Federation reform is not yet a ‘barbeque stopper’ and perhaps never will be.
However the way we distribute responsibilities between various levels of government makes a profound difference to productivity, service quality and the overall well-being of our nation.
While we have a good federation that has served us well since 1901, the opportunity is to have a great one.
A great federation could underpin an economy aiming for growth, productivity, adaptability and innovation.
Today, I would like to outline why the Government believes that we need to reform our federation, the direction we are heading, and what the opportunities are from reform. I would like to invite you, the Centre for Independent Studies, and the broader public to continue to contribute to the debate about our federal structure as we undertake the Federation White Paper process.
It might not be a barbeque stopper, but we do need to have a broad public discussion about how we can improve. A White Paper process is aimed at doing exactly that.
It is fitting to be having this discussion at the Centre for Independent Studies. You have been at the forefront of federation debate for some time, including through your forum last year with The Hon Nick Greiner, Robert Carling, Anne Twomey and Jeremy Sammut.
Indeed, one of the stand-out quotes from that forum was from Nick Greiner who captured the essence of the federation debate in stating: “the basic question is who does what to whom and why or who should do what to whom and why.”
In some respects this is the central question that has been guiding the work to date.
As you would be aware, there are very few areas of government responsibility that fit entirely within one level of government’s jurisdiction – where the one level raises the money, delivers the service and is accountable back to the people.
This then leads to all sorts of accountability and practical problems, which I will get to later.
Our aim, at least in part, is to get closer again to that objective – for governments to be fully responsible in their space. However, it is more than just trying to get cleaner lines of responsibility. We are trying to deliver better outcomes for citizens and ideally create incentives in the process which lead to ongoing improvement.
This is a challenging area, but there is considerable goodwill across the levels of government to make a difference. Good progress has already been made.
The reform process is being capably guided by an Expert Advisory Panel comprising former South Australian Premier John Bannon, former Victorian Treasurer Alan Stockdale, former WA Attorney General Cheryl Edwards, ACU Vice Chancellor Greg Craven, Business Council CEO Jennifer Westacott, and former Queensland Public Service Commissioner Doug McTaggart.
In addition, and in the background, the Secretary and senior officials from Department of Prime Minister and Cabinet have been meeting regularly with their counterparts in the States and Territories over the past months.
THE EVOLUTION OF OUR FEDERATION
Before delving into the practical problems in some key portfolios, it is worth noting the evolution of our federation.
We actually started out with very clear lines of responsibility between the States and the Commonwealth.
Essentially, the Commonwealth looked after a select number of matters as set out in the Constitution, including defence and foreign affairs. The States were responsible for everything else, such as funding and operating public schools, public hospitals, public transport, roads, police, housing, and planning.
Under our constitution, the states still have responsibility for these things, but overtime as the Commonwealth’s fiscal powers increased (and the states decreased) the Commonwealth started getting involved in areas that traditionally weren’t its responsibility.
There is barely an area of government today which at least some members of the public don’t call for the federal government to be involved because of its “national importance”. Ask yourself a question: what area of policy doesn’t have “national importance”?
During the Rudd years, we went through a period of what was called ‘cooperative federalism’. The intent seemed fine in principle, but 6 National Agreements, 51 National Partnership Agreements and 230 Implementation Plans later, did it make a difference, or just lead to a whole lot of bureaucratic reporting?
The Victorian Government said the number of reports they must submit to the Commonwealth under these arrangements had increased from 90 in 2008-09 to 180 in 2012-13.
Can the Commonwealth really be a good agent for taxpayers in holding state governments to account for service delivery? Aren’t taxpayers their own best agent through the ballot box?
MAKING PROGRESS IN KEY PORTFOLIO AREAS
There are two ways of reforming the federation: realign the revenue disparity (which often drives the overlap in responsibilities); or realign the portfolio responsibilities.
The Commonwealth and state governments have decided to tackle the problem from the latter perspective. That is, to work out what makes sense for each level of government to be doing first, and then to determine the fiscal implications of realigned responsibilities.
It is not quite as neat as this, but this is broadly the approach. Of course, the Tax White Paper also touches on revenue issues. Consequently, the two White Papers are working together in parallel.
Five portfolio areas have been agreed for focus: health, schools, VET, early childhood and housing.
Let me briefly touch on a few of the issues in some of these areas and the broadly agreed direction.
Health is the Commonwealth’s second largest area of expenditure, surpassed only by social security and welfare.
It is also an area where there is complete overlap between state and commonwealth governments. Consider:
- The Commonwealth funds the majority of primary care, such as visits to the GP, through the Medicare Benefits Schedule.
- The Commonwealth also funds the PBS.
- The states run the public hospitals, but the Commonwealth provides funding for about 37% of the costs. The Commonwealth of course provides the private health insurance rebate.
