Wouldn't it be loverly to have a state that works?

A CENTURY of Australian federalism and state government has come to this: Kristina Keneally, playing Eliza Doolittle, aspirates "The rain in Spain falls mainly in Balmain"; Joe Tripodi and Eddie Obeid, improbably cast as Professor Higgins and Colonel Pickering, gasp "By George, she's got it!"; and the dustman, played by Nathan Rees, is history.

Yet NSW's saga should not distract from the deeper crisis afflicting state government. Good governance is hard to define, but we know it when we don't see it. Queensland, Tony Fitzgerald warns, has slunk back into cronyism. Tasmania's government is NSW without the ethnic flavours. And Victoria's claims of good government clash with a reality of public transport chaos, a groaning hospital system, and (in the bushfire state) emergency services unable to save lives.

Like nature abhorring a vacuum, the space state governments vacate is being filled by an encroaching commonwealth.

It would be easy to view these developments as inevitable, for Australian federalism was always an uncertain construct.

Other federal systems -- the US, Canada, Germany, India -- rested on deep historical divisions. Australia's federalism, in which there was little to distinguish a Victorian from a Queenslander, did not.

To that infirmity was added a crippling birth defect. Federation was intended to remove the barriers to trade between the states, while allowing a common tariff to be imposed on goods from the rest of the world. Customs duties therefore had to flow to the commonwealth, stripping the states of crucial revenues.

But the states retained the bulk of the spending responsibilities, including servicing debtsincurred to provide infrastructure and operate loss-making, but politically vital, utilities.

The momentum inherent in this "vertical fiscal imbalance", in which the commonwealth collects more than it spends, while states spend more than they raise, was obvious even as the federation began. There is an eerie prescience in Alfred Deakin's warning of 1902, that while the states were "legally free", fiscal imbalance left them "bound to the chariot wheels of central government".

The inevitable outcome: "The less populous (states) will first succumb; those smitten by drought or similar misfortunes will follow; and finally, even the greatest and most prosperous will, however reluctantly, be brought to heel."

It is easier to derive the Schrödinger wave equation than to explain the history of Australian fiscal federalism since Deakin's grim assessment.

The 1927 Financial Agreement, in which the commonwealth assumed the burden of state debt, gave some relief, but not enough for the poorer states.

Matters came to a head in April 1933, when at a state referendum, a two-thirds majority of WA electors voted for secession.

To calm the waters, the Commonwealth Grants Commission was established two months later, institutionalising the "special grants" the commonwealth had made to Western Australia since 1910-11.

The result: a complex system of "horizontal" redistribution between states was added to the pre-existing vertical flows.

World War II brought a further crucial step to centralisation: the Uniform Income Tax Act of 1942. There were then 26 separate commonwealth and state income taxes. The act merged these into a single commonwealth tax. In dismissing an appeal by the states against that legislation, the chief justice of the High Court, John Latham, noted its inevitable consequence: "to make the states almost completely dependent, financially and therefore generally, upon the commonwealth".

Especially in the Menzies era, that did not prevent strong premiers, ambitious for state development and with well-entrenched power bases, from asserting their independence.

But it was telling that when Robert Menzies, in 1953, sought to give the income tax back to the states, they rejected it.

This is understandable, as taxing is unpopular. But the states had made a Faustian bargain. Writing shortly after Menzies' offer was rejected,economic historian S.J. Butlin said it was "patent and immediate" that "the states have no future, except as administrative agents of a central government". For while taxation without representation is wicked, nothing is more corrosive of good government than the ability to spend without taxing, as decades of subsequent experience with foreign aid show. Black faces aren't required for Third World fiscal structures to give rise to Third World governance. And sooner or later, he who pays the

piper calls the tune.

That moment came in 1973, when Gough Whitlam told the premiers that "from now on, we will expect to be involved in the planning of the functions in which we are financially involved". From there, it was only a short step to today's COAG, in which the commonwealth treats the states as mere nuisances in its dreams of central planning.

True, the Rudd government prides itself on having reduced the number of Special Purpose Payments, which bind the states' uses of funds. But it has merely replaced them with some 80 National Partnership agreements, which are no less coercive, have been rushed in design, lack transparency and impose layer upon layer of requirements.

This is as inefficient as it is ineffective: and not merely because COAG has fallen far short of the Rudd government's vaulting ambitions. Some problems require national solutions.But it is absurd for Canberra -- 12 suburbs in search of a city -- to determine master plans for those who live in Sydney, Melbourne or Perth and who will have to bear those plans' consequences. The same applies for education, hospitals and public transport.

Unambiguously giving those functions back to the states will not result in the neat uniformity the bureaucrats and the Business Council seem to want. Rather, it will lead to diversity and even messy competition. Well, three
cheers for that. It is thanks to that messiness that genuinely federal structures perform better than unitary states in economic growth and political legitimacy.

Those benefits will, however, prove elusive unless fiscal imbalance is addressed. States will not be responsible spenders if they do not have to raise the taxes needed to pay for expenditure, especially when they are deciding whether to expand or contract particular areas of spending. The solution? Return taxing powers and responsibilities to the states, while reducing the Commonwealth tax take. There are many ways to do this, none easy. But at least it is feasible. Running the continent from Canberra is not.

It is therefore time to tackle the unfinished business of federation. Not out of atavistic respect for the founders, nor from a misplaced belief in "state's rights". But because we face a choice between responsible federalism, based on fiscal decentralisation, and an ersatz federalism that is inherently irresponsible, ineffective and inefficient. Until that is resolved, we will continue to have the states we deserve.