Proceedings of the Standing Senate Committee on
National Finance
Issue 3 - Evidence - Meeting of October 3, 2006
OTTAWA, Tuesday, October 3, 2006
The Standing Senate Committee on National Finance met this day at 9:32 a.m. to examine and report on issues relating to the vertical and horizontal fiscal balances among the various orders of government.
Senator Joseph A. Day (Chairman) in the chair.
[English]
The Chairman: Honourable senators, I call this meeting to order. The committee will begin a new study this morning into the vertical and horizontal fiscal balance among the various orders of government in Canada. This is a timely study of an issue that is attracting more attention. We will build on our previous work on the equalization formula that this committee worked on in 2001-02. The report of the committee has been made available to all honourable senators.
We will begin with an overview of the current issues surrounding the horizontal balance, including recent developments such as the recommendations of the various expert and advisory panels, and the current state of intergovernmental negotiations.
I am pleased to welcome Professor Robin Boadway from the Department of Economics at Queen's University. Professor Boadway has degrees from the Royal Military College of Canada, Queen's University and Oxford University. He has taught at Queen's since 1973 and has taught at various institutions overseas. He is a fellow of the Royal Society of Canada and has an extensive list of publications and studies.
Welcome, Professor Boadway. Please proceed with your presentation, after which we will have questions from members of the committee.
Robin W. Boadway, Professor, Department of Economics, Queen's University, As an individual: Thank you, Mr. Chairman, it is a pleasure to appear before the committee again. As a federalism junky and student of Canadian federalism, I am happy that the committee is taking on this work. An earlier report on equalization is a fine example of a studied and balanced overview. I prepared a set of notes, which I hope are not too terse, that I will speak to briefly but I will begin with some general statements.
Fiscal balance is a phrase often heard in the news. It is the outcome of various aspects of the federation and its decentralization, the division of spending responsibilities, the division of revenue-raising responsibilities and the system of federal-provincial transfers, of which the Canada Health Transfer and the Canada Social Transfer equalization system, are the main components. Fiscal balance is not a precise concept. It refers roughly to the ability of each provincial government and the federal government to meet its respective responsibilities with the resources available to it in a way that accords with the objectives of the federation. One's view of fiscal balance depends on one's view of the desirable amount of fiscal decentralization, equity and efficiency in the federation, and the best way to achieve them.
The system of federal-provincial fiscal transfers includes both a horizontal and a vertical component. The horizontal component arises because equalization makes per capita transfers to the provinces that reflect their differences in abilities to raise revenue. The vertical component reflects the fact that all provinces, to some extent, obtain some of their revenues from federal transfers. It is important to note at the outset that both the CHT/CST and the equalization system contribute to horizontal and vertical balance in the federation. In the case of equalization, the horizontal component is explicit because this system distributes horizontally in favour of the recipient provinces. At the same time, equalization has a vertical component because it is financed out of federal general revenues.
Even if there were no social transfers, equalization would entail some vertical ``fiscal gap,'' as we call it. In the absence of the CHT/CST system, the amount of transfers required to achieve a given level of horizontal equalization would inevitably have to increase because provincial tax rates would be higher. The CHT/CST system has an obvious vertical component, but it is also equalizing. An equal per capita transfer, financed out of federal general revenues, implicitly transfers from provinces with high revenue capacities to those with lower revenue capacities. In that sense, equalization and the social transfer system are interdependent and jointly contribute to horizontal and vertical balance.
In my following remarks, I will concentrate mostly on equalization, but I will recognize implicitly that interdependence. I will begin with the basic principles of horizontal balance, although I apologize if this is well known to many members of the committee.
The issue of horizontal balance or imbalance is a consequence of the decentralization of fiscal responsibilities. Provinces have responsibility for providing public goods and services and for raising revenues to finance those services. Different provinces are inevitably left with differences in the ability to provide given levels of public services with the tax bases at their disposal. There are two reasons for viewing this as a problem. First, from a constitutional point of view, section 36(2) commits the federal government to the principle of providing ``reasonably comparable levels of public services at reasonably comparable levels of taxation.'' One might suppose that horizontal balance is achieved when the commitment to section 36(2) is fulfilled. Second, normative principles of public policy support the principles outlined in section 36(2). These principles can be best understood with the concept of Net Fiscal Benefits, a term used by the expert panel on equalization and territorial formula financing.
The NFB refers roughly to the benefits that a person obtains from public services relative to the taxes that he or she pays in their province of residence. If one is fortunate enough to live in a province in which a high level of public service is provided at relatively low tax rates, a purely fiscal incentive would exist for persons and businesses to move to that province. To the extent that this fiscally induced migration occurs, persons and businesses will be allocated inefficiently across provinces. Equally important, and perhaps more important, is the equity argument associated with differences in net fiscal benefits. Depending upon in which province they reside, persons in otherwise identical circumstances would be treated differently by the government. This violation of the equal treatment of equals, what economists refer to as horizontal equity, leads to fiscal inequity in the federation. Whether society views fiscal inequity as a problem depends upon one's values, in particular one's notion of social citizenship or social solidarity. If the sense of social citizenship applies at the national level, one would want to eliminate net fiscal benefits across the provinces nationwide.
The fact that section 36(2) hedges its bets by using the modifier ``reasonably,'' can be given various interpretations. Requiring only reasonable comparability across provinces reflects the fact that there may be conflicts between the principle of fiscal equity, which is found in section 36(2), and other competing principles. An important competing principle that we will probably talk about involves the provincial ownership of natural resources and the provinces' right to obtain revenue from them.
Reasonable comparability might simply reflect the fact that in the federal system provinces should have the discretion to choose their spending and taxing programs as they see fit. If one province prefers to provide a lower level and another a higher level of public services, or if one prefers a more progressive tax transfer system than another, net fiscal benefits for given types of persons can differ across provinces. To attempt to undo that through a system of federal transfers would violate the purpose of the federation.
The accepted compromise to this problem is to ensure that provinces have the potential to provide comparable levels of public services at comparable levels of taxation without compelling them to do so.
Affordability might preclude the federal government from engaging in policies that enable all provinces to have comparable capacities to provide public services. This is an issue to which I will return shortly.
Deviating from full comparability of fiscal capacity among provinces might be justified if so doing would lead to adverse incentive effects on provincial behaviour. This is a form of equity efficiency tradeoff. In the federation in which provinces make different fiscal choices, measuring differences in the capacity to provide public services is inherently ambiguous.
The implication of this discussion is that the concept of horizontal balance is inherently ambiguous, even if one takes a highly principled approach. Nonetheless it is worth looking where that principle will take us, even if there is bound to be some ambiguity.
Let me briefly outline sources of difference in fiscal capacity across provinces before turning to some key issues that we need to address. Provinces may not be able to provide comparable levels of public services at comparable levels of taxation for two main reasons. On the taxation side, they may not be able to raise comparable levels of tax revenue per capita using comparable rates of taxation. On the expenditure side, comparable levels of public services may require different amounts of per capita spending. If one were to fulfill exactly the terms of the commitment in section 36(2), one would want to focus both on the revenue raising side and on the expenditure side.
