Fiscal federalism and the equalization system in Canada: Lessons for other federal countries?

Fiscal federalism and the equalization
system in Canada
Lessons for other federal countries?
Presentation by David Péloquin in the conference
“Desafíos institucionales y económicos en países federales:
Los casos de Canadá y Argentina”
Embassy of Canada in Argentina and Fundación Dos Siglos, in cooperation with
the Universidad Nacional del Litoral (FCE-DAP) and Instituciones Regionales
Santa Fe (Argentina), March 29 to 31 2016

A quick overview of Canada
Provinces and territories
(date of entry into Confederation)
and % share of total estimated 2015
population of 35.9 million
North-West
Territories
(1870) 0.1%
New Brunswick
(NB) (1867) 2.1%
Nova Scotia (NS)
(1867) 2.6%
Prince Edward
Island (PE)
(1873) 0.4%
Newfoundland &
Labrador (NL)
(1949) 1.5%
Yukon
(1898)
0.1% Nunavut
(1999) 0.1%
Saskatchewan (SK)
(1905) 3.2%
Manitoba (MB)
(1870) 3.6%
Alberta
(AB)
(1905)
11.7%
Ontario (ON)
(1867) 38.5%
Québec (QC)
(1867)
23.0%
British
Columbia (CB)
(1871) 13.1%

Governmental autonomy in Canada
Fiscal disparities in Canada
Canada’s system of fiscal equalization
Lessons for others?
1
2
3
4
Outline of presentation

1

 The design of (foundational) Constitution Act, 1867 had envisaged:
 “watertight” federal and provincial powers (with few exceptions)
 dominant federal government (both fiscally and legislatively)
 In practice, Canada has evolved toward:
 typically overlapping (or “entangled”) legislative/regulatory and (especially)
spending powers
 joint occupancy of all major direct and indirect tax fields
 a relatively “equal partnership” of federal and provincial governments
(or a “vertical competition” between equally-matched competitors?)
5
Canada: a federation that is centralized in principle,
but not in practice

 A political system dominated by a powerful executive branch, with
limited “checks and balances” exercised by the legislative branch
… both at the level of the federal government and at the provincial level
 A high degree of autonomy exercised by both federal and provincial
(though not municipal) governments that is further reinforced by:
 insistent demands in all regions for significant provincial autonomy
 Canada-wide acceptance of the legitimacy of such demands
 broad consensus in favour of decentralization of both service delivery and the
system of government taxation and finance
6
Canada: a federation where all (“senior”) governments
also exercise significant autonomy

 Long history of uninterrupted self-rule from colonial times (1840s)
through to the present:
 provinces are Canada’s original political units and still command significant
(sometimes dominant) allegiance of residents
 provinces have very substantial policy and administrative capacity
 long-established habits of managing high provincial autonomy:
 inter-governmental compromise / accommodation / cooperation
 accountability to informed and engaged electorates and media
 provincial spending (and borrowing) closely tied to provincial taxation
7
Canada’s provinces have a “critical political mass”
that makes them particularly autonomous

The high degree of fiscal decentralization in Canada
Revenues by level of government,
selected OECD countries, 2005
(% of total government revenues)
46.2%
25.1%
20.2%
27.9%
21.8% 21.4% 24.0%
8.9%
15.6%
11.3%
11.7%
15.6%
14.1% 8.7% 7.8%
9.6%
43.0%
59.3%
65.7% 69.2% 69.5% 70.8% 71.0%
81.5% 83.3% 86.5%
2.9%
2.2%1.1%
5.0%
0%
20%
40%
60%
80%
100%
Canada(2008)
Switzerland
US
Australia
Spain
Germany
Belgium
Austria
Mexico
Italy
Source: OECD and Statistics Canada
Revenues by level of government,
selected OECD countries, 2005
(% of GDP)
16.8%
10.7%
7.3% 7.9% 7.5% 8.6%
5.5%
4.3%
2.2%
4.6% 3.1% 2.7%
4.2%
15.7%
31.6%
17.3%
25.1% 24.7%
21.3%
18.0%
35.7%
43.6%
16.5%
3.9% 4.6% 3.1%
0.9%
3.9% 2.2%
0.2%
0%
10%
20%
30%
40%
50%
60%
Canada(2008)
Belgium
Switzerland
Spain
Germany
Australia
US
Austria
Italy
Mexico
Federal/Central
Provinces/States/Regions
Municipal
8
The autonomy of Canadian provinces also reflects:

