The Impact of the CHST on Interprovincial Redistribution in Canada

Transcription

1 The Impact of the CHST on Interprovincial Redistribution in Canada The Impact of the CHST on Interprovincial Redistribution in Canada 49 TRACY R. SNODDON Department of Economics Wilfrid Laurier University Waterloo, Ontario En 1996, les transferts effectués sous le Financement des programmes établis (FPE) et le Régime d assistance publique du Canada (RAPC) ont été remplacés par le Transfert canadien en matière de santé et de programmes sociaux (TCSPS). Cet article analyse l impact du TCSPS sur la redistribution nette des revenus entre les provinces lors des premières années de sa mise en application. Les résultats démontrent que le TCSPS modifie les tendances récentes dans la redistribution nette mais que les effets sont modestes lorsqu on les compare à ceux des mesures antérieures comme le gèle des droits per capita du FPE et le plafond du RAPC, imposés en La décision récente du gouvernement fédéral d augmenter le plancher du TCSPS réduit d avantage l effet du TCSPS sur la redistribution par rapport au statu quo tout comme le fait la décision d ajuster l allocation du TCSPS graduellement (plutôt qu immédiatement) en vue d obtenir des parts per capita égales. Finalement, la distinction entre les transferts monétaires et les droits est importante lorsque l on mesure la redistribution nette des transferts fédéraux vers les provinces. In 1996, transfers made under Established Programs Financing and the Canada Assistance Plan were replaced with the Canada Health and Social Transfer (CHST). This paper examines the impact of the CHST on the net redistribution of revenues across provinces in its first few years of operation. The results show that, while the CHST alters recent trends in net redistribution, the effects are modest when compared to the impacts of earlier measures such as the freeze in per capita EPF entitlements and the cap on CAP, imposed in The federal government s recent decision to raise the CHST cash floor further reduces the CHST s effect on redistribution relative to the status quo as does the decision to adjust the allocation of the CHST slowly (rather than immediately) in the direction of equal per capita shares. Finally, the distinction between cash transfers and entitlements is important when measuring net redistribution from federal transfers to provinces. INTRODUCTION Prior to 1996, the federal government transferred revenues to provinces under three major programs: equalization, Established Programs Financing (EPF), and the Canada Assistance Plan (CAP). These fiscal arrangements involved not only a substantial amount of revenue sharing from the federal government to the provinces but a significant amount of redistribution across provinces. In 1995, following 15 controversial years of federal government cuts, freezes, and caps in transfers to provinces,

2 50 Tracy R. Snoddon Ottawa replaced EPF and CAP with the Canada Health and Social Transfer (CHST) effective The CHST affects the allocation of revenue across provinces and the overall scale of transfers. To what extent is the redistribution of revenues across provinces affected by the switch to this new transfer? To address this question, this paper documents recent trends in interprovincial sharing from federal transfers to provinces and estimates the impact of the CHST on interprovincial sharing in its first few years of operation. Interprovincial sharing is measured using net redistribution, a particularly useful measure since it includes not only transfers received by provinces but also takes into account a province s indirect contribution to financing transfers through federal government revenues collected in that province. 1 If a province receives a share of total transfers equal to the proportion of federal government tax revenue raised in that province, then transfers involve revenue sharing and do not redistribute revenues across provinces. When transfer shares do not correspond to the proportion of federal revenue raised in a province, net redistribution is positive or negative and transfers permit some revenue sharing but are also redistributive. The paper begins with a brief description of EPF, CAP, equalization, and the CHST. While a number of excellent descriptions of Canada s fiscal arrangements are available elsewhere, a basic understanding of these transfers and recent changes to them is necessary to understand recent trends in net redistribution and the implications of the new CHST for interprovincial redistribution in Canada. 2 Following a summary of the data and methodology, net redistribution from federal transfers to provinces is calculated for the period to For comparison, net redistribution under alternative scenarios such as a continuation of the old system of transfers or an equal per capita allocation rule for the CHST are also considered. Given the importance attached to cash transfers rather than transfer entitlements, net redistribution is calculated on both an entitlements and a cash basis to determine whether the distinction is important in the context of interprovincial sharing. The results demonstrate that while the replacement of EPF and CAP with the CHST affects the extent of net redistribution from cash transfers, this effect is modest when compared to the impact of other changes to transfers. In particular, the effects on net redistribution of the freeze in per capita EPF entitlements and the selective cap on CAP transfers in 1990 are much bigger than the effects of the switch to the CHST. Relative to a continuation of the old system of EPF and CAP, the level of interprovincial sharing is lower under the CHST. The recently announced increase in the CHST cash floor from $11 billion to $12.5 billion to take effect in , however, reduces the CHST s negative impact on net redistribution. Sensitivity analysis shows that a CHST with an equal per capita allocation formula (in contrast to the gradual adjustment of CHST shares in this direction) has a predictably larger effect on net redistribution. Finally, net redistribution is sensitive to whether transfers are measured on a cash or entitlements basis. In per capita terms, the difference is small but increases over time. Thus, the distinction between entitlements and cash is important for discussions of interprovincial sharing, especially when forecasting net redistribution in the future. EPF, CAP AND EQUALIZATION Established Programs Financing Prior to 1977, the federal government transferred a significant amount of revenue in the form of conditional, cost-sharing grants to the provinces to help fund postsecondary education and health care. The open-ended nature of these transfers as well as the deterministic link between provincial spending decisions and federal expenditures under this program prompted Ottawa to shift to a block grant system in The new EPF grant consisted of two independent components: a cash payment and a tax transfer. 3

