Garnaut Fitzgerald Review of Commonwealth-State Funding

CHAPTER 2: How the System Grew:
A History of Commonwealth Grants to the States
By the time this legislation was introduced, however, it was too late to create the
Interstate Commission before the CGC expired. The CGC appointments were extended
for another six months (CGC 1995). A 1937 election stifled further attempts at reform,
with CGC appointments extended again. The issue was abandoned in the late 1930s
when war precautions consumed the attention of Parliament (May 1971). Although
revisited in 1945 and 1947, by then the CGC was too well embedded in
Commonwealth–State financial relations to be readily removed (May 1971).
2.4 Increased vertical fiscal imbalance
through Commonwealth monopolisation
of income tax
The CGC’s role and responsibilities expanded from 1942 to 1945. At the June 1941
Premiers’ Conference the States rejected a Commonwealth proposal to levy uniform
income tax legislation for the duration of the war, but in May 1942 the Commonwealth
used its expanded wartime powers to override them.
After the War, and with subsequent High Court sanction, the Commonwealth used its
grants powers to block the States from re-entering the income tax field, with the States
Grants (Tax Reimbursement) Act 1946 obliging States either to forgo levying income
taxes or to operate without Commonwealth grants (Mathews and Jay 1997). This
effectively excluded the States from taxing income, and the Loan Council, established in
1927 to regulate and coordinate borrowing by the Commonwealth and State
Governments, severely restricted them in their borrowings (Mathews and Jay 1997).
Constitutionally the States could still levy income taxes, but they would have to do so in
addition to the Commonwealth tax and re-establish separate administration. This was
politically infeasible.
Figure 2.1 compares State and Commonwealth tax revenues over time as a percentage
of gross domestic product. It shows the dramatic impact of the assumption of control of
the income tax by the Commonwealth on vertical fiscal imbalance. Between 1938–39
and 1946–47 Commonwealth tax revenue as a percentage of gross domestic product
more than doubled. This is mirrored by a large reduction in States’ tax revenue.
FINAL REPORT [26]