The answer to tax reform is simple. Let the States levy a piggy-back income tax.
The High Court's striking down of State franchise fees will push the federal system into crisis. But the truth is the system has been in decline for some time.
It seriously degenerated under the Keating Government. It has grown worse under John Howard. Indeed, the Howard Government has proved to be more centralist and less interested in working with the States than its predecessor.
The Council of Australian Governments (COAG), which is essential to the carriage of most public sector reform, is all but defunct. Most reforms are either stalled or operating on autopilot.
The decision earlier this week to cap the amount of tax depreciation on privatised assets was another major blow -- an act of venality on the part of the Howard Government in seeking to grab for itself revenue that would otherwise go to the States, simply to artificially improve its bottom line.
This decision, for example, is likely to cut at least $5 billion off the sale proceeds of electricity assets in NSW and transfer it to the Commonwealth. It will reduce the value and, therefore, the incentive for States to privatise.
The High Court decision simply pushes the system over the edge. It removes one of the States' largest and most buoyant set of taxes. Franchise fees on tobacco, liquor and petrol have been the States' best earners, having more than doubled over the past five years. At present, they deliver nearly $5 billion to State coffers -- about 20 per cent of State own-source revenue.
The States have no option but to accept the Commonwealth's money. Their remaining tax bases provide no capacity to replace franchise fees. The States could introduce a service tax along the lines of the NSW bed tax, but this would raise relatively little money, cost heaps to collect and make the indirect tax system even more of a patchwork quilt.
The effective transfer of these taxing powers to the Commonwealth will turn the States into vassals of the Commonwealth. The imbalance in taxing powers was already excessive before this decision -- far greater than in any comparable federal nation.
This decision will result in States becoming dependent on the Commonwealth for more than 50 per cent of their revenue, which is a greater level of centralisation than exists in France -- the archetypical centralised nation.
If the situation remains, it will seriously undermine the quality of government in the States. The State Governments would effectively lose control and responsibility for their own fiscal positions.
They could not predict their revenue streams beyond the next Premiers' meeting. They could not really be held accountable for Budget outcomes. Their spending decisions would become hostage to Commonwealth policies.
Crucially, the greater imbalance may induce the States to slow micro-economic reform or more probably turn their trading enterprises back into cash cows.
In the longer term, State leaders do have options. They can put huge pressure on the Commonwealth Government to provide leadership and undertake tax reform -- something the Howard Government apparently wants to do.
The Premiers can also veto any tax reform that does not include the devolution of tax powers to the States. The 1993 election showed that tax reform, specifically a GST, can easily be blocked by an astute political leader.
The need to restore the balance in the federal system also undermines Federal Labor's current refusal to countenance tax reform. Rationally, most State Labor leaders will now favour restoring the balance. The only way this can be done is via reform of the tax system.
The solution is straightforward. Indeed, it was almost implemented six years ago. This is to allow the States to levy a piggy-back income tax along the lines that exist in Canada and the United States.
Under such a system, the Commonwealth makes room for the States by cutting its own personal income tax rates and the States fill the gap by putting in their own top-up rates. There would be one set of tax collections administered by the Commonwealth and there would be no need to increase the total amount of tax raised.
This system has the important added benefit of allowing competition among the States over the tax rate (but not the base). While he is at it, Mr Howard might as well slip in a GST to replace the wholesale sales tax and the messy interim arrangements.
If he provides the required leadership, John Howard can prove that he is no Malcolm Fraser and will deliver lasting reform to our federal system.
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