John Brumby: an Australian federation for the future

More than 100 years after Federation, the government's White Paper on Reform of the Federation presents a historic opportunity to reconsider federal-state relations and responsibilities. How can state and federal governments work effectively to deal with the increasing demographic, social and global economic challenges facing Australia?

As a former Premier of Victoria and current chair of the COAG Reform Council, John Brumby offered his insights into the future of Australian federalism when he delivered the 2014 Hamer Oration at the University of Melbourne on Monday night. Below is an abridged version of that address.

This evening I would like to talk about the nation – or rather, the particular political structure and system of government that has guided us as a nation since 1901. I'm talking about federalism, and the Australian federation.

The Australian federation

The issue of federalism is particularly topical at the moment. I expect that the government will very shortly release its terms of reference for the White Paper on Reform of the Federation.

Discussion of our federation also featured heavily in the recent Commission of Audit report, which stated that:

…the current operation of the federation poses a fundamental challenge to the delivery of good, responsible government in Australia.

As might be expected, this sparked a flurry of commentary in the media on how the Australian federation is broken and dysfunctional. Commentators referred to it as "wasteful", "multifaceted" and an "ineffective shambles".

As someone who has spent more than 25 years in public life – in the federal parliament, state parliament, as opposition leader, treasurer, premier, and more recently Chair of the COAG Reform Council – I don't accept this analysis at all. What my experience has shown me, despite the colour, movement, and occasional shrillness of media and political commentary is that Australia's federation has actually served us rather well.

Despite our small population, we are now the world's 12th largest economy, with our median wealth amongst the highest in the world. And unlike many countries, we enjoy a stable democracy and a vibrant multicultural society.

When much of the rest of the world struggled through the global financial crisis, Australia maintained an economy with low inflation, low interest rates, low unemployment and solid growth.

And our achievements are not just economic. In the latest report from the OECD Better Life Initiative, Australia is rated as above average in ten of the 11 life dimensions examined.

Australia is rated as at the top when it comes to governance and civic engagement, and close to the top when it comes to environmental quality and health status. We rate in the top 20% when it comes to housing, personal security, jobs and earnings.

These fantastic results didn't all just happen by chance or accident. Among other things, it is a result of our system of government – a federation – that is uniquely well-suited to responding quickly and creatively to global events and trends, while also meeting the diverse and changing needs of our local communities.

I don't say for a moment that our federation is perfect – but I do say that it has served us well, and serves us well today.

Benefits of our federation

Certainly, much has changed since six independent colonies became one nation in 1901. In an 1897 pamphlet advocating the federalist cause, South Australian politician Richard Baker listed one of the probable benefits of federalism as creating:

…greater economy and efficiency in the management of the postal and telegraph departments, no doubt ultimately resulting in a penny postage and a six penny telegram.

And now today, more than 14 million Australians have internet access in their own homes. There are more than 31 million personal mobile services in use in a population of 22 million.

The point is, the world is more connected than ever before. We are subject to more competition than ever before. And change occurs more quickly than ever before.

Many of you may ask if a system of government drawn up at the end of the 19th century and activated at the dawn of the twentieth century can still have currency in the 21st century? Absolutely it does. Federalism works.

In 2007, the states commissioned professors Anne Twomey and Glenn Withers to prepare a report for the Council for the Australian Federation on what federalism has to offer Australia today. In their report they identified six major benefits:

1) Federalism provides a check on power – it divides power and limits the amount of it that any one government can enjoy.

2) It offers choice and diversity – people can vote for one party at a federal level, and another at a state level.

3) Federalism offers customisation of policies – the various Australian states and territories differ in climate, geography, demography, culture, resources and industries. A policy that works well in Tasmania may not work as well in Alice Springs.

4) It allows for creativity and innovation. As US Supreme Court Justice Louis Brandell famously put it, a:

…state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country.

States are forced to innovate to meet their distinctive challenges, and to compete with other states. Successful innovations can then be picked up by other states or the Commonwealth, while the damage caused by failed policies is limited.

There are numerous examples of this innovation strength in our federation. Many new approaches to social and environmental policy were trialled by Dick Hamer's government and are now the law of the land nationally. Public sector reform was introduced by the Cain government and adopted Australia-wide.

Case-mix funding for public hospitals was introduced by the Kennett government and is now applied Australia-wide. South Australia pioneered anti-discrimination legislation. Western Australia set up the first health care call centres. These innovations are much harder to strike with a centrally managed unitary form of government.

5) Federalism has the potential for healthy competition between the states. In the economy, healthy competition means that the consumer benefits from lower cost, more effective and more innovative products.

