Australia

Abstract

This chapter discusses Australia’s unique brand of fiscal federalism, which has evolved under a Constitution that is more than 120 years old. While Australia’s fiscal federation is stable, Australia has high vertical fiscal imbalance with strong centralisation of taxing power and revenues at the national level, while many expenditure and governance responsibilities remain with subnational States and Territories. Vertical equalisation is delivered through unconditional and conditional grants from the federal government to subnational governments, and horizontal equalisation by a formula based on taxing capacity and spending needs, combined with conditional grants, politicised in various ways. The Chapter recommends reform to establish a new fiscal bargain supporting sharing of income tax and GST by both levels of government and to update fiscal arrangements to recognise and support Indigenous sovereignty self-government in the federation.

1 Overview of Australia’s Federal System

Australia’s federation, established in 1901, is now more than 120 years old. After 50 years of the federation, one analyst commented: “Australians are not federalists except momentarily half a century ago” (Butlin 1954: 461). Yet the Australian federation has survived in its original form with 6 (originally 5) sovereign states and 2 territories, weathering a petition for secession from Western Australia in 1933. The federation has survived with only a few changes to the constitutional framework in the written Australian Constitution (Commonwealth of Australia Constitution Act 1900 (Imp.).

The Australian Constitution is modelled in part on the Constitution of the United States of America and in part on British constitutional and parliamentary structures and practices. The Constitution establishes the federal (Commonwealth) government and recognises the sovereignty of State governments which were self-governing colonies of the British Empire before federation (New South Wales, Queensland, Victoria, South Australia, Tasmania and Western Australia). The Australian Capital Territory and the Northern Territory are subject to federal legislative control with delegated tax and administrative powers. Australia is a dual federation, as local government is not recognised in the Constitution. However, in practice Australia has three tiers of government: federal, state and local. The Constitution is entrenched and can only be amended by a referendum supported by a majority of votes in a majority of States. This threshold is rarely reached in practice and therefore it is difficult to achieve reform of Australia’s fiscal federal system (or other aspects of the federation) by Constitutional amendment.

Despite strong “nationalist” feeling and a centrist system of economic governance and tax system in Australia, State and Territory governments play an important role in democratic law making and delivery of services. The importance of State governments has been highlighted in the response of the federation to the COVID-19 pandemic, which revealed the importance of State leadership this is discussed further below. State governance is likely to become more, not less, important in the future and some differences between States including population and wealth are becoming more marked as time goes on.

Australia is one of the most multicultural nations in the world, with a population of more than 25 million. Its population growth rate of about 1.5% or close to 400,000 people each year has slowed temporarily because of the COVID-19 pandemic (ABS 2019b). Australia’s population lives on a vast land territory of 7.692 million km², the world’s sixth-largest country and largest island. Australia’s land mass is close to the size of the United States of America (excluding Alaska), which has 10 times the Australian population; or of the European continent, which has 30 times the Australian population. In 1901, the population of 3.8 million people were mostly from the United Kingdom and Ireland, with a small number of Indigenous peoples who had survived the invasion of 1788, frontier wars and disease. Today, nearly 30% of the population are born overseas, with the top ten foreign countries of birth being England, China, India, New Zealand, Philippines, Vietnam, South Africa, Italy, Malaysia and Scotland. More than 300 languages are spoken and more than 20% of Australians speak a language other than English at home, most commonly Mandarin, Arabic, Cantonese and Vietnamese. Just over 50% of the population identify as Christian (including 22.6% Catholic, 13.3% Anglican, 3.7% Uniting Church and 2.6% other), 30% stating no religion, 2.6% Islam and 2.4% Buddhism.

A century prior to federation, Australia was established as a series of British colonies commencing with the convict colony of New South Wales in 1788, described as “settlement” but in reality an invasion. The legal fiction of “terra nullius” that was the basis of settlement by the British and the concomitant denial of Aboriginal sovereignty meant that there was never a formal treaty process, unlike in comparable countries including Canada and New Zealand. This legal fiction was overturned by the High Court of Australia in the historic decision in Mabo (1992) 175 CLR 1, which recognized Indigenous native title over land. The existence and continuation of native title was subsequently acknowledged in the Native Title Act 1993 (Cth) and in subsequent cases. Today, about 3% of the population identifies as Aboriginal and Torres Strait islander, a growing population compared to the time of federation (ABS 2019a). Aboriginal and Torres Strait Islander land title and some elements of Indigenous self-government extends over nearly half of the Australian land mass through native title agreements, land rights and various claims and negotiations. There is a growing movement for treaties with State governments and in support of formal recognition of Aboriginal and Torres Strait islander first nations in the Constitution (Davis and Langton 2016). The implications for reform of Australian fiscal federalism are addressed in Sect. 7 of this chapter.

The Australian population is spread unevenly across the States and territories (ABS 2019a). The largest state by population is New South Wales, with a population of 8 million. Victoria has 6.5 million (and has recently been the fastest-growing state), while Queensland has 5 million people. At the other end of the spectrum, Tasmania has about 530,000 people and the Northern Territory about 246,000 people. Australia’s population is highly urbanized in large cities including Sydney (5.2 million), Melbourne (4.9 million), Brisbane (2.4 million) and Perth (2 million). The dominance of these cities, which are engines of Australian economic growth, creates significant tensions in the federal system.

Australia had GDP of USD $1.39 trillion in 2019, ranked in the top 20 wealthiest countries globally (World Bank 2019). Australia experienced nearly three decades of economic growth to 2019 but, like the rest of the world, faced a significant economic contraction as a result of the COVID-19 pandemic. Prior to the pandemic, growth had slowed to about 2.5% of GDP in the years since the Global Financial Crisis of 2009, half the average of the previous two decades. Australia is an open trading and investment economy and a net capital importer, with an inbound investment of about $3.5 trillion, and outbound investment of $2.5 trillion in 2018 (DFAT 2020). Investment in the resources sector, and the benefits of the resource industry, is unevenly distributed across the States and Territories. The States of Western Australia, New South Wales and Queensland depend heavily on extractive industries of iron ore, coal and gas. This contributes to difficult federal politics around benefits and costs of the resources sector (see, e.g., Eccelston and Krever 2017). The uneven benefit and impact of resource extraction also contribute to difficult environmental politics that Australia has not been able to resolve. Australia has previously enacted, and repealed, a carbon emissions trading scheme. Australia has an average per capita footprint of 17 tonnes of carbon emissions, above the United States and Canada and exceeded only by the middle eastern oil-producing states.¹

The Commonwealth government and all State governments operate a system of parliamentary democracy. The Head of State is the Queen of Australia (who is currently also the Queen of the United Kingdom), represented in Australia by the Governor General.² The Commonwealth Parliament has a lower House (the House of Representatives) and an upper House (the Senate) which was established as a states’ house (as in the United States), as well as a house of review. Elections are held every 3 to 4 years at federal, state and local government levels. The major parties of the Liberal/National Coalition and the Australian Labor Party operate at all levels of government. Typically, the party that has a majority in the House of Representatives establishes the government of the day. Voting is compulsory and generally, a preferential system is applied, resulting in a “two-party preferred” outcome for the House of Representatives. Different voting approaches and minimum numbers of Senators for each State and Territory in the Senate mean that the party which governs, by majority in the House of Representatives, usually will not control the Senate. As a result of Australia’s strong party-based democracy, Senators generally act along party lines and not as representatives of State interests, reducing the role of the Parliament as a site of federal negotiation. Minor parties including the Green party and some Independents usually hold the balance of power in the Senate. The current Labor government led by Prime Minister Anthony Albanese and Treasurer Jim Chalmers was elected at the 2022 federal election with a slim majority.

2 The Structure of Government and Expenditure Responsibilities

The Constitution establishes the Commonwealth government’s power to enact laws with respect to taxation, to appropriate funds and to grant money to the States. It limits the legislative power of the Commonwealth Parliament to a list of enumerated matters, including defence, external affairs, taxation, social security and pensions, corporations, interstate trade and commerce, an executive power and other matters (section 51). The State governments retain primary for core functions including education, health and hospitals, police and criminal justice, city and town planning, sport and recreation, roads and other transport infrastructure (apart from national rail), although funding is often shared with the Commonwealth under national partnership agreements. The States retain sovereign power to legislate on any subject matter, subject only to constraints imposed by the federal Constitution.

2.1 Commonwealth Power of Expenditure

All federal taxes and other revenues must go into consolidated revenue and the Commonwealth government must appropriate funds by a law of the Commonwealth Parliament to be spent “for purposes of the Commonwealth” (sections 81 and 83 of the Constitution). This is, as noted by French C.J. of the High Court in Pape v. FCT (2009) 238 CLR 1 (p. 37), “central to the idea of responsible government”. However, the extent of this federal spending power has long been unsettled (Saunders 2009). The issue can be stated as follows: if the Commonwealth Parliament is not free to spend the taxes that it has raised in the manner that it sees fit (we return to its almost unlimited power to tax, below), this contradicts a basic principle of political and legal accountability by the federal government. On the other hand, if the Commonwealth Parliament had unlimited power to spend the taxes it raised, this would permit it to spend on a wide range of matters that would otherwise be solely within the legislative power of the States and would enable the federal government to encroach significantly on state government functions. Consequently, this breaches the Constitution and sovereignty of several States.

High Court cases including Pape v. Cth (2009) 238 CLR 1 and Williams v Cth [2012] HCA 23 have indicated that sections 81 and 83 of the Constitution do not themselves confer a substantive “spending” power on the Commonwealth Parliament. This suggests that the power of expenditure relies on the legislative and other powers of the Commonwealth set out in the Constitution. As it is relevant to governing in a crisis, and therefore to the COVID-19 pandemic, this chapter will briefly discuss the Pape case. Mr. Pape challenged the Rudd government stimulus package in response to the Global Financial Crisis of 2008, in which the government handed out a “cash bonus” on a means-tested basis to about 8.7 million taxpayers. The High Court held that the monies for the cash bonus were validly appropriated and the majority upheld the expenditure on the cash bonus, based in part on the taxation power (as some of the bonuses were paid by tax refund) and in part on the executive power under section 61 of the Constitution to respond to the “large scale adverse effects of the circumstances affecting the national economy” (per French C.J., [8]). The executive power is supported by the power of the Parliament to legislate applying its “incidental” power in section 51(xxxix) and this was relied on as the Parliament passed the law to pay the cash bonus. The High Court appears to have accepted that the Global Financial Crisis and the potential damage to the Australian economy satisfied the requirement of a crisi triggering the exercise of executive power (see, e.g., Appleby 2009; Appleby and McDonald 2011). The very much larger federal fiscal package in response to the COVID-19 pandemic in 2020, including JobKeeper and JobSeeker payments to businesses and individuals, has not been challenged but would undoubtedly be upheld and is supported by other powers for example relating to borders and quarantine.

