INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

39

7.5| INDEPENDENCE
The actions and decisions of intergovernmental relations must be free from undue influence from political or private interests. They must have high-level commitment.
The Productivity Commission has a very important role in Australia’s economic competitiveness in identifying reform priorities for Australia, and conducting detailed research and making recommendations on potential solutions. The Productivity Commission’s contribution to the understanding of our federal system has been seen in a number of reports it has produced, including the recent compilation of materials from the 2006 Roundtable
Proceedings in Canberra entitled Productive
Reform in a Federal System. The Productivity
Commission’s role in federal–state relations is limited however:
+ The

research priorities are set by the
Commonwealth Government (and therefore potentially guided by political interests of the day rather than long-term objectives) and there is limited opportunity for the Productivity
Commission to set its own work priorities.

+ There

is no ‘buy-in’ by the state governments
(either in terms of the direction of the
Productivity Commission’s work agenda, the funding of the Commission or the outcomes).

+ There

is no requirement for the Commonwealth
Government to respond to the reports of the
Productivity Commission, and therefore less accountability for the findings.
Two considerations relating to independence are:

1. nsuring that a research body such as the
E
Federal Commission is able to consider reform priorities and initiatives that may not be politically palatable as well as propose solutions without influence from political interests (e.g. division of powers between levels of government).
2. n addition, COAG requires some independent,
I
institutionalised mechanisms to ensure that it is not captured by one specific jurisdiction/level of government.

40

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

SETTING ITS OWN WORK PRIORITIES
The Federal Commission should be free to achieve the policy objectives without interference (including political, financial and operational independence). As a matter of principle, the greater the independence, the greater should be its level of accountability and transparency. Just some of the reasons that independence is important are the need to establish a credible and expert body; ensure a degree of transparency and accountability to the wider community; and create a long-term stable economic environment free from short-term political or private sector influences.
Independence may be achieved by ensuring that the body is staffed by representatives and experts from a variety of backgrounds and political influences, including from both state and federal government. Some examples of where there are experts/private individuals involved in intergovernmental relations are the working groups within the Russian State
Council and the US Advisory Commission on Intergovernmental Relations (see Exhibit
5) and the Health Council of Canada (see below). Similarly, the intergovernmental body should be jointly funded by state and federal government so that it is not reliant upon any one sphere of government. This was seen in the funding arrangements in the Canadian
Council of Federation.
The Council of Australian Governments is currently an ad hoc body. Meetings are called by the Prime Minister, and much preparatory work is undertaken by the
Department of Prime Minister and Cabinet.
This means that the Commonwealth dominates the Council. Mandated meetings of the Council of Australian Governments would enhance the Council as a forum for joint Commonwealth–State decision making.72 PRINCIPLES OF INTERGOVERNMENTAL RELATIONS

INSTITUTIONAL MECHANISMS
The Federal Commission must therefore be able to form its own work program and create its own agenda, so that it can review aspects of the economy that may not be politically expedient or agreeable. This should allow the problems associated with buck passing or lack of agreement across governments to be avoided. In order to be effective, the Federal Commission must also be sufficiently funded so that it can conduct wide ranging reviews and be staffed by experts. The staff must have sufficient knowledge and experience to be able to make economy wide assessments about the future of Australia’s economy and to make recommendations about a national reform agenda.
It was encouraging that the most recent
COAG communiqué in July 2006 outlined more details about the COAG Reform Council
(CRC), which was proposed to be independent and would comprise up to six members. The
CRC will comprise a Chairman appointed by the Commonwealth, a Deputy Chairman appointed by the states and territories, and four members to be agreed by COAG, with at least one member having the appropriate skill sets with regional and remote experience. COAG would agree on staffing arrangements for the
CRC. However, it still remains unclear what the exact role of the CRC would be but it will be primarily involved in monitoring implementation and therefore unlikely to be anticipating or researching new policy areas. In particular, it is unlikely to have the opportunity to initiate its own work and to anticipate new challenges facing the economy.

As previously discussed, many mechanisms for intergovernmental relations, where they are not formalised and institutionalised, will vary in their frequency and transparency depending on the political will of the leaders at the time.
It is essential that the frequency, transparency and accountability are not determined by the political agendas, but that there are mechanisms for forced regularity of meetings, monitoring the progress of agreements and implementation of reform on an on-going basis.
In Canada, the politicisation of the intergovernmental process led to a loss of legitimacy of the process and a lack of satisfactory outcomes:
A new type of ‘summit federalism’ began to emerge, with all the paraphernalia of international conferences, flags, government limousines, rolling cameras, and press conferences after lengthy and often night-long meetings behind closed doors. Yet all the orchestrated hype could not prevent the eventual constitutional settlement of 1982 being concluded without
Québec. After Trudeau’s departure in 1984, two further attempts of bringing Québec into the constitutional fold ultimately failed because the process itself had begun to lose legitimacy and because support for the recognition of Québec as a distinct society faltered in English Canada.73
High-level leadership is crucial to ensure that reform priorities are consistently monitored.
Without institutionalised mechanisms to pressure those high-level leaders to meet and agree a reform program, reforms will stagnate. For example, the NCP reforms in
Australia were an example of successful outcomes from intergovernmental relations.
However, commentators have highlighted that the ‘difficulty of replicating it, of course, is that the circumstances that gave rise to the NCP are almost totally unlikely to emerge again.’74

