Australian Local Government Association

Why do we need an efficient tax system?

The Commonwealth Treasury defines effective government taxation arrangements as follows:

"Taxation measures should meet revenue objectives (or other public policy objectives) and have regard to the principles of economic efficiency, horizontal and vertical equity, certainty and transparency whilst minimising compliance and administrative costs. By meeting these aims, taxation measure contribute to the wellbeing of Australians, either directly or by providing the revenue base to finance government ".

Australia has progressed in the direction of a highly centralised taxation system particularly since the introduction of the Goods and Services Tax in 2000. This is an appropriate response for a country with such a dispersed population across a large area. However, it also means that the Australian government is primarily responsible for delivering horizontal and vertical fiscal equity.

The Australian Government raises more revenue than it needs to cover its own expenditure programs. In contrast, both the state and territory governments and local government expenditure commitments exceed their revenue raising capacity.

This mismatch of spending and taxing power is known as 'vertical fiscal imbalance' (VFI).

Horizontal equity ensures that people in similar financial positions are treated in an equitable manner in regard to taxation.

In practice, VFI is offset by the Australian government providing financial assistance to the deficit levels of government (i.e. the states, territories and local government) with such financial assistance being in the nature of tax sharing grants. These grants however do not eliminate VFI and the underlying fiscal imbalances remain. The only way of eliminating VFI is to redistribute taxing powers and expenditure functions - which is unlikely to occur.

The following diagram (Diagram 1) demonstrates how the three spheres of government interact financially to help resolve vertical inequities. It also indicates the revenue, expenditure and borrowings of each level of government¹.

Diagram 1

This diagram shows, the Commonwealth Goverment provides $55.5 billion to the states and $2 billion to local governments. The states also pass on $0.5 billion to local government.