11 February 2016
by Laura Tingle

John Howard's bastard tax turns up to ruin the Coalition party

Some of the biggest questions in the lead-up to the unveiling of John Howard and Peter Costello's 1998 tax package were how the government would get the states to agree to the introduction of a GST and the removal of some state taxes, and what could be done to address the states' diminishing revenue base.

Howard's outside-the-square solution was to do something no one expected: offer to give the states all the revenue that a GST would raise.

It was seen at the time as a master stroke, providing a revenue base to the states which would grow over time – a model that would get rare agreement from the states for major change and block pressure for the GST rate to rise, as it would require the agreement of all state and territory leaders.

Great in theory, but throw forward to 2016 and this formulation has made the GST Australia's bastard tax: owned by no one but claimed by everyone when the will is being read. At the same time, the Coalition dramatically locked in a massive long-term "middle class welfare bill" that is now making federal tax reform almost impossible.

Having characterised the GST as the state's tax – even defining it as a state tax in the budget papers as a way of reducing the apparent federal tax take – federal government has created a nightmare for both levels of government.

Whatever the accounting fancies, voters see the GST as a federal tax. The federal government wears the odium of a conversation about putting the GST rate up or of broadening the base.

Yet the confusion of voters about what is exactly the purpose of the current tax reform debate was amply illustrated by this week's Essential Report poll.

Asked to nominate the first and second reasons why they believed politicians were talking about tax reform, 58 per cent of voters thought it was about addressing the budget deficit; 30 per cent thought it was to maintain funding to health and education; 26 per cent to encourage growth; 14 per cent to make the system fairer; 10 per cent to boost employment; and 5 per cent to invest in infrastructure.

An honest 20 per cent said they didn't know.

It's not just voters who seem confused.

Feds claiming GST as their own
What the federal government has been doing for the past few months is quietly claiming the GST for its own: arguing that it can use the revenue raised from increasing the tax rate from 10 per cent to 15 per cent to fund massive federal personal income tax cuts.

You can understand why the states might feel a little aggrieved to find the feds taking liberties with "their" growth tax (even if it has not proved to be quite so "growthy", as exemptions such as fresh food negotiated to get Senate agreement to the tax have seen its rate of growth wither over time).

For its part, Canberra feels aggrieved that the states seem to take the view that funding their activities simply involved the federal government bearing the brunt of raising the tax then sharing it with the states.
As the prime minister observed this week "the states have got themselves into a way of thinking that every time they need more money, they just go to the ATM of the federal government".

"When you say to the states, as we did at COAG at the end of last year, 'OK you guys, you are sovereign governments, you have tax bases of your own. You have got actually very efficient tax bases, you've got land tax, you've got payroll tax, what are you going to do about that?' And they say, 'Oh, that would be politically difficult', and you say 'Well, that you are asking us to put up the GST, do you reckon that is politically easy?'"

Where all this leads us is to point out that, beyond the immediate shift of rhetoric on the GST this week, something rather momentous has happened in federal politics and federal-state relations.

The federal government has essentially confirmed what it has been saying for some time, but which the states have not really believed: it won't increase the GST and, as a result, the states can give up any residual hopes that they might get to share the increased revenue a higher GST would produce to fund their budgets.

Prime Minister Malcolm Turnbull and Treasurer Scott Morrison are effectively telling the states they are going to have to raise their own taxes.

Of course, the federal leaders argue that this would not be necessary if the states were just to be good and cut spending. But this is a little disingenuous given that at least part of the states' problem is the $80 billion of federal cuts to funding for services overseen by the states.

But if the federal government takes this tough line, it really shifts the drama of our ongoing tax and spending debate to the states.

The feds might have some tax cuts in the budget to offset the effects of fiscal drag funded by changes to things like super. But the real action will be at the state level, where the huge imbalances between taxing powers and spending responsibilities is finally, finally coming home to roost.

Choices for the states
So what are the options open to the states?
One (however unlikely this seems) would be that the states agree among themselves to approach the federal government and say "We want a 15 per cent GST, and we want all the revenue it generates (after compensation) to fund the services we are responsible for providing."

After all, the Prime Minister has talked about not overseeing a rise in federal taxes, but has invited the states to raise taxes if they are so keen on continuing to spend at current levels.

It seems that, on the basis of the government's argument about the importance of tax reform generating growth, such a request would fall on deaf ears as far as the Treasurer is concerned, because it would not meet his test that tax changes have to generate growth.

The other option is the idea of sharing the income tax take under an explicit formula where the states get a guaranteed split of the revenue in exchange for giving up, or seeing significantly reduced, the payments they get from the feds to fund jointly funded activities such as schools and hospitals.

There is some sympathy within the federal government for this idea, and also some sympathy for the states on the basis that the 2014 budget tax cuts did involve a massive cost shift by the federal government which decency suggests it should assist them to address.

But let's be honest here. All that has happened this week is that the federal government has shunted the political problems onto the states.