Provinces will have different abilities to raise revenues to the extent that the revenues they can obtain from applying comparable tax rates to their tax bases differ. The representative tax system approach used in the Canadian equalization system — the RTS approach — addresses these problems by including each tax base that provinces use separately in the equalization system and, for each base, measuring the ability to raise revenues by applying the average tax rate used in all provinces to the province's tax base. I hope you got all that.
In principle, this is a straightforward procedure, but in practice several issues arise. First, provinces define their tax bases in differing ways. Thus representative tax bases may be hard to define. Provinces may apply different tax rates to the same tax base even within their jurisdictions. Progressive income taxes apply different tax rates to different income levels. Property tax rates typically differ across communities depending upon property values. Provinces may be able to vary their tax bases with discretion, in which case incentive problems can arise. The case of resources is an example. In addition, in the case of resources, the quality of deposits for any different type of resource may differ, which means it may not be feasible for provinces to apply common tax rates to their resource deposits. There also may be various non- tax ways of raising revenues, some of which generate revenues that do not go into general revenues but are used for specific purposes.
Despite these problems there are reasonable ways of overcoming them and the Canadians RTS approach has been successful in doing so.
Differences in expenditure requirements can arise for two reasons. One is because different provinces have different needs for public services depending upon their demographic makeup. The second is that provinces may have different costs in providing public services because of differences in wage costs, for example, geographic differences and so on.
In Canada, we do not take expenditure differences into account explicitly in the equalization system, although we do take them into account from time to time in other transfer systems. It is widely recognized that incorporating expenditure requirements into an equalization system would be difficult. It is difficult to measure comparable levels of public services delivered across provinces when different public services are heterogeneous in quality and in cost. There is some suggestion that differences in need for public services are typically offset by differences in costs, as the Australian example indicates.
This has led most observers, including most recently the Expert Panel on Equalization and Territorial Formula Financing of the federal government and the Council of the Federation Advisory Panel, to recommend against using expenditure needs as a component of the equalization system.
In what follows I will stick to the revenue side in talking about horizontal balance. I will refer explicitly to the recommendations of the expert panel and the advisory panel. Both these studies are very competent, detailed and serious studies. Their recommendations are to be taken seriously, even though they differ somewhat in some instances.
As a way of perhaps focusing questions and discussion, let me list a number of key issues that arise in addressing the problem of horizontal balance and how the two panels have chosen to address them. First, there is the standard to which recipient provinces should be equalized. Both the expert panel and the advisory panel recommended a 10- province standard which is essentially equivalent to recommending that the fiscal capacities of recipient provinces be brought up to the national average. One thing that is important to note about the choice of a standard is that under an RTS system, if you move from one standard to another, if you move from a five-province standard to a 10-province standard to a top-province standard, if you like, basically you are increasing the equalization entitlements for all the recipient provinces by equal per capita amounts. You are not changing the horizontal balance.
The choice of standard in some sense, once we are in the RTS system, is really a choice of how high we should equalize recipient provinces relative to those not receiving full equalization. Equalization that satisfied fully the requirements of section 36(2) would require all provinces to end up with equal revenue raising capacities. That would be achieved by a top-province standard, which presumably would be very expensive. In a sense, the standard chosen reflects what the federal government decides it can afford. That is the first issue.
The second issue is the scope of revenues sources. The advisory panel recommended including all of the existing 33 revenue sources in the RTS formula as in the current system. The expert panel recommended using only five revenue sources. They are personal income tax, business income tax, sales tax, resource revenues and property tax.
There are various arguments for advocating this reduction to five revenue sources. The first is to simplify the system, the perception being that people will understand the system better if there are five sources rather than 33.
The expert panel also argued that some taxes lead to only moderate disparities, so it is not worth calculating them and putting them into the equalization system. Other tax bases were omitted because disparities are hard to measure or because provincial practices vary considerably so that the RTS system is difficult to apply.
The expert panel also recommended dropping user fees, since some proportion of them do not go to general revenues. That is the second issue. To what extent do we include all tax bases in the representative tax system as opposed to a selected number?
The most important difference between the two panels is the treatment of natural resource revenues, and the most contentious one I would say. The advisory panel recommended full inclusion of resource revenues using the representative tax system approach. The expert panel recommended including only 50 per cent of resource revenues, using actual revenues to calculate equalization entitlements rather than the representative tax system approach.
I will identify five main arguments for this special treatment of resources. The first one is the issue arising from provincial ownership of natural resources. Some argue that fully equalizing resource revenues is equivalent to taking away the property rights of these resource revenues from the recipient provinces. Against this is the counterargument that this would contradict the commitment of section 36(2), which does not distinguish among types of revenue. It might also be argued that equalization is not equivalent to taxing resource revenues and, if the ownership argument can be applied to natural resources, then it should also apply to all provincial revenue sources, which are equally in some sense the ownership of the provinces.
Affordability is the second argument. The ability of the federal government to equalize resources is said to be compromised by the fact that they do not have direct access to taxes on resources. This is a difficult argument to counter as well. The federal government does not have direct access to natural resource revenues, but it certainly has indirect access through its taxes on business and other taxes. Moreover, the fact that it does not obtain direct resource revenues does not preclude it from fully equalizing all provincial revenue sources in principle. To the extent that affordability is an issue, it is better addressed by adjusting the standard than by reducing the proportion of natural resources included in the formula. The latter affects the horizontal balance among recipient provinces by systematically discriminating against provinces that are resource poor.
Incentives is the third argument, being that provinces have a disincentive to develop their nature resources if the public revenues they get from developing those natural resources are implicitly taxed back by equalization. In judging this, it is hard to know how seriously to take it. There is no empirical evidence that the full equalization of natural resources that we have had for many years has induced provinces to restrict their resource exploitation.
The fourth argument is measurability. Natural resource revenues are much more heterogeneous than other tax bases. The different resource deposits are of different qualities and have different costs of extraction, so the ability to raise revenues using the royalty system varies from one deposit to another. This was the main reason the expert panel recommended in favour of using actual revenues as a basis for equalization, thereby departing from the RTS approach, simply because it was difficult to measure on a comparable basis a representative tax system for natural resources. While the use of actual resource revenues simplifies the system and addresses the measurability problem, it does so at the expense of introducing real incentive concerns into the system and virtually ensures that resources cannot be fully included in the formula. The RTS system attempts to deal with this problem by disaggregating revenue bases by type.
Finally, we have the cost of development. Some observers have argued that natural resources should have special treatment to recognize the fact that provinces incur some cost of developing them. The problem with this argument is that it is not restricted to natural resources. One can equally argue that provincial income taxes reflect provincial expenditures on education and health. Moreover, once one admits the cost of resource development as a consideration, there is no reason not to include other needs and costs in the equalization formula, that is, to go on to the expenditure side. If, as a matter of principle, equalization is to be based on a revenue raising ability, making piecemeal exceptions violates the principle in a discriminatory fashion.