Despite this recent line of authority, control of the federal expenditure power remains a weakness in the Australian federal system, and the ability to spend revenues it raises is a constant temptation to federal governments. An example is the use of the expenditure power by Commonwealth ministers to make financial grants to organisations, businesses and regions that fall outside Commonwealth regulatory power, exercised bypassing State governments, often with implications of political influence or “porkbarrelling”. During the 1970s, the issue arose in relation to Commonwealth grants to local and regional agencies. These grants were upheld by a bare majority of the High Court in AAP case, Victoria v. Cth (1975) 134 CLR 338. In 2019, a scandal arose about federal ministerial grants to sporting organisations that ignored independent assessments and benefited marginal electorates in the months before the federal election (e.g. Grattan 2020). These “sports rorts” were strongly criticized in a report of the Australian National Audit Office (ANAO 2020) and were the subject of Senate inquiry.³

2.2 Commonwealth Power to Grant Funds to States

The main way in which Commonwealth Parliament controls policy and expenditures across the federation is by relying on its power to grant monies to the States under. Section 96 of the Constitution states that “until Parliament otherwise provides, the Parliament may grant financial assistance to any State on such terms and conditions as the Parliament thinks fit”. The grants power is a key element in shaping Australia’s particular form of fiscal federalism. Grants have been used dramatically by the Commonwealth government to influence policy in areas over which the States have nearly exclusive legislative power. Payments to the States of general revenue assistance from GST revenue (see Sect. 5) are special appropriations of the federal Parliament under section 22 of the Federal Financial Relations Act; specific grants subject to conditions are appropriated under a variety of relevant legislation.

Historically, the Commonwealth paid surplus revenues back to the States and then began to make special grants to needy claimant states, primarily Western Australia, Tasmania and South Australia. These grants had the goal of enabling those states to operate at a standard “not appreciably below that of the other States” (Brown 1952). An attempt was made in a referendum in 1926 to entrench in the Constitution the approach of federal grants to the States on a per capita basis but this failed, perhaps because the per capita formula was already perceived to disadvantage some states (Saunders 1989).

During World War II, the grants power was used to force States to stop levying income taxes, thereby centralising the income tax as a single national tax. As explained below, this cemented central fiscal supremacy. The Commonwealth Parliament cannot discriminate between States in imposing taxation but it can discriminate in respect of its power to make grants (Moran (WR) Ltd v. DFCT (1940) 63 CLR 338).

After World War II, both Liberal-National and Labor Commonwealth governments expanded the use of grants under section 96 for a range of purposes, from roads and infrastructure to drought relief, national fitness, and funding universities, in what appeared to be an inexorable process of centralisation of responsibilities and expenditure. State governments often contested this exercise of the Commonwealth grants power but on the whole, the High Court has affirmed the Commonwealth power to make conditional grants, and it has also upheld some important limits on State taxation (also discussed in Sect. 3). On the other hand, State governments have sometimes been willing to hand over expensive responsibilities to the Commonwealth, on the basis that they could not finance them adequately. For example, in the 1970s the States handed the financing and regulation of tertiary education entirely to the Commonwealth, “apparently with some relief” (CEDA 1975: 15).

In this unequal fiscal context, the management of federal financial relations has been a process of continual political bargaining, sometimes presented as the States having to “beg” or go “cap in hand” to the Commonwealth; and sometimes in a more positive light as a form of cooperative federalism balancing diversity and national standards through cooperative partnership agreements. The Commonwealth has from time to time sought to leverage conditional grants to support nationwide economic and competition reform. Today, financial responsibility for the expensive core functions of education and health is substantially shared between Commonwealth and State governments and there has been a trend for regulatory responsibilities also to be shared in these areas (e.g. Warren 2006). In this, Australia appears to be different from some other federations. This approach of shared funding and regulatory responsibility presents both opportunities and challenges for managing accountability and finances in the federation.

3 Taxation in the Australian Federation

The Constitution provides the foundation for the Commonwealth power to tax, establishes limits on State government taxing powers and sets up a skeletal regime for intergovernmental financial relations. The issue of federal and state taxation, and the federal power to make grants, has been the subject of some of Australia’s most heated federal-state disputes, which have played out in a context of overall growth in Australian governmental taxation and expenditures through the twentieth century. The growth of taxes to finance the public sector as a share of GDP from the beginning of the federation to today is shown in Fig. 1, which tells the story of Australia’s growth as a nation in fiscal terms.

Fig. 1

(Source Reinhardt and Steel [2006]. A brief history of Australia’s tax system; updated with budget revenue figures and ABS Taxation Revenue Statistics to 2017–18)

History of tax revenue in Australia

As Fig. 1 shows, from the start of the federation, when the Commonwealth government took over the customs and tariffs base, most tax revenues were raised at the Commonwealth level and this pattern has continued throughout the history of the federation. The expansion in the size of the government was similar to other member states of the Organisation for Economic Cooperation and Development (OECD), although Australia has had a smaller public sector than many other OECD countries. Total government revenue in Australia was 36% of GDP in 2018, among the lowest in the OECD.⁴ Australia is a relatively low taxing country by OECD standards, raising 28.5% of GDP in taxes in 2018, below the OECD average of 34.3% and significantly lower the tax levels of countries such as France and Denmark which are above 40% of GDP.⁵

3.1 Commonwealth Taxing Power

The Commonwealth government has power to tax under section 51(ii) of the Constitution. The definition of a “tax” defines the boundaries of the power; this has been controversial from time to time, but is essentially defined as any compulsory exaction of monies under statutory power, for public purposes that are not a fee or penalty (Matthews v Chicory Marketing Board (1938) 60 CLR 263, per Latham CH at 276). It has been established since the early days of federation that a tax is not unconstitutional because it may be oppressive, unfair or imposed to achieve purposes other than taxation (Osborne v. Cth (1911) 12 CLR 321). The Commonwealth Parliament is prohibited from giving preference to one state or another in taxation by section 99 of the Constitution.⁶ It cannot tax property of the States or State governments by section 114 of the Constitution and the principle of intergovernmental immunity.⁷ Various Commonwealthj taxes have been challenged as unconstitutional because they apply to State functions or employees but most of these challenges have failed.⁸ There are some procedural requirements for the passage of tax legislation including that tax bills must originate in the House of Representatives. By section 53 of the Constitution, the Senate (in form, but not in practice, a “States” house) does not have the power to amend tax bills (see, e.g., Cominos and Dwyer 1999).

Australia’s most important taxes are imposed by the Commonwealth Parliament: the personal income tax on individuals and corporations, including capital gains tax; fringe benefits tax on employee benefits; Goods and Services Tax (GST); customs duties; excises on fuel, alcohol and tobacco; and petroleum resource rent tax. Australia’s heavy reliance on personal and corporate income tax, and less heavy reliance on GST contrasts with the pattern of reliance on social security taxes and value-added taxes in many other OECD countries. Australia has no wealth, inheritance or gift taxes at Commonwealth or State level. All Commonwealth taxes, apart from customs and excise, are administered by the Australian Taxation Office (ATO). State and local governments raise less than 20% of taxes in Australia, as shown in Table 1. The states of NSW and Victoria raise the most tax revenues, with NSW raising more than a third and Victoria nearly one-quarter of total State and local tax revenues.

Table 1 Commonwealth, State and local taxes, 2017–18

The Commonwealth income tax was introduced in 1915 but became a “mass tax” after World War II (WWII). As indicated in Table 1, total income tax revenues on individuals, companies and superannuation funds were AUD 312.4 billion in 2017–18, comprising 73% of Commonwealth taxes and about 60% of total tax revenues. Corporate income tax comprises 20% of federal tax revenues. The Medicare Levy of 2% under the Medicare Levy Act 1986 (Cth) is a surcharge on taxable income and is intended to contribute to support the Medicare and National Disability Insurance schemes; however, it is not legally hypothecated and is not sufficient to fund their cost, which is funded out of consolidated revenue.

The second-largest Commonwealth tax is the GST, introduced in 2000 to replace a wholesale sales tax on goods, after 30 years of political struggle (Eccleston 2005). The GST generated revenue of AUD 64 billion in 2017–18, comprising 15% of Commonwealth tax collections. It is a broad-based consumption tax imposed at a flat rate of 10%, structured as an invoice-credit value added tax. The GST has significant exemptions including basic foods, health, education, housing (except new housing), water and sewage, childcare and financial transactions which are input-taxed. The Commonwealth Parliament also imposes excises on fuel, tobacco and alcohol which raise about 9% of federal revenues; customs duties, which raise only a small percentage of revenues; and some other minor indirect taxes.

3.2 State Taxes

The Commonwealth power to tax in section 51(ii) is a “concurrent” power that does not remove the power of the States to legislate with respect to taxation. The source of the States’ power to tax is in their nature as sovereign political entities having plenary legislative power, which includes the power to tax. This is implicitly protected by sections 106 and 107 of the Australian Constitution, which ensure the continued existence of the States. The process for enacting tax laws depends on the State constitution, but in general, such laws must originate in the lower house; pass both houses of parliament; and receive the assent of the Governor of the State. States cannot tax the property of the Commonwealth (section 114) and are prohibited from discriminating in tax or other laws on the basis of a person’s State of residence under section 117 of the Constitution.⁹ Table 1 summarised the taxes levied by states and territories. In spite of their broad legal power to tax, concurrent with the commonwealth, the States and Territories impose a limited range of taxes which are often said to be less than optimal.

