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The Fiscal Balance in Canada: The Facts

July 2002

Related document:

• Annex: Response to Conference Board of Canada Report on Vertical Fiscal Imbalance.

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The argument by provincial governments that the money is in Ottawa while the needs are in the provinces does not withstand the test of facts, or take into account the reality that sound fiscal management by the federal government through balanced budgets or better benefits all Canadians.

The fiscal balance debate is not new. In the early 1980s there was considerable debate as to whether there existed an imbalance in favour of the provinces. Eventually, the claims were dismissed, largely due to provincial arguments against the existence of a fiscal imbalance. To make this point, Ontario's 1982 budget quoted a study by the Economic Council of Canada, which stated:

Therefore, the key issue in this debate is whether both orders of government have access to revenue sources so that they can fulfill their responsibilities. A recent study by Norrie and Wilson^[1] makes the point that the distribution of taxation powers in Canada is unique - both levels of government do in fact have full access to all current major revenue sources, and therefore the traditional concept of a vertical fiscal imbalance does not apply to Canada.

Is the money in Ottawa?

Fact: Both orders of government have access to the same major revenue bases.

• Both the federal and provincial governments have access to all the major tax bases - personal and corporate income taxes, sales taxes and payroll taxes - and both can set their own tax rates (see Table 1).
• Provinces also have exclusive access to certain tax bases, such as resource royalties, gaming and liquor profits, and property taxes - some of which are growing rapidly.

Table 1
Access to diversified revenue sources

	Federal	Provincial
Common revenue sources
Personal income taxes	ü	ü
Corporate income taxes	ü	ü
Sales taxes	ü	ü
Payroll taxes	ü	ü
Unique provincial revenue sources
Resource royalties		ü
Gaming, liquor profits		ü
Property taxes		ü
Unique federal revenue sources
Customs import duties	ü
Taxes on non-residents	ü

• Compared to other federations, Canadian provinces have a very high degree of freedom to set their tax policies (see Chart 1). The new tax-on-income arrangement, introduced in 2001, provides provinces with considerable flexibility to customize their personal income tax systems to their own policy objectives.

• Total provincial revenues - that is, their own-source revenues plus federal transfers - have substantially exceeded federal revenues for more than two decades (see Chart 2).

• In 2000-01 total provincial revenues amounted to about $196 billion, including $29 billion in federal cash transfers, compared to about $179 billion in total federal revenues, or $149 billion net of cash transfers to the provinces (see Chart 3).

• Total provincial revenues are expected to continue to exceed federal revenues for the foreseeable future.
• As a result of the $100-billion Five-Year Tax Reduction Plan announced in 2000 and the recent economic slowdown, federal revenues are expected to grow by an average annual rate of only 1.9 per cent between 2000-01 and 2005-06. Federal tax cuts will total about $20 billion in 2002 alone.
• In addition, federal cash transfers to the provinces (that they can spend on their priorities such as health and education) are expected to grow at an average annual rate of 6.1 per cent between 2000-01 and 2005-06; that is more than three times faster than the expected growth in federal revenues (see Chart 4.1). This reflects recent federal investments in the Canada Health and Social Transfer (CHST) and continued growth of equalization payments to the provinces (see Chart 4.2).

Fact: The federal government's larger share of personal income tax revenues does not give it an advantage over provincial governments.

• Although the federal share of personal income tax collections is larger than that of all the provinces, it did not lead in the past to faster overall revenue growth. In fact, over the last 20 years provincial own-source revenues have increased faster on average than federal revenues (see Chart 5).

• Looking forward, personal income tax revenues will not be growing faster than revenues from other sources.
• More than three-quarters of the $100 billion in federal tax reductions is concentrated in personal income taxes.
• This includes the restoration of full indexation of the personal income tax system, reductions in tax rates, increases in income tax thresholds and increases in the Canada Child Tax Benefit.
• The full indexation will permanently reduce the growth of personal income tax in the future.
• The federal government will face continuing pressure to reduce taxes, particularly in light of the personal income tax cuts recently introduced in the United States. This is particularly a federal pressure because, for fairness and equity considerations, only the federal government can provide countrywide income tax relief that improves the standard of living for all Canadians, and not just those in more affluent provinces. For example, it is estimated that provincial governments in Ontario, Alberta and British Columbia reduced their taxes by about 30 per cent over the last six years, almost twice the tax reductions seen in the less affluent provinces.

Are the needs mainly in the provinces?

Fact: The federal government faces a much greater fiscal constraint than the provinces as a result of its debt burden.

• Debt charges consumed about 24 cents of every federal revenue dollar in 2000-01 compared to an average of about 11 cents for the provinces (see Chart 6). Thus, the federal government paid $42 billion in interest costs compared to about $22 billion for all the provinces combined.

• The federal government's higher debt burden reduces its fiscal room-to-manoeuvre when managing its own responsibilities and pressures, and makes it more vulnerable to volatility in global interest rates.

Fact: Both orders of government have key areas of responsibility and are facing growing demands on their resources.

• While the provinces face spending pressures mainly in the areas of health care and education, which represent a large share of provincial spending, the federal government has made significant reinvestment into both health and education through the CHST.
• Since the federal government balanced its budget, about 70 per cent of all new federal spending initiatives have been related to health care and education, including research and development and skills upgrading. This includes the $21-billion increase in the CHST over five years under the September 2000 health accord.
• The provinces have full flexibility to use federal transfers where they deem their priority pressures to be. Provincial governments are accountable to their citizens, not to the federal government, for how they use these funds.
• The federal government also faces growing spending pressures in other areas such as: elderly benefits, aboriginals, research and development, skills and learning and, more recently, security.
• The federal government is also the financial backstop in national or regional emergencies. For example, the 2001 budget provides $7.7 billion over five years to enhance security for Canadians following the events of September 11, 2001.

Conclusion

There is no evidence of a vertical fiscal imbalance in Canada.

• Provinces in Canada have the constitutional powers and independence to make their own choices about taxes, spending and debt, just like the federal government. Provincial governments have access to all the major tax bases and they are free to set their own priorities.
• The fact that virtually all provinces have chosen to reduce taxes in recent years implies that they believe that they have sufficient revenues to manage their spending pressures. Indeed, provincial tax cuts enacted since 1995 will reduce provincial revenues by about $19 billion this year.
• Sound fiscal management by the federal government through balanced budgets or better benefits all Canadians.
• Improving federal finances have helped maintain lower interest rates across the country. This benefits provincial governments, businesses and families.
• Only the federal government can stand behind nationwide programs and standards.

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¹

Kenneth Norrie and L.S. Wilson, "On Re-Balancing Canadian Fiscal Federalism," Toward a New Mission Statement for Canadian Fiscal Federalism, ed. H. Lazar, Institute of Intergovernmental Relations (Montréal and Kingston: McGill-Queen's University Press, 2000), pp. 79-98.   [Return]