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The tax reform ball is stuck in the states’ court

It is a very particular moment in the life of a nation. Scott Morrison started well by seizing it as a great reform opportunity. In his list of a dozen reform priorities, the Prime Minister named tax reform and federation reform. These are tasks that no government has pursued successfully in the past 20 years.

Indeed, Australia is about to mark the 20th anniversary of its last major tax overhaul, the last one to actually survive. It was the July 1, 2000, introduction of the tax reform package best remembered by its most controversial feature – the GST.

Yet this week an alarm went off about Morrison’s seriousness. Only two weeks after his speech to the press club, his Finance Minister, Mathias Cormann, seemed to be arguing against major change.

When asked why Treasurer Josh Frydenberg hadn’t raised the question of the GST in talks with his state counterparts, Cormann told by Kieran Gilbert on Sky News: “We are focused on lower taxes. We are focused on lowering the tax burden in the economy, not increasing it.”

Illustration: Jim Pavlidis

Illustration: Jim PavlidisCredit:

In just 20 words, Cormann had set up a straw man, a distracting fake argument. Nobody was proposing raising Australia’s total tax take. Worse, he’d made the sort of remark that an opposition leader would make, arguing against a reform process that hadn’t even started.

Frydenberg followed up by parroting that he had no plan to change the GST, a line written in another era. It sounded very much like political timidity had come rushing back.

That seems to be the way that the NSW Treasurer, Dominic Perrottet, read it. He wrote an opinion piece in this newspaper on Friday under the headline: “We can’t govern by focus group”. In critiquing focus-group politics, Perrottet quoted the American carmaking pioneer Henry Ford: “If I had asked people what they wanted, they would have said faster horses.”


Is the national moment of possibility about to die amid a resurgence of the pointless politics of the past decade? Perrottet hopes not. And we’ll find out very soon when a provocative new report that he commissioned hits the table.

If there is to be any meaningful reform of tax and federation, it seems that it will be driven by the states. NSW and Victoria in particular. This has the advantage of combining the economically dominant states, as well as pairing one Liberal government and one Labor.

Perrottet last year appointed a review panel to look into federal financial relations. It’s chaired by businessman David Thodey. Its recommendations are due to be published in the next two or three weeks. Its aim? To make the overall national tax system more efficient, or, as Perrottet puts it, “to streamline our economy so tax causes as little drag as possible when we hit the accelerator on recovery, but also to realise the long-term benefits of a fairer more efficient tax system”.

In particular, Perrottet is keen to abolish two state taxes that are universally deplored as economic vandalism – payroll tax and stamp duty. Payroll tax penalises businesses for hiring staff. It penalises them every time they pay their people. And stamp duty penalises people and businesses who buy real estate, discouraging movement and inhibiting workers from moving to take jobs.

Perrottet would prefer to replace this with land tax; he has suggested giving homebuyers the option of choosing a big, one-off stamp duty lump sum, or a smaller annual land tax. The expectation would be that, in effect, stamp duty would be phased out and land tax in.

Why wouldn’t the Morrison government support dumping these two harmful taxes? It does. Frydenberg has urged the states to get rid of them, but says they have to “use their own balance sheets”. In other words, do it yourselves – Canberra isn’t going to help.


Which seems entirely reasonable. Except that NSW collects only 60 per cent of the revenue it needs to deliver services – health, schools, transport, and so on – and relies on Canberra to give it the other 40 per cent. The other states are even more reliant on federal funds.

The Howard-Costello precedent was to give the states all the money that Canberra collected from the GST, and in return they’d get rid of inefficient taxes of their own. The NSW Treasurer wants to repeat the trick: “Of course, this requires a serious conversation about adjusting the GST in order to remove other taxes.”

But, as Perrottet acknowledges, this is “something the federal government isn’t game to broach, even now, when the case for change is strongest. Perhaps that’s because, for the pollsters, this kind of policy thinking sets off focus-group alarm bells.”

He’s right. Besides, the federal government doesn’t like the idea of taking political criticism for increasing the GST when the proceeds would all go to the states. So the Thodey report will canvass a wider range of ideas. One is sharing the Commonwealth’s incomes tax with the states. This would be a big change – Canberra has a monopoly on income taxes. But not a radical change.

Why not? Because historically the states levied income taxes. The Commonwealth for a time levied its own parallel income taxes, then wrested all income tax power from the states as an emergency measure in World War II.

Constitutionally and legally, the states can tax income if they choose. That’s what happens in the US – the federal government taxes your income, and your state of residence taxes it separately. Of course, it’s inefficient and messy. That’s why it’s more sensible to share income taxes between the two levels, state and federal.

Which is what Germany does. “That’s what most federated countries do,” says Anne Twomey, a professor of constitutional law at Sydney University. “We are unusual by not doing some kind of income tax sharing.”

And it has been suggested in Australia before, a number of times. The Fraser government legislated for it, but the system was never actually implemented.

“What you need to do in a rational system is to match revenue with need rather than use it for your political benefit,” says Twomey in arguing the case for a greater share of revenue for the states.

Twomey has not only written a paper on the history of federal finances for the Centre for Independent Studies, she’s also a member of the Thodey review.

“All governments, federal and state, are facing dire circumstances,” she says, “so you would think the most rational thing you can do is to get the most value out of the tax system – wring the best value out of your existing level of taxation. If you have an inefficient tax system that wastes money, you are an idiot.”


But then, as Twomey acknowledges, “politics will drive it”, a recognition that idiocy stands an excellent chance of winning.

Josh Frydenberg tells colleagues that he is fully prepared for the discussion with the states. He puts three caveats on this. First, he won’t “front-run” the process by putting proposals publicly. Second, he doesn’t want to raise expectations. Third, the federal government insists on living within its means.

So the onus of action is on the states, with Canberra as respondent, in the reform debate to come. Or in a tennis metaphor better suited to Frydenberg’s tastes, the states will serve and the Commonwealth return.

Perrottet is not deterred. His view of politics, as he put it to me a few weeks ago: “Why are we here? Is the point just to win elections? Why go into politics if you just go through day to day doing Sky News and press conferences?”

It may not be coming from Canberra, but it does sound like leadership.

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