The most important state tax in terms of revenue is the payroll tax, which raises much more revenue in populous and industrialised NSW and Victoria than in states that have smaller populations. In Australia, payroll taxes are not used to finance social security, and consequently are less important than such taxes in other countries. The NSW payroll tax raised 30% ($9.4 billion) of its tax revenue in 2018–19 (Government of NSW 2019: 74). The Commonwealth levied payroll tax concurrently with State governments from 1941 to 1971, when it left what has been described as its least favourite tax base to the states (Smith 2004). The payroll tax base has been reasonably well harmonised between the States on a largely similar base and rate, essentially total payments for employee wages of employers over specified thresholds (including wages, fringe benefits, bonuses and commissions). Most small businesses are exempt. The tax was described by the NSW Review of Federal Financial Relations (the NSW Review) as one of the “better” taxes on grounds of revenue and efficiency, but the Review expressed concern that it is being eroded by interstate tax competition (NSW Government 2020: 75–76). The NSW Review found that, all jurisdictions had raised their tax-free threshold for payroll tax, while three had cut headline tax rates, two introduced concessional rates and various states added concessions for regions, trainees or to attract investment. State governments have provided payroll tax relief in response to the COVID-19 crisis.

The second most important State tax is transfer or stamp duty on the conveyance of residential and commercial immovable (real) property, by sale or gift, and on the transfer of interests in land-rich entities such as trusts and companies. Duty is usually payable by the purchaser calculated on the sale price of the property. Duty rates are progressive, ranging in NSW from 1.25 to 5.5% (over AUD $1,013,000 in value) and in Victoria from 1.4 to 5.5% (on total value, if over AUD $960,000).¹⁰ The base includes the main residence of taxpayers. In states with growing populations and rising property prices, most importantly NSW, Victoria and Queensland, transfer duty has an increasingly important role in raising revenue. The reliance on transfer duty leaves states vulnerable to revenue volatility as house prices fluctuate.

Land tax is levied by all states and territories except the Northern Territory, on the aggregate holding of unimproved land value that is owned by a taxpayer in the jurisdiction. In the early years of the federation, the Commonwealth levied a land tax at steeply progressive tax rates but in 1952, the Commonwealth vacated land tax, leaving this tax base for the states; NSW re-entered the land tax base in 1955 (Smith 1992: 26). State land taxes are generally progressive. For example, in Victoria, rates range from 0.2% above a tax-free threshold of AUD $250,000 to 2.25% over a value of AUD 3 million. However, the base for land tax in all states is relatively narrow, as it excludes the principal place of residence of taxpayers—which comprises about half of the potentially taxable land value.

Economists generally agree that transfer duty is inefficient and inequitable and should be replaced with a broad-based land tax (NSW Government 2020; Freebairn et al. 2015). Property taxes (rates) are levied to a limited extent at the local government level but this comprises a relatively small share of the tax base. The Australian Capital Territory is the only state or territory to have commenced a process of transitioning away from transfer duty to land tax, and it therefore levies a land tax on the home. The case for the transition from transfer duty to land tax is discussed in detail in the NSW Review. There are significant disincentives for such reform by any State acting alone, or without the support of the Commonwealth government, including potentially being disadvantaged in the federal horizontal fiscal equalisation regime and financing the significant transition (NSW Government 2020: 52–53).

States (but not Territories) are sovereign owners of resources in their jurisdiction. Royalties are a price for access to a nonrenewable resource. States levy a range of royalties including a fixed rate per unit (e.g. tonne) of production; ad valorem royalties as a percentage of value or price of resources or profit-based royalties. Although not as big as most of the State tax bases, royalties are particularly important in Western Australia, Queensland and NSW. In Western Australia, royalty income in 2019–20 was $6.3 billion which comprised 20% of state revenues; in Queensland, royalties and land rents comprised $4.9 billion, or 8.3% of State revenues; in NSW, royalties comprised only 2% of State revenue and in other States, the proportion is lower.¹¹ In some states and territories, royalties are also paid to Indigenous or native title land holders.

3.2.1 Why No State Income Taxes?

Prior to WW II, all States levied income taxes (some had done so since colonial times). Constitutional protection of the states’ power to levy income tax did not prevent the Commonwealth from driving them out of this “concurrent” legislative area, using a combination of its own power to tax and the grants power described in Sect. 2. This unique Australian history provides a striking contrast with the Anglo-federations of Canada and the United States, where states held tightly to their income tax base.

Leading up to and during WWII, the Commonwealth took over the income tax to fund the war effort and to streamline collection. The Commonwealth and States concurrently enacted the Uniform Income Tax Act (1936) aimed at harmonising income taxes. In 1942, a Committee on Uniform Taxation recommended that the Commonwealth take over all income taxation (Mills et al. 1942). The Commonwealth Parliament enacted the “Uniform Tax Scheme”, which took over the tax base and prevented the States from levying income taxes for the duration of the war. The Scheme was challenged by the States in the High Court. The challenge failed, in part due to the deference given to the Commonwealth Parliament during war time (South Australia v. Cth, First Uniform Tax Case (1942) 65 CLR 373). After the end of WWII, the so-called “temporary” scheme remained in place. A decade followed during which various reform proposals were made and negotiations conducted on returning the income tax base to the states, but these all failed. In 1957, Victoria and NSW again challenged the scheme , and again the High Court upheld its validity (Victoria v. Cth, Second Uniform Tax Case (1957) 99 CLR 575). The most important element of the Second Uniform Tax Case was the finding by the High Court that it was legitimate for the Commonwealth to use its power to make grants to the States under section 96 of the Constitution, so as to require the States not to impose an income tax. A State government could have rejected a grant and instead levied its own income tax, but none was prepared to do this.

The Constitutional challenges show that the Commonwealth “takeover” of income tax was disliked by at least some of the states. It led to a significantly increased vertical fiscal imbalance, which is generally seen to be a major problem in the federation. However, the uniform federal income tax was popular with Australian taxpayers, especially businesses that increasingly operated across state borders; it was not opposed by the smaller states. The web of income taxes that had spread across Australia in the early decades of the twentieth century had become extraordinarily complex. Earlier attempts at harmonisation, culminating in the Uniform Income Tax Act (1936), apart from an administrative collection agreement of 1920, failed to ensure simplicity and stability (e.g., Laffer 1942). Most acknowledged the advantages of uniform taxation and there was “surprising hesitancy” of State governments and others in suggesting alternative schemes (e.g. Binns and Bellis 1956). In 1959, the Liberal government under Prime Minister Robert Menzies enacted the States Grants Act (Cth) to remove the condition that States had to restrain from imposing income taxes in order to receive grants, which had been a critical element in the Uniform Tax Scheme. No State took up the opportunity Menzies (1961: 12) expressed doubt that State governments would seek the return of income taxation:

There has been no positive evidence that most of the State governments really want a return of taxing powers on terms which would be reasonably acceptable to the Commonwealth and still permit it to discharge its admittedly major responsibilities. Yet a return of taxing powers by unilateral Commonwealth action would be pregnant with disaster if a genuine agreement between Commonwealth and States were not arrived at.

It has been suggested that the reason that no State has yet enacted an income tax was “primarily because the Commonwealth did not ‘make room’ for a state income tax by reducing its own income tax rates to accommodate a State income tax without raising the overall level of income tax” (Warren, 2006: 19; Carling 2007). In 1964, the Victorian government proposed a State income tax but this failed after the Commonwealth refused to collect it (Smith 2004: 30). In 1976, the Fraser Liberal-National government elected on a platform of “new federalism” proposed, first, a new formula for grants based on a tax-sharing approach under the States (Personal Income Tax-Sharing) Act 1976, and second, a law to allow a State to enact a surcharge on the Commonwealth personal income tax, excluding company and international aspects under the Income Tax (Arrangements with the States) Act 1978 (Cth). No state took up the opportunity to levy an income tax surcharge, and the Commonwealth law was repealed in 1989. In 2015, during the last (brief) federation reform attempt, Liberal/National Prime Minister Turnbull announced that he would give the states the ability to raise a proportion of personal income tax, but the idea was described as a “caricature” of policy making that could not be taken seriously (Fenna 2017: 134).

3.2.2 Why No State Sales Taxes?

The main exclusion from State taxing power is the exclusive Commonwealth power to legislate with respect to excise and customs duties under section 90 of the Constitution.¹² This is the second main constitutional provision shaping Australian fiscal federalism. The High Court has held that a duty of excise is a tax on the production, manufacture, distribution or sale of goods up to the point of consumption. This broad definition denies the States jurisdiction to levy any tax on goods (Parton v. Milk Board (Vic.) (1949) 80 CLR 229).

State governments for many years levied “licence fees” on businesses selling tobacco, alcohol and petrol, calculated in a variety of ways on of the quantity or value of goods sold, initially at relatively low rates. Early High Court authority suggested that a licence fee would not be a duty of excise this held, at least, where the fee was not imposed in relation to goods sold in the licence period and where the goods were inherently susceptible to regulation, such as tobacco and alcohol (e.g. Dennis Hotels Pty Ltd v. Victoria (1960) 104 CLR 529, Dickensons Arcade Ltd v. Tasmania (1974) 130 CLR 177). By the late 1980s, licence fees in various states had crept up to around 30% of the value of the goods sold; these were upheld by the High Court as a long-standing exception to the excise prohibition.¹³ In the 1990s, some states increased tobacco “licence fees” to 100% of the value of the tobacco sold. This prompted yet another Constitutional challenge. In Ha v. State of New South Wales (1997) 189 CLR 465, the High Court by majority struck down the fee in question, finding it to be a duty of excise on goods. It was widely recognised that the reasoning extended to similar licence fees in other states and on other goods, notably alcohol and petrol. To protect the States from financial difficulties, the Commonwealth Parliament enacted legislation to tax at 100% any amount recovered from the States in relation to invalidly imposed excise duties: Franchise Fees Windfall Tax (Imposition) Act 1997 (Cth). This “tax” was returned to the relevant States and was constitutionally permitted. As a result of Ha’s case, such taxes were, in effect, denied to the States (see Dick 1998; Williams 1999).