In regard to the treatment of property taxes, both the expert panel and the advisory panel recommend the full inclusion of property taxes. The expert panel further argues that market values for property should be used and a stratified approach adopted to reflect the fact that properties of different values in different locations have different revenue-raising capacities. I find this to be an eminently reasonable suggestion.
I will make one notation about equalization of property tax revenues, and that is to note that in fully equalizing property taxes, as we do under the current system, the equalization system is implicitly treating both provincial and municipal public services in the interpretation of section 36(2). That is to say, recipient provinces should have the ability to provide comparable levels of both municipal and provincial public services to their residents. Doing so, of course, may require provincial and municipal equalization schemes, but neither panel deals with the issue of municipal financing. This point might be relevant in assessing the case for direct federal transfers to municipalities.
Turning to a few other points, the first being volatility, both the advisory and the expert panel recommended that equalization entitlements be calculated with a two-year lag, based on a three-year moving average. This is an eminently reasonable assumption to get around problems that have arisen in the past about the volatility of equalization entitlements from year to year and the recalculation of equalization entitlements after new information comes in.
On the issue of formula-driven versus discretionary principles, both panels recommend a formula-based approach to equalization, although the advisory panel suggests that, when affordability is an issue, it should be addressed by changes in the standard and should be negotiated with the provinces. In the past, especially the recent past, discretionary and ad hoc changes have been made to the equalization program in ways violated the principles of the representative tax system approach, and you are no doubt aware of the many examples. That makes the system less predictable for the provinces, introduces the perception of unfairness and undermines the integrity of the program with the public. This is avoided by insisting on a formula-driven approach, including for the aggregate equalization fund.
As far as equalizing elements in other programs, the expert panel recommends that equalization be achieved through the equalization program alone. I have a few comments here. As I mentioned before, it is important to realize that the CHT/CST system contributes in important ways to the objectives of section 36(2) and is also effectively equalizing. Equalization itself would be much more difficult to sustain were it not for the fact that the system of social transfers had a significant equalization component attached to it. It is the case, however, that other federal programs implicitly include an element of equalization that favour poorer provinces. Examples include the EI system, the infrastructure programs, immigration programs, various expenditures programs that are directed at particular reasons. Whether these ought to be treated as a matter to be addressed in the debate over fiscal balance is a matter for debate. One thing that should be kept in mind is that the distinction among equalization, regional development and interpersonal redistribution programs is that they all serve different purposes. The federal government has some constitutional responsibility for all of these three objectives and, in all cases, the outcomes are likely to be skewed heavily in favour of the lower income provinces.
Finally, and this is more your expertise than mine, turning to governance issues, the expert panel recommended that a process should be in place to improve transparency, communications and governance, but this should be done within existing institutions. The advisory panel recommended the formation of a first ministers' fiscal council to deal with intergovernmental fiscal issues and a Canadian institute for fiscal information to provide timely and accurate information. The concern is to make the process of decision-making with respect to federal-provincial fiscal arrangements more transparent and open and subject to public debate and scrutiny, and not subject unduly to short term budgetary considerations, while recognizing that fiscal matters are ultimately budgetary decisions.
I will leave that as my background statement. I apologize for it being hastily prepared, but this was set up at a fairly late date.
The Chairman: Thank you, Dr. Boadway. No apology is necessary. We appreciate your presentation and your document will assist us in our work. Your presentation has provoked some questions.
Senator Ringuette: Thank you for this very good document. You touched on the problem of the difference in cost to the different provinces in providing services to Canadians. There is certainly an economy of scale. How can we ensure that per capita transfers will be fair for the provinces and its citizens vis-a-vis equalization?
I am from New Brunswick where it is more expensive to provide services for the citizens because there are only 750,000 residents, many of whom are scattered across the province. It is decidedly less expensive to provide, for example, health care services in downtown Toronto where the economy of scale allows for larger hospitals.
You stated that it is difficult to look at the geography and the economy of the geography for the delivery of services. To what extent should we pursue this issue?
Mr. Boadway: This is an important issue, without question. You have only to look within the provinces to see how important an issue it is. The differences in the level of public services provided between rural and urban areas is much greater that the differences in the level of public services provided between rural areas in two different provinces or between urban areas in two different provinces.
It is a difficult problem that makes it difficult for provincial governments to determine how to finance municipalities within their jurisdictions. There are conceptually difficult problems associated with trying to incorporate cost elements into an equalization formula. Moreover, factors are working in opposing directions.
Certainly, there might be economies of scale associated with providing health services as well as other kinds of public services, which gives an advantage to provinces with more concentrated populations. However, differences in wage and property value costs across urban and rural areas make it more difficult to provide services in heavily populated areas than in lightly populated areas.
The evidence from Australia, which is the main country trying to equalize on the basis of cost and revenue, shows that these elements of need and cost tend to be roughly offsetting. The extent of fiscal disparities that arise from their calculations of expenditure requirements are much smaller than the disparities that exist on the revenue-raising side.
In a perfect world, you would want to equalize across provinces for differences in the cost of providing services and the differences in the need for those services. In practice, it is difficult to do that. It is also difficult to define the ``representative bundle of services'' that you would expect the provinces to apply, given that quality differences are important. The panels and many other bodies have recommended against taking that route not because it would be undesirable to do it but because it would be difficult to do it in a way that would inspire confidence in its accuracy.
Senator Ringuette: On the other side of the scale, should we question per capita based transfers?
Mr. Boadway: Per capita transfers, equalization in particular, are simply reflections of the fact that we are trying to equalize the amount of revenue that can be raised per person. It would not be clear how you would deviate from a per capita basis other than by bringing these expenditure differential needs into account. Simply, it is not clear which way you would deviate from the per capita basis and it is not clear whether the per capita cost of providing a given level of public services is higher or lower in Ontario than it is in New Brunswick, for example. Some people in Ontario argue exactly the opposite and say strongly that the cost of providing public services is higher in Ontario because wages and property values are higher and because it is more expensive to run public services in Metro Toronto than in Moncton.
It is not that per capita transfers are the ideal measure, in any sense, but rather that it is not clear which way to deviate from per capita transfers if you do not know how to calculate expenditure need differences.
Senator Ringuette: My last question is on the property tax issue. Based on the value of property, property taxes are collected by the municipalities, except for non-incorporated areas. I have some difficulty incorporating property tax into the formula because it is not revenue for the provinces, although some provinces delegate their social service responsibility to the municipalities. When you look at the overall picture and the inclusion of property tax, one would ask why we do not look at Canada's third, or municipal, level of government. Some property taxes collected by the provinces are being re-channelled to the municipal governments that bear more responsibilities than simply municipal infrastructures because they have social program delivery and social housing. If we were to include the property tax element in this scenario, why would we not include the municipal level of government?
