federal system

With own source revenue, sub-national governments are able to determine how they raise and spend their revenue. With tied grants they may have little or no control over how these funds are raised and how they can be spent. Funding from own revenue sources may, however, not provide sub-national governments with sustainable fiscal autonomy if the revenue raising instruments are of poor quality. Tax base sharing or revenue sharing arrangements may provide sub-national governments with a better capacity to manage their fiscal position compared to taxes that are subject to base erosion or that are highly unpopular.

Own source revenue

Own source revenue refers primarily to revenue from taxes and other sources, such as royalties and user charges, that are levied independently by sub-national governments. For example, the States in Australia levy a range of taxes, including payroll tax, conveyance duty, land tax and gambling taxes. Other revenue sources are user charges for services provided by government, regulatory fees, dividends (including property income and tax equivalent revenue), interest income and fines (Section 9.2 examines state taxes).

With own source taxation, sub-national governments have the ability to modify the bases and rates in accordance with their individual circumstances. The trade-off to this, as a number of submissions highlight, is that it can increase the complexity of the tax system, particularly for those dealing in multiple jurisdictions. To reduce this concern, sub-national governments may choose to cooperate and agree on uniform tax rates and/or bases. Submissions support recent steps to harmonise the payroll tax arrangements across the States.

Some taxes are better levied by certain levels of government. Submissions note that land-based taxes are more appropriate for lower levels of government because of their immobile base. Box 9.1 further discusses the theory of tax assignment in a federal system.

Box 9.1: The theory of tax assignment

There is a great diversity of federal arrangements worldwide and so there is no universally applicable theory of tax assignment. However, some experts have identified useful principles that may apply in many, although not necessarily all, cases.

In his article 'Who Should Tax, Where, and What?' Richard Musgrave (1983) outlined a set of principles for the assignment of taxes between different levels of government in a federal system. These principles are:

  • middle and especially lower-level jurisdictions should tax those bases which have low inter-jurisdictional mobility;
  • personal taxes with progressive rates should be used by those jurisdictions within which a global base can be implemented most efficiently (that is, consideration needs to be given to how easily a government can tax the income of its residents if it has been earned in another jurisdiction);
  • progressive taxation designed to secure redistributional objectives should be primarily central;
  • taxes suitable for purposes of stabilisation policy should be central, while lower-level taxes should be cyclically stable;
  • tax bases that are distributed highly unequally among sub-jurisdictions should be used centrally; and
  • benefit taxes and user charges are appropriate at all levels (although the significance of these instruments at each level of government depends on the nature of public services provided at that level of government).

Tax base sharing

Tax base sharing is where two (or more) levels of government tax the same, or roughly the same, base. Tax base sharing generally requires greater coordination and harmonisation of the tax base and can involve lower compliance costs than if separate levels of government utilise the same tax base independently. Each jurisdiction can set its own rate and receive the revenues raised in, or derived from, that jurisdiction. Further, the collection of revenue can be undertaken centrally or by each individual jurisdiction.

Tax base sharing arrangements are not currently in use in Australia but are used in other federal systems. For example, Canada applies tax base sharing across major tax bases (Box 9.2). A few submissions raise the possibility of introducing a tax base sharing arrangement between the Australian government and the states, using the income tax base.

Box 9.2: Tax base sharing in Canada

There are a number of tax base sharing arrangements that operate in Canada, where both the federal government and provincial governments apply taxes to the same base. Tax base sharing arrangements are in place for personal income tax and corporate taxes in most provinces, as well as sales taxes for some provinces. For example, with the exception of Quebec which administers its own personal income tax, all provinces have a base sharing agreement with the federal government for personal income tax. The provinces can set their own rates and thresholds, which apply in addition to the federal rates and thresholds. British Colombia currently has a progressive five rate income tax scale, while Alberta levies a single 10 per cent rate on taxable income.

Federal taxes are collected by the Canada Revenue Agency (CRA). Tax collection agreements enable provincial governments to levy taxes which are administered by the CRA and remitted to the provinces. For personal income tax, this means individuals only file one set of tax forms each year covering both their federal and provincial tax.

Revenue sharing

Revenue sharing is where one level of government has access to a specific share of revenues collected by another level of government. This usually involves the national government setting a uniform tax rate and base, being responsible for administration and collection, and distributing a share of the revenue to sub-national governments.

