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Federalism Up in Smoke? The High Court Decision on State Tobacco Tax
Denis James
Economics, Commerce and Industrial Relations Group
13 August 1997
Contents
Major Issues Summary
Introduction
Vertical Fiscal Imbalance
Business Franchise Fees
The Commonwealth's Response
Implications for Federal Financial Relations
Endnotes
List of Tables
Table 1. State and Territory Taxation Revenue, 1995-96
Table 2. State and Territory Revenue from Business
Franchise Fees, 1995-96
Table 3. Rates of Business Franchise Fees
- Section 90 of the Constitution vests the Commonwealth with the exclusive
power to impose duties of customs and excise. A series of High Court
decisions have defined excise duties to be any levy imposed upon goods
at any point in the production and distribution chain. This has had
the effect of preventing the States from imposing any form of sales
tax on goods.
- The States attempted to find ways of levying consumption taxes which
were structured in such a way as to circumvent the High Court's definition
of an excise. The States had long imposed licence fees on the right
to sell liquor. When these fees were validated by the High Court in
1961, the States saw a chance to extend this mechanism to other products.
Commencing in the late 1970s, the States began to impose business franchise
fees on tobacco and petroleum products in addition to liquor. By 1995-96,
these fees were raising $4.9 billion, representing just over 16 per
cent of total State and Territory taxation revenue.
- Even though these fees have survived a number of previous High Court
decisions, often by a slim majority of judges, they have always been
regarded as vulnerable. On 5 August 1997, the High Court of Australia
brought down a combined decision in the cases of Walter Hammond and
Associates v the State of NSW and others and Ha and anor v the
State of NSW and others. Even though the cases heard related to
the imposition of franchise fees on tobacco, the decision has effectively
declared all current State business franchise fees to be constitutionally
invalid.
- The Commonwealth has, as a 'stop-gap' measure, agreed to impose its
own tax on the affected commodities on behalf of the States. It has
therefore increased, from midnight on 6 August 1997, petrol and diesel
excise by 8.1 cents per litre, tobacco excise by $167 per kilo and sales
tax on alcoholic beverages by 15 percentage points. The proceeds of
these taxes will be paid to the States.
- The Constitution only permits the Commonwealth to impose taxes on
a 'uniform' basis across the nation, while there was great variation
in the rates of State franchise fees. Where the taxes collected by the
Commonwealth exceed the fees that would have been raised by the States,
the States will refund the excess back to wholesalers. This is designed
to meet the Commonwealth's requirement that the new arrangements should
not lead to price rises for the affected commodities.
- The Commonwealth has also announced its intention to levy a 100 per
cent 'windfall gains' tax on any successful claims for refunds of monies
paid under the now invalidated franchise fee system, with the proceeds
being paid back to the States and Territories. While this appears to
be a possible solution to the problem, one can only presume that this
will still be a fertile area for litigation.
- Federal-State financial relations in Australia are characterised by
a substantial degree of vertical fiscal imbalance, that is, an imbalance
between the revenue sources available to each tier of government and
their expenditure responsibilities. With sole access to both the sales
tax base and, since 1942, the income tax base, the Commonwealth raises
around 80 per cent of all tax revenue but is responsible for only 63
per cent of all own-purpose expenditures. The invalidation of State
business franchise fees has further reduced the States' financial independence.
- The invalidation of this substantial source of State revenue may be
a catalyst for a further review of both Federal-State financial relations
and the structure of taxation in this country.
- If it is felt desirable to redress the worsened fiscal balance in
the Federation, one option might be amendment of section 90 of the Constitution
to give the States greater access to the consumption tax base. Another
alternative might be for the Commonwealth to make room for the States
to impose their own personal income tax in tandem with that of the Commonwealth.
- The current crisis also highlights the limited structure of consumption
taxation in Australia. Already, around one half of Federal indirect
tax is raised from petroleum, tobacco and alcohol. The new tax arrangements
will make the fiscal dependence upon these products even more marked.
The narrowness of the indirect tax base and the huge disparities that
apply to the taxation of different goods and services in Australia distort
resource allocation and impinge upon economic efficiency. The present
crisis in Federal-State finances may thus be the stimulus required to
undertake major restructuring of the present pattern of consumption
taxation.