All up, total expenditure on health care was $155 billion in 2013-14, with total government expenditure more than $100 billion, or about 9.4% of GDP.
Health expenditure accounts for 25 to 31 percent of states expenditure and it has been growing well in excess of GDP growth.
There are really three core interrelated problems that have been identified from a federation perspective:
- Lack of political accountability in relation to health
- The growing cost of health care – who is responsible and how can cost growth be minimised?
- A rising incidence of chronic disease.
Better chronic disease management can address at least the bottom two.
Our system is largely geared for people who have a single problem. If you have a broken arm, or appendicitis, then our health system is world class.
However, with an aging population, chronic diseases are becoming more common and a larger part of the budget. The four most costly chronic disease groups constitute about 36% of the health budget.
When you have a chronic disease, you may be in and out of hospital, receiving GP care, perhaps physio and other primary care. Our public system is poorly set up for this. No one person oversees the patient; records are hard to transfer between providers.
If there was better coordination between GPs and public hospitals it has been estimated we could potentially avoid 600,000 hospital admissions of which 286,000 were for chronic conditions in 2013-14.
This equates to about 6.5% of hospital admissions. Getting this right would make a significant dent in our public hospital waiting lists.
These are not esoteric arguments; there are real and significant benefits to be gained for all Australians if we can do things better.
COAG has agreed to look at trialling coordinated chronic health care management which if successful could be rolled out across the country.
COAG has also agreed to undertake details investigation and modelling into what’s being called at the moment ‘Hospicare’. This is, where funding would follow an individual. The Commonwealth would fund a portion of the cost of each procedure – with the price to be determined by an independent body.
Importantly, the benefit would be payable regardless of whether the procedure in a public or private setting or whether an individual elects to be treated as a public or private patient. Put simply, your Medicare card will work in a private hospital.
The second financial ‘big ticket’ item is that of school education funding.
As you would be aware, the Commonwealth provides the majority funding for the non-government sector and is a minor funder of government schools, while the states are the majority funder of government schools and minor funder of private schools.
Is this an optimal situation? It depends on who you ask!
From a broader school education perspective, we have been doing poorly in the last decade. We have massively increased funding to school education by 37% above inflation over the last decade, yet our results have gone backwards, in absolute terms and relative to other nations.
In 2000, Australia performed equal third in science and equal second in mathematics and reading out of 65 countries and economies surveyed by the OECD. By 2012, Australia had dropped to equal 17th in mathematics, equal eight in science and equal 10th in reading.
How much of this is a federation issue versus a teacher quality and curriculum issue?
Certainly, there is overlapping political accountability for school performance. Each level of government is seen as responsible and no level fully accountable. State governments are keen to spend more on schools, but then often look to the Commonwealth for funding.
Arguably this could be addressed by placing all school funding in the domain of one level of government, but what would this do to the non-government school sector? At present, they provide the competitive tension in the system. How would they fare if the state governments had full responsibility, where state governments would be both a provider and funder of schools?
COAG considered a number of options, including the States and Territories taking complete responsibility for all schools, and another where the States would be responsible for all government schools and the Commonwealth would wholly fund non-government schools.
In the end, COAG did not agree to massive changes. They agreed that improving the standard of teachers is critical to delivering better educational outcomes.
Perhaps the greatest area to consider streamlining responsibilities lies in the area of vocational education and training.
It is an area that is complex, is frequently not delivering for students and employers, and has overlapping responsibilities across Commonwealth and the States and Territories.
The system itself is vital for our productivity and economic growth. In 2013, about 1.5 million people participated in government funded training delivered by TAFEs, other government providers, universities, community organisations and private providers at 25,000 locations.
A further 1.5 million students were full fee paying in private institutions or public VET institutions.
Several federation problems are apparent:
- An individual considering whether to undertake a VET course is faced with different choices in each jurisdiction with different fees, different rules for accessing government-subsidised places, differences in implementation of the ‘national entitlement’ to a training place and different regulatory systems in Victoria and Western Australia than the rest of Australia.
- This similarly affects national providers and firms who must transact different contractual requirements, pricing and even course duration requirements in each jurisdiction.
- The current split of funding responsibility – where the States operate subsidy schemes and the Commonwealth provides VET-FEE-Help – also makes it hard for governments to create the right incentives for students and providers.
The Commonwealth and States through COAG have agreed to consider an option of responsibility for VET shifting to the Commonwealth, provided the States could elect to remain TAFE providers within the national system.
Housing is a further area that is under consideration through the White Paper process and requires reform.
Collectively, governments spend $10 billion annually on housing assistance and homeless services. The issue for the Federation White Paper is whether this expenditure can be better used by reallocating roles and responsibilities.
