The federal government must stop holding the states to ransom and match service delivery responsibility with funding, a major think tank says.
Launching a new Committee for Economic Development of Australia (CEDA) report into federalism, chief executive Stephen Martin said the federation has largely worked well, delivering political stability and economic prosperity for over a century.
"(But) it can do better," Prof Martin says.
"Reforms need to focus on making government funding more citizen-focused and able to deliver the services and infrastructure Australians need."
Nick Greiner, former NSW premier and contributor to the CEDA report, was more critical, describing the current state of federalism as "dysfunctional".
"It is a shambles in a sense that everyone is doing everything," Mr Greiner told ABC radio on Monday.
"The public doesn't know where to look and the politicians blame each other."
Prime Minister Tony Abbott has laid out a rough timetable for a federalism review, with a green paper produced in the second half of 2015 and a white paper in the run-up to the 2016 election.
The white paper coincides with a similar review of the taxation system, renewing speculation it will result in changes to GST given it is a key sources of funding for the states.
But Mr Greiner said the argument about how much tax you raise and who raises it obviously depends on what you want to spend it on.
"Start with federalism and then go to tax, rather than starting with tax without knowing what you want to fund," he said.
The CEDA report recommends the creation of a Federation Reform Council to monitor and evaluate the effectiveness of reforms and to make sure there are no unintended consequences.
It also believes there should be a series of Federation Conventions to be held in conjunction with the white paper process to encourage the participation of as many people as possible.
The CEDA considers a range of options to align revenue and expenditure requirements including:
* Assigning a fixed portion of income tax to states for school funding.
* Allowing state governments to develop a comprehensive land tax or property charge with funds raised to be used specifically for public transport.
* Let state governments extend road-use charging and receive the fuel taxes collected by the commonwealth to build and maintain roads.
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