What a tax-swap GST reform deal with the states would mean

A tax reform deal along the lines of the revenue swap proposed by South Australia could give the Turnbull government the money it needs for significant tax reform.

But it also could alter the balance of fiscal power by enough to make the job of balancing the federal budget more difficult.

The deal would involve the states getting a permanent share of personal income tax revenue. That would give the state governments the equivalent of a growth tax and an additional measure of fiscal independence – something that some would see as a valuable reform in its own right.

In return, the federal government would keep the additional revenue raised from the GST.

The upside for the federal government is that the deal would get the states' formal approval for a change in the GST and give the premiers an incentive to pressure their senators to pass the legislation.

However, the federal government would have paid a high price.

It would have given the states almost a fifth of its personal income tax revenue to replace the slower-growing health and education grants.

TALKING DOWN EXPECTATIONS

While the Prime Minister, Malcolm Turnbull, and his Treasurer, Scott Morrison, have been talking down expectations about the size of tax reform, the South Australian proposal was based on an increase in the GST to 15 per cent.

It is estimated that this would initially raise about $30 billion a year and, after compensation, would leave the federal government a net revenue gains of about $15 billion for tax cuts.

The upside for the states is obvious. The fixed share of faster growing income tax would help them with their budgets.

Tony Abbott's medium term fiscal strategy was to cut the growth of state grants to help balance his own budget. His idea was to force the states to raise more of their own revenue.

Morrison also has talked about the possibility of the state governments increasing their own taxes, saying that this would be a matter between them and their voters.

This was a clear signal that the Turnbull government was retaining the Abbott government's option of squeezing the states' finances.

However, with the health and education grants out of the picture, the political opportunities to dip into the states' finances may be more limited. It's harder to raise large amounts of money by squeezing the states slowly.

There are other risks for the federal government, some of which clearly worry Morrison.

POOR RECORD

State governments have a poor record when it comes to managing growth taxes. Payroll tax was a growth tax when it was transferred to the states by the McMahon government in 1971. However, the premiers promptly degraded their new tax base with election-year tax breaks for small business and bidding wars with each other to win the investment dollars of footloose industries.

Morrison is rightly concerned that the fixed share of income tax will meet a similar fate.

Obviously the income tax base cannot be given away by the state governments. But the revenue can be frittered away in pay rises and increased public servant recruitment and handouts for businesses and residents in swinging electorates. And don't make the mistake of thinking that it would be just the Labor premiers who squandered money at the behest of their public service unions – although in recent years they have been the worst offenders. There also is a long history of Coalition premiers bidding for the public service vote.

The states also are poor at managing large fluctuations in revenue.

While income tax grows more quickly than the GST, it also is more volatile, and the premiers always are under pressure to spend every tax dollar they get.

It doesn't take much imagination to see premiers ramping up their recurrent spending in periods of strong revenue growth and then running cap in hand to Canberra when the revenue boom ends.

Morrison says he won't agree to give the states a share of income tax if the money is just going to be used for increased recurrent spending. However, it is not entirely clear what he can do to stop that happening.

There is another broader political risk. A deal that gives the states more fiscal independence could also make it harder (or, at least, more expensive) for the Turnbull government to intervene in state affairs to satisfy the demands of the national electorate.

The forces of centralisation remain strong. Australian voters insist on believing that they live in one country, and they will continue to expect Canberra to intervene decisively on their behalf in any state matter they regard as being of national importance.

From history we know that a federal government that fails that test risks serious electoral punishment.