The proportion of revenue that each level of government receives from revenue sharing may influence the operation of a revenue sharing agreement. If sub-national governments receive the greater share of revenue, it might provide them with a greater sense of 'ownership' of the tax. This may increase accountability if citizens associate the tax with the level of government receiving the revenue. However, the lower the share of the revenue that the collecting government keeps, the less concerned it may be about the integrity and sustainability of the tax base.

Untied grants

Untied grants are provided by the national government to sub-national governments without conditions on how the money is to be spent. Untied grants can either be an arbitrary amount of money or set by a formula which, depending on institutional arrangements, may be subject to unilateral change. Given there are no attached conditions to their receipt, untied grants can be administratively simple to deliver. However, as it is more difficult for citizens to explicitly link paying a tax with untied grants, sub-national governments that receive untied grants may have diminished accountability to the public.

Some submissions suggest that issues with federal financial relations could best be addressed by funding the abolition of a number of state taxes using untied grants. These submissions generally acknowledge VFI as a problem, but consider the efficiency, equity and simplicity of the tax system to be more important.

Tied grants

Tied grants from the national government to sub-national governments come with conditions on how the money is to be spent. Tied grants may be an efficient way to address externalities or spillovers across the borders of sub-national jurisdictions (such as in the Murray-Darling basin where the actions of one State affects the wellbeing of another).

Where tied grants are used for purposes other than addressing externalities, they can create efficiency and accountability problems. If the conditions on service delivery are different to the preferences of the sub-national government, citizens may hold the sub-national government responsible for the services provided, even though it is unable to provide them in its preferred way. Further, tying grants may increase administration costs, for example due to the need to monitor the conditions of the grant. By determining the amount of funding to be spent on the delivery of a particular service, tied grants can also reduce the incentive for the service provider to pursue efficiency in service delivery.

An alternative approach to tied grants is for the national government to provide funding to any service provider that can deliver a specific outcome. Under this approach the national government would tender for service provision. Sub-national governments would have the option of applying to be a service provider and, if successful, would receive the necessary funding (along with any other successful tenderers) to deliver the specified outcomes. For example, if the national government wanted people with low incomes to be able to access particular services charged on a user pays basis — the loss in revenue to service providers from this concession could be funded by the national government (see Section 9.3 for further discussion of this issue).

A few submissions note the possibility of the Australian government contracting service delivery, with one suggesting that the Australian government purchase services from the States on a per unit basis, with the unit price linked to quality and reliability performance criteria.

The choice of funding approaches

In most federal systems, sub-national governments are financed from a combination of the approaches in Chart 9.1. The extent to which each of these methods of funding is used is partly dependent on how the trade-off between the benefits of a centralised tax system and its effects on the accountability of governments is viewed. It is also dependent on a number of other factors such as:

  • the constitutional framework of the federation;
  • the extent to which the equalisation of fiscal capacities of sub-national governments is viewed as important, as this will influence the choice of taxes assigned to sub-national governments and the need for revenue sharing or untied grants to more easily implement fiscal equalisation;
  • the existence of externalities across the borders of sub-national governments; and
  • the capacity for sub-national governments to raise revenue from their own sources in a sustainable way.

Consultation question

Q9.1 Noting the overall structure of Australia's federal financial arrangements, what changes, if any, should be made to the assignment of revenue raising powers and intergovernmental transfers in Australia?

9.2 State and local taxes and other own-source revenue

The States currently have access to a range of tax bases and other revenue sources. These taxes could be reformed independently of changes to the way the States are funded (outlined in Section 9.1). However, changes to funding arrangements may provide greater flexibility for state tax reform.

Summary of key messages from submissions

Of those submissions which consider state and local taxes, many raise concerns with the imposition of one or more of these taxes, noting issues of inefficiency and equity. Many highlight the need to rationalise the number of taxes.

A number of business groups note the complexity and compliance costs arising from the different structure and administration of taxes across States.

Many submissions propose the abolition of a number of state taxes. Few submissions identify ways the States could fund the abolition of these taxes, but those that do propose improving the application of some existing taxes (or introducing new ones).

Many submissions call for the abolition of payroll tax. However, several recent efficiency analyses of state taxes indicate that payroll tax is one of the more efficient state taxes (see Charts 9.2 and 9.3). Many submissions suggest that, if payroll tax is to be maintained, the current exemptions and thresholds should be removed and that the tax be harmonised across the States. An option put forward is to apply a uniform system with the Australian Taxation Office (ATO) collecting the payroll tax on behalf of the States.

