The commonwealth would invite the state or territory host of a project to apply the MRRT to its half of the taxation capacity. The state could choose to vary the rate from 20 per cent if it wished to do so. The commonwealth would collect the tax for the state. If some states and territories simply chose to duplicate the commonwealth’s rate of tax, thus exhausting the taxation capacity, this would be a good outcome for economic efficiency. Alternatively, the state could ask the commonwealth to levy and to collect an additional portion of MRRT or PRRT at a rate of its choosing.
Or else, the state could choose to apply a royalty in a form and at a rate of its choosing. Neither the additional resource rent tax nor the additional royalty would be deductible against the commonwealth resource rent tax, although both would be deductible (not creditable) against commonwealth corporate income tax. So all of the resources revenues would be returned to the states – half directly to the state of origin, and half to the pool for general purpose grants to be allocated across the states and territories.
Good governance and the High Court in Fortescue v. the Commonwealth suggest that this result for resource taxation should be achieved through agreement between the commonwealth and the states.
A NEW FEDERAL AGREEMENT
Such an agreement would only be possible in the context of a comprehensive revision of federal financial relations. The political difficulties of this change to the overall structure of federal financial relations would be large, but the suggested arrangements could be phased in over time. This process would be accompanied by guarantees of minimum payments to the states and territories under the new arrangements: for example, the commonwealth could guarantee that a state or territory’s share of the general purpose grants pool would not cause the real value of grants (replacing current general purpose and specific purpose payments) to fall by more than 1 per cent per annum. What matters is that we move steadily towards satisfactory long-term arrangements.
The Commonwealth Grants Commission could be given two roles: reporting on the fiscal health of the Federation independently of the political interests of the commonwealth or any state; and assessing the amount of the lump sum payments necessary to cover the minimum overhead costs of government. If one or other state or territory found itself in difficult short-term fiscal circumstances, the independent commission could make recommendations on temporary special grants. This would return the role of the Commonwealth Grants Commission to something like that in the 1930s, when it was first established.
Now, over a century after the federal compact, is a good time to review thoroughly the distribution of powers between the two levels of sovereign government. This is unlikely to lead to a shrinking of formal commonwealth powers; it may lead to their expansion. But if change in the division of powers is not possible, let us confirm the established division and introduce fiscal arrangements that will allow it to work efficiently. Whatever the outcome of the review, let us establish a norm in which the states have unambiguous fiscal authority within their jurisdictions, and in which the commonwealth’s intervention mainly takes the form of provision of advice and comparative information, assessment of performance, analysis of policy and definition of national norms where they are appropriate.
I say mostly, because the dynamics of politics will from time to time propel the commonwealth into areas of state sovereignty. But let us see such initiatives as deviations from a desirable norm.
SOLVING THE TRANSPORT STAND-OFF
In the meantime, we can do something quickly to solve one of the most debilitating problems of the Federation. Nowhere has the cost and absurdity of the overlapping commonwealth and states been greater than in funding major transport infrastructure. Commonwealth and state each undertake to fund part of some major infrastructure project if the other level of government funds the balance – often after purely political assessments and without consulting one another.
The dysfunction of these arrangements reached bizarre depths when the commonwealth, in early 2013, undertook to fund a proportion of an underground railway across Melbourne if the Victorian government matched its commitment. For its part, the state government undertook to fund a major proportion of an underground road across Melbourne if the commonwealth matched its commitment. There was no evidence of rigorous analysis of the economic value of the road project – so far as the community was concerned, little evidence of any analysis at all. Whether or not one or other of the projects goes ahead, the electorate will be unable to allocate responsibility for the result.
There is a simple remedy for these problems. The commonwealth would withdraw from decisions on which transport projects should proceed and their implementation. It would establish an independent authority with a strong capacity for analysis. This could be built from Infrastructure Australia. The independent authority would undertake rigorous cost-benefit studies of projects from a national point of view. It would define a list of projects with benefits exceeding costs that would qualify for commonwealth funding. If a state or territory wished to proceed with any project on the list, it could draw down a substantial fixed proportion of the capital expenditure requirements (say, 50 per cent in normal circumstances) as a loan from the commonwealth, at the commonwealth’s long-term borrowing rate. The state or territory government would be entirely responsible for the project.
The commonwealth authority would look only at the economic costs and benefits of various projects. It would have no bias for or against particular transport modes: road and rail projects would each be judged according to their economic contribution. The effectiveness of the proposed approach would depend on the quality of analysis and planning within the states. They would need to develop their own independent, transparent assessment mechanisms. In contrast with current practice, state planning would focus on cost-effective integration of the different transport modes.
