Current Issues Brief 5 1997-98

Federal and State Taxation: A Comparison of the Australian, German and Canadian Systems

Denis James
Economics, Commerce and Industrial Relations Group
3 November 1997

Contents

Major Issues Summary

Introduction

Public Finance Principles and Tax Assignment

Tax Assignment in Australia

A Brief History of Taxation in Australia

Vertical and Horizontal Distribution in Australia

Tax Assignment in the Federal Republic of Germany

Horizontal Equalisation
Horizontal Tax Distribution Horizontal Fiscal Equalisation Federal Supplementary Allocations

Tax Assignment in Canada

A Brief History of Taxation In Canada Horizontal Fiscal Equalisation in Canada

Conclusion

Endnotes

Glossary of Terms

Related Publications

Major Issues

• On 5 August 1997, the High Court of Australia declared State tobacco franchise fees to be unconstitutional. In 1995-96, these fees raised $4.9 billion and represented 16 per cent of State taxation revenue.
• In response the Commonwealth agreed to immediately implement a package of measures to provide a safety net for State revenues. The measures involve the Commonwealth increasing its taxes on the affected products and providing the revenue so raised to the States. However, these arrangements are to be regarded as a stop-gap solution and are to be subject to review within six months from their implementation date.
• The Prime Minister announced, on 13 August 1997, the establishment of a Taxation Task Force to 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. The Prime Minister has also directed the Task Force to address the issue of reforming Commonwealth-State financial relations.
• Given the political focus being directed at these two issues, it is the aim of this paper to outline the assignment of taxation responsibilities in the Federal Republic of Germany and Canada (both of which are federations which impose broadly-based consumption taxes) and to draw comparisons with Australia.
• The Australian Constitution gives little guidance as to the allocation of taxing powers between the Commonwealth and the States. In the early years of Federation, the States had very poor tax bases following the ceding of their customs and excise raising powers to the Commonwealth. However, by the beginning of World War II, the States were reasonably financially self-sufficient due to their sharing with the Commonwealth of the income tax base. However, with the Commonwealth taking over sole responsibility for income taxation since 1942, the States have reverted to very limited taxes, especially since High Court interpretation of section 90 of the Constitution has prevented them from imposing any form of sales tax on goods.
• As a result, in Australia the Commonwealth levies all of the major taxes and raises around 75 per cent of all government tax revenues. The States therefore must derive almost one-half of their revenues from Federal grants. However, through the provision of these grants, Australia also implements a very sophisticated system of horizontal fiscal equalisation between the States. The Australian model assesses the need for such equalisation on both the expenditure and revenue sides of State budgets. It also ensures that the richer States are equalised down to the standard while the poorer States are equalised up to the standard. By contrast, in both Canada and Germany, the equalisation standard applied only takes the revenue side of the equation into consideration.
• The German Basic Law (Germany's constitution) embodies the philosophy of ensuring that each tier of government has adequate access to financial resources. It is very specific about the allocation of revenues from the major taxes between the Federation, Länder and municipal governments. All three tiers of government share in the personal income tax while the Federation and the Länder also share corporate taxes and the proceeds from the German value added tax (VAT). Whilst there is no constitutional requirement to do so, a business tax is also shared between the three tiers of government.
• In Germany, horizontal fiscal equalisation between the Länder is achieved through the formula for sharing the proceeds of the VAT, through the provision of funds from richer Länder to poorer Länder, as well as through supplementary payments provided by the Federation from its share of the VAT. The German equalisation model only takes into consideration the revenue side of Länder budgets. Moreover, equalisation payments need only ensure that the poorer Länder are equalised to at least 95 per cent of the average revenues of all Länder.
• Canada had a very similar tax history to Australia up to the beginning of World War II. The Canadian Provinces shared the income tax bases with the Federal Government and were able to word their legislation imposing sales taxes in such a way as to survive court challenges. As in Australia, during the War, the Provinces vacated the income taxing field in favour of the Federal Government. However, whereas the Commonwealth has failed to restore access to this base to the States, the Canadian Government allowed the Provinces to resume income and corporate taxes in 1957. Most Provinces currently set their own marginal income and corporate tax rates and have these taxes raised on their behalf by the Federal Government, although a number of Provinces impose their own taxes. The Federal Government has provided tax room by reducing its call on the income tax base.
• The Canadian Provinces do not share the Federal goods and services tax, but continue to raise revenue from their own local retail sales taxes and excises. Quebec has its own value added tax and this is harmonised with that of the Federal Government.
• Assistance aimed at achieving horizontal equalisation is provided by the Canadian Government. Equalisation only takes into account the revenue side of Province budgets and currently the poorer Provinces are equalised up to a standard represented by the average revenues of five 'representative' (ie. neither rich nor poor) Provinces.
• It is difficult to posit why these three federations have adopted such different approaches to the question of tax assignment. Factors which might have led to a more decentralised approach in Germany and Canada might include the strong 'States' house' function of the Bundesrat and the old historical, religious and tribal origins of the German Länder. In the case of Canada, the existence of strong, independent Provinces, especially Quebec and more distinctive cultural differences may have ensured that the Federal Government has had to adopt a more flexible approach to Federal-Provincial financial relations.

Introduction

On 5 August 1997, the High Court of Australia declared State tobacco franchise fees to be invalid.(1) By extension, this decision effectively struck down all State franchise fees, which had been applied to petrol, diesel, alcoholic and tobacco products and, in certain States, gas. These fees had been imposed by the States for almost twenty years and were a significant source of revenue to them. In 1995-96, these fees raised $4.9 billion and represented 16 per cent of State taxation revenue.

Even prior to this decision, Federal-State financial relations in Australia had been characterised by a substantial degree of vertical fiscal imbalance, that is, an imbalance between the revenue sources available to the various tiers 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 had been one initiative taken by the States to expand their revenue base.

The Commonwealth, on the other hand, has sole access to the major 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. On the other hand, the Commonwealth has often argued that its financial dominance is essential for the effective implementation of national fiscal policy. The invalidation of State business franchise fees has therefore had the effect of increasing the degree of vertical fiscal imbalance in Federal-State financial relations.