Several submissions propose that insurance duty and the fire services levy imposed on insurers be abolished. They argue that these levies result in multiple taxation of insurance products and highlight the risks associated with non-insurance or underinsurance.

Submissions canvass a range of changes in relation to land taxes — from complete abolition to broadening by removing exemptions and concessions. A few submissions consider that land tax should be harmonised across the States, or that it should be a federal tax. Some submissions propose abolishing local government rates, while others suggest it is an appropriate tax base for local governments.

There is general agreement in submissions that stamp duty on conveyances should be abolished, with a number of submissions noting the inequity of this tax.

Several submissions express concerns about the impact that property taxes and charges (for example, stamp duty on conveyances and land taxes) have on housing prices.

Many submissions propose changes to state motor vehicle taxes, where the rate of tax depends on the carbon emitted from the car. One notes that such an approach would require tax to be based on fuel usage rather than annual vehicle charges.

One submission argues that gambling should be taxed the same as other industries.

One submission suggests that the States should make more use of user charging.

Some submissions express concern that not all taxes identified for abolition under the Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations have been abolished. Some suggest all state taxes could be replaced by the GST.

Issues with state and local taxes

In considering alternatives to the current mix of state taxes, a number of factors need to be taken into account. The ability to reform state taxes will depend upon:

  • the revenue raised by broadening the base of efficient taxes and any revenue forgone if tax rates are lowered as part of these reforms;
  • the revenue lost due to the abolition (or reduction) of inefficient taxes;
  • any changes to revenue sources of state governments;
  • the constitutional restrictions on the states levying some taxes; and
  • the scope to raise additional revenue from user charging.

Insurance taxes

Submissions note that stamp duty on insurance may encourage people to either under insure or to not insure at all by increasing the cost of insurance products relative to other goods. While this in itself is inefficient, it may also lead to an increase in government expenditure if assistance is provided to the uninsured in the event of a disaster. Further, the fire services levy — which is levied on insurance companies to partly fund fire brigades — can exacerbate the effects of the stamp duty on insurance.

Payroll tax

As noted in the Architecture paper, it is difficult to determine the precise economic incidence of a tax. Many submissions are concerned that payroll tax acts as a disincentive to businesses to hire workers. However, a recent review by the NSW Independent Pricing and Regulatory Tribunal (IPART) found that the economic effect of a broadly based payroll tax is similar to a broad consumption tax or a flat-rate income tax, concluding that the view that payroll tax is a tax on employment is not supported by the evidence (IPART 2008).

This reflects the generally accepted view that the economic incidence of a comprehensive payroll tax is likely to fall on labour, either directly through lower after tax wages or indirectly through higher prices for goods and services. However, in the short run it is possible that, due to certain market conditions, businesses which pay the tax are not able to pass it on through prices or wages, and this in turn could affect business investment decisions.

Charts 9.2 and 9.3 (from the submissions) suggest payroll tax is a relatively efficient tax, notwithstanding its narrow base. While payroll tax is shown to be relatively efficient, the efficiency rankings of taxes vary considerably. The Review Panel has commissioned work on the efficiency of Australia's main taxes.

Chart 9.2: Australia-wide ranking of state/federal taxes

% change in consumption / % change in tax revenue (relative to personal income tax)

Chart 9.2: Australia-wide ranking of state/federal taxes - % change in consumption / % change in tax revenue (relative to personal income tax)

Source: Investment and Financial Services Association submission (2008).

Chart 9.3: Inefficiency ranking of selected taxes

Impact on output relative to benchmark tax set at 1.0

Chart 9.3: Inefficiency ranking of selected taxes - Impact on output relative to benchmark tax set at 1.0

Source: Property Council of Australia submission (2008).

While the payroll tax threshold may make it less efficient, this outcome needs to be balanced with the compliance costs that would be faced by small business if there were no threshold. However, the tax threshold means that a higher rate is needed to raise an equivalent amount of revenue.

Land taxes

Many submissions consider land tax an efficient and under utilised tax base. It is generally accepted that a broad-based land tax is relatively efficient, as landowners cannot reduce the supply of land to avoid the tax. As supply is unable to respond to the tax, its primary impact is to reduce the current after-tax price of land so that the future after-tax earnings on the asset reflect the return on equivalent assets.

However, where there are exemptions in the state land tax base, as currently exist for owner-occupied housing and land used for primary production, there is scope to move some land from a taxable to a non-taxable use. This opens the possibility that the supply of taxable land can decrease, resulting in at least part of the tax being passed to users of land. Thus the exemptions from land tax can create an efficiency cost by distorting the use of the land.