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

41

Further, it is essential that the intergovernmental arrangements have independence to ensure the regularity of meetings as well as adequate outcomes from the meetings. The lack of such independence of COAG has resulted in various problems, including infrequent meetings, lack of transparent agenda and decision making and politicised outcomes. Indeed ‘COAG meets only briefly and only once a year ... The underlying reality, though, is not entirely consistent with this image. COAG has no statutory – let alone constitutional – foundation; it has not changed the powerful imbalance in Australian federalism; and it is an institution existing and functioning at the pleasure of the Prime
Minister.’75
Finally however, it must be recognised that our democracy depends on the elected representatives being the ultimate decision makers. Accordingly, each government must answer to its own democratically elected legislature. For this reason, intergovernmental bodies ‘must remain non-legal and consensual instruments. They are not a substitute for any parliament or legislature’.76
A number of independent and effective intergovernmental bodies have proven useful when applied to a specific sector of the economy. The National Competition Council
(NCC) in Australia and the Health Care Council of Canada (HCC) are examples of these types of bodies (see Exhibit 16).

EXHIBIT 16
HEALTH CARE COUNCIL OF CANADA

The Kirby Report, The Health of Canadians
– the Federal Role, (October 2002) and the
Romanow Commission on the Future of
Health Care in Canada (November 2002) both identified the value of an independent council informing Canadians on health care matters while promoting accountability and transparency. The Prime Minister and the
Premiers accepted the advice of those reports and Canada’s First Ministers established the
Health Care Council of Canada in their 2003
Accord on Health Care Renewal and enhanced its role in the 2004 Ten Year Plan.
Funded by the government of Canada, the
Council reports to the Canadian public and operates as a non-profit agency. There are
26 councillors including representatives of federal, provincial and territorial governments, experts and citizen representatives. Councillors have a broad range of experience bringing perspectives from government, health care management, research and community life from across Canada. The Members of the
Council are rather like a corporate board of directors, performing a liaison function between the Council and Canada’s First
Ministers, as well as approving the Council’s budget. Supporting the work of the Health
Council of Canada is a small secretariat located in Toronto.
Source: www.healthcouncilcanada.ca/en/.

Conclusion: Independence might require the following considerations, among other things: a Federal Commission with an ability to determine its own work program; a funding formula to ensure ‘buy-in’ by all levels of government; staffed by experts from a variety of backgrounds; and a rotating chairmanship.

+ Establishing

COAG, considerations may include mandated meetings (not called by any particular level of government).

+ For

42

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

INTERGOVERNMENTAL FISCAL ARRANGEMENTS

8| INTERGOVERNMENTAL FISCAL
ARRANGEMENTS
In Australia, the taxing powers of the states are limited by the Constitution and historical political circumstances. Neil Warren recently completed a report for the New South Wales
Government titled Benchmarking Australia’s
Intergovernmental Fiscal Arrangements’, and stated that:
The conclusion of this study is that
Australia performs comparatively poorly in intergovernmental fiscal arrangements
… Australia’s system of intergovernmental fiscal arrangements is characterised by very high vertical fiscal imbalance (VFI) due to inadequate State tax powers, and complex and high level equalisation.77
Theoretically there are certain principles that can be used to assess the efficiency of the intergovernmental fiscal arrangements of a federation. Neil Warren highlights thirteen benchmarks by which to assess such arrangements. While a detailed assessment of such benchmarks are beyond the scope of this paper, a brief discussion and comparison of Australia’s intergovernmental fiscal arrangements follows (although the complexity of such an analysis means that all issues will not be discussed here). Neil
Warren highlights four main categories
(expenditure responsibilities, tax assignment, intergovernmental fiscal transfers and dynamic federalism) that might be used to design and evaluate a fiscal system, but states in relation to such an assessment: ‘… the nature of the arrangements is very complex. A whole range of issues need to be taken into account when determining the appropriate mix of expenditure responsibilities, taxing powers and intergovernmental transfers where necessary.’78

