April 27, 2014
The Finances of the Canadian Federation
This Mowat Note uses refined methodology to look at how how regional redistribution is being carried out by the Canadian government, and to assess the net annual contribution Ontarians make to the federal government.
Canada has a deeply entrenched system of inter-regional redistribution. The system is designed to ensure that Canadians have comparable access to public services, regardless of where they live in the country. Because Canada is a federation and provinces are responsible for delivering most public services, achieving the goal of equitable access to programs and services requires a mix of federal transfers, both to provincial governments and to individuals, and direct federal spending. In theory, this permits equal access to public services across the country while maintaining the autonomy of provinces to manage their own programs.
It is to be expected that the taxpayers of different provinces will send different amounts of tax revenue to the federal government and that the federal government will return to different provinces—in the form of transfers and spending—different amounts. It would be expected that all provinces would see a “gap” between their contributions and receipts. This is the natural product of a system that includes policies of progressive taxation and redistributive spending. We would expect that the residents of more prosperous provinces would contribute more and receive less. This would be consistent with the principle that the federal government has a responsibility in its own programs and its relationships with provincial governments to ensure that all Canadians have access to comparable levels of service.
Throughout most of the post-war period in Canada, these mechanisms of federal spending and transfers led to this redistribution from more prosperous provinces to less prosperous regions. Ontario, Alberta and British Columbia residents would usually contribute more than they received, while residents of other provinces would receive more than they contributed. This was principle-based and a reflection of Canadians’ commitment to equality of opportunity and a desire to have comparable access to government programs and public services across the country.
Over the past decade, however, this principle-based redistribution is occurring less, with distinctive anomalies arising.
The explanations for these anomalies is clear: Saskatchewan and Newfoundland and Labrador have surging resource royalties, while Ontario does not. Because our system of fiscal federalism deals with resource revenue differently than it deals with other sources of revenue (i.e., the federal government has no access to revenue from these exclusively provincial assets, and only a portion of them are included in calculations of fiscal capacity), the major driver of current fiscal imbalances between provinces is not properly addressed in current policies. The result is Ontario—with below average fiscal capacity—supporting other provinces through inter-regional redistribution, while Saskatchewan and Newfoundland and Labrador—with above average fiscal capacity—are net beneficiaries of inter-regional redistribution.
This is not sustainable. Ontario spends less per capita than all other provinces, taxes at rates comparable to the national average, and yet has the highest deficit per capita in the country. The functioning of fiscal federalism contributes to Ontario’s deficit.
Our analysis suggests that while federal revenue collection is largely principle-driven and consistent across the country, federal spending patterns are not and help explain the continuing fiscal gap experienced by Ontarians.
The conclusions are simple. First, a reform of the Equalization program is necessary to better account for the major contributor to growing horizontal inequities in the country—the uneven distribution of natural resource revenue. Second, the federal government should adjust its spending patterns on major items—including labour market training, housing and infrastructure—many of which continue to have built in allocation formulae which presume that Ontario is more prosperous than other provinces and less in need of federal spending.
April 23, 2014