Fatal flaw in GST design dooms us to state-federal funding stalemate

OPINION: The states are facing some big bills. They should pay their share each year of the $6.5 billion to implement the Gonski report and the extra $8 billion required for the National Disability Insurance Scheme. However, it is hard to see them funding these initiatives when they cannot even afford to maintain existing services.

The answer lies in the states generating more revenue from the GST. Unfortunately, even though it is regarded as a ''state tax'', it lies beyond state control. Fixing this requires reform of a structural problem within the federal system.

When Australia became a federation in 1901, the states were the dominant financial partners. They levied income tax. The big shift came when the Commonwealth wrested the tax away from the states during World War II.

The states' financial problems were compounded by High Court decisions. In particular, the constitution was applied to prevent any state from levying a tax on goods. One decision in 1997 ended state taxes on alcohol and tobacco, stripping them of $5 billion in annual revenue.

Their tax base destroyed, the states have been forced to accept whatever grants the Commonwealth will give them, on whatever terms. This unhealthy dependency fulfilled the prediction of Alfred Deakin, Australia's second prime minister. He said soon after federation that the states would find themselves ''legally free, but financially bound to the chariot wheels of the central government''.

Today, the state revenue base is largely limited to a series of regressive and inefficient taxes, including stamp duty and taxes on land, real estate transfers and gambling. This leaves little scope to raise extra revenue or to cover for downturns. In desperation, states have sought to raise extra money by stimulating the housing market or licensing more poker machines.

The only other significant source of extra revenue is the Commonwealth. The federal government's fiscal dominance means that it collects much more tax than it needs. All up, it collects 73 per cent of all government revenue, but only accounts for 56 per cent of total government spending. The states on the other hand collect 27 per cent of the revenue, but are responsible for 44 per cent of government spending.

This imbalance has a profound, long-term impact. It distorts policy priorities by favouring federal over state objectives, irrespective of their merits. The result is a continuing decline in areas of state responsibility such as public education and hospitals.

A ray of light in this gloomy picture was the Howard government's decision in 2000 to channel all GST revenue directly to the states. This provided a major source of funding to the states without federal strings attached. In NSW, such grants now support a quarter of the state budget.

However, the good times provided by the GST are over. GST revenue has sunk along with retail spending, losing NSW alone $5.2 billion over four years. This is being felt nationwide in the loss of tens of thousands of state public service jobs and cuts in important services.

The states might have responded by raising more revenue through altering the rate or extending the coverage of the GST. The GST is often described as a state tax, and was introduced with the political proviso that it would only be changed with state consent. However, the GST is actually a federal law that only permits changes by the Commonwealth.

Not surprisingly, increasing the GST has been ruled out by both sides of federal politics, and was even excluded from the Henry tax review. The problem is that no federal politician will take the political fallout since the states and not the Commonwealth would receive the financial benefit.

Something has to give if we are to arrest the decline in community services and have the states contribute their share to the Gonski reforms and NDIS. The answer is to empower the states to broaden the GST or increase its rate, subject only to the possibility of a veto by new federal legislation. This would leave political responsibility for the tax where it belongs, with the tier of government that ultimately receives the revenue.

Supporting reforms in education and for people with disabilities should not come at the expense of other essential state services. A better alternative is to enable the states to pay for these by extending the GST to food, education and health or by slightly increasing the rate.

George Williams is a Professor of Law at UNSW

This opinion piece first appeared in The Sydney Morning Herald