3 The Impact of the CHST on Interprovincial Redistribution in Canada 51 The per capita cash transfer for was based on half the national average per capita transfers made for postsecondary education and health in Each province received an equal per capita cash transfer under EPF which, from this point forward, escalated based on the rate of growth in GNP per capita. The second component involved a transfer of 13.5 personal income tax (PIT) points and one corporate income tax point from the federal to provincial governments. Since the revenue-generating potential associated with the transferred tax points differed across provinces, the tax transfer was equalized under the equalization program. All provinces with below average revenue-generating potential received the same equalized tax point transfer while the value of the tax transfer for provinces with above average revenue-generating potential was higher and varied across these provinces. Quebec received some of its EPF cash as an additional unequalized tax abatement of 8.5 PIT points. In , for example, this abatement equalled $1.2 billion. While Quebec received the same per capita cash transfer as all other provinces on paper, its actual cash payment was lower by the amount of the province s special tax abatement. Historically, this abatement has been treated as cash rather than a tax transfer by both Quebec and Ottawa. In 1982, several changes were made to EPF, the main effect of which was to link the tax and cash components. Under the new scheme, a province s EPF cash transfer was calculated as the difference between its entitlement and the value of the tax transfer including associated equalization. While generated by the tax transfer, associated equalization is paid out as part of the province s equalization transfers and, to avoid double counting, must be deducted from the EPF entitlement when determining the cash transfer. Per capita EPF entitlements (as opposed to cash) were to grow based on the rate of growth in GDP. With these changes, the federal government treated the tax point transfer as if it was, in effect, transferred anew each year. Much of the provincial discontent over fiscal arrangements has been rooted in these changes. For example, the federal government s decision to freeze the per capita EPF entitlement from 1991 to 1996 implied an eventual decline in cash transfers. This outcome sharply contrasted with the original 1977 arrangement of annual growth in EPF cash. For Quebec, the issue of declining cash is more pressing because of its special tax abatement in lieu of cash. In , EPF entitlements equalled approximately $21.8 billion of which $805 million took the form of associated equalization. 4 EPF cash transfers equalled $10.6 billion in EPF entitlements and associated equalization are provided for selected years in Tables A.1 and A.2 of the Appendix. 5 A chronological summary of the federal measures pertaining to EPF since is also given in the Appendix in Table A.3. In the 1995 federal budget, EPF was discontinued and replaced with the CHST. Canada Assistance Plan (CAP) Under CAP, the federal government transferred revenues on a cost-sharing basis to provide financial support to provinces and territories for social assistance and welfare. Until recently, the federal government was responsible for 50 percent of the costs of eligible provincial expenditures and CAP transfers took the form of open-ended, matching grants equally available to all provinces. While administration of CAP-eligible programs was the exclusive domain of the provinces, the objectives of CAP were to provide assistance to needy individuals and to address poverty. In 1990 the federal government imposed a limit of 5 percent growth in CAP payments to Alberta, Ontario, and British Columbia, often referred to as the have provinces. The cap was extended until and, in , CAP transfers to all provinces were frozen at levels. Both Ontario and British Columbia hit the limit in all years the cap was in place while, in Alberta, the cap was binding only in the early years owing to the reductions in welfare spending undertaken by the Klein government during the early 1990s.