On 5 August 1997, the High Court of Australia brought down a combined
decision in the cases of Walter Hammond and Associates v the State
of NSW and others and Ha and anor v the State of NSW and others.(1)
Even though the cases heard related to the imposition of franchise fees
on tobacco, the decision has effectively declared all current State business
franchise fees on petroleum, tobacco and alcoholic products to be constitutionally
invalid.(2) These fees have been imposed by the States for almost twenty
years and have been a significant source of revenue to them. In 1995-96,
these fees raised $4.9 billion. However, the Constitutional basis for
these fees has always been insecure. There has always been a suspicion
that these imposts might be characterised as an excise and, under section
90 of the Constitution, only the Commonwealth can levy an excise. Even
though these fees have survived a number of previous High Court decisions,
often by a slim majority of judges, they have always been regarded as
vulnerable. It is for this reason that the States have been very loathe
to extend this form of taxation to other commodities. The decision also
leaves open the possibility that, based upon the High Court's clarification
of what legally constitutes an excise, other State taxes such as stamp
duties on 'real' property transactions (e.g. new motor vehicle registrations,
house purchases, etc), might now come under threat.
Even prior to this decision, Federal-State financial relations have
been characterised by a substantial degree of vertical fiscal imbalance,
that is, an imbalance between the revenue sources available to each tier
of government and their expenditure responsibilities. The States have
major expenditure responsibilities in the fields of education, health,
law and order, transport and housing yet they have very limited means
of raising revenue. Resort to business franchise fees has been one initiative
taken by the States to expand their revenue base.
The Commonwealth, on the other hand, has sole access to the main taxes
such as income tax, sales tax and duties of customs and excise. These
revenues considerably exceed the Commonwealth's own expenditure requirements.
As a result, the Commonwealth provides a significant amount of financial
assistance to the States. This 'power of the purse' has enabled the Commonwealth
to engage in policy making in areas over which it has no direct constitutional
powers and has also given it influence over State borrowing. The invalidation
of State business franchise fees will have the effect of increasing the
degree of vertical fiscal imbalance in Federal-State financial relations.
Even if the Commonwealth follows through with its pledge to raise such
taxes on behalf of the States, this will only serve to increase the States'
dependence on the Commonwealth as a source of revenue.
Australia is characterised by a larger degree of vertical fiscal imbalance
between its tiers of government than any other federal nation. In 1995-96,
the Commonwealth raised $115.5 billion in tax, representing 79 per cent
of total Commonwealth and State taxation receipts. On the other hand,
Commonwealth outlays for its own purposes were only 63 per cent of total
general government outlays.(3) As a result, in the same year the Commonwealth
provided the States with grants amounting to $34.4 billion ($15.8 billion
in general purpose assistance and $18.7 billion in specific purpose funding).
These grants represented 46 per cent of State and Territory general government
revenue.
To a large extent, the source of this vertical imbalance lies in the
Constitution. The Commonwealth's power to tax is found in section 51(ii)
of the Constitution. Such power is certainly concurrent with the taxing
power of the States, except in relation to the imposition of duties of
customs and excise which, by virtue of section 90 of the Constitution,
is a power exclusive to the Commonwealth.
With the exception of customs and excise duties, therefore, the States
can have access to any tax base, including income taxation. The High Court
has ruled that section 109, which ensures that where Commonwealth and
State laws are in conflict Commonwealth law will prevail, would have limited
application in the taxing field. For that reason, it is possible for the
Commonwealth and the States to impose taxes on the same tax base. Such
taxes would not be interpreted as being in conflict with each other, but
would be seen as a sharing of the available tax base. Even though the
States have the legal power to impose income tax concurrently with the
Commonwealth, they have not done so since 1942 due to the political difficulties
they would face in attempting to take this course of action.
The Constitution does require (sections 51(ii) and 99) that any tax
imposed by the Commonwealth shall not discriminate between any States
or parts of States. In this respect, the imposition of taxation by the
Commonwealth must be 'uniform'.
Despite the apparent scope that the Constitution grants to the States
to impose tax on a great variety of tax bases, in reality, the Commonwealth
has been able to rely on High Court interpretations of powers bestowed
upon it by certain sections of the Constitution, most notably sections
96 and 90, to effectively prevent the States from fully exploiting their
taxing potential. Section 96 of the Constitution permits the Commonwealth
to grant financial assistance to any State on such terms and conditions
as the Parliament thinks fit.
Perhaps the greatest source of the current vertical fiscal imbalance
was the takeover of personal income tax by the Commonwealth during World
War 2. A number of the States had been levying small amounts of income
tax even before Federation, although the main source of taxation revenue
available to them at that time were duties of customs and excise. When
the power to levy customs and excise became the exclusive preserve of
the Commonwealth upon Federation, the States began to develop their income
tax base. Even so, the Commonwealth began to compete for this base by
commencing to levy income tax in 1915. Nevertheless, prior to World War
2, the States and the Commonwealth shared the income tax base in such
a way that the States were reasonably fiscally self sufficient.
