• George Williams

10 December 2008COAG has made great progress on reforming federalism, but the next step must be to lock in a new era of federal-state relations, argues GEORGE WILLIAMS

THE Rudd government was elected with a promise to modernise Australia’s federal system. The reason for this is simple. It has been apparent for decades that the system is dysfunctional. Not only is our federal structure costing us around $9 billion in wasted taxes each year, its inefficiencies and bottlenecks pose a barrier to Australia’s future prosperity. Something had to be done, and under the rhetoric of ending the blame game, the government has assumed the challenge of reform.

The government has done well in its first year. It chose to tackle reform through the Council of Australian Governments (COAG), the peak intergovernmental forum for the prime minister, the premiers, the territory chief ministers and the president of the Australian Local Government Association. COAG is a newcomer to the federal system, first meeting in 1992, and has since been used to achieve change in areas of national significance like water scarcity.

The role played by COAG depends on whether the prime minister of the day sees it as a useful means of driving their own agenda, and in the case of Kevin Rudd the body has been propelled into unprecedented action. COAG met four times in 2008. The meetings have produced important outcomes that have brought about real federal reform. The last meeting was the most significant in tackling one of the hardest areas, federal-state financial relations.

The constitution was meant to secure the states’ financial position and independence. At Federation in 1901, it was the states and not the Commonwealth that levied income tax. However, the demands of two world wars and the rise of a national economy, combined with some canny manoeuvring by the Commonwealth, left the states with no income tax revenue. The Commonwealth takeover was ratified by the High Court in the Uniform Tax Cases of 1942 and 1957. These court decisions also dealt with section 96 of the constitution, which permits the Commonwealth to make grants to the states on such terms and conditions as the Parliament thinks fit. It was held that the Commonwealth has an almost unfettered power to make such grants.

As time has gone by, these grants have been used increasingly to micro-manage state functions in a way that matches the political objectives of the federal government and not necessarily the best delivery of state public services. Federal money has, for example, come with strings attached requiring state schools to use a specific student report card or even to erect a flagpole. The financial problems of the states were made worse by the 1997 High Court decision in Ngo Ngo Ha. The court struck down excise duties levied by the states over alcohol and tobacco, thereby stripping them of around $5 billion in annual revenue.

That decision sealed the states’ financial fate. They had lost their primary sources of income, and were forced to accept whatever the Commonwealth would give them. The impact has been devastating. It can be seen in the erosion of the status and authority of state governments, including a failure to attract their share of the best political and bureaucratic talent. It can also be seen in the decline in the quality of public services. This is a consequence of a federal system in which the Commonwealth controls the money and the states have primary responsibility over expensive and growing areas like health and education. The result has too often been a chronic underfunding of essential services, along with an unfortunate misdirection of some funds, and excessive administrative duplication and red tape.

Put simply, if you care about the quality of our schools and hospitals, you need to care about the problems in our federal system. The dire condition of state finances has had a further negative effect. In order to increase their revenue, states have provided more opportunities for gambling, including new casinos and poker machines, so that they can tax the extra activity. States have been prepared to levy socially damaging taxes to at least gain some income free of Commonwealth control. Despite this, they remain heavily reliant on grants, given that the Commonwealth still collects over 80 per cent of all taxation revenue.

This unhealthy dependency fulfilled the prediction of Alfred Deakin, Australia’s second prime minister, who soon after Federation said that the states would find themselves legally free, but financially bound to the chariot wheels of the central government.

Last weekend’s COAG meeting dealt with the crisis in financial relations. In money terms, the meeting delivered massive new Commonwealth funding for the states and territories in education, health, housing and indigenous disadvantage. The five-year package of $15.2 billion includes extra grants of $3.5 billion to schools and $7.7 billion to hospitals and healthcare.

However, extra money does not amount to structural reform. Longer-term change will instead be brought about by a new inter-governmental agreement on federal financial relations. It will deal with one important aspect of the problem, namely the conditions imposed on the states when they receive federal money. These tied grants, known also as specific purpose payments, will be reduced from 96 separate categories of payment to just five, covering healthcare, schools, skills and workforce development, disabilities services and affordable housing. Moreover, they will be paid in a way that gives the states far more flexibility in how the money is spent.

The states will not be left at large as to how they spend the money. With flexibility will come performance indicators to ensure that the choices made by the states produce results. By giving the states greater choice in how they spend Commonwealth money, and judging them against the choices they make, the system should produce better services and better value for the taxpayer’s dollar. There will be incentives to reward good performance.

This reform is one step towards ending the blame game in areas like health. The question now for the Rudd Government is whether COAG alone can drive the agenda in the years to come. While it is the right body for reaching agreement between governments, it does not have the power to entrench those decisions, nor the capacity to bring about deeper structural reform. COAG can only bring about a suspension of the blame game, it cannot fix its cause.

A future federal government could easily undo the new financial deal. The motivation will certainly be there to do so, such as to attach conditions to state grants that enhance the prospects of federal re-election. With the Commonwealth maintaining its financial dominance, only self-restraint will prevent the system from slipping back into its parlous state. This is not a sound basis for long-term reform, especially in a nation where short-term political considerations have had a way of winning out.

COAG was the right place to start, but it cannot by itself drive the larger agenda of federal reform. This will require a broader group of Australians to get involved, whether though a constitutional convention or other body. It must be charged with developing a new deal for the federal system as a whole that addresses the allocation of powers and responsibilities across governments and the remaining problems of federal financial relations. This will require attention to the rules of the federal system as set out in the constitution.

Constitutional change should only be attempted where it is absolutely necessary. However, in this area, some reform will be necessary because the constitution controls many aspects of how the federal system works. If we do not change the constitutional rules and structure, there will be a tendency over time for bad habits to resurface and problems to re-emerge. •

George Williams is the Anthony Mason Professor at the University of NSW and a visiting fellow at the ANU College of Law. This article first appeared in the Canberra Times.

Photo: Prime Minister Rudd and Victoria premier John Brumby at the Council of Australian Governments meeting in Canberra on 29 November 2008. AAP Image/Alan Porritt