The Historical Role of Financial Governance in Federal Evolution

How does fiscal power shape a federation?

Mian Ashiq Hussain argues that the fiscal part of a constitution is the main force shaping and reshaping a federation. Independent taxing powers at federal, provincial and local levels give each tier financial self-reliance, which he calls the heart of a thriving federalism, while grants from the centre tend to steer provincial policy.

Historical role of financial governance in federal evolution i. The principal factor shaping and reshaping federal structure is the fiscal part of a constitution. Independent taxing powers of the federation, the provinces and local governments sustain their financial self-reliance, which is the heart of a thriving federalism. A little later, it will be seen how fiscal factors radically transformed the Commonwealth of Australia into a highly centralised federation while it was initially conceived as almost a confederation. On the other hand, the fiscal autonomy of the Canadian provinces, binational character of the country, acted as the factors of decentralization of its highly centralised state structure conceived at the time of its foundation. It is a common observation that grants-in-aid or intergovernmental transfers of funds influence the policies of the provinces. For instance, the federal grants by the US government for Medicare/Medicaid, food stamps, federal aid to schools and other programmes to help fight poverty did strengthen peoples’ bond of loyalty with the Federal Government.

Why did Australia's federation become so centralised?

Australia was designed in 1901 as a highly decentralised federation. The author explains that control of customs and excise gave the Commonwealth far more revenue than it needed, and broad High Court rulings then let it take over sales, company and income taxes, leaving the states financially dependent on the centre.

ii. Gradual centralization of Australian Commonwealth shows that financial governance plays pivotal role in the growth of a constitution. In 1901, the Australian Commonwealth was conceived as a highly decentralised government. Like the US Constitution, the framers of Australian Constitution conferred exclusive enumerated powers on the Commonwealth in common policy areas, such as defence, regulation of trade, external affairs, levying of customs tariffs, currency and raising of military force. Maintaining a range of potential concurrency, bulk of domestic governance responsibilities were supposed to be exclusively left to the states. The subject of local government was left open as an instrumentality of the States. Thus, the States retained impliedly exclusive jurisdiction over all the residual subjects in a single list approach. Apparently, it was believed that the Constitution would vouchsafe US model of “dual federalism”. The most crucial factor of fiscal autonomy was, however, not set down. Resultantly, the financial dependence of the States on the Commonwealth of Australia gradually but fundamentally changed the course of Australian history.

iii. The authors of the Australian Constitution did not foresee that without textual support vertical fiscal imbalance would flow from broad interpretation of the constitution by the courts with regard to enumerated powers of the federation. For the creation of a common market, the Commonwealth of Australia was assigned exclusive power over the customs and excise tariffs which empowered the Commonwealth to conveniently collect far more revenue than the requirements of the national government in peace times. Over time, High Court of Australia’s broad interpretations of the Commonwealth powers tilted the fiscal balance in favour of the national government. Consequently, the Commonwealth government successfully monopolised sales tax as well as the corporate and personal income taxes. Overwhelming taxing power of the Commonwealth made the federating units financially dependent on the financially stable central government. Resultantly, the Commonwealth could exercise spending powers according to its choice. Gradually, wide financial powers of the Commonwealth expanded its fields of activities and curtailed autonomy of financially dependent States. “Conditional or tied grants have been a powerful instrument of centralization in Australian federalism”; “financial relations are the chief determinant of the character of the Federation.”

Do residuary powers protect provincial autonomy?

Not on their own, the author concludes. Australia gave the states vague residual powers, which proved easier to erode than enumerated ones. The US avoided this through the Tenth Amendment, which expressly reserves undelegated powers to the states, so he argues a single legislative list needs similar safeguards.

iv. Test of time revealed that specific enumeration of powers of the central government and leaving residuary powers for the provinces do not necessarily guarantee provincial autonomy and a balanced federal structure. Commenting upon the inadequacy of residual powers in preserving the original scheme of the Australian Constitution, Alan Fenna commented: “The framers of the Australian Constitution saw this (the assignment of residual powers to the States) as part and parcel of decentralised Union. In practice, rather the contrary seems to be the case; implicit powers are much more easily ‘eroded’ than enumerated ones. Possessing only a vague residual power has been a source of vulnerability for the Australian states in Constitutional jurisprudence, leaving little textual obstacle to broad interpretation of Commonwealth powers”. “We can see with hindsight that the rejection of the Canadian scheme intended to bolster State powers, has had the effect, in the hands of the courts, of assisting the development of national power”.

v. Although the framers of the Australian Constitution purportedly followed the US model of distribution of powers between the Union and states, but they lost sight of the fact that enumerated powers of the US federation in the provisions of the Constitution did not subsume States’ powers beyond a certain limit because the US Constitution guaranteed federal balance by the Constitutional Amendment X in 1791.

“The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

Due to such express reservation of residuary powers to the states, the US courts could not go beyond the express Constitutional mandate. Unless single legislative list is hedged by appropriate provisions, broad interpretation of enumerated powers by the courts may subsume residuary powers.

What did Western Australia's 1933 secession vote show?

