Section

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Section 8 (a)
Fiscal Federalism
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Fiscal Federalism

• Fiscal Federalism is the division of taxing and
  expenditure functions among levels of government.
  
• To understand Canadian fiscal federalism, and its
  taxing and spending arrangements between federal,
  provincial and territorial levels of government,
  one must first appreciate the legal framework and
  historical context.

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The Legal Framework

• Federal systems normally entail an explicit legal
  or constitutional division of powers and
  responsibilities among two or more levels of
  government.
• The BNA Act of 1867 is an example is this, where
  taxing and spending powers of the federal and
  provincial governments were specified.

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The Legal Framework

• Section 91 of the Act gives the federal
  government the power to make laws for the peace,
  order and good government of Canada.
• This includes the power to raise money by any
  system or mode of taxation, although Section 125
  prevents the federal government from levying
  taxes on provincial lands and property.

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Centralized System

• It was the intent of the Fathers of Confederation
  to have a strong centralized federal system,
  which is why, for the most part, taxing powers
  used at the time tended to reside at the federal
  level.
• For example, at the time of Confederation, the
  provinces raised 99 of their revenue from
  imports and excise taxes.
• However, with its introduction, the Constitution
  excluded provinces from future use of these and
  other indirect taxes.

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Centralized System

• The federal government was also given
  responsibility for defence, navigation and
  shipping, regulation of trade and commerce, the
  criminal justice system, and money and banking,
  among other areas.
• The intent at the time was to balance
  responsibilities with revenues, and to achieve
  this the federal government provided statutory
  subsidies to provinces for general government,
  justice, education, welfare, and internal
  transport services.

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Early Funding Arrangements

• These subsides were specific at the time of
  Confederation, and any future growth in subsidies
  was strictly limited.
• The fathers of Confederation did not foresee the
  extent to which federal grants to provinces would
  grow and change.

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Early Funding Arrangements

• The federal government managed to extend its
  spending powers into areas of provincial
  responsibility through the use of conditional
  grants (first in 1912 in the area of
  agricultural education).
• By 1936-37, conditional grants accounted for 69M
  of the 90M transferred by the federal government
  to the provinces.

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Conditional Grants

• Conditional grants, by the end of the depression,
  covered areas like
• Education (an area of exclusive provincial
  jurisdiction)
• Employment services (exclusive provincial
  jurisdiction)
• Highway construction (exclusive provincial
  jurisdiction)
• Disease prevention (exclusive provincial
  jurisdiction) and
• Social assistance.

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Sources of Revenue

• As late as 1919, excise and customs duties
  accounted for 78 of federal tax revenues.
• As well, income and sales taxes had no role in
  federal government finance for more than half a
  century.

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Sources of Revenue

• Changes to the Act in 1940 and later in 1951
  resulted in a rapid growth in payroll tax rates.
• Income, payroll and federal sales taxes, all
  unknown at the time of Confederation, grew from
  37 of federal revenues in 1934, to 94 by 2000.

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Provincial Governments

• The 1867 Constitution Act limited provinces to
  the use of direct taxation (personal income tax)
  within the province in order to raise revenue for
  provincial purposes.
• Per capita subsidies, revenue from lands and
  natural resources, and federal grants are
  examples of how provinces were to fund the
  necessary services.

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Provincial Governments

• This situation, with fiscal capacity mostly in
  the hands of the federal government, was not well
  received by provincial governments.
• With added pressures for welfare, health, and
  education, provinces began to seek new sources of
  revenue.
• The Great Depression of the 1930s placed enormous
  strain on provincial finances.

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Provincial Governments

• Federal transfers rose from 10 in 1930 to 25 of
  provincial revenues by 1937 due to this
  increasing welfare need.
• However, by 1940, financial pressures had forced
  all provinces to introduce taxes on personal and
  corporate incomes.
• Saskatchewan and Quebec also used a retail sales
  tax.

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Provincial Governments

• Following WWII, a series of federal-provincial
  agreements provided for federal transfers to
  provinces based on a combination of per capita
  grants and a share of the revenues from the
  income taxes.
• These agreements were the beginning of the
  equalization grants to provinces designed to
  guarantee that per capita provincial revenue
  would reach a certain standard for all Canadians.
  

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Equalization Grants

• The Canadian Constitution now entrenches the
  equalization payments
• 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 service at reasonable
  comparable levels of taxation.

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Provincial Governments

• Amendments to The Constitution Act of 1982 now
  give provinces greater control over their natural
  resources, explicitly allowing them to levy
  indirect taxes on natural resources.
• Provinces may also now raise money using any mode
  or system of taxation with respect of
  non-renewable resources, forestry, and primary
  production.

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Local Governments

• The 1867 Constitution Act does not actually refer
  to local government.
• Local authorities have only those taxing and
  spending powers that provincial governments
  choose to delegate to them.
• Although there is substantial variation across
  provinces, the dominant revenue source for local
  authorities was, and is, the property tax.

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• Any Questions on
• Legal framework
• Historical context

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Why Centralize?