However, in 1942, the Treasurer appointed a Committee to consider the
question of the Commonwealth becoming the sole income taxing authority
for the duration of the War, and for reimbursement payments to be made,
using section 96 powers, to the States upon their retirement from the
income taxing field. At the time, the various States imposed their income
taxes at very different levels. The Commonwealth wished to raise income
taxes to finance the War, but found itself in a quandary. If it set its
income tax at a uniformly high level, this would impose a serious burden
on those inhabitants in States with high income tax. Imposing low Commonwealth
tax would not yield sufficient revenue. The solution was for the Commonwealth
to impose a uniform, high rate of tax and reimburse the States for the
income tax that they would have forgone.
The Committee presented its report and recommended that, for the duration
of the War and one year afterwards, the Commonwealth government should
be the sole authority to impose taxes on income and that the States should
be duly compensated. In May 1942, legislation was introduced in the Federal
Parliament to give effect to this recommendation and a uniform income
tax scheme came into operation on 1 July 1942.
At a Premiers' Conference in January 1946, the States were informed
that the Commonwealth proposed to continue uniform taxation indefinitely.
A formula approach was adopted to the distribution of tax reimbursement
grants which continued to be provided on condition that the States made
no attempt to re-enter the income taxing field. This left the States with
little alternative other than to devise new forms of taxation.
However, the States' ability to devise new taxes was constrained by
High Court interpretation of section 90 of the Constitution. Section 90
states:
'On the imposition of uniform duties of customs the power of the Parliament
to impose duties of customs and of excise, and to grant bounties on the
production or export of goods, shall become exclusive...'
There appears to be a significant difference between an economist's
view of what constitutes an excise and the view taken by the High Court.
To an economist, an excise is a tax which is imposed upon goods which
have been produced domestically (as against customs duties which are imposed
on imported goods). An excise is usually applied at the point of production,
for example, being paid by the oil refiner or by the cigarette manufacturer.
In this respect, an excise is different from a sales tax, which is usually
imposed at the wholesale or retail level and which generally does not
discriminate between domestically produced and imported goods. This distinction
is even more important in a federal system of government. The incidence
of an excise applied at the point of production, say in one State, is
likely to fall upon consumers in all States where the product is sold.
The incidence of a State sales tax, however, will fall almost entirely
upon the residents of the State imposing the tax. The sales tax thus does
not have the 'spillover' effects of an excise and one might surmise that
it was the avoidance of such spillover effects that the framers of the
Constitution had in mind when drafting section 90.
In its early decisions on section 90, the High Court adopted a narrow
definition of an excise - one which was more closely aligned with the
economic definition. However, in later cases, the Court widened its definition
of an excise to be any tax on goods applied anywhere in the production
and distribution chain.(4) It is this broader definition of what constitutes
an 'excise' which has effectively prevented the States from applying any
form of tax on the production or distribution of goods. This has seriously
eroded the financial independence of the Australian States. In most other
federations, either direct access to, or formula-based sharing of, the
sales tax base is an important source of State revenue. In the United
States, for example, the Federal government collects no general sales
taxes at all. These are the preserve of the States and local government.
Such sales taxes generate around one-third of State taxation revenue in
the US and around 10 per cent of local government tax revenue.
Faced with these Constitutional and political obstacles, the States
have had difficulty in expanding their tax bases. At various times, the
States have negotiated with the Commonwealth and mounted High Court challenges
to restore their access to the income tax base. In January 1970, for example,
the Premiers of all States signed a document entitled The Financial
Relationships of the Commonwealth and the States. This document, among
other things, requested that State and Commonwealth Treasury officers
be instructed to devise a scheme whereby the States should have access
to income tax, broadly along the lines of the system operating in Canada.(5)
At the subsequent Premiers' Conference in February 1970, the Prime Minister
rejected this proposal out of hand.
Nevertheless, the Commonwealth did attempt to assuage the States by
increasing their financial assistance, by agreeing to assist with State
debt, and by agreeing to co-operate in identifying potential 'growth'
taxes that the States might apply. It was this last agreement which ultimately
led to the transference of payroll tax from the Commonwealth to the States
in June 1971.
Currently, the States raise tax revenue mainly through payroll tax and
a range of other taxes which frequently tend to be economically distorting
and involving significant administration and compliance costs. Such taxes
include stamp duties, taxes on gambling, taxes on motoring, financial
transactions taxes and land tax. The following table sets out the structure
of State taxation in 1995-96.
