Reforming Australian federalism has become a clear priority for the Rudd Government. While a more negotiated and consensual style of federalism has the potential to deliver significant dividends, this article argues that intergovernmental relations in Australia will remain prone to conflict as long as the States remain financially dependent on the Commonwealth. Given this premise, the paper examines the extent of the vertical fiscal imbalance (VFI) in the Australian federation and whether the States have access to, and control over, sufficient revenues to deliver the services and infrastructure for which they are constitutionally responsible. The article throws some light on these issues by evaluating whether the post-GST Intergovernmental Agreement (IGA) of 1999 has enhanced the State’s fiscal and budgetary capacity. Having provided an overview of developments in federal financial relations, the second half of the article assesses the implications of a federal takeover of public hospital funding, and concludes in favour of such a takeover.