8.1| REVENUE RAISING
In general: ‘As the subsidiarity rule expresses, powers and responsibilities should be allocated to the lowest practical order of government.
This applies on both the taxing and the spending sides.’79 Ideally, this would mean that governments would have fiscal resources equal to their spending responsibilities and ‘that way the government providing the benefits to the voters also inflicts the pain, and thus a measure of accountability is in operation’.80
Vertical fiscal imbalance (VFI) occurs where the allocation of revenue between the federal and state governments does not match the expenditure responsibilities of those governments. VFI is measured as a ratio of the federal government’s revenue (measured as a percentage of total government revenue) to its expenditure (measured as a percentage of total government expenditure).81
All federations have a degree of VFI, which has arisen from a number of circumstances including the growth in personal and corporate income tax as a source of revenue (which are generally controlled at a national level, although there is variation in the degree to which national governments dominate taxation revenue).
At one extreme lies Australia, where a high degree of fiscal centralization has funded a high degree of policy centralization. At the other extreme lie Switzerland and Canada, where revenues are more evenly balanced between national and subnational levels of government. The outlier is the EU, which
... has taken quite a different direction, one reflecting its quite different circumstances.82

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

43

FIGURE 2 VERTICAL FISCAL IMBALANCE IN AUSTRALIA
%
100
80
60

40
20

0
Taxation

Own purpose outlays

Local
State
Commonwealth
Source: N Warren, Benchmarking Australia’s Intergovernmental
Fiscal Arrangements, Final Report to the New South Wales
Government, May 2006, Figure 4, p. 51 (2004–2005 data).
Note: own purpose outlays include compensation of employees, use of goods and services, social benefits and other expenses, but do not include consumption of fixed capital, interest, subsidies and grants.

44

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

In Australia, while there is sharing of spending responsibilities in many categories (e.g. health and education) there is no sharing in taxing responsibilities. The Commonwealth has control over some of the broadest based taxes
(e.g. personal and corporate income tax and customs and excises). The states, on the other hand, receive the GST (a consumption tax), for which the rates and base are set and can only be changed with agreement by all of the states, the endorsement of the Commonwealth and both Houses of Federal Parliament. The states are able to levy taxes, for example on property
(e.g. rates) and payroll taxes.
Accordingly, a large vertical fiscal imbalance arises because the largest taxes are collected at the Commonwealth level, but a considerable amount of spending responsibility rests at a state (or local government) level.

INTERGOVERNMENTAL FISCAL ARRANGEMENTS

FIGURE 3 DECOMPOSITION OF PUBLIC EXPENDITURE BY FUNCTION AND GOVERNMENT LEVEL Own purpose expenditure, 2004 –05
Australian Government
(Commonwealth)

State Government

Local Government

A$170 billion

A$122 billion

A$19 billion

Social security and welfare (48%)
Health (16%)
Defence (9%)
General public services (7%)
Education (4%)
Other (17%)

Education (28%)
Health (25%)
Transport and communications (9%)
Public order and safety (10%)
Other (28%)

Transport and communications (24%)
Housing and community amenities (23%)
Recreation and culture (15%)
General public services (17%)
Other (22%)

Source: OECD, Economic Surveys: Australia, Volume 2006/12, July 2006, p. 76 (The Treasury, Australian Government and ABS [2006], Government
Finance Statistics 2004–05, cat. No. 5512.0).
Note: Australian Government excludes specific purpose payments (SPPs), state government includes SPPs to the states but excludes SPPs through the states to local government, local government includes SPPs.

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

45

FIGURE 4 SOURCES OF TAX REVENUE Per cent of total, 2004 –05
Total taxation revenue

Australian Government
(Commonwealth)

States

A$278 billion

A$194 billion

A$42 billion

Australian Government (69%)
States (15%)
Goods and services tax (13%)
Local (3%)

Personal income tax (58%)
Company tax (26%)
Indirect tax (15%)
Other (1%)

Payroll (29%)
Property conveyance (23%)
Land (11%)
Gambling (10%)
Insurance (8%)
Motor vehicles (13%)
Other (6%)

Source: OECD, Economic Surveys: Australia, Volume 2006/12, July 2006, p. 77 (ABS (2006), Taxation Revenue Australia (cat No.5506.0) and national authorities.
Note: All GST revenue is collected by the ATO but distributed to the states. Therefore the Australian Government revenue of 194 billion excludes GST and is excluded from the chart depicting state revenue.

46

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

INTERGOVERNMENTAL FISCAL ARRANGEMENTS

VFI results in the need for the Commonwealth government to transfer funds to State governments to make up for their revenue shortfalls. The problem with such transfers is that accountability between the raising of revenue and the responsibilities for funding certain programs can become blurred. For example, the Commonwealth can avoid accountability for expenditure of funds, because the states have responsibility for a lot of the expenditure. Similarly, states can either become unable to provide certain services through lack of revenue raising capabilities, or alternatively claim they cannot provide such services due to lack of funding from the
Commonwealth. States may also be less able to provide the services demanded by their electorates if much of their funding is ‘tied’ to conditions set out by the Commonwealth.
Ensuring that revenue raising abilities and expenditure responsibilities are aligned may increase the chances of accountability for levels of governments in reaching their commitments.
In Australia, there is a very high degree of VFI, which has increased over time and is one of the largest among comparable federations.

