Canadian Fiscal Federalism

Published by the Forum of Federations · www.forumfed.org · Publié par le Forum des fédérations
1
Notes for Presentation by George Anderson
President, The Forum of Federations
Canadian Fiscal Federalism
Buenos Aires, 20 March 2007
A. Context
1. Constitutional:
o Largely distinct federal and provincial powers: few concurrent
o Provinces have big spending areas of health, social policy and
education
o Federal both direct and indirect; provinces only direct
o Provinces own resources
o Federal spending power
o Ten provinces: two very large
o Parliamentary system with "strong governments”: executive
federalism
2. Societal
o Continental scale
o Quebec: linguistically distinct; highly protective of its autonomy
o Ontario: 40% of country
o Eastern four: relatively poor
o West: resource based economy; Alberta energy
o Consequence: truly federal society
Published by the Forum of Federations · www.forumfed.org · Publié par le Forum des fédérations
2
B. Revenue Arrangements
1. Early fiscal history:
o Early Confederation: federal dominant but growing provincial role
o 1930s
o balanced federal and provincial-municipal spending and each
order essentially self financing
o major fiscal disparities between provinces
o "tax jungle”
o Depression
o First federal-provincial tax agreements for federal government
to income taxes for provinces
o Royal Commission leads to constitutional amendments re
unemployment insurance (1940) and old age pensions (1951)
2. War: King government
o "Tax rental agreements”: federal government takes over personal and
corporate income taxes and succession duties and agrees to set
payments to provinces
o By 1945, federal government over 80% of spending and about 80% of
revenues
3. Early Post-war to 1962
o Federal government renegotiates tax rental agreements but Quebec
withdraws: other provinces continue to get share of federal tax
o To avoid double taxation in Quebec, where province must raise rates
to cover loss of tax rental revenues, federal government introduces
"tax abatement” in Quebec : i.e. it vacates tax space equivalent to
what would have been Quebec’s provincial share of transfers
o Federal share of revenues slowly declines to 60% and of expenses to
50% through 50s and 60s
o Equalization program introduced 1957
o "Tax abatement” also used as a mechanism for Quebec retreat from
federally supported programs: but subject to conditions that have
Quebec maintaining largely similar programs
Published by the Forum of Federations · www.forumfed.org · Publié par le Forum des fédérations
3
4. 1962: Tax collection agreements: Diefenbaker government
o Federal government vacates some tax room in favour of provinces
o Federal government collect will collect provincial taxes for free.
Condition: Provincial taxes must be a "tax on tax” on personal
income tax and on federal definition of "taxable income” for
corporate tax. Maintains strong elements of unified tax regime.
o Quebec out; Ontario out of corporate
5. Oil shocks: late 70s early 80s: Trudeau government
o National Energy Program: major federal intervention in oil and gas
sector: export taxes; export controls; "made in Canada price”;
incentives for federal lands
o Western accord: NEP undone; federal government limited to
corporate tax on petroleum
o East coast provinces get access to offshore revenues
6. Tax reform: Mulroney government, late 80s, early 90s
o End of Manufacturing Sales Tax: replaced with Goods and Services
Tax (VAT)
o Four provinces agree to harmonize provincial sales taxes with GST:
big federal incentives
o Federal government lets Quebec collect GST in Quebec
7. Federal tax hikes: Chrétien government
o 1996: part of federal measures to address major deficits
o Most provinces do not follow; some cut taxes, led by Ontario
8. 2000: Tax on income
o New system of tax on income (not tax on tax) provides greater
flexibility for provinces
o Also, protects provinces from impacts of federal measures
o New joint revenue agency for collection of taxes: variable
arrangements with provinces
Published by the Forum of Federations · www.forumfed.org · Publié par le Forum des fédérations
4
o Federal government provides incentives (free collection) for
provinces not to vary from federal tax structure, even if rates and
brackets differ (thus provinces must pay to be different)
9. Era of surpluses: Chrétien and Martin governments
o 1999
o Federal tax rates start coming down
C: Transfer arrangements
1. Areas of federal transfers (2006)
o Health: $25B
o Education and PSE: $15B
o Equalization: $11B
o Small programs for housing, agricultural incomes, official languages,
young offenders: about $2B
2. Equalization
o Introduced in 1957
o Originally "10” province formula of national average fiscal capacity
of all provinces
o Based on "fiscal capacity”, not revenue or need
