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Archived - Chapter 4:
Concerns Over Predictable, Long-Term Funding for Fiscal Arrangements

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Fiscal arrangements underpin federal support for less prosperous provinces and territories, for shared national priorities and for federal efforts to address specific needs with a regional focus.

Subsection 36(2) of the Constitution Act, 1982 commits the federal government "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." This commitment is met through the Equalization program. The Government is also committed to this principle in respect of territorial governments who receive funding through Territorial Formula Financing (TFF), taking into account the unique needs in the North.

There is also a clear consensus among Canadians on the importance of support for health care, post-secondary education and training, and infrastructure. Federal and provincial-territorial governments must continue to work together on these shared priorities to ensure that Canadians have:

There are also circumstances that require the federal government to address unique circumstances, such as natural disasters, where its support must be targeted to the specific needs of a province, territory or region of the country. This federal role is critical to the functioning of the federation, because it ensures support for all parts of the country in times of need.

There have always been debates about the Equalization and TFF programs, the appropriate level of the federal contributions to shared priorities, and targeted federal spending to address regional needs. Over the past decade, concerns have been raised that the stability, predictability and fairness of these transfers were being compromised. While overall transfer levels have been restored, concerns remain that not all transfers have been put on a principle-based, long-term, predictable funding track.

Chart 4.1 - Major Transfers Have Largely Been Put Back on a Long-Term Funding Track, Though Concerns Remain in Some Areas

The remainder of this chapter examines, in turn, federal support for:

Annex 3 provides additional background information on the workings and evolution of major fiscal transfers.

Equalization and Territorial Formula Financing (TFF)

Concerns Over a Loss of Direction in Equalization

In recognition of the fact that provinces have varying levels of fiscal capacity, or ability to raise revenues, the federal government provides Equalization payments to less prosperous provinces, so that all provincial governments are in a position to provide reasonably comparable services at reasonably comparable tax rates.

Unlike other major transfers, Equalization was not cut as part of the fiscal restraint measures of the mid-1990s, and the five-province standard, which had been part of the Equalization formula since 1982, was maintained.

In recent years, the operation of that formula nevertheless generated a sharp decline in Equalization payments, from a peak of $10.9 billion in 2000–01 to $8.8 billion in 2003–04—reflecting the combined impact of a reduction in fiscal disparities, tax reductions in several provinces, and a series of data revisions.

This decline in Equalization created concerns about the predictability and stability of payments—an issue that has become increasingly important for provinces as they attempt to maintain annual balanced budgets. The lower payments also raised concerns that the declines largely offset—for Equalization-receiving provinces—the positive effects of increased federal support for provincial health spending.

The decline in Equalization also generated renewed debate on three long-standing issues that have important implications for the size of Equalization payments and their distribution among Equalization-receiving provinces:

Concerns Over the Adequacy of Territorial Formula Financing

Concerns have also been expressed about the adequacy of Territorial Formula Financing. While the territories do not receive Equalization, they receive significant federal support through TFF.

Prior to 2004, the program was based on a formula that calculated the difference between an expenditure "base" and eligible revenues in each territory. This "gap-filling" approach to territorial funding recognized the unique circumstances facing territorial governments and the higher costs of providing public services in the North.

TFF was subject to a ceiling between 1988–89 and 2001–02 that limited growth in TFF grants from 1990–91 to 1993–94. The 1995 budget also imposed restraint on TFF with a 5-per-cent cut to each territory’s Gross Expenditure Base—the proxy for territories’ expenditure requirements in TFF. Subsequent growth in the program was based on these lower Gross Expenditure Bases.

Since this cut, territorial governments have been consistent in calling for restoration of funding. Territorial governments believe that their funding was subject to greater restraint measures than Equalization, and that TFF does not adequately fund their expenditure requirements.

October 2004 Changes to Equalization and TFF

In the wake of these concerns, a new framework for Equalization and TFF was put in place in October 2004, following the September 2004 health funding discussions among First Ministers. A key aspect of this new framework is that total payments for Equalization were increased by $2.0 billion to $10.9 billion in 2005–06. TFF was increased by $0.2 billion to $2.0 billion. These amounts were then legislated to grow at 3.5 per cent annually up to 2013–14. Establishing fixed amounts for these programs represented a marked departure from the long-standing approach of having overall payments determined each year by a formula.

