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Archived - Annex 2
Recent Evolution of Fiscal Balance in Canada

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This annex summarizes key developments in the evolution of fiscal balance in Canada over the last few decades, including:

Budgetary Balances and Debt Burdens

The past quarter-century has witnessed dramatic changes to federal and provincial-territorial budgetary balances. The 1980s and early 1990s were characterized by large, chronic federal deficits, which peaked at more than 8 per cent of GDP in 1984–85. Over this same period, provincial deficits were also significant but did not reach the same levels as those recorded by the federal government.

After some improvement in the late 1980s, the 1990–91 recession resulted in a deterioration of the fiscal situation for provinces and territories and a further setback for federal efforts to reduce its deficit. For both orders of government, spending control as well as the post-recession return to economic growth led to a significant turnaround from large deficits to surpluses.

The federal government recorded its first surplus in 1997–98 and provinces achieved a combined positive budgetary balance in 1999–2000 after decades of deficits. With the projected surplus in 2005–06, provincial-territorial governments will have recorded a combined positive budgetary balance in five of the past seven years.

Eight provinces are forecasting balanced budgets or surpluses in 2005–06 and 2006–07, with the remainder also seeing a considerable improvement in their fiscal situation over the last few years.

Chart A2.1 - Return to Surpluses by Both Federal and Provincial-Territorial Governments After Years of Large Deficits

Table A2.1
Substantial Improvement in Budgetary Balances in Recent Years


2001–02 2002–03 2003–04 2004–05 Estimate
2005–06
Projection
2006–07

(millions of dollars)
Federal 6,742 7,073 8,891 1,456 8,000 3,600
N.L. -468 -644 -914 -489 77 6
P.E.I. -17 -55 -125 -34 -18 -12
N.S. 113 28 38 165 78 93
N.B. 79 1 -173 242 117 22
Que. 22 -728 -358 -664 0 0
Ont. 375 117 -5,483 -1,555 -1,369 -2,350
Man. 63 4 13 405 3 3
Sask. 1 1 1 383 298 102
Alta. 1,081 2,133 4,136 5,175 7,375 4,096
B.C. -1,184 -2,737 -1,275 2,575 1,475 600
Y.T. -21 -5 12 5 38 9
N.W.T. 120 -34 -65 -17 18 31
Nun. -47 12 7 -8 6 -8
Total provincial-
territorial
117 -1,907 -4,187 6,184 8,098 2,592

Sources: Federal and provincial-territorial Public Accounts and budgets.

Reflecting improvements in budgetary balances, both federal and provincial-territorial debts have declined as a share of gross domestic product (GDP), with the federal debt ratio falling more dramatically. However, federal debt as a share of GDP still exceeds that of most provinces and remains significantly higher than the provincial average.

Lower debt-to-GDP ratios, combined with lower interest rates and an improved credit rating, have enabled both orders of government to allocate a smaller portion of revenues to debt interest payments and a greater portion to program expenditures, tax reductions and debt repayment. Both orders of government have also benefited from increased revenues generated by sustained economic growth.

Overall, Canadians witnessed an impressive fiscal recovery for both orders of government in the past decade. However, such a recovery was made possible only by making difficult choices in the mid-1990s to reduce spending.

Chart A2.2 - The Federal Debt-to-GDP Ratio Has Been Declining Rapidly but Still Exceeds That of the Provinces and Territories

Program Spending

Program spending expressed as a share of GDP provides a good measure of spending trends and of the size of governments relative to the economy. It is important to examine the data over a long period of time in order to distinguish between cyclical and structural trends.

Federal program spending as a share of GDP has declined significantly since 1983–84. As a result of spending restraint and strong economic growth, the ratio of federal program spending to GDP declined steadily throughout the latter half of the 1980s. The 1990–91 recession triggered increases in certain federal expenditures like employment insurance, which contributed to a rise in the program spending-to-GDP ratio. The federal government underwent a program of expenditure review and restraint between 1993–94 and 1996–97, which was an essential factor in its fiscal recovery.

Chart A2.3 - Federal and Provincial-Territorial Program Expenditures Have Both Declined Significantly Over the Last Two Decades

Since 1983–84, provincial-territorial program spending has also declined as a share of GDP, but to a lesser extent. Provinces and territories were also hit hard by the recession, which caused a significant increase in spending on social assistance and social services in the early 1990s. Starting in the mid-1990s, most provinces undertook major restructuring to reduce or stabilize their program expenditures. The sustained job creation over the past decade has also significantly reduced provincial spending pressures in the areas of social assistance and social services.

