The Federal System in Australia Part 2

Vertical Fiscal Imbalance

Vertical fiscal imbalance is used to refer to the imbalance in finances between State and Federal Governments. It is estimated, for example, the States raise 20% of taxes collected in Australia, with 80% collected by the Commonwealth, even though the spending of these taxes is approximately 50% each. Again, VFI is attributed to various sections of the Constitution and several High Court decisions that favour the centralist system.

s. 90 gives exclusive powers to the Federal Government over customs, excise and bounties. This section was upheld in Ha v. New South Wales (1997) where NSW attempted to make tobacco sellers pay a licence fee. The majority ruled in favour of a very broad definition of excise, i.e. a tax on the sale or production of goods before consumption, disregarding whether or not it was produced locally. The minority held to the legalist definition of excise, a tax specifically on locally produced goods. This broad definition of excise allowed the Federal Government to raise more revenue whilst barring the States from it.

The High Court cases South Australia v. Commonwealth (1942) and Victoria v. Commonwealth (1952) concerned s. 51 (ii) and the power to raise taxes. During WWII, the Federal Government persuaded the States to allow it to claim income tax first so that it could support the war effort. When the war ended, the Federal Government retained the power, causing outrage amongst the States.

When they took it to the High Court, the Court ruled that, although taxation is a concurrent power, the Commonwealth had first go at income tax. The States could raise their own income taxes if they wished, but the Income Tax Act 1942 precluded this eventuality by making the tax rate so high that it would be politically impossible for the States to raise their own taxes. The Commonwealth would give away the extra money in the form of grants, which leads to more fiscal imbalance and ultimately the undermining of a federal system.

Grants may sound innocent, but s. 96 of stipulates that the Commonwealth may attach conditions to the money it gives to the States. There are general purpose grants, where the States may spend it on anything they want (usually funded by GST revenue); tied grants, where the money must be used in a specific area or by a certain department, e.g. Health or Education; and specific purpose grants, where the money must be used for a specific project, such as the construction of Fiona Stanley Hospital.

This means that the Federal Government may set terms and conditions to the money that they grant, and may even threaten to withhold funding if the States do not comply. They can also promise States more funds, all of which leads to vertical fiscal imbalance.

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