In tandem with the introduction of the new framework, an Expert Panel on Equalization and Territorial Formula Financing was established to publicly review many aspects of the two programs. (The terms of reference of the Expert Panel are summarized in Annex 1.)

Since the results of the Expert Panel’s work would not be available for payments in 2005–06, a temporary formula for allocating the aggregate Equalization and TFF funding amounts among provinces and territories was adopted.

Most provinces, territories and the majority of academic experts in fiscal federalism have been critical of the move to a "fixed envelope" approach to these programs, arguing that the size of the programs would no longer automatically respond to changes in fiscal disparities.

The report of the Expert Panel on Equalization and Territorial Formula Financing will be released in spring 2006. This and other recently released reports including the report of the Council of the Federation Advisory Panel on Fiscal Imbalance, along with subsequent consultations with provinces and territories, will be critical elements in arriving at renewed, principle-based Equalization and Territorial Formula Financing programs.

Concerns Over Delays in Restoring Federal Support for Health Care

Federal, provincial and territorial governments have long shared the common goal of providing Canadians with high-quality health care. In addition to its own responsibilities in the area of health care, the federal government supports provinces and territories in the provision of health care through fiscal arrangements. Federal transfers support the Government of Canada’s commitment to maintain the five criteria of the Canada Health Act (comprehensiveness, universality, portability, accessibility and public administration), and the provisions discouraging extra billing and user fees.

Reductions in Federal Support

As part of overall fiscal consolidation, the federal government announced in Budget 1995 a 30-per-cent cut to its $18.7 billion in cash transfers supporting provincial and territorial health, post-secondary education, and social assistance and social services; it also restructured its funding into a single transfer called the Canada Health and Social Transfer (CHST).

These transfer cuts—amounting to $6 billion a year—were criticized as a unilateral offloading of the federal deficit onto provinces and territories. Pressure to restore transfers—and to put them back on a predictable long-term track—intensified once the federal government’s fiscal position began to improve.

Pressures to Increase Funding for Health Care

At roughly the same time, concerns began to emerge about the sustainability of the public health care system in Canada. Provinces and territories experienced mounting fiscal pressures due to rising health care costs, which began to crowd out other spending priorities. An aging population and the need for reinvestments after many years of restraint were also putting pressure on the health care system.

Widespread consensus emerged on the need for reform of the publicly funded health care system and new investments to support such reform. The federal government responded slowly by first stabilizing cash transfers in the late 1990s and then increasing them several times through the CHST. These increases were largely directed at health care support, including the 2000 Agreements on Health Renewal and Early Childhood Development, which provided more than $23 billion over five years to provinces and territories.

Growing Concerns Over the Sustainability of the Health Care System

While transfers were being restored, the question remained whether the federal contribution was adequate, particularly in the wake of continuing rapid cost increases. In addition, the issue of the sustainability of the public health care system was being questioned, particularly since provincial health spending was growing at 7 per cent or more annually. A number of provinces commissioned major reports on health system performance, reform and health care funding. The federal government, for its part, established the Commission on the Future of Health Care in Canada (The Romanow Commission), which consulted widely with Canadians, stakeholders and governments. (See Annex 1 for further details.)

In February 2003, following the release of the Romanow Report, First Ministers reached a new Accord on Health Care Renewal, which provided increased federal funding of almost $37 billion over five years in transfers and federal direct spending targeted to health. The CHST was restructured to create a separate Canada Health Transfer (CHT) and a Canada Social Transfer (CST) effective April 1, 2004, in order to increase transparency and accountability as recommended by the Romanow Commission.

While significant new investments were provided in support of the 2003 Accord, funding levels did not meet the financial benchmarks established by the Romanow Report. Pressure therefore continued on the federal government to close what became known as the "Romanow gap" in transfers.