9
Source: Statistics Canada (Tables 380-0017, 380-0064, 384-0004, 384-0005, 384-0026, 385-0032,
385-0038 and published historical series) and author's calculations
The fiscal and budgetary weight of governments in Canada
(% of GDP)
Revenues
0%
10%
20%
30%
40%
50%
2012
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
1958
1956
1954
1952
1950
1948
1946
1943
1939
Provincial and municipal
(own-source revenues)
Federal
(revenues retained for own-purposes)
Expenditures
2012
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
1958
1956
1954
1952
1950
1948
1946
1943
1939
Provincial and municipal
(expenditures funded from own sources)
Federal
(non-transfer expenditures)
Federal
revenues
transferred to
provinces and
municipalities
Provincial and
municipal
expenditures funded
through federal
transfers
The long history of that fiscal decentralization
and a limited dependence on federal transfers
The autonomy of Canadian provinces also reflects:

Provincial autonomy can also be seen in:
10
Other
User fees
Resource/investment revenues
Transactions taxes
Property and wealth taxes
Consumption taxes
Corporate taxes
Personal income taxes
Payroll taxes
Own-source revenues of provinces / states,
selected OECD countries
(USD per capita at PPP)
** Shared revenues (payroll tax, personal income tax, corporate tax and VAT) treated as own-source.
Notes: * Shared revenues (personal income tax and VAT) treated as own-source.
Source: Published national data and author's calculations
0
2,000
4,000
6,000
8,000
Canada
Belgium*
Switzerland
US
Australia
Germany**
Near-total control over the rates/bases
of the own-source revenues they raise
… and their broad, diversified
access to all major tax fields
Source: OECD
Provincial/state own-source revenues by degree of
revenue-raising autonomy, selected OECD countries, 2005
(% of total provincial/state own-source revenues)
0%
20%
40%
60%
80%
100%
98.4%
60.1%
53.2%
20.7%
13.8%
38.1%
81.4%
25.2%
100%100%
7.2%
1.6%
52.8%
23.5%
58.7%
16.1%9.4%
89.8%
86.2%
46.8%
US
Switzerland
Canada
Spain
Australia
Belgium
Mexico
Austria
Germany
Italy
Restricted discretion on provincial/state rates and/or base
Full autonomy in setting tax rates and base
Tax sharing with split set with provincial/state consent
Rates/base/split set by central government

1
Fiscal disparities in Canada
2

In large part, these disparities reflect the significant revenues certain provinces can raise
from their natural resource endowments (and from oil and gas in particular)
Canada’s provinces have very unequal
revenue-raising capacities
0
2
4
6
8
10
12
Fiscal capacity, 2015-16
(thousands of CAD per capita)
0
2
4
6
8
10
12
Source: Finance Canada (equalization estimates) and author’s calculations
PEI NS
NB
MB NL
AB
QC
ON BC
SK
Non-resource fiscal capacities
Natural
resource
revenues
PEI NS
NB
MB NL
AB
QC
ON BC
SK
Natural
resource
revenues
12

Disparities track trends in economic development
(and especially natural resource) trends
… while the economies of the three
largest provinces continued their
long-standing relative decline
Provinces with substantial natural
resource revenues saw major
GDP gains in recent years
… and those of the other provinces
stabilized (after decades of
convergence)
Source: Statistics Canada (Tables 051-0001, 380-0056, 384-0001, 384-0014 and 384-0037) and author’s calculations
13