4 52 Tracy R. Snoddon Total CAP entitlements for all provinces equalled $7.8 billion in Owing to the cost-sharing nature of this program, per capita CAP transfers varied across provinces. With the exception of Quebec, each province received the full value of their entitlement as a cash transfer. Quebec received an additional tax abatement of 5 PIT points in lieu of cash which, in , reduced its $2.7 billion CAP entitlement by $700 million. As of , CAP was discontinued and replaced with the CHST. Equalization Canada s equalization program, introduced in 1957, is designed to unconditionally transfer revenues to provinces with low revenue-generating capacity and is the only transfer where interprovincial redistribution is an explicit goal. Section 36 (2) of the Constitution Act 1982 commits the federal government to the principle of equalization and to ensuring that provincial governments can provide reasonably comparable levels of public services at reasonably comparable levels of taxation. Entitlements are determined by an explicitly legislated formula, usually in place for five-year intervals, based on the average revenue-generating potential in Ontario, Quebec, Saskatchewan, Manitoba, and British Columbia. The only provinces that do not receive equalization are Alberta, British Columbia, and Ontario. A ceiling on the rate of growth in total equalization protects the federal government against dramatic increases in equalization and floor provisions protect provinces to varying degrees for year over year reductions in entitlements. 7 Current funding arrangements for equalization are in effect from to Total equalization amounted to $8.6 billion in THE CHST In , the federal government eliminated EPF and CAP transfers and introduced the CHST, arguing that block funding offers provinces more flexibility in the provision of social assistance and, at the same time, provides greater predictability and financial sustainability of transfers. Like EPF, the CHST consists of both a cash and a tax transfer. Thus, the estimated value of the tax transfer made in 1977 is included as part of the CHST entitlement and cash is again determined residually. Associated equalization resulting from the tax point transfer continues to be paid as part of a province s equalization entitlement. With the CHST, both the scale and the allocation of transfers across provinces are different as compared to the case for EPF and CAP combined. Total CHST entitlements are set at $26.9 billion and $25.1 billion for and respectively. The legislated, five-year CHST funding arrangement for the period to freezes total entitlements at $25.1 billion until the year 2000 after which the aggregate entitlement increases by a GDP-based escalator. Two additional features of the CHST are important to note. Unlike its predecessor, the CHST includes a cash floor of $12.5 billion below which total cash transfers to provinces cannot fall. 9 For , each province receives a CHST share equal to its combined share of EPF and CAP in From and onwards, however, the allocation formula adjusts annually in the direction of equal per capita entitlements to reflect population growth and migration among provinces with the goal of reducing existing funding disparities in per capita entitlements by half by the fiscal year METHODOLOGY AND DATA The major transfer programs are most often discussed on an individual basis and in absolute or per capita dollar terms or as a percentage of the national average. To understand interprovincial redistribution from transfers, however, an aggregate measure is appropriate. This paper uses the concept of net redistribution developed in Reid and Snoddon (1992) to measure interprovincial sharing where net redistribution for a province is defined as total transfers

5 The Impact of the CHST on Interprovincial Redistribution in Canada 53 received net of the province s contribution to the financing of transfer costs, summed over all major transfers. 11 Transfer costs are assumed to equal the transfers made in total to all provinces, and so issues of deficits, administration costs, and the welfare costs of taxation are ignored. Provinces are assumed to share in the costs of transfers in proportion to the share of federal government revenue generated in that province. For example, Ontario s contribution to the financing of transfers or cost share in year t is calculated as the federal government s revenue from Ontario in that year divided by the federal government s total revenue for year t. To illustrate, consider Ontario s net redistributive gain for Ontario receives $10.7 billion from EPF and CAP transfers (Ontario does not receive equalization). Ontario s cost share in is indicating that roughly 42 percent of the $37.3 billion in transfers are financed by federal government revenue collected in Ontario. Therefore, net redistribution for Ontario is: Net gain = $10.7 billion ($37.3 billion x ) = $5.092 billion This represents a net per capita contribution to other provinces of $459. Note that net redistribution for a given province can be positive or negative. In this example, net redistribution is calculated using entitlements rather than cash payments. Entitlement refers to the total value of the transfer as calculated by the Department of Finance. For equalization and CAP transfers there is no distinction between entitlements and cash transfers. 12 For EPF and the CHST, entitlements are distinct from cash transfers since a portion of these entitlements are paid out as a tax point transfer. Net redistribution can also be calculated using cash transfers. For province i, the difference in net redistribution from entitlements, NR i, and from cash, NR i E, is: C NR i E NR i C = NR i X = ä å TAXi ã TAX TAX T ë ì i cost share H TAX T T í = ( TAX share i cost share i ) H TAX T where TAX i and TAX T represent province i s tax point transfer and the aggregate tax transfer respectively, NR i is province i s net gain from the tax X transfer, and TAX share i and cost share i are province i s share of the tax transfer and of transfer costs respectively. NR i NR i measures a province s net E C gain from the tax transfer and is positive if a province s share of the aggregate tax transfer exceeds its cost share. In Ontario, for example, the net per capita contribution is $459 when measured on an entitlements basis as compared to $464 when measured on a cash basis, indicating that Ontario is a net gainer from the tax transfer. There is a good deal of debate on the issue of declining cash transfers and whether transfers to provinces should be measured using entitlements or cash. The main argument in favour of using entitlements and including the tax transfer is that entitlements represent forgone tax revenues (actual and potential) by the federal government. Those who focus on cash transfers argue that the inclusion of tax transfers is confusing and, since no cash is exchanged, an entitlements measure overstates the federal government s contributions to provincial coffers. If a province s cost share is close to its tax transfer share, then the distinction between cash and entitlements is of little importance, at least with respect to the concept of net redistribution. The results presented below, however, indicate that this is probably not the case. Data on cash transfers, entitlements, and population, as well as projections for equalization, associated equalization, CHST transfers and population were supplied by the Department of Finance. Prior to , provincial cost shares can be calculated using data on federal government revenue by

