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Archived - Annex 1:
A Brief History of the Fiscal Relations Debate in Canada

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This annex summarizes:[1]

Historical Evolution of Fiscal Relations in Canada

Federal and provincial roles and responsibilities have evolved throughout Canadian history in response to sometimes dramatic changes in circumstances (see box below).

While the terms themselves were not used in earlier debates, many of the major events of the 20th century—the Great Depression of the 1930s, the two World Wars, the emergence of the post-war welfare state—all involved dramatic shifts in "fiscal balance" either vertical (between the federal and provincial governments) or horizontal (e.g. changing fiscal disparities among the different provinces).

Fiscal relations have had to evolve alongside these shifts in roles and responsibilities—and corresponding shifts in fiscal balance. Throughout Canada’s history, federal and provincial-territorial governments have found a variety of ways of meeting these challenges. In many cases, adjustments to shifts in fiscal balance were achieved through incremental spending and taxation choices by individual governments. In other cases, they involved coordinated action by federal and provincial-territorial governments to realign revenues or expenditure responsibilities. In only a few cases were constitutional changes involved.

The variety of fiscal rebalancing mechanisms used over the years reflects a high degree of flexibility in Canadian fiscal federalism. Unlike many other federal countries, both the federal and provincial-territorial orders of government are able to exercise significant autonomy across a broad range of expenditure and taxation areas. As a result, all governments in Canada are able to raise revenues from all major tax fields, enabling them to shift relative emphasis on different tax fields over time in response to changes in roles and responsibilities.

A Brief History of Fiscal Relations in Canada

Early in Canada’s history, the largest part of expenditure responsibilities and most of the revenues from the major tax fields then in use (primarily customs, excise and indirect taxes) lay with the federal government.

However, by the 1920s, the role of provinces in delivering programs and services (including the predecessors of many social programs today) had already grown significantly. Their own-source revenues had also increased substantially, as provincial sales taxes, personal income taxes and corporate taxes came to be widely used. The uncoordinated presence of both federal and provincial governments in these tax fields came to be known as the era of the "tax jungle" in Canada and resulted in a vigorous debate over the need for greater clarity in the allocation of taxing powers and the need to harmonize federal and provincial taxes.

The Great Depression of the 1930s had a dramatic impact on the revenues and expenditure requirements of both orders of government—but especially the provinces, given their role in providing income support to persons in need. The resulting financial strain led to calls for a major restructuring of federal and provincial roles and responsibilities in relation to both taxing powers and expenditure responsibilities—and for new federal transfers to the provinces.

The Second World War resulted in an equally dramatic change to the pattern of government expenditures and revenues: provincial expenditures declined as employment increased while federal defence expenditures rose markedly. The fiscal rebalancing required as a result of these developments was achieved through temporary "tax rental agreements," under which provinces "leased" a number of tax fields to the federal government, including personal and corporate income taxes.

In the years following the war, provinces re-entered these tax fields as the federal government reduced its own taxes as a result of demobilization. Provinces also resumed their pre-war expenditure responsibilities and began to take on new roles. To avoid a return to the "tax jungle" of earlier decades, federal and provincial governments agreed to harmonize their personal and corporate income taxes to a substantial degree.

From the 1950s to the 1970s, the development of most of the major social programs familiar to Canadians today (in the fields of health, education and social services) led to significant new pressures on provincial and territorial expenditures, corresponding increases in provincial-territorial taxes and significant increases in federal transfers, including both cash transfers and formal transfers of tax room from the federal government to provinces and territories.

The period starting in the 1980s was marked by consolidation of Canada’s system of intergovernmental fiscal relations. By the mid-1990s, increasingly large deficits and debt burdens, especially those of the federal government, led to fiscal restraint that culminated in significant reductions across a wide range of federal expenditures, including transfers to provinces and territories.

Chart A1.1 - Fiscal Balance Among Governments Has Undergone Significant Shifts Over the Course of Canada's History

Past Debates on Fiscal Relations

Given their importance in supporting programs and policies that meet the evolving needs of Canadians, fiscal relations have naturally been the focus of much public debate over the years (see box below). Several key themes have emerged in these debates. Most prominent are discussions of the ongoing need for:

Key Issues Raised in Past Fiscal Relations Debates

Rowell-Sirois Commission

Report of the Royal Commission on Dominion-Provincial Relations, 1940

  • Federal government assume all provincial debts.