Disparities track trends in economic development
(and especially natural resource) trends
14
Looked at overall, economic disparities narrowed
through to the early 1990s, but since then the trend
has been toward increasing disparities…
… a pattern that is largely reproduced in overall
fiscal disparities (and in those attributable
specifically to natural resources)
10%
11%
12%
13%
14%
15%
16%
17%
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
Trend
(1991-present)
Overall
economic
disparities
Trend
(1961-1991)
Trends in overall economic disparities
(population-weighted average absolute deviation
of GDP per capita as a % of average GDP per capita
Source: Statistics Canada (Tables 051-0001, 380-0056, 384-0001, 384-0014 and 384-0037)
and author’s calculations
Decomposition of trends in fiscal disparities
(population-weighted average absolute deviation
of per capita disparities as a % of average GDP per capita
Source: Finance Canada (Equalization estimates) and author’s calculations
0%
1%
2%
3%
4%
5%
6%
7%
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
2011
Total fiscal
disparities
Resource
revenue
disparities

Its large disparities reflect both uneven natural resource endowments and the high proportion of
government spending financed through provincial own-source revenues
Fiscal disparities in Canada are among the largest
across OECD federations
15
Source: Individual country equalization calculations, OECD (population, GDP, PPP exchange rates) and
U.S. Census Bureau (2010 Survey of State and Local Government Finances) and author's
calculations
Pre-equalization fiscal disparities, selected federations
(population-weighted standard deviation in USD per capita)
0
400
800
1,200
1,600
2,000
1,794
1,607
565 532 496
Switzerland Canada Australia US Germany

2 Fiscal disparities in Canada
1
3

Fiscal capacity and equalization, 2015-16
0
2
4
6
8
10
12
Source: Finance Canada (equalization estimates) and author’s calculationsSource: Finance Canada (equalization estimates) and author’s calculations
Current equalization ($17.4B)
Even after equalization transfers, better-off provinces retain important
revenue-raising advantages that can reach CAD 5,000 per person per year
Through federal equalization transfers to provinces, Canada
(modestly) reduces the fiscal disparities among them
17
Natural
resource
revenues
PEI NS
NB
MB NL
AB
QC
ON BC
SK

18
Moreover, its equalization “effort” has not responded to
the volatility of natural resource disparities over time
… since equalization transfers were repeatedly restructured to preempt large swings
in equalization entitlements that could have undermined federal fiscal planning
Natural resource revenues and equalization transfers
(% of GDP)
Equalization transfers
have fluctuated within a
narrow range between
1972 and today
0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
1972-73
1974-75
1976-77
1978-79
1980-81
1982-83
1984-85
1986-87
1988-89
1990-91
1992-93
1994-95
1996-97
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
Equalization transfers
Natural resource revenues

19
In practice, reduction of fiscal disparities through
Canada’s equalization transfers has always been modest
… though Canada’s equalization “effort” has had a greater impact on reducing disparities
during periods (e.g. the 1990s) when resource prices (and disparities) were low
Pre- and post-equalization fiscal disparities over time
(population-weighted average absolute deviation as a % of GDP per capita)
1972-73
1974-75
1976-77
1978-79
1980-81
1982-83
1984-85
1986-87
1988-89
1990-91
1992-93
1994-95
1996-97
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
0%
1%
2%
3%
4%
5%
Pre-equalization
Post-equalization

In fact, only in very centralized federations (e.g. Australia) where the federal government is
fiscally dominant does “full” equalization seem achievable
Given its large disparities, Canada’s transfers achieve less
equalization than many other federations
20
Source: Individual country equalization calculations, OECD (population, GDP, PPP exchange rates) and
U.S. Census Bureau (2010 Survey of State and Local Government Finances) and author's calculations
Pre- and post-equalization fiscal disparities, selected federations
(population-weighted standard deviation in USD per capita)
0
400
800
1,200
1,600
2,000
Pre-Equalization
Post-Equalization
1,794
1,607
565 532 496
1,388
1,268
0
532
358
Switzerland Canada Australia US Germany

Increment to reach a
"10-province" standard
(+ ≈$11 B per year)
Fiscal capacity and equalization, 2015-16
0
2
4
6
8
10
12
Increase required to achieve
“full” equalization
( > $125 billion per year !)
Very large (i.e. fiscally centralizing) federal revenue increases
would be needed to achieve greater equalization
Natural
resource
revenues
Current equalization ($17.4B)
PEI NS
NB
MB NL
AB
QC
ON BC
SK

