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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
Governmental autonomy in Canada1
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
Non-resource fiscal capacities
PEI NS
NB
MB NL
AB
QCON BC
SK
Natural resource revenues
Source: Finance Canada (equalization estimates) and author’s calculations
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
Governmental autonomy in Canada1
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
Natural resource revenues
Non-resource fiscal capacities
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
Natural resource revenues
Source: Finance Canada (Equalization estimates) and author’s calculations
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
Source: Finance Canada (Equalization estimates) and author’s calculations
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
Source: Finance Canada (equalization estimates) and author’s calculations
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)
Non-resource fiscal capacities
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
Governmental autonomy in Canada1
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
What are (or can be) the objectives of equalization systems?
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
What are (or can be) the objectives of equalization systems?
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?