On 6 August 1997, the Commonwealth agreed to immediately implement a package of measures to provide a 'safety net' for State revenues.(2) 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 are to be subject to review within six months from their implementation date.

The High Court decision has not only highlighted the imbalance in revenue raising capacities of the Commonwealth and the States, it also highlights the narrowness of the indirect tax base in Australia. In 1997-98, Commonwealth indirect tax collections (sales tax, excises and customs duties) were expected to amount to $31.1 billion. Already, Federal excise on refined petroleum, tobacco and alcoholic products was 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 Commonwealth indirect taxation.(3) 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.

Addressing both of these issues the Prime Minister announced, on 13 August 1997, the establishment of a Taxation Task Force (with its membership drawn from the Australian Tax Office and 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.(4) At the same time, the Commonwealth announced that these issues should be discussed with the States at the November 1997 Council of Australian Governments meeting.

Given the political focus being directed at these two inter-related issues, it is the aim of this paper to briefly examine the assignment of taxation responsibilities between the tiers of government in two other federal countries-the Federal Republic of Germany and Canada-both of which also raise substantial taxation revenues from broadly-based consumption taxes. For purposes of comparison, tax assignment in Australia will also be outlined.

Public Finance Principles and Tax Assignment

Federal structures will vary, both between countries and within any country over time, reflecting a wide range of political, legal and historical factors. However, it is possible to theorise on a set of public finance principles which might form the basis for an appropriate allocation of expenditure responsibilities and access to sources of taxation revenue.

Russell Mathews, one of Australia's principal writers on Federal-State financial relations, argues that the following factors may be relevant in determining which level of government is best qualified to accept responsibility for particular functions(5)

• access to information sources
• responsiveness to those affected by government decisions
• political accountability for decisions taken
• effects on stability and growth
• capacity to administer the function
• the existence or otherwise of economies of scale
• capacity for contributing to economic equality and social justice and
• the possibility of encompassing all relevant 'spillover' effects into the decision making process.

On the basis of these criteria, the federal government should have a prime responsibility for activities with an international, interstate or national character. Such functions are likely to be more efficiently and economically undertaken by the central government. State governments could address these functions, but only through complicated, co-ordinated policy agreements. The states, on the other hand, would be given responsibility for providing those functions which are closest to the individuals within their jurisdictions.

The central government, on the above criteria, might be seen as the more appropriate level at which to set economic stabilisation and growth priorities and to oversee the process of intergovernmental and interpersonal transfer payments. It is, however, by no means certain that the high degree of vertical fiscal imbalance found in Australia is necessary for the effective conduct of fiscal policy. Fiscal policy still appears to be an effective instrument in other federations characterised by a lower degree of fiscal centralisation.(6)

Services of a national nature, such as post and telecommunications services, might also be provided by the central government. The states would be more concerned with policies affecting the allocation of resources within their own jurisdictions. In concrete terms, this might include the provision of such services as law and order, education, health, housing, community services, transport and regional economic development. The allocation of functions within Australia matches this model reasonably well.

Even more theoretical is the question of the appropriate assignment of taxation powers amongst the various levels of government. The criteria which are frequently cited are(7):

• the distribution of taxing powers should be related to expenditure responsibilities and borrowing powers
• taxes on bases with high mobility as between state jurisdictions should be reserved to the federal government (eg. death duties, company income tax)
• taxes designed primarily to achieve economic stabilisation or redistributive functions should be assigned to the central government
• all levels of government need to impose particular taxes and charges to achieve desirable resource allocative decisions in the community (eg. road user charges)
• a central government should be able to impose tax on either an origin-basis or a residence basis, while states should only levy residence-based taxes (eg. states could have access to personal but not corporate income tax) and
• regard should be had to the administrative convenience on the part of the collecting authority and the payer of the tax.

Unfortunately, while these criteria look appealing in theory, they are difficult to apply in practice. However, when considering the tax assignment systems in the countries discussed below, these criteria do provide some yardstick against which the revenue assignment arrangements found in those countries might be compared.

Tax Assignment in Australia

When Australia's founding fathers framed the Constitution in the late 1800s, it is unlikely that they could have foreseen the extent to which the Commonwealth would come to fiscally dominate the States. The Constitution was designed to conserve the powers of the States while reaping the benefits which would flow from federation. It was for this reason that the Constitution does not specify powers for the States. These powers were taken as given. Only the powers available to the Commonwealth were carefully defined and the majority of these powers were only granted on a concurrent basis with the States.(8) Only where commonsense dictated that certain functions were unambiguously of a national nature were the requisite powers granted exclusively to the Commonwealth. Some of these functions include the right to raise armies, matters relating to coinage, power over territories and over Commonwealth places. The Constitution also cedes to the Commonwealth exclusive power to impose duties of customs and excise, although the definition of an excise has been one of our most vexed legal questions.

It would appear then, that the framers of our Constitution viewed the roles of the Commonwealth and the States as co-ordinate. Each level of government would carry out the tasks for which it was most suited and each would have access to the financial resources necessary for the exercise of these functions. That such an outcome has not eventuated must imply that our founding fathers were either myopic or overly optimistic about the political processes which would develop over successive generations. It must have been obvious to them that as the nation developed, imbalances were bound to occur between the powers exercised by the various tiers of government and the available financial resources. However, the Constitution gave very little guidance as to the mechanisms which could be put into place to handle these developments. Even though the Constitution provided guidelines for protecting the revenue of the States, these provisions ceded ultimate power over Federal-State financial arrangements to the Federal Parliament. These provisions can be found in sections 86 to 97 of the Constitution.

Three sections in particular deal with the provision of revenue to the States. Section 87 states:

This section recognised that the main taxation revenue available to the colonies had been customs and excise revenue. The power to raise such revenue was now to be transferred exclusively to the Commonwealth. It was further recognised that the overwhelming bulk of government functions would continue to be performed by the States. However, the Commonwealth Parliament saw fit to abandon this transitional provision at the earliest possible opportunity.