Tax $m % of Total
Payroll tax 7088 23.3%
Land tax 1483 4.9%
Stamp duties 4165 13.7%
Financial institutions taxes 1904 6.3%
Gambling taxes 3306 10.9%
Taxes on insurance 1730 5.7%
Motor vehicle taxes 3454 11.4%
Franchise fees 4903 16.1%
Other taxes 1278 4.2%
Fees and fines 1049 3.5%
Total Taxes, Fees and Fines 30 360 100.0%
Source: Australian Bureau of Statistics. Taxation Revenue, Australia
1995-96. (Cat. No. 5506.0).
Despite the constraints upon the States, they have not been immune from
the criticism that they have not attempted to fully utilise the tax bases
available to them. For example, even though the High Court interpretation
of section 90 has prevented the States from imposing a sales tax upon
goods, there is nothing preventing the States from imposing such taxes
on services such as accommodation, travel, entertainment, personal services
and so forth. To date, the States have really only applied such taxes
in the field of financial and insurance services.(6) Granted, there may
be difficulties in applying such taxes, since the price of many services
would also include the cost of goods associated with the provision of
those services and doubt may arise as to whether part of any sales tax
is actually falling upon those goods.
The States have also been accused of not fully exploiting their land
tax base, which exempts residential and agricultural land, while competition
between the States in the payroll tax arena may have led to higher exemption
thresholds and lower rates than might otherwise have been applied.(7)
Australia would also appear unique in that it has neither inheritance
taxes nor estate duties. Death and estate duties were phased out by all
States over the late 1970s and early 1980s, following Queensland's abolition
of death and estate duties in 1977.(8)
In an attempt to find some way of overcoming the High Court's interpretation
of section 90, the States began, in the 1970s, to experiment with business
franchise taxes. Such taxes are applied by requiring the vendor of a particular
commodity to be licensed. The tax then takes the form of a licence fee.
The fee usually consists of a flat-rate amount plus some ad valorem
component, usually expressed as a percentage of turnover over some specified
preceding period. In this way, the impost is portrayed as a licence fee
for the right to conduct a particular type of business rather than as
a tax on the commodity being sold.
License fees had long been applied by the States on the suppliers of
liquor, who were required to be licensed to engage in such trade. The
validity of licence fees on the sale of alcohol was upheld by the High
Court in the case of Dennis Hotels(9) in 1961. It thus became obvious
that such a scheme might be extended to other commodities and, to date,
such business franchise fees have been levied on the sale of petroleum
products, tobacco products, liquor and, in South Australia, gas. An attempt
by Victoria to impose a similar type of fee on oil pipelines was found
by the High Court to be in breach of section 90 in August 1983.(10)
The first attempt at introducing a business franchise fee occurred in
Tasmania in February 1973 in respect of tobacco. The legislation imposing
the fee was challenged in the High Court, where it was found to be valid,
although certain technical flaws with the legislation, especially in regard
to a consumption tax element of the scheme, were identified. The State
redrafted its legislation to overcome these but before it could be retested
in the High Court the fee was suspended following the negotiation of revised
financial arrangements with the Commonwealth. The collection of licence
fees was suspended from 1 July 1974.
NSW introduced a franchise fee on petroleum products to apply from March
1975, while South Australia introduced a similar fee in 1974. South Australia
also applied a licence fee to the supply of gas for final consumption,
with effect from December 1974. Both Victoria and South Australia legislated
for business franchise fees on tobacco products in 1974. These fees took
effect from April 1975 in South Australia and from January 1975 in Victoria.
In 1975, NSW and Western Australia joined Victoria and South Australia
in applying a business franchise fee on tobacco. Tasmania reintroduced
its business franchise fee on tobacco from January 1981 as did the Northern
Territory. Queensland resisted the trend, until it too introduced a tobacco
franchise fee in 1988-89.
Petroleum products franchise fees were abolished in NSW in early 1976,
while the South Australian petroleum fee was abolished as from December
1975. In both States, these fees were regarded as politically unpopular
and inflationary. Both States gave as their excuse for abolishing the
fees improved financial arrangements with the Commonwealth. However, following
the truck highway blockades of April 1979, all States which had road maintenance
charges abolished them. In 1979-80, Victoria, South Australia and Western
Australia reacted by introducing fuel franchise schemes for petroleum
products. Tasmania followed suit in 1981 while NSW reintroduced its petroleum
products fuel franchise fee in 1982-83. The Northern Territory imposed
its fuel franchise fee in 1987-88.