6 54 Tracy R. Snoddon province from the Provincial Economic Accounts and from CANSIM. Beyond , however, the necessary data to calculate these shares are unavailable. Provincial cost shares for to are approximated using existing trends in federal government revenue by province, projections for growth in provincial tax transfers, and the historical relationship between a province s tax and cost shares. Appendix Table A.7 shows provincial cost shares for selected years. Two caveats are noted. As both Quebec and the federal government treat Quebec s special abatements under EPF and CAP, and under the CHST, as cash, this is the approach adopted in this paper. Finally, since the Yukon and the Northwest Territories are excluded from the analysis and aggregate CHST entitlements include transfers to these territories, entitlements for these territories are netted out of the net redistribution calculations. NET REDISTRIBUTION FROM FEDERAL TRANSFERS TO PROVINCES, TO Each province s net redistributive gain, calculated on both an entitlements and cash basis, is summarized in Table 1 for selected years over the period to On an entitlements basis, Quebec receives the largest net gain and the largest contribution comes from Ontario in every year considered. Table 1 also shows that federal-provincial transfers generate significant positive net gains for all provinces except Ontario, Alberta, and British Columbia, or the have provinces. A similar pattern of interprovincial sharing emerges when net redistribution is calculated using cash transfers. In Table 2, net redistribution from entitlements and cash transfers is shown in per capita terms. Newfoundland receives the largest per person gain while TABLE 1 Net Redistribution from Total Entitlements (Cash) Nfld. PEI NS NB Que. Ont. Man. Sask. Alta. BC (883) (169) (608) (732) (2639) (-4910) (664) (288) (-678) (-395) (990) (198) (817) (851) (2990) (-5500) (849) (482) (-826) (-851) (1020) (175) (922) (791) (3646) (-5143) (932) (276) (-1310) (-1311) (1014) (174) (922) (805) (3403) (-4903) (928) (269) (-1310) (-1301) (1008) (181) (968) (833) (3311) (-4886) (968) (231) (-1293) (-1321) Note: All numbers are in millions of dollars. Source: Author s calculations based on data provided by the Department of Finance.

7 The Impact of the CHST on Interprovincial Redistribution in Canada 55 TABLE 2 Net Per Capita Redistribution from Total Entitlements (Cash) Nfld. PEI NS NB Que. Ont. Man. Sask. Alta. BC (1555) (1330) (692) (1028) (400) (-530) (616) (283) (-285) (-135) (1748) (1534) (915) (1182) (441) (-561) (783) (468) (-332) (-269) (1771) (1289) (984) (1042) (497) (-464) (820) (272) (-477) (-349) (1777) (1271) (979) (1055) (461) (-436) (812) (263) (-470) (-338) (1766) (1301) (1018) (1087) (442) (-422) (845) (220) (-444) (-333) Note: All numbers are in dollars. Source: Author s calculations based on data provided by the Department of Finance. Saskatchewan traditionally receives the smallest net per capita gain from both entitlements and cash transfers. The per capita contributions in the have provinces range between $350 to $477 for From Tables 1 and 2, it is clear that interprovincial sharing as measured by net redistribution differs depending on whether cash transfers or entitlements are used. For example, the difference in Ontario s net contribution from entitlements and from cash in is $63 million or $6 per person. While the difference for any one province is generally not greater than ± $90 per capita for the entire period, the discrepancy is growing over time for most provinces. If not for this evidence, the distinction between entitlements and cash would be unimportant at least in a discussion of interprovincial sharing. The argument in favour of including the tax point transfer to reflect cash foregone by the federal government is not very compelling. This argument hinges on the belief that EPF entitlements are paid out by the federal government entirely as cash in the absence of a tax transfer. Recent experience suggest this is unlikely. Even with tax transfers, the federal government has, by reducing the EPF escalator and eventually freezing per capita EPF entitlements, reduced its EPF cash obligations. The pressures to reduce cash obligations are likely to be even greater if EPF entitlements are paid out entirely as cash. One additional argument can be made in favour of cash transfers. Forecasts of net redistribution in the future are based on projections for population growth and the growth in the value of the tax point transfer in each province. For a given value of the aggregate tax transfer under the CHST, predictions

8 56 Tracy R. Snoddon for provinces net redistributive gains from entitlements are not sensitive to projections for how this tax transfer is shared across provinces. Estimates of net redistribution from cash are, however, sensitive to differential growth rates across provinces that affect their share of a given aggregate tax transfer. For these reasons, and given the evidence on the growing disparity between net redistribution from entitlements and from cash, this paper focuses on net redistribution from cash transfers. Figure 1 shows the trends in net per capita redistribution for the Atlantic provinces, Quebec, Manitoba, and Saskatchewan, the have-not provinces. The net per capita gain in Quebec and Saskatchewan, declining since the mid 1990s, continues to do so at least in the first few years the CHST is in place. For Manitoba, Nova Scotia, and New Brunswick, the modest growth in the net per capita gain in recent years continues under the CHST. There has been little change in the net per gain from cash transfers for Prince Edward Island and Newfoundland since even with the introduction of the CHST. Figure 2 shows the trends in net per capita redistribution for the have provinces. For Alberta and British Columbia, the switch to the CHST clearly reduces the net per capita contribution reversing the historical trend of increasing, and then relatively constant, net per capita contributions. The decline in Ontario s net per capita contribution in recent years also continues under the new CHST. FIGURE 1 Net Per Capita Redistribution from Cash Transfers, Have-Not Provinces

