Australian federalism is dysfunctional. If you care about the quality of schools and hospitals, you must care about how power and responsibility is divided. The federal system has increasingly become a barrier to delivering services efficiently and at the highest level of quality. When Australia became a nation on January 1, 1901, it also became a federation and the people of the colonies agreed to “unite in one indissoluble Federal Commonwealth”. To reflect this, the Constitution shared power and money between state and federal governments. This was designed to prevent one government exercising complete control.

Drafted by colonial politicians like the former premier of Queensland, Sir Samuel Griffith, the Constitution was meant to establish the states as the master of the system. They had greater authority; the Commonwealth was restricted to listed areas from marriage to corporations, external affairs and defence. The Commonwealth had power over forty specific areas, leaving everything else to the states, including taxation, health, education and industrial relations.

Those who voted for the new federation expected the states to have greatest responsibilities, a view that was reinforced by their control of the purse strings. This made sense at the time: no one had experience of a nation and communication across the country was poor. Few imagined the need for national leadership in areas like the economy or the environment.

For the first two decades of the new nation, the High Court interpreted the Constitution to maintain the position of the states and limit Commonwealth power. This changed abruptly in 1920. In that year, in the famous Engineers’ Case, the High Court overturned many of its earlier decisions. A new approach evolved that involved a generous reading of listed Commonwealth powers. The case was won by a young Robert Menzies, and provides yet another example of the conservative side of politics leading the charge for greater centralisation in our system of government.

Over time, the Engineers’ Case allowed powers like those over external affairs and corporations to be extended to other areas like the environment and industrial relations – something that had not been anticipated or intended by the framers of the Constitution. If the court had adopted this interpretation in 1903 when it began, it could have derailed the young federation. High Court Justice Victor Windeyer pointed out decades later that the decision was itself the product of the changing nature of Australian society. It was a result of the Constitution being “read in a new light that had, over twenty years, led to a growing realisation that Australians were now one people and that national laws might meet national needs”.

After the case, ideas like “federal balance” and “states’ rights” became constitutional heresy. Today, they are nothing more than political slogans. The Engineers’ Case was a major blow to the states. Another equally significant loss was in the area of taxation – in governance, as in life, control of revenue matters even more than the power to pass laws. Without the money to fund programs and services, new laws may have little effect. It was another two decades before High Court decisions – in the Uniform Tax Cases of 1942 and 1957 – upheld the Commonwealth takeover of the income tax system and gave it the ability to attach conditions to the money it granted to the states. Under section 96 of the Constitution, the Commonwealth can make grants “on such terms and conditions as the Parliament thinks fit”.

The Commonwealth’s financial control increased a decade ago when the High Court struck down excise duties levied by the states over alcohol and tobacco. The result in 1997 in the Ha Case stripped the states of more than $5 billion a year. As a result, the states do not raise income taxes and cannot impose taxes on goods. Their financial position is dire because they cannot raise the revenue they need to provide the services they are constitutionally expected to provide.

While they have turned to new sources of taxation, such as gambling, they depend heavily on Commonwealth grants – including $45 billion of GST revenue. Federal handouts account for almost half of New South Wales revenues; without them, New South Wales would be bankrupt. All the states are in the same predicament. The Commonwealth grants money with strings attached and the states have no real choice but to accept the money, thereby fulfilling the prophesy of the nation’s second prime minister, Alfred Deakin, who wrote in the London Morning Post in 1902 that the states would find themselves “legally free, but financially bound to the chariot wheels of the central Government”.

Australian federalism is in tatters because it is based on rules that no longer match reality. High Court decisions and canny prime ministers from John Curtin to John Howard have transformed the system. Australia now has one of the most centralised federal systems of government in the world. The states are shadows of their former selves, rarely able to check Commonwealth power. The High Court’s 2006 decision in the Work Choices Case exacerbated the situation: the Commonwealth can now pass laws in any field in which corporations operate. As most business is done by corporations, the potential reach extends almost everywhere goods or services are supplied.

Despite its dominance, the Commonwealth cannot exert compete control – a recipe for buck-passing and administrative duplication which the Business Council of Australia estimates to cost at least $9 billion a year, and probably more like $20 billion when the costs of duplication and red tape are factored in. This is 9 per cent of all general government expenses, and 3 per cent of gross domestic product. This is not just a loss to taxpayers, but a lost opportunity: every dollar squandered could have been used for schools, hospitals, aged care or affordable housing.

There is a stark choice: to continue to pay extra tax for second-rate services, or to accept the challenge and opportunity of reform and fix the system of government by a proper allocation of tax revenue and a more appropriate division of power over areas of responsibility.

The answer is not to abolish the Australian states. That would be unrealistic and bad policy. Few local problems can be solved by unilateral action from Canberra. At least one lower tier of government is needed to help develop regional solutions and deliver services. Problems of legitimacy are a reason why federal systems evolved: people in Western Australian were the last to accept federation and, at a time of unprecedented economic success, are as unlikely to ever accept rule by a single government in Canberra.

While Australia’s federal system of government is broken, the answer is to fix that system, not to jettison it. We should focus on pragmatic, achievable change that lowers taxes and improves the quality of government services. In the short term, there are many things that can be done to improve how our federal system works, facilitating cooperation and re-examining finances. In the longer term, the text of the Australian Constitution will also need to change. If the rules are not changed, bad habits will resurface and blockages re-emerge. There is a need for a revised set of rules to accommodate the changes of the past century and to prepare for the next – a new deal for the federal system.

Many have called for a constitutional convention to consider the future of the federation. Such conventions were crucial in the development of the Constitution – a place where disagreements were teased out and resolutions found. In today’s interconnected world, a convention may seem old-fashioned, but it remains an effective way of bringing together many interests and perspectives. A convention should be held as soon as possible to develop a program for federal reform.

This is an edited extract from Griffith REVIEW 19: Re-imagining Australia (ABC Books)www.griffithreview.com. Click here to learn more.