Transcript Financing Federalism: The Canadian Experience

Financing Federalism:
The Canadian Experience
Bev Dahlby
Department of Economics
University of Alberta
and
Tony Morehen
Alberta Finance
Government of Alberta
Outline
• Description of federal and provincial
governments’ expenditure
responsibilities and tax powers.
• Description of the evolution of the
federal-provincial fiscal arrangements
since WW II.
• Description of the main elements of
federal grants to the provinces and
tax collection agreements.
0.10%
0.13%
0.09%
1.7%
13.2%
23.7%
38.4%
9.9%
3.7%
3.2%
0.45%
2.4%
3.0%
Federal Constitutional
Responsibilities
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Defence
Criminal justice
Old age security
Unemployment insurance
International trade and treaties
Regulation of trade and commerce
Aboriginal issues
Monetary policy
Provincial Constitutional
Responsibilities
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Education
Health
Social welfare
Civil law
Municipal government
Gambling, liquor
Natural resources (oil and natural
gas, mining, and forestry)
Shared Constitutional
Responsibilities
• Income support
– especially the Canada Pension Plan and
Quebec Pension Plan
• Environment
• Law enforcement
• Agriculture
Table 1
• Table 1 shows the allocation of
expenditures by the federal and
provincial-local government sectors
in Canada in 2002.
• There are significant overlaps or
interdependencies in the spending
responsibilities of the two levels of
government, e.g. Unemployment
insurance (federal) and welfare
(provincial).
Tax Powers
• The federal government has the power to
raise revenues “by any mode or system of
taxation”.
• The provincial governments are
empowered to levy “direct taxation within
the province.”
– Provinces are not able to levy tariffs on
imported goods.
– This is the only effective constitutional
limitation on provincial tax powers.
Table 2
• Both the federal and provincial
governments levy taxes on the most
important tax bases:
– personal and corporate income taxes,
sales and excise taxes, and payroll
taxes.
• The provinces have exclusive control
over property taxes and resource
revenues, such as oil and gas
royalties.
Major Provincial Tax Rates, 2003
The Federal Spending
Power
• The courts have determined that the
federal government can offer
conditional grants to the provinces to
promote national programs in areas
of provincial jurisdiction, such as
Medicare, post-secondary education,
infrastructure or labour market
development .
• This is referred to as the federal
“spending power”.
Government Borrowing
• The provincial governments can borrow to
finance deficits.
• The federal government is not responsible
for provincial government debt.
• Although there are annual meetings of
federal and provincial finance ministers to
discuss their upcoming budgets, budgetary
policies (including borrowing) by the federal
and provincial governments are largely
uncoordinated.
General Characteristics of the
Canadian Federal System
• The provinces have extensive tax powers
and jurisdiction in the most important
expenditure areas--health, education, and
social assistance.
• There is a high degree of overlap in federal
and provincial taxes and expenditure
programs.
• The federal government has the right to
make grant to the provinces in areas of
provincial responsibility.
Reasons for FederalProvincial Fiscal
Arrangements
• Mismatches between expenditure
responsibilities and the revenue generating
capacity of the provinces
• Unequal fiscal capacities among the
provinces.
• Federal government’s desire to promote
expenditures in some areas of provincial
jurisdiction.
• Overlapping tax bases -- the need for
harmonization.
Types of Federal Transfers
to the Provinces
• Block Transfers
– Equalization Grants
– The Canada Health and Social Transfer
• Cost-Shared Grants
–
–
–
–
Labour market development agreements
Young offenders
Disabled persons
Farm disaster assistance
• Detailed information available at:
– www.fin.gc.ca/activty/fedprov-e.html
History of FederalProvincial Fiscal Relations
• Taxation
– Pre-World War II
• a Royal Commission described the tax system as a ” tax
jungle”
– World War II
• all income taxes transferred to the federal government
– Post-World War II
• Quebec opted to collect its own income taxes
• tax collection agreements signed with the provinces
• tax points transferred to the provinces
History of FederalProvincial Fiscal Relations
• Equalization
– The equalization program established 1957.
– The Constitution was amended in 1982 to require
the federal government to make equalization grants
to ensure that “provinces can provide reasonably
comparable levels of services at reasonably
comparable levels of taxation”.
– Equalization grants are financed out of the federal
government’s general revenues.
– The program is renewed every five years and is
scheduled for renewal in April 2004.
History of FederalProvincial Fiscal Relations
• Health, Education, and Social
Assistance Transfers
– Hospital Insurance 1957 + Medicare, 1968
– Canada Assistance Plan (welfare programs),
1966
– Established Programs Financing (combined
health care and post-secondary education
grants and a tax point transfer), 1977
– Canada Health and Social Transfer, 1996-97
– Canada Health Transfer (CHT) and Canada
Social Transfer (CST), 2004.