9 The Impact of the CHST on Interprovincial Redistribution in Canada 57 FIGURE 2 Net Per Capita Redistribution from Cash Transfers, Have Provinces These figures show that the most dramatic changes in net per capita redistribution over the period do not coincide with the introduction of the CHST but occur in The freeze in per capita EPF entitlements in 1990 combined with the growth in the value of tax transfers cause EPF cash and the net per capita gain to fall in the following one to two years for most have-not provinces. The freeze and the cap on growth in CAP transfers in 1990 both contribute to an increase in the net per capita loss in Alberta and British Columbia. During the same period, Ontario s net per capita contribution declines largely as a result of a reduction in its cost share during the recession. Alberta s net per capita contribution increases from to more quickly than British Columbia s and at the same time that Ontario s net per capita contribution is falling. This increase in net per capita contribution corresponds to Alberta s significant cuts to welfare spending and the subsequent reduction in the province s CAP transfer. A number of factors influence the level and pattern of net redistribution. The cap on CAP, the freeze in EPF, the recession, the introduction of the CHST, and Alberta s welfare reform clearly affect net per capita redistribution across provinces. The single most important determinant of net redistribution at any time is, however, equalization. Table 3 shows the net per capita redistribution by transfer for , , and Equalization accounts for over 75 percent of the net per capita

10 58 Tracy R. Snoddon TABLE 3 Net Per Capita Redistribution by Transfer Nfld. PEI NS NB Que. Ont. Man. Sask. Alta. BC EPF Cash CAP Equalization Total EPF Cash CAP Equalization Total CHST Cash Equalization Total All numbers are in dollars. Source: Author s calculations based on data provided by the Department of Finance. gain in the Atlantic provinces and Manitoba and a somewhat smaller percentage in Quebec and Saskatchewan. Equalization also accounts for the largest percentage contribution from the three have provinces. By , the relative importance of equalization to a province s net per capita gain or loss increases for all provinces except Alberta and British Columbia. That equalization dominates the level of interprovincial sharing in Canada is not surprising since, unlike other federal transfers to provinces, the explicit intention of this program is redistribution. With the reduction in the scale of transfers under the CHST relative to EPF and CAP, it is also not surprising that equalization accounts for an even larger share of net redistribution in the future. NET REDISTRIBUTION: THE CHST VERSUS THE STATUS QUO The replacement of EPF and CAP transfers with the CHST has two distinct effects: a reduction in the scale of transfers (a scale effect) and an adjustment in the share of transfers across provinces (a share effect). The scale effect reduces the extent of net redistribution across provinces if aggregate transfers are lower under the CHST. The share effect also reduces the extent of redistribution since the adjustments in provincial shares of transfers favour the more populous and wealthier provinces, Ontario, British Columbia, and Alberta. To fully assess the impact of the CHST on redistribution, net redistri-

11 The Impact of the CHST on Interprovincial Redistribution in Canada 59 TABLE 4 Total Entitlements, Tax Point Transfers and Cash Under the CHST and the Status Quo Entitlements Tax Point Transfer Cash CHST and EPF and CAP in Revenue-Neutral Status Quo Status Quo EPF and CAP a a No estimate is provided in the 1995 Budget. EPF + CAP are estimated to be 1 percent higher than level. Note: All numbers are in billions of dollars. bution under a continuation of the old system of transfers, or the status quo, is calculated and compared to net redistribution given the CHST. To estimate net redistribution in the status quo, the level of and an allocation for EPF/CAP transfers must be determined for , , and The 1995 Budget Plan estimates of the aggregate level of EPF/CAP entitlements under a continuation of the status quo are summarized in Table 4. Since in both aggregate EPF/CAP entitlements and provincial entitlement shares were frozen at levels, it is not unreasonable to assume shares remain relatively constant over the next few years. Provinces are, therefore, assumed to maintain their shares of EPF/CAP entitlements for the next three years. Province i s EPF/ CAP entitlement in the status quo, EPF/CAP i, is E calculated as the province s share of EPF and CAP combined in multiplied by the aggregate entitlement for EPF and CAP, EPF/CAP T, or, EPF/ CAP i = ( EPF/ CAP share i ) H EPF/ CAPT E 95/ 96 E The cash transfer is determined by subtracting the estimated value of the province s tax transfer from EPF/CAP i. Equalization transfers are, of course, E independent of the EPF/CAP or CHST variant in place. E A comparison of net per capita redistribution given the CHST versus the status quo captures both the CHST s scale and share effects. To separate these effects, net redistribution under a revenue-neutral status quo is estimated. This scenario measures the effects on net redistribution if EPF and CAP are continued but aggregate entitlements are scaled back to the level of entitlements projected for the CHST and provincial shares are assumed to equal the combined shares of EPF and CAP in As suggested in Boessenkool (1996), the announced totals for the CHST may provide an indication of the amount the federal government is willing to transfer under any EPF/CAP variant. The revenue-neutral case thus captures the impact of adjusting provincial CHST shares in the direction of equal per capita transfers. Province i s EPF/CAP entitlement in the revenue-neutral status quo is: ( EPF/ CAP i E ) RNSQ = ( EPF/ CAP share i 95 / 96 ) H CHSTT E where CHST T represents the aggregate CHST entitlement. Province i s cash transfer is then found by E subtracting the value of the CHST tax transfer estimated for that province from its EPF/CAP entitlement in the revenue-neutral case. The net redistribution calculations for cash transfers given the status quo, the revenue-neutral status quo, and the