It's the same in a federation where constituents can, if they wish, vote with their feet and move to a jurisdiction with better infrastructure, schools and regulatory environments.

6) The final benefit of federalism is co-operation. Our federal model means that many of the most important national reforms require the agreement of one or more of the states and territories – often all of them.

The mechanism for this in Australia is the Council of Australian Governments process. Admittedly, what happens around the COAG table is not always pretty, but many of the decisions taken there have transformed Australia. And the truth is that most of the big decisions that have transformed Australia couldn't have happened without Commonwealth-state co-operation and agreement.

For example, the gun buy-back scheme introduced after the Port Arthur massacre; the National Competition Policy which has contributed to 23 years of economic growth; the GST which was both a major taxation and economic reform; the 2008 National Reform Agenda; the agreement to introduce a National Disability Scheme.

All of these transformative policies couldn't have happened without Commonwealth-state co-operation and agreement.

And so these six benefits of federation combine to form a type of governance system that is flexible and responsive to both the needs of its individual citizens, and the needs of the nation as a whole. That's why it works.

Competitive federalism

But this is not to say that there isn't room for improvement in our Federation. Some argue for more co-operation and collaboration; others for a much more competitive model. The recent Commission of Audit report advocated for a focus on "competitive federalism".

As I have outlined, a level of healthy competition between states is certainly one of the many benefits of our federation. However, when it comes to competitive federalism we should be careful that we don't end up with destructive competition between states, displayed as chest-beating and parochialism, combined with a disdain for collaboration in the national interest.

We should also be careful that we do not get into a situation where we are "competing" with each other in a "race to the bottom" of lower taxes, but also lower services.

And we should be careful that we don't end up with a fragmented patchwork of different rules and regulations that stifle domestic and international trade, where it might once again be easier, for example, to sell gas across the borders of Europe than across the state borders of Australia.

Treasury secretary Ken Henry, speaking at the Productivity Commission's 2005 Productive Reform in a Federal System roundtable, questioned whether the excess of inconsistent state-based regulatory requirements in areas such as occupational licensing, occupational health and safety, road transport and water trading – could be attributed to federalism.

One of the examples Henry provided was an operator of an interstate train having to:

…deal with six access regulators, seven rail safety regulators with nine different pieces of legislation, three transport accident investigators, 15 pieces of legislation covering occupational health and safety of rail operations, and 75 pieces of legislation with powers over environmental management.

Henry also noted that Australia had seven rail safety regulators for a population of around 20 million people whereas the United States, with a population of 285 million, has only one. This example demonstrates the inefficiencies and duplication that can arise between governments without appropriate central coordination.

Thankfully, a great many of those problems were fixed as part of the COAG Seamless National Economy reforms introduced in 2008. However, others have remained and there is danger that the gains that were made will be undone with the passing of time.

The truth is we need a sophisticated combination of both co-operation and competition. This is because we need to remember that we are not just competing between states – we're also competing with the world. And our region has some of the best competitors around.

In China, we are neighbours to a country that has taken over even the US in terms of manufactured output, energy use and car sales. According to the IMF, China will overtake America as the world's largest economy, at purchasing-power parity, in 2017.

According to the OECD's latest assessments, four of the five highest performing school systems in the world are Hong Kong, Korea, Shanghai and Singapore. The Grattan Institute recently pointed to the fact that the average 15-year old in Shanghai is two to three years ahead of his or her counterpart in Australia.

But in contrast to these impressive gains, Australian educational performance has been more mixed in the past ten years. It is vital that we think, discuss and debate how best to harness the key strengths of our federation in order to compete in a world, and a region, that is in profound and lasting transition.

And it is also vital that we think, discuss, and debate how best to improve our current federation. I'm thinking more specifically about how to solve the vexed issue in our federation of "roles and responsibilities".

Roles and responsibilities

As a fellow ex-Premier, Nick Greiner, said in an op-ed earlier this month:

The question of who does what to whom and why in Australian governments is not theoretical or artificial: it is fundamental to the quality of life of Australian citizens.

I couldn't agree more. Our federal system was based on the idea that the greater body of power would remain with the state governments. Indeed, it was intended by most of the framers that, in the new nation, the states would be the dominant partner.

This is reflected in how power is divided by the Constitution. There were certain defined powers for the federal government that made logical sense for a national government to provide and all other powers outside of the list remained with the states.

The topics granted to the Commonwealth by the Constitution range from areas like marriage to defence and the regulation of corporations. The states retained control over major areas like health and education.