Mr. Boadway: This is an important issue that can be answered on different levels. You need to ask yourself what you will include in the comparable levels of public services that are stated in section 36(2), which states that provinces should be required to provide comparable levels of public services at comparable levels of taxation. Would you include municipal services? In equalizing all of the revenue sources available to the provinces and their municipalities, you are implicitly saying that all public services are important whether they are provided by the provincial or municipal government.
In assessing that from a non-constitutional point of view, you should recognize that many of the services provided by municipalities are of province-wide importance, such as social services, housing, et cetera. I would suppose that you would deem those necessary to include under the purview of section 36(2). Once you go that route, it is hard to disentangle which public services you would like to include. You might decide that certain public services are important and should be provided by the municipalities while others are not so important. Then you will find yourself in a quandary because you will have to determine how much revenue provinces require to provide the public services that we think should be equalized, as opposed to the ones that we do not think should be included. You could not feasibly do that. From a practical point of view, it is not easy to separate the provincial from the municipal public services that you would want to include.
Property tax is not easily interpreted as a one-to-one tax for municipalities alone. In some provinces, property taxes have a provincial component and they are used to finance provincial public services such as education. Different provinces rely, to differing extents, on property tax for financing their municipalities. The difficulties in the property tax are not conceptual difficulties with respect to whether or not we should be equalizing them. I am convinced that municipal services are as important as provincial services, and provinces ought to be able to provide comparable levels of municipal services as well as comparable levels of provincial services. The issue that arises with property taxes is equalizing property taxes per se, which is slightly different from the conceptual issue of whether we should be equalizing property taxes.
Senator Murray: Professor Boadway has appeared before this and numerous other parliamentary committees on various pieces of legislation and policy matters. We have always appreciated his willingness to come and assist us in our deliberations.
I would like to start by discussing what I take to be the position of the Government of Ontario on some of these matters. Premier McGuinty has raised several issues, which I think tend to become confused in terms of media and perhaps public perception. The first issue he raised was the famous $23-billion gap; that is, the gap between the amount the money the federal government collects in revenue in the province of Ontario and the amount of money that the federal government puts into Ontario in various goods and services. As it turns out, the $23-billion gap is a function of the fact that the economy is stronger in Ontario and Alberta than it is in most of the rest of the country. A good 40 per cent of the gap, I seem to recall, is due to the fact that incomes are higher and therefore more money is contributed to the federal fisc from Ontario and Alberta. There is less unemployment and therefore less Employment Insurance money coming into Ontario, and so on, with other factors relating to the economy. They are not recipients of equalization as the other provinces. That is the $23-billion gap.
Where I thought he had a stronger case, and still does, was the fact that certain other provinces are better treated in terms of the federal-provincial arrangements relating to integration of immigrants. In addition, — and this is the point I come to now — in terms of the transfers for health and post-secondary education, when you take into account the equalization component of those transfers, Ontario and Alberta end up with less per capita cash than the other provinces. Mr. McGuinty has a case there.
The Premier's solution, if I understand it correctly, is to have a real equalization program to address the horizontal fiscal imbalance, but do away with what he calls hidden equalization; in other words, no more equalization component to federal transfers such as the Canada Health Transfer and Canada Social Transfer. What do you have to say about that?
Mr. Boadway: I agree with pretty well all that you say. I will just add a few extra words.
Ontario has argued rightly that there are certain instances in which discretionary changes to programs have been made in a way that favours some provinces relative to others, and Ontario is not very often in that situation. You mentioned the case of immigration, which is certainly true. Ontario is particularly concerned with special deals that were given within or beside the equalization formula with respect to offshore oil arrangements in Nova Scotia and Newfoundland and Labrador; with respect to the treatment of property taxes under equalization for British Columbia; and with respect to adjustments made for Saskatchewan through the budget concerning its resources. This series of special deals upset the Government of Ontario. Of course, these were small compared to the $23-billion gap that the Premier discussed.
There is also the issue of the way in which the social transfers are calculated. The problem of the social transfer issue was that the way these transfers were being calculated was not entirely transparent. The Canada Social Transfer and the Canada Health Transfer are essentially advertised as an equal per capita transfer among the provinces. However, for reasons having to do with history, the federal government maintained that part of the component of these transfers consisted of tax points that had been turned over to the provinces in 1977. When the EPF system was formulated, they turned over some personal income tax points and some corporate tax points and they started to calculate these tax point transfers. They continue to calculate those tax point transfers as part of their contribution to the social transfers.
This has led to various anomalies, one being the one to which Senator Murray refers, which is that these tax point transfers were equalized and were worth more to Ontario and Alberta than to the other provinces. As a result, in calculating the cash transfers these provinces received, there was some clawback taken because of the fact that the accounting showed them as having more tax point transfers.
Senator Murray: They were equalized for the poorer provinces.
Mr. Boadway: That is correct. There have been other anomalies that have arisen as a result of the way in which those tax point transfers were treated. For example, not wanting to offend anyone here, but in the 1994-95 budget when transfers to the provinces were cut back, the federal government calculated the cutback of those transfers as a percentage of their total payment to the provinces, which included the tax point transfers, whereas if they had calculated them solely on the basis of the cash transfer, the percentage would have been much higher.
The existence of these tax point transfers and their continual treatment as part of the contribution of the federal government to social programs has led to these ad hoc anomalies over the years, of which this particular one is an example.
Referring back a little to the first question, some people have actually argued that the CHT/CST transfers could be used as a way of achieving more equalization than we get under the current system. The current system of equalization, as you know, equalizes the have-not provinces up, but it does not equalize the have provinces down. Some people argue that is a shortcoming of the system and that we should find ways to equalize the have provinces down, in which case social transfers would be one way of doing that. I am not particularly in favour of doing that — it would be expensive to do — but if it were to be done, it should be done in a more transparent and formula-based way than the way it is being done now.
Senator Murray: What about the principled position of Premier McGuinty and the Government of Ontario that there should be one equalization program only and no equalization component to health, social and post-secondary education transfers? Does that make sense to you?
Mr. Boadway: It does make sense, with the proviso that I mentioned earlier, which is that the social transfers are parts of the equalization system. The social transfers are a form of equalization. They take general revenues from all provinces and they make equal per capita transfers, so they implicitly redistribute from provinces with higher incomes to those with lower incomes. One cannot avoid the fact that these social transfers are equalizing in that general sense.
That is not an answer to the question you are raising. The more fundamental question is: How much equalization do you think there should be in the system? How close should we get to the commitment outlined in section 36(2)? As I said, if one really wanted to take section 36(2) seriously, one would have to equalize down the have provinces as well as equalize up the have-not provinces.
