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 withthe 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 2015population of 35.9 million

North-West Territories(1870) 0.1%

New Brunswick(NB) (1867) 2.1%

Nova Scotia (NS)(1867) 2.6%

Prince EdwardIsland (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

Governmental autonomy in Canada1

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”) governmentsalso 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%

Cana

da (2

008)

Switz

erla

nd US

Aust

ralia

Spai

n

Germ

any

Belg

ium

Aust

ria

Mex

ico

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%

Cana

da (2

008)

Belg

ium

Switz

erla

nd

Spai

n

Germ

any

Aust

ralia US

Aust

ria Italy

Mex

ico

Federal/Central

Provinces/States/RegionsMunicipal

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%20

1220

1020

0820

0620

0420

0220

0019

9819

9619

9419

9219

9019

8819

8619

8419

8219

8019

7819

7619

7419

7219

7019

6819

6619

6419

6219

6019

5819

5619

5419

5219

5019

4819

4619

4319

39

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)

Federalrevenues

transferred toprovinces andmunicipalities

Provincial andmunicipal

expenditures fundedthrough federal

transfers

The long history of that fiscal decentralizationand a limited dependence on federal transfers

The autonomy of Canadian provinces also reflects:

Provincial autonomy can also be seen in:

10

OtherUser feesResource/investment revenuesTransactions taxesProperty and wealth taxesConsumption taxesCorporate taxesPersonal income taxesPayroll 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

Cana

da

Belg

ium

*

Switz

erla

nd US

Aust

ralia

Germ

any*

*

Near-total control over the rates/basesof 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

Switz

erla

nd

Cana

da

Spai

n

Aust

ralia

Belg

ium

Mex

ico

Aust

ria

Germ

any

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


Fiscal disparities in Canada2

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

QCON BC

SK

Non-resource fiscal capacities

Natural resource revenues


PEI NS

NB

MB NL

AB

QCON BC

SK



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)

Overalleconomic

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 largestacross 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

2,0001,794

1,607

565 532 496

Switzerland Canada Australia US Germany

2 Fiscal disparities in Canada


Canada’s system of fiscal equalization3

Fiscal capacity and equalization, 2015-16(thousands of CAD per capita)

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



PEI NS

NB

MB NL

AB

QCON BC

SK

18

Moreover, its equalization “effort” has not responded tothe volatility of natural resource disparities over time

… since equalization transfers were repeatedly restructured to preempt large swingsin 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



19

In practice, reduction of fiscal disparities throughCanada’s equalization transfers has always been modest

… though Canada’s equalization “effort” has had a greater impact on reducing disparitiesduring 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

1,3881,268

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(thousands of CAD per capita)

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


Current equalization ($17.4B)


PEI NS

NB

MB NL

AB

QCON 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)

113107

117110

127103

8596

10368

0 25 50 75 100 125

PENBNSMBQUON

BCSKNLAB

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 forstandardized expenditure needs) across four

major expenditure categories*, 2009

Index (Canada = 100)

102106

9799

10797

95106107

101

0 25 50 75 100

PENBNSMBQUON

BCSKNLAB

… 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 debt2013-14

% of GDP

37%36%38%

28%

38%

17%5%

25%-3%

-10% 0% 10% 20% 30% 40% 50%

PENBNSMBQUON

BCSKNLAB

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


Canada’s system of fiscal equalization3

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?

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

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