  • Provincial governments cede corporate income, personal income and estate taxes to the federal government.

  • Unconditional grants to the less prosperous provinces.

  • Unemployment insurance assigned to the federal government.

Carter Commission

Report of the Royal Commission on Taxation, 1966

  • Federal government to act as collection agent for personal income taxes; federal and provincial rates should be harmonized.

  • Corporate income taxes left to the federal government.

  • Provinces to control retail sales taxes.

  • Tax system criticized for inefficiency and lack of fairness, harmonization and consultation.

Breau Committee

Fiscal Federalism in Canada: Report of the Parliamentary Task Force on Federal-Provincial Fiscal Arrangements, 1981

  • Ceiling on Equalization on account of resource revenues, but all resource revenues to be included.

  • Federal government to have some responsibility for income redistribution.

  • Need for better fiscal harmonization, economic coordination and accountability for fiscal arrangements.

  • Federal support for higher education to be separate from support for health, with clearer program conditions for health.

Economic Council of Canada

Financing Confederation: Today and Tomorrow, 1982

  • Correction of fiscal imbalance through raising taxes, restraining expenditures, or both.

  • Need for better harmonization while maintaining a high degree of individual autonomy.

  • Health care and post-secondary education transfers to be separate, and monitored more closely for greater accountability.

  • Resource revenues included in Equalization, but only equalized as if distributed to provincial residents.

MacDonald Commission

Report of the Royal Commission on the Economic Union and Development Prospects for Canada, 1985

  • Equalization based on representative tax system, 10-province standard and partial inclusion of resource revenues.

  • Federal government to consult provinces before making tax changes that would also affect them; greater tax harmonization.

  • Federal spending power to be retained, but with some conditions.

  • Need for better public accountability, transparency and harmonization.

The Current Debate

Many of the debates from the past still resonate today, albeit with new elements that reflect particular developments since the mid-1990s.

In 2002, the report of the Séguin Commission, A New Division of Canada’s Financial Resources, brought considerable attention to concerns over an emerging fiscal imbalance. Since then, there have been many contributions to the debate on fiscal relations in Canada.

As noted below, several independent commissions and panels and parliamentary committees have made extensive recommendations to address current strains within the federation, as have individual provincial and territorial governments, public policy institutes, and academics.

Independent Commissions and Parliamentary Committees

Séguin Commission

A New Division of Canada’s Financial Resources, 2002

  • Additional financial resources of $2 billion in the short term and $3 billion in the medium term for Quebec to assume the responsibilities under its jurisdiction; $8-billion increase for the provinces overall.

  • Eliminate federal health and social transfers through a new division of tax room.

  • Cede GST base to the provinces (or accept new division of personal income tax field); new division of taxation must not lead to federal deficits.

  • 10-province Equalization standard; eliminate floor and ceiling provisions; full inclusion of all revenues.

  • Maintain the right to opt out of federal programs with full compensation.

  • A genuine, permanent and effective process of exchanges and discussion between the two orders of government on intergovernmental fiscal relations.

Standing Senate Committee on National Finance

The Effectiveness and Possible Improvements to the Present Equalization Policy, 2002

  • Return to a 10-province Equalization standard.

  • Remove ceiling on Equalization payments, but retain floor provisions.

  • Continue to include non-renewable natural resource revenues in Equalization, but increase the share of entitlements sheltered when provinces’ non-renewable resource revenues increase.

  • Establish consultation process between federal government, provinces and Statistics Canada to allow provinces to assess and comment on changes in how Equalization is calculated.

  • Review Equalization provisions of the Atlantic Accords to determine if they have met the design intent.

House of Commons Standing Committee on Finance

The Existence, Extent and Elimination of Canada’s Fiscal Imbalance, 2005

  • Governments should be able to finance their spending responsibilities without imposing unduly high taxes.

  • Comprehensive approach to transfer arrangements to minimize the use of ad hoc bilateral arrangements.