The tighter spending control exercised by both orders of government during the 1990s reflected the need to rebalance government finances after a long period of large and unsustainable deficits.

Since 2000–01, program spending as a percentage of GDP has begun a modest rebound as both federal and provincial-territorial governments addressed significant spending pressures.

Chart A2.4 - Recent Rapid Growth in Provincial-Territorial Health Expenditures Has Been Matched by Growth in Federal Transfers (2000-01 to 2005-06)

Health care has proven to be the number one priority in terms of new investments:

Access to Revenues

Both orders of government have access to all major sources of tax revenue: personal and corporate income taxes, sales taxes and payroll taxes. Provinces have access to resource revenues, gaming and liquor profits, and property taxes while the federal government has exclusive access to customs import duties as well as taxes on non-residents.

Moreover, among major industrialized federations, only in Canada and the United States do sub-national governments have full control over their tax bases and tax rates—though in some cases, provinces in Canada have chosen to enter into harmonization agreements (notably in the area of income and sales taxes) in order to reduce compliance costs on Canadians and administrative costs.


Both Orders of Government Have Access to Major Tax Fields


  Federal Provincial

Common revenue sources    
Personal income taxes
Corporate income taxes
Sales taxes
Payroll taxes
Total in 2005 (billions of dollars) 192.0 130.0
Unique provincial revenue sources    
Resource royalties within provincial jurisdiction  
Gaming, liquor profits  
Property taxes  
Total in 2005 (billions of dollars)   30.3
Unique federal revenue sources    
Customs import duties  
Taxes on non-residents  
Total in 2005 (billions of dollars) 8.4  

Source: National Economic and Financial Accounts

In Canada, sub-national governments raise the largest share of total government revenues among industrialized federal countries, which is a reflection of the high degree of decentralization of the Canadian federation.

Chart A2.5 - Canadian Provinces, Territories and Local Governments Together Account for a Larger Share of Government Revenues Than Sub-National Governments in Other Federal Countries

Given their broad access to major tax fields and the control they exercise over their tax bases and rates, provinces and territories are more fiscally autonomous than their counterparts in other federal countries. In particular, they rely more on own-source revenues—and less on federal transfers—to fund their programs and policies.

Chart A2.6 - Own-Source Revenues as a Per Cent of Total Provincial-Local Revenues Are Among the Highest in Canada

Provincial revenues (including federal transfers) have generally exceeded federal revenues for more than 25 years, with the gap increasing in recent years. While governments have the legal authority to increase their revenues as required, concerns about competitiveness and the overall tax burden of Canadians limit the extent to which they can and should raise additional revenues in practice.

Chart A2.7 - Federal Revenues Have Declined Significantly More Than Those of The Provinces and Territories Since the 1990s

Starting in the late 1990s, most governments in Canada implemented tax reductions, primarily targeting personal and corporate income tax reductions. As a result, revenue-to-GDP ratios declined for both orders of government. For provinces and territories, the rebound in the revenue ratio in recent years is in large part attributable to increases in federal transfers and resource revenues. Federal tax cuts exceeded provincial tax cuts in dollar terms.

Table A2.2
The Sharper Decline in Federal Revenues is Due in Part to Larger Federal Tax Reductions Since the 1996 Federal Budget


  Federal Provincial

  (billions of dollars)
Personal income taxes -31.5 -21.3
Corporate income and capital taxes -5.3 -4.6
Employment insurance premiums/payroll taxes -7.2 -0.4
Other revenue measures1 0.8 5.9

Total -43.2 -22.4

1 Includes sales taxes, property taxes, health premiums, tobacco taxes, gasoline taxes and various measures to fight tax evasion.
Sources: Department of Finance Canada estimates; provincial governments.

Federal Cash Transfers

While Canadian provinces are less dependent on federal cash transfers than their counterparts in other federal countries, transfers still represent a significant source of revenue for the provinces and territories.

As part of its deficit reduction efforts, the federal government cut cash transfers to provinces and territories for health care and other social programs by 30 per cent between 1994–95 and 1997–98, from $18.7 billion to $12.5 billion. Equalization was not cut but a ceiling did temporarily constrain entitlements in 2000–01. Territorial Formula Financing (TFF) was also subject to a ceiling that limited the growth of grants from 1990–91 to 1993–94, and each territory’s Gross Expenditure Base was cut by 5 per cent in the 1995 budget.