In 1965, the economist Mathews had proposed a “general tax on production … in the form of a ‘value-added tax’” to be levied by the States businesses (Mathews 1965). There has been debate about whether a tax imposed at the point of consumption of goods would be an excise and the matter has never been legally tested, as no State has ever attempted to legislate a broad-based consumption tax.¹⁴ In partial substitution, State governments started to levy gambling taxes, a trend noted by some who see states as becoming addicted to gambling revenues (e.g. Williams 1999).

3.3 Local Government

Local government is not recognised in the Constitution. Local governments are generally statutory bodies incorporated by State governments and exercising delegated State legislative power. In 2014, there were 569 local governing bodies eligible to receive federal financial assistance grants (Department of Infrastructure and Regional Development 2017: 219). The majority of Australia’s population lives in urban centres and the earliest local governments were established in the cities of Adelaide, Sydney and Melbourne in the 1840s. However, the size and diversity of the country means that local government areas are extremely diverse, ranging in population from fewer than 100 to close to 1 million people and in size from 2 to 372,571 km² (the Shire of East Pilbara, servicing about 20,000 people) (Productivity Commission 2017: 4). Local governments have powers of general competence and deliver services, such as waste management, street safety, parks and libraries, and services to members of the community. Some local governments manage infrastructure including water and sewerage. They can make and enforce local laws and make land-use, development and planning decisions.

Local governments self-fund most expenditures; in 2014–15 on average 90% of expenditures from own-source revenue, about half from property rates, and half from fees, developer charges, fines and investment revenue (Productivity Commission 2017). Local governments exercise delegated legislative power to levy rates (property tax) on immovable property (e.g. Local Government Act (Vic), Part 8). Rates are charged on the value of residential and commercial immovable property in the jurisdiction, with value calculated in various ways.

NSW and Victoria cap the rates that can be levied by local governments in those states, a matter that is the subject of some controversy. The Hawker Report (2003) found some evidence of “cost shifting” to local government by State and Commonwealth governments, putting increased pressure on local budgets while “squeezing” their ability to raise revenues in some cases. The Hawker Report (2003) and the Productivity Commission (2017) recommended the abolition of rate capping and State-mandated exemptions (nonrateable land).

The balance of local government funding is grants from State and Commonwealth governments. Self-funding capacity is variable and some rural and remote councils are heavily reliant on grants. Federal grants directly to local government commenced under the Whitlam Labor government during the 1970s on the advice of the Commonwealth Grants Commission (see Sect. 5.1 below).

The Whitlam government established a program by which funds would be paid directly to Regional Councils for Social Development, bypassing the States, after appropriation from consolidated revenue under section 81 of the Constitution. This was soon abolished, although Victoria v. Cth (1975) 134 CLR 338 (Australian Assistance Plan case), the High Court by a bare majority (4:3) upheld the appropriation to fund regional councils as valid. This decision may have indicated a relatively expansive view of federal power to appropriate money for spending under section 81 of the Constitution (Saunders 2009: 258). Pape in 2009 did not explicitly overturn the case, but the power of the Commonwealth government to fund regional or local initiatives outside section 96 of the Constitution must be in doubt since Pape. The Liberal-National Fraser government in 1979 provided to local government 1.52% of net personal income tax collections in the previous year, increased to 2% in 1980–81. This revenue sharing arrangement was dropped during the 1980s but direct grants from the federal government continued although they are currently below this level (Hawker Report 2003: 99 et seq). Commonwealth federal grants to local government are delivered under section 96 of the Constitution via State Government Grants Commissions which allocate the funding between local councils in their jurisdiction, on an “untied” basis without conditions.¹⁵ Fiscal equalisation between councils is one of the national principles for distribution to local government.

Local governments are permitted to borrow under State legislation, usually with approval of the State Minister for Local Government and subject to restrictions related to the nature of security for borrowing. Some local governments borrow from the State government, while others cannot do so and must seek finance on the open market. Local governments are usually restricted to for capital investment and not for recurrent expenditure. In general, Australian local governments have extremely low levels of debt and are debt-averse, although this stance has been criticised, see, e.g., Comrie (2014). There have been various proposals to leverage local government assets or establish a national financing facility for local governments, especially to improve financing for infrastructure (e.g. Ernst & Young 2013).

Regional and local government financing is missing from the Intergovernmental Agreement on Federal Financial Relations. There has long been concern in regional and rural Australia that State governments do not adequately respond to the needs of their communities and that local governments are facing high and increasing infrastructure liabilities (see, e.g., Dollery 2009; Twomey 2008; Brown and Bellamy 2006). The Hawker Report acknowledged the desire for legal recognition of local government at the federal level and recommended a tripartite financial agreement and national Summit on Intergovernmental Relations, neither of which has been carried out. The President of the Australian Local Government Association was a member of the former Council of Australian Governments (COAG) and on the National Federation Reform Council which replaced it in 2020.. is only one minor voice in this forum. In 2006, the Commonwealth Parliament unanimously passed a resolution acknowledging that local government is an integral part of Australia’s federal system, but this has only symbolic value. Referendums to change the Constitution to provide recognition of local government have been held twice, and have twice failed to pass, since 1973. It seems unlikely that Constitutional recognition of local government will be achieved in the future.

4 Federal Economic and Fiscal Coordination

4.1 National Economic and Debt Management

The Commonwealth Government controls most of the levers for economic management in Australia: monetary, fiscal, and trade and investment policy. The independent Reserve Bank sets the interest rate and controls monetary policy using an inflation target as the main goal (during the COVID-19 pandemic, the Bank has been mainly focused on liquidity and economic recovery). As indicated in Sects. 2 and 3, the Commonwealth government raises 80% of tax revenues and manages the social security (transfer) system, and grants to States, thereby controlling most fiscal policy. Commonwealth Australia had (before the COVID-19 pandemic) relatively low debt across all levels of government, with gross debt of 73% of GDP in 2019 , increased to 84% of GDP in 2021; in contrast, household debt in Australia is among the highest in the OECD.¹⁶

The first major institution of fiscal cooperation in the federation concerned government borrowing. One of Australia’s founders noted that Canadian provinces and US states were “practically free of debt”; in contrast, the Australian States had liabilities “the annual interest on which absorbs more revenue than they have been accustomed to raise, or are likely to raise, by direct taxes” (Deakin 1902, 1952: 242). On one estimate, the colonies had nearly 15 times the debt of Canada (Saunders 1989). The Commonwealth and the States entered into the first federal financial agreement in 1909. After the Commonwealth government also began borrowing seriously, to fund WWI, it was clear that a coordinated approach was needed and this had not been properly planned in the Constitution. A successful referendum amended the Constitution inserting section 105A to allow the Commonwealth Government to take over State debts. The Australian Loan Council was established in 1926 and it became a forum for coordinated borrowing and enforced strict limits on State borrowing, as well as managing federal loans to the States (Saunders 1989).

The Loan Council was a model for the use of cooperative institutions, whether legislated or informal, to manage the fiscal federation. Some described the Loan Council as involving a surrender of sovereign powers of the States (e.g. Cowper 1932); however, it has been eclipsed in this role by the vertical fiscal imbalance and federal grants power discussed in Sects. 2 and 3 above. The Loan Council operates to the present day as a borrowing and deficit control mechanism, together with binding financial agreements. In response to the Global Financial Crisis of 2008, the Council expanded “fiscal space” for the States and Commonwealth by allowing deficits to creep up (with timelines for reduction). The Loan Council was also the vehicle by which the Commonwealth government provided a timelimited guarantee for State debt to ensure they maintained good credit ratings. In response to the economic impact of the COVID-19 pandemic, this role may be refreshed as governments at all levels take on more debt.

4.2 From The Council of Australian Governments to the National Federation Reform Council

The grants power in section 96 of the Constitution has substantial political weight, in particular in forcing states not to do certain things (such as levy an income tax). However, it is more difficult for the Commonwealth government to leverage the grants power to regulate and deliver services in large and complex areas of government activity, such as education or health, in respect which it does not have direct legislative power. To facilitate joint federal-state funding and regulation, a series of “soft law” federal-state agreements and institutional arrangements have been established. Intergovernmental agreements are in effect political compacts, which may have aspects legislated at Commonwealth and State level, and engage funds legislatively appropriated.

From 1992 until 2020, intergovernmental agreements were negotiated and managed by the Council of Australian Governments (COAG), a series of councils of ministers, supported by bureaucratic representatives and a secretariat, from Commonwealth, State and territory governments. In some councils, New Zealand was also represented. The COAG councils comprised:

• Federal Financial Relations Council

• Disability Reform Council

• Transport and Infrastructure Council

• Energy Council

• Skills Council

• Council of Attorneys-General

• Education Council

• Health Council

• Joint Council on Closing the Gap

• Indigenous Affairs Council

• Australian Data and Digital Council

• Women’s Safety Council.

In 2019, in response to the COVID-19 pandemic, the Liberal/National Morrison government established a so-called National Cabinet of the prime minister and premiers or chief ministers of the States and Territories. On 29 May 2020, the National Cabinet agreed to replace COAG with a National Federation Reform Council. This includes the Prime Minister, Commonwealth Treasurer, premiers, chief ministers and treasurers of States and Territories, and the President of the Australian Local Government Association. To date, the newly elected Labor Albanese government has continued the Council and convened the first meeting under his leadership in June 2022.¹⁷

The dependence of the States on the Commonwealth (going “cap in hand”) in bargaining about future funding has been widely criticised (e.g. Senate Select Committee on the Reform of the Australian Federation 2011).¹⁸ Intergovernmental partnership agreements may be lauded as processes of cooperation and partnership, or criticised as vehicles for Commonwealth interference in areas of State primary responsibility and for being short-term, contingent, uncertain and non-transparent.

An example education funding, which is complicated because of a mix of public and private provision, as well as the division of financial and organisational obligations and responsibilities between State and Commonwealth governments, all subject to overarching standards and equalisation processes. The result was described by Hinz (2017: 35) as a system that, while reasonably well performing when compared with other countries, is “characterised by fragmentation, complexity, suboptimal resource allocation, blurred accountability, and an incoherent policy mix”. Education funding in Australia has been subject to ongoing shifts in policy direction and funding arrangements in the last decade. School funding was subject to a major review (“Gonski 1.0” after the Chair, David Gonski) initiated by a Labor Government in 2011 which proposed significant changes in the allocation of school funding to public and private schools. This fed into federal-State 5 year funding agreements at that time, but the findings were controversial and debated. A second review in 2017 by the Liberal-National Government (Commonwealth of Australia 2018a). This, together with other reviews, informed the development of the next 5 year National Schools Reform Agreement between the Commonwealth, State and Territory governments which commenced on 1 January 2019 (Department of Education, Skills and Employment 2018). In 2019–20, the Commonwealth rovided funding of $21.5 billion to support school and early childhood education under the agreed framework and other national partnership agreements (Commonwealth of Australia 2019: 30).