FIGURE 5 STATE GOVERNMENT OWN-SOURCE TAXES
AND REVENUES AS A PROPORTION OF STATE
GOVERNMENT EXPENDITURES
%
80

60

40

20

0
Australia

Austria

Canada

Germany Switzerland

Taxes
Revenues
Source: N Warren, Benchmarking Australia’s Intergovernmental
Fiscal Arrangements, Final Report to the New South Wales
Government, May 2006, Figure 8, p. 56 (Government Finance
Statistics Yearbook 2004, International Monetary Fund).

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

47

FIGURE 6 STATE GOVERNMENT DEPENDENCE ON PARTICULAR TAXES
General taxes (e.g. VAT) as a % of state tax revenue

Income tax as a % of state tax revenue

Payroll tax as a % of state taxes

USA

USA

USA

Taxes on specific goods and services as a % of state tax revenue

Property taxes as a % of state revenue

Switzerland

0

Germany

0

Canada

0

Austria

4

Australia

15

Switzerland

20

Germany

8

Canada

30

Austria

40

Australia

12

Switzerland

45

Germany

60

Canada

16

Austria

60

Australia

80

Taxes on use of goods as a % of state tax revenue

USA

Switzerland

Germany

Canada

0

Austria

0

Australia

0

USA

3

Switzerland

5

Germany

6

Canada

6

Austria

10

Australia

12

USA

9

Switzerland

15

Germany

18

Canada

12

Austria

20

Australia

24

Source: N Warren, Benchmarking Australia's Intergovernmental Fiscal Arrangements, Final Report to the New South Wales Government, May 2006,
Figure 10, pp. 65–66 (OECD Revenue Statistics 1965–2004, Table 136).

48

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

INTERGOVERNMENTAL FISCAL ARRANGEMENTS

In Canada, Germany and Switzerland, the states have a greater capacity to spend from own source revenues than the states in Australia. Similarly, state governments depend to a greater extent on transfers from the Commonwealth government.

In some circumstances, it makes sense for some taxes to be collected centrally as this ensures efficiency and lowering of costs. Accordingly, the GST collected at a central level is a form of efficiency in the Australian taxation system.

As a result, it is harder to hold governments to account for the revenue raising and expenditure:
Australia represents the most acute case of VFI, with the Commonwealth controlling all major tax sources and engaging in massive annual transfers to the states.
Through idiosyncratic judicial interpretation, the states have been prevented from levying their own general sales taxes and thus lack that important revenue source available to subnational governments in
Canada and the United States. Through the coercive spending of the Commonwealth ... the states have been excluded since 1942 from the income tax. They were granted all the net revenue from the national value-added tax (the ‘GST’, Goods and
Services Tax) introduced in 2000. However, that remains a Commonwealth government tax and the revenues are effectively an intergovernmental transfer. The Australian states rely on transfers for almost half their entire budgetary needs.83

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

49

However, the flexibility for states to impose taxes is limited, and often limited to inefficient taxes, which will ultimately place a cost burden on the economy. Because the states lack access to the most efficient sources of taxation, this limits their ability to increase their revenue in a manner that will not increase the cost burden to the economy:
A further simplification which should be considered would involve broadening the
GST base. Revenue from this measure could be used to reduce the direct tax burden on labour and further address the vertical fiscal imbalance. However, such a change in the tax base would require the agreement of all state governments and would also require significant changes to the financial arrangements between the federal and state governments.84

FIGURE 7 PROPORTION OF STATE GOVERNMENT
TAX REVENUE FROM EFFICIENT SOURCES
%
100
80
60

40
20

0
Australia

Austria

Canada Germany Switzerland USA

Inefficient taxes
Less Efficient taxes
Efficient taxes
Source: N Warren, Benchmarking Australia's Intergovernmental
Fiscal Arrangements, Final Report to the New South Wales
Government, May 2006, Figure 11, p. 67 (OECD Revenue Statistics
1965–2004, Table 136).
Note: taxes include taxes on incomes and profits, payroll taxes, property taxes, general taxes (e.g. VAT), taxes on specific goods
& services, taxes on use of goods and ‘other taxes’. ‘Other taxes’ have not been included in Figure 7 so Austrian and Canadian taxes do no sum to 100 per cent.