Exemptions for owner-occupied housing mean that home owners do not face a land tax liability, which could potentially represent a significant proportion of their income depending on the value of the land on which their home is located. Removing exemptions may mean it is necessary to ensure there are sufficient mechanisms to ameliorate potential cash flow problems for such people, such as reverse mortgages or personal loans, or tax deferment arrangements. Removing exemptions would also mean that the same amount of revenue could be raised with lower rates of land tax. However, it could be argued that the land tax exemption for owner-occupied housing creates room for local governments to apply rates.

While a few submissions consider the exemptions necessary for equity reasons (with reference to income not asset value), exemptions may be seen as inequitable (due to wealthy and/or high income home owners being exempt from the tax) and this may reduce the community's acceptance of the tax. In this context, Carling (2008) notes the relative acceptance of local government rates, which are primarily land taxes applied on a uniform basis.

Gambling taxes

Unlike most other activities, the States restrict the supply of gambling providers in an attempt to reduce social problems associated with some gambling. These restrictions generate 'rents' to gambling operators, as they are able to earn higher profits without the fear of competitors entering the market. As a tax on rents, gambling taxes have the potential to be efficient and redistribute above normal returns to the community at large.

If gambling taxes do no more than recoup the increased profits accruing to gambling operators from the restrictions on gambling supply, they will have no impact on the overall level of gambling or on the return to the gambler (see Box 9.3).

Effective taxation of rents would imply taxing more restricted segments of the market more heavily than less restricted segments. However, this could be difficult to do in practice. While the States have differing tax rates on different forms of gambling (for example, lotto compared to horse racing) there is no clearly articulated reason for these differences. If the States are not taxing differing rents, or levying taxes to address different social costs associated with different forms of gambling, there may be an argument to tax gambling at a uniform rate. This would ensure that the type of gambling activity reflects the benefit to the gambler of the activity, rather than the rate of tax.

Box 9.3: Gambling taxes — collecting the rents created by regulation

Chart 9.4: Rents created by the regulation of gambling

Chart 9.4: Rents created by the regulation of gambling

In an unregulated gambling market the amount of gambling is determined by supply and demand. State governments may choose to regulate the amount of gambling, for example by placing a cap on the number of poker machine licences. This restriction in the supply of gambling provides an advantage to those operators who remain in the market: they are able to charge a higher price to gamblers (a higher player loss, PD). The restriction in supply means these gambling providers yield additional profits (area A). If the government taxes away this increased profit, it is effectively recouping the benefit that it created through the restriction in supply.

User charging

As noted in Section 3.4, the essence of user charging is that a program is funded not from general tax revenue, but rather by charging those who access the program. As the user charge is generally collected by the entity that provides the service (which will usually have the best information about who is using the service and the cost of providing it) and State governments provide the majority of services to the Australian public, the potential for them to apply user charging appears greater than for the Australian government. One submission highlights that States are able to generate own source revenue from user charging.

Currently, the States charge for a wide range of activities including transport, education and environmental services. Technology is improving the ability of governments to measure and charge individuals for what are essentially publicly provided private goods (for example, roads). While this can produce efficient outcomes, governments may also choose to under-price the provision of the good or service to pursue social policy goals (although often such goals can be achieved through other mechanisms, such as the transfer system).

Other taxes

Many submissions call for a rationalisation of the number of taxes in the federation. The States raise a number of taxes which are levied on narrow bases and raise relatively small amounts of revenue. For example, NSW and the ACT impose a levy on health insurance (known as the ambulance services levy in the ACT), while NSW, Victoria and WA impose a parking space levy. The small amounts of revenue that come from these taxes may mean that the costs of administering them are high relative to the revenue raised. However, each may have favourable efficiency implications which support their continued use.

Consultation question

Q9.2 Given the widely held view in submissions that the current state tax arrangements need to be reformed, what changes should be made to state and local government own source revenue instruments? What scope is there for greater use of user charging to bring social, environmental or economic benefits?

9.3 Redistribution in the federation

In Australia, redistribution of income among households is primarily a function of the Australian government, which is responsible for the policy and administration of a range of payments to individuals and families. State and local governments are also involved in redistribution, mainly through indirect transfers in the form of concessions and exemptions for certain groups in respect of some taxes and services. With multiple levels of government involved in redistribution, there are potential issues with the complexity that individuals face and the compatibility of different redistributive policies.