As has already been mentioned, the States appeared to be reticent about
extending the franchise fee approach to other commodities. This nervousness
has been exacerbated by a number of recent High Court decisions. On 24
August 1989, the High Court handed down its judgement in a case involving
the imposition of a franchise fee on tobacco (the Philip Morris(11)
case). The validity of the scheme was upheld by a majority of five to
two, but two of the assenting justices stated that they might have come
to a different conclusion had the product concerned not been tobacco or
alcohol. In December 1993, the High Court also ruled in the Capital
Duplicators (No. 2)(12) case that franchise fees might only be applied
in instances where a public interest component existed, that is, where
the fees performed a regulatory function. Furthermore, the Court argued
that any such fees should only be applied at a level commensurate with
a regulatory role rather than containing a purely revenue component. At
the time, this decision cast doubt on the constitutional validity of franchise
fees on petroleum products and gas.
In its most recent decision in the Walter Hammond and Ha
cases, the High Court could have clarified the definition of an excise
so as to distinguish between a tax on domestic production and a sales
tax on the wholesale or retail sale of imported or domestically produced
goods. However, by a 4 to 3 decision, the Court upheld its more general
definition of an excise and has thus effectively struck down all current
State franchise fees as being in contravention of section 90 of the Constitution.
This decision will have a major impact upon State revenues. Tables 2
and 3 below set out the rates of business franchise fees applying just
prior to the High Court decision and the revenues raised from these fees.
Product NSW Vic. Qld SA WA Tas NT ACT Total
Petroleum 539 505 .. 155 221 48 34 27 1531
Tobacco 871 591 501 212 282 83 43 39 2621
Liquor 282 162 131 46 72 18 10 14 735
Gas 8 .. .. 8 .. .. .. 1 17
Source: Australian Bureau of Statistics. Taxation Revenue, Australia
1995-96. (Cat. No. 5506.0). p. 20
Product NSW Vic. Qld SA WA Tas NT ACT
Petrol $10 per month $50 per month Nil $50 per month $50 per month $50 per month $10 per month $10 per month
plus 17.89% plus 12.1% of plus 15.84% plus 9.67 plus 12.68% plus 7.0 plus 7.51
of declared declared of declared cents per of declared cents per cents per
value. value. value. litre value. litre litre
(Equals 7.51 (Equals 8.99 (Equals 9.62 (Equals 6.15
cents per cents per cents per cents per
litre) litre) litre) litre)
Diesel (for $10 per month $50 per month Nil $50 per month $50 per month $50 per month $10 per month $10 per month
road use only plus 29.61% plus 15.5% of plus 17.78% plus 7.45 plus 12.68% plus 7.0 plus 7.55
in NSW, Vic of declared declared of declared cents per of declared cents per cents per
and WA) value. value. value. litre value. litre litre
(Equals 7.55 (Equals 11.03 (Equals 10.80 (Equals 6.11
cents per cents per cents per cents per
litre) litre) litre) litre)
Tobacco $10 per month $50 per month 100% of sales $2 per month $20 per month $12 per month $10 per month $10 per month
plus 100% of plus 100% of plus 100% of plus 100% of plus 100% of plus 100% of plus 100% of
sales intrastate intrastate sales sales sales sales
sales sales
Liquor 13% of sales 11% of sales $600 and 14% 11% of sales 11% of sales 8.8% of sales 11% of sales $125 plus 13%
of sales of sales
Low alcohol Nil Nil $600 and 14% Nil 7% of sales 5% of sales 4% of sales Nil
beer and wine of sales
* Most relevant rate where a range of rates apply.
Source: Commonwealth Grants Commission. Report on General Revenue
Grant Relativities 1997 Update. AGPS. Attachment N. pp. 404-407
When the Capital Duplicators case was being heard in 1993, the
States were concerned that the High Court might disallow all business
franchise fees. The Commonwealth Government assured them that, if such
a decision should eventuate, the Commonwealth would legislate to collect
equivalent taxes on their behalf. As it turned out, the High Court restricted
its decision solely to the ACT's taxation of X-rated videos, so the contingency
plans were not required. However, as a result of the High Court's decision
in the most recent tobacco case, the Commonwealth has resurrected its
plan to collect the disallowed imposts.
On 6 August 1997, the Commonwealth agreed to a package of measures to
provide a 'safety net' for State revenues.(13) The measures involve the
Commonwealth increasing its taxes on the affected products and providing
the revenue so raised to the States (after deducting the cost to the Commonwealth
of administering the scheme). These arrangements are to be regarded as
a stop-gap solution and will be subject to review within the next six
months.