  • Fiscal arrangements to respect principles of adequacy, sustainability, equity, efficiency, transparency, accountability and consistency with constitutional responsibilities.

  • Canada Social Transfer (CST) to be split into separate post-secondary education and social programs/social assistance transfers and grow at a rate similar to that of health transfers under the 10-Year Plan of 2004.

  • Federal-provincial-territorial review of fiscal capacity every three years to ensure governments are able to fulfill their constitutional responsibilities.

O’Neill review of federal fiscal forecasting

Review of Canadian Federal Fiscal Forecasting—Processes and Systems, 2005

  • Federal government to shift from a no-deficit target to a fiscal rule of achieving a surplus, on average, over the economic cycle, increasing its focus on medium/long-term.

  • If no-deficit rule is retained, provide for contingent allocations of unanticipated surpluses among tax cuts, spending initiatives and debt reduction.

  • Increase the transparency of budget-related information.

Council of the Federation Advisory Panel on Fiscal Imbalance

Reconciling the Irreconcilable: Addressing Fiscal Imbalance in Canada, 2006

  • Increase total cash for health and social transfers by $4.9 billion with new funding mainly targeted to the CST, and automatic escalator of 4.5 per cent for CST and 6 per cent for Canada Health Transfer (CHT) until 2013–14.

  • Create a new Tax Point Adjustment program: de-link the existing tax transfers from CHT/CST cash to create a stand-alone transfer. Tax points would continue to be fully equalized to the "top province" standard.

  • Base Equalization payments on a 10-province standard with full resource inclusion; address volatility through the use of a moving average; scale down entitlements to achieve federal affordability.

  • Abandon the Territorial Formula Financing (TFF) fixed framework and return to separate formula-based grants with funding increases.

  • Provide more than equal per capita funding to the territories for national sectoral programs, expedite negotiations on the devolution of lands and resources and provide Nunavut with "extraordinary investment."

  • Establish a First Ministers’ Fiscal Council to deal with intergovernmental fiscal issues, and an independent research organization.

Expert Panel on Equalization and Territorial Formula Financing

Forthcoming, 2006

The Panel will review and provide advice on:

  • The allocation of Equalization and TFF including consideration of the current representative tax system and various revenue sources such as natural resource revenues.

  • Mechanisms to ensure that payments for programs to provinces and territories are stable and predictable.

  • Evidence-based aggregate measures of the evolution in fiscal disparities among provinces, and of the evolution of the costs of providing services in the North.

  • The need for a permanent and independent body to provide ongoing advice on the allocation of Equalization and TFF.

 

Parliamentary and Government-Commissioned Reports on Health Care

Quebec’s Commission of Study on Health and Social Services

Emerging Solutions: Report and Recommendations (Clair Report, 2000)

A Framework for Reform

Report of the Premier’s Advisory Council on Health (Alberta) (Mazankowski Report, 2001)

British Columbia’s Select Standing Committee on Health

Patients First: Renewal and Reform of B.C.’s Health Care System (Roddick Report, 2001)

Saskatchewan’s Commission on Medicare

Caring for Medicare: Sustaining a Quality System (Fyke Report, 2001)

Alberta’s M.L.A. Task Force on Health Care Funding and Revenue Generation

A Sustainable Health System for Alberta (Graydon Report, 2002)

Health Renewal

New Brunswick Premier’s Health Quality Council Report (2002)

State of the Health Care System in Canada

Final Report of the Standing Senate Committee on Social Affairs, Science and Technology (Kirby Report, 2002)

Commission on the Future of Health Care in Canada

Building on Values: The Future of Health Care in Canada
(Romanow Report, 2002)

 

Provincial and Territorial Governments

Newfoundland and Labrador

Budget address, March 2006

  • Acknowledge the benefits of the offshore arrangement.

Prince Edward Island

Budget address, March 2006

  • Ensure that Equalization is adequate for provinces without natural resources.

Nova Scotia

Budget Address, April 2005.

  • Acknowledge the benefits of the offshore arrangement.

New Brunswick

Budget address, March 2006 and New Brunswick’s Perspective on the Equalization Program, July 2005

  • Restore a 10-province standard for Equalization that includes all natural resource revenues.

