Date created: 12 March 2004

Last modified: 12 March 2004

Maintained by: Craig Mosely

Commonwealth must take responsibility for services

Author: John Quiggin John Quiggin is professor of economics at JamesCook University and author of Great Expectations. Microeconomic reform andAustralia forthcoming from Allen & Unwin
Date: 07/08/1996
Source: AFR
Words: 635

Publication: Australian Financial Review
Section: News
Page: 19

Faced with the choice between lower taxes and improved services, the public will opt for the latter, writes John Quiggin.

Two of the most intractable problems faced by any Federal government are health policy and financial relations with the States.

In the case of health, the Federal Government, despite its free-market credentials, is now contemplating civil conscription as a remedy for the shortage of country doctors. This shortage results, of course, from the same government's policy of seeking to hold down the total number of doctors to a target level determined by its central planners.

The relationship with the States has the same paradoxical features. As Michelle Grattan pointed out recently, a supposedly "States rights" government is rapidly discovering the need to be even more centralist than its predecessors.

The core of the difficulty in relations with the States is the problem of vertical fiscal imbalance, that is, the fact that the Commonwealth raises the bulk of tax revenue, while the States undertake most public expenditure. The gap must be made up by grants from the Commonwealth to the States, some for specific purposes and some for general financial assistance.

In an unbalanced relationship of this kind, the power of the purse is ultimately dominant. The Commonwealth Government holds the whip hand, and its interests are best served by keeping taxes low, maintaining own-purpose expenditure and passing the burden of expenditure restraint onto the States. The Fraser and Keating governments cut general purpose grants to the States by half as a proportion of GDP. Despite promises to the contrary, the Howard Government has carried on this tradition.

The difficulties of vertical fiscal imbalance are nowhere more evident than in the health sector. The interaction between the Commonwealth and the States involves cost-shifting and buck-passing. More importantly, the Commonwealth's role as paymaster leads to the adoption of the view that health expenditure, as a proportion of GDP, should be kept as low as possible.

In fact, because health services are a superior good, their share of expenditure should rise as income grows. Moreover, technical progress in health has been characterised mainly by product innovations creating new services. In a properly functioning economy this would imply growth in output. Finally, the health sector is an intensive employer of labour, particularly skilled labour. Policies aimed at artificially constraining demand for health services have depressed labour demand and contributed to rising unemployment.

We could start to resolve the problems of the health sector if the Commonwealth took complete responsibility for health. This would go a long way towards eliminating the present cost-shifting and duplication. More important, voters would be faced with a clear choice between lower Commonwealth taxes and better health services. Survey research consistently shows that a majority would choose better health services.

In addition, a transfer of responsibility for health would eliminate much of the vertical fiscal imbalance problem. First, it would wipe out a large class of specific purpose payments. Second, it would remove the need for around half of the present general purpose Financial Assistance Grant. If a transfer of responsibility for health was combined with some smaller transfers of expenditure responsibilities to the Commonwealth (say, for housing and roads) and some modest transfers of revenue sources to the States, it would permit the elimination of general purpose grants. This would finally allow both levels of government to be fiscally self-sufficient and present voters at both levels with a clear choice between lower taxes and better services.

Self-proclaimed advocates of micro-economic reform and economic rationalism chide Australians for their unwillingness to embrace change. However, those same advocates will certainly dismiss out of hand the economically rational changes proposed here. Their true commitment is not to rational policy, but to cuts in public expenditure and taxes, particularly income taxes, regardless of whether such cuts are economically sensible or are desired by the electorate.

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