The Equation for Calculating
Equalization Grants
• A province’s fiscal capacity is calculated using
a “Representative Tax System.”(RTS)
• A province’s equalization entitlement for a
particular tax base is calculated as follows:
• Eij = tsj(Bsj - Bij)
– where Eij the per capita equalization entitlement for
province i with respect to tax base j
– tsj is the standard tax rate for tax base j
– Bsj is the standard per capita tax base j
– Bij is the per capita tax base j in province i
– i = 1…10, j = 1…34
The Equalization Standard
• A five-province standard is used to calculate
the standard tax bases.
– This is the average per capita tax bases in
British Columbia, Saskatchewan, Manitoba,
Ontario, and Quebec.
• A province with deficient fiscal capacity
receives a payment from the federal
government equal to the sum of its Eijs over
34 revenue sources.
• Provinces with adequate fiscal capacities
(Ontario and Alberta) do not receive
payments and do not directly contribute to
financing the grants.
The Impact of Equalization on the
Fiscal Capacities of the Provinces
2002-03 Fiscal Capacity by Province
160
Pre-Equalization
% of the national average
140
Post-Equalization
120
100
80
60
40
20
0
BC
AB
SK
MB
ON
QC
NB
NS
PE
NL
Problems with the
Equalization Program
• The federal government has imposed
ceilings on entitlements and changed
the formula for calculating the grants.
• Variations in “fiscal need” are not
taken into account, as in Australia.
• The formula may affect the fiscal
decisions of the recipient provinces:
– rate equalization effect
– base equalization effect
– discourages development of resource projects
The Canada Health
and Social Transfer (CHST)
• The Canada Health and Social
Transfer (CHST) was established in
1996-97 to provide block funding for
provincial health, post-secondary
education and social assistance
programs.
• It replaced the Established Programs
Financing (health and postsecondary education) and Canada
Assistance Plan (social assistance)
programs.
How the CHST Works
• The federal government arbitrarily sets the
value of the cash to be transferred to the
provinces.
• The value of the tax points transferred to
the provinces in 1977 is then calculated.
• The total value of cash plus tax points is
allocated among provinces on an equal per
capita basis.
• Each province’s cash transfer is equal to its
allocation of tax plus cash minus the value
of its tax points.
CHST Calculation for
2002-03
National
•Cash
plus
•Tax Point Transfer
equals
$19.1 billion
•Total Entitlement
$35.2 billion
$16.1 billion
Alberta’s CHST Grant
(based on Alberta’s 9.9% share of Canada’s population)
•Total Entitlement
less
$3.5 billion
•Tax Point Transfer
equals
•Cash Transfer
$1.9 billion
$1.6 billion
Major Federal Transfers to the
Provinces and Territories,
1982-2002
35,000
30,000
20,000
15,000
10,000
5,000
CHST
Equalization
Territorial Financing
0
82
-8
3
84
-8
5
86
-8
7
88
-8
9
90
-9
1
92
-9
3
94
-9
5
96
-9
7
98
-9
9
00
-0
1
02
-0
3
($ millions)
25,000
Federal Transfers to the
Provinces and Territories,
in 2003-04
Major Federal Transfers
12,000
($ millions)
10,000
2002-03
Territorial Financing
Equalization
CHST
8,000
6,000
4,000
2,000
0
BC AB SK MB ON QC NB NS PE NL NT NU YK
Federal Transfers as a Percentage
of Provincial Revenues
2002-03
35
CHST
Equalization
30
25
20
15
10
5
0
BC
AB
SK
MB
ON
QC
NB
NS
PE
NL
Recent Developments
• The current CHST will be split into a
Canada Health Transfer (CHT) and a
Canada Social Transfer (CST),
effective April 1, 2004.
• The Equalization program ceiling was
removed, effective 2002-03.
• The total increase in federal transfers
by $Cdn 20 billion over five years.
Tax Collection Agreements
(TCAs)
• Under the TCAs, the federal
government collects personal and
corporate income taxes on behalf of
the provinces.
– Quebec collects its own personal income
taxes, while Quebec, Ontario and Alberta
collect their own corporate taxes.
• Federal and provincial personal and
corporate income tax bases exhibit a
higher degree of harmonization than
in the United States.
Financing Local Government
• Constitutionally, municipalities are
“creatures of the province.”
• Municipalities derive their revenue from
municipal property taxes, transfers from the
provincial governments, user fees, and
business taxes.
• Municipal spheres of jurisdiction
–
–
–
–
–
Safety, health and welfare of people
Protection of people and property
The enforcement of bylaws
Transport and transportation systems
Operation and maintenance of public places
Sources of Funding
for Local Government
8,000
7,000
($ millions)
6,000
5,000
4,000
3,000
2,000
1,000
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Own Source
Provincial Transfers
Strengths and Weaknesses of
the Canadian Fiscal System
• Has allowed decentralization of tax and
expenditure decisions, while maintaining
comparable levels of public services and tax
rates in spite of large variations in the fiscal
capacities of the provinces.
• Overlapping tax and expenditure
responsibilities reduces transparency and the
accountability of politicians to the voters.
• Interdependencies can lead to negative fiscal
externalities for other governments.