… though they are generally able
to finance those expenditures
with lower levels of taxation
Source: Finance Canada (Equalization estimates)
and author's calculations
Overall non-resource "tax effort“
(adjusting for standardized revenue capacity)
2012-13
Index (Canada = 100)
113
107
117
110
127
103
85
96
103
68
0 25 50 75 100 125
PE
NB
NS
MB
QU
ON
BC
SK
NL
AB
Better-off provinces do not
generally appear to offer more
generous expenditure policies
* Health; elementary and secondary education;
post-secondary education; and social services
Source: Mowat Centre and author's calculations
Overall "expenditure effort" (adjusting for
standardized expenditure needs) across four
major expenditure categories*, 2009
Index (Canada = 100)
102
106
97
99
107
97
95
106
107
101
0 25 50 75 100
PE
NB
NS
MB
QU
ON
BC
SK
NL
AB
… and are better able to avoid
levels of indebtedness that may
require higher taxes in the future
Source: Finance Canada (Fiscal reference tables), Statistics
Canada (Table 384-0037) and author's calculations
Provincial net debt
2013-14
% of GDP
37%
36%
38%
28%
38%
17%
5%
25%
-3%
-10% 0% 10% 20% 30% 40% 50%
PE
NB
NS
MB
QU
ON
BC
SK
NL
AB
50%
Given their post-Equalization situations, provinces need to
pursue different fiscal and budgetary policies
22

Provinces with large resource
endowments are often subject to
fluctuating debt levels, reflecting
volatility in commodity prices
… while debt burdens in other provinces have been converging
toward levels of around 40% of their GDP
• i.e., a level that (with other public debt and assets also taken into
account) remains modest by international standards
23
… though there are few signs of increasing “debt stress”
among provincial governments

2 Fiscal disparities in Canada
1
3
Lessons for others?
4

25
 They can improve “horizontal” fiscal equity, i.e.:
 the capacity of provinces to deliver “(reasonably) comparable levels
of public services at levels of taxation that are also (reasonably)
comparable”
 In this way, they may also enhance “vertical” equity…
…to the extent that more equal levels of services and taxation (across
provinces) improve income distribution (across citizens) or respond
to the needs of the most disadvantaged
What are (or can be) the objectives
of equalization systems?

26
 In principle, they can also enhance economic efficiency…
 i.e. to the extent they ensure that mobility of resources responds to
real differences in productivity (and to the real costs and benefits of
moving)…
… any not to the existence of fiscal and budgetary policies that are
more (or less) favorable due to accidents of history or geography

27
 They can reinforce provincial autonomy, given that:
 real autonomy requires that decisions on the level of provincial
spending and taxation be those of provinces themselves
 large, unequalized fiscal disparities can narrow the real range of
policy options open to them
 They can improve the outcomes of inevitable horizontal competition
between provinces in the areas of fiscal and budgetary policy
… i.e., by ensuring a level playing field that minimize the likelihood of
excessive provincial debt or taxation burdens

28
A federation’s actual equalization policies reflect:
 The value its society places on “fiscal equity” and on solidarity
 i.e. the possibility of offering ““(reasonably) comparable levels of public services
at (reasonably) comparable levels of taxation” in all its provinces
 The degree to which the federation is fiscally centralized and the scale
of the fiscal disparities across its provinces, since:
 the more provinces deliver public services that they themselves must finance, the
greater the fiscal disparities that may result
 the greater the fiscal disparities, the harder it is to achieve a high degree of
equalization
“Revealed” principles of equalization?

29
A federation’s actual equalization policies reflect:
 The extent of vertical “fiscal imbalance” between the federal and
provincial orders of government:
 the greater the federal government’s access to fiscal resources that it can share
with provinces, the greater its ability to achieve a high degree of equalization
through the mechanism of federal-provincial transfers
 The value accorded to provincial autonomy by its society:
 the greater the dependency of provinces on federal transfers, the less
autonomous they can really be
“Revealed” principles of equalization?

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