Fiscal Federalism in Canada

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Fiscal Federalism in Canada Norman Betts, PhD, FCA University of New Brunswick Fredericton, NB, Canada March 30,2005 Presented at: Roundtable on Division of Revenues between the Levels of Government in Federal Countries and Fiscal Equalization Location: Brasilia, Brazil Date: March 30 & 31, 2005..An event co-organized by the Forum of Federations

Outline of presentation 1. Overview of Canadian federalism 2. Federal Transfers to Provinces 3. Key issues 4. Conclusion

(1898) 0.1% (1870) 0.1% Overview of Canada (date of entry into Confederation) and Share of present-day population of 31.6 million (2004) (1949) 1.7% (1999) 0.1% (1867) 23.7% (1871) 13.1% (1905) 10.0% (1905) 3.1% (1870) 3.7% (1867) 38.7% Source: Statistics Canada (Provincial Economic Accounts,, 2004) (1867) 2.4% (1867) 2.9% (1873) 0.4%

1. Overview of Canadian Federalism Division of revenue and expenditure responsibilities

1.1 Division of powers Federal and provincial governments have independent constitutional basis of authority Few / no constraints on spending / taxation powers or ability to borrow Federal and provincial have extensive areas of separate legislative powers Strong executives at both federal and provincial levels

1.2 Access to tax bases Traditional tax bases are shared by Ottawa and the provinces Provincial-only tax bases Personal income tax Corporate income tax Sales taxes Payroll taxes Common revenue sources Gambling, sale of alcohol Property taxes Natural resource revenues Federal Provincial-only revenue sources Federal Provincial Provincial Federal-only tax bases Federal-only revenue sources Customs tariffs and import duties Taxes on non-residents Federal Provincial

1.3 Expenditure areas Few concurrent powers (agriculture, pensions, immigration) Residual power lies with federal level Much interdependence in practice areas where jurisdiction is not clear or overlaps through use of the spending power and transfers to provinces Provincial spending pressures Health care Education Social services Federal spending pressures Security and national defence Seniors benefits Aboriginal people R&D and skills Transfers (CHST, Equalization)

1.4 Decentralisation in Canada: historical trends Evolution of government revenues and expenditures 1945-2001 60% Revenues (% of GDP) 60% Expenditures (% of GDP) 50% 50% 40% 40% 30% 20% Provinces Federal transfers 30% 20% Provinces 10% Federal 10% Federal 0% 0% 1945 1955 1965 1975 1985 1995 1945 1955 1965 1975 1985 1995 Source: Statistics Canada (National Accounts)

1.5 Canada: a decentralised federation Federal share of direct spending (1998) Federal share of tax revenues (1998) Austria 69% Argentina 83% Spain 68% Spain 81% Germany 62% Mexico 77% Mexico 61% Austria 76% Brazil 57% Germany 69% Australia 56% Australia 67% Switzerland 53% Brazil 66% U.S. 51% U.S. 58% Argentina 50% Switzerland 58% Canada 41% Canada 47% 0% 20% 40% 60% 80% 0% 20% 40% 60% 80% 100% Sources: World Bank,, Fiscal Decentralization Indicators,, March 2001 (based( on IMF s Government Finance Statistics), Inter-American Development Bank

2. Federal Transfers to Provinces

2.1 Canadian provinces relatively autonomous Federal transfers as a % of total revenues of other levels of government 2001 2003-04 04 Argentina 56% N.S. 38% Spain 55% P.E.I. 37% Austria 35% N.B. 36% Australia 35% Man. 35% Mexico 35% Nfld. 32% Brazil 34% Qué. 23% U.S. 28% B.C. 21% Switzerland 25% Ont. 21% Germany 24% Sask. 19% Canada 12% Alta. 16% 0% 10% 20% 30% 40% 50% 60% 0% 20% 40% 60% 80% 100% Sources: World Bank,, Fiscal Decentralization Indicators,, March 2001 (based( on IMF s Government Finance Statistics); Finance Canada; Inter-American Development Bank

