Malcolm’s tax mistake was asking the State premiers

A strange thing happened the other week. The Prime Minister had a good idea, and then asked the natural opponents of the idea for permission to pursue it.

The essence of the Prime Minister’s idea was to abolish a whole bunch of tied grants to the states so he could afford to cut federal income tax rates.

This is straight from the Liberal Democrats’ policy platform and is a brilliant idea, even if I do say so myself.

It’s brilliant because federal income tax is the worst tax on the books. It encourages spending over saving, discourages potential entrepreneurs from creating jobs and growing the economy, has huge compliance costs, and requires a massive bureaucracy to administer. If you had to dream up the stupidest tax, it would look a lot like the federal income tax.

The Prime Minister’s idea was particularly brilliant because it involved cutting all income tax rates, including the top rate, which causes the most damage.

The idea of abolishing tied grants to the states is also brilliant. These are grants for things like hospitals and schools – administered by the states but which require the federal government to employ 5000 people in the Department of Health (and associated agencies) without employing a single doctor or nurse to treat patients, and 2000 people in the Department of Education (and associated agencies) without employing a single teacher to teach children.

Canberra has no idea what conditions to put on these grants. It tries, but whenever a state falls short of a key performance indicator, Canberra never knows whether to cut the state’s grant to punish it, or top up its grant to help it.

Unfortunately, the Prime Minister complicated and weakened his brilliant idea in two ways.

First, he only talked of abolishing some of the tied grants, so he could only offer to slice two points off the federal income tax rates. If you abolished all tied grants you could slice up to six points off each rate. While all taxpayers would benefit, reducing our effective top income tax rate from 49 to 43 per cent would be an especially important contributor to the economy.

NO PERMISSION NEEDED

Second, the Prime Minister proposed that the states impose their own income tax to exactly offset the federal tax cut over a transitional period. This was a mistake. The states already have the power to impose their own income tax, so they don’t need permission from the federal government. Moreover, they also have the option of using their existing state taxes to generate revenue to replace the tied grants. These are less destructive than income tax.

When the Prime Minister invited the states to increase their taxes, he reduced the pressure on them to eliminate wasteful spending, such as providing free schooling and hospital care to those who can afford to pay.

For all that, the Prime Minister’s idea remains a good one, and it was a mistake to ask the state premiers for permission to pursue it. The premiers naturally rejected the idea because they don’t like pressure to eliminate wasteful spending, and they don’t want to risk their popularity by raising their own taxes if Canberra will do it for them. Asking the premiers for permission to cut tied grants is like asking dole bludgers who refuse a job if they’d like to still receive the dole. It’s even crazier once you realise that the states each have healthier balance sheets than the federal government.

So, in recognition you don’t need the premiers’ permission to cut tax and fix the federation, I’m starting a campaign for the Prime Minister to #DoItAnyway. The budget on 3 May should deliver cuts to federal income tax rates of up to 6 percentage points, and abolish tied grants to the states so the state premiers begin to responsibly manage their own finances.

Perhaps the Prime Minister is planning this anyway. Without a surprise of that kind, the budget will be more a whimper than a bang. But I doubt it. It would require a government comprised of Liberal Democrats to be so bold. We seem to be the only ones arguing against harmful government intrusion, especially when it comes to high tax rates that punish job creators.

From the Australian Financial Review, 15 April 2016.