Summary of key messages from submissions

Some submissions note the interaction between transfers provided by the Australian government and concessions provided by state and local governments for services (such as public transport) and taxes (most notably, local government rates). The link between transfer payments and concessions can create stronger attachment to (means-tested) payments and this can have implications for workforce participation.

Some submissions highlight the equity concerns of existing state and local government taxes and propose that the Australian government take over a number of state and local taxes. Other submissions see an ongoing role for state and local taxes, but the Australian government, given its capacity to achieve equity across the country, should be the only government involved in redistribution. This may also improve the capacity for state and local governments to raise revenue more efficiently from their own taxes.

Submissions proposing an income tax base sharing arrangement note that consideration would need to be given to how this would affect the ability of the Australian government to coordinate redistribution.

Alternative methods of redistribution

Section 4 notes that the redistributive function is applied mainly at the Australian government level. In 2006-07 the Australian government provided around $70 billion in cash transfers to individuals and families. State and local governments do not have a system of general income support but provide transfers to individuals in a number of ways, including:

  • through services directed to assist low income people, such as public housing schemes to provide affordable accommodation;
  • subsidised services, such as electricity, water and public transport; and
  • tax concessions, such as motor vehicle registration and local government rates concessions, and stamp duty concessions to eligible first home buyers.

Tables 2.27 to 2.34 of the Architecture paper show the range of concessions available to people in each of the States and some of the interactions between these concessions and eligibility for certain Australian government programs (such as the Pensioner Concession Card and the Commonwealth Seniors Health Card). The tables illustrate considerable variation in the concessions provided.

Some submissions note that the interaction between eligibility for transfer payments and eligibility for concessions can affect the incentives for workforce participation. As the eligibility for some of these concessions can be withdrawn in a 'sudden-death' nature, this can create a disincentive for people to earn extra income and move off transfer payments, particularly those facing high effective marginal tax rates.

A number of submissions note that the Australian government is in the best position to coordinate redistribution. Wellisch (2000) suggests that in federal systems the redistribution function is best assigned to the national government because competition between sub-national governments can lead to a sub-optimal level of income redistribution. For example, if one jurisdiction had higher rates of payment (financed by higher taxes), it may attract non-workers, and repel workers, from other jurisdictions increasing the tax burden on its citizens relative to those in other jurisdictions. There could therefore be an incentive for sub-national governments to reduce redistribution. As migration responses can be expected to be lower at the national level, these distortions would be lower where the national government is in charge of redistribution.

However, sub-national governments are often in a better position to provide public services. This stems from their comparative advantage in being able to vary levels of service provision based on localised information and the preferences of their constituents. State and local governments in Australia provide a wide range of services and generally set the policy for the provision of those services, although some are provided within agreed frameworks between the Australian government and the States.

The concessions provided by the States can be used for services which are operated by state and local governments or by private enterprises. A number of problems arise with this approach:

  • the administration of concessions can be complex;
  • there can be different equity outcomes in different parts of the country depending on the accessibility and need to use particular services;
  • redistribution and equity outcomes can become dependent on consumption choices;
  • concessions for specific services can dampen the effect of price signals; and
  • concessions might provide a subsidy to particular businesses.

Submissions from local government note that concessions to certain groups weaken the local government tax base (although the cost of these concessions may be met by state governments) and the redistributive function should ideally be addressed by the Australian government. Such an approach could also reduce vertical fiscal imbalance, as the cost of providing concessions for services and taxes would be moved from state and local governments to the Australian government.

If a nationally consistent approach to redistribution is desirable, this could be done in two ways. State and local government concessions could be removed, with the Australian government focusing on the capacity of individuals to use services and pay taxes. This could be done through the Australian government providing vouchers to eligible people to use certain types of services, or through increases to existing Australian government transfer payments. State and local governments would continue to be service providers (competing against private businesses in some sectors). Alternatively, the states could harmonise their concessions to achieve a similar outcome. Again, if considered appropriate, the value of the concessions could be provided in a transfer payment rather than concessions.

An issue requiring further consideration under this approach is the appropriate cost and value of the services and concessions for which certain groups are currently eligible. Another issue is how changes to transfer payments might affect workforce participation decisions.

In another respect, applying the principle that redistribution is a national government responsibility may reduce the extent to which the states can use certain tax bases. For example, submissions that raise the possibility of introducing an income tax base sharing arrangement between the Australian government and the states note that an important consideration is the ability for the Australian government to coordinate redistribution (given the interaction between personal income tax and the transfer system).