2.2 Canada: transfers mostly unconditional Shared-cost/high-conditionality transfers (% of total transfers) U.S. Malaysia 86% 100% 100% 90% 80% Canada, 1945-1999 Switzerland 73% 70% Austria 69% 60% Germany 65% 50% Australia 53% 40% India 38% 30% Spain 24% Canada 17% 0% 20% 40% 60% 80% 100% 20% 10% 0% 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 Sources: Ronald Watts (Comparing( Federal Systems); Finance Canada

2.3 The Equalization program was created in 1957 to equalize provincial fiscal capacity $ per capita 50 40 Equalization Formula 1957-1958 Standard = average of the best two provinces (38.20$ per capita) 30 Equalization 20 10 0 Fiscal capacity of provinces PEI Nfld NB NS Sask. Man. Alb. Qué. BC Ont. The equalization program was created by the Liberal government of Prime Minister St-Laurent just just before his defeat at the hands of the Progressive Conservatives under Diefenbaker

The Equalization program was significantly modified in 1982 with the introduction of a 5 province standard $ per capita Equalization Formula 10000 2003-04 8000 6000 Standard (fiscal capacity of five provinces) = $5,872 per capita Equalization 4000 2000 Fiscal capacity 0 PEI NB Nfld NS Man. Qué. Sask. BC Ont. Alb. Equalization transfers are completely funded by the federal government, i.e., the program is financed by the citizens of all provinces

The Canadian Constitution (1982) PART III: Equalization and Regional Disparities 36.(1) without altering the legislative authorities of Parliament or of the provincial legislatures, or the rights of any of them with respect to their legislative authority, Parliament and the legislatures are committed to: (a) promoting equal opportunities for the well being of Canadians (b) furthering economic development to reduce disparities in opportunities; and (c) providing essential public services of reasonable quality to all Canadians 36.(2) 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 (emphasis added).

The Evolution of the Equalization Program from 1957 to today Years Sources of Revenue Coverage Standard Other Tax Revenue Natural resources Other Revenues of local govt s 1957-58 1962-63 Income tax Income tax None Partial None None None None Two Best Provinces National Standard 1964-65 1967-68 Income tax Partial None Nearly all None None Two Best Provinces National Standard 1973-74 Nearly all Education National Standard 1974-75 1977-78 1982-83 1987-88 1992-93 1994-95 1999-00 2003 Restricted Restricted Nearly all Nearly all Nearly all** Education Education Education/property Education/property Education/property Education/property Education/property National Standard National Standard 5 Provinces 5 Provinces 5 Provinces 5 Provinces 5 Provinces Ceiling/floor Revised ceiling/floor Revised ceiling/floor Revised ceiling/floor Revised ceiling/floor Ceiling eliminated 2004 New Framework for equalization*** ** User fees excluded *** In October of 2004 equalization entitlements were capped at $10B for 2004-05 and $10.9B for 2005-06

2.4 The Canada Health Transfer and Canada Social Transfer CHT and CST (2004-2005) $1 200 $1 000 $800 1256 1256 1256 1256 1256 1256 1256 1256 1256 1256 504 641 504 504 582 504 504 504 504 504 1. Starting point : equal per capita entitlements in all provinces 2. The value of transferred tax points is then deducted from total entitlements $600 $400 752 614 752 751 673 751 751 751 751 751 3. The remaining per capita amount is then paid out to provinces as a cash transfer $200 $0 B.C. Alta. Sask. Man. Ont. Qué. N.B. N.S. P.E.I. Nfld. Cash Tax points Source: Finance Canada

3. Key Issues

3.1 Fiscal recovery in the late 1990s Federal and provincial governments fiscal balance, % of GDP (1981-82 to 2001-02) 10% 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% Federal government Provincial governments 81-82 83-84 85-86 87-88 89-90 91-92 93-94 95-96 97-98 99-00 01-02 Source: Finance Canada

