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July 25th 2014 print

James Allan

Our Federalism’s Sorry $tate

Scotland may soon gain the authority to levy income taxes, a remarkable development in a nation with a unitary system entirely unlike that wrought by Australia's founding fathers. Turn back the clock or copy what is likely to happen in the UK, it wouldn't matter, but something needs to change

federationIn September of this year the voters in Scotland will be asked if they wish to separate from the rest of the United Kingdom.   As someone who hails from a long line of Scots-Canadian Presbyterians I hope they answer with a resounding and overwhelming ‘no’.  Union with England has been very good for Scotland and separation will be a disaster in financial terms. For what it’s worth, way back in late eighteenth century those wonderful men at the heart of the Scottish enlightenment, David Hume and Adam Smith, thought this as well.

If I am correct, and the polls seem to show that a ‘no, we want to stay in the UK’ outcome is very likely indeed, many of you may not have noticed what most pundits are saying, which is that British Prime Minister David Cameron will offer a stay-in-the-UK Scotland its own income tax powers.

Of course this is not unusual.  In Canada, in addition to a national, or federal, income tax, each of the ten provinces has its own income-tax powers and raises its own funds to pay for separate spending needs in areas such as health and education. The same goes for the United States, where each state decides for itself what income tax rate to levy in order to underwrite those spending matters that are a state responsibility.  Some US States have relatively high income taxes, some have low income taxes, and some US States charge no income tax at all.

That delivers one of the main benefits of federalism, namely competition.  If one state becomes sclerotic and high-taxing, people move elsewhere and, ultimately, the rules in that state change.  If you like your government services to be high end, you can move to a state that charges big time.  Federalism’s main virtues are that it satisfies more overall preferences of its citizens  and that competition in the long run delivers good consequences. Those wanting low taxes and low services can live in a place like Texas, while those wanting higher taxes and more government services can move to New York or California

In terms of economic benefits, federalism stands or falls on its ability to create a competitive environment where different States try and do different things and there is plenty of competition.  This is taken for granted in my native Canada, as well as in the US.  Here in Australia it is widely seen as bizarre.  Australia strikes me as the home of ‘one-size-fits-all’ thinking.  Everyone in every part of the country ought to pay the same taxes, get the same services, have the same education system, and so on.  So in Australia federalism has been reduced to pious talk of ‘co-operative federalism’.  As far as I can see there are no benefits at all that flow from having layers of state duplication, and then a sort of forced co-operation, to achieve exactly the same outcomes.  You get the extra costs of federalism without any (or very, very few) of the extra benefits of federalism.

No doubt this idea that competition, and hence extra layers of decision-making, delivers more ultimate wealth can be a tad counter-intuitive, in the same way that comparative advantage, say, can be a counter-intuitive notion.  But if you look at the wealthiest countries in the democratic world, they are overwhelmingly ones that have strong federal systems.  Think here of the US, Germany, Canada and Switzerland.  Sure, unitary systems do okay.  France and the UK are by no means poor.  But the unspoken assumption of so many Australians that the costs of a federal system (all the duplication and that extra layer of decision-making) are simply a waste is patently wrong.

What is stupid is to have a federal structure without any autonomy or scope for the states to do different things — pretty much where we are in Australia.  The blame lies overwhelmingly in two camps.  On the one hand we have had repeated Commonwealth governments from both sides of politics taking every chance they can get to overrule the states (and here one can point to a Labor government that tells Tasmania it cannot build a dam or a Coalition government that decides it will legislate in the field of labour relations).  On the other hand we have a High Court that overwhelmingly and continually sides with the Commonwealth and lets the centre take over areas that an originalist interpretation (be it original intentions or original understanding) of the written Constitution would never have allowed.  We have seen such abominations as the Tasmanian Dams and Work Choices cases, ones where incredibly expansive readings are made of an external affairs or corporations power.

Heck, after four decades of our states having Canadian and US-style income taxing powers that they used, the states lost those income-taxing powers for all practical purposes.  How?  During World War II the Commonwealth government passed legislation setting Commonwealth taxes at a high rate.  (In Canada and the US the central rate is comparatively low to cover only central spending, with the state taxes on top of that, and with the joint or combined rate being about our single rate here.)  It then required people to pay this new high Commonwealth tax before they paid their state taxes.  And then the Commonwealth promised to pass on some of this new money to the states, provided the states refrained from collecting any income taxes themselves.

Needless to say, the High Court gave this Commonwealth legislation the big tick in the First Uniform Tax Case in 1942.  And when the States tried again after the war, in the hope that particular High Court decision might be seen as a wartime one, the states lost again in the Second Uniform Tax Case in 1957.   So today we have the worst vertical fiscal imbalance in the democratic world.  We have mendicant states which spend far more than they can ever hope to raise and continually look for handouts (while perhaps setting up speed traps all over the place to garner a few extra crumbs).  We’ve even reached the stage where some States have become so house-trained they don’t really seem to want their own income taxing power and would probably say ‘no’ if it were offered to them.  They prefer begging from the centre and blaming everything on the feds.

If you have a federalist bone in your body this is all depressing.  I have more or less given up on federalism in this country.  I lament the fact that our top court has one of the most pro-centre, decide-against-the-states hit rates of any federalist common law court going.  Here in Australia you rarely go wrong if you bet on the centre if the case matters, if losig the case would really cause the centre pain. Do that, bet on the Commonwealth, and the odds are short that you’ll collect.  Sure, our High Court justices may make pro-state noises here and there on occasion while actually deciding for the centren as in Pape.  Or on issues that don’t much matter they may throw the states the odd bone, as in Williams 2, knowing that the centre can always buy the outcome it wants using s.96 if need be.  But until the states ask for the Engineers Case to be reconsidered, and the High Court does actually overturn its interpretive approach in that case, we will continue to have the most emasculated version of federalism going.

Meantime the United Kingdom, which is most definitely a federal system, may well give Scotland the sort of income-tax powers our states have not had here since the Japanese war bombing Darwin.  Incredibly, we will have a less federalist system than the UK, a theoretically non-federalist country. Can you get lower than that?

 

James Allan is Garrick Professor of Law at the University of Queensland. His new book, Democracy in Decline is out now from Connor Court