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The Henry Report, state taxes and the commonwealth-state divide

By Robert Carling - posted Thursday, 13 May 2010

The Resource Super Profits Tax (RSPT) has captured most of the attention since the Henry tax review was released, but other parts of the report also point to far-reaching change. One of them concerns state taxation and Commonwealth/state fiscal relations. If the recommended reforms in these areas ever see the light of day, the tax system will be more rational and efficient in one sense, but the Commonwealth could gain even more financial power at the expense of the states, further shrinking the states’ fiscal autonomy and undermining federalism.

The issues are how much power should the states have to set their own taxes, and which taxes are best assigned to them. The Henry report sees a trade-off between tax efficiency and government accountability. Efficiency generally argues for more centralised taxes or at least harmonisation across states. Accountability requires that spending and revenue raising responsibilities be matched at each level of government. Within a federation this implies a degree of tax decentralisation with each state having the freedom at least to set its own tax rates, if not its tax bases as well.

The course of history has resulted in much more weight being given to the advantages of centralised taxation than to the advantages of accountability and devolution of tax powers in the Australian federation. The Henry report, on the face of it, would take us even further in that direction. Not a single state tax escapes criticism. As for accountability and fiscal autonomy, the report argues that these conditions can be satisfied provided the states have sufficient flexibility at the margin to make their own expenditure and tax choices. According to this view, the states do not need to raise enough revenue from their own sources to cover every dollar they spend on their own functions.


Payroll tax, land tax (in its current narrow form), stamp duties, gambling taxes and mining royalties all come in for criticism by the Henry review panel for their distorting effects, complexity, high compliance costs or poor design. The solution set out in the report is to get rid of payroll tax, stamp duties and mining royalties, redesign and greatly broaden the scope of land tax, and revamp gambling taxes.

The report recognises that these reforms would deprive states of a large chunk of their revenues and that a substitute source of revenue would have to be found. It favours what it calls a “simple cash flow tax” on business, which is a value added tax by another name, or a way of increasing the GST without saying so. As the cash flow tax would need to be a Commonwealth tax at a uniform rate, the states would have to surrender some of the limited fiscal autonomy they now have. They would be left with just a broad land tax, gambling taxes in some form and taxes on motor vehicle usage and operation such as registration fees.

Recognising that these leftovers would not be enough to give the states sufficient fiscal autonomy even at the margin, the report leaves the door open to states sharing in the personal income tax base, or in other words a state personal income tax on top of the Commonwealth one. This has often been floated as a way of strengthening the states’ revenue base but has usually been resisted by the Commonwealth. The one exception was when the Commonwealth offered it to the states in the mid-70s. The key difference between then and now is that in the mid-70s the Commonwealth made no attempt to reduce its personal income tax take to make room for the states, whereas the Henry report recognises that making room would be a precondition.

Of course we are a long way from seeing any Commonwealth offer on the table, but at least the idea of a state income tax was not included in the government’s “never ever” list. In contrast, the government did reject the notion of a land tax on the “family home” even if accompanied by the abolition of stamp duty, while noting that it was a matter for the states.

The proposition that the states only need fiscal autonomy at the margin if they are to behave as fully accountable, independent sovereign entities is open to challenge. They have a degree of autonomy at the margin now, but that does not stop them from behaving like dependants of the Commonwealth. That is perhaps not surprising when almost half their revenue comes in the form of Commonwealth grants. But the resistance to a broad land tax and the Commonwealth’s historical resistance to readmitting the states to the income tax field illustrates how challenging it will always be to protect even the current limited degree of state fiscal autonomy in the context of tax reform, let alone strengthen it.

It is easy to agree with the Henry report that the current array of state taxes leaves much to be desired. But in finding a replacement it is important not to throw the baby (accountability and state fiscal autonomy) out with the bathwater (economic inefficiency of present state taxes) if Australian federalism is not to be further undermined.

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About the Author

Robert Carling is a Senior Fellow at The Centre for Independent Studies.

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Creative Commons LicenseThis work is licensed under a Creative Commons License.

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