The following OECD assessment and recommendations summarise Chapter 3 of the Economic Survey of Australia 2006 published on 31 July 2006.
Co-operative fiscal federalism works overall well
The special chapter in this Survey considers fiscal federalism, which is inevitably a difficult and controversial issue, but one which permeates many areas which are key to determining long-run economic performance. As in other countries where such systems operate there is an inevitable tension between pressures for greater subsidiarity to harness localised knowledge and accountability and those for more centralisation to pursue national objectives. While it is difficult to judge whether the current balance is ideal, in international comparison the overall system does appear to work well. In particular, there is an established co-ordination process with a proven track record for delivering reforms, even if the process is sometimes frustratingly slow.
Spending assignments between the central government and the states should be clarified
Key areas of public service provision are subject to complex joint government involvement, sometimes leading to inefficiencies. Fragmented decision making and funding arrangements are particularly notable in hospital services and old-age care, creating incentives for cost and blame-shifting between government levels. States have responsibility for funding public hospitals, while the Commonwealth funds private medical services under Medicare and is responsible for old-age care. This can, for example, induce public hospitals to refer patients being discharged to their general practitioner, rather than providing post-hospital services directly. Moreover, aged care is funded by the states if a person is in a hospital and paid by the federal government if the person is in an aged care facility. Efficiency gains in the health sector could be reaped by a better co-ordination of health care supply between the central government and the states. The potential for cost and blame-shifting between government levels seems to be lower in education. Even so, clarifying government roles and responsibilities in all areas of government could significantly improve public sector efficiency. A collaborative approach between government levels to overcome some of these problems has been adopted. Building on earlier arrangements, the Council of Australian Governments has recently endorsed a National Reform Agenda that focuses not only on competition and regulatory issues, but also on human capital issues. It is imperative that the Commonwealth and state governments co-operate closely to ensure the timely implementation of the reform agenda.
A simpler system of inter-governmental transfers involving so-called “specific-purpose payments” would contribute to a clearer specification of spending responsibilities. The specific-purpose payments should become less complex and inflexible. A first step would be to develop an outcome/output performance and reporting framework for each SPP. This is an ambitious task as outcome/output measures of service delivery are difficult to clearly define, measure and enforce in a robust way. Nevertheless, such frameworks could ultimately lead to a move towards the funding of such payments on an outcome/output basis in certain areas, such as education.
Australian Government payments to sub-national governments(1)
1. Data from 2005/06 onwards are estimates.
2. NCP: National competition policy.
3. Specific purpose payments (SPPs) for current and capital purposes.
Source: Australian Government (2006), Budget Paper No. 3: Federal Financial Relations 2006-07 and Final Budget Outcome papers for earlier years, Australian Government, Canberra.
The vertical fiscal gap raises design issues for inter-governmental transfers, while inefficient taxes should be abolished
A vertical fiscal imbalance exists because the largest tax bases are assigned to the Commonwealth, while expenditure responsibilities are significantly more decentralised. The existence of a vertical imbalance does not by itself indicate a problem, and there is little agreement over the ideal degree of centralisation. But there are concerns that it undermines the accountability to taxpayers for expenditure decisions; creates duplication and overlap in the provision of services; constrains beneficial tax competition across jurisdictions; and weakens incentives for tax and microeconomic reform. On the other hand, this imbalance and the associated need for specific-purpose payments provides the federal government with a lever with which to pursue national objectives. If some increase in the revenue-raising capacity of the states to meet their expenditure responsibilities were considered warranted, the most direct solution would involve broadening the states’ land property and payroll tax bases. A less direct option would be to allow the states to “piggyback” on the personal income tax levied by the Commonwealth, with the centre making “tax room” by lowering its personal income tax. An advantage of this option is that it would not significantly raise tax administration costs, since it would still be administered and collected by the Commonwealth. However, a difficulty is that its introduction would require a fundamental adjustment of Commonwealth-states financial arrangements which would require agreement of all jurisdictions. In any event, the efficiency of the state tax system should be raised by eliminating the remaining distortionary stamp duties.
The vertical fiscal imbalance: a comparison with other federations
In per cent of total sub-national revenue, 2003(1)
1. Provincial government level only for Canada. The vertical fiscal imbalance (VFI) is defined as the total of federal payments to total sub-national revenue.
2. For Australia, VFI is the share of Commonwealth payments in total state revenue. The GST levied on a value added basis at a single rate of 10% was introduced in July 2000 and replaced the Commonwealth wholesale sales tax and a range of inefficient state taxes, including financial institutions duties, accommodation taxes, stamp duties on marketable securities and debit taxes. The states have further adjusted their gambling taxes to take account of the GST impact on gambling operators.
Source: International Monetary Fund (2005), Government Finance Statistics Yearbook; US Bureau of Economic Analysis; OECD (2005), OECD Economic Surveys: Mexico; Australian national authorities.
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.
The complete edition of the Economic Survey of Australia 2006 is available from:
For further information please contat the Australia Desk at the OECD Economics Department at firstname.lastname@example.org. The OECD Secretariat's report was prepared by David Turner and Vivian Koutsogeorgopoulou under the supervision of Peter Hoeller.