Effective from midnight on the 6 August, the rate of Commonwealth customs
and excise duty on petrol and diesel was increased by 8.1 cents per litre.(14)
The rate of excise and customs duty on manufactured tobacco and tobacco
products was increased by $167 per kilogram.(15) The Commonwealth has
acknowledged the impact that the change in tobacco taxation (from the
value-based taxes of the States to the weight-based excise of the Commonwealth)
will have on tobacco manufacturers and has agreed to discuss this matter
further with the industry. Finally, the rate of wholesale sales tax on
alcoholic beverages was raised by 15 percentage points. It should be remembered
that all Federal excises on traditional commodities (refined petroleum,
tobacco and alcohol) are subject to six-monthly indexation in line with
changes in the consumer price index.(16)
As Table 3 (on page 8) shows, there are significant differences between
the levels of franchise fees levied by the various States on the products
concerned. As pointed out earlier, however, the Commonwealth is only permitted
by the Constitution to levy taxes on a uniform basis across the nation.
This introduces a complication into the Commonwealth's safety net package.
To give effect to the package, the Commonwealth has had to levy a relatively
high uniform rate of additional tax on petroleum, tobacco and alcoholic
products. Once collected and paid to the States, it will be up to the
States to reimburse wholesalers for any Commonwealth tax paid by them
in excess of the tax they were paying under the States' franchise tax
regimes. Arrangements will also have to be put into place to ensure that
off-road users of diesel fuel who, as can be seen from Table 3 have been
exempted from State franchise fees in a number of States, are not disadvantaged.
There is no doubt that the rescue package is extremely convoluted and
will be quite complex to execute.
The Commonwealth has made it clear that it does not want the new arrangements
to lead to any significant increase in the overall price of the affected
commodities and has tasked the Australian Competition and Consumer Commission
and State regulatory agencies with monitoring the prices of these products.
However, confusion about the impact of the Commonwealth's taxes and the
stance that the States will take on the reimbursement of 'excess' taxes
paid has already caused quite a number of manufacturers to foreshadow
increases in the prices of their products.
The question also arises as to what mechanisms might be put in place
to deter claims for refunds of franchise fees paid in the past to the
States, now that these have been declared to have been invalid. The Commonwealth
has announced that it will legislate to impose a 100 per cent 'windfall
gains' tax on any successful claim for refund, with the proceeds being
paid back to the States and Territories. While this appears to be one
possible solution to the problem, it can only be presumed that this will
still be a fertile area for litigation. The question of refunds is further
complicated by the fact that in a number of States, the franchise fees
on some of the affected commodities have already been paid in advance.
Even if no refunds are given for fees paid on past sales, the likely treatment
of those fees effectively paid in respect of future sales is far from
clear.
Obviously, the new arrangements devised in response to the High Court's
decision in Hammond and Ha have significantly increased
the degree of vertical fiscal imbalance in Federal-State relations. The
dependence of the States on the Commonwealth has been exacerbated. This
must come as a serious blow to the States who, through the Special Premiers'
Conference forums of the early 1990s and through the Council of Australian
Governments (COAG) mechanism in later years, have argued strongly for
measures to be put in place to reduce the degree of vertical fiscal imbalance
and to reduce their reliance on Commonwealth grants, especially tied grants.
One can appreciate the concern of the States over the loss of yet more
of their autonomy. To be blunt, the history of Federal-State relations
in Australia is littered with broken promises, with the initial intent
of agreed arrangements being subverted at a later date and with agreed
positions on both sides being negotiated away as political and economic
circumstances change. The only revenue which is really secure for the
States is State-own revenue (although even this has been undermined on
occasions due to interstate fiscal competition). Regardless of the goodwill
now shown by the present Commonwealth Government on this matter, there
is always the possibility that the initial intent of the safety net arrangements,
should they survive for any length of time, could be lost at some future
date.