And yet, in 2014, we have vast federal departments of health and education. The reasons for this are complex, but mainly relate to the bane of many federations – Vertical Fiscal Imbalance.

Vertical Fiscal Imbalance refers to the mismatch between what the various levels of government in Australia are required to do, and the amount of revenue they are able to raise in order to do it.

The Commonwealth took over the states' main source of revenue – income tax – around the time of World War Two. However, the states retained responsibility for two of the largest costs in our country – health and education – and nowhere near the ability to pay for it from their own revenue base.

To offset this, the Commonwealth government pays the states grants to cover their responsibilities. For every dollar the Victorian government spends on police, public transport, education or health, around 50 cents comes directly from the federal government.

But this can leave the public unsure of who is really accountable for their services. It can encourage blame shifting and buck passing between the state and federal governments. The federal government also has a natural tendency to micromanage exactly how the money it gives the states is spent, and this kills the ability of state governments to innovate in their delivery of services, or make services more appropriate for specific local needs.

Finally, the federal government is often tempted to just take over areas of state responsibility – for whatever reason they wish – so that they can effect a particular policy outcome. They are able to do this due to broad readings by the High Court of Commonwealth power under the Constitution, as well as the Commonwealth's ability to raise so much revenue.

Thus we have the often heavy-handed influence by the Commonwealth over great swathes of policy areas that they were never intended to have. What all this means is that our federation has become increasingly out of balance. To remedy its faults, and get it back into balance, we need to better align roles, responsibilities and revenues.

Dealing with 'roles and responsibilities' – the GST

Clearly the roles and responsibilities in our federation have changed from what was intended by the framers of our Constitution. But does that mean that we should go back to how everything was back in 1901?

I don't necessarily think so. I think that we should assess the nature of the issue and then determine the level of government best suited to dealing with it in 2014, and the future.

We need to work to clarify the roles and responsibilities of the states and federal government. When deciding who should do what, the principle of subsidiarity should be central.

That is, specific roles and responsibilities should go to the level of government closest to the people affected, who is capable of effectively delivering them. It makes sense for the states to have responsibility for things like health and education, just like it makes sense for the Commonwealth to be in charge of Defence and Foreign Affairs.

We then need to compare these agreed responsibilities with the current revenue-raising capacity of each state and the states generally. If they don't have the revenue raising capacity, then we need to examine ways to fund their service responsibilities. In essence, this can be done in one of four ways:

1. give the states a share of income tax;

2. increase the GST and give the proceeds to the states;

3. increase transfers from the Commonwealth to the states, or

4. leave the states to increase their own taxes.

The recent Commission of Audit report advocated providing states with an ability to raise their own income tax. This would allow the federal government to lower the amount that they collect by the same proportion.

A number of current state premiers were very interested in this idea, and it has a certain elegance. However, prime minister Tony Abbott said at the post-COAG meeting press conference on Friday, May 2, that he was against the idea of "double taxation".

Of course, what he didn't mention at the time was that the Commonwealth was about to withdraw A$80 billion in Commonwealth funding to the states for education and health over the next decade. Abbott said that as the states have responsibility for education and health under the Constitution, then they should be as far as possible "sovereign in their own sphere."

I agree with his view about the role of the states. But it follows that if the states have these responsibilities, they also require the revenue to properly discharge them.

As I mentioned earlier, at the beginning of World War Two, the states were reasonably financially self-sufficient due to their sharing with the Commonwealth of the income tax base.

However, since then, there has been an increasing "monopolisation" of the most lucrative taxes by the Commonwealth, particularly with the Commonwealth's take over of income taxation in 1942 and the High Court's rulings on taxation of goods and services.

At the same time as the states' own sources of revenue have decreased, the costs of their liabilities – the essential services required for their populations – have increased. And they will continue to do so. A key driver of increasing costs is our rapidly ageing population.

As opposition leader Bill Shorten pointed out in his budget response last week, when he was at school there were 7.5 taxpayers to support each Australian aged 65 or over, but "by 2050, it will be only 2.7 to one".

Population growth and ageing will affect labour supply, economic output, infrastructure requirements and governments' budgets. Collectively, it is projected that Australian governments will face additional pressures on their budgets equivalent to around 6% of national GDP by 2060, principally reflecting the growth of expenditure on health, aged care and the age pension.

And the current GST is certainly not going to fill the hole in state finances.

Many commentators seem to have forgotten that in the Intergovernmental Agreement (IGA) agreed in 1999, the states were required to abolish up to ten existing state taxes in order to get access to GST revenues.