My opinion on that should not hold any weight. That is a policy value judgment that Canadians have to make. I would only say that once you decide on how much equalization will be done, it should be done in as transparent a way as possible. I would support the Ontario government in suggesting that we think of the Canada Health and Canada Social Transfers as being transfers that are essentially designated for health, post-secondary education and welfare. Let us recognize that it is going to be difficult for us to measure the costs of health, post-secondary education and welfare to the provinces, so let us treat those as equal per capital transfers and have that as a separate program. Let us take our equalization program and decide how much we want to equalize. How much we want to equalize will essentially be reflected in the standard that we choose. If we want to equalize from the other provinces, let us just increase the standard.
Senator Murray: Let me approach this in another way. It has been shown to be relatively easy to articulate a number of principles behind equalization. To begin with, equalization should measure the relative fiscal capacity of provinces. To do that, there should be a 10-province standard, nothing less; and to do it properly and fairly, all revenue sources should be included in the measurement. There are other principles that one could mention. However, it is rather more difficult to articulate a set of principles for the Canada Health and Canada Social Transfers. I cannot think of a set of principles that one could articulate and implement. Can you?
Mr. Boadway: The decision about what principles to put into the amount of money allocated for the social transfer seems to me to be essentially a decision about how decentralized the federation should be. The choice is between giving equal per capita transfers as opposed to cutting back the size of those equal per capita transfers, turning tax points over to the provinces, and letting the equalization system take care of the consequences. I certainly have views about why we should not do that, why we should maintain the system of social transfers where they are now, given that the alternative is to turn over tax points to the provinces and keep the vertical balance the same, as it otherwise would be.
For example, reducing the size of the social transfers creates more fiscal capacity to differences across the provinces because it entails the provinces raising more revenues for their own requirements, and some provinces have better revenue sources than others. Reducing the size of the social transfers would put more pressure on equalization, would make equalization less affordable, and we would end up with a standard of equalization that is lower than we would want.
Another important problem associated with reducing social transfers and turning over tax points to the provinces is that it would make it much more difficult to maintain a harmonized tax system and it certainly would make it more difficult to introduce a harmonized tax system for sales tax, which many people think is one of the biggest sources of competitive inefficiency in the economy. We would also have to take a view about the proactive role that social transfers might have, which involves issues of spending power and so on, in addition to the two arguments that I have made.
The principles associated with the level of social transfers are ones that can be enunciated. They are not nearly as clear as the principles associated with horizontal balance because they do not have the analog of a section 36(2) to provide some guidance. Nonetheless, I think there are important principles at stake in deciding how much should be given to the provinces as equal per capita transfers, whether one labels it as a social transfer or whether it is just an equal per capita transfer that is relatively unconditional.
Senator Murray: It need not be tax points. There is cash.
Mr. Boadway: I am viewing the CHT/CST as essentially a cash transfer and setting aside the conditional aspect of it. From a purely fiscal balance point of view, what principles could be brought to bear which would argue for or against reducing the size of those cash transfers? My point is that reducing the size of those cash transfers could only be done in a system which rebalanced itself by having the provinces raise more revenues and rely less on transfers from the federal government.
I am suggesting that there would be some adverse consequences from doing that. One consequence would be that equalization would become much more difficult. Greater disparities would be created among provinces. Second, tax harmonization would become much more difficult. Third, for those have strong views about this, the federal government would have less spending power, less clout at the table and less influence over the way provinces deliver their programs. That would be a matter that would have to be debated.
Senator Murray: I was intrigued to see that the Cape Breton Regional Municipality is taking the Province of Nova Scotia to court, alleging that the Province of Nova Scotia has not remitted to the Cape Breton Regional Municipality Cape Breton's fair share of the equalization money that Nova Scotia receives from Ottawa. I was also intrigued to read somewhere that you had filed a brief on this matter.
I am not asking you to speculate on the outcome of this litigation, but perhaps you could indicate whether you believe this is a constitutional issue between the Cape Breton municipality and the Government of Nova Scotia or whether it is essentially a political issue.
Mr. Boadway: I am not a lawyer.
Senator Murray: However, you do know the difference between a constitutional issue and a political issue.
Mr. Boadway: Indeed. I should preface this by saying that my involvement in this was simply as an expert witness. I was asked to prepare a paper talking about the role of provincial and municipal equalization and how it fits into the general structure of equalization and how it fits into the federal equalization program.
As I understand the argument, the argument is based partly on section 36(1), as well as 36(2). The Cape Breton Regional Municipality is suggesting that the municipality is not getting enough revenues from the province to be able to provide reasonably comparable services to their citizens as other jurisdictions within the province. It is really an issue of whether the wording of section 36(2) is something that is relevant across municipalities as well as across the provinces.
What I am saying here has nothing to do with that case because I do not know that I have a strong opinion on it. Section 36(2) provides an obligation to the federal government; that is, a commitment imposed on the federal government. Section 36(1), on the other hand, is a joint obligation between the federal government and the provinces. I do not have the exact wording in my mind, but section 36(1) commits the federal government and the provinces to providing essential public services to all citizens, to providing equality of opportunity, and to pursuing regional development. My understanding of the Cape Breton Regional Municipality case is that the municipality is arguing that the province of Nova Scotia is not living up to its commitment under section 36 to pursue these objectives. As part of that argument, it is using the fact that the federal equalization system does explicitly include provincial services in it — in particular, provincial property taxes — and any provincial taxes that go to finance municipal services. The second part of the argument is that there is an equalization system in most provinces and, in particular, in Nova Scotia. Their claim is that this equalization system under-equalizes the municipality relative to other comparable municipalities. Whether or not they have any chance, I am not prepared to say. As an economist, it is a lovely economic objective to pursue the principle of communities being able to provide comparable levels of public service at tax rates. What obligation that imposes on a provincial government in designing its equalization, however, goes beyond economics.
Senator Eggleton: As you point out, neither the expert panel nor the advisory panel dealt with municipal financing. The municipalities, in arguments similar to what we hear from provinces these days, say they have responsibilities that are not matched by the revenues, whereas they say the federal government has more revenues than it has responsibilities. The same argument is given by municipalities, namely, that the upper levels of government have the revenues but they have a lot of responsibilities and they do not have sufficient revenues to cover them.
How might we at the federal level be dealing with that issue? I know there are constitutional challenges in all that, but those public services that are provided at the local level are every bit as important as the other services. People living in communities want the roads maintained, the water distributed to their homes, the fire department, the police department, the garbage pickup, and all those essential public services. Why would not they come into play here? Why should they not be part of all this? In what ways could we do that?
Mr. Boadway: In principle, these cities have a good argument. There is some evidence of some vertical balance problem for the municipalities relative to the provinces. A consequence of the restructuring done in the 1990s was to squeeze municipalities. In Canada, we have among the highest property tax rates especially on businesses in the OECD. This is some source of a competitiveness problem for businesses and some source of problem for the cities.
What can the federal government do about it is really difficult, given the hierarchical structure of government in Canada. The question is whether the federal government should deal directly with the municipalities or deal through the provinces. In principle, the issue of financing municipalities is part and parcel of the issue of vertical balance between the federal government and the provinces. If the provinces have less money, they will have less money to turn over to municipalities.
