June 20081 Decentralization, Provincial Tax Autonomy and Equalization in Canada
Overview What are the interrelationships/connections between the high degree of tax decentralization and provincial tax autonomy in Canada, on the one hand, and Canada s Equalization program, on the other? Decentralization Tax Autonomy Equalization 2
Three Themes The origins of Canada s Equalization program are closely tied to tax decentralization. The program has helped make decentralization acceptable to provinces with lower fiscal capacities. The degree to which fiscal disparities can be equalized in Canada is limited (constrained) by the high degree of tax decentralization The substantial variation among provincial tax systems in Canada poses significant challenges in terms of fiscal capacity measurement and the determination of equalization payments 3
The Canadian Constitution allows for a high degree of decentralization The Constitution Act gives provinces primary responsibility for (what have turned out to be) some of the most important expenditure areas: social welfare, health care, education, etc. access to, and full discretion over, most major revenue sources: personal and corporate income taxes, sales taxes, estate taxes, natural resource taxes and royalties, property taxes, etc. 4
Share of Total A defining feature of the evolution of the Canadian federation in the postwar period is a gradual by persistent decentralization of fiscal responsibilities 80% Federal and Provincial-Local Shares of Government Expenditure, Excluding Inter-Governmental Transfers 70% 60% 50% 40% 30% 20% 1933 1936 1939 1942 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 Provincial-Local Federal 1996 1999 2002 2005 5
From its beginnings in 1957, the Equalization program has helped to make tax-decentralization acceptable to revenuepoor provinces The Equalization program was launched in 1957 in conjunction with a major tax decentralization for personal and corporate income taxes and inheritance taxes. Without the program, the devolution of tax shares to provinces would not have been acceptable to revenue-poor provinces. As tax decentralization progressed, the Equalization program has continued to play a central role in making decentralization acceptable to provinces with lower fiscal capacities. 6
Percent of Total Tax Decentralization Canada is one of the most tax-decentralized federations in the world. Tax Revenue of State and Local Government Sub-Sectors as Percentage of Total Tax Revenue, 2005 50% 46.8% Local Government 40% 40.7% 8.4% State/Province/Länder Government 34.2% 30% 29.0% 5.0% 29.2% 7.8% 14.1% 15.6% Source: OECD Revenue Statistics, 1965-2006 20% 10% 0% Mexico 17.8% 17.9% 38.4% 3.0% 9.4% 24.0% 25.1% 21.4% 20.1% 3.2% 14.8% 1.1% 8.5% 2.1% Australia Austria Belgium Germany United States Switzerland Canada State/Province/Länder and Local government revenues are shown as a percentage of total tax revenues, including revenues of federal government, social security funds (separate government sub-sector) and supranational governments. 7
Share of Total Own-Source Revenue Provinces and municipalities together raise significantly more revenue than the federal government Federal, Provincial, and Local Government Shares of Own-Source Revenue: 1961 to 2006 70% 60% 50% Federal 46.2% 40% 42.5% 30% 20% 10% 0% 1961 1963 Provincial Local 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 11.2% 8
Percent of State Revenue Tax Autonomy Canadian provinces have the highest degree of tax autonomy among state-level sub-central governments in the OECD federations Tax-Autonomy of State/Province/Länder Governments, 2002 100% 80% 60% 40% 11 86 7 10 83 54 64 90 98 Full discretion on rates and reliefs Rates and reliefs set by central government Tax sharing arrangement Full or partial discretion on rates only 20% 46 36 Other 0% Germany Austria Australia Belgium Switzerland 10 Canada Source: Fiscal Autonomy of Sub- Central Governments, OECD Network on Fiscal Relations Across Levels of Government, 2006. 9
Tax Differences Among Provinces Canadian provinces have access to virtually all tax fields, including some not available to the federal government. Provinces have full discretion over the choice of tax bases and tax rates, although they are able to freely participate in federal-provincial income and sales tax harmonization agreements. The result is a set of provincial tax regimes with some commonalities but which generally differ significantly among one another. 10
Even for income taxes there are growing differences among provinces Traditionally, the greatest degree of commonality has been in the area of personal and corporate income taxes. But even here, there is a trend towards greater differences. New tax collection arrangements with the federal government give provinces the flexibility to choose their own rate structures and their own tax credits for personal income taxes. 11