12 60 Tracy R. Snoddon CHST are summarized in Table 5. Since equalization is the same in all three cases, differences in net per capita redistribution reflect differences in nonequalization transfers. A comparison of net redistribution under the CHST with the revenue-neutral case measures the share effect of the CHST. The scale effect from the CHST is seen by comparing net redistribution under the revenue-neutral status quo and the status quo. Net per capita redistribution under these alternatives for all provinces are illustrated in Figures 3 to 8. These figures show that, while the extent of redistribution is lower under the revenue-neutral case as compared to the status quo, the revenue-neutral case involves a greater degree of sharing than predicted for the CHST. Notice that net per capita redistribution in under the CHST and the revenue-neutral case are identical. This is to be expected since aggregate transfers and provincial shares are the same in both cases. From this point forward, provincial CHST shares are adjusted to reflect population growth and migration and so differ from the shares in the revenue-neutral status quo. Both the reduction in the scale of transfers and the change in the allocation of transfers across provinces work to reduce net per capita gains (and losses) from cash transfers although, for Saskatchewan and Prince Edward Island, the share effect is quite small. 14 A comparison of net per capita redistribution between the CHST and the status quo indicates that TABLE 5 Net Per Capita Redistribution: Alternative Scenarios Cash Transfers Scenario Nfld. PEI NS NB Que. Ont. Man. Sask. Alta. BC With CHST Status Quo Revenue-Neutral Status Quo Equal Per Capita CHST Note: All numbers are in dollars. Source: Author s calculations based on data provided by the Department of Finance.

13 The Impact of the CHST on Interprovincial Redistribution in Canada 61 FIGURE 3 Net Per Capita Redistribution, Newfoundland and Prince Edward Island FIGURE 4 Net Per Capita Redistribution, New Brunswick and Nova Scotia

14 62 Tracy R. Snoddon FIGURE 5 Net Per Capita Redistribution, Manitoba and Saskatchewan FIGURE 6 Net Per Capita Redistribution, Alberta and British Columbia

15 The Impact of the CHST on Interprovincial Redistribution in Canada 63 FIGURE 7 Net Per Capita Redistribution, Ontario FIGURE 8 Net Per Capita Redistribution, Quebec

16 64 Tracy R. Snoddon not all provinces are affected equally. For example, in , the net per capita gain for Saskatchewan and Quebec is estimated to be 17.1 percent and 13.9 percent higher respectively in the status quo relative to the CHST. Ontario s net per capita contribution is 8.4 percent higher under the status quo and, in Alberta and British Columbia, the net per capita contribution in the status quo is estimated to be 13.2 percent and 10 percent higher as compared to net per capita contributions when the CHST is introduced. In comparison, the impact on net per capita redistribution for Prince Edward Island, Nova Scotia, and New Brunswick are much smaller. For these provinces, net per capita redistribution would have been 2 percent to 3.6 percent higher under the status quo. NET REDISTRIBUTION: CHANGING THE CHST CASH FLOOR Only one year after the CHST was introduced, the federal government increased the cash floor from $11 billion to $12.5 billion, effective for the transfers. Based on Department of Finance projections for the value of the tax point transfers, CHST cash is estimated to fall below $12.5 billion in With an $11 billion cash floor, the net per capita loss from transfers in Ontario, Alberta, and British Columbia and the net per capita gain in all other provinces are smaller relative to net redistribution in with the $12.5 billion floor. Thus, the move by the federal government to raise the cash floor further mitigates against the adverse effects on net redistribution brought about by the switch to the CHST. SENSITIVITY ANALYSIS The results are sensitive to the provincial cost share estimates for to A reasonable alternative is to assume cost shares return to shares based on some historical average or to shares. Under both alternatives, net per capita redistribution is more favourable for most provinces except Ontario and Quebec. Boessenkool (1996) explores the impact on alternative growth scenarios on CHST cash transfers to provinces. Since differential rates of growth in tax bases and tax transfers across provinces can affect net redistribution, net redistribution is recalculated assuming the rate of growth in the value of the tax transfer for each of the have provinces is one percentage point higher than projected by the Department of Finance. In this case, all have-not provinces receive higher net per capita gains and each have province makes higher net per capita contributions. It is interesting to note that if net redistribution is calculated using entitlements, a different allocation of the same aggregate value of the tax transfer across provinces would not alter the predictions of the net redistributive gain or loss for any province. Before the CHST was revealed, much discussion centred around provincial shares of any transfer meant to replace EPF and CAP. Under the CHST, provincial shares gradually adjust over time in the direction of equal per capita CHST entitlements to reduce funding disparities. What is the impact on net per capita redistribution if, for example, the CHST is instead introduced with an equal per capita allocation rule in ? The net per capita redistribution given an equal per capita allocation rule for the CHST is shown in Table 5. In this scenario, interprovincial sharing is largely the result of equalization and the financing of equalization from federal government revenue. To the extent that population shares differ somewhat from provincial cost shares, some additional sharing comes about as a result of financing CHST transfers from federal government general revenue. Not surprisingly, the three have provinces do better with equal per capita CHST entitlements as does Saskatchewan. The net per capita gain in all other provinces is lower as compared to the case where CHST shares gradually adjust. In , for example, Quebec suffers the biggest loss from the switch to equal per capita CHST entitlements with its net per capita redistributive gain falling by over 17.5 percent. If

