Budgetary Policy and Public Finance Instructor: Yulia Minaeva Winter 2012 PAP3355

PAP3355 – Week1 Introduction to Public Finance Public finance focuses on the taxing and spending activities of government and their influences on the allocation of resources and distribution of income. The government services in Canada are provided by three levels of government: federal, provincial, and local. Accordingly, both federal and provincial/territorial governments enjoy the power to decide their own budgets and levels of spending, taxation, and borrowing. It is a very fragmented system constituted by many governments, each with their own fiscal priorities and stances. This, however, is not to suggest that federal and provincial/territorial governments pursue fiscal policy completely independently of one another. Often they will attempt to coordinate their efforts, particularly in times of great economic crisis and instability.

PAP3355 – Week1 Introduction to Public Finance The federal government is a very complex financial entity. The federal government actually has two budgets that it makes every year: The Revenue budget: This budget concerns only government income, or how much money the government expects to collect over the course of the year. The Expenditure budget: This budget concerns only government expenses, or how much money the government expects to spend over the course of the year. The government’s budgets are not formulated solely on economic and fiscal priorities. The budgetary process is usually highly influenced by the partisan- political interests of the government, such as securing the support of Canadian voters. As such, annual budgets tend to represent a balance between the government’s partisan goals/constraints and its economic and fiscal strategy.

PAP3355 – Week1 Introduction to Public Finance The Government posted a budgetary deficit of $33.4 billion for the fiscal year ended March 31, 2011, compared to a budgetary deficit of $55.6 billion in Total revenues: $237 billion in Total expenses: $270 billion in Unemployment rate: 7.5% (December 2011). Monthly GDP growth: 0.0% (October 2011). Inflation: 2.9% (November 2011).

PAP Week1 Introduction to Public Finance Source: Public Accounts 2011

PAP Week1 Introduction to Public Finance Source: Public Accounts 2011

PAP Week 1 Introduction to Public Finance Source: Public Accounts 2011

PAP3355 – Week1 Introduction to Public Finance The accumulated debt-to-GDP ratio was 33.9 percent in The debt ratio is expected to decline to 29.7 percent in The OECD estimates recorded an average net debt of 71.4 percent of GDP in that same year.

PAP3355 – Week1 Introduction to Public Finance Source: Public Accounts 2011

PAP3355 – Week1 Introduction to Public Finance Source: OECD 2007

PAP3355 – Week1 Introduction to Public Finance Canada’s system encompasses all the elements essential to being a federation: - a constitutionally established two orders of government with genuine autonomy; - the division of powers between the two levels; - specified and independent revenue sources for each level of government; - mechanism for intergovernmental relations; and -representations of regions in central political institutions. -Federalism is based on the principles of autonomy, non-subordination, participation, heterogeneity, solidarity and interdependence between the two orders of government.

PAP3355 – Week1 Introduction to Public Finance Fiscal relations are shaped by the documents and conventional practices that together make up the Canadian Constitution.The constitutional allocation of powers affects fiscal relations in the Canadian federation in three ways: 1. The Canadian Constitution emphasizes exclusive fields of jurisdiction. 2. The Canadian Constitution gives the two senior levels of government full access to the most important and most broadly based sources of taxation. 3. The third important feature is the allocation of what is known as the spending power. The spending power has been a means by which the federal government has promoted a national approach to social programs, including direct payments to individuals and to organizations for redistributive purposes.

PAP3355 – Week1 Introduction to Public Finance The optimal federal state must achieve free major objectives: 1. It must create and maintain fiscal equity among all citizens of the federation and never just equity among subcomponents of the population. 2. It must be conductive to economic efficiency by allowing both people and capital complete freedom to locate in those part of the country where their contributions to national output are greatest. 3. It must ensure that the assigned fiscal responsibilities among national and regional governments represent a stable equilibrium arrangement.

PAP3355 – Week1 Introduction to Public Finance Important features of the optimal federal state: 1. The national government should control all stabilization policies (to stabilize economy, bearing on employment, inflation, etc), all income redistribution programs and policies, and all allocation policies (resource allocation) where the market failure problem is at a national level. 2.The regional government should engage only in allocation policies designed to resolve market failures occurring at the regional and local levels. 3. For optimal economic results taxation may be more centralized than expenditure. An argument for inter-governmental transfers to equalize fiscal capacity across regions.

PAP3355 – Week1 Introduction to Public Finance Advantages of a decentralized system: Tailoring government to local tastes – Preferences may differ across jurisdictions – Inefficient to provide everyone with the same level of public services if they have different preferences or needs – Lower level governments may also be more able to obtain information about peoples preferences Fostering intergovernmental competition – Decentralized system may provide greater incentives for policy-makers and government managers to produce efficiently – Citizens may be able to observe better performance in other jurisdictions – ‘yardstick competition’. Experimentation and innovation in regionally provided goods and services – A decentralized system may provide more opportunities for experimentation – Spillovers from successful experience and from innovation

PAP3355 – Week1 Introduction to Public Finance Disadvantages of a decentralized system: Externalities – The activities of one community can affect the welfare of people in other communities – Inefficient allocation of resources Fiscal competition – Horizontal -- Factor mobility - Sub-optimal level of provision of public goods Equity issues – May be difficult to implement income redistribution in a decentralized system if people are mobile across jurisdictions.

PAP3355 – Week1 Introduction to Public Finance Consider the following example of tax competition: -There is a single mobile factor of production, usually called “capital”, that is the single source of revenue for a government that provides a single public good or service. -Capital mobility implies that heavier taxation will drive capital to other jurisdictions, creating incentives for the government to limit the local tax burden. -Since capital taxation is the sole source of local government revenue, capital mobility limits government expenditure. - In this model, competition for mobile capital may lead to underprovision of public services ( “race to the bottom”) and can be harmful to economic welfare.

PAP3355 – Week1 Introduction to Public Finance Exclusive provincial jurisdiction: Anything local or private in nature Direct taxation Crown lands and natural resources Hospitals (health sector) Education Welfare Municipalities Local works Intraprovincial transportation and business Administration of justice Property and civil rights Cooperatives and savings banks

PAP3355 – Week1 Introduction to Public Finance Joint federal and provincial jurisdiction: Pensions Agriculture Immigration

PAP3355 – Week1 Introduction to Public Finance Peace, order and good government: Any form of taxation International/interprovincial trade and commerce, communications & transportation Banking and currency Foreign affairs (treaties) Militia and defense Criminal law and penitentiaries Naturalization Weights, measures, copyrights, patents First Nations Residual powers Declaratory power Disallowance and reservation Unemployment insurance and old age pensions