Long-Term Predictable Funding

First Ministers met again in September 2004 to find a long-term solution to health care funding. Building on the earlier federal-provincial agreements and reports, First Ministers for the first time signed an agreement on health care reform, known as the 10-Year Plan to Strengthen Health Care. Federal cash transfers for health were increased by a total of $41 billion over 10 years. The CHT was increased to $19 billion in 2005–06 and an automatic annual escalator of 6 per cent was legislated.

The 6-per-cent annual escalator is higher than the projected growth in nominal gross domestic product (GDP) and reflects a reasonable estimate of the projected rate of growth in underlying health costs over the medium term. As noted below, the escalator means that federal support for health care will increase each and every year—about $1.1 billion in new funding in 2006–07, an additional $1.2 billion on top of that in 2007–08, and growing larger amounts each year for the balance of the Accord.

Beyond the CHT, the 10-Year Plan also provided targeted funding for medical equipment and long-term funding for wait times reduction. The funding attached to the Plan met and exceeded the benchmarks set out by the Romanow Report.

Chart 4.2 - Impact of 6-Per-Cent Escalator for CHT

Chart 4.3 - Federal Health Transfers Have Now Been Put Back on a Predictable, Long-Term Growth Track

The Shifting Focus of the Debate

Both orders of government have increased their financial support for health care well in excess of the growth of nominal GDP for a number of years. The federal government was able to commit to further growth of 6-per-cent a year over the life of the 10-year agreement because of the fiscal dividends associated with a declining debt burden.

Given the contributions by both orders of government, the focus of concerns regarding the future of health care is now turning from the respective contribution of each order of government to the implementation of the 10-Year Plan, and in particular to achieving measurable progress on reform and wait times reduction while ensuring that health care spending is managed efficiently. Cost increases that continuously exceed the growth of government revenues will eventually require governments to resort to tax increases, a move that could undermine Canada’s competitiveness.

Governments must work together to achieve the health system reforms identified in the 10-Year Plan, including reductions in wait times, primary care and home care reform and expanded catastrophic drug coverage, and to meet the targets identified in the 2004 Accord with respect to improved public reporting.

Concerns Over a New Mix in Federal Support for Post-Secondary Education

The federal government is a long-standing contributor to post-secondary education (PSE) in Canada. The system of universities and colleges that exists today reflects decades of collaboration and cooperation between the two orders of government.

As with health care, the federal government provides substantial support for post-secondary education through transfers to provinces and territories. These transfers traditionally accounted for a significiant proportion of federal support for post-secondary education, with the balance taking the form of direct support for students and research at universities.

As in the case of transfer support for health care and social programs, federal transfers for post-secondary education were also affected by the 30-per-cent cut in cash transfers announced in the 1995 budget.

Once the federal deficit was eliminated, transfer support to the CHST and its successor program, the Canada Social Transfer (CST), for post-secondary education and other social programs was increased—although most of the transfer increases in recent years were directed to health care. Recent federal investments in post-secondary education have been targeted to direct support for research at post-secondary education institutions, student financial assistance and training initiatives.

Increased Federal Support for Research

Canada’s overall investments in research as a share of the economy placed it in the middle ranks of Organisation for Economic Co-operation and Development (OECD) nations in the mid-1990s. Universities were facing reduced research budgets and a lack of adequate research infrastructure.

Since the deficit was eliminated, the federal government has increased its support for post-secondary education research, with nearly $11 billion in incremental funding. These investments have assisted Canadian universities in strengthening their research capacity and building a global reputation for excellence, which has helped reverse the "brain drain" and attract leading researchers to Canada. Canada now ranks first in the G7, and second in the OECD (behind only Sweden) in terms of research and development performed in the post-secondary sector as a share of the economy.