The issue of accountability is an important issue here. The role of the federal government in terms of dealing with municipal problems on a one-to-one basis is a very difficult role. In principle, you could argue that if the federal government wants to make transfers to the municipalities, it could do them by a mechanism similar to the mechanism that it uses to give support to the health system. That is, some kind of transfer to the provinces that has conditions attached associated with using them for the provinces, with suitable opting out conditions.
The issue of how to encourage municipalities to do things or whether you really must do things to put more money into the municipalities is quite a difficult issue. I am not sure that I have a clear view on this. My instinct is to say that accountability and everything else will work better if the provinces are responsible for dealing with municipalities rather than the federal government. However, if affordability is an issue and if what the municipalities are doing has nationwide consequences, the federal government has an interest in what goes on in those circumstances by virtue of section 36(1). An example is the dynamic metropolitan Toronto region that presumably has benefits for the rest of the Canada and in which the federal government has an interest. Maybe the more appropriate way of dealing with those issues would be to deal with them via a system of transfers to the provinces rather than directly to the municipalities. I would say the same for federal direction intervention in many other areas like post-secondary education. We would be better off if the federal government did those via transfers to the provinces and let the provinces be responsible for their universities rather than the federal government getting directly involved in micro managing projects at the municipal level. I am not an expert on governance and I am thinking of it from a fiscal and accountability perspective.
Senator Eggleton: I understand the answer. If this was to come into the equation — after all, it is one taxpayer and it is a series of public services that are important to that same taxpayer — you would see it as transferring to the provinces to keep the constitutional framework in place, with some conditions that are relevant to the municipalities and to go to the municipalities?
Mr. Boadway: There are nations that have systems whereby the national government makes project-specific transfers to municipalities. I am thinking, for example, of Japan or some of the Scandinavian countries — that is, unitary states that nonetheless have different levels of government for administrative points of view.
One thing that you must worry about when the federal government gets involved in making project-specific transfers to municipalities or dealing directly with the municipalities because they have financial constraints, is the issue of what is referred to as soft budget constraint. Once the federal government gets in the business of thinking itself responsible for making direct payments to the cities, you have to worry about the discretionary use of that kind of power leading to problems of soft budget constraints, if you know what I mean by that term. That is, the perception by the cities that the more they make themselves in need of money, the more they will get from another government, including the federal government. That was a big concern that economists had with some of the special deals made on the East Coast. There was this concern that the explicit reason for doing that was ``to bail out the province from its debt.'' Economists worry that once you go down that route, it is a self-perpetuating thing.
There is danger of the federal government starting to get it directly involved with municipalities who are short of funds, leading in the long run to some kind of self-perpetuating system. I would find it much cleaner if federal transfers to the municipalities were first done through the provinces and, second, kept on a formula-based, non-discretionary set of principles.
Senator Eggleton: You mentioned Japan. What is done in Australia or the United States?
Mr. Boadway: In Australia and the United States, it is like the Canadian system, which is a hierarchical system, where the states are responsible for the cities within their jurisdictions, both in Australia and in Canada.
The Chairman: You talked about transfer of tax points. Could you explain how that works?
Mr. Boadway: The principle is simple. A transfer of tax points is an implicit agreement between the federal government and the provinces, whereby the federal government says it will reduce its federal income tax rate by 5 percentage points, and the provinces can, if they want, raise their rates by 5 percentage points, and if they do, the taxpayer is equally well off one way or the other. Therefore, it is an offer made to the provinces saying, ``We will explicitly reduce our tax take by 5 per cent, giving you the opportunity to raise yours by 5 per cent,'' which they do not have to take.
The Chairman: The province does not have to take that up?
Mr. Boadway: No, because they have discretion over their tax rate in any case, so a promise would not mean much.
The Chairman: When the federal government reduces its tax rate without making any offer, the opportunity is still there for the province to pick up the slack. What is the difference?
Mr. Boadway: The issue arises, essentially, in the case where the federal government and provinces are tapping the same tax base. For example, when the federal government reduces its GST rate from 7 per cent to 6 per cent, that is not thought of as being a tax point transfer because the provinces do not levy GST. They cannot come along and do the equivalent by raising their tax rates. However, in the case of income taxes, that is the only area where tax point transfers make a lot of sense because they are both tapping the same base, and there is a formal tax collection agreement that means that, for most provinces, they are using exactly the same base and same collection machinery. It is simple for the feds to reduce their tax rate and for the provinces to increase theirs under the existing system.
Senator Fox: I do not quite understand your point. If the federal government reduces the GST by 1 per cent, the Province of Quebec or the Province of Ontario could raise its sales tax by 1 per cent. What is the difference?
Mr. Boadway: No question they could, but Quebec is an exception because it has a harmonized sales tax system, so raising the tax rate by 1 per cent would be roughly equivalent to the federal government reducing its by 1 per cent. However, in the case of Ontario, a 1 percentage point reduction in the GST does not translate into a 1 per cent increase in the provincial retail sales tax because their bases are quite different.
Nonetheless, I take your point. It is certainly true that any time the federal government reduces its tax rate, the provinces could always come in and increase a comparable tax rate, and the taxpayer would be more or less in the same situation.
Senator Mitchell: The provinces, in an ideal world, from their perspective, would like the federal government to collect all the taxes and give them all the money. That is why they do not particularly like tax points and why they have forgotten or tend to not acknowledge the fact they have been given tax points in the past with respect to the social and health transfers. Is that right?
Mr. Boadway: Yes.
Senator Mitchell: Maybe this is more pejorative, but it is probably true they tend not to acknowledge that as a transfer of money. It is more of a problem because of the inequality it creates or they would see it creating.
Mr. Boadway: Tax point transfers in 1977, at the time, were done under a sort of bigger package which reformed the transfer system, and viewing those tax point transfers as part and parcel of that deal was certainly sensible at the time. However, 30 years down the road, thinking of those tax point transfers as still consisting of federal contributions to provincial programs probably does not have a lot of substance to it. That is really all we are saying.
Senator Mitchell: Is there an inherent accountability issue if you have one level of government collecting taxes and another level of government spending it, or is that not a huge issue even in this era of accountability concerns?
Mr. Boadway: This is certainly a big point that comes up every time one talks about the vertical balance. A substantial group of people argue that any money that provinces do not raise from their own sources will reduce accountability, that they will somehow treat that money as different from money they got on their own from the federal government.
I am a bit skeptical about that point of view as a raw point of view. I do not see the difference it makes to the Province of Ontario, for example. Ontario has a retail sales tax with a rate of 7 per cent that has not changed for a long time. The amount of money that it gets from that provincial retail sales tax comes into its general revenues, and the province does not use it for fine-tuning anything. The province presumably spends that money out of general revenues on programs that it is accountable for to the electorate. Why they would be any less accountable for moneys that come in that they would get directly from the federal government on a formula-based approach has never been completely clear to me, but it is certainly an argument many people use.