Section 94 was also designed to give guidance on the matter of intergovernmental financial transfers. This section states:

This also reflected the view that the resources of the Commonwealth were likely to exceed its expenditures. However, the Commonwealth did not take long to subvert the intent of this section of the Constitution by setting up a succession of trust funds into which any 'surplus' could be paid, hence ensuring that no such surplus would, in an accounting sense, eventuate. Faced with relatively heavy defence and social security expenditure, the Commonwealth in 1908, set up a pension trust fund into which it could pay all 'surplus' revenue and the States were only paid their three-quarters share of customs and excise revenue (as per section 87). In 1910, even the section 87 provision was abolished and the States grudgingly accepted annual per capita payments from the Commonwealth. This represented a significant decline in the level of Commonwealth grants to the States.

The remaining important section of the Constitution dealing with intergovernmental transfers is section 96. This section states:

One can only wonder if the founding fathers had any inkling at all as to the power that they were providing the Commonwealth under this section. Not only has it been instrumental in allowing the Commonwealth to extend its influence into areas which were not assigned to it under the Constitution, but also allowed the Commonwealth, in the early 1940s, to gain sole access to the income tax base, hence ushering in the period of Commonwealth financial domination of the States.

With the Constitution providing no longer term solution to the question of intergovernmental fiscal relations, the development of policies and institutions to address this issue has been left up to political processes. These processes have not, however, been particularly happy ones. While at times they have reflected genuine attempts at co-operation and co-ordination, unfortunately they have also all too often reflected political self aggrandisement, suspicion, self-interest (often of a short-sighted nature) and ideological conflicts. There have been many occasions on which the problems of fiscal federalism could have been addressed, but mostly these attempts have been thwarted by conflicting objectives on the part of the Commonwealth and the States or, as often happened, between the States themselves.(9)

The Constitution has been of little assistance in the assignment of tax powers in Australia. 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 an exclusive power of the Commonwealth.

With the exception of customs and excise duties, therefore, the States can, legally, 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.

The Constitution does require (sections 51 (ii) and 99) that any tax imposed by the Commonwealth does 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 the 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 has been used to great effect by the Commonwealth since 1942 to exclude the States from the income taxing field. In that year, the Commonwealth reached agreement with the States that they should cede to it their income taxing powers on a 'temporary' basis. 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 uniform 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. Later, in 1946, the Commonwealth informed the States that it would retain the sole income taxing position, but would make appropriate tax reimbursement grants to the States on condition that they did not attempt to reimpose their own taxes. The High Court ruled, in 1957, that the imposition of this condition on the provision of general revenue assistance to the States was a valid use of section 96. Thus, in this manner the Commonwealth has effectively excluded the States from a major potential source of taxation revenue.

A further major constraint on the States' ability to exploit a significant tax base has been the High Court's interpretation of section 90 of the Constitution. Section 90 states:

Although economists make a clear distinction between an excise, which is applied at the point of production of a good, and a sales tax, which is applied at the point of wholesaling or retailing, the High Court has effectively ruled that a tax applied anywhere in the production and distribution chain is a 'tax on production' and hence an excise, to be applied exclusively by the Commonwealth. This view found its strongest expression in the August 1997 Ha and Hammond decision referred to in the introduction.

The upshot of the High Court's interpretation of section 90 is that the States have effectively been denied access to any meaningful taxes on the sale of goods. This probably makes the Australian States unique, since in most other federations, sales taxes are an important source of State revenue. It remains to be said, however, that the States might have more success in applying taxes on services. To date, however, the States have not really attempted to explore this field, the imposition of various taxes on the provision of banking and insurance services being the only major application.

A Brief History of Taxation in Australia

Just prior to Federation, the main revenues available to the colonies were customs and excise duties. Upon Federation, the power to raise such duties was ceded to the Commonwealth. Over the next ten years, therefore, there was a need for considerable grants to the States to compensate them for the loss of this revenue source. The States, which had always levied small amounts of income tax, began to develop this as a primary source of tax revenue. Of course, the States also derived a reasonable amount of non-tax revenue from other sources, such as railway profits, land sales and royalties. The Commonwealth entered the income taxing field for the first time in 1915, but this did not constrain the States from further exploiting this tax base.

In 1909-10, total State revenue amounted to $52 million. Commonwealth grants to the States made up 31 per cent of this revenue ($16.2 million). State taxation made up a further 15 per cent ($8 million). Taxation revenue comprised, in the main, income tax and estate tax receipts ($2.5 million and $2.6 million respectively). Just over half of State own revenue was derived from non-tax sources, with railway profits and land sales making up the bulk of these receipts.

By 1918-19, the States were becoming more independent financially. Grants from the Commonwealth had declined to only 17 per cent of State revenue. Total tax receipts of $23.9 million represented 32 per cent of revenue. Of this amount, approximately one-half was derived from income tax. Again, substantial revenues were also raised from the profits of the railways and other public enterprises.

From 1929 until the beginning of World War II, the Commonwealth provided around 14 per cent of total State and local revenues. It would be fair to say, therefore, that just prior to the War, the financial resources raised by the States themselves were basically sufficient for them to meet their own expenditures. In 1938-39, for example, total State and local revenues were $216 million. Of this, 14 per cent was provided as grants from the Commonwealth. Tax receipts represented 61 per cent of revenue, with income taxes representing around one-half of those receipts. Other significant taxes were estate duties and taxes on motoring.

As has already been mentioned above, this situation changed dramatically in 1942. On 23 February 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 to the States upon their retirement from the income taxing field. The Committee presented its report on 28 March 1942 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.

Four State Governments challenged the validity of this legislation, but it was upheld by the High Court. Interestingly enough, in its 1942 decision the High Court ruled that the Commonwealth had priority in the imposition of income tax, that is, that the States could only levy income tax on incomes after Federal income tax had been paid. This left the States with very little room to manoeuvre and they had to comply with the Commonwealth's scheme. Of course, by 1957 when the High Court reversed its decision on priority, the Commonwealth had such a grip on the income taxing field that it would have been politically very difficult for the States to have applied their own income taxes in any significant way.

Later in 1942, the Commonwealth Government, in agreement with the States concerned, also established a uniform entertainments tax on a similar basis and provided for annual reimbursement grants to be paid to the five States which previously had levied entertainments tax.