Of course, the question might be asked whether, in a national sense,
vertical fiscal imbalance is a problem. In fact, there are both advantages
and disadvantages arising from the present pattern of Federal-State financial
relations. The perceived advantages might include:
- administrative advantages for both governments and taxpayers in having
the major taxes collected and administered by only one level of government
- the facilitation of policies aimed at achieving national economic
stability and growth(17)
- the existence of adequate scope for the Federal Government to provide
grants producing a strong horizontal equalisation effect across the
States (reflecting the fiscal equalisation principles developed by the
Commonwealth Grants Commission)
- the facilitation of interpersonal horizontal equity through relatively
uniform taxation and social welfare payments throughout the nation
- the ability to take a more 'national' approach to resource allocation
and the setting of standards
- reduced scope for 'destructive' tax competition amongst the States
On the other hand, various criticisms are also levelled at the present
system
- there may be a loss of diversity and responsiveness to regional and
local needs and preferences
- the separation of revenue raising and expenditure decisions at each
level of government may lead to fiscal inefficiencies. These might arise
from (i) imposed priorities not reflecting preferences, (ii) a lack
of direct accountability to taxpayers for expenditure decisions, (iii)
'buck passing' amongst the various tiers of government and (iv) the
waste of resources inherent in financial negotiation processes
- there may be uncertainty on the part of States as to future levels
of funding especially if, as has so often happened, the basis of such
funding has been somewhat ad hoc
- the States have had to resort to 'nuisance' taxes, often with a high
ratio of compliance and administration costs to revenue, which can be
both inequitable and economically inefficient
- there may be reduced scope for 'constructive' competition between
the States, whereby an improvement in tax performance by one State encourages
other States to follow suit
- the political power of the 'sovereign' States is seriously diminished
through the financial power of the Commonwealth.
However, should it be decided to redress the further reduced fiscal
autonomy of the States, bearing in mind the constraints imposed upon them
by the recent High Court decision, there are only a limited number of
alternatives. One would be to amend section 90 of the Constitution to
give the States better access to the consumption tax base.(18) Given the
poor success rate of attempted constitutional amendment in Australia,
this approach might be problematical, especially if voters considered
that they might be opening the flood gates to a raft of new State taxes.
A further difficulty with this approach is that the existence of different
State consumption tax regimes might complicate the task of introducing
any VAT-style broadly based consumption tax in Australia, should this
ever be deemed desirable. Such a problem would be lessened if a broadly
based retail sales tax regime were implemented.(19)
Another option would be for the Commonwealth to provide 'tax room' for
the States to impose their own personal income taxes. This option was
espoused in a position paper circulated by Premiers and Chief Ministers
prior to a Heads of Government meeting on 11 May 1992 in Canberra, with
Mr Keating as Prime Minister.(20) Actually, this paper set out two main
options for redressing what the States perceived as the problem of vertical
fiscal imbalance.
The first option was an income tax sharing plan having the following
structure:
- the States would be accountable for an identifiable component of national
personal income tax
- the State component would be set at approximately six cents in the
dollar of taxable income for the first three years, with a corresponding
reduction in financial assistance grants
- after three years, any proposed changes to the States' component rate,
either individually or collectively, would be a matter for agreement
between the Commonwealth and the States and
- income tax would continue to be collected by the Australian Tax Office
under a single tax regime determined by the Commonwealth.
The States emphasised at the time that these arrangements would be revenue
neutral with no effect on the rate of personal income tax paid by individuals,
that is, there would be no double taxation.
Another possible solution to the problem, that of the States receiving
a guaranteed share of Commonwealth tax collections was canvassed as the
second option in the States' discussion paper. While this might be an
easier option to implement politically, it still would leave the States
in a somewhat vulnerable position and could constrain the ability of the
States to tailor revenue raising to their own particular needs or preferences.
Such an approach might also not overcome one of the major disadvantages
associated with vertical fiscal imbalance, that is, the separation of
State spending decisions from revenue raising responsibility.
The current safety net package is so complex that it is hard to imagine
it lasting in its present form for any length of time. The High Court
decision may well be a catalyst not only for a review of Federal-State
relations but also of the whole structure of taxation in Australia.
One ramification of the safety net package is that it highlights the
narrowness of the indirect tax base in Australia. In 1997-98, Commonwealth
indirect tax collections (sales tax, excises and customs duties) are expected
to amount to $31.1 billion. Already, Federal excise on refined petroleum,
tobacco and alcoholic products is expected to be $13.5 billion. To this
might be added the amount of customs duty levied on these products and
sales tax on alcoholic products. The taxation of these three products
therefore already accounts for around one-half of all indirect taxation.(21)
Adding the $5 billion additional taxes on these products on behalf of
the States simply illustrates more clearly the dependence of our indirect
taxation system on these goods. It might also be noted that taxes on these
products are quite regressive (that is, they fall relatively heavily on
lower income earners), especially the excise on tobacco.(22)
The narrowness of the indirect tax base and the huge disparities that
apply to the taxation of different goods and services in Australia distort
resource allocation and impinge upon economic efficiency. The present
crisis in Federal-State finances may thus be the stimulus required to
undertake major restructuring of the present pattern of consumption taxation
in this country.
