1. Financing Federalism: The Canadian Experience
Bev Dahlby Department of Economics University of Alberta
and
Tony Morehen
Alberta Finance
Government of Alberta 1

2. Outline
Description of federal and provincial governments’ expenditure responsibilities and tax powers.
Description of the evolution of the federal-provincial fiscal arrangements since WW II.
Description of the main elements of federal grants to the provinces and tax collection agreements. 1

3. 13.2%
38.4%
9.9%
0.10%
0.09%
23.7%
0.13%
0.45%
1.7%
3.7%
3.2%
3.0%
2.4% 1

4. Federal Constitutional Responsibilities
Defence
Criminal justice
Old age security
Unemployment insurance
International trade and treaties
Regulation of trade and commerce
Aboriginal issues
Monetary policy 1

5. Provincial Constitutional Responsibilities
Education
Health
Social welfare
Civil law
Municipal government
Gambling, liquor
Natural resources (oil and natural gas, mining, and forestry) 1

6. Shared Constitutional Responsibilities
Income support
especially the Canada Pension Plan and Quebec Pension Plan
Environment
Law enforcement
Agriculture 1

7. Table 1
Table 1 shows the allocation of expenditures by the federal and provincial-local government sectors in Canada in 2002.
There are significant overlaps or interdependencies in the spending responsibilities of the two levels of government, e.g. Unemployment insurance (federal) and welfare (provincial). 1

8. Tax Powers
The federal government has the power to raise revenues “by any mode or system of taxation”.
The provincial governments are empowered to levy “direct taxation within the province.”
Provinces are not able to levy tariffs on imported goods.
This is the only effective constitutional limitation on provincial tax powers. 1

9. Table 2
Both the federal and provincial governments levy taxes on the most important tax bases:
personal and corporate income taxes, sales and excise taxes, and payroll taxes.
The provinces have exclusive control over property taxes and resource revenues, such as oil and gas royalties. 1

10. Major Provincial Tax Rates, 20031

11. The Federal Spending Power
The courts have determined that the federal government can offer conditional grants to the provinces to promote national programs in areas of provincial jurisdiction, such as Medicare, post-secondary education, infrastructure or labour market development .
This is referred to as the federal “spending power”. 1

12. Government Borrowing
The provincial governments can borrow to finance deficits.
The federal government is not responsible for provincial government debt.
Although there are annual meetings of federal and provincial finance ministers to discuss their upcoming budgets, budgetary policies (including borrowing) by the federal and provincial governments are largely uncoordinated. 1

13. General Characteristics of the Canadian Federal System
The provinces have extensive tax powers and jurisdiction in the most important expenditure areas--health, education, and social assistance.
There is a high degree of overlap in federal and provincial taxes and expenditure programs.
The federal government has the right to make grant to the provinces in areas of provincial responsibility. 1

14. Reasons for Federal-Provincial Fiscal Arrangements
Mismatches between expenditure responsibilities and the revenue generating capacity of the provinces
Unequal fiscal capacities among the provinces.
Federal government’s desire to promote expenditures in some areas of provincial jurisdiction.
Overlapping tax bases -- the need for harmonization. 1

15. Types of Federal Transfers to the Provinces
Block Transfers
Equalization Grants
The Canada Health and Social Transfer
Cost-Shared Grants
Labour market development agreements
Young offenders
Disabled persons
Farm disaster assistance
Detailed information available at: 1

16. History of Federal-Provincial Fiscal Relations
Taxation
Pre-World War II
a Royal Commission described the tax system as a ” tax jungle”
World War II
all income taxes transferred to the federal government
Post-World War II
Quebec opted to collect its own income taxes
tax collection agreements signed with the provinces
tax points transferred to the provinces 1

17. History of Federal-Provincial Fiscal Relations
Equalization
The equalization program established 1957.
The Constitution was amended in 1982 to require the federal government to make equalization grants to ensure that “provinces can provide reasonably comparable levels of services at reasonably comparable levels of taxation”.
Equalization grants are financed out of the federal government’s general revenues.
The program is renewed every five years and is scheduled for renewal in April 2004. 1