  • Continue a "new, dynamic partnership" with the federal government through cost-sharing of infrastructure investment and other priorities.

Quebec

Inaugural Address, March 2006 and Budget Address, March 2006

  • Restore a 10-province standard for Equalization that includes all natural resource revenues.

  • Find "common ground" on day care, post-secondary education (PSE), social assistance, and climate change and restore federal PSE transfers to previous levels.

Ontario

A Fair Share: A Strong Ontario for a Stronger Canada/Ongoing Campaign

  • Reduce "$23-billion gap" between federal revenues and expenditures in Ontario.

  • Ensure that health and social transfer programs are provided on an equal per capita cash basis.

  • One clear Equalization program.

  • Call for a Royal Commission.

Manitoba

A New Focus on Fiscal Relations, March 2006

  • Restore a 10-province standard for Equalization that includes all natural resource revenues.

  • Divide Canada Social Transfer into three separate and more generous transfers for PSE, social services and early childhood initiatives.

  • Consider addressing "third-tier" issues through new, needs-based transfers outside of Equalization.

Saskatchewan

"Federal Equalization: Saskatchewan’s Case for Fairness," provincial budget, April 2006 and Equalization Reform: A Fair Deal for Saskatchewan, June 2005

  • Negotiate "Energy Accord" that exempts Saskatchewan’s oil and gas revenues from Equalization.

  • Restore a 10-province standard but exclude non-renewable natural resource revenues.

Alberta

Letter to the Major Party Leaders, December 2005

  • Achieve a "fiscally balanced" federation.

  • Increase federal funding for PSE, invest "unallocated" federal fuel taxes in transport infrastructure.

British Columbia

Throne Speech, February 2006

  • Amend Canada Health Act to include a sixth ("sustainability") principle for health care funding.

Territories

Budget addresses, February and March 2006

  • Enhance Territorial Formula Financing and devolve responsibility for resources to the territories.

  • Provide support for Alaska Pipeline and Mackenzie Valley Pipeline.

  • Lift $300-million borrowing limit on the Northwest Territories.

 

Public Policy Institutes and Think Tanks (Selected Studies)

Atlantic Institute for Market Studies

Equalization Reform That Works: Taking seriously the idea that incentives matter and The Old Shell Game, or the Mystery of the Missing Fiscal Imbalance, 2005

  • Removal of non-renewable natural resources and sales of Crown corporation assets from Equalization; 10-province standard; some ceiling on Equalization; part of Equalization allocated to debt repayment.

  • One-off deals to be replaced by a rules-based Equalization formula.

  • Evidence of a fiscal imbalance weak, given that provinces can increase their own taxes.

Canadian Council of Chief Executives

From Bronze to Gold: A Blueprint for Canadian Leadership in a Transforming World, 2006

  • While accountability is important, governments should realign responsibilities to match the evolving needs of Canadians, e.g. provinces delegating regulation of the securities market.

  • The perception of fiscal imbalance, health cost pressures and "ad hoc deals" are leading to calls to better align spending responsibilities and taxing capacities.

C.D. Howe Institute

McKenzie, 2005; Poschmann and Tapp 2005; Smart, 2005

  • Reduce federal taxes (GST or personal income tax) to create tax room in favour of the provinces.

  • Reduce transfers to provinces to partially compensate for the loss in federal revenues.

  • Eliminate retail sales taxes in favour of value-added taxes and federal-provincial tax harmonization.

  • Retain the federal role in addressing horizontal equity issues.

Conference Board of Canada

Fiscal Prospects for the Federal and Provincial/Territorial Governments, 2002

  • Vertical fiscal imbalance is a situation where the distribution of revenues between the federal and provincial orders of government is inconsistent with the cost of meeting their constitutional spending responsibilities.

  • A vertical imbalance exists; without structural changes it will widen in the future.

  • Projections show large and growing federal surpluses over the next two decades and small provincial sector deficits; new projections recently done for the Council of the Federation Advisory Panel on Fiscal Imbalance.

Fraser Institute

Is There a Fiscal Imbalance? Yes, 2005

  • The federal government should remove itself from areas of provincial jurisdiction.

  • Tax room should be vacated to the provinces.

  • Equalization payments to less-wealthy provinces should be sensibly structured.