50

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

INTERGOVERNMENTAL FISCAL ARRANGEMENTS

Neil Warren writes in relation to the states’ revenue raising efficiency:
Australian states rely on efficient taxes for a smaller proportion of their tax revenue than other federations ... The result would look even worse if the GST was not included as a State tax by the
OECD, from which the data in [the figure above] is drawn.85
There are methods of overcoming or altering this centralising trend. This has been seen in some overseas jurisdictions like Canada, where the taxing powers were restored to the provinces over time and the conditionality on the remaining transfers was reduced. ‘By the late 1990s, provincial reliance on cash transfers had been almost halved to 13 per cent of their total expenditures.’86 Other countries have also been reviewing and undertaking reforms in relation to their fiscal relations. In Italy, for example, the regions have been assigned new taxing powers and a new system of interregional transfers has been developed
(this process of reform is as yet incomplete).87

8.2| SPENDING
There is a pattern of spending responsibilities across federations (with some exceptions). In general, Australia differs from other federations in relation to health and education spending, and this therefore increases the likelihood of policy duplication and blame shifting in those areas that are shared.88 However, even those shared responsibilities that are commonly shared among federations (e.g. economic affairs, housing and community amenities) will have the risk of lack of accountability if appropriate fiscal and coordination mechanisms are not properly considered.

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

51

FIGURE 8 HEALTH EXPENDITURE –
CENTRAL GOVERNMENT V STATE GOVERNMENT

FIGURE 9 EDUCATION EXPENDITURE –
CENTRAL GOVERNMENT V STATE GOVERNMENT

%
100

%
100

80

80

60

60

40

40

20

20

0

0
Australia

Austria

Canada

Germany Switzerland

National
States
Source: N Warren, Benchmarking Australia's Intergovernmental
Fiscal Arrangements, Final Report to the New South Wales
Government, May 2006, Figure 1, p. 37 (Government Finance
Statistics Yearbook 2004, International Monetary Fund).

52

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

Australia

Austria

Canada

Germany Switzerland

National
States
Source: N Warren, Benchmarking Australia's Intergovernmental
Fiscal Arrangements, Final Report to the New South Wales
Government, May 2006, Figure 2, p. 37 (Government Finance
Statistics Yearbook 2004, International Monetary Fund)

INTERGOVERNMENTAL FISCAL ARRANGEMENTS

While there are a number of federations that have shared spending responsibilities between levels of government in certain areas of the economy, the ‘lack of transparency appears to be less problematic where State governments have relatively high levels of fiscal autonomy, as in Canada and the USA.’89
In Australia, GST revenues collected by the
Commonwealth are automatically provided as revenues to the states.90 However, there is a comparatively high degree of other transfers from the Commonwealth to the states in
Australia as well.

FIGURE 10 TRANSFERS AS A PROPORTION OF STATE
GOVERNMENT EXPENDITURE
%
60
50
40
30
20
10
0
Australia

Austria

Canada

Germany Switzerland

Source: N Warren, Benchmarking Australia's Intergovernmental
Fiscal Arrangements, Final Report to the New South Wales
Government, May 2006, Figure 9, p. 57 (Government Finance
Statistics Yearbook 2004, International Monetary Fund).

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

53

Section 96 of the Constitution allows the
Commonwealth to ‘grant financial assistance to any State on such terms and conditions as the Parliament sees fit.’ These transfers are commonly known as conditional grants or
Special Purpose Payments (SPPs).
Conditional grants have become commonly used in federations and have led to a major centralising trend. ‘Those who pay the piper call the tune in federal systems as elsewhere.
The stronger fiscal position of central governments has proven a tempting and powerful lever for the extension of central government power into areas of subnational jurisdiction.’91 In Australia, SPPs to the states make up about 13% of Commonwealth expenditure, and include areas that are traditionally the spending responsibility of the states (e.g. health and education).
Section 96 of the Constitution has been given broad interpretation by the courts and the High
Court, which ‘has interpreted this as precluding any possible limitations on the conditions that the Commonwealth imposes on state governments through the spending power.
Indeed, it has endorsed the use of the spending power as a weapon to exclude the states from access to the kind of tax bases that would reduce their dependence on such grants.’92 For example, the High Court upheld the ability of the federal government to make grants to the states contingent on the states agreeing not to impose income tax, and banning state sales taxes.

54

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

Therefore, giving the states access to greater taxing powers (e.g. allowing a broader GST taxation base) may have the effect of reducing
SPPs from the Commonwealth Government to the states.
In Spain, there has been a process of reform whereby healthcare and social services spending has been assigned to Autonomous
Communities. France has also undergone a reform process whereby public functions such as higher education, industrial policy and regional infrastructure have been decentralised
(constitutional reform of 2003).93 In Germany, an expert panel has been established to consider the allocation of responsibilities in the federal system.94
A simpler system of inter-governmental transfers involving so-called ‘specific-purpose payments’ would contribute to a clearer specification of spending responsibilities. The specific-purpose payments should become less complex and inflexible. A first step would be to develop an outcome/output performance and reporting framework for each SPP This
.
is an ambitious task as outcome/output measures of service delivery are difficult to clearly define, measure and enforce in a robust way. Nevertheless, such frameworks could ultimately lead to a move towards the funding of such payments on an outcome/output basis in certain areas, such as education.95
The OECD notes, however, that the UK experience shows that outcome-focused performance targets should be clear. Those targets should be simple to quantify and audit
(and should be tied to financial incentives such as the competition payments that proved useful in the NCP reforms).