4.3 The Intergovernmental Financial Agreement

The Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations of 1999,¹⁹ requires all of the GST revenue collected by the Commonwealth government to be paid to the States and Territories, applying principles of horizontal fiscal equalisation. The equalisation analysis is carried out by the Commonwealth Grants Commission. The difficult financial situation in which the States found themselves in the late 1990s, after license fees on tobacco, alcohol and fuel were struck down as “excises” (Sect. 3.2.2 above), was an important contributing factor to this successful fiscal reform under the Liberal-National government led by Prime Minister Howard. The GST is administered federally by the ATO and is, legally speaking, a Commonwealth tax.

The Intergovernmental Agreement was legislated in a Schedule to A New Tax System (Commonwealth-State Financial Arrangements) Act 1999 (Cth) with A New Tax System (Managing the GST Rate and Base) Act 1999. The latter Act states in section 10 that it is the “intention” of the federal government to abide by the Agreement. The State and Territory governments have a right of unanimous decision-making and veto, by means of the Council because of the requirement that “the rate of the GST, and the GST base, are not to be changed unless each state agrees to the change” (section 11). Changes to the GST law are also required to be consistent with: (a) maintaining the integrity of the GST base; (b) administrative simplicity; and (c) minimising compliance costs for taxpayers. The Act cannot bind future federal (or state) Parliaments – it can be amended by an ordinary Act of the federal Parliament and the agreement is unenforceable as a matter of constitutional law (Saunders 2000: 99). The Agreement is administered by the Council for Federal Financial Relations comprising the treasurers of the Commonwealth, States and Territories, an arrangement which will presumably continue under the new Federation Reform Council. Agreement objectives include collaboration in achieving fair and sustainable financial arrangements; enhanced public accountability; reduced administration and compliance overheads; stronger incentives to implement economic and social reforms; the ongoing provision of GST payments to the States and Territories; and the equalisation of fiscal capacities between States and Territories. The Agreement was amended and updated in 2009.

Payment arrangements under the Intergovernmental Agreement are established under Schedule D, which explains that financial transfers comprise four categories of payment: (a) National Specific Purpose Payments (SPPs) in respect of key service delivery sectors; (b) three types of National Partnership payments: (i) project payments; (ii) facilitation payments; (iii) reward payments; (c) general revenue assistance, consisting of: (i) GST payments; and (ii) other general revenue assistance; and (d) National Health Reform funding. Payments are legislated under the Federal Financial Relations Act 2009 (Cth).

5 Horizontal Fiscal Equalisation

5.1 History of Equalisation and the Commonwealth Grants Commission

The need for horizontal fiscal equalisation (HFE) across States and Territories, because of their differing tax capacities and spending needs, was identified early in the life of the Australian federation. In general, the States with smaller populations (and often extremely large land masses) were less able to raise adequate revenue for their infrastructure and services needs. Initially, grants from the Commonwealth to States were made on a per capita basis, but there were needs in the smaller (population-wise) states and extra grants were provided to needy claimant states in many early years (Brown 1952).

The second major federal fiscal innovation after the Loans Council was the establishment of the Commonwealth Grants Commission (CGC) as an independent agency in 1933, under Commonwealth legislation and not by Constitutional amendment. The CGC originated out of dissatisfaction of the States about previous grant processes who called for an independent expert body to prevent “log-rolling” and abuse of Commonwealth grants to States. The CGC was introduced at the same time as a failed attempt to secede by the Government of Western Australia in 1933 (a referendum vote on secession was passed by a significant majority of the Western Australian people, but the majority of votes in a majority of States was not achieved, so the referendum failed) (CGC 1995: 16). The CGC had the role of assessing claims by States for grants of financial assistance to support functioning at a level not significantly below that of other states.²⁰ After uniform income taxation was established in 1942, the capacity of all states including previously self-sufficient states of Victoria and NSW fell far short of increasing expenditure demands, while the Commonwealth had surplus budgets. Large grants have been paid from the Commonwealth to the states in every year since 1942, with a portion always calculated on an equalisation basis.

In 1973, the CGC was re-established as an independent statutory authority with the role of assessing the relative financial capacity of all the States so as to recommend to the Commonwealth the allocation of financial assistance grants “at standards not appreciably different from the standards of government services provides by the other States”.²¹ The CGC provides advice to the Treasurer on the allocation among the States and Territories of the GST revenue based on its assessment of HFE relativities. This forms the basis for the annual Determination of GST relativities issued by the Treasurer. From 1981 to 2018, the mission of the CGC was full and comprehensive equalisation, in which a given pool of funds were to be distributed among the States and Territories. From 1999, the pool of revenue to be equalised was capped at the GST revenue, so that horizontal equalisation was a “zero-sum game”. The standard of full equalisation commenced as “not appreciably different” capacities to deliver services, but evolved to the “same” capacity by the year 2000 (Productivity Commission 2018: 67). The Commission defined “equalisation” in 2010 as follows (2010: 34):

State governments should receive funding from the pool of goods and services tax revenue such that, after allowing for material factors affecting revenues and expenditures, each would have the fiscal capacity to provide services and the associated infrastructure at the same standard, if each made the same effort to raise revenue from its own sources and operated at the same level of efficiency.

The GST equalisation analysis is carried out each year by the Commission based on the average level of revenue collection and service delivery across states and calculated over the previous three years. For example, an assessment in 2018–19 would average the result over the previous three years (2017–18, 2016–17 and 2015–16) and the relativity factor would then be applied for the next year (2019–20). Actual expenditures or policies are not relevant, except in so far as they may affect the average against which all states are judged. Applying the average, the GST relativity is calculated.This is then applied to modify the per capita allocation, in the formula:

$$\frac{{{\text{Adjusted State population }} \times {\text{ GST revenue}}}}{{{\text{Adjusted State population}}}}$$

(where Adjusted State population is the estimated State population on 31 December in the payment year, multiplied by the GST relativity).

The pool for equalisation is capped by total GST revenue. The result is that all States and Territories receive a grant of GST revenue but some States are “donors” while others are “recipients” of equalisation. The full equalisation approach of the CGC has two components. First, it aimed to bring all states and territories up to the strongest fiscal capacity in the federation. Historically, this has meant equalising all states to the fiscal capacity of NSW or Victoria, but in more recent years, it has meant equalising to the fiscal capacity of Western Australia, because of the mining boom. The second element of equalisation was to ensure that government services could be delivered to the same standard in all States, “if each state made the same effort to raise revenue from its own sources and operated at the same level of efficiency” (Australian Government 2018b: 7).

The factors that have the biggest impact on HFE relativities are mining royalties; land and property sales and taxable land values; remoteness of the population; the share of Indigenous people in the population (both discussed in Sect. 7 below); payrolls of large companies; the existence of big cities; and the existence of Commonwealth Payments for Specific Purposes (Table 2). The HFE determination applies directly only to the GST, but the effect of specific Payments is “equalised” away over time, because most State taxes and other grants are taken into account in applying the formula.

Table 2 Revenue and expenditure categories for equalisation assessment

The distribution of GST revenues, and relativities, are shown in Table 3, for 2017–18, 2018-19 and the average relativity since 2000. Table 3 shows that in 2017–18, the NSW received 87.67% of its per capita GST revenue and the Victoria received 93.24%. Western Australia received a very low proportion of 34.43% of its per capita GST allocation. On the other hand, South Australia received 144% of its per capita allocaiton and the Northern Territory received an enormous 466% of its per capita allocation (three categories of mining royalties, remoteness and Indigeneity are significant in this result).

Table 3 GST distribution relativities and outcomes

5.2 The “Reasonable Equalisation” Approach and Top-Up for Western Australia

The arrangements for payment of the GST on general revenue assistance basis, subject to HFE under the Intergovernmental Agreement were reasonably stable for two decades. However, the Agreement began to show cracks as a result of the resources boom. The massive increase in the price and export of iron ore located in Western Australia meant that it became the fiscally strongest state under the HFE analysis because of its capacity to raise revenues through mineral royalties and other taxes, in the period from 2002 to 2014. The consequence, subject to a lag because of the HFE averaging approach, led to Western Australia being a large donor of GST to other States and Territories. The impact on the Western Australian budget was severe because the rolling averaging approach meant that it remained a large donor even after the resources boom had ended. As in 1933, but this time because of its good fortune, significant political unhappiness in Western Australia about fiscal equalisation was the trigger for negotiation of a new political compromise phased in from 2020.

Tshe Commonwealth government established an inquiry into HFE and made interim top-up grants to Western Australia. Following a Productivity Commission report (2018), the Commonwealth Parliament passed a bill for a new equalisation formula to commence in 2021–22, by amendment to the Federal Financial Relations Act and Commonwealth Grants Commission Act.²² It is notable that the new approach was not achieved by an amendment to the Intergovernmental Agreement on Federal Financial Relations (which would have required unanimous agreement of all the States and Territories); nor does it implement many of the recommendations in the Productivity Commission report. The Explanatory Memorandum for the bill explained that the GST distribution system had worked reasonably well but “the mining boom revealed that it does not function well when faced with economic shocks”.²³

Information about Commonwealth Government funding to the States and Territories is provided in the annual federal budget.²⁴ The revenue sharing relativity for the 2020–21 year is set out in Table 4; this will be topped up by additional payments of $1.4 billion over three years to Western Australia to ensure a floor on the relativity factor of 0.7 (which is much more than the factor of 0.449 indicated in Table 4). Additional short-term transition payments are paid to the Northern Territory if needed.

