The proposal announced by the prime minister to allow states to raise their own income tax to better fund their education and health expenses is that classic case of a solution that looks great if you think of the world as an economics textbook, but which should be rejected as just a move towards cutting services.

When perusing this tax plan, at first you have to try to make sense of just what is the plan, and then it’s best not to be left thinking: “Malcolm, I think that needs a bit more time in the oven. It seems half-baked.”

The main gist under Turnbull’s proposal is that the federal government would lower tax rates by a certain amount (say 10%) and the states would be able to raise a “surcharge” of 10%. The federal government would then reduce grants to states by that amount raised in each state.

As the Turnbull would have it, no extra spending would occur, and nor would there be extra tax raised – but in the future states would be able to raise or lower tax rates (and the federal government grants would be lowered ... or possibly raised?).

So where is the advantage?

Well apparently this measure would mean the states would raise the money and thus would be responsible for it and would be more careful with how they spend it.

The premise is based on the idea that vertical fiscal imbalance – that is, the federal government raises the money and the states spend, leading to bad decisions – is a terrible thing.

It’s a premise that sounds feasible, a bit like saying kids aren’t really responsible for their spending because their parents give them pocket money rather than them going out and earning money.

Except state governments already do raise money, do have to produce annual budgets and are awarded credit ratings (Queensland and Western Australia, for example, have had theirs downgraded in the past few years).

Essentially those in favour of this idea suggest it will mean state governments are more accountable to voters, because if states can raise or lower taxes they have a better determination over the level of education and health services in their state. In effect: low income tax (voters say yay!); low services (voters say booo!).

Thus if a government wanted to improve services without raising income tax it would have to do things more efficiently.

But that rests on a premise that there is no incentive already to do that.

Clearly there is.

As I noted, the states already have budgets, credit ratings and elections. The incentive to deliver health and education as efficiently as possible is there because state governments also spend money on other areas, infrastructure, for one. They also know that if they can somehow deliver services more efficiently they can deliver lower taxes that they already raise, such as payroll tax rates and stamp duties.

That the state government would now have an extra source of revenue would not introduce much more of an incentive than already exists.

And I’ll leave aside the issue of how inefficient the tax system will become if the federal government changes the tax rates or thresholds but states keep theirs the same. And let’s just also acknowledge that if states are reliant upon income tax it inevitably will force poorer states such as SA and Tasmania to have higher rates or reduce services.

The states’ main complaint has been the lack of ability to make local decisions as the grants they get are mostly tied. This was why the SA premier, Jay Weatherill, proposed giving the states a share of income tax revenue in place of the grants.

His proposal did not allow for states to raise (or lower) income tax rates, but merely that they would get a set share of income tax, in much the same way they get a share of GST.

The allowance for states to raise or lower tax rates introduces a whole new dynamic. It introduces competitive taxation, a recommendation of Tony Abbott’s commission of audit.

The belief goes that states could lower taxes to entice people to come to its state, but this would be countered by the need to provide services. Thus once again the belief is that states would again seek to deliver more efficient services in order to lower tax rates to again attract people to their state.

By contrast, if a state lowered taxes too greatly and services suffered, people would leave to another state that might have higher taxes but better services.

It sounds great if you love economics.

The problem is people generally move for one reason: jobs.

We know this already.

As I noted last year Victoria is experiencing a large net interstate migration boom, while WA is not:

Has anyone ever suggested this is happening because WA’s school system or health system is falling behind Victoria’s, or because stamp duty is different in either state?

Nope. It’s because the mining boom has ended and Victoria for the first time in a decade has been doing well job-side.

Given the costs of moving interstate, the difference in tax rates between the states would have to be massive to make the decision logical.

But lack of logic is never much of an issue when it comes to pressure for lowering income tax.

And this is the problem with competitive taxation – it only works if there is also a real “competitive federalism” – that is, competitive services and if the costs of moving between states is essentially nil.

I have seen a number of jobs advertised in Sydney that I would love to do, but there is no way I am going to apply for them because the cost of leaving is too great: my wife has a job, my kids love their school and their friends. Were NSW to have a 2% lower tax rate than the ACT, it still wouldn’t matter.

The other problem with the story is that there is asymmetrical information.

On the revenue side you have a very visible tax rate – easy to compare, easy to know, and with a lot of pressure on state governments to cut or at least to not raise (as Paul Keating told Tony Blair: “Don’t ever put up income tax, mate ... Do that and they’d rip your fucking guts out.”)

On the other side we have schools and hospitals and other healthcare.

Do you know if your child’s school is better or worse than that in another state? Is your nearest hospital more efficient than that elsewhere?

Sure we have the MySchool website, but really? C’mon, be honest. Unless you are a researcher in those areas you have no idea, and even then the difference in test scores, waiting times, standard of care are hotly debatable and dependent upon various factors such as demographics.

No one is moving across the nation because they heard a hospital in Victoria or Adelaide or Sydney or wherever has better service than their nearest. You might do it for a special operation or treatment – but even then it is only temporary.

So what incentive is there for a state to raise taxes to produce better services that is not already there?

How good does your state’s healthcare need to be to entice people to move to access it? Or perhaps the more pertinent question: how bad does your service have to get before people will leave?

For in reality all the incentive to be competitive is on the revenue side to lower taxes, and there is very little real competition on the expenditure side to improve services other than already exists.

This policy thus introduces more incentive to cut revenue, and little incentive to improve services – the incentive on that side is to cut services and shift them on to the private sector.

That’s fine if you think that is a good result, but let’s not pretend this is about improving government service delivery.

If you are worried about service delivery, look at service delivery, not at the ability for states to lower taxes.

If there is a funding issue for services because of an ageing population, then raise more revenue. Don’t rearrange how the revenue is raised and hope the magic wand of reduced vertical fiscal imbalance will solve the rest.