INTERGOVERNMENTAL FISCAL ARRANGEMENTS

8.3| FISCAL EQUALISATION
It is common among federations around the world for the national government to distribute funds to the states (as previously discussed), and it is also common for equalisation across states to occur. Horizontal Fiscal Equalisation
(HFE) occurs when funds are transferred from one subnational region to another to ensure that some form of uniformity of service provision occurs.
In Australia, compared to some other federations such as Canada and Switzerland, there is no reference to HFE in the Constitution.
However, even though there is no reference to
HFE, Australia has a complex system of HFE. In fact, Australia employs a system that attempts to fully equalise the revenue-raising capacity and expenditure needs of the states, even though it has one of the lowest pre-equalisation fiscal disparities.96
In Australia, VFI and HFE are integrated, with the large volume of Commonwealth transfers (including GST revenues) being divided among the states according to the equalization formula. Since 1993, an autonomous agency, the Commonwealth
Grants Commission, has had statutory responsibility for those allocations ...97

There are a number of different examples of equalisation formulas employed across jurisdictions, each with their own characteristics (and benefits and pitfalls). For example, in Australia the complex equalisation formula ensures that weaker states are ‘brought up to the national average’ and that ‘stronger states are bought down’.98 In Germany, equalisation is almost ‘punitive’ in character, given that surplus revenues are distributed directly from affluent to poorer Länder.99 This has led to some criticism of the equalisation program in Germany, as it is suggested that it removes the incentives for Länder to perform well or improve their performance. In contrast, in Canada the richest state (Alberta) is excluded from the calculation of the national average, which means that the poorer states are brought
‘up to the adjusted average without bringing the richer ones (Ontario and Alberta) down’.100
At the other extreme, the United States practices very little systematic equalisation
(which may arise from the historical formation of the federation and the presidential system of government).101
There are differing views on the efficacy of fiscal equalisation, particularly as such a practice modifies market outcomes. For example, some argue that subnational governments lose the incentive to improve their performance if equalisation practices diminish the costs and benefits of the market outcomes and signals. ‘Most fiscal equalisation methodologies in comparator federations are significantly less complex and more transparent than in Australia.’102

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

55

8.4| MONITORING
It is important for countries to assess their intergovernmental fiscal arrangements on a regular basis. Over time revenue raising and expenditure responsibilities in federal systems evolve, often on an ad hoc basis and relating to changes in the local economy and global environment. Whether the intergovernmental fiscal arrangements are optimal requires an assessment across the board of the fiscal arrangements.
Changing circumstances have meant that the original intentions of founders of federations may not fit with a modern economy because: ‘The classic legislative federations were established in an altogether different era when the size and scope of government were limited, and it was relatively easy to divide responsibilities and to imagine two levels of government operating in their own spheres with little clash or overlap ... The ‘mixed economy’, the welfare state, the rise of environmental policy, and the enormous increase in taxation have all greatly complicated policy making in a system of divided jurisdiction – as have the vastly greater mobility of labour, geographical scope of economic activity, and quality of communication and transportation.103

56

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

Many other countries have undergone assessments of their fiscal arrangements:
Australia needs to reconsider the allocation of expenditure responsibilities between levels of government, and the consequent assignment of tax bases and intergovernmental financial transfers.
Over recent years, Belgium, Germany and Switzerland have all significantly revised their federal arrangements.
Reforms are underway in Italy, and
Austria comprehensively reviews its intergovernmental arrangements every four years.104

INTERGOVERNMENTAL FISCAL ARRANGEMENTS

8.5| POLICY
What is clear is that there are a variety of potential models of fiscal federalism that may be employed in Australia, and many examples of different methods from overseas. Furthermore, there is little constitutional constraint on what might be done from a fiscal perspective. The arrangements that are currently in place have arisen over time from historical circumstances.
Australian states have comparatively low levels of fiscal autonomy compared with overseas countries. Perhaps a comprehensive review of intergovernmental fiscal arrangements and comparative analysis with overseas models may yield some insights into what might be a more optimal arrangement.
One level of government may have the constitutional authority but not the fiscal resources or ability to contain spillovers, while the other level of government may have the resources and reach but no the requisite authority.105

FIGURE 11 MEASURES OF FISCAL AUTONOMY
%

60

40

20

0
Australia Austria Canada Germany

Italy Switzerland

State taxes as a proportion of total state revenue
State taxes as a proportion of general government tax revenue
Source: N Warren, Benchmarking Australia's Intergovernmental
Fiscal Arrangements, Final Report to the New South Wales
Government, May 2006, Figure 12, p. 73 (Government Finance
Statistics Yearbook 2004, International Monetary Fund; note data not available for USA).