By 1942-43, therefore, State and local taxation receipts had fallen from 61 per cent of total revenue just prior to the War to 28 per cent. Even then, around one-half of this amount was local government rates. The only two significant tax bases available to the States themselves were estate and gift duties and motor taxation. Around 36 per cent of revenue was derived from Commonwealth grants and, fortunately for the States, they were still able to derive significant income from their business undertakings.

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, although the States did make various attempts between 1950 and 1970 to regain access to the income tax base ('access' being used in a practical sense, since there was never much doubt that the States had a legal right to impose such taxation).

The States moved very slowly to expand their tax bases in the 1950s. When the Commonwealth ceased to impose land tax during 1952-53, the States were slow to increase their own land taxes, and only Victoria, Western Australia and Tasmania reimposed entertainments tax when the Commonwealth withdrew from that field in 1953-54. Even today, the land tax imposed by the States exempts residential and rural land, so it can be argued that no real attempt has been made to fully exploit this tax base. Stamp duties were also expanded to some extent during this period.

As mentioned above, various attempts were made by certain States to regain access to income taxing powers. In July 1952, the Commonwealth informed the States that it was willing to discuss with them the possibility of them resuming State income tax. A report entitled Resumption of Income Tax by the States was prepared by Commonwealth and State Treasury officers and the matter was discussed at Premiers' Conferences in February and August 1953. No agreement could be reached between the Commonwealth and the States on the extent to which the Commonwealth should withdraw from the income taxing field and the subject was consequently dropped.

In 1955 and 1956, Victoria and NSW again challenged the right of the Commonwealth to use section 96 to effectively exclude the States from the imposition of income tax and asked the Court to rule on the matter of Commonwealth priority. The Court ruled unanimously in 1957 that the Commonwealth could use section 96 to make the provision of financial grants conditional upon the States not levying income tax but negated the principle of Commonwealth priority.

In September 1964, the Victorian Government announced its intention of introducing a 'marginal' income tax, to be payable by individuals living in Victoria and to operate from the beginning of 1965-66, and requested the Commonwealth to collect the tax on its behalf. The Commonwealth refused to accede to this request. Victoria indicated that it would not collect the tax itself but raised the matter at the June 1965 Premiers' Conference. None of the other States supported the idea of a 'marginal' income tax and the matter did not proceed.

On 19 January 1970, 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. At the subsequent Premiers' Conference in February 1970, the Prime Minister rejected this proposal out of hand, citing a number of objections. These included macro-economic policy making considerations, the 'equitable' treatment of all Australians brought about by uniform taxation, the budgetary problems that would be faced by the States as income tax receipts fluctuated and the problems that would arise in the process of calculating equalisation grants by the Commonwealth Grants Commission.

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, combined with the High Court's invalidation of State receipts duty on certain types of transactions, ultimately led to the transference of payroll tax from the Commonwealth to the States in June 1971.(10)

The attempt by the States to gain access to the income tax base in 1970 was the last significant action on their part to resume such taxation until the series of Special Premiers' Conferences conducted in the early 1990s, as will be discussed below. When the Commonwealth attempted to allow the States to levy marginal income tax surcharges or rebates under the Income Tax (Arrangements With the States) Act 1978 as part of the Fraser Government's New Federalism policy, the offer was declined. This Act was eventually repealed by the Hawke Government in 1989.

There have been various interpretations of the States' reticence to impose such marginal income taxes in the 1980s. On the one hand, it might be argued that the States are quite comfortable receiving grants from the Commonwealth, which can then be blamed for any financial shortcomings the States might face. The reticence of the States to fully exploit tax bases such as taxes on services and land tax and the abolition by them of estate and gift duties is often presented as further evidence of this acquiescence. Certainly, in a number of States, such as NSW, the marginal tax rates were portrayed for political reasons as a form of 'double taxation'. This would have made it difficult for such States to take up the offer at a later date.

On the other hand, it can be argued that the Fraser Government did not make sufficient 'tax room' for the States to impose marginal income taxes. The Commonwealth made no attempt to retreat from the income taxing field to give the States the political space to impose their own taxes. Nor did the Commonwealth retreat sufficiently to force the States to take compensatory taxing measures.

The last major attempt by the States to gain greater access to the income tax base occurred in the early 1990s. In the communique from the October 1990 Special Premiers' Conference, Heads of Government agreed that a fundamental review of Commonwealth-State financial arrangements was needed. In conducting such a review, the Commonwealth and the States recognised "the need to address the question of vertical fiscal imbalance with a view to reducing that imbalance while recognising the necessity for the Commonwealth to have adequate means to meet its national responsibility for effective macro-economic management". It should be noted that the Commonwealth had only reluctantly yielded to State pressures for the question of vertical fiscal balance to form part of the Hawke Government's New Federalism process. While the Commonwealth was prepared to countenance an in-depth investigation of the issues, it was not prepared to make any hard and fast commitment to substantially alleviating the problem, especially through any transfer of income taxing powers to the States.

A Working Group of senior Commonwealth and State treasury officials was established to review the distribution of Commonwealth and State government taxation powers. The principles guiding such a review were, among others, that appropriate arrangements should:

• enable each level of government to have access to reliable sources of revenue which are, so far as possible, commensurate with expenditure responsibilities and national responsibilities for macro-economic management
• ensure a rational allocation of revenue powers between levels of government that further improves the efficiency, effectiveness, equity and simplicity of the Australian tax system
• maintain revenue neutrality on a national basis and
• reflect an acceptance of the principle of fiscal equalisation.

The Committee produced a report for consideration at the November 1991 Special Premiers' Conference to be held in Perth.(11) However, just prior to this Conference, the States approached Prime Minister Hawke with a plan for the imposition of a marginal State income tax. This plan was attacked by former Treasurer, Mr Keating(12), who had recently moved to the backbench and, following considerable political debate within the Government, the Prime Minister refused to countenance the proposal. In the process, the Working Group report was consigned to the wastebasket. With the Commonwealth being perceived as downgrading its commitment to allow a full and meaningful debate on the problem of vertical fiscal imbalance, the States boycotted the proposed November Special Premiers' Conference and held their own Premiers' and Chief Ministers' Meeting in Adelaide, also in November.