Postscript
On 13 August, the Prime Minister announced the establishment of a Taxation
Task Force (with its membership drawn from the Commonwealth Departments
of Treasury and Prime Minister and Cabinet) which will prepare options
for reform of the taxation system. The Task Force has been asked to give
consideration to a broadly based indirect tax to replace some or all of
the existing indirect tax bases, with any new taxation system involving
major reductions in personal income tax. As part of this process, the
Prime Minister has also directed the Task Force to address the issue of
reforming Commonwealth-State financial relations.(23)
- High Court of Australia, Matter No. 845 of 1996; decision handed down
in August 1997.
- For a brief overview of High Court decisions on the validity of franchise
fees, see Spry, Max. What is an Excise Duty? Ha and Hammond v NSW.
Research Note (forthcoming). Information and Research Services. Department
of the Parliamentary Library.
- By way of comparison, in Cananda, the Federal Republic of Germany
and the United States, the national governments raise approximately
the same amount of revenue as they require to meet their own outlay
needs. See Taxation and the Fiscal Imbalance between Levels of Australian
Government: Responsibility, Accountability and Efficiency. Report
of the Working Party on Tax Powers to the November 1991 Special Premiers'
Conference. October 1991. p. 8
- It might be noted, however, that even in the recent Hammond
and Ha cases, three of the seven judges suggested a return to
the more narrow definition of an excise as being a tax only imposed
upon the manufacture or production of goods.
- Income taxation (personal and corporate) is a major source of revenue
for the Federal Government and the Provincial governments in Canada.
Under Tax Collection Agreements, the Federal Government collects, without
charge, the personal income tax for nine Provinces and corporate income
tax for seven Provinces. Each Province sets its own personal income
tax rate as a percentage of the basic Federal rate, with Provincial
corporate tax rates applied directly to corporate taxable income. The
Province of Quebec has its own, separate personal income tax system.
- There have been limited attempts to impose taxes on other services.
For example, in its 1997-98 Budget, the NSW Government announced the
imposition of a 'bed tax' in the Sydney central business district.
- See Walsh, Cliff. The Radical Reform Options, in Issues
in State Taxation. Walsh, Cliff, ed. ANU Press. Canberra. 1990 pp.
66-67.
- The Commonwealth also phased out its death and estate duties over
the latter part of the 1970s.
- Dennis Hotels Pty Ltd v Victoria (1961) 104 CLR 621.
- Hematite Petroleum Pty Ltd v Victoria (1983) 151 CLR 599.
- Philip Morris Ltd v Commissioner of Business Franchises (1989) 167
CLR 399.
- Capital Duplicators [No. 2] (1993) 178 CLR 561.
- For details of this package, see the Treasurer's Press Release, Constitutional
Invalidation of State Business Franchise Fees: Temporary Commonwealth
Safety Net Arrangements. No. 85. 6 August 1997.
- This has the effect of raising Federal excise from 34.697 cents per
litre on unleaded petrol and diesel to 42.797 cents per litre and from
36.872 cents per litre on leaded petrol to 44.972 cents per litre.
- This has the effect of raising Federal excise from $84.27 per kilogram
of tobacco to $251.27 per kilogram.
- Since State franchise fees on alcoholic and tobacco products were
levied on a value basis, collections on these products would have reflected
inflationary trends to some extent. However, the fees on petroleum products
were expressed in terms of cents per litre. There was no explicit indexing
of the fees applying to these latter products at the State level.
- Note though that the lack of fiscal imbalance in the US certainly
does not appear to have impinged upon that country's ability to successfully
implement its macroeconomic policies.
- It might be noted in this context that the 1989 Constitutional Commission,
in its Report of the Constitutional Commission 1989, recommended
that section 90 be amended to remove any reference to duties of excise.
- VAT stands for value-added tax. It might be noted that in Canada,
for example, the Federal government levies a VAT-style goods and services
tax, while the Provinces levy their own retail sales tax in addition.
- Commonwealth-State Financial Arrangements. A Position Paper by
Premiers and Chief Ministers. May 1992.
- Furthermore, the remaining indirect taxation falls exclusively on
goods. The sale of services is free of any taxation.
- For evidence of the degree of regressivity involved in these taxes,
see James, Denis. Beer and Cigs Up!: A Recent History of Excise in
Australia. Background Paper No. 5. Parliamentary Research Service.
April 1996.
- Prime Minister's Press Release. Taxation Reform. 13 August
1997.
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