Thursday, March 31, 2016

Why the states should charge income tax

Suddenly the election is about something else: how our states have had it too good for too long. And about how we've had it even better.

In every previous election we've been able to vote for better hospitals, schools and roads at the state level (which of course we want) and for lower taxes or lower budget deficits at the Commonwealth level (which of course we also want).

We've been able to kid ourselves we can achieve both.

It's been excruciating for our prime ministers and treasurers, and for anyone who cares about things being done properly. Elected in 2013 to cut the deficit without putting up tax, Tony Abbott and Joe Hockey slashed future grants to the states for hospitals and schools by $80 billion over10 years. They said after 2017 they would lift grants for hospitals by only inflation and population growth. The actual cost of running hospitals is climbing much faster.

It's the sort of thing we asked them to do, to find savings to eliminate the deficit. But then the state governments squealed and said they were unable to do the sort of things we asked them to, and pressured Malcolm Turnbull to relent.

He will relent. He'll offer to lift grants more or less in accordance with the actual cost of running hospitals for another three years. But only if the states agree to negotiate in good faith about what happens next. Beyond 2020 he'll revert to the miserly formula of inflation plus population growth. If the states feel they need more (and over time they will) they'll have the option of imposing their own income tax surcharge. Turnbull will cut Commonwealth income tax by a few percentage points to make room, and then allow each state to replace some or all of those points.

Initially the states >would be limited to merely replacing what the Commonwealth took away, but after that they could charge more. In Turnbull's words, they would be "accountable to their own voters".

It would cut both ways. Any state that wanted to offer a Rolls-Royce hospital service would be able to do so, as long as it charged for it through tax. Any state that wanted to keep its taxes low would be able to do that, so long as it offered fewer grand services.

Voters would be able to choose, or in extreme cases move. Queensland (to use a hypothetical example) might want to position itself as the low tax state. Anyone who moved there, attracted by the low tax, would know they were also taking chances with their health. Anyone who moved to South Australia to take advantage of good health services would know they had to pay for the privilege.

Every election, for decades now, the Australian National University has surveyed voters about what matters to them most. Until recently their number one concern was tax. In 1998 about 23 per cent labelled it "extremely important". Only 10 per cent thought health and Medicare were extremely important.

But at the turn of the century things began to shift. In 2001 tax and health were on level pegging at 16.3 per cent and 16.1 per cent respectively. By 2013 the positions had reversed. Now 19 per cent think health and Medicare are extremely important and only 11 per cent are as concerned about tax. It's the sort of change you would expect as the population gets older and richer.

Critics of these surveys say they don't mean much. People aren't asked to put their money where their mouths are. But under the scheme being hatched by Turnbull they will. For the first time Australians would be forced to choose between more health spending and lower tax when they vote. I'm betting the surveys are right and people will opt for better hospitals. But that's not what excites me. It's that voters will have to make a choice, to acknowledge that good hospitals cost money and wear the consequences of their decisions.

To tell the truth, I'd love it if each state decided on a different mix. Then each could look at the other and see what worked best. NSW was the first to make Australian history compulsory in high school. Victoria was the first to make seat belts compulsory. Tasmania was the first to introduce daylight saving. Each picked what worked. Experimentation is what federations are meant to be about. It's no accident that federations such as Canada, the United States and Germany usually work better than unitary states such as Italy, Greece and France.

By presenting states with hard choices Turnbull will not only make the experimentation more real, he'll also make the states run things better. There isn't a terribly strong incentive to run hospitals and schools well when you're not coming up with all the money yourself. There's a much stronger incentive if you're paying for the lot.

States funding what they provide is hardly new. Each state raised its own income tax before the Commonwealth entered the field in 1915 and then generously offered to also collect income tax as an agent for the states during the depression. In the Second World >War, without consultation, it kept the lot for itself as a "temporary" measure and never gave it back.

It isn't surprising that in modern times the states haven't asked for its return. Politically they've had the best of both worlds and we've been able to vote as if we are in La La Land. Turnbull wants us to face reality.

In The Age and Sydney Morning Herald