17 The Impact of the CHST on Interprovincial Redistribution in Canada 65 Quebec s special tax abatements are taken into account, the loss is probably greater. Like EPF, the CHST includes both a tax transfer with the cash payment determined residually as the difference between the CHST entitlement and the tax point transfer. In the absence of a cash floor, growth in the value of tax point transfer over time implies an eventual decline in cash transfers under the CHST. A cash floor prevents this cash erosion since, once the $12.5 billion floor becomes binding (as early as ), future growth in the value of the tax transfer leaves cash unaffected. Suppose the federal government considers a separation of the tax point transfers from CHST cash transfers and redefines a $12.5 billion cash entitlement shared on an equal per capita basis as suggested in Courchene (1995). Under this alternative, net redistribution is reduced and Ontario, Alberta, and British Columbia are the clear winners. Another alternative is to convert the equivalent of $12.5 billion in cash into a PIT tax point transfer with provincial shares equal to the proportion of federal government PIT tax collected in each province. In this case, the additional tax transfer is equalized up to the five province standard and the value of the transfer to each province fluctuates based on the growth of provinces PIT tax bases. This option reduces the overall extent of net redistribution in Canada as compared with net redistribution given the existing CHST or given the equal per capita cash option discussed above with provinces like Ontario and British Columbia the clear beneficiaries. CONCLUSIONS This paper examines recent trends in interprovincial sharing from federal transfers to provinces since and estimates the impact on redistribution across provinces of replacing EPF and CAP transfers with the CHST in the next few years. The results show that the CHST s effects on net redistribution are modest and that the federal government s recent move to increase the CHST cash floor further reduces the CHST s impact. The switch to the CHST reduces the amount of net redistribution away from Alberta and British Columbia, reversing the historical trend of increasing, and then relatively constant, net per capita redistribution. Net redistributive gains for Newfoundland and Prince Edward Island fall relative to recent levels with the introduction of the CHST. For the other provinces, however, existing trends are unchanged with the introduction of the CHST. The paper shows that the CHST s impact on net redistribution is greater if introduced with equal per capita entitlements rather than the current allocation formula that adjust shares only very slowly over time in this direction. In recent years, the most significant changes in trends in interprovincial sharing do not coincide with the replacement of EPF and CAP with the CHST. The freeze in per capita EPF entitlements and the cap on CAP transfers for Alberta, Ontario, and British Columbia in 1990 have a much bigger impact on net redistribution across provinces than does the CHST in its first three years of operation. The level of interprovincial sharing is higher under a continuation of the old system of EPF and CAP as compared with net redistribution given the CHST. The results also show that the net redistribution measure of interprovincial sharing is sensitive to whether transfers are measured on a cash or entitlements basis. In per capita terms, the difference is small but has been increasing over time. Thus, the distinction between entitlements and cash is important for discussions of interprovincial sharing, especially when forecasting net redistribution in the future. NOTES The author would like to thank participants at the Canadian Economic Association meetings in June 1996 for helpful comments and Rob Sager for research assistance. Support provided by an internal research grant from the Office of Research, Wilfrid Laurier University is gratefully acknowledged.