Personal and corporate income tax regimes differ significantly There are differences in statutory rate structures, overall effective tax rates, and tax reliefs to individuals and firms. Personal Income Tax: 2006 Corporate Income Tax: 2006 Statutory Tax Rates Average Effective Rate NL 10.57% to 18.02% 8.98% PEI 9.80% to 16.70% 7.41% NS 8.79% to 17.50% 8.03% NB 9.68% to 17.84% 7.63% QUE 13.21% to 19.82% 9.61% <-- High ONT 6.05% to 11.16% 7.91% MAN 10.90% to 17.40% 8.25% SASK 11.00% to 15.00% 7.43% ALTA 10.0% 6.59% BC 6.05%-14.70% 5.48% <-- Low Average Effective Rate NL 9.9% PEI 14.0% <-- High NS 10.9% NB 11.8% QUE 7.4% <-- Low ONT 10.9% MAN 9.7% SASK 11.7% ALTA 7.5% BC 7.4% 12
For other taxes, differences are generally more substantial than for income taxes General sales tax systems differ greatly across provinces. There are important differences in payroll taxes, product specific consumptions taxes, and revenues derived from government business enterprises (electricity, alcohol, lotteries, casinos, etc.) For property taxes there is a more or less common base, but rates differ by municipality and property use (residential, commercial, farm, etc.) Resource taxes, which are a very important source of revenue for some provinces, are completely unharmonized. 13
Dollars Pre-Equalization Fiscal Disparities Compared to some other federations, there are large preequalization fiscal disparities among regions in Canada. Per Capita Fiscal Capacity, 2008-09 16,000 14,000 $13,660 12,000 10,000 8,000 $7,176 $7,365 $8,002 $7,481 6,000 $4,909 $5,881 $5,140 $6,196 $5,646 4,000 2,000 NL PE NS NB QC ON MB SK AB BC 14
Disparities in Fiscal Capacity for Natural Resource Revenues Dollars Natural resource are a particularly important source of fiscal disparities in Canada Per Capita Resource Fiscal Capacity, 2008-09 4,500 4,000 $3,868 3,500 3,000 2,500 2,000 $2,070 $2,030 1,500 1,000 Average $692 500 0 $359 $199 $87 $96 $2 $50 NL PE NS NB QC ON MB SK AB BC 15
National Average = 100 Because fiscal disparities are large, there is a high need for equalization. 180 Fiscal Capacity Index 160 Quebec 140 Ontario 120 Alberta 100 80 60 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 Resource-Rich Provinces (AL, SK, BC, NL) Non-Resource-Rich Provinces (ON, QC, MB, PEI, NS, NB) 16
The Canadian Equalization program reduces horizontal disparities only partially Large disparities remain after equalization, notably between Alberta and the other nine provinces. Pre-equalization Post-equalization Alberta British Columbia Saskatchewan Ontario Newfoundland Quebec Nova Scotia Manitoba New Brunswick Prince Edward Island Alberta British Columbia Saskatchewan Ontario Newfoundland Quebec Nova Scotia Manitoba New Brunswick Prince Edward Island -4,000-2,000 0 2,000 4,000 6,000-2,000 0 2,000 4,000 6,000 17
Equalization The principle of equalization is enshrined in the Canadian Constitution: Parliament and the Government of Canada are committed to the principle of making Equalization payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation. (Subsection 36(2) of the Constitution Act) 18
Dollars Per Capita The Equalization Program This graph shows the basic mechanics of the program as it has operated throughout most of its history Equalization: Illustrative Example of Basic Mechanics 14,000 12,000 10,000 8,000 Standard 6,000 Equalization 4,000 2,000 Own-Source Fiscal Capacity 0 PE NB MB NS NL QC SK ON BC AB 19
Increasing decentralization has led to a lowering of the standard The Equalization standard has changed several times throughout the history of the program. Examples: Top-2 province standard in 1957, 10-province standard in 1962, 5-province standard in 1981. With increasing decentralization, the trend has generally been towards a lowering of the standard. Increasing decentralization has resulted in higher fiscal disparities, making it more difficult (costly) for the federal government to equalize to a given standard. 20
Natural resource revenues have played a key role in the history of Equalization Relative Per Capita Fiscal Capacity, 1972-73 to 2007-08 250 Alberta 200 Resource-rich provinces 150 100 Ontario Quebec Resource-poor provinces 50 1972-73 1977-78 1982-83 1987-88 1992-93 1997-98 2002-03 2007-08 21
Equalization payments for 2008-09 total $13.6 billion dollars Equalization Payments ($ millions) 2004-05 2005-06 2006-07 2007-08 2008-09 Newfoundland and Labrador (NL) 762 861 687 477 158 Prince Edward Island (PEI) 277 277 291 294 322 Nova Scotia (NS) 1,313 1,344 1,386 1,465 1,465 New Brunswick (NB) 1,326 1,348 1,451 1,477 1,584 Quebec (QC) 4,155 4,798 5,539 7,160 8,028 Ontario (ON) Manitoba (MB) 1,607 1,601 1,709 1,826 2,063 Saskatchewan (SK) 772 89 13 226 Alberta (AB) British Columbia (BC) 682 590 459 Total 10,894 10,907 11,535 12,925 13,620 22