Increased Funding for University-Based Research Provided in Previous Budgets


   1998–
1999
1999–
2000
2000–
2001
2001–
2002
2002–
2003
2003–
2004
2004–
2005
2005–
2006
2006–
2007

  (millions of dollars)
Canada Foundation for Innovation1 30 115 185 230 325 350 265 430 430
Genome Canada1       43 60 85 82 90 85
Canada Research Chairs     60 120 180 240 300 300 300
Canada Graduate Scholarships 25 55 85 105
Medical Research Council of Canada/Canadian Institutes of Health Research 40 72 145 255 330 385 424 456 456
Natural Sciences and Engineering Research Council of Canada 71 111 118 118 154 209 248 281 283
Social Sciences and Humanities Research Council of Canada 9 26 38 58 67 82 94 108 88
Indirect costs of research       200 nil 225 245 260 260
Networks of Centres of Excellence 30 30 30 30 30 30 35 35
Tri-University Meson Facility 15 15 21 21 21 21 21 25 26

Total (annual) 165 369 597 1,075 1,167 1,652 1,764 2,070 2,068
Total (cumulative) 165 534 1,131 2,206 3,373 5,025 6,789 8,859 10,927

1 Amounts shown represent actual or anticipated spending flowing from the $3.65 billion invested in the Canada Foundation for Innovation, and $600 million provided to Genome Canada by the Government through previous budgets.

Source: Department of Finance Canada.

Increased Direct Federal Support to Students

In addition to providing increased support for research and human capital, new federal investments in post-secondary education have focused increasingly on direct support and tax measures to students and their families. In 1995–96, approximately $2 billion in direct support measures for post-secondary education was provided. By 2004–05, this direct support had grown to approximately $5 billion.

Federal direct support to post-secondary education students totals about $3.5 billion annually, including Canada Student Loans to some 330,000 students; non-repayable student financial assistance through the Canada Study Grants and Canada Access Grants; and measures to help students and families save for future education, including the Canada Learning Bond and the Canada Education Savings Grant. Over $1.5 billion in tax relief is also provided to help offset the costs of pursuing higher education, through measures such as the Tuition and Education Amount credits, and the Student Loan Interest Credit.

This increased direct support has helped Canada achieve the highest level of post-secondary education attainment among OECD countries: 43 per cent of Canada’s population aged 25-64 has some post-secondary education. For younger Canadians (25-34), this proportion increases to 51 per cent, again the highest in the OECD.

Change in the Mix of Federal Support for Post-Secondary Education

While the total share of federal support has remained relatively constant over time (at about 25 per cent of overall expenditures by post-secondary education institutions), the mix of federal instruments has changed. Today, a larger proportion of support is provided through direct measures than through transfers to provinces and territories. Federal cash transfers for post-secondary education—an estimated $2 billion of the CST—have declined as a share of total post-secondary education expenditures.

Chart 4.4 - Total Federal Support for Post-Secondary Education Has Been Relatively Constant since the Mid-1990s

Pressures on Post-Secondary Education and Training

During the 1990s, provinces also reduced their direct support for post-secondary education, resulting in an increased reliance of post-secondary education institutions on tuition fees. This change in the level and mix of support is now raising concerns over the need for renewed investments, necessitated in large part by increasing demand for post-secondary education.

As a result, there has been growing concern over the need for additional transfer support to provinces and territories for post-secondary education. Stakeholders have also pressed for a separate post-secondary education transfer to be created to enhance transparency of the federal contribution.

In addition, while progress has clearly been made in building a well-educated and innovative work force within Canada, gaps remain, and greater attention needs to be given to the full range of learning and training opportunities. Technological change is altering the level of skills required in many work environments, yet Canada currently has a lower rate of workplace training investment by firms and individuals than many of our competitors. Another important gap is in our support for the trades: young Canadians are often not encouraged enough to consider the trades, or unable to access this type of training because of financial barriers.

Concerns Over Federal Support for Infrastructure

Canada’s quality of life and economic competitiveness depend in part on having reliable, efficient infrastructure that is provided in large part by the municipal, provincial, territorial and federal governments. For example, a world-class transportation network is required for businesses to bring goods to market, both within Canada and abroad, and to meet the travel needs of urban and rural Canadians. Also, Canadians deserve and expect a high standard of basic services, such as clean and safe water to drink.

A Decline in Infrastructure Investments

While comparatively large infrastructure investments were made in the 1950s and 1960s, spending by all orders of government on public infrastructure as a proportion of GDP declined over the subsequent three decades.