Consultation question

Q9.3 What is the appropriate allocation of the roles of the Australian and state governments in income redistribution?

9.4 Streamlining tax-transfer administration in the federation

Section 2.1 highlights the complexity of the federation's tax-transfer system and the duplication of administration arrangements. At present, an individual may have to deal with several different agencies at an Australian government, state and local levels to understand the taxes that they have to pay and the transfers that they may be entitled to receive. Duplication in administrative structures may lead to unnecessary costs. There may be scope to streamline the administration of the tax-transfer system to reduce the complexity that individuals face and reduce operating costs.

Summary of key messages from submissions

Submissions consider that greater efficiency and simplicity of the tax system could be achieved by having a central agency (such as the ATO) administer either individual state taxes (such as payroll tax) or the States' entire tax system. The administration and legislation of these taxes should be harmonised.

Alternative approaches for administrative reform

Streamlining the administration of the tax-transfer system in the federation may yield two broad types of benefit. First it may reduce the cost of administration. Second, members of the community may face less 'red tape' in accessing their benefits and more certainty with regard to the taxes they need to pay and the transfers they are entitled to receive.

Streamlined administration could be a by-product of tax-base sharing arrangements described in Section 9.1. Beyond this, consideration could also be given to three broad kinds of administrative reform.

First, improved sharing of information provided by individuals to tax authorities could reduce the number of interactions people need to have with different levels of the system. This could be implemented along similar lines to the Standard Business Reporting model where the goal is for businesses to provide reports, used by tax and regulatory authorities across jurisdictions, using standardised definitions and a single secure channel, with business software automatically pre-filling forms to satisfy their reporting obligations and regulatory compliance. State revenue offices are already participating in the Standard Business Reporting project as one way of reducing red tape.

Second, some or all of the actual collection of state taxes (and payment of state transfers) could be undertaken by centralised agencies. An individual would still be paying (receiving) local, state and Australian government taxes (transfers), but would only have relationships with the centralised agencies (for example, the ATO and Centrelink). A further extension of this approach, discussed in Section 8.2, would be to have only one agency at the Australian government level with which individuals would interact regarding both taxes and transfers.

A third approach would be to retain the existing administrative architecture across jurisdictions (including state revenue offices) but overlay it with an intermediary function that would provide a 'one-stop' interface for individuals. That is, administering the taxes and transfers would remain with several institutions but citizens would only interact with the one body.

While reducing the number of agencies involved in the administration of the tax-transfer system may reduce the complexity and costs for individuals interacting with the system, there may be a loss of transparency for citizens and a risk that the information sharing arrangements may be inadequate. The extent to which the administration of the tax-transfer system can be integrated and centralised will also depend on the degree to which jurisdictions are prepared to give up distinguishing features of their systems in order to harmonise relevant taxes and transfers.

Consultation question

Q9.4 What opportunities could be pursued to deliver more seamless administrative arrangements of the tax-transfer system across the federation?

9.5 Other issues

Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations

Some submissions express concern that taxes listed for abolition in the Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations (the IGA) have not been abolished. Under the IGA, wholesale sales tax and accommodation taxes were abolished on 1 July 2000, financial institutions duty and stamp duty on quoted marketable securities were abolished on 1 July 2001, and bank account debits tax was abolished in all states by 1 July 2005.

The IGA also provided that the Ministerial Council for Commonwealth-State Financial Relations would, by 2005, review the need to retain stamp duty on: non-residential conveyances; non-quotable marketable securities; leases; mortgages, bonds, debentures and other loan securities; credit arrangements, instalment purchase arrangements and rental arrangements; and cheques, bills of exchange and promissory notes. With the exception of the real property component of non-residential conveyance duty (that is, conveyance duty on real business property), the Australian government agreed timetables for the abolition of these taxes with each of the States.

Some submissions suggest that the abolition of other taxes (that is, those not listed in the IGA) should be funded by the GST. However, there was no specific commitment in the IGA to abolish taxes other than those noted above. It was the intent of the IGA to improve the financial position of the States over time, rather than have the additional revenue provided by the GST being fully offset by reductions in other taxes.

Horizontal fiscal equalisation

Several submissions express a concern that the current horizontal fiscal equalisation (HFE) process affects the incentives for states to undertake economic reforms. As agreed by all the States in the IGA, GST payments are distributed among the States in accordance with the principle of HFE and having regard to the recommendations of the Commonwealth Grants Commission. The panel considers that HFE is beyond the scope of its terms of reference.