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

57

What is clear is that if the subnational governments are given more taxing responsibilities, then accountability must also be assured through a process of adequate assignment of responsibilities.
With regard to the revision of subnational government financing systems, the reforms pursued have the general aim of improving decentralised governments’ accountability, by assigning them more tax autonomy and by providing more flexibility in the use of central government financial transfers. In Italy, Spain and France decentralisation has been coupled with the assignment of new taxing powers to subnational governments.106

58

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

CONCLUSION

9| CONCLUSION
There are a number of themes arising from this international comparison of intergovernmental arrangements that could provide examples of practical solutions in the Australian context.
In summary, some of the considerations could include:
+ A

formal institutional arrangement or mechanism – a permanent independent intergovernmental body at a federal–state level
(e.g. formal institutionalisation of COAG) as well as a permanent independent policy body
(in this paper called the Federal Commission).
Such formalisation could be through a scheme of cross-jurisdictional uniform legislation or by formal agreement.

+ Administrative

mechanisms to facilitate decision making – including the establishment of a permanent intergovernmental Secretariat to provide administrative and policy support (to the CRC, the Federal Commission and COAG); an independent and rotating chair; sufficient resources (e.g. staff). Other considerations are whether there should be consensus or majority voting mechanisms within the decision-making bodies, the funding of both the Secretariat and the Federal Commission and the role of the
Secretariat (e.g. research and agenda setting).

+ Flexibility

to determine innovative solutions
– a sound ‘theoretical’ framework and basis for decision making (for example, mandated principles of federalism/goal setting as a framework for dividing responsibilities may be one method as a basis for decision making).

+ Transparency

– for example, if a Federal
Commission were established it could provide independent and publicly available reports to COAG on policy items. Such a report could make recommendations that would put pressure on all governments to consider the issues. Further, if a Secretariat were established then publicly available agendas and preparatory material could be developed prior to any meeting of COAG (agendas must flow from one meeting to another) – this would enable public discussion of policy items prior to the meetings.

+ Accountability

– achieved by ensuring that an independent body to do research on policy issues is established – called a Federal
Commission in this paper (see discussion in
‘Independence’). The Federal Commission should have a clearly publicised charter
(e.g. its make-up and objectives and role).
The outputs of the Federal Commission should also be made public.

+ Efficiency

– there must be an agreed number of meetings of COAG per year (e.g. at least
2 per annum) as well as agreement that COAG will respond to the recommendations of the
Federal Commission in a given time frame.

+ Independence

– the Federal Commission should have the ability to determine its own work program, a funding formula to ensure
‘buy-in’ by all levels of government, staffed by experts from a variety of backgrounds and a rotating chairmanship.

+ Review

of federal fiscal arrangements – a review of fiscal arrangements should be undertaken to obtain a greater degree of responsibility and transparency about which level of government is responsible for delivering outcomes in which policy areas.
Comparisons with overseas countries reveal that reform of fiscal arrangements is possible and has been undertaken overseas.

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

59

NOTES
1 RL Watts, ‘Intergovernmental Councils in Federations’, in
Constructive and Co-operative Federalism? Institute of
Intergovernmental Relations, Institute for Research on Public
Policy, 2003, p. 9.
2 Watts, p. 9.
3 Productivity Commission, Productive Reform in a Federal
System, Roundtable Proceedings, Canberra, 2006, p. 4.
4 Federal–State Relations Committee, Federalism and the Role of the States: Comparisons and Recommendations,
Parliament of Victoria, 13 May 1999, para. 9.13.
5 TO Hueglin & A Fenna, Comparative Federalism: A
Systematic Inquiry, Broadview Press, Canada, 2006, pp. 32–3.
6 www.forumfed.org.
7 Hueglin & Fenna, p. 215.
8 Hueglin & Fenna, p. 219.
9 Productivity Commission, p. 2.
10 Productivity Commission, p. 61.
11 Federal–State Relations Committee, para. 9.614.
12 Productivity Commission, pp. 18–19.

37 Forum of Federations, ‘New Law Stimulates Federal
Cooperation’, Federations, vol. 15, no. 2, March/April 2006,
p. 9.
38 D Dennison, ‘Intergovernmental Relations in Canada’, presented at ‘Mechanisms of Intergovernmental Relations:
International Experiences and Challenges for Brazil’, Forum of
Federations, 17–18 September 2003, p. 8.
39 Productivity Commission, p. 20.
40 Meekison, p. 35.
41 Meekison, p. 38.
42 Federal–State Relations Committee, para 9.23.
43 www.thecanadianencyclopedia.com.
44 Federal–State Relations Committee, para. 9.5.
45 Federal–State Relations Committee, para. 9.6.
46 Federal–State Relations Committee, para. 13.
47 Meekison, p. 14.
48 Meekison, p. 14.
49 Dennison, ‘Intergovernmental Relations in Canada’, p. 7.
50 Hueglin & Fenna, p. 226.
51 Dennison, ‘Intergovernmental Relations in Canada’, p. 10.