18 66 Tracy R. Snoddon 1 This paper deals with intergovernmental transfers. Interpersonal sharing and federal transfers to persons are not addressed. 2 See Courchene (1984, 1994) and Boadway and Hobson (1993). 3 See Courchene (1995) for a detailed description of cash versus tax point transfers. 4 Unless otherwise noted, associated equalization is included under equalization and deducted from total EPF and CHST entitlements to avoid double counting. 5 Full results for all years are available upon request. 6 Provincial CAP entitlements for selected years are shown in Table A.4 in the Appendix. 7 See Courchene (1994) for an easy-to-understand guide to equalization. 8 Appendix Table A.5 shows provincial equalization entitlements for selected years. 9 The CHST was originally introduced with a cash floor of $11 billion. In December 1997, the federal government tabled legislation to raise the cash floor to $12.5 billion effective Canada. Department of Finance (1996), p This methodology has been used elsewhere. For example, see Boadway and Hobson (1993). 12 In practice there is a distinction under CAP for Quebec. However, since Quebec s special abatements under CAP, EPF, and the CHST are treated as cash, this distinction is ignored. 13 Per capita EPF entitlements have been frozen since 1990 and the federal government froze CAP plus EPF transfers in at levels. The continuation of EPF and CAP assumes a continuation of the status quo since ; it does not capture net redistribution had EPF and CAP been unrestrained by the federal government. 14 Similar results are found when net redistribution is measured using entitlements. 15 Even more recent estimates indicate cash transfers for of less that $12.5 billion which explains why the federal government made the new cash floor effective for rather than as originally intended. This paper works with the original estimates for CHST entitlements as given in Tables 4 and A.6. REFERENCES Boadway, R. and P. Hobson (1993), Intergovernmental Fiscal Relations in Canada (Toronto: Canadian Tax Foundation). Boessenkool, K. (1996), The Illusion of Equality: Provincial Distribution of the Canada Health and Social Transfer. C.D. Howe Institute Commentary 80 (Toronto: C.D. Howe Institute). Canada. Department of Finance (1995), Budget Plan. Ottawa. February 27. (1996), Budget Plan. Ottawa. March 6. Courchene, T.J. (1984), Equalization Payments: Past, Present and Future (Toronto: Ontario Economic Council). (1994), Social Canada in the Millennium: Reform Imperatives and Restructuring Principles, The Social Policy Challenge 4 (Toronto: C.D. Howe Institute). (1995), Redistributing Money and Power: A Guide to the Canada Health and Social Transfer (Toronto: C.D. Howe Institute). Hobson, P. and F. St. Hilaire (1994), Reforming Federal- Provincial Fiscal Arrangements: Towards Sustainable Federalism (Montreal: Institute for Research on Public Policy). Reid, B. and T. Snoddon (1992), Redistribution Under Alternative Constitutional Arrangements for Canada, in Alberta and the Economics of Constitutional Change, ed. P. Boothe (Edmonton: Western Centre for Economic Research).

19 The Impact of the CHST on Interprovincial Redistribution in Canada 67 APPENDIX TABLE A.1 Total EPF Entitlements Nfld. PEI NS NB Que. a Ont. Man. Sask. Alta. BC Canada a Includes Quebec s abatement of 8.5 PIT points. Notes: 1. All numbers are in millions of dollars. 2. Includes associated equalization. Source: Department of Finance. TABLE A.2 Associated Equalization Nfld. PEI NS NB Que. Man. Sask. Canada Note: All numbers are in millions of dollars. Source: Department of Finance.

20 68 Tracy R. Snoddon TABLE A.3 Federal Measures Pertaining to EPF Year Federal Measures technical changes made to EPF federal government places a cap on growth of the postsecondary component of EPF equal to 6 percent over level federal government places a cap on growth of the postsecondary component of EPF equal to 5 percent over level in federal government announces EPF escalator will be limited to the rate of growth in GDP - 2 percent (GDP - 2 percent) for subsequent years to escalator limited to GDP - 2 percent in 1989 federal government announces that EPF escalator will be further reduced to GDP - 3 percent in 1990 federal government announces per capita EPF entitlement will be frozen at levels for two years in 1991 federal government announces that the freeze on EPF will continue until to freeze continues EPF escalator reverts to GDP - 3 percent TABLE A.4 Transfers to Provinces Under the Canada Assistance Plan Nfld. PEI NS NB Que. a Ont. Man. Sask. Alta. BC Canada a Includes Quebec s abatement of 5 PIT points. Note: All numbers are in millions of dollars. Source: Department of Finance.

21 The Impact of the CHST on Interprovincial Redistribution in Canada 69 TABLE A.5 Equalization Entitlements Nfld. PEI NS NB Que. Man. Sask. Canada Note: All numbers are in millions of dollars. Source: Department of Finance. TABLE A.6 CHST Entitlements and CHST Cash Nfld. PEI NS NB Que. Ont. Man. Sask. Alta. BC Canada Entitlements Cash Entitlements Cash Entitlements a Cash b Entitlements a Cash b Entitlements a Cash b a Entitlements given binding $12.5 billion cash floor. b Additional cash is added to ensure that the difference between aggregate CHST entitlements and the total tax transfer equals $12.5 billion and is distributed based on province s share of total CHST entitlements in that year. Note: Entitlements include associated equalization, are expressed in millions, and exclude the Yukon and Northwest Territories. Source: Department of Finance.