Federalism and the corporate governance analogy

Australians have a marked lack of interest in our federal constitutional system. One suspects this is largely because it’s difficult to get passionate about defending or attacking a political system characterised by competent but uninspiring state governments, chronically under-funded and seemingly incapable of tackling major improvements to health and education or renewing crumbling transport and other public infrastructure.

Instead, we’re subjected to continual blame-games designed to evade or confuse accountability, with state governments crying poor, federal government blaming the states for failing in their constitutional responsibilities, and media-savvy (though now retired) Premiers like Carr and Beattie elevating the strategic mea culpa to a performance art form. More recently, John Howard’s cynical, selective and electorally-driven interventionist stunts (for example, Mersey Hospital in Tasmania; plebiscites on local government amalgamations in Queensland) make the picture even more depressing.

Nevertheless, the problems of Australian federalism are overstated and relatively easily fixed given the requisite political will. Australia will have a rare opportunity for constructive “root and branch” federalism reform if a Rudd Labor government can be persuaded by the eight State and Territory Labor governments to implement some relatively simple but far-reaching fiscal and structural changes.

The formal model

As Curtin University academic Alan Fenna explains:

Like the American system on which it was closely modelled and which likewise does not grant a list of exclusive powers to the national government, Australian federalism was created on the presumption that the national government could be restricted to responsibilities of a specifically “national” character. Almost the full range of internal domestic responsibilities previously exercised by the constituent units would continue to be controlled at the sub-national level.

National powers were essentially of two kinds: those concerning external affairs, and those concerning the integrity of the common market. Australia’s constitutional architects were still operating in a world where the limited role of government made it quite possible to envisage a division of powers where two levels of government could operate in their own discrete policy realms. “Generally, the Commonwealth and the states were seen by many delegates as independent entities, each carrying out its governmental functions within its own territory.” Accordingly they saw little need to build intergovernmental relations into the system.

Our federal system is a good one

Despite this inauspicious formal model for achieving the sort of co-operative governance structures needed in a complex, inter-connected 21st century world, Australia’s federal system has evolved into a remarkably co-operative one. Indeed, despite the picture of conflict and stubborn state government obstruction and neglect that John Howard desperately sought to create for cynical electoral purposes, only a year or so ago both he and the state premiers were hailing the healthy, co-operative state of federal relations.

The Commonwealth and states have co-operated to positive effect in areas as diverse as corporate law reform; national competition policy; national professional accreditation standards; defamation law reform; a national secondary schools curriculum (albeit a work in progress); literacy and numeracy testing at years 3, 5 and 7; and a variety of anti-terrorism laws.

There has even been co-operation over solving the problems of the Murray-Darling basin (except for Victoria) despite a deliberately provocative attempt on Howard’s part to create a “wedge”; and in achieving environmental flows in the Snowy River. Australian co-operative federalism actually has an impressive record over the last decade, despite the fact that most State governments have been Labor ones dealing with a Coalition federal government.

The Council of Australian Governments (COAG) system, with the various Ministerial Councils operating under its auspices and its National Reform Agenda, is an impressive if imperfect structure. It makes sense for the levels of Australian government to co-operate to mutual advantage, especially given the complex international commercial and environmental situations we all face. It also makes sense in governance terms. As Michael Keating and John Wanna argue:

The evolution of Australian federalism has encouraged an administrative paradigm whereby the Commonwealth, in consultation with the states, accepts responsibility for consistent policy frameworks while the states are largely responsible for implementation.

The modern system of Australian co-operative federalism is in some ways analogous to the functional division in corporate governance between a Board of Directors which exercises policy oversight and the company’s management which runs the day-to-day operations. The dividing line between policy and management is a blurry but useful one, and readily transferrable to the public governance arena. It’s a dichotomy which also ties in neatly with notions of subsidiarity often associated with federalism (that matters ought generally to be handled by the competent authority which is smallest, lowest or closest to the people).

But not without its problems …

The major problem with Australian federalism, partly evident from its inception, is the eye-glazingly titled phenomenon “vertical fiscal imbalance”. This and other related trends are explained in a Sydney Morning Herald article by Steve Burrell:

Not only is a growing proportion of the funds going to the states now earmarked by the Commonwealth for purposes that fit its policy priorities, but its overall funding has effectively been shrunk, contrary to the Federal Government’s claims that its post-GST revenue-sharing arrangements have been a bonanza for the states.

Howard’s implementation of the GST as a supposedly “state tax” went some way towards repairing the shattered fiscal imbalance in one sense, but it remains completely under federal control and subject to alteration or removal at its whim. Although GST is a so-called “growth” tax, it isn’t growing anywhere near as fast as GDP, partly because it doesn’t capture revenue from the export sector of the economy but also because health and education are removed from the GST revenue base. Hence state budgets come under ever-increasing pressure and progressively fall behind as a proportion of GDP, while the Commonwealth’s share of revenue rises inexorably because of its control of corporate and personal income tax.