Chart A2.8 - Federal Cash Transfers Declined in the Mid-1990s But Have Increased in Recent Years

Since the federal government balanced its budget in 1997–98, federal cash transfers for health and social programs have rebounded substantially:

Equalization and TFF transfers were also put on a legislated 10-year growth track through to 2013–14 under a new framework announced in October 2004. However, the new framework constituted a departure from past practice, under which both the level and allocation of these transfers were determined by a formula. As a result, concerns have been raised about the ability of both programs to meet their objectives over the longer term. In particular, there is a broad consensus that the programs need to be returned to a formula-based approach for determining both the level and allocation of entitlements under these two transfers.

Regional Disparities

In all countries, there are differences in economic performance across regions. Given the diverse nature of Canada, substantial economic disparities exist.

Chart A2.9 - Significant Economic Disparities Continue to Exist in Canada

The coefficient of variation, illustrated in the charts below, measures the magnitude of the disparities across provinces in each year, thus making it a useful indicator to track trends in disparities over time. Even though economic disparities between provinces are still substantial, they have nevertheless declined significantly over the past 25 years.

Chart A2.10 - Economic Disparities Between Provinces Have Narrowed Significantly in Recent Decades

Fiscal Equalization

In federal countries—and especially in fiscally decentralized countries such as Canada—these economic disparities translate into fiscal disparities (i.e. differences in the ability to raise revenues) among sub-national governments. The pattern of fiscal disparities in Canada has largely mirrored the pattern of economic disparities.

While fiscal disparities (like economic disparities) have generally declined over the past 25 years, the recent rise in natural resource prices that began in 2000 has generated stronger economic and revenue growth in provinces with significant natural resources (notably Alberta, Saskatchewan, British Columbia and Newfoundland and Labrador). As a result, economic and fiscal disparities have widened somewhat, though they remain significantly smaller than in the early 1980s.

Chart A2.11 - Disparities in Provincial Fiscal Capacity Have Also Narrowed, Albeit With a Modest Widening in Recent Years

Most federal countries, including Canada, have fiscal equalization programs to help reduce fiscal disparities. The principle of equalization is enshrined in subsection 36(2) of Canada’s Constitution Act, 1982. Canada’s Equalization program significantly reduces fiscal disparities among the provinces (see Annex 3).

Federal Revenue-Expenditure Balances Across Provinces

In all federal countries, economic disparities and the implicit inter-regional redistribution that results from the operation of federal tax and expenditure policies result in different "balances" between federal revenues and expenditures in different regions. Generally speaking, the residents of more prosperous regions, taken as a whole, receive less federal spending and make larger contributions to federal revenues. The opposite is true in less prosperous regions.

Canada is no different in this regard. Because of their relatively higher incomes, citizens and businesses residing in more prosperous provinces, such as Alberta and Ontario, contribute relatively more to federal revenues than they receive from federal programs.

In Canada, as in other federal countries, the "gaps" between federal revenues and expenditures in different provinces reflect the structure of the tax and transfer systems of the federation, including the progressivity of federal taxes, the targeting of support to individual Canadians or families in need, and the commitment to the reduction of provincial-territorial fiscal disparities.

In particular, a number of factors determine the measured balance of individual regions at any given point in time:

Changes in the federal budgetary balance are particularly important in explaining recent changes in regional balances:

Chart A2.12 - Federal Fiscal Balances Have Risen in All Provinces Since the Mid-1990s as a Result of Improved Federal Finances

In effect, the resulting $18-billion Ontario "gap" is a reflection of the province’s greater prosperity relative to most other provinces. The "gap" can be decomposed based on the extent to which federal revenues and expenditures in Ontario deviate from the national average:

These four areas accounted for over 97 per cent of the "gap," with the remaining 3 per cent reflecting other smaller expenditures, some of which are more heavily weighted towards Ontario (such as federal spending on goods and services) and others that are not.

Chart A2.13 - The Ontario

Federal fiscal balances in Canadian provinces are similar in size to those that would be observed across the United States if the federal government in both countries ran balanced budgets, even though the United States does not have an equalization program:

Chart A2.14 - Federal Fiscal Balances in Canada Are Smaller Than Those That Would Be Observed in the U.S. if Both Federal Governments Had Balanced Budgets (2003)

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