• A major question of Fiscal Federalism is on how
  best to supply public goods and services and how
  to finance them among the various levels of
  government.
• Typically, central governments will undertake
  these functions when
• Goods are collectively consumed on a national
  level.
• Local coordination is too costly or ineffective.
• Programs significantly redistribute income.
  

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A Decentralized System

• The traditional arguments for a decentralized
  system with enhanced provincial control and
  autonomy include
• Tailoring government to local tastes.
• Fostering intergovernmental competition.
• Experimentation and innovation in regionally
  provided goods and services.

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A Decentralized System

• Disadvantages to a decentralized system
  include
• Externalities
• Economies of scale in the provision of public
  goods.
• Inefficient tax systems.
• Economies of scale in tax collection.
• Issues of Equity.

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Intergovernmental Grants Funding
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Intergovernmental Grants Funding

• There are essentially two types of grants
• Conditional and
• Unconditional.

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Conditional Grants

• Conditional grants are sometimes referred to as
  categorical grants because the donour often
  specifies, to some extent, how the funds are to
  be used.
• Conditional grants to provinces today are far
  less detailed than previous agreements that had
  pages and pages of regulations.
• For example, the only requirement for social
  assistance grants is the prohibition of
  provincial residency.

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Conditional Grants (matching)

• A common conditional grant is the Matching
  Grant, whereby for every dollar given by the
  donour to support a particular activity, a
  certain sum must be expensed by the recipient.
• For example, the federal government may agree to
  spend 1 for every 1 a province spends on an
  approved infrastructure project.

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Conditional Grants (matching)

• Matching grants are considered a subsidy on the
  consumption of a public good.
• Matching grants are also viewed as an effective
  way to correct for the presence of a positive
  externality, whereby an appropriate subsidy can
  enhance efficiency.

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Conditional Grants (matching)

• The provincial response to matching grants is
  two-fold
• Buy more of the public good and/or
• Reduce its tax burden.

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Conditional Grants(matching closed-ended)

• With respect to matching closedended conditional
  grants, the donour may specify some maximum
  amount it will contribute
• This approach outlines the one-for-one matching
  provision, but only up to a point or maximum
  dollar amount.

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Conditional Grants(non-matching)

• Under a non-matching provision, the donour
  gives a fixed sum of money with the stipulation
  that it be spent on a certain public good.
• The challenge with this approach is that, even
  though provinces are required to spend the entire
  amount, they do not have to match it.
• In reality, then, provinces tend to either reduce
  their own expenditures or eliminate them
  altogether.

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Unconditional Grants

• Why provide dollars to provinces without some
  conditions attached?
• When are categorical provisions not beneficial
  for grant funding?

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Unconditional Grants

• There are three common reasons
• To correct the imbalance between revenue-raising
  capacity and expenditure responsibility.
• To mitigate against tax competition among
  provinces.
• To equalize income distribution.

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Intergovernmental Grants in Canada

• Most federal-provincial transfers fall under one
  of the three major federal government transfers
  programs
• Canada Health and Social Transfer (CHST)
• Equalization and
• Territorial Formula Financing.
• These funding programs make up 85 of total
  intergovernmental transfers.

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Intergovernmental Grants in Canada

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Intergovernmental Grants in Canada

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Canada Health Social Transfer

• The CHST program transfers money to support
  provincial programs in the areas of health,
  post-secondary education, and social services.
• The transfer is essentially a block grant
  meaning that few conditions are attached to use
  the funds.

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Canada Health Social Transfer

• Some conditions apply, including
• The prohibition of residency requirements to
  determine eligibility for social assistance and
• An adherence to the five principles of the Canada
  Health Act.

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What is Equalization?

• A program of grants by the federal government to
  make more equal the ability of Canadas provinces
  to provide a basic level of public services.

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What is Equalization?

• More on this in the following Section!

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Territorial Formula Financing

• This program is similar in nature to equalization
  and is designed to allow the three territories to
  provide public services comparable to those
  available in other provinces.

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Vertical Fiscal Imbalances

• The concept of vertical fiscal imbalances exists
  when the national government has an excess
  supply of revenue while the state and local
  governments have an excess supply of needs.
• The cause of such an imbalance is a mismatch
  between revenues and expenditures of different
  levels of government.

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Vertical Fiscal Imbalances

• On the revenue side, imbalances may originate
  from three sources
• Access to different revenue streams
• Different revenue growth rates and
• Different shares of total revenue.
• Provinces have access to a revenue mix with lower
  potential for growth and are estimated to grow at
  about four-fifths of the federal rate.

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Vertical Fiscal Imbalances

• On the spending side, imbalances are affected by
  different cost pressures.
• Federal spending is estimated to grow at about
  half of GDP. Provinces expenditures are
  estimated to grow at three-quarters of GDP
  (expenditures on health and education combined
  account for nearly half of provincial
  expenditures at a rate above GDP).

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Vertical Fiscal Imbalances

• Studies have demonstrated the following
• Federal surpluses are large enough to safely
  accommodate potential increases in its spending,
  but provincial future surpluses are precarious.
• The federal government surpluses are large enough
  to withstand major recessions.
• For some provinces, even moderate growth in
  health ad education spending may translate into
  deficits.

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Questions on Fiscal Federalism?