In 2012-13, the Commonwealth spent $3.95 billion on Commonwealth Rental Assistance, which was a 40% or $1.6 billion increase from 2007-08. Some 1.3 million individuals and families receive assistance under this scheme. However, there are now some 150,000 people on the States’ public housing waiting lists. The number of public housing dwellings actually fell by about 21,000 between 2004 and 2014.
Broadly speaking, the Commonwealth approaches this sector as an income support issue whereas the States look at it as a bricks and mortar issue.
The three options being canvassed are essentially, first, the status quo with a commitment for the Commonwealth and States to address the causes of supply and affordability.
Secondly, the States take over full responsibility for policy, funding and service delivery but the Commonwealth retains responsibility for Commonwealth Rental Assistance.
And finally, the States take over full responsibility including administering what is now Commonwealth Rental Assistance.
Either way, there is recognition at COAG that we can’t keep going on the way we have been, and there must be reform in housing policy.
THE VERTICAL FISCAL IMBALANCE
Our efforts to date have been largely focussed on working through portfolio by portfolio to determine opportunities for streamlining of responsibilities and getting greater accountability. A good agenda has been established.
Clearly there will be fiscal implications from any changed arrangements. For example, if the Commonwealth ends up taking on full responsibility for training, then that has fiscal implications.
As well as fiscally equalising following any realignment of responsibilities, we also need to address the overarching vertical fiscal imbalance.
In my view, if we don’t address this, then any federation improvement may be short-lived.
We need to work with the States to look at their inefficient taxes, look at their responsibilities and the areas where they can do things better.
These reform processes need to be done in cooperation with the States if firstly, they are to succeed, and secondly they are to endure the test of time.
The mismatch between revenue and expenditure (or vertical fiscal imbalance) lies at the heart of the federation problems. The states’ revenue is insufficient to meet their expenditure responsibilities, while the federal government’s revenue exceeds its direct responsibilities.
All federations have some form of vertical fiscal imbalance, but Australia has one of the largest.
At the moment, 45 percent of state and territory funding comes from the Commonwealth either via the GST or through specific purpose payments. In comparison, in Canada, arguably the federation that is most like Australia, the figure is just 20 percent; in the United States, it’s around 25 percent.
As soon as the federal government becomes the primary revenue collector for all governments, a number of things happen.
First, it creates temptations for the Commonwealth to step into areas that are traditionally the domain of the states. At the beginning of the twentieth century, the Commonwealth had no involvement in schools; now it is seen by many as jointly responsible.
When the Commonwealth does get involved, it typically puts conditions upon the funds it provides. These conditions are sometimes at odds with state governments’ own priorities that might be more reflective of local citizen preferences.
All this adds to blame shifting, lessens accountability, and adds to cost and complexity.
Equally importantly, expenditure restraint is also lessened when there is a cash supply from elsewhere. A state government can raise expectations for more money for a certain service (such as smaller class sizes) and then put pressure on the Commonwealth to pay for it. Whereas if it had to ask the taxpayer directly for more money, it might determine that smaller classes are not worth the political pain of raising taxes.
This view is backed by the International Monetary Fund which notes a 10 percent shift from grants to taxing improves the fiscal balance by an average of 1 percent of GDP.
The Federation White Paper process will outline options as to how to address this fiscal imbalance.
One option is for the states to raise more of its own revenue, rather than relying on transfers from the Commonwealth.
For example, New South Wales Premier Baird had floated the idea of the states being able to levy their own income tax under a sharing arrangement with the federal government. This could follow the model suggested by the National Commission of Audit, or the Canadian model.
Under such a model, the Commonwealth would reduce its proportion of income tax collected to make room for a state tax.
Of course, until World War II, the states had sole responsibility for levying income tax. The “temporary” war measure has never ceased.
Others have suggested that the states should consider levying a property tax, or increase the GST.
Federation reform is never easy. However, since earlier this year, we have had a rare window of opportunity of having no Commonwealth or State election due for an 18 month period. We are seizing this opportunity.
Change is required.
The Discussion Paper is not a ‘solutions’ paper.
It presents options in the policy sectors of health, education, housing, and federal financial relations and governance.
Any changes must improve the standard of living and wellbeing of Australians through better services. And, they must be durable.
When the Green Paper is released there will be an opportunity for the public, and for organisations such as yours, to have a say—through a formal submissions process—on the options presented.
The Centre for Independent Studies has always provided thoughtful commentary on the GST and other social policy matters so your voice is important in the discussion on the reform of the Federation and why change is necessary.
The window has been opened for a serious discussion and it’s incumbent on all Governments and Opposition parties to take this opportunity to explore how we can do things better for the people we serve.
Reform of the Federation is an important part of the Government's economic and social reform agenda. It is fundamental to how we position Australia to embrace the opportunities in the global economy and lift our level of innovation and productivity - both of which are critical to economic growth.