At that meeting, the Premiers and Chief Ministers reiterated their support for a national income tax sharing scheme based on providing States and Territories with access to the personal income tax base and with a corresponding decline in financial assistance grants. The Premiers pointed out that the Working Group had identified a figure of 6 per cent (amounting to some $10 billion) of the personal income tax base as a maximum figure for collections to be provided to the States without impinging on fiscal equalisation arrangements between the States.(13) Furthermore, they noted that the scale of tax sharing proposed by the States was assessed by Commonwealth and State treasury officials as being unlikely to adversely impact upon the effectiveness of the Commonwealth's macro-economic policy responsibilities. Finally, the Premiers proposed that a panel of independent experts from Australia and overseas should be invited to undertake an objective assessment of a range of options, including the States' proposal, to reduce vertical imbalance.

It is quite clear that the Premiers' proposals were designed to keep the issue of vertical fiscal imbalance at the forefront of the discussions on Federal-State reforms, especially in view of the equivocating approach being taken by the Commonwealth on the issue. It was within this environment that the Premiers and the Commonwealth next met on 11 May 1992 in Canberra, with Mr Keating as Prime Minister. A position paper by Premiers and Chief Ministers was circulated prior to this meeting.(14) This paper set out two main options for redressing what the States perceived as the problem of vertical fiscal imbalance.

The first option was the income tax sharing plan that had been previously proposed by them. The details of this plan were:

• 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 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'.

The second option proposed was as follows:

• total grants, excluding grants for on-passing, should be a fixed share of total Commonwealth taxation revenue, broadly in line with that applying in the early 1980s and sufficient to re-establish, over time, a revenue base for the States commensurate with their expenditure responsibilities
• a guarantee that total payments, excluding grants for on-passing, in any year do not fall below the 1991-92 level in real per capita terms with
• the above arrangements to be adjusted, where appropriate, to reflect changes in functional responsibilities.

At the Heads of Government Meeting in May, no decisions were taken on these matters. As the communique from that meeting points out, in discussing the paper prepared by the States on Commonwealth-State financial relations, the Commonwealth acknowledged that the States needed to be adequately resourced and that the predictability, flexibility and growth of State funding were agreed objectives. However, these objectives continue to remain unmet.(15)

With the exclusion of the States from the field of income tax, they have made some attempts to improve their tax position. During the 1960s, some States imposed surcharges on motor vehicle third party insurance premiums. All States imposed gambling taxes of various forms, such as on horse racing betting turnover, or poker machines. In recent years, gambling taxes applied to casinos have also been an important source of State revenue.

The States had also been collecting stamp duty on various financial transactions. In the 1960s they attempted to extend these stamp duties to virtually all business receipts. The 0.1 per cent receipts duty was an attempt on their part to impose some form of taxation on turnover, as a surrogate for a broadly-based consumption tax. In 1969, however, two cases were heard before the High Court which led to a decision by the Court that stamp duties imposed by a State on receipts in respect of sales, at any stage from manufacture to consumption, of goods produced in Australia were duties of excise.

This effectively invalidated any attempt to impose receipts duties on transactions involving goods. Interestingly enough, the Court did not invalidate duties imposed on receipts of wages or salaries. This helped clear the way for the States to take over payroll taxes in 1971, although it was understood by the States that if they were to attempt to impose receipts duties on all incomes, this would be regarded as a proxy income tax and would breach the conditionality associated with the provision of financial grants from the Commonwealth.

With the invalidation of the receipts duties, the States looked for other ways of overcoming the High Court's interpretation of section 90. The States' next approach was that of business franchise taxes. Such taxes were 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 consisted of a flat-rate amount plus some ad valorem component, usually expressed as a percentage of turnover over some specified preceding period.

Such a tax had long been applied by the States on the suppliers of liquor, who have to be licensed to engage in such trade. It 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 certain States, gas. An attempt by Victoria to impose a similar type of tax on oil pipelines was found by the High Court to be in breach of section 90 in August 1983. Of course, all business franchise taxes were struck down in the 1997 Ha and Hammond decision.

The only other major tax imposed by the States in recent times has been the financial institutions duty. This is a transactions duty rather than a stamp duty in its traditional sense. It applies to receipts by all financial institutions, not just banks. In NSW and Victoria, the financial institutions duty was introduced on 1 December 1982, while South Australia and Western Australia followed suit as from 1 January 1983. Tasmania introduced a slightly different scheme as from 20 December 1983. Queensland has no financial institutions tax.

It might be noted that, even in the area of financial institution taxation, the States initially had to share the field with the Commonwealth. The Commonwealth introduced its own bank account debits tax, which applied from 1 April 1983. This is a tax on all debits charged to any bank account arising from cheques being presented, periodic debits, interest charged and bank fees. It also applies to certain accounts with cheque drawing facilities at savings banks, building societies, credit unions and the like. However, in his 19 July 1990 speech to the National Press Club entitled Towards a Closer Partnership, the Prime Minister announced that the Commonwealth would relinquish the bank accounts debits tax to the States. This was done as from 1 January, 1991.

Certainly, however, the States have abandoned a number of taxes which they used to apply. The most important of these was estate and gift duties, a tax which they also shared with the Commonwealth. In 1976-77, these taxes were raising around $250 million for the States. Queensland started the process by abolishing its gift and death duties from 1 January 1977. The other States felt that, for both political and practical purposes, they would have to follow suit. Most of the other States therefore abolished their duties over the period from 1977 to 1982. Victoria took a little longer to phase out its duties. They ceased as from 1 January 1984. The Commonwealth also vacated this field as from 30 June 1979.

Table 1 shows the distribution of taxation in Australia as at 1995-96. As shown in Table 1, the Commonwealth raises around three-quarters of all taxation in Australia. Yet, Commonwealth outlays for its own purposes represent only around 60 per cent of total general government outlays. As a result, the Commonwealth is required to make substantial financial payments to the States to enable them to fulfil their expenditure functions. Given the paucity of the taxation bases available to the States, the assistance provided by the Commonwealth to the States (currently in excess of $34 billion ) represents around 45 per cent of State general government revenues. As can also be seen from Table 1, the major source of tax income to local government is property tax, generally in the form of rates. Local government also raises funds from various fees.