There is another problem with major infrastructure that is not caused by the federal framework, but which could be eased considerably as part of the proposed reform of federal financing. Australian governments can borrow over long periods at low rates of interest – on average, over the last century, for ten years at around 2 per cent per annum in real terms. It is not obvious that the ‘risk’ of devoting funds to carefully assessed infrastructure projects is greater than that of spending money in other ways and thereby accepting the risk – indeed, the certainty – of continued increase in transport and congestion costs within our major cities. And yet assessments of public investment in transport infrastructure typically apply discount rates that incorporate allowances for risk that make the rates many times higher than the real cost of borrowing to government.
At the discount rates currently applied to infrastructure projects in Australia, no transformation ever seems worth doing. All major structural change in transport takes many years to implement, and most of the benefits are discounted to trivial values by the use of high discount rates. These are sometimes called market interest rates, although the market rate at which governments can borrow is more like 2 than 7 or 8 per cent in real terms.
For the states, one reason for caution about borrowing for infrastructure is that modest increases in debt may trigger a ratings downgrade and so increase the cost of past debt as well as impose political costs. Partial commonwealth funding would ease this problem. The matching loans would be on the commonwealth’s balance sheet alone, but would be serviced by the state. Guarantees of servicing the loans could be made by securing them against general purpose grants.
The matching loans would be available whether the state was managing infrastructure projects directly or through the private sector. In the latter case, the cost of the project would be lowered to the extent that it is not funded at the higher private-sector discount rate.
WAYS TO IMPROVE HEALTHCARE AND EDUCATION
Health and education services lie within the constitutional authority of the states, but have become joint responsibilities wi
th the commonwealth through the provision of special purpose payments. Health and education are huge industries, comprising approximately 13 per cent of the Australian economy, and almost 20 per cent of jobs. There has been a large increase in public spending on health and education over the past decade or so, but this has not led to a commensurate improvement in outcomes.
In recent years, there has been a productive expansion of independent research on the effectiveness of health programmes, including at the Institute of Applied Economic Research at the University of Melbourne, the Grattan Institute and now the Mitchell Institute. We are in a stronger position to define reform in the public interest and to argue for it against private interests in the health and education sectors than we were a generation ago.
More effective provision of health and education services begins by establishing unambiguous responsibility with one or other level of government. Currently, the main expertise lies within the states. While a precise assessment of productivity is not possible in health and education, the opportunities for improvement can be illustrated quickly. One such opportunity in health is the removal of requirements that highly trained and expensive medical personnel perform tasks that could be done by others with adequate training: the issuance of a medical certificate or a prescription; the exclusive role of doctors in the administration of routine vaccinations; the restricted role of paramedics as first responders to situations where early intervention would yield the greatest benefit; and underinvestment in preventive interventions.
In health, there are significant gains to be made simply by raising the performance of lagging states. In public hospitals, it is said that New South Wales and Queensland would each save about $1 billion per annum if they operated at Victorian levels of efficiency. There are large opportunities for more effective provision of health services by shifting the emphasis from treating disease to prevention. Important gains have already been made since health insurers were allowed to invest in preventive actions in order to reduce costs. More generally, there are opportunities for improving health outcomes cost-effectively by shifting a proportion of health dollars from the hospital to the primary-health sector.
The ageing of the population alongside improvements in medical technology have led to decisions at the beginning and end of life taking on large economic as well as moral consequences. It is thought that 10 per cent of total healthcare costs may be incurred at the end of life on interventions that recipients would prefer not to have done.
In education, current research emphasises the critical importance of teacher quality: it is essential to improve the quality of training and to create incentives to keep the best teachers in the system. There has been much emphasis on reducing class sizes over the past generation. Class sizes are a significant driver of costs. International studies suggest that higher salaries to retain more of the best teachers would be more cost-effective in improving education outcomes than smaller classes.
While there are apparently straightforward opportunities for improvement, reform must find a way through complex political and policy processes. During the long booms, political parties have responded to demands for better health and education with promises of higher spending – and they continued to do so in 2013. Health and education costs are mainly labour, with a low import component, so the real depreciation that is at the core of Australia’s adjustment to the end of the boom will reduce real costs in international currency without any cutting of programmes. But improved effectiveness in service delivery is going to be critical to maintaining quality and providing for the aged.
