US Should Follow Australia’s Lead: Return to Federalist System Founders Envisioned

“Returning income taxing power to the states would have resulted in a fierce interstate economic battle that would see Australians vote with their feet and move their lives across borders to get a better deal, economists warn.”

“The Prime Minister met with state premiers and territory chief ministers yesterday to discuss his plan to lower the federal government’s income tax and have the states make up the rest by collecting their own tax, to do with which whatever they please. If his bold scheme had gone ahead, they would eventually have been able to set their own tax rates as well.”

“… premiers and chief ministers weren’t keen and the idea is now off the table, for now, after Malcolm Turnbull conceded there was ‘nothing like a consensus.’”

“What he had been attempting to do with the tax shift was to force more responsibility onto state governments, and encourage greater accountability to its voters. It’s a new way of funding school and hospitals and is also designed to encourage competition between the states and force them to operate more efficiently. It’s a model called competitive federalism, which allows states to battle it out over a range of issues to compete to provide their citizens with the best value goods and services at the best cost.”

“RMIT economist Professor Sinclair Davidson explains … ‘At the moment, because the federal government has so much power over the revenue that goes into health and education, for example, there’s not much difference between the states … But once that changes, for people whose state’s bundles of goods and services don’t suit their needs, they can start looking around.’ With a mobile population threatening to abandon its state government, effectively stripping it of a major revenue supply, the voting public would have a lot more control over state governments, Prof Davidson says. … With state governments made more eager to please, it sounds like this new tax plan would be a win for voters, if those downward pressures on tax rates the system’s meant to encourage do come off.”

“Curtin University Associate Professor Helen Hodgson argues state tax competition could lead to a race to the bottom. ‘The biggest challenge that would emerge is if states chose to exercise the right to increase or decrease their income tax rates,’ she writes … Prof Hodgson says boosting migration between the states would put pressure on state governments to reduce their own rates as they compete to retain their populations, while ‘a general lowering of tax rates would defeat the stated intention of allowing states to raise additional funding for health and education.’”

“Malcolm Turnbull has called for a dramatic shift in Australia’s model of federalism … Many economists regard this as sensible and much‐​overdue reform … the argument is for a shift from a federal income tax to a state income tax. In principle, this can be done in a completely revenue‐​neutral way. … that would, on the whole, benefit Australian taxpayers because a more efficient tax system is a less costly tax system.”

“[S]tate premiers … hated the idea. It’s important to understand why. This is not because the idea is bad for the citizens of the states, with the premiers being outraged on their behalf. Rather it is because it is bad for the political classes themselves, and the premiers in particular.”

“The basic idea is that the states compete with each other by offering bundles of public goods at different prices (i.e. taxes). This is the significance of the state‐​level income tax. Victoria, for example, may offer very high levels of public services, but also at a high price through high state income taxes. NSW may offer more moderate public services, but also much lighter taxes. What happens next is that citizens sort themselves over the states according to their preferences. Those who value high levels of public services move to Victoria, where they pay that marginal valuation in high taxes. Citizens with preferences for lower levels of public services and also taxes move to NSW. This is a market, not a political, model of local public goods. Economists like it because it encourages competition between the states to provide an efficient bundle of public goods and services at a point that voters (as consumers) are willing to pay. This competition tends to produce an efficient outcome.”

“That is not the situation we have now. Premiers are incentivised to represent their citizens as all wanting the maximum amount of public goods and services, because someone else is paying for them. State income taxes (coupled with reduced federal income taxes) are a way of implementing this mechanism. The main winners from this will be the 7 million or so Australian taxpayers, because it will deliver a much more efficient supply of public goods and services. The main losers will be the state and territory premiers, because they will have to compete in the market for political goods and services.”