Table 1. Commonwealth, State and Local Government Taxes in Australia, 1995-96

• These taxes were abolished in 1997 and replaced by equivalent Commonwealth taxes.

Sources: Commonwealth Budget Paper No. 1, 1997-98 and Australian Bureau of Statistics, Taxation Revenue Australia, 1995-96 (Cat. No. 5506.0).

Vertical and Horizontal Distribution in Australia

Given the assignment of taxation responsibilities in post-war Australia, mechanisms have had to be put into place to ensure that the States have access to the resources necessary to meet their expenditure responsibilities. This has been achieved in Australia through the provision of general purpose and specific purpose grants to the States. For the most part, these grants have been determined by the Commonwealth and have tended to reflect its own priorities. The only recent attempt at more co-operative federal financial relations was the period between 1976 and 1985, when the States and local government were guaranteed a specified share of Commonwealth taxation revenue.

Between 1976-77 and 1980-81, the States received tax sharing grants (a major component of general purpose revenue assistance), expressed as a proportion of Commonwealth personal income tax receipts. After a transitional year in 1981-82, the States received a share of total Commonwealth taxation receipts from 1982-83 until 1984-85. Tax sharing was abolished from 1985-86 and replaced with a financial assistance grants system which is still current today. Local government also received a legislated share of Commonwealth personal income tax collections between 1976-77 and 1984-85.

Not only has the Commonwealth had responsibility for addressing the vertical fiscal imbalance, it has also accepted sole responsibility for ensuring horizontal fiscal equalisation between the States. As early as 1910, some of the smaller States in the Commonwealth pointed put that they were unable to provide the same standard of service as the richer States. The Commonwealth therefore began to provide Special Grants to Western Australia, Tasmania and, later, South Australia to assist them with their budgetary difficulties. However, the provision of these grants was somewhat ad hoc. In 1933, following the development of strong secessionist movements in both Western Australia and Tasmania, the Commonwealth Grants Commission was established to devise a methodology for formulating recommendations aimed at ensuring that the smaller States were adequately funded.

Over time, the Commission's methodology has changed significantly. In the early years, the Commission's recommendations were designed simply to provide additional grants to the poorer States so as to enable them to provide services close to the same level as the other States. This methodology has since been developed into a very sophisticated model aimed at ensuring that fiscal capacity is equalised across all States and Territories. The model assesses the relative fiscal needs of the States by comparing both their capacities to raise revenue and potential difficulties faced by them in the provision of services. Each State is compared with a standard based on the finances of all States and Territories and fiscal needs are expressed as a set of per capita relativities which are then used in the distribution of general revenue assistance.(16)

Tax Assignment in the Federal Republic of Germany

Unlike the Australian situation, the German Basic Law (Grundgesetz) not only specifies the basis upon which the financial relations between the Federation and the Länder are to be organised, but is also prescriptive as to the assignment of powers to make tax legislation and, in the case of income and corporate profits tax, how such taxes shall be distributed between the tiers of government. Also, unlike Australia, the Basic Law gives constitutional recognition to municipalities (Gemeinde) or groups of municipalities and specifies how this level of government too shall share the proceeds of certain taxes.

It is not surprising that the Basic Law is specific in this respect. When the German constitution was being drafted in the immediate post-war years, it was an aim of the allied powers overseeing the process to ensure that political power in Germany remained decentralised. Not only does the Basic Law protect the rights of the States, it also provides for the existence of an upper house in the Federal Parliament, the Bundesrat, to represent the Länder. The Bundesrat is perhaps the most powerful States' house of any federal country.

The basic philosophy underlying German federal-state relations has been summarised in an official publication of the Finance Ministry as follows:

The relative tax powers of the Federation and the Länder are set out in Article 105 of the Basic Law. In terms of the ability to legislate on taxation, the Federation has exclusive power to make laws concerning customs duties and fiscal monopolies (such as the former brandy monopoly).(18) The Federation has concurrent powers to legislate on all other taxes, the revenue from which accrues to it wholly or in part. The Federation may also legislate in tax matters where the matter cannot be effectively regulated by the legislation of individual Länder, where regulation by one Land may prejudice the interests of other Länder or where the maintenance of legal and economic unity calls for federal legislation. Most importantly, however, federal legislation on taxes, the revenue from which accrues wholly or in part to the Länder or municipalities, requires the consent of the Bundesrat.

The Länder have legislative powers:

• where the preconditions for concurrent legislation by the Federation do not exist
• where the Federation does not avail itself of its concurrent rights
• over local consumption and expenditure taxes so long as these are not identical to those taxes levied by the Federation.
• over the imposition of church tax.

In practice, the Federation has significantly exercised its legislative competence in the areas of exclusive and concurrent taxation so that only a relatively limited scope remains for the Länder to derive taxation income through their own tax measures.

Notwithstanding the legislative competence of each tier of government, the apportionment of actual tax revenues between the tiers of government is specified in Article 106 of the Basic Law. Revenue from the following taxes accrue to the Federation:

• the yield from fiscal monopolies
• customs duties
• excise taxes (on such commodities as tobacco, coffee, tea, salt, petroleum products, etc.) but not on beer
• road freight tax
• capital transactions taxes, insurance tax and tax on bills of exchange
• non-recurrent levies on property
• income and corporation surtaxes

levies applied within the framework of the European Union The Länder, on the other hand, derive revenue from the following:

• wealth tax
• inheritance tax
• motor vehicle tax
• beer tax
• taxes on gambling establishments.

The municipalities may derive tax income from:

• taxes on real property
• local taxes on expenditure (such as dog licences, excises on drinks, etc)

However, as provide by Article 106 para.(3), the most important taxes, income tax, corporate profits tax and value added tax (VAT) are shared between the Federation, the Länder and, in the case of income tax, the municipalities.(19)

The Basic Law prescribes that revenue from income tax must be shared equally between the Federation and the Länder although a share of income tax must also be passed on to the municipalities. As a result of these provisions, the Federation and the Länder both receive 42.5 per cent of income tax collections, while the municipalities receive the remaining 15 per cent.

