Reducing Vertical Fiscal Imbalance in Australia: Is There a Need for State Personal Income Taxation?

Tax reform is back on the economic and political agendas. Two significant reports to governments in 1996 have highlighted deficiencies in the current arrangements. First, the Australian Productivity Commission (1996) has submitted to the Howard Government that there is a need for fundamental tax reform, given the inappropriate incentive and efficiency effects of the existing tax system. Secondly, the Queensland Commission of Audit has argued more specifically that “the degree of vertical fiscal imbalance (VFI) in the Australian Federation is extreme and dysfunctional”. The Commission adds that accountability of both State and Federal Governments is blurred in consequence, thereby reducing fiscal responsibility. Recent High Court decisions on the definition of excise taxes add further significance to the need for economic analysis of, and political debate of, plausible changes to Commonwealth-State financial relations. While the overall tax reform debate focuses on the issue of broadening the tax base, one specific issue important to the debate is VFI and the possible reassignment of Commonwealth and State taxes. In this context we argue that a State personal income tax surcharge would facilitate a reduction in the extent of VFI, and thus promote a more efficient economy and effective federation. Various tax options for reducing VFI are considered, along with implications for public sector accountability and efficiency.