Any effective reform of health or education will have to deal with the powerful forces of ‘provider capture’, and the ability of private interests to mobilise resources in defence of the status quo. Short timeframes are imposed on decision-making by the electoral cycle and are at odds with the time required for the benefits of reform to be realised; private interest groups have become increasingly effective at exploiting this mismatch. The political influence of the doctors’ unions and pharmaceutical organisations is legendary, and other healthcare and teaching groups are not averse to exerting industrial and political pressure.
There are measurement gaps in health and education. A related problem is that of ‘information asymmetries’: in a market economy where we increasingly rely on the rational and ‘optimising’ behaviour of the individual, the consumers of health and education are unable to act in this way because they lack the information that providers have. Public mechanisms for provision of information need to be developed if a larger role for market mechanisms is to lead to better outcomes. The national assessment programme for literacy and numeracy that was introduced in 2008 is a model for commonwealth information services to assist informed choices.
There appear to be some straightforward opportunities for lowering costs without lowering the quality of services, but none can be taken up without the public interest prevailing in a fierce contest of ideas. The opportunity for vested industrial and other interests to play one level of government against the other is fatal for efforts to improve effectiveness.
Ending ambiguity in responsibility within the Federation is the first requirement for more effective services. If the commonwealth is better placed to manage hospitals, let it be given responsibility to do so. But if such a change in the division of powers within our Federation is judged not to be desirable or possible, let us have no ambiguity about responsibility lying with the states.
Health and education are especially well suited to competitive federalism, with states and territories seeking to establish in the eyes of their electorates that they are more effective than others in delivering services. The essential commonwealth role is to establish minimum national standards and norms, to measure performance, and to allow residents of different parts of our Federation to measure the effectiveness of services against the best Australian and international practice.
FEDERAL REFORM AND THE END OF THE BOOM
The big resources states, Western Australia and Queensland, face severe fiscal pressures as their royalty income is equalised away by the Grants Commission just as it is falling. The downgrading in the credit rating of the WA government in September 2013 was a reflection of this pressure. The sum of the budget deficits of the states and territories in the years immediately ahead would be recognised as being of large national significance if all were measured in the same way as the commonwealth’s. The states cannot fund deficits as readily and at such low cost as the commonwealth, so we will probably be dealing with severe fiscal problems of the Federation. Weakness in one part of it will generate problems and costs for every part. The challenge will be to manage short-term problems in ways that are consistent with long-term reforms.
The commonwealth government’s decisions following the review of federal relations proposed by the prime minister would be placed before a premiers’ council-type forum to consider reform of the Federation. From the beginning, the prime minister could make it clear that he was working towards a package of new arrangements to be implemented from some distant date, such as 2020 – long enough in the future for short-term political calculations not to dominate each head of government’s perspectives. A Long-Term List of federal financial reforms, like the Long-Term List of productivity-raising reforms discussed in Chapter 6, would underpin confidence in Australia’s growth prospects. From now till 2020 seems a long time, but it is nevertheless shorter than the time in office of prime ministers who have presided over Australian governments for over three-fifths of the time since Federation. The new prime minister can reasonably aspire to being around to experience the fruits of his labours in office, and not only as a historic legacy.
CHAPTER 9: AVOIDING DANGEROUS CLIMATE CHANGE
Around 250 years ago, the onset of modern economic development added a new component to climate change on Earth: human activity leading to the partial return to the atmosphere of carbon that had been sequestered in liv
ing things and in the Earth’s crust through natural processes. The clearing of forests and woodlands for agriculture and, above all, the combustion of fossil carbon began to raise the atmospheric proportion of carbon dioxide and other greenhouse gases. These processes became larger and faster after World War II, and again in the Platinum Age of the early twenty-first century.
While modern physics recognised in theory the warming effect of carbon dioxide and other ‘greenhouse gases’ from the late nineteenth century, only since the 1980s have scientists understood the empirical relationships between ongoing economic growth and warming well enough to be confident about suggesting strong action. By the early 1990s, there was international agreement on the need to reduce the dangers of human-induced climate change. It was then widely thought that most of the world’s greenhouse gas emissions would continue to be generated in the old industrial countries for a considerable period. There would be time later for developed countries to take early action and for the developing countries to join the mitigation effort.
But the same Chinese economic growth that gave Australia its resources boom also accelerated the increase in atmospheric greenhouse gases. In the early twenty-first century, the Chinese, Indian and Indonesian economies were growing strongly – they were the world’s most populous developing countries. All three were at stages of development in which economic growth was particularly energy-intensive. And for all of them, coal was a relatively low-cost source of energy, if environmental problems were ignored. Unless action was taken to break the link between economic growth and emissions, China would account for 41 per cent of global emissions in 2030, and India for 11 per cent. Major interventions were required.
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