Corporate profits tax must also be shared between the Federation and the Länder on an equal basis. The municipalities do not share in this tax, with the result that 50 per cent of the tax accrues to each of the Federation and Länder. Whilst there is no constitutional requirement to do so, a business tax (Gewerbesteuer) is also shared between the three tiers of government, with the Federation and the Länder each receiving 12.5 per cent and the municipalities receiving 75 per cent.

Whilst the Basic Law is specific about the allocation of the income tax and corporate profits tax, it is less prescriptive about the VAT. Article 106 para.(3) states that revenue from the VAT shall accrue jointly to the Federation and the Länder, but provides that the respective shares in such revenue shall be determined by federal legislation requiring the consent of the Bundesrat. Interestingly, the principles governing this distribution are specified in the Basic Law as follows:

The distribution of the VAT revenue is thus the 'moveable' component in the process of vertical equalisation between the Federation and the Länder. Basically, it can be said that the vertical distribution of taxation between the levels of government reflects the distribution of responsibilities. Thus the distribution of the VAT requires periodic renegotiation. The shares must be renegotiated if the income and outlays of the Federation and the Länder should significantly change.

Despite the existence of these guidelines for the allocation of the VAT, in practice, they can be very difficult to implement. In fact, there exists between the Federation and the Länder constant bickering over the appropriate allocation. The determination of the VAT shares is one of the most difficult problems in financial relation between the Federation and the Länder. The problem is that there is no objective measure for ensuring that 'necessary' outlays are met from appropriate current revenues. The question of what responsibilities on the part of the Federation or the Länder really are necessary is a matter for political assessment and is not objectively measurable. However, since legislation relating to the distribution of the VAT tax requires the approval of the Bundesrat, the Federation and the Länder must agree. The difficulties surrounding the distribution of the VAT shares have led to a series of agreements being negotiated. Since 1986, the shares have been 65 per cent for the Federation and 35 per cent for the Länder.

Apart from these tax sharing arrangements, the financial constitution also provides other instruments in the area of vertical fiscal balance. These include:

• excess burden equalisation-where there are short term additional expenditures or reduced incomes as a result of federal legislation, the Länder can receive an additional allocation from the VAT revenue without the need for a renegotiation of the VAT agreement
• special burden equalisation-where the Federation has set up particular establishments within the Länder or municipalities (such as defence bases) thus causing these governments to incur greater outlays or reduced incomes (eg. due to lower land tax from which the Federal establishments are exempt) the Federation shall grant necessary compensation
• federal supplementary allocations to financially weak Länder as part of the horizontal fiscal equalisation process

Horizontal Equalisation

Article 107 of the Basic Law sets out, firstly, the basis for the distribution of the total pool of revenue available to the Länder amongst the individual Länder (horizontal tax distribution) and secondly, the achievement of horizontal fiscal equalisation in a narrower sense.

Tax distribution and equalisation amongst the Länder occurs in a series of steps. In accordance with Article 107, three different possibilities are presented:

• a larger share of the Länder component of the VAT may be provided to tax poor Länder
• equalisation payments from financially stronger to financially weaker Länder, ie. the actual Länder fiscal equalisation
• supplementary allocations from the Federation to financially weaker Länder.

Horizontal Tax Distribution

The basic principle underpinning horizontal tax distribution is that tax income will be available to individual Länder in the same proportion as taxes are raised in those Länder by the taxing authorities. This distribution on the basis of geographic revenues applies to Länder taxes and the income and corporation tax.

There has to be some adjustment to the geographic basis of tax distribution in the case of corporate and PAYE income tax instalments, especially where these are paid by the central office of a company operating in several Länder. Under separate federal legislation, it has been decided that the corporation tax may be allocated amongst Länder according to the location of the various branches while the income tax is calculated on the basis of the residence of the employee.

The Länder distribution of the VAT tax is not determined on a geographic basis. In accordance with Article 107 para.(1), at least 75 per cent of the revenue is distributed on a per capita basis. Up to 25 per cent of the Länder component serves the purpose of providing additional allocations to the fiscally weak Länder. The current arrangements enable the fiscally weak Länder to attain up to 92 per cent of the average per capita revenues of all Länder.

Horizontal Fiscal Equalisation

Following the distribution of taxation, the relative fiscal strength of the individual Länder, measured in terms of their available revenues, determines the starting point for actual horizontal equalisation. It might be noted that on the basis of different historical and structural characteristics there are significant differences in the fiscal strengths of the individual Länder.

In order that the fiscally weaker Länder can reasonably perform their responsibilities and in order to achieve the equality in living conditions guaranteed in the constitution, Article 107 para.(2) prescribes that fiscally stronger Länder should make payments to fiscally weaker Länder. Note that this equalisation approach is revenue oriented only and does not take into account the special fiscal responsibilities of individual Länder. In this respect, the philosophy of horizontal equalisation in Germany is akin to that in Canada. Neither of these countries has the full fiscal equalisation approach of Australia, which addresses both the revenue and expenditure sides of the equation.

It might be further noted that the Basic Law only requires that the financial disparities amongst the Länder are 'reasonably equalised'. On the basis of current fiscal equalisation legislation, the fiscally weak Länder need only be equalised to at least 95 per cent of the average per capita revenue of all Länder.

It follows, therefore, that current equalisation arrangements only lead to an alleviation, rather than an equalisation, of fiscal situations. The German view is that this is not necessarily a bad thing, since it ensures that the Länder remain responsible for their own fiscal decisions (at the margin). The system also encourages the fiscally weak Länder to seek their own fiscal solutions as well as ensuring that the capacity for other Länder to pursue their own initiatives and improve their performance is not significantly prejudiced. In particular, the horizontal equalisation system aims to ensure that no Land is able to formulate its own budgetary policy at a cost to the Federation or to other Länder.

Federal Supplementary Allocations

Article 107 para.(2) also allows for the provision of federal supplementary allocations (Bundesergänzungszuweisungen) to fiscally weak Länder. Increasing resort to this measure has been made since the financial reforms of 1969. From 1988 the federal supplementary allocations, as set out in the Fiscal Equalisation Law (Finanzausgleichsgesetz), have been 2 per cent of VAT revenue. They have therefore grown at the same rate as VAT revenues. These allocations are paid out of the Federation share of VAT revenue.

