With attention focused elsewhere, summer is always a good time for politically important developments to slip under the radar. Two decisions with important implications for federal-state relations have slipped through this summer, and they suggest that the Gillard government could have another fight on its hands.

The first development came in mid-December when Liberal premiers Barry O’Farrell and Ted Baillieu announced that they were forming an Interstate Reform Partnership to bypass the Council of Australian Governments, or COAG, and accelerate reforms in areas such as energy efficiency and skills. Both premiers were careful not to badge their partnership as a rival to COAG, but the move was clearly born out of frustration with both the pace of reform through COAG and the Commonwealth’s control of the process.

The decision by New South Wales and Victoria to go it alone on some economic reforms is hugely significant when we consider that, together, the two states account for 57% of Australia’s population and 54% of its GDP. Their partnership could soon have a new member, too, with the Queensland opposition hinting that it might join up should it win government this year. A grouping of the three most populous states could not help but threaten the cohesion and stability of the COAG process.

The second spanner in the works came last week, in response to a threat by the prime minister that she would revoke $450 million in reward payments to the states and territories if they stalled on introducing agreed productivity reforms. O’Farrell, rather than stay silent, decided to call Julia Gillard’s bluff. He declared that his priority was pursuing reforms in the best interests of New South Wales, even if it meant forgoing $177 million in reward payments from the Commonwealth.

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Both developments are signs of a growing bullishness among the states. After years of complaining about Commonwealth interference in their affairs they are showing a willingness to take the fight up to Canberra. This poses a potential headache for the federal government, and how it responds could affect the health of the federation for years to come.

The fact that we have got to this point shows how much federal-state relations have deteriorated since the heady days of 2008 when Kevin Rudd declared the dawn of a new era of “co-operative federalism”. Rudd’s pledge to “fix the federation” was never feasible but, with Labor premiers in every state, he set in train some genuinely ambitious reforms.

On the policy front, he expanded COAG’s relatively modest reform agenda to include a wide range of areas essential to national prosperity, including education and training, health care, disability, housing, indigenous disadvantage, water and climate change. The slate also encompassed sweeping reforms of business regulation and competition, including commitments to uniform regulation in areas such as trades licensing, electronic conveyancing and workplace safety.

To support this larger agenda, Rudd introduced new funding arrangements. Rather than micromanage the states through prescriptive grants, as it had done in the past, the Commonwealth agreed to give state governments more flexibility as to how they spent federal money. In return, the premiers and chief ministers consented to having their performance in delivering services evaluated by the independent COAG Reform Council. Where they fell behind in certain areas, the Commonwealth would be entitled to penalise them by withholding their “reward payments”.

These reforms were widely praised for striking a balance between flexibility and public accountability. They were also seen as a strong foundation for improving the relationship between Canberra and the states. But looking back from our current vantage point, the high hopes of 2008 seem overblown, if not naive.

For one thing, the push for uniformity in so many policy areas was always overly ambitious. Even if the idea of national regulation is supported in theory, some states — often following a change of government — have baulked at it in practice. The continuing debates about workplace safety laws are a case in point, while New South Wales continues to hold out over the introduction of a national school curriculum. These differences serve as a reminder that one of the features of a federation is policy diversity and that uniform approaches are not always achievable, or desirable.

The 2008 rhetoric of flexibility has also faded as the Commonwealth has reverted to old habits. This is most apparent in its increasing use of national partnership payments, which permit the Commonwealth to place strict conditions on how states deliver on their programs. It is old-style micromanagement in a different guise. At last count there were 53 such agreements, including on subjects as specific as noise insulation in a Sydney high school. And the states complain that the new financial regime imposes crippling reporting burdens, with the Commonwealth asking for more and more information on the progress of reforms, often to the point of fine detail.

The reform process has also been hampered by a general breakdown in trust between the Commonwealth and the states. The main causes of this were the Rudd government’s unilateral approach to its health and hospital reforms (which would have seen the states surrender one-third of their GST revenue to the Commonwealth) and its failure to consult the states over the proposed resource super-profits tax. These developments sapped much of the goodwill that is essential to the COAG process.

*Read the rest of the article at Inside Story