18. History of Federal-Provincial Fiscal Relations
Health, Education, and Social Assistance Transfers
Hospital Insurance Medicare, 1968
Canada Assistance Plan (welfare programs), 1966
Established Programs Financing (combined health care and post-secondary education grants and a tax point transfer), 1977
Canada Health and Social Transfer,
Canada Health Transfer (CHT) and Canada Social Transfer (CST), 2004. 1

19. The Equation for Calculating Equalization Grants
A province’s fiscal capacity is calculated using a “Representative Tax System.”(RTS)
A province’s equalization entitlement for a particular tax base is calculated as follows:
Eij = tsj(Bsj - Bij)
where Eij the per capita equalization entitlement for province i with respect to tax base j
tsj is the standard tax rate for tax base j
Bsj is the standard per capita tax base j
Bij is the per capita tax base j in province i
i = 1…10, j = 1…34 1

20. The Equalization Standard
A five-province standard is used to calculate the standard tax bases.
This is the average per capita tax bases in British Columbia, Saskatchewan, Manitoba, Ontario, and Quebec.
A province with deficient fiscal capacity receives a payment from the federal government equal to the sum of its Eijs over 34 revenue sources.
Provinces with adequate fiscal capacities (Ontario and Alberta) do not receive payments and do not directly contribute to financing the grants. 1

21. The Impact of Equalization on the Fiscal Capacities of the Provinces1

22. Problems with the Equalization Program
The federal government has imposed ceilings on entitlements and changed the formula for calculating the grants.
Variations in “fiscal need” are not taken into account, as in Australia.
The formula may affect the fiscal decisions of the recipient provinces:
rate equalization effect
base equalization effect
discourages development of resource projects 1

23. The Canada Health and Social Transfer (CHST)
The Canada Health and Social Transfer (CHST) was established in to provide block funding for provincial health, post-secondary education and social assistance programs.
It replaced the Established Programs Financing (health and post-secondary education) and Canada Assistance Plan (social assistance) programs. 1

24. How the CHST Works
The federal government arbitrarily sets the value of the cash to be transferred to the provinces.
The value of the tax points transferred to the provinces in 1977 is then calculated.
The total value of cash plus tax points is allocated among provinces on an equal per capita basis.
Each province’s cash transfer is equal to its allocation of tax plus cash minus the value of its tax points. 1

25. CHST Calculation for 2002-03 National Alberta’s CHST Grant
Cash $19.1 billion
plus
Tax Point Transfer $16.1 billion
equals
Total Entitlement $35.2 billion
Alberta’s CHST Grant
(based on Alberta’s 9.9% share of Canada’s population)
Total Entitlement $3.5 billion
less
Tax Point Transfer $1.9 billion
Cash Transfer $1.6 billion 1

26. Major Federal Transfers to the Provinces and Territories, 1982-2002

27. Federal Transfers to the Provinces and Territories, in 2003-041

28. Major Federal Transfers1

29. Federal Transfers as a Percentage of Provincial Revenues1

30. Recent Developments
The current CHST will be split into a Canada Health Transfer (CHT) and a Canada Social Transfer (CST), effective April 1, 2004.
The Equalization program ceiling was removed, effective
The total increase in federal transfers by $Cdn 20 billion over five years. 1

31. Tax Collection Agreements (TCAs)
Under the TCAs, the federal government collects personal and corporate income taxes on behalf of the provinces.
Quebec collects its own personal income taxes, while Quebec, Ontario and Alberta collect their own corporate taxes.
Federal and provincial personal and corporate income tax bases exhibit a higher degree of harmonization than in the United States. 1

32. Financing Local Government
Constitutionally, municipalities are “creatures of the province.”
Municipalities derive their revenue from municipal property taxes, transfers from the provincial governments, user fees, and business taxes.
Municipal spheres of jurisdiction
Safety, health and welfare of people
Protection of people and property
The enforcement of bylaws
Transport and transportation systems
Operation and maintenance of public places 1

33. Sources of Funding for Local Government1

34. Strengths and Weaknesses of the Canadian Fiscal System
Has allowed decentralization of tax and expenditure decisions, while maintaining comparable levels of public services and tax rates in spite of large variations in the fiscal capacities of the provinces.
Overlapping tax and expenditure responsibilities reduces transparency and the accountability of politicians to the voters.
Interdependencies can lead to negative fiscal externalities for other governments. 1