Institute for Competitiveness and Prosperity

Fixing Fiscal Federalism, 2005

  • $16.1-billion "gap" between federal expenditures made and revenues collected in Ontario.

  • Canadian system of regional redistribution harmful to prosperous provinces and ineffective in raising competitiveness and prosperity levels in poorer provinces.

  • Federal trend toward current "consumption" and away from "investing" in future prosperity.

  • Transfer payments need to be rethought and the employment insurance program converted to a true insurance program.

  • Introduce new mechanisms to deal with unanticipated federal surpluses.

Institute for Research on Public Policy

Courchene, St-Hilaire, 2005

  • The federal government occupies too much tax room and does not provide sufficient transfers.

  • Evidence of both excess vertical fiscal gap and fiscal imbalance.

  • Resource revenues should be equalized, at least in part, but representative tax system inappropriate for resource revenues.

  • Equalization should be reworked to integrate and accommodate recent agreements such as the offshore arrangements.

  • Both the funding and the allocation-of-benefit sides of the Equalization formula should be considered.

  • Introduce a formal mechanism for allocating unanticipated budget surpluses.

 

Selected Academic Contributions

Robin Boadway

Should the Canadian Federation be Rebalanced? 2004

  • Imbalance should be addressed by increasing federal transfers to the provinces.

  • The federal share of tax room should be "jealously guarded and even enhanced."

  • Transfers should not depend on the size of the federal surplus.

  • Equalization should be based on a 10-province standard and include natural resource revenues.

  • Social transfers should be disaggregated into three parts: health, welfare and post-secondary education, increased in accordance with some index of provincial spending requirements and allocated among provinces on the basis of need.

  • Address the process of managing fiscal relations to make it more accountable and transparent.

Bev Dahlby

Dealing with the Fiscal Imbalances: Vertical, Horizontal, and Structural, 2005

  • A vertical fiscal imbalance exists if the marginal cost of raising tax revenue varies between the orders of government.

  • Mobility of tax bases is one reason why the federal government should raise more in taxes than it spends and transfer part of the extra revenues to provinces.

  • Federal surpluses and provincial deficits are not an indication of vertical fiscal imbalance.

  • No pressing need to expand the scope of equalization, i.e. adding a needs component.

  • A revised representative tax system with partial Equalization of non-renewable resource revenues and property taxes would be an adequate basis for Equalization over the long term.

  • The five provinces that levy retail sales taxes should switch to value added taxes and the GST should be reduced to 5 per cent and provinces should increase their sales tax rates.

  • Excise taxes on alcohol, tobacco and motive fuels should be turned over to the provinces; resulting federal shortfall could be reduced by cutting transfers to provinces.

Harvey Lazar

Trust in Intergovernmental Fiscal Relations, in Canadian Fiscal Arrangements: What Works, What Might Work Better, 2006

  • Need to have stable and reliable federal transfers to the provinces.

  • Reductions in federal transfers should not exceed federal cutbacks to its own programs.

  • Remaining vertical imbalance to be rectified through transfers to the provinces and direct spending initiatives.

  • Need for greater transparency in federal-provincial fiscal relations.

  • Establish an independent finance commission to review intergovernmental relations.

André Plourde

Natural Resource Revenues and Fiscal Equalization: A Partial Overview of Selected Issues, 2005

  • Non-renewable resource revenues should not be equalized if saved/invested rather than spent.

  • The fact that almost all revenues from non-renewable resources were historically spent makes it difficult to justify treating such revenues differently from renewable resource revenues.

  • Using average tax rates to estimate capacity could discourage exploitation of high-cost sources; it is better to use actual revenues.

François Vaillancourt

Reforming Equalization in Canada: Some Observations, 2005

  • A single standard of Equalization among provinces should be used.

  • The choice of the overall level of Equalization is a political decision.

  • Natural resources should be shared among provinces using a pooling mechanism.

  • Representative tax system but with improvements.

  • Increase transparency and publicly available information by setting up a five-year program of research and analysis, jointly managed by the federal and provincial governments.

 


1 Note: Summaries have been prepared by the Department of Finance Canada, which takes responsibility for any errors or omissions.[Return]

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