o 1982: five province standard because of Alberta at 190% fiscal
capacity: excludes richest (Alberta) and poorest (Atlantic) provinces
to calculate standard—effectively a few per cent less than a national
average, but more stable
o 2004: value of program delinked from five province standard in that
there is now a guaranteed floor value with an annual escalator: this
enriches program
o As well, federal government agrees to some special side deals with
particular equalization receiving provinces: Saskatchewan protected
from what should have been a large reduction in 04-05; East Coast
Published by the Forum of Federations · www.forumfed.org · Publié par le Forum des fédérations
5
provinces protected from "clawback” (reduction in equalization
transfers) because of non-renewable resource revenues
o Gives rise to major issue: whether and how to include non-renewable
resource revenues; Ontario increasingly attacks regime because
equalization receiving provinces can end up with higher fiscal
capacity than Ontario
o Longer-term issue: equalization program does not equalize down and
Alberta’s growing fiscal capacity is putting it at a strong advantage to
other provinces: it has low taxes and high spending; potential
distortion effects on real economy
o Program becoming more controversial
3. Social programs
o Variety of health, education and social welfare programs
o 1950-70 all of these programs started as "shared cost” but all moved
to per capita "bloc transfers” for "established programs” over time
o Quebec "opted out” of programs, but did so subject to
conditions that maintained a large measure of comparability in
actual programs (Quebec got "abatements” or additional
transfers)
o Move to bloc transfers permitted greater provincial flexibility in
program design and less federal exposure to cost pressures
o But provinces carry more risk for cost pressures and health a big
driver of government spending
o Move to bloc transfers based on population hit poorer provinces
harder because welfare programs disproportionately expensive
for them
o Health insurance program became a bloc transfer but subject to five
conditions which federal government monitored: occasionally federal
transfers reduced because of lack of respect of these conditions, but
the amounts were typically small; over time, health becomes largest
transfer
o Starting in 1980s federal deficits led to progressive chipping away at
these major transfers
Published by the Forum of Federations · www.forumfed.org · Publié par le Forum des fédérations
6
o 1994 budget: major federal cuts equal one-third of health, education
and social transfers as of 96-97 (also major cuts in federal own
spending)
o Extremely negative reaction from provinces
o Federal government moves quickly from major deficits to period of
large surpluses: begins major federal "reinvestments” in health, with
federal government getting some new program undertakings from
provinces (e.g. re integrated national health information system)
o Federal government also introduces major new program of tax credit
for low income families with children, relieving provinces of some
welfare expenses; soft undertaking by provinces to "reinvest”
savings.
o By 2006, federal health transfers more than make up earlier cuts, but
social assistance transfers and post-secondary transfer still not back to
previous peak levels; issue most acute in post-secondary area where
cost pressures are strong
4. Some observations
o Canadian transfers relatively small compared to total government
spending in most federations and with relatively few conditions
o Macro-fiscal environment has had major impact on transfers story,
with ups and downs reflecting federal fiscal priorities and balances
o All governments at or near surpluses now
o Federal government engages in extensive consultations and shared
technical work with provinces: this sometimes leads to agreed
"deals”, other times to unilateral federal decisions
o Federal-provincial agreements are not legally enforceable
o Transfers system has been through great stress because of various
cuts, cost pressures, and some special deals
o Generally, Canadian system works:
o High level of public services
o Tax system and major social programs reasonably coherent
across country, with large measure of integrated tax collection
o Provinces ample space for experimentation, initiative and
competition
Published by the Forum of Federations · www.forumfed.org · Publié par le Forum des fédérations
7
o Fiscal situation, which was serious, now extremely healthy
o But some aspects of transfer regime have become more
controversial, especially equalization which has been subject to
controversial special deals
This presentation was made the day after the new federal budget in Ottawa. It
does not include any references to measures in that budget. These are available
on the Finance Canada website.