3.3 Program expenditures significantly reduced Federal and provincial program spending (% of GDP) 25% 20% 15% 10% 1980-81 1982-83 1984-85 1986-87 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 Provincial Federal Source: Finance Canada

3.2 Canada in good fiscal shape today Total Government Budget Balances, 2002 Projection (% of GDP) Canada 1.0% United Kingdom United States Italy France Germany -0.8% -1.0% -1.4% -2.0% -2.8% Japan -8.0% Source: OECD Economic Outlook (June( 2002) -8% -6% -4% -2% 0% 2%

3.5 Vertical Fiscal Gap (VFG) VFG means that federal own-source revenues are greater than federal direct spending VFG reflects policy choices Degree of centralization Transfer issues related to VFG Size Conditionality Regional distribution

Excerpts: This study examines the issue of vertical fiscal imbalance between the federal and provincial governments over the long term. It answers the basic question: is there an imbalance between the budgetary leeway of the federal government and that of the provincial and territorial governments in Canada? Based on a projection of the fiscal and budgetary status quo, the answer is definitely yes. Under current revenue and spending structures, the federal government is forecast to achieve multibillion-dollar surpluses large enough to virtually eliminate its interest-bearing debt by 2019/20. On the other hand, the aggregate provincial net debt will increase by 54 per cent to reach $386.9 billion. In contrast, the provinces and territories will have no leeway to implement new policy initiatives over the next two decades. On aggregate, they will neither be able to increase spending nor cut taxes without falling more into deficit.

Canadian Federal vs Provincial Fiscal Projections 2001-2020 $85B -$12B $387B $50B

Principles vs Practice The Barriers Fiscal Imbalance and Equalization A New Brunswick Perspective Fall 2001 Whether the Equalization Program is upholding the constitutional commitment has been the source of considerable debate. It is undeniable that equalization has contributed to a narrowing of relative fiscal disparities. However, it is debatable whether provinces have the ability, after Equalization, to provide reasonably comparable levels of public services and taxation (pg 10). Barriers Ceiling 5 Province Standard Non-inclusive revenue coverage Solutions Remove ceiling National Standard Comprehensive revenue coverage

Re-Balancing Solutions

Executive Federalism in Canada First Ministers The Prime Minister of Canada meets with Premiers of the Provinces and Territories, but there is no set schedule for these meetings Used for Constitutional and Fiscal Issues and for Program Coordination Premiers have pressed for more regular F/P/T meetings They have also recently established a Council of the Federation to discuss and coordinate their positions on issues which might be raised with the Federal Government There are also regional meeting of Premiers in the Western provinces and territories, in Atlantic Canada and in central Canada.

Executive Federalism in Canada Ministers of Finance Ministers of Finance of the provinces and territories traditionally meet with their federal counterpart twice annually, before and after budget season They are supported by a number of committees of officials, who provide common briefing notes on economic and fiscal data and projections, tax coordination, fiscal arrangements and the CPP/QPP The Governor of the Bank of Canada often is invited to attend a portion of the pre-budget meetings.

Executive Federalism

Executive Federalism 2001 Feb 26, 2001

More Executive Federalism Feb 27, 2001

Recent Developments In 2004 a new framework for equalization was put in place A new ceiling of $10 billion for 2004-05 Protection for the provinces against reductions globally or individually A new ceiling of $10.9 for 2005-06 Creation of a five person independent expert panel to review the equalization program

What have we learned? Maintaining Fiscal Balance Ensure the principles are entrenched Balance fiscal capacity; do not reward inefficiencies Ensure the practical application (the formula) captures the principles Differentiate between horizontal and vertical transfers Differentiate between equalization responsibilities and economic development responsibilities Ensure the authority over re-balancing the formula is not biased to one level of government An entrenched co-operative process An independent process

QUESTIONS? Links to source information: http://www.gnb.ca/0024/reports/index.asp My Email: betts@unb.ca