In 1933, 66 percent of Western Australian voters backed secession, driven by economic grievances from the Great Depression, though separation was averted. The author treats it as an exception to the general centralising trend and an illustration of how economic and fiscal factors can pull a federation apart.

vi. For appreciating the role of economic factors and fiscal measures in fostering centripetal or centrifugal tendencies, Referendum of 1933 in Western Australia offers a typical illustration. 66% voted in favour of secession in the statewide referendum of 1933 though separation was eventually averted. It was the fallout of economic grievances caused by The Great Depression. However, that was an extraordinary exception to the general trend of concentration of powers in the Australian Commonwealth. It is, however, appropriate to point out that the provisions of referendum in terms of Section 128 of the Australian Constitution to some extent served as a brake on centralization. All the same, the transformation of Australian federalism was reinforced by sub-constitutional legislation and judicial pronouncements in fiscal matters.

vii. Besides, Australia, being almost mono-national Commonwealth, without wide diversity of population generally did not face distinct problems of ethnic or linguistic centrifugal strains, though indigenous Australians mostly remained disenfranchised. If citizens share homogeneous culture and have security of lives and living, they may not be much concerned about the distribution of powers between the national and provincial governments. Australian population is predominantly homogeneous with a marked linguistic, racial and regional concord. Thus, over time, identification of people with the Commonwealth boomed. The Australian Labour Party’s political agenda went so far as to demand unification of the states and establish centralized planning for unified market and economy.

How did Canada's federation decentralise?

Canada began in 1867 as a quasi-federal state with strong unitary elements. The author explains that rising revenue from direct taxes gave its provinces growing fiscal self-reliance, while cultural diversity and Privy Council rulings also favoured them, so Canada moved towards decentralisation as Australia centralised.

4. Decentralisation of Canadian Federation is a saga of devolution.

i. Practical realities of each federation determine its federal character and viability of its polity. Viewing the opposite odysseys of Australian and Canadian federations, one may develop insight into the forces and factors which transform the nature of federalism and throw light on how vital role is played by economic and fiscal factors in the evolution of modes of governance. In contrast to evolution of the Australian Constitution, the British North America Act, 1867, created a quasi-federal state. Under the constitutional monarchy, the quasi-federal scheme of Canada incorporated certain unitary elements such as:

a) Lieutenant governors were appointed by Governor General in Council as representative of the Crown.

b) The Parliament of Canada was allowed to reserve exclusive extensive powers.

c) The Canadian Parliament’s power to make laws for “the Peace, Order and Good Governance of Canada” was broad enough to subsume unspecified powers.

d) In case of conflict, federal legislation prevailed over provincial laws relating to concurrent subjects.

K. C. Wheare termed such powers as “unitary elements”.

ii. Nevertheless, at the time of the foundation of highly centralized Canadian Constitution, the potential of direct taxes assigned to provinces was not very significant but with economic development and rising affluence of its people, revenue from direct taxes like Income Tax and Succession Duties boosted a considerable degree of fiscal self-reliance of its provinces. The federal grants, therefore, did not assume crucial proportion. “By the 1930s, the proportion of provincial own source revenue out of total provincial revenues had reached 90%, up significantly from the first decades of the federation when it was under 60 percent.” Thus, fiscal autonomy of Canadian provinces relatively decentralised Canadian federation, notwithstanding a generic worldwide trend of centralisation of powers.

iii. Besides, diverse cultures of the French Canadians and English Canadians also acted as a factor preserving autonomy. Relative rise of classic federalism in Canada was attributable to various factors. Firstly, it was initially overcentralized and there was lesser room for further concentration of powers. Secondly, diverse linguistic and cultural background of people of its provinces preserved significant distinctions. More importantly, fiscal autonomy inbuilt in design of the Canadian Constitution provided wider scope for competitive and distinctive developments in province-building. Unlike centralising effect of decisions of tax cases by the High Court of Australia, “decentralisation in the first half of the Canadian federation’s life came mostly as result of Judicial Committee of the Privy Council’s (JCPC’s) decisions and the constitutional room for provincial governments to tax while the politics of Canadian federalism, more specifically processes of nation-building in Quebec and of province building elsewhere, have induced decentralisation in the last 75 years”. Empirical evidence affirms that economic self-reliance vis à vis resource limitations play defining role in determining the direction of federal relations

Frequently asked questions

What made Australia's states financially dependent on the Commonwealth?

The author points to the Commonwealth's exclusive power over customs and excise and to the High Court's broad reading of Commonwealth powers. Together these let the centre monopolise the main taxes, producing a fiscal imbalance the constitution's framers had not foreseen.

Why does the US Tenth Amendment matter to federal balance?

The author explains that by expressly reserving undelegated powers to the states or the people, the Tenth Amendment stopped US courts from stretching federal powers beyond the constitution's text. Australia, lacking a comparable guarantee, saw its residual state powers eroded.

How did Canadian provinces become fiscally self-reliant?

As the economy grew, direct taxes such as income tax and succession duties assigned to the provinces brought in more revenue. The author cites figures showing provincial own-source revenue reaching 90 percent of their total by the 1930s, so federal grants never became decisive.

Why did Australia and Canada take opposite paths?

The author contrasts a culturally homogeneous Australia, whose people came to identify with the Commonwealth, with a Canada of French and English communities and fiscally autonomous provinces. Court rulings pushed Australia towards the centre and Canada away from it.

Related Minds

• Fiscal Federalism: Lessons from Five Federations
• Provincial Autonomy in Pakistan: Beyond Legislative Lists
• The NFC Award and How Federations Share Revenue
• The 18th Amendment in Pakistan: Devolution Compared

Read the full argument in the book How Constitutions Flourish or Fail by Mian Ashiq Hussain.