Tasmania’s devil is in the details

Mike Nahan
National Post

Thursday, April 15, 2004

MELBOURNE – Last month’s federal budget renewed one of Canada’s most sacred policy cows — our $10-billion equalization program — for another five years. The second of a three-part series looks at how equalization doesn’t work Down Under.

Tasmania, Australia’s island state, is caught in a classic welfare trap. While not quite the Appalachia of Australia, it is on the same path and subject to the same type of jokes, with its economy in relative decline, its best and brightest people leaving and poverty and despondency on the increase.

How could a resource-rich state be failing within a federal system of redistribution designed expressly to avoid large divergences in economic and governmental capacity? In the main, the fault lies with that system itself. In spite of good intentions, it has created a perverse set of incentives that lures states into dependency and locks them into decline.

The Commonwealth’s domination of taxing powers sets the context. Even at the time of federation in 1900, Australian states were more dependent on the central government than their North American counterparts, the United States and Canada. Over time, the Commonwealth steadily accreted more taxing power to itself. As a result, the average state now relies on the Commonwealth for 43% of its total revenue, with the smallest state, Tasmania, dependent on the Commonwealth for 65%.

Australia’s most articulate founding father, Alfred Deakin, warned of this flaw prior to federation, when he stated that the Constitution left the states “legally free but financially bound to the chariot wheels of the central government.” His successors did not listen. While the state leaders have at times complained about the imbalance, in the end they acquiesced. Their rationale was best expressed by a former premier of Queensland who said “the only good tax is a Commonwealth tax,” meaning he and his colleagues were happy for the Commonwealth to do their taxing for them.

The tax imbalance naturally led to a large flow of payments from the Commonwealth to the states. The growth of the equalization program was augmented by the fact that the Australian Constitution gives the lion’s share of spending responsibilities to the states.

Initially, the Commonwealth’s surplus funds were allocated on a one-off basis to struggling states. There was no attempt to equalize income or services across the states and the grants were viewed, at least by the Commonwealth, as temporary. Starting in the 1930s, the perennially struggling states, including Tasmania, demanded a more comprehensive and permanent system. They also argued that the system should be put at arm’s-length from the political process and turned over to a dedicated bureaucracy.

The Commonwealth and the more prosperous states resisted these demands. But in the 1930s a successful pro-independence referendum in Western Australia frightened the Commonwealth into acceding. It set up a Commonwealth grants commission to devise a methodology for the transfers and provide advice on their allocation amongst the states. Under the commission, the scope and purpose of the grants steadily changed from providing temporary respite from hardship to permanent relief, and from considering the equalization of some services and revenue to the equalization of all.

From its inception, the process was criticized for its potential to create dependency, as well as the potential for gaming and other unproductive activity. Despite efforts to avoid these distortions, the commission inevitably failed. The task of simulating something as complex and malleable as a “standard level of service” in an independent and objective manner across a large continent nation such as Australia was simply impossible.

Indeed the commission’s process has a number of central flaws. First, it gives no consideration to the effect of the state’s own decisions on its economy. Second, the benchmarks used to determine an acceptable level of services are not based on effectiveness or efficiency, but rather on other values. As such, it not only compensates for inappropriate policies but at times perpetuates them.

As Tasmanian governments lock away larger chunks of the state’s resource base from development, they suffer no penalty for poor choices but instead receive more compensation for the loss of revenue-earning power. As they impose disincentives for job creation and economic growth, such as higher levels of tax and regulation, they face no consequences. As they borrow heavily to fund unproductive jobs in government-owned businesses, they receive additional compensation.

Over the past two decades, Tasmania’s economy has stagnated, but its per capita grants have increased. They now stand 87% above the all-state average.

Official reports have tended to blame natural causes, such as the state’s small size and remote location, for its poor economy. But the evidence points clearly to poor policy choices, aided and abetted by the federal equalization system. The system has sheltered Tasmanians from taking responsibility for their own future and induced them to become dependent on the generosity of their fellow Australians. This has bred a culture of complacency and political resistance to change.

The future is not rosy for Tasmanians. Federal generosity is under strain and donor states are pressing for change in the direction of less welfare and more self-reliance.

The question is: After decades of equalization, dependency and a lagging economy, can Tasmania change and recover? Only one thing is clear. The adjustment cost will be high.

Tomorrow: Transformative equalization

Mike Nahan is the executive director of the Institute for Public Affairs, an independent think-tank based in Melbourne, Australia.

© National Post 2004