Perseus,
If the states were removed and the state government powers were
divided between the Commonwealth and the councils in an appropriate way
then your aims would be met.
There would be an increase in shire council activity in minor
infrastructure such as roads, water reticulation, power reticulation,
social services, planning etc etc.
The commonwealth would cover long distance transport such as shipping,
rail, and defence, foreign affairs, law courts, health etc etc.
All the things where we get bombarded with, "Thats the Feds/States responsibility, no ours".

It might mean that some councils would be amalgamated to form larger
regional councils.

Housing Affordability Problem ? Where is your faith? Where is your trust? The Market will take care of everything! People "fleeing" Sydney's Market ? Seems perfectly natural to me! And I detect a Trudge rather than a Flee ...... I live in Brisbane these days, and there is about a State electorate a year coming in from the South. We are having no problem coping with that (apart from water supply... and that is Nature's fault, not Peter Beattie's). In fact that population drift is what is going to "make" Queensland, and it is great for all concerned. More demand for everything from people who are able to pay their way - the Baby Boomers and Sea Changers. As for Sydney and Melbourne .... why would you want to live there anyway ? They seeth with the machinations of the ambitious, tremble with the thrashings of the anxious, and echo with the screams of the downtrodden. Any individual who has not yet achieved a Harbour View lifestyle should cut their losses and head for Dubbo or Broome or even Ross, where the holiday will feel as good as a change ....
Stretching prices on the supply side will only go so far before it twangs back in the faces of the greedy. There has always been an exquisite balance in the housing market in Australia, based on the cold hard fact that it takes two to make a deal. And it is all in the hands of the master deal makers, the estate agents ...... who are addicted to BMWs and Bluetooths. Entering the housing market has never been painless or easy - but it has ALWAYS been worth it. And the New Trend towards the Provinces promises to be the next Discovered Solution ..... for the lucky ones with the sense to surf just in front of the crest.