Table 4 GST revenue sharing relativity 2020–21

The new “reasonable equalisation” regime for general revenue assistance does the following (in summary):

• 1. The HFE regime will transition to a “reasonable equalisation” approach over the years to 2026–27 which will benchmark the fiscal capacity of each State and Territory to the stronger of either NSW or Victoria, the most populous (and, for most of the last century, the most prosperous) of the States;

• 2. A minimum GST revenue sharing relativity (or “floor”) will be introduced, at the discretion of the Commonwealth Treasurer for any individual State or Territory;

• 3. The GST revenue pool will be permanently boosted with additional Commonwealth funds.

5.3 Lack of State Tax Reform

It was the intention of the 1999 Intergovernmental Agreement on Federal Financial Relations that the distribution of GST revenue on a general assistance basis, subject to HFE, would provide a growing revenue base for the States. This was in exchange for the State and Territory governments reforming and harmonising some of their State taxes. Some reform was achieved at the time, but the State governments still levy a large number of taxes with diverse structures, bases and rates, generating complexity and compliance costs for businesses operating nationally. States also tend to compete down their tax bases. Australian experience of State tax reform suggests that federal fiscal competition is not always a good thing. Tax competition led to the demise in Australia of what has been called the most efficient tax base of all (inheritance or estate duty) and contributed to the failure of the States, even the richest and most populous, to agree on how to enact income taxes when this became possible after WWII. The States have a poor record at developing uniform laws and regulatory regimes in any field and it is difficult to rely on them retaining a single tax base unless forced upon them.

The challenge of State tax reform was addressed in the NSW Review of Federal Financial Relations (NSW Government 2020). Many State tax reforms that support equity and efficiency, such as transitioning from stamp duties to land taxes, may in the short term increase rather than decrease vertical fiscal imbalance. State tax reform requires federal cooperationincluding additional Commonwealth funding, as well as leadership by the wealthiest states, as was done in 1999 when the GST was enacted.

Resource taxation has also been a thorny issue in the Australian federation. The State governments are sovereign owners of mineral resources and they have the primary right to levy royalties on extraction. The Henry Tax Review took special note of state royalties, identifying over 60 different and complex royalty arrangements (Australian Treasury 2009: Table 2.19). A key finding was that States tended to under-price mineral resources in their royalty systems (given the level of profit derived, in particular, from iron ore and coal in the last decade). This un-used State fiscal capacity caused the HFE issues for Western Australia, described above. In 2012, the Gillard Labor government enacted a mineral resource rent tax (MRRT) to apply to iron ore and coal; however, this reform failed, and on a change of government, the MRRT was repealed. There is no scope here to discuss the complicated tax and federal issues arising from the MRRT, or why it failed (see, e.g., Eccleston and Hortle 2016; Murray 2015). However, one consequence of the enactment of the MRRT—and perhaps a contribution to its failure because of the treatment of State royalties in that regime – was the reform of royalties in a number of States, leading to them raising more revenue from mining in their jurisdiction (e.g. de Souza et al. 2017, Murray 2015). Royalties remain important revenue sources for some State governments, as indicated in Sect. 3 above. This will continue to be taken into account in the HFE process but, in effect, to a more limited extent in future.

6 Vertical Fiscal Imbalance

6.1 Australia’s High Vertical Fiscal Imbalance

Vertical fiscal imbalance (VFI) arises when subnational governments have inadequate revenues to fund their expenditure responsibilities. Australia’s VFI is one of the largest of any federation (Bird and Smart 2009; Koutsogeorgopoulou 2007; Webb 2003). The Commonwealth raises more than 80% of taxes in the federation, and controls the most important tax bases of income and consumption as explained in Sect. 3 above. Figure 2 shows the share of State own-source and grant revenues, divided into general revenue assistance (GST revenues) and specific purpose payments (conditional grants). Overall, State and Territory governments raise just over half of the revenue required to finance their expenditure responsibilities and the balance must be provided by grants from the Commonwealth Government.

Fig. 2

(Source Commonwealth of Australia 2018b, Figure 1). Total state revenue figures are sourced from the States’ 2018–19 Budgets, with the exception of SA, which is sourced from its 2017–18 Mid-Year Budget Review. Payments from the Commonwealth figures are sourced from the Commonwealth’s 2018–19 Budget)

State own-source and grant revenue, 2017–18

The high level of VFI in Australia was one of the issues addressed by the 2015 White Paper for reform of the federation, which was quickly abandoned (DPMC 2015). However, the problem existed from the beginning of federation. It was left by the founders in 1901, to be resolved in the arena of federal-state political negotiation rather than by legal allocation of taxing powers. However, VFI has been exacerbated in ways that could not have been foreseen in 1901, through the judicial interpretation of the meaning of “excise” and the takeover of the income tax base by the Commonwealth Government as explained in Sect. 3.

Bird and Smart observe that vertical fiscal “imbalance” has long been seen to require “balance” as a solution, such that “every tub should stand on its own bottom in the sense that the revenues from sources under control of each level of government should be sufficient to finance expenditures” (Bird and Smart 2009: 73). But it is easy to make a fetish out of “balance”. The main argument that fiscal capacity should be "balanced in a federation is that subnational governments need a “hard budget constraint” to ensure financial responsibility (Australian Treasury 2009: 671; Bird and Smart 2009: 119). If a government thinks it is going to be bailed out, or that it can come back and request more money next year, it will become inefficient and wasteful in its spending. However, achieving a hard budget constraint does not necessarily require that state and local governments must fund all or even most of their spending from their own taxes. As explained by the Australian Treasury (2009: 672):

In a developed federation, it can be expected that there is some base level of goods and services that all sub-national governments will provide and that requires a commensurate amount of revenue. This revenue can be provided by the national government. … So that they can meet the preferences of their citizens, sub-national governments should have the capacity to raise tax revenue to fund significant marginal expenditure beyond the base level. … the question becomes how much of their own tax revenue State governments need in order to fund significant marginal expenditures.

It has been said that this is outcome of Australian fiscal federal system—thus, “the normal accountability that economists talk about is present” (Boadway 1997: 166). The States raise marginal revenues from State taxes which they do occasionally increase or decrease in response to local political demands, and in competition with other states, but a significant proportion of their core functions are funded from federal grants.

The principle of a hard budget constraint does not indicate how much revenue should be raised by taxation at the subnational level to fund “significant marginal expenditure”. Tax sharing arrangements involve guesswork about how much revenue should be allocated to the subnational level and may be too rigid for governmental needs. For example, the tax-sharing arrangement briefly in place in 1976, under which State and local governments received a fixed proportion of Commomwealth income tax revenues, created a hard budget constraint that was both inflexible and unpredictable. States were dependent on a fixed share of federal revenues that they could not modify and took direct cuts to their budget if the federal government cut its tax rates.

Bird and Smart further argue that greater transparency is needed through the allocation of taxation and expenditure responsibilities, so that “citizens [are] less confused as to what exactly they are paying for in taxes and who should be held accountable for both taxes and expenditures” (2009, 73; 83). In Australia’s federation, State and local governments may be more “accountable” to the Commonwealth government, because of their dependence on grants, than to their local population. Saunders suggests that both the responsibility of the executive to parliaments, and the accountability of elected representatives to citizens, may be “distorted” if revenues come from “formula-based” grants from another tier of government rather than from direct taxation (2000: 100).

However, in a federal system in which all levels of government are democratically elected, it may be better to think of accountability as layered (Rubin 2006). The Australian system ensures accountability of governments to the citizens as a whole, via the Commonwealth Parliament (which legitimately taxes and appropriates grant revenues). If there is a mismatch between the political party elected at Commonwealth level which raises the revenue, and that elected at State level which spends it, does this make the governments less accountable? This situation is not uncommon in Australia. On one view, a Commonwealth government is likely to be stricter with its grants to States of a different political persuasion than otherwise, potentially enhancing the budget constraint. On the other hand, State dependence on federal grants may hinder sensible planning about major expenditures, while detailed federal direction in specific purpose payment agreements may not be appropriately designed, monitored or implemented. A consequence may be that neither States nor the Commonwealth is properly accountable for the use of the funds or outcomes from grants.

6.2 Reforming the GST

The federal financial arrangements explained in Sect. 5 mean that half the revenues distributed to states and territories are “sourced” from the GST as “general revenue assistance” subject to HFE (as shown in Fig. 2). Since 2000, with numerous albeit relatively minor amendments to the GST law have been unanimously agreed, in line with the Agreement principles of maintaining the integrity of the tax base, simplicity of administration and minimising compliance costs. For example, recently, the Commonwealth, States and Territories agreed to extend the GST base to cover digital service downloads (the “Netflix tax”) and imports of low-value goods (the “Amazon” tax).²⁵

However, the chief limitation of the GST is the originally enacted base and rate. To date, no government has been prepared to address the challenging equity and political issues associated with GST reform that would raise the rate or broaden the base of the GST so as to raise more revenue. Australia’s GST raises a lower share of total revenue than do similar consumption taxes in many other countries. It is levied at a rate of 10% with significant exemptions in the base (about half of the household consumption base is exempt). The decline in share of household spending and low GST coverage is illustrated in Fig. 3.

Fig. 3

(Source NSW Review of Federal Financial Relations, Charts 4 and 5, Discussion Paper, 2019, p. 15)

GST coverage (consumption)

The NSW Review concluded that the GST does not raise enough revenue to fund core services and it is no longer a “growth” tax base for the states (NSW Government 2020; confirming earlier findings, e.g. GST Distribution Review 2012). The new “reasonable equalisation” approach to HFE and distribution of GST revenues, explained in Sect. 5.2 above, commits the Commonwealth government to ost the pool of revenue to be distributed as general revenue assistance beyond the revenues raised by the GST itself. The increase will reach $9 billion by 2028–29. This is an acknowledgement of the need of State and Territory governments for more revenues to deliver on their core expenditure responsibilities of education and health.

6.3 A New Approach to Revenue Sharing Between the Commonwealth and the States

Attempts to reform Australia’s model of fiscal federalism in the last two decades have almost all “non-starters” (Bruerton and Hollander 2018). The Henry Tax Review (Australian Treasury 2009) initiated by the Rudd Labor Government raised many issues to do with fiscal federalism and state tax reform. The Abbot Liberal/National Government White Paper (DPMC 2014), with substantial research and consultation, was abandoned in 2015 by Prime Minister Turnbull of the same party. The Re:Think tax reform process (Australian Treasury 2014) launched by the same government was abandoned. The NSW government has proposed State tax reform following its Review (NSW Government 2020) but it is unclear if this will proceed. A key issue in all of these reform processes is whether some part of the tax base should be “returned” to the States, or whether a better revenue sharing approach should be adopted.