The determination of Länder eligible for federal supplementary allocations is based on their actual fiscal circumstances and include Bremen, Niedersachsen, Nordrhein-Westfalen, Rheinland-Pfalz, Saarland and Schleswig-Holstein. Bremen has been included since 1986. Since 1988 Bayern has not received any supplementary allocations.

Table 2 summarises the allocation of own taxes and shared taxes in the Federal Republic of Germany.

Table 2. Federation, Länder and Municipal Taxes in Germany, 1995

(DM million)

Tax Assignment in Canada

Since Canada became a confederation in the mid 1800s, it has had a remarkably similar history to that of Australia.(20) However, each country took different paths in the post-World War II period, with the result that Canada gradually became fiscally more decentralised at the same time as Australia was becoming more fiscally centralised.

Even though the Canadian Constitution (as set out in the British North America Act 1867, also referred to as the Constitution Act 1867 (as amended), and the Constitution Act 1982) is somewhat more specific about the allocation of taxation powers between the tiers of government than the Australian Constitution, the actual exercise of those powers, as in the case of Australia, has more reflected political manoeuvring between the Federal Government and the Provinces and the impact of court interpretations of Provincial taxation rights. However, whereas these processes have acted to constrain the access of Australian States to the tax base, they have actually granted wide powers to the Canadian Provinces to levy a range of taxes.

The relative tax powers of the different tiers of government in Canada are set out in sections 91, 92 and 92A of its Constitution. Section 91 states:

Despite the apparent carte blanche provided to the Federal Government by this provision in the field of taxation, section 92 states:

Furthermore, paragraph 92A(4) states:

To appreciate the way these constitutional provisions have influenced access to taxation sources in Canada, a short history of Canadian taxation will now be provided.

A Brief History of Taxation In Canada(21)

As in the case of Australia, when Canada federated in 1867 the three main sources of revenue available were customs duties, excises on liquor and tobacco and property taxes.(22) By granting the central government extensive taxing powers relative to those of the Provinces, it would appear that the framers of the Constitution believed that the Federal Government should be the main taxing agency, providing grants-in-aid to the Provinces. Certainly, the Provinces had been given the exclusive power to impose direct taxation within their own boundaries, but it was thought that such taxation would be unpopular and limited only to property taxation on the part of the Provinces and their municipalities.

The Federal Government did take control of the major revenue sources and, as in Australia, for quite a number of years after federation, per capita federal grants in aid accounted for more than one-half of total provincial revenues. Again, as in Australia, the pressures on the Provinces to expand their public expenditures meant that, by the turn of the century, a number of Provinces had begun to impose new taxes on personal income and corporate income, as well as introducing estate and inheritance duties.

During World War I, the Federal Government was forced to boost its revenue raising capacity. Parallelling developments in Australia, the Canadian Federal Government began to impose its own taxes on personal and corporate income. It also introduced a 1 per cent turnover tax, designed to assist with eliminating the federal wartime deficit. This tax was later restructured, in 1924, to become a 6 per cent manufacturers sales tax which, in turn, was again restructured in 1991 to become a VAT-style goods and services tax.

During the 1930s, the Provinces again expanded their tax bases and introduced new forms of taxation. By the end of this decade, seven Provinces were levying personal income tax and all but one were imposing corporate tax. It was also during this period that the Provinces began to impose local retail sales taxes. Whilst at first sight, these might be seen to contravene the Provinces' power only to impose direct taxation within their boundaries, the legislation imposing such taxes made it clear that they were taxes on the purchasers of the goods, with the retailers simply acting as tax collecting agencies. Whilst such semantic devices have not saved the Australian States from High Court disallowance of indirect taxation, in Canada such legislation has survived court challenges. The Provinces were also able to compete with federal excises on liquor and tobacco by establishing Province-owned retail outlets for these products (so-called 'fiscal monopolies'). With the growth of private motoring at this time, the Provinces also began to impose motoring taxes and began to levy substantial taxes on petrol.

Continuing the parallels with Australia, the Provinces agreed to relinquish their use of personal and corporate taxes during World War II to enable the Federal Government to have sole access to these important bases in order to finance the war effort. In return, they began to receive 'tax rebates' (reimbursements) from the central government on an equal per capita basis. These arrangements existed until 1957, although Quebec negotiated slightly different arrangements after 1947. Quebec had established its own personal income tax system in 1954, so in 1957 the Federal Government replaced tax rebates to the other Provinces with a system of direct tax sharing. Under this regime, the central government returned to the Provinces, on the basis of origin, 10 per cent of federal personal income tax, 9 per cent of corporate income tax and one-half of federal estate tax collections.

From 1962 onwards, there have been a series of Tax Collection Agreements negotiated between the Provinces and the Federal Government under which the Provinces set their own tax rates on personal and corporate incomes. These taxes are collected by the central government and remitted to the Provinces. Unlike Australia, the Federal government retreated from the income taxing field to some extent to provide the Provinces with 'tax room'. Currently, the Federal government collects personal income tax for all Provinces except Quebec, which has continued to collect its own tax. Corporate income tax is also collected for all Provinces except Ontario, Alberta and Quebec, which impose their own corporate taxes. There is some variability in the tax rates and structures levied by the various Provinces.

It is interesting to note that the Federal Government also vacated the field of estate taxation in 1972 to provide greater scope for Provincial tax raising from this base. Given the unpopularity of such taxation, very few Provinces have imposed taxes on these intergenerational transfers of property.

One further area of revenue raising is worthy of mention. The Constitution provides the Provinces with the exclusive right to impose taxes on resources and minerals. This has been a substantial source of revenue to several Provinces. Interestingly, when Alberta and Saskatchewan were admitted to the Union in 1905, the Federal Government withheld control of sub-surface mineral rights from them. After much bickering, these rights were restored in 1930 and Alberta in particular has derived a significant amount of revenue from this source.

To summarise, the Federal and Provincial Governments share the important personal and corporate income tax bases. While the central government derives significant revenue from its goods and services tax, the Provinces also access the indirect tax base through the imposition of local retail sales taxes. Quebec has the most sophisticated indirect system since it also imposes a VAT-style tax. As a result, the Federal VAT has had to be harmonised with that of Quebec.

As already mentioned, not only has there been significant sharing of the ava