Victoria, NSW, and every other Australian state have been mugged.

Here's how it happened. The Coalition came to office in 2013 promising to continue to properly fund state hospitals and schools. It left the impression the commitment had no expiry date. Then in its first budget it abandoned funding some state programs (encouraging the states to continue them "at their expense") and announced that from 2017-18 it would lift hospital and school funding only in line with population growth and inflation.

Think about that. Population growth is 1.7 per cent in Victoria and 1.4 per cent in NSW. Inflation is 1.7 per cent. Combined, they are about 3 per cent. But the costs of running hospitals are soaring. In the past decade they've jumped 7.2 per cent a year.

What are the states supposed to do? Not pay those costs? Limit spending growth to population plus inflation, even though the cost of wages and medical technology is growing much faster? Or are they supposed to find more money.

In the days immediately following the budget, then treasurer Joe Hockey seemed to have an answer, or at least a wink and a nod. Asked whether the states should raise more tax, he replied: "Well, that is a matter for them because they do run the schools and hospitals."

He had made his budget better by making theirs worse, and he expected them to do something to make up the difference. Asked specifically whether they should push for an increase in the GST, he replied that that was up to them. "They get all the money from the GST. If they want to change it, they've got to argue for it," he said.

Two of them did just that. Mike Baird in NSW and then Jay Weatherill in South Australia argued for an increase in the GST to continue to properly fund their schools and hospitals.

Then Hockey skipped the country. His replacement changed the script. "If the proposition was that you should increase the GST to give the states a bucket of money to spend more, that has never been a proposition, I'm sure you know, that I or the government have countenanced," Scott Morrison said on Monday.

"We have been very clear about that. If that is what the purpose was, then that has never been something the government has really given any comfort to," he said.

Which leaves the states in an awful hole. The Feds have ripped $80 billion out of their budgets over the next 10 years: $50 billion out of grants for hospitals and $30 billion out of grants for schools. Each year the shortfall will grow, unless the cost of medical technology suddenly plateaus or schools become less ambitious.

The most obvious means of maintaining standards, the so-called states tax, has been pulled out from under them. Victoria's idea of a hike in the Medicare levy won't fly either. The Feds won't permit an increase in the total tax take. Which leaves the states desperate for taxes they can raise all by themselves.

At the moment, they are doing all right. The extraordinary boom in Sydney and Melbourne house prices has earned them a fortune. In the past year prices in both cities have climbed 11 per cent. But in the year ahead the BusinessDay forecasting panel expects only 2 per cent for Sydney and 2.8 per cent for Melbourne. Stamp duty will no longer fill the gap.

The ACT is weaning itself off, phasing out stamp duty over 20 years and phasing in an annual land tax charged as a top-up to municipal rates. When in, it will be able to lift it at will. Land taxes are next to impossible to escape. Home owners can always sell and move interstate (where they will be hit by stamp duty) but they will be replaced by others who will buy.

One of the unusual properties of land taxes is that they actually depress land prices. The higher they are the less likely home buyers will find properties out of reach.

Land taxes are only one of five taxes graphed in the Treasury's tax discussion paper that do no economic damage whatsoever. At the other end of the scale, stamp duties do 80¢ worth of damage for each dollar collected.

The states get it. South Australia is experimenting with a land tax by progressively upping what it calls its "emergency services levy". But a full-blown land tax would have to be phased in. Otherwise someone who had just paid, say $50,000 in stamp duty would find themselves also paying the land tax that was meant to replace it.

The change mightn't phase in quickly enough to get the states the money they will need. Which leaves payroll tax. Removing all of the exemptions would raise the states a fortune. To stop businesses moving interstate to escape it, they would need to band together and act at once. Payroll tax isn't quite as good as the goods and services tax because it falls on only Australian products instead of Australian products plus imports, but it's a lever the states could actually pull.

And death duties. Until the mid-1970s all the states charged them. Applied to only the 0.3 per cent of families with assets of more than $10 million, they could raise billions. The US and Britain charge 40 per cent.

The states have to do something. Their citizens want properly functioning hospitals and schools. They are being forced to do the tax reform the Commonwealth will not.

Peter Martin is economics editor of The Age.

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