This was the right move at the time. Many of these taxes were inefficient, and impacted specific areas of the economy such as stamp duty on mortgages, duty on quoted marketable securities, duty on leases and Financial Institution Duty. Getting rid of those taxes was a good idea and the result was a better tax system and a more efficient economy.

However, revenues have fallen well short of the "rivers of golds" that were promised. GST collections are barely above the minimum level that the Commonwealth agreed to underwrite back in the 1999 IGA.

In fact, from a purely selfish point of view, some of the states would probably be in a better fiscal position today if they just retained the state taxes they gave up as part of GST. Much of the reason for this is that there are large and growing structural weaknesses in the GST revenue base. Fresh food, health and education expenses are exempt, and banking services are comparatively lightly taxed.

GST revenue has been growing more slowly than the economy as a whole, because the untaxed components make up a larger share of consumption. The truth of the matter is that even before the budget announcement of the withdrawal of $80 billion of Commonwealth funding, the issue of how to fund education and health care – and how to get the federation back into better balance – was a conversation we were going to have to have anyway.

And it's not just about Commonwealth-state responsibilities and who does what. The reality is that post-GFC, Australian governments – state and federal – have a major revenue problem. Our existing taxes and charges are simply not adequate to provide the responsible and reasonable services in health and education the community expects us to provide.

As a young backbencher who in 1985 publicly supported Paul Keating's option C – that famously included a consumption tax – I've been around long enough to know how difficult it is to get a consensus on tax issues. But when we look at the possible other outcomes of either crushing deficits, or failing to care for our most vulnerable people, GST reform looks more and more like the best option we've got.

In my view, the real debate about the GST is not about whether it needs to increase. I think that's inevitable. The real debate is about the nature of the increase (base versus rate, or both), the compensation provided to low-income earners and pensioners, and the distribution of the proceeds (the states versus the rest).

And by the way, we should immediately move to reduce the erosion of GST collections from overseas internet purchases. Not only does the current situation place Australian suppliers at a competitive disadvantage, it is costing the states hundreds of millions of dollars in lost revenue.

COAG was the vehicle of reform for the original GST conversation in the late 1990s, and it should be again. The original GST could have been introduced with or without the co-operation of the states. And without the involvement of COAG and the agreement of the states, the GST would still have been a useful tax reform – but of no major note.

By involving the states and linking the proceeds of the GST to the abolition of inefficient state taxes, the introduction of the GST was both a major taxation and economic reform for all Australians.

This time around, the circumstances are quite different. We have a federation that over time has become increasingly out of balance, exacerbated by the recent federal budget which shifts $80 billion of spending to the states and which makes their medium and long term budget position completely untenable and unsustainable.

Conclusions

In these circumstances, I believe we have a unique opportunity to rebalance the federation and provide an enduring and better match between roles, responsibilities and revenue.

Throughout this process, it's vital that the public and opinion leaders are able to participate in this debate. I therefore strongly support a Federation Convention to be held later this year or early 2015. I also believe it's vital to properly monitor the performance of the federation and the progress of reforms.

Shifting federal-state relations to reflect greater subsidiarity and reduce duplication is a significant reform ambition. As with any major reform, it requires a plan with identified steps and activities with associated milestones, targets and timelines. It also requires a way to hold governments to account for the outcomes sought by the federation.

I therefore support the early establishment of a Federation Reform Council to independently monitor the timetable, milestones, and progress of any new arrangements.

As I said earlier, Australia is doing very well in comparison to the rest of the world – and this is due partly to our structure of government – to our federation.

But we should realise that there are many important junctures coming up for our nation that we must deal with. It will be up to the media, interest groups, business and our political leaders to ensure this opportunity to improve our federation is not wasted – because we cannot run away from the discussion.

I'd like to leave you tonight with an anecdote from David Hamer's book, Can Responsible Government Survive in Australia? In it, he describes the ancient Goth's approach to deciding matters of importance, in the context of our own Senate:

The ancient Goths of Germany had all of them a wise custom of debating everything of importance to their state, twice; this is, once drunk—that their councils might not want vigour; and once sober—that they might not want discretion.

Discretion meaning, of course, sober consideration of the facts.

I hope the upcoming debate on our federation is certainly vigorous, but will be grounded in sober consideration of the facts. And if we get it right, this debate will lead to a federation built on co-operation, focused on driving clear outcomes to advance our national interest, and with a better balance between roles, responsibilities and revenue.

John Brumby, Vice Chancellor's Professorial Fellow at Monash University and, University of Melbourne

This article is republished from The Conversation under a Creative Commons license. Read the original article.