However, even vertical fiscal imbalance has its upside. It has facilitated the uniquely Australian institution of the Commonwealth Grants Commission with its poorly understood, regionally egalitarian and nation-building mission. The Grants Commission helps to ensure that smaller states are able to deliver comparable service levels to the mega-states of NSW and Victoria, a highly desirable outcome that would be much more difficult to achieve in the absence of a predominant national government revenue-raising role. In pure economic efficiency terms as well, it makes much more sense to have a single national income tax and GST system rather than separate ones for each of the eight states and territories and the Commonwealth. What is required is a system that restores a workable sovereign role for the states while maintaining predominantly unitary national tax collection.

A federal reform agenda

The election of a Rudd Labor government provides a unique opportunity for fundamental reform of Australian federalism. Tackling vertical fiscal imbalance must be a critical part of any such reform package, but we also need to redesign and sharpen the functional policy/management division between Commonwealth and states. The SMH article by Steve Burrell mentioned earlier also reports a proposal by Glenn Withers for repairing vertical fiscal imbalance:

SPPs [Special Purpose Payments] should be abolished and replaced with an equivalent share of income tax to be given to the states to spend as they see fit.

“A crucial first step … would be folding all specific-purpose payments into a general-purpose payment and keeping them as a fixed share of GDP … pending a constitutional convention which would review state tax powers,” he argued.

The only problem with solutions like this is realpolitik: no Commonwealth government is likely to surrender control of the federal purse-strings without receiving a compensating advantage from the states. At the moment, the Commonwealth mostly exercises policy oversight over the states through using tied grants or SPPs under Constitution section 96. Providing the states with a guaranteed untied share of revenue sufficient for their needs, as Withers proposes, would largely destroy the Commonwealth’s policy leverage over the states.

However, as I argued above, it actually makes sense in governance terms to have policy centrally co-ordinated via a co-operative federal structure like COAG, with day-to-day management and operational control vested in states and local governments able to understand and respond to local circumstances, needs and wishes.

In order to persuade the Rudd federal government to agree to permanently restoring vertical fiscal balance (as Withers proposes), the states will need to agree to refer powers to the Commonwealth under Constitution section 51(xxxvii). It isn't generally understood that our Constitution already contains the machinery necessary to redesign the federal balance of powers. The Commonwealth should logically have general power over the incorporation of companies (it controls them once they’re incorporated anyway); river flows in the Murray-Darling basin; and (subject to some safeguards) industrial relations. The states should also agree to refer policy but not operational control over health, education, transport activities directly affecting exports, and climate change, subject to COAG's co-ordinating role.

The major advantage the states would gain by agreeing to make these sorts of wide-ranging referrals of their constitutional powers to the Commonwealth would be that they would agree to do so only at the price of effectively entrenching a reciprocal Commonwealth guarantee to restore vertical fiscal balance. The states would refer these powers only for so long as the Commonwealth kept its promise of maintaining the states’ reasonable fiscal requirements as defined in the referral enactments, with that funding to be delivered in accordance with the recommendations of an independent and apolitical Commonwealth Grants Commission (to maintain equity in service provision between smaller and larger states).

Hence the states collectively would have a veto against overweening exercises of Commonwealth power. On the other hand, the Commonwealth would still possess the ultimate threat of pulling the pin on the entire arrangement and reverting to its current reliance on coercive section 96 grants if the states proved unduly obstructive in COAG.

Commonwealth threats to the states’ grant funding under our existing federal arrangements have been critical to the successful achievement of consensus on several key instances of “co-operative” federalism, notably the gun buyback scheme in the wake of the Port Arthur massacre, and less overtly in achieving national numeracy and literacy testing and agreement-in-principle on a national secondary education curriculum. The existence of some tension or ultimate threat/power residing in the Commonwealth may well be necessary to avoid permanent gridlock, inertia or a tendency of the states to relegate critically important but politically contentious issues to the “too hard” basket. However, at least with this proposal the Commonwealth is constrained by the fact that the states have a countervailing power to threaten to withdraw their referrals of power.

The states can refer powers under section 51(xxxvii) subject to conditions. In R v Public Vehicles Licensing Appeal Tribunal (Tas); Ex parte Australian National Airways Pty Ltd, a relatively rare unanimous High Court decision and one of the few dealing with section 51(xxxvii), the Court observed:

There is no reason to suppose that the words “matters referred” cannot cover matters referred for a time which is specified or which may depend on a future event even if that event involves the will of the State Governor-in-Council and consists in the fixing of a date by proclamation.

The states have in fact adopted this suggestion, most notably in their referral to the Commonwealth of powers to enact anti-terrorism legislation including so-called “control orders”. None of the Justices who considered the question in the recent High Court decision in (Jihad Jack) Thomas v Mowbray doubted that a referral in tightly limited terms was constitutionally valid. A flexible system of federal division of powers, whereby the states make strategic use of the referral provisions of the Constitution as a counterbalance to federal fiscal dominance, has significant advantages over any rigid constitutionalised division of powers.

Sadly, these ideas are likely to prove too utopian for our political practitioners. Nevertheless, they’re eminently feasible in legal and constitutional terms and would truly make Australia a world’s best practice model of federal governance, a worthwhile objective in a political environment mostly characterised by electorally driven, unadventurous “me-too-ism”.