14 Productivity Commission, p. 1.

52 Dennison, ‘Intergovernmental Mechanisms: What Have We
Learned?’ Looking Backward, Thinking Forward, Institute of
Intergovernmental Relations, 12–15 May 2005.

15 Hueglin & Fenna, p. 215.

53 Federal–State Relations Committee, para 9.32.

16 JP Meekison (ed.), Intergovernmental Relations in Federal
Countries, A Series of Essays on the Practice of Federal
Governance, Forum of Federations, 2002, p. 91.

54 Meekison, p. 4.

13 Productivity Commission, p. 19.

17 Meekison, pp. 92–3.

55 Dennison, ‘Intergovernmental Relations in Canada’, p. 8.
56 Meekison, p. 8.

18 Hueglin & Fenna, p. 73.

57 Dennison, ‘Intergovernmental Mechanisms: What Have We
Learned?’

19 Meekison, p. 35.

58 Meekison, p. 104.

20 Meekison, p. 35.

59 Meekison, pp. 5–6.

21 Hueglin & Fenna, p. 239–40.

60 Meekison, p. 6.

22 Meekison, p. 103.

61 www.citizen.org

23 Hueglin & Fenna, p. 215.

62 J Kramer, Germany, A Global Dialogue on Federalism
.

24 Federal–State Relations Committee, Federalism and the Role of the States: Comparisons and Recommendations,
Parliament of Victoria, 13 May 1999.

63 Dennison, ‘Intergovernmental Mechanisms: What Have We
Learned?’

25 GP Marchildon, ‘The Health Council of Canada Proposal in
Light of the Council of Federation’ in Constructive and
Co-operative Federalism? Institute for Research on Public
Policy, Montreal, 2003, p. 6.

64 Meekison, p. 323.

26 Meekison, p. 84.

67 Meekison, p. 4.

27 Meekison, p. 84.

68 http://www.collectionscanada.ca/02/02012002/0201200212_
e.html.

28 Meekison, p. 84.
29 Meekison, p. 57.
30 Productivity Commission, pp. 13, 18 and 19.
31 Meekison, p. 99.
32 Federal–State Relations Committee, para. 9.29.
33 Hueglin & Fenna, p. 239.
34 Meekison, p. 92.
35 Meekison, p. 98.
36 Meekison, p. 14.

60

INTERGOVERNMENTAL RELATIONS IN FEDERAL SYSTEMS

65 Federal–State Relations Committee, para. 9.40.
66 Meekison, p. 7.

69 Dennison, ‘Intergovernmental Mechanisms: What Have We
Learned?’
70 Meekison, p. 30.
71 Federal–State Relations Committee, para. 9.26.
72 Federal–State Relations Committee, para. 0.71.
73 Hueglin & Fenna, p. 223.
74 Productivity Commission, p. 323.
75 Hueglin & Fenna, p. 229.
76 Marchildon, p.6.

NOTES

77 Warren, p. xix.
78 Warren, p. 12.
79 Hueglin & Fenna, p. 319.
80 Hueglin & Fenna, p. 319.
81 Federal–State Relations Committee, para. 5.3.
82 Hueglin & Fenna, p. 323.
83 Hueglin & Fenna, p. 327.
84 OECD, Economic Surveys: Australia, July 2006, p. 14.
85 Warren, Fig. 11, p. 67.
86 Hueglin & Fenna, p. 335.
87 Warren, p. 11.
88 Warren, p. 36.
89 Warren, p. 47.
90 As per the 1999 Intergovernmental Agreement on Reform of
Commonwealth–State Financial Relations.
91 Hueglin & Fenna, p. 330.
92 Hueglin and Fenna, p. 333.
93 Warren, p. 11.
94 Warren, p. 48.
95 OECD, Economic Surveys: Australia, Vol. 2006/12, July 2006,
p. 14.
96 OECD, p. 90.
97 Hueglin & Fenna, p. 337.
98 Hueglin & Fenna, p. 337.
99 Hueglin & Fenna, p. 339.
100 Hueglin & Fenna, p. 337.
101 Hueglin & Fenna, p. 338.
102 Warren, p. xx.
103 Hueglin & Fenna, p. 315.
104 Warren, p. xxiv.
105 Hueglin & Fenna, p. 342.
106 Warren, p. 11.

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61

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