Why income-taxing states is Australia’s best April Fool's joke ever

The Commonwealth Labor government wrote to the States on April 1, 1942 telling them it was taking over their income tax powers. It is quite ironic that Prime Minister Turnbull will launch into a discussion with the states about access to income taxes on almost the same day, more than 70 years later.

Given their historic fight to keep their income tax powers, it is delightfully ironic to see the states reject almost immediately the current proposal to give them back such powers.

Since the idea had been debated extensively over the period from the 1916, and subject to Royal Commissions, Premiers’ Conferences, and a variety of expert groups, the Commonwealth move in 1942 was not too surprising. This was also the darkest period of the war: Darwin having been bombed in February of that year, and Japanese troops advancing. War expenditures were rising rapidly.

The big joke however is that the Curtin Labor government structured the take-over in such a way as to make it virtually impossible for the states to return to the field. Then Treasurer Ben Chifley had legal advice, and at least some of the states had too, that the temporary take-over of state income taxes was constitutional under the powers of the Commonwealth in the time of war.

Instead of using this power, the government structured its legislation to minimise the use of war powers. One act gave priority to Commonwealth income taxes over state income taxes, a second act gave a grant to any state which gave up its income taxes equal to the amount its income taxes had been yielding. A third act set a uniform rate of taxation across the nation and a final act used the war powers to transfer all state public servants involved in income tax collection to the Commonwealth. It was a crafty and durable solution.

To further insulate the solution against constitutional challenge the Commonwealth did not use its powers to immediately raise more revenue. Despite the war emergency, my estimate is that the Commonwealth only gathered an extra £5 million in 1942-43 when war expenditure reached £560 million.

The Commonwealth advice was that if it used the new powers to raise significant revenue, the whole scheme of bills might be construed by the High Court as effectively a use of war powers.

Accordingly, the states challenged the legislation and lost.

The long wrangle over income tax was set off in 1916 when the Victorian Premier proposed that the various states should become the designated tax collection agencies for the Commonwealth.

In the Commonwealth’s response Treasurer William Higgs wrote:

“To do what you suggested would require the same income tax laws for all of Australia … the same schedules; and in such a case it would appear that the Federal Government and not the states should administer the Act”.

Queensland Treasurer Ted Theodore warned that the endeavour was futile. He insisted that there was no hope of achieving uniformity on a general scheme of taxation.

It was debated again in 1918 and 1919 with no advance. Everyone agreed that administrative savings were possible, but they were all reluctant to cede control. Western Australia stood apart in allowing the Commonwealth to collect its income taxes.

A subsequent Royal Commission recommended to the Bruce Government in the mid-1920s the unification of income taxation under the Commonwealth. Stanley Bruce however felt that the states would never agree and that he lacked the constitutional power for force them to do so.

The Labor opposition challenged his viewpoint, saying the Commonwealth should withhold grants to the states until they agreed. In an effort to simplify administration, Bruce did however move to allow the states to administer the Commonwealth income tax, retaining only enough staff to deal with cases of income derived in multiple states.

Faced with the challenges of the Great Depression the states increased the number of taxes in Australia sharply. Some were levied on where the income was sourced, some on place of residence.

There were also a variety of rebates for taxes paid to other governments and for other sorts of taxation. One analyst suggested that by 1935:

“some taxpayers were paying as many as fourteen different income taxes, and receiving as many as a dozen rebates in the following year."

While some simplification was achieved over the next few years, in 1941 between them the Commonwealth and the states were still levying some 26 separate taxes on income.

Even the advent of war was not enough to get agreement. Conservative Treasurer Arthur Fadden in 1940 proposed that the states retire from income taxation for a number of years in return for system of fixed grants. Only South Australia and subsequently Tasmania were willing to agree.

Prime Minister and Treasurer Fadden’s 1941 budget was rejected and the government fell. The budget included a proposal for a uniform “national contribution” from all taxpayers with any amount which exceed their potential income tax payment to be treated a temporary war loan.

Reflecting on all this history, it does seem funny that the states would not want more control over income tax powers once more.