Senator Mitchell: One of the most or least fortunate aspects about federal-provincial relations is that often provinces use this idea of federal intervention or fiscal imbalance as a lever in currying political favour in their own jurisdiction and, essentially, attacking the federal government to do it. It is interesting that that is muted often from the West when we get a Conservative federal government, and it is not therefore government related but more party related.
In Alberta, when the federal government says ``fiscal imbalance,'' it is often interpreted to mean ``they are coming to get our money.'' In the case of equalization, it is not as though the federal government asks the premier of Alberta to write a special cheque and hand that money to several other provinces. It is rather that the federal government raises taxes in each province — certainly, in Alberta — and some of those taxes are mine and some of that money goes to other provinces to assist them in being raised to national standards or some facsimile of them. Many of us in Alberta, for example, are quite happy to do that.
Mr. Boadway: There is no question that equalization is a federal expenditure program financed out of federal general revenues. It is not a program that explicitly takes revenues from one province and gives to another. No doubt, as you mentioned, on average, the funding for equalization comes from provinces that have higher federal tax bases, but it is not a program that explicitly transfers from one province to another province.
Senator Mitchell: Roger Gibbons of the Canada West Foundation has written in a speculative way that the huge, disproportionate wealth of a province like Alberta and, we hope, one day like Newfoundland, Nova Scotia and others, would, in a sense, not create jealousy, but it can create jealousies across the province.
First, have you given thought to that as a possibility? Second, is there a body of literature or study or suggestion of ideas where a province like Alberta could in creative ways contribute to the rest of the country that would help the rest the country but are also for Alberta's own good? I am thinking, for example, that Alberta takes huge portions of the workforce of the country, many of whom are trained tradespeople, and perhaps it could assist other provinces in training those people in their jurisdictions because eventually it would benefit those provinces and benefit Alberta.
Mr. Boadway: I think the problem we are facing with horizontal imbalance between Alberta and rest of Canada is unprecedented. It is not clear how the fiscal transfer system can deal with it very well.
The problem goes beyond the fact that Alberta is becoming much richer relative to the rest of the provinces. It is not simply the fact that they are getting all this money. What some people worry about is how this will impact on the industrial structure of the economy and on the viability of some of the other regions.
The potential for Alberta to use the vast amount of money it is getting from its natural resources to explicitly engage in really significant province building, which would be something that many people are advocating, has implications for the rest of Canada that I do not think people have thought through carefully. It goes much beyond the issue of horizontal or vertical balance. This is something that could affect the industrial structure of Canada, resources versus manufacturing; it could affect the viability and the growth potential for other provinces that are losing the best and the brightest of their young people, who are going to work in Alberta.
It is not hard to think of the big boom in Alberta as being a mixed blessing. People are going to Alberta and other regions are losing their best people. The other regions are suddenly facing ageing populations and all of the young workers have gone to work in Alberta. All the money in Alberta is being used to build up other industries, infrastructure, and human capital investment and so on. This is unprecedented and I do not think we have thought it through very carefully.
Senator Mitchell: We have to give it thought. There is no question.
Senator Fox: Every time we delve into a subject in any depth, it gets to be more complicated and complex than we initially thought. Having surfed on my television set on Saturday night, late at night I found the retransmission of these committee hearings on Bill C-2, which I thought would be interesting. However, from that anecdotal experience, I wonder what, if anything, people who are listening to us here this morning will gain in their understanding of fiscal imbalance.
When I think of the fiscal imbalance, I think of my own personal experience at the PMO in dealing with the question of equalization with the provinces and the changes that were made over the past couple of years. Then I think, more specifically, of what the average Canadian hears.
What the average Quebecer has heard that the Seguin report established that there was a fiscal imbalance of $2.4 billion. It would take $2.4 billion in additional transfers to Quebec in a given year to correct the fiscal imbalance.
What I hear from Mr. McGuinty, in terms of numbers, is just as eloquent — that Ontario pays $23 billion more into the pot than it receives back from the federal government. Therefore, there is a fiscal imbalance there.
I am not sure what the average Canadian should think about this. Perhaps you can tell us whether you think there is a fiscal imbalance or whether that is a question one can answer. Is it something that will be with us until the end of time? As pressures build for greater funding by the provinces, they will always say there is a fiscal imbalance, but start with that question.
Mr. Boadway: This is a very difficult question. Not to deflect it, but getting too hung up on whether or not there is a fiscal imbalance may not be the most productive thing to do. The issue is which government should be responsible for doing which things and which government should be responsible for raising which revenue. To me, the issue of fiscal balance is really more an issue of how much decentralization, in particular of revenue raising, would we like to see in our federation.
I do not think there is any doubt that at the time that the Seguin commission report was written, immediately following the drastic changes that were implemented in the 1994-95 budget, that a situation was created which was completely different from the year before. Suddenly the provinces woke up and they had a lot less transfers from the federal government.
Given the fiscal structures in place at the time that change was made, there was a fiscal imbalance in the sense that suddenly they had less money and something had to be done about it. The Seguin report argued that what has to be done about that is we have to prevent that from happening again. We have to reduce the amount of transfers that the federal government makes to the provinces.
They argued that for two reasons: first, it was a way of adjusting to the initial impact of the big change that occurred in the 1994-95 time period, when they lost all those transfers. However, they also argued there had to be a more fundamental rebalancing of the federation, that they had to be given much more responsibility for raising their own revenues than had existed in the past.
I interpret the Seguin commission as not simply addressing the temporary imbalance that occurred as a result of those big transfers. I do not think anybody can doubt that some adjustment had to be made at that time. However, they were also saying that in order for this not to happen again, we have to take away from the federal government, as much as possible, the right to make transfers to the provinces or the need to do that. All we want to do is leave them with the responsibility for equalization. That was one way of addressing the issues that came out of the 1994 budget.
The other way of addressing them is to say there are some reasons why we might want the federal government to make transfers to the provinces over and above what they require for equalization. Let us put in place a structure that prevents them from doing it in a way that they did in it the 1990s, that somehow ties them down to a formula-based approach that requires them to consult with the provinces, that has a more open process, that does things in a more cooperative way.
I think that the debate after the 1994 budget, and when all of the small, ad hoc discretionary changes were made in the meantime, was as much about re-establishing a level of cooperation and trust. You really have these two things. Is the only way we can run this federation on a long-term basis by insisting that provinces have more revenue raising so that the federal government cannot, any time in the future, do what they did in the 1990s? Is there another way of organizing this federation so that we can ensure that those kinds of surprises do not happen in the future?
Senator Fox: I have one last question that gets back to the accountability questions of Senator Mitchell, to which I have not heard a satisfactory answer. Obviously, we have constitutionalized the principle of equalization and we all recognize that an appropriate equalization formula is a necessity in a country like Canada. This being said, how do we reconcile that with the fundamental principle that he who spends should tax?
