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Response to Conference Board of Canada Report on Vertical Fiscal Imbalance

Related document:

The Fiscal Balance in Canada: The Facts.

The provincial and territorial Ministers of Finance commissioned the Conference Board of Canada to produce 20-year fiscal projections for the federal government and the aggregate of the provinces and territories. The resulting report shows large and growing federal surpluses over the next two decades while the provincial-territorial sector records small deficits. The report thus concludes that a vertical fiscal imbalance exists in Canada.

However, the Conference Board report does not prove the existence of a fiscal imbalance. A closer examination of the facts suggests that the results must be interpreted with caution.

Access to revenues: the key factor in assessing vertical fiscal imbalance

Although long-term fiscal projections can be useful in some contexts, they are not relevant in assessing the existence of a vertical fiscal imbalance because this is determined by access to the revenue sources required to meet expenditures needs.
The fact that both orders of government have access to all the main revenue sources required to fulfill their obligations implies that a vertical fiscal imbalance cannot exist in Canada, regardless of what surpluses or deficits are projected over the long term.

A flawed definition of vertical fiscal imbalance

The Conference Board report defines vertical fiscal imbalance as a situation where “the distribution of revenue resources between the federal and provincial/territorial orders of government is inconsistent with the cost of meeting their respective constitutional spending responsibilities” (p. 1).
This definition, when applied to Canada, is flawed since the “distribution of revenue resources” is not a constraint imposed on governments; this distribution can be modified by federal and provincial tax policy choices.
A recent study by Norrie and Wilson^[1] argues that both orders of government have full access to all major revenue sources and therefore the traditional concept of vertical fiscal imbalance does not apply to Canada.

Two Conference Board reports with conflicting results

Interestingly, the new report’s methodology and results are inconsistent with a previous Conference Board report^[2] - published in October 2001 - that projected that the provinces would record surpluses over the next 20 years under reasonable assumptions.

Long-term projections are extremely sensitive to the assumptions

The conflicting results between the two reports illustrate the fact that long-term fiscal projections are notoriously sensitive to the choice of assumptions.
A small change in an assumption can alter revenue or spending projections by billions of dollars over a 20-year horizon.
For example, if federal program spending were to grow 1 per cent faster each year than assumed by the Conference Board, the federal government would record a surplus of less than $2 billion in 2019-20, rather than the $85-billion surplus projected in the latest Conference Board report.
On the other hand, if total federal revenues were to grow 1 per cent slower each year, the federal government would record a deficit of $15 billion in 2019-20.
Because of the high degree of uncertainly surrounding long-term projections, governments must remain vigilant and not lock themselves into actions today based on projections that may not materialize in the future.

The federal government will not apply 100 per cent of its future surpluses to debt reduction

The Conference Board made the key assumption that the federal government will not introduce any new tax cuts or spending measures for the next 20 years, with all surpluses being earmarked exclusively for debt reduction. This assumption tends to inflate federal surpluses.
It is simply unrealistic to assume the absence of any new federal initiatives for two decades. For instance, federal tax cuts and spending initiatives implemented since the 1997 budget amounted to about $44 billion in 2001-02.
If none of these measures had been introduced and if all resulting budgetary surpluses had been applied to debt reduction, the federal government would have recorded a surplus of about $60 billion in 2001-02.
This unrealistic result illustrates the purely hypothetical nature of the Conference Board projections.

Limited federal fiscal room-to-manoeuvre over the medium term

In the short to medium term, where projections tend to be more helpful, the report shows only small federal surpluses, even before fiscal prudence is subtracted. This confirms the view that the federal government will have limited fiscal room-to-manoeuvre over the next five years.
In addition, over this period, federal cash transfers to the provinces are projected to grow at a faster rate than total provincial spending.
The new report also counters the provinces’ argument that federal revenues grow faster than provincial revenues. The report shows virtually the same growth rate for both orders of government.

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]

² The Future Cost of Health Care in Canada, 2000 to 2020. Conference Board of Canada, October 2001. The report can be accessed at http://www.conferenceboard.ca/press/documents/futurehealth.pdf.[Return]