The national income tax law and administration has generated significant economic and fiscal gains for Australia and has avoided issues of tax competition, base erosion and complexity. In this author’s view, it would be a backward step to “return” income tax law-making or collection to state governments. History suggests that the Australian population would oppose the enactment of State income taxes. Allocating some (necessarily limited) income tax base to the States would be unlikely to address fiscal sustainability challenges and may lead to tax competition. It could also lead to distributional issues across rich and poor states (see, e.g., Eccleston and Warren 2015). Shifting the taxing authority to subnational governments has significant disadvantages.

In this author's view, sharing income tax revenue is a different matter and has much to recommend it. The income tax (as the largest federal tax besides the GST) implicitly funds other grants to the States but, unlike the GST, State and Territory governments do not bear any responsibility for maintaining the integrity of the income tax base. They are not incentivised to carry out economic reforms that would generate a fiscal benefit for the Commonwealth government through greater income tax revenues, rather than a direct benefit to States. The federal government has a political incentive to reduce income tax rates or revenues which is unchecked by state governments that must maintain core public expenditures. The HFE reforms outlined in Sect. 5.2 expand the size of the pool to be distributed to the States, implicitly recognising the need for sharing of more revenue. However, the “top-up” of the GST pool for general revenue assistance delivers additional amounts out of Commonwealth consolidated revenue without any commitment from States to reform their own tax systems, or to take any responsibility for the management of the federal tax base.

A reform to federal financial arrangements that retains the law and administration of the income tax and GST at the Commonwealth level but shares the revenue of both income tax and GST on a more equal basis with the States and Territories could provide more, and more secure, revenue for their core expenditure responsibilities. This could be implemented as part of a new federal financial agreement in exchange for a State tax reform package. The new Federal Financial Agreement can be implemented in legislation and reformed institutions; an amendment of the Constitution would not be necessary. An alternative could be to amend the Constitution to embed the financial arrangements, and establish a Financial Council, similar to the Loan Council, that would from time to time govern the federal financial agreement. However, the referendum process for Constitutional amendment makes this difficult to achieve.

6.3.1 Inspiration from the German Revenue Sharing System

The reform proposal suggested here takes inspiration from the German system approach. While superficially different, the German fiscal approach is similar in many respects to Australia. In Germany, as in Australia, the personal income tax, corporate income tax and Value Added Tax (VAT) are legislated at the federal level and contribute about 80% of tax revenues.²⁶ In both countries, taxes under subnational control are comparatively negligible in scope and revenue. However, in Germany, unlike Australia, the Basic Law establishes rules for sharing of revenues from each tax between the federal, State (Länder) and local governments. Most importantly, the personal income tax, corporate income tax and VAT in Germany are established as “joint taxes” (Gemeinschaftssteuern) under FRG Basic Law, Art 106 and are thereby subject to approximately equal division between the central government and the Länder, with a component distributed to local governments. The division of revenues from these core taxes is made on an entitlement basis, without conditions.

Most comparative analyses of fiscal federalism obscure the centralised nature of German taxation, implying that Germany has low VFI (e.g. DPMC 2015, Figure 3.1; see also Kim 2015). In fact, the centralisation of taxation in Germany is strikingly similar to Australia. The key difference is that the Basic Law provides that where any revenues from a tax flow to the Länder, the tax law must receive the assent of the Bundesrat which is the legislative organ that represents the Länder at the federal level, comprising delegations appointed by their governments. Nonetheless, as Fuest and Thone write (2008: 16):

The design of the shared taxes is controlled by the central government. The Länder governments admittedly have joint influence on tax legislation through the Bundesrat. But the Bundesrat is a federal legislative organ. The collective voice of the Länder governments [in that chamber] has little to do with subnational tax autonomy, seeing as the legislators of individual Länder - the state parliaments - have no influence on tax legislation.

The conceptual starting point for the German revenue sharing system is that there is an entitlement to the “joint tax” revenues in the Länder which are then accountable to their own population for expenditures. The “joint tax” revenues to which they are entitled are not subject to federal conditions, as is the case for the Australian general revenue assistance grants of the GST (topped up), but in contrast to Commonwealth Specific Purpose Payments. There are some circumstances in which conditions are required in the German system, for example for “joint tasks” for the improvement of living conditions; to fund large investments in particular states needed to ensure economic stability; or to equalise economic power across the federation, promote economic growth or deal with disasters or emergencies (Arts 91a and 91b, 104b of the FRG Basic Law). No doubt, the range of joint taxes, and federal control, is a matter for constant political debate, as in any federation (see, e.g., Jochimsen 2013).

6.3.2 Establishing the Income Tax and GST as “Joint Taxes” in Australia

There seems never to have been any serious consideration of the German revenue-sharing approach as a model for Australia. The German model was briefly discussed in the Federation White Paper Issues Paper 5 (DPMC 2015) and was studied four decades ago (Rydon and Wolfsohn 1980; Mathews 1980). One reasons why the approach has been ignored is a preoccupation with the Bundesrat as the legislative forum for a state voice on centralised tax laws in Germany. The inadequacies of the Australian Senate for achieving this goal may have been perceived as an obstacle. Thus, Mathews observed in 1980 that the German system is “more successful than the Australian system seems to be in reconciling political power and fiscal responsibility” (Mathews 1980: 341).

However, the Australian institutional fiscal landscape has changed significantly since 1980. The Agreement on Federal Financial Relations could be renegotiated to establish the personal income tax and the GST as “joint taxes”, the revenue from which is shared on an entitlement basis among Commonwealth, State and Territory governments. It is important to share both income tax and GST revenues because the GST is too small to fund core state expenditures, while the income tax is too large “Joint taxes” would be subject to HFE. Other taxes such as excises and tariffs serve policy goals that are better dealt with at the Commonwealth level, including public health, environmental policy and trade policy. It would be appropriate for all levels of government to have a direct stake and responsibility for the sustainability of Australia’s most important taxes in the longer term. Scope for conditional and special grants from the Commonwealth would remain, under s 96 of the Constitution. Different sharing proportions could be applied to each kind of tax and local governments could be included with a specific, smaller share, as is done in the German Federation. The company income tax and superannuation fund taxes are legally part of the general income tax law in Australia; however, it is possible to track company and superannuation tax revenues, rate and base separately and so they may be either included or excluded from the revenue sharing agreement.

In Germany, although tax law is centralised, the administration of taxes is handled by Länder authorities that act on behalf of the federation where the revenues go to the central government (Art 108 of the FRG Basic Law). The opposite occurs in Australia, where the income tax and GST are administered nationally by the ATO. However, this should not be an impediment to extending revenue sharing to personal income tax. The cost of administration of the GST is shared between the States and Territories. The GST Administration Performance Agreement (2020–23) which requires them to pay the Commonwealth for the agreed costs of administering the GST.²⁷ This approach could be extended to the future management of the personal income tax as a “joint tax”.

When the total funds currently granted from the Commonwealth are considered, the proposal to share equally on an entitlement basis the revenues from the personal income tax and GST would not be a dramatic change. The estimate for personal income tax revenues in 2021–22 was about $240 billion, and for GST revenues about $72 billion, or $312 billion in total.²⁸ For the 2021–22 year, total payments to the States were estimated to be $167 billion.²⁹ An agreement to share equally the “joint tax” revenues from personal income tax and GST with the State and Territories would transfer a total of $56 billion. This could be expanded by including some corporate income tax revenue as a “carrot” to encourage states to participate in a package that could include reforming state taxes.

This “joint tax” proposal would not necessarily increase funding to the States, but it would change the conditionality of intergovernmental transfers. The equal sharing of personal income tax and GST revenues on an entitlement basis would remove much of the scope for conditionality for Commonwealth payments to the states, currently delivered in Specific Purpose Payments associated with agreements. However, the new approach does not have to eliminate conditionality from federal-State grants. The overall allocation to States and Territories could be determined through the “joint tax” approach and then a second stage could allocate a proportion of this total to partnership and specific purposes agreements establishing national indicators and standards. It should be noted that a proportion could also potentially be shared with local governments.

A modified approach could be to share a lesser proportion of the income tax and GST with the states on an entitlement basis, with the remainder to be subject to partnership and specific purpose agreements as is done currently. For example, the Intergovernmental Agreement could transfer one third of personal income tax and GST revenues unconditionally to state and territory governments. This would be a 50% increase on the general revenue assistance of $75 billion in 2021–22 and it would leave room for negotiation of partnership or specific purpose grants above that threshold. Such a change may be a more incremental and acceptable move from our current system to a more sophisticated revenue sharing system in future.

A further challenge concerns the relationship between the sharing of personal income tax revenue, GST revenue and HFE. There may be a good argument that only a portion of the distributed “joint taxes” should be equalised horizontally across states. This requires insulation of that proportion from the HFE relativities calculation, which could be achieved by a sequential distribution. This is likely to be a matter of significant political debate.

6.3.3 Towards Limited Sharing of the Income Tax Base?

The NSW Review proposed a limited, experimental, sharing of federal income tax revenues with the states. The proposal differs from the “joint tax” proposal above, as the sharing would be “based on the state in which the income is earned to ensure states are accountable for revenue raising and expenditure” (NSW Government 2020: 59). The income tax revenue is proposed to be quarantined from the CGC’s calculation of GST relativities. The stated goal is to deliver greater revenue to a state which undertook reforms to support economic recovery, and to ensure that benefits are not redistributed to other states. This would require a calculation of the “entitlement” of a state to personal income tax. It is not clear how this would be achieved other than on a per capita basis. The Review proposed a pilot to be designed by the NSW government with the Commonwealth government, for example substituting a set of “smaller” agreements (not including the large education and health grants); there is not, yet a response from the Commonwealth on its view of this proposal.