While these declines in infrastructure investment were not unique to Canada, the country’s infrastructure has been showing signs of stress, risking tangible adverse economic and social impacts. For example, there have been instances where the deteriorating quality and insufficient capacity of public infrastructure, such as roads and water systems, has had a direct impact on the quality of life of Canadians and Canada’s ability to attract and retain businesses. As the state of their public infrastructure declined, Canadians had to endure longer commutes due to gridlocked highways. As well, continued rapid growth in trade has created congestion at Canada’s "gateways"—including major border crossings—constraining the country’s ability to increase its trade with the rest of the world.

Chart 4.5 - Investment in Public Infrastructure Has Been Declining as a Percentage of GDP

A Rebound in Infrastructure Investments

After the fiscal restraint of the mid-1990s, investment in infrastructure has begun to rebound. But it is clear that larger, ongoing investments in Canada’s infrastructure will be needed to build a stronger economic union, take advantage of opportunities abroad and enhance quality of life. The federal government, provinces and territories, cities and other communities each have important roles to play in this regard.

The federal government has historically invested heavily in infrastructure that falls under its areas of responsibility. This includes railways, marine facilities (e.g. ports and the St. Lawrence Seaway), airports and the air navigation system. Much of this infrastructure has been commercialized or privatized over the past two decades. This has resulted in better approaches to managing these assets and has promoted investments in line with users’ needs.

Increased Federal Support in Recent Years

Provinces, territories, cities and other communities are also responsible for major elements of Canada’s infrastructure, including highways and local roads, water and sewage systems, and urban transit. The federal government has provided these governments with financial assistance to help them meet their infrastructure responsibilities. This level of support has fluctuated over time, but has increased significantly in recent years.

Much of this support is being delivered through federal infrastructure programs:

A number of trade facilitation and security measures have also been put in place to ensure the seamless and secure movement of people and goods across the Canada–U.S. border, but additional investments will be required.

New Federal Support for Cities and Communities

Federal initiatives support cities and communities, which play a vital role in creating and maintaining well-functioning infrastructure:

Taken together, these federal investments in infrastructure are significant, but this funding needs to be put on a long-term track to allow for long-term planning, especially given the time spans involved in planning and building major infrastructure projects. Municipal governments are notably calling for a commitment from the federal government to continue its funding support for municipal infrastructure projects. There is also pressure for additional funding to provinces and territories for transportation infrastructure, particularly the National Highway System.

To ensure that Canadians get value for their governments’ investments in infrastructure, there is also a need to ensure greater transparency and accountability in relation to those investments—including a need for clarity in respective roles and responsibilities of all governments, as well as active collaboration and coordination of their investments.

Concerns Over Funding Arrangements Targeted to Address Specific Regional Needs

The confidence of Canadians in the overall fairness of federal programs has been undermined in recent years as the result of federal actions that were seen to be departing from the principle of comparable treatment of all Canadians and their provincial and territorial governments. In particular:

These actions were seen as a departure from the norm for federal programs: federal tax policies, direct programs and funding of shared priorities through transfers to provinces and territories are typically Canada-wide in nature and seek to address the needs of Canadians on as comparable a basis as possible in all parts of the country.

Targeting Federal Assistance on Needs

By their nature, the federal government’s Canada-wide programs focus on providing comparable support to Canadians. These programs inevitably result in some degree of inter-regional distribution between more prosperous and less prosperous provinces or regions. For example, the federal government raises more tax revenue in more prosperous provinces, and uniform Old Age Security pensions flow disproportionately to provinces with more elderly and low-income residents.

Comparability does not mean uniformity. The federal government is, like provincial governments, committed by subsection 36(1) of the Constitution Act, 1982 to "promoting equal opportunities for the well-being of Canadians," "furthering economic development to reduce disparity in opportunities" and "providing essential public services of reasonable quality to all Canadians." To address the sometimes very different situations of Canadians living in different parts of the country, federal support must sometimes be tailored specifically to those needs, often in collaboration with provincial and territorial governments.

In the case of federal financial support for shared priorities in areas of provincial responsibility—where needs are Canada-wide—the approach has been to make transfers to all provincial and territorial governments to enable them to tailor their programs to local variations in needs and priorities.

In other cases, federal programs target needs that are not Canada-wide in scope, but concentrated in particular regions or at particular times. For example:

 

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