Fiscal capacities are equalized, but provinces are left free to choose actual levels of taxation and expenditure The Equalization system is only meant to provide provinces with the capacity to provide reasonably comparable levels of services at reasonably comparable tax rates. But provinces are free to choose any actual level of taxation and any actual level of expenditure they want. Given their high degree of tax and expenditure autonomy, provinces in fact make significantly different choices. 23
Provinces choose to impose substantially different tax rates Provincial-Local Fiscal Capacity, Own-Source Revenue, and Tax Effort, 2006-07 Fiscal Capacity Per Capita Own-Source Revenue Per Capita Tax Effort NL $6,250 $6,728 107.6% PE $4,864 $5,162 106.1% NS $5,637 $5,800 102.9% NB $5,152 $5,282 102.5% QC $6,117 $7,079 115.7% ON $7,273 $7,310 100.5% MB $5,519 $5,982 108.4% SK $7,681 $8,863 115.4% AB $12,765 $9,833 77.0% BC $7,121 $7,073 99.3% 24
and to provide significantly different levels of government services. Total Expenditures of Provincial-Local Government Sector, 2006-07 Provincial-Local Government Expenditure ($ Per Capita) Percent of Average NL $11,051 103.7% PE $10,002 93.8% NS $10,564 99.1% NB $10,045 94.2% QC $11,931 111.9% ON $10,107 94.8% MB $10,842 101.7% SK $11,625 109.1% AB $10,751 100.9% BC $9,664 90.7% 25
Other major transfers to provinces and territories also have important equalizing effects Canada Health Transfer $21.3 billion Major Transfers, 2007-08 Canada Social Transfer $9.5 billion Territorial Wait Times Reduction Formula Transfer Equalization Financing $1.2 billion $12.9 billion $2.2 billion 26
The CHT and CST are equalizing because federal taxpayers in richer provinces contribute more to the funding of these transfers Net Redistribution of Revenue Through CST and CHT, 2005-06 ($ million) Gross transfer Origin of federal revenue to fund transfer Net transfer NL 488-341 148 PEI 131-100 31 NS 889-658 230 NB 713-487 227 QC 7,205-5,789 1,416 ON 10,903-12,082-1,179 MB 1,114-814 300 SK 988-765 222 AB 2,166-4,023-1,857 BC 4,037-3,575 462 Total 28,634-28,634 0 27
Equalization and Tax-Autonomy: Measuring Tax Disparities The high degree of tax autonomy of Canadian provinces poses important measurement challenges for equalization. Because of the high degree of tax autonomy of provinces, the use of actual revenues is not possible in Canada. The approach that has been used in Canada since 1967 to measure the relative fiscal capacities of provinces is the representative tax system (RTS) approach. 28
Representative Tax System The RTS approach determines fiscal capacity by measuring the per capita revenue provinces could (potentially) raise if they implemented a typical ( representative ) provincial tax system. Fiscal capacity is measured separately for each provincial and local government revenue source. The fiscal capacity of each province for each revenue source is measured by applying the national average effective tax rate to the representative tax base for each provinces. A key challenge is to define a common representative base for each revenue source, given that the actual tax bases of the 10 provinces may differ greatly. 29
Measuring Fiscal Capacity for Natural Resource Revenues Measuring fiscal capacity for resource revenues has always presented a special challenge for Equalization. The key reason for this is that provinces generate natural resource revenues through taxes on the volume or value of the resources produced. But while tax rates are directly applied to statutory volume or value bases, provinces are actually (though indirectly) taxing economic rent. 30
Natural Resource Bases Volume and value bases were used in the past for Equalization purposes as well as one economic rent base (for revenues from mining). On the advice of an expert panel, the government moved to the use of actual revenues for natural resources in 2007. The inclusion rate for natural resource revenues was reduced to 50%. 31
Federal-Provincial Fiscal Arrangements Issues for Canada 1. Size of the Equalization program 2. Treatment of natural resource revenues in Equalization 3. Sharing of Alberta s resource rents 4. Transfer of further tax room 5. Use of the federal spending power 6. Tax harmonization 7. Reassignment of tax fields 32
Federal-Provincial Fiscal Arrangements Issues (cont d) 1. Size of the Equalization program 2. Treatment of natural resource revenues in Equalization 3. Sharing of Alberta s resource rents 4. Transfer of further tax room 5. Use of the federal spending power 6. Tax harmonization 7. Reassignment of tax fields 8. Use of the federal spending power 33