7 Federal Fiscal Policy for Indigenous Self-Government

7.1 Australia’s Failure to Recognise Indigenous Fiscal Self-Government

An increasingly important challenge in the Australian federation is recognition of Indigenous sovereignty through treaty and other governance recognition processes. Other challenges include fiscal compensation for land taking, and revenue sharing from exploitation such as mining. The movement for the Recognition of Indigenous first peoples in the Australian Constitution (Davis and Langton 2016) produced the Uluru Statement which calls for a First Nations voice in the Commonwealth Parliament and for agreement process with all Australian governments.³⁰ The Albanese Labor Government was elected in May 2022 on a platform that included a commitment to implement the Uluru Statement. Before these developments, Indigenous peoples such as the Dja Dja Wurrong and Yorta Yorta in Victoria and the Noongar through the South West Land and Sea Council in Western Australia, had taken significant steps towards self-determination in substantial agreements with State governments that cover land, income, assets and services (Langton and Longbottom 2012).

However, there remain many limits on the exercise of Indigenous self-governance and recognition of land title (see Langton et al. 2003, 2006). Indigenous organisations around the country, especially in remote areas, often struggle to develop effective self-governing processes, lack capacity and confront unstable and poorly funded administrative and institutional arrangements for the implementation of agreements and community governance.

State governments, under the Constitution; and, by legislation, Territory and local governments, are exempt from Commonwealth taxation. Similarly, many Indigenous governing entities, such as Native Title and Land Councils are exempt from taxation. Indigenous corporations, associations and trusts are usually not-for-profits that qualify as charitable entities which are exempt from federal and state taxation. The exemption from taxation vacates some fiscal space for the raising of revenues by Indigenous organisations from a range of sources. However, there is little formal recognition of their responsibility for Indigenous expenditures. These processes are not recognised as fiscal self-government for the community concerned or in the federation.

Public and policy attention about fiscal matters for Indigenous peoples usually focuses on the apparently “high” level of government expenditures “on” Indigenous people and widespread failure of federal and state governments in delivering policies to enable Indigenous peoples to share in the economic wellbeing of the nation. The Productivity Commission Indigenous Expenditure Report has the purpose to contribute to “closing the gap” to overcome Indigenous disadvantage. The most recent report finds, that in 2015–16, “nationally, Australian Government plus state and territory government direct expenditure on services for Aboriginal and Torres Strait Islander Australians was AUD$33.4 billion” or an estimated $44,886 per capita expenditure, “around twice the ratio for non-Indigenous Australians” (Productivity Commission 2017: xii). The estimate includes a share of mainstream expenditures, and Indigenous-specific expenditures. The main reasons for higher expenditures are greater intensity of service use because of greater need; for example, health needs; a younger population therefore greater per capita use of childcare and schooling; and greater per capita expenditure on incarceration of Indigenous compared to non-Indigenous people. A further reason is the higher cost of providing services to Indigenous people in remote locations or targeted support such as Indigenous liaison officers in hospitals.

The second way in which Aboriginal and Torres Strait Islander people are taken into account in the fiscal federation is through the HFE process for equalising GST revenues across the States and Territories, discussed in Sect. 5. The HFE process takes account of a factor of “Indigeneity” and a factor for “remoteness”. Together with mining production (royalties), these two factors are among the most important in the HFE relativities, as illustrated in Fig. 4 (and see Table 2).

Fig. 4

(Source Commonwealth Grants Commission, trends in horizontal fiscal equalisation [Information Paper CGC 2016-01, April 2016], Figure 5)

Main contributors to relativities for horizontal fiscal equalisation

The “Indigeneity” factor in the HFE formula reflects increased cost and higher demand for services affecting education, health, justice services, welfare and housing and services to communities. The distribution of the Indigenous population combined with the large “per capita” expenditure allocation is the reason for the importance of this factor. The State of NSW has the largest population of Aboriginal people by number but they comprise a small fraction of the state's population and hence New South Wales is a net donor on this factor. In contrast, Aboriginal people make up more than 30% of the Northern Territory's population. The “remoteness” factor takes account of community size, distance, cost of delivery of services such as electricity, and road length. This also reflects particular features of service delivery for Indigenous people in remote communities.

The additional funding under HFE is paid to State or Territory governments in the grants process. There is no entitlement to this funding by Indigenous peoples themselves in the State or Territory, and no direct accountability or consultation with Indigenous people about this funding. The last time a significant allocation of funding was explicitly made by the Federal Government to an Indigenous representative organisation was to the Aboriginal and Torres Strait Islander Council (ATSIC), which was established in 1990 and abolished in 2005 (Pratt and Bennett 2005). Since then, Australia has not had a representative Indigenous body with a budget for services.

In sum, Australia’s federal fiscal arrangements have not kept up with the significant developments in recognition of Indigenous sovereignty through treaty processes, or the need for better support for self-governance, agreements and native title. A greater recognition of Indigenous self-government requires attention to be paid to fiscal matters, especially grants, revenue sharing and responsibility for expenditures.

7.2 Inspiration from Canada for Recognising Indigenous Fiscal Self-Government

In contrast to Australia, developments in Canada during the last two decades show that federal fiscal policy has been recognised as fundamental to the realisation of Aboriginal self-determination. The evolving Canadian approach to federal relations explicitly incorporates recognition of Indigenous first peoples (see, e.g., Prince and Abele 2003). This part presents ideas drawing on developments in fiscal federalism and public finance concerning First Nations’ fiscal self-government in Canada, (see further Stewart 2017).

Canadian treaties with First Nations address tax and expenditure policy, revenue sharing and own-source revenue responsibilities. Some agreements address the relationship between First Nations and provincial governments, or allow for a sharing of taxing power and “fiscal space” between provincial and Aboriginal governments (Boucher and Vermaeten 2000: 151). For example, the Nisga'a Treaty contains taxation provisions and represents “the beginning of a greater attempt to weigh Aboriginal interests in tax policy” (Borrows and Rotman 1998: 809). Some tribes have established self-governing territories that are responsible for delivery of all services to the local area and levy taxes on their own populations as well as drawing on other revenues to fund services. The Northern Territories exercise powers delegated by the Canadian Parliament. Land claims settled in the North, for example with the Nunavut, Gwich'in, Sahtu and the Dogrib, include royalty sharing with the Canadian government with respect to mineral, oil and gas.

In 2006, the Canadian Government enacted the First Nations Fiscal Management Act, an optional regime to promote the economic development of participating First Nations by empowering them to collect property tax and to borrow. More than 300 First Nations are scheduled under the Act and many collect property tax or other local revenues under its authority. The Act established institutions with shared governance including a First Nations Tax Commission which regulates the approval of property tax and other local revenue laws and a First Nations Finance Authority, which has since 2014 issued more than CAD $1.3 million in Indigenous finance bonds for participating First Nations governments to finance community projects.³¹

In 2015, the Canadian Government released a policy setting out the fiscal approach for self-government for First Nations that have a comprehensive land and self-government agreement (Government of Canada 2015), presented as “Canada’s collaborative self-government fiscal policy”.³² Principles include that all levels of government share responsibility for the financing of Aboriginal self-government, to ensure that communities have access to public programs and services that are reasonably comparable to those available to other Canadians living in communities of similar size and circumstance; and that Aboriginal governments should receive reasonably consistent and equitable allocations of federal funding.

What can we bring to Australia from the Canadian experience? First, a move towards recognition of Indigenous fiscal self-governance in Australia would recognise expenditure responsibilities and independent revenues where possible and agreed by the communities and other levels of government. Importantly, suggesting that Indigenous organisations can take a level of responsibility for fiscal self-government, and may have access to resources such as native title payments and benefits, does not absolve the federal, state, territory and local governments in Australia of their responsibilities to Indigenous and other local citizens. The principle of equalisation of services, which is set out in the Canadian First Nations fiscal governance approach, would also be critical in Australia.

A pathway towards fiscal self-government could be negotiated based on the Indigenous land and community agreements and organisations which now exist around the country or linked to ongoing treaty processes. Accompanying the recognition of Indigenous fiscal self-government, a collaborative fiscal policy should be established that explicitly recognises an entitlement to a share of revenues by Indigenous self-governing organisations. State, Territory and Commonwealth governments must continue to deliver services. However, as Indigenous fiscal self-government is established, some funding should be redirected through self-government structures of Indigenous communities which would be supported to develop capacity to provide such services.

8 Future Directions

In 2020, the relatively stable process of intergovernmental agreement-making and grant distribution was disrupted by the COVID-19 pandemic. State and Territory governments have been highly visible during the pandemic, as most governmental interventions, both prohibitive and enabling, have been carried out by State governments, applying legislative powers of emergency and disaster. Initially, a reasonably cohesive national response was initiated under the National Cabinet formed to respond to the crisis. Since COAG ceased operations and the new National Federation Reform Council was formed, with it is unclear what shape federal governance will take in future under the Albanese government.³³

No details have been provided about future collaborative governing arrangements since the abolition of COAG. A failure to develop alternative arrangements would leave a significant vacuum in detailed inter governmental negotiation and cooperation across a range of fields. In the midst of the pandemic, the NSW Review of Federal Financial Relations sought to restart the debate about taxation and allocation of responsibilities between State and federal governments. Albanese government is unlikely to make any dramatic changes before its budget scheduled for October 2022.

The Australian federation under the Constitution of 1901 has delivered, over the last 120 years, a generally stable and fair democracy and economic prosperity shared among most Australians. Nevertheless, today, reform is needed to address fiscal challenges. It is clear that current arrangements do not serve Australians well. The need for reform has been exacerbated by the COVID-19 pandemic, but the significant fiscal challenge of the pandemic and need to restart the economy is likely to be the first priority of the Commonwealth government. The fiscal sustainability of state and territory governments, which have core responsibility for delivering core government services of education, health, policing and infrastructure, is the first significant challenge discussed in this chapter. The second challenge is how to achieve a fiscal bargain that will support needed State tax reform to release resources to the economy and improve efficiency and equity overall. Chapter takes inspiration from Germany and argues that a "joint taxation" approach for income tax and GST is suitable for Australia. The second challenge to reform HFE in response to significant disputes between States and Territories; this has been partly addressed by recent reforms including a top-up of revenues. The third challenge to address the lack of any policy or legal framework for Indigenous fiscal self-government in Australia. This chapter recommends the model adopted in Canada for Indigenous fiscal self-government and support.