Basically, with the level of transfer payments, the federal government is taxing the citizen and yet the federal government cannot be held accountable for the delivery of the programs. As political parties go across the land during any election campaign, they will respond to pressures, let us say from students — and I can well understand why — to increase post-secondary transfers; yet, education is a provincial responsibility.
As another example, all of us around this table would probably like to see a catastrophic drug plan put in place at some point so that Atlantic Canadians can have access to drugs without crippling financial effects on their families; yet, this too is a provincial responsibility. How will we reconcile that issue?
With a greater portion of the federal expenses being transferred to the provinces, accountability goes out the window. As far as the provinces are concerned, the federal government can bring in a catastrophic drug plan, but Ontario and Quebec, who already have such plans, will want to take their share without conditions such that they can spend it in other areas of their respective provincial jurisdictions. With that, you are getting much further away from the principle of accountability. How are we to reconcile those two principles — the constitutional principle of equalization and the usual principle of accountability for taxing people and spending the revenues?
Mr. Boadway: Our federation is full of conflicts in principles and we have to find a compromise. It is not only equalization in the Constitution but also section 36(1), which states other commitments, such as equal opportunity, regional development and essential public services. As well, there are broader commitments to run an efficient economy and have a good internal economic union. Every time you think of the federal government as having such responsibility, it is difficult to imagine how it would accomplish that without a substantial size of transfers. The government could not even run an equalization system if that were the only thing they were doing without a fairly significant amount of transfers to the provinces. The question of accountability is presumably an important one, although I do not understand the details of it and how it works on the ground. You have to compromise that principle with other equally important principles, which entail the federal government having some financial transfers to the provinces that can be used in various ways. The key is to try to structure those relationships between the federal government and the provinces so that there is accountability and trust and so the federal government is accountable for its actions to both the public and the provinces.
This problem is not unique to Canada, although Canada is one of the most, if not the most, decentralized federation in the world, whereas both Australia and Germany, for example, are highly centralized. If you were to apply this argument of accountability within a province, where would you get? Every province has exactly the same kind of vertical balance issue that the federal government has with respect to the municipalities. In some way, you have to compromise the argument that he or she who spends must also be the one that raises the revenues. That is one principle among many. Take that to the limit and you will find that there will be no redistribution, among other things, such that everyone will be responsible for financing their own public services. I know that is not a very good answer.
Senator Di Nino: I will follow Senator Fox's line of questions. Some questions have been raised on the role of judicious spending when a province runs out of money. They pertain to whether there should be some accountability or controls in respect of that spending. Should the federal government impose some kind of conditions of accountability for the expenditure of the funds that it transfers to the provinces so that we do not have politically driven, rather than policy driven situations? This would avoid the debate between the provinces and the federal government on how much money should be transferred.
Mr. Boadway: Initially, I thought you were asking about what happens with extra money that the federal government has on hand at the end of the year. I understand now that you were asking whether there should be some accountability attached to the money that the federal government transfers to the provinces. One could argue that accountability would be reduced if the federal government were accountable for how the provinces spend the transferred funds. Accountability is enhanced when the strings attached to money that the federal government gives to provinces are general and limited rather than specific. I do not know how you could run a federation if the federal government were accountable for the way in which the provinces spent the money that the federal government transfers to them. On the contrary, rather than increase accountability, it would completely blur the lines of accountability. If you insisted the federal government be accountable for the money that it transfers to the provinces for post-secondary education, for example, that would in some sense reduce the accountability that the provinces have for spending that money.
Senator Di Nino: We will leave that to the electoral process, in effect to the electors, when it comes to re-electing the government. That would be the ultimate accountability in this issue.
Mr. Boadway: Yes.
Senator Di Nino: Like others, I too am concerned about whether the CHT/CST and equalization system is working. What is your opinion on that system?
Mr. Boadway: I spent a little time working in other countries talking about federalism through various organizations, some international. One thing I learned is that Canadian institutions for managing our federation are actually viewed as model institutions. Our system of equalization is considered one of the best in the world, as are our tax collection agreements and block transfers for social programs. In many countries you will find that there is much more specificity in transfers made by the central government to the sub-national jurisdictions. The extent of decentralization of revenue raising in the Canadian federation is truly quite high and is admired around the world. In Australia the state governments do not have access to income and sales taxes. They are stuck with small revenue sources and have to rely on transfers from the central government for most of their money. Canada's institutions are working well and the strains we face are not so much because of the structure but rather because we have a large country with diverse geographical, cultural and linguistic challenges.
Senator Di Nino: The system will have its problems and create differences of opinions, but it is a good system that is serving the Canadian public fairly well.
Mr. Boadway: I would say that there is one thing we could do better and that is re-establish a sense of trust and cooperation among the levels of government and perhaps have a slightly more transparent way of taking decisions that affect the federation.
Senator Di Nino: One of those irritants, I believe, has been how to incorporate the natural resources component in this discussion of equalizations, et cetera, which you touched upon during your presentation. Could you be more specific and comment on the difference that the advisory panel and the expert panel have taken in respect of the issue.
Mr. Boadway: My view on the appropriate way to treat natural resources is basically the same as the advisory panel that Senator Murray was on: Natural resources should be fully included in equalization and we should use a representative tax system approach. I say that not so much because we should try to equalize a province like Alberta to all other provinces or vice versa but because we need to ensure that there is fair treatment among the recipient provinces. Recipient provinces that do not have natural resources ought still to have as much capacity to provide reasonable levels of public services as those recipient provinces that have natural resources.
The issue of equalizing natural resources is often interpreted as one of affordability, whereas that is not really the issue. The issue of equalizing natural resources is more about establishing a level playing field among the recipient provinces, particularly between those that do not have natural resources and those that do.
The Chairman: Dr. Boadway, at page 12 of your comments, you analyze natural resources. I thank you for doing that. You recognize that there is a bit of a disagreement with respect to natural resources and you point out that the expert panel has recommended 50 per cent of actual revenue. You comment that when you go for actual resource revenues as opposed to the representative, ``...it virtually ensures that resources cannot be fully included in the formula.''
Can you expand on that comment?
Mr. Boadway: My point is the following: If you include the actual revenues that a province receives as a measure of their fiscal capacity for the purposes of equalization, then you have to recognize the fact that provinces can directly control the amount of revenues that they raise. They can change the rate at which they tax natural resources and change the amount of revenues they get, whereas under a representative tax system, they cannot control the rate that is applied to the base in determining their entitlement. I do not know if that makes it any clearer.
The Chairman: Yes.
Mr. Boadway: Whenever you include actual revenues, as a basis for equalization, you are raising the potential that that will have adverse effects.
Senator Cowan: You go on to say that, there is no empirical evidence that they have toyed with the system in that way to distort the level of revenue that they would have received. Could you just comment on that a little bit?
Mr. Boadway: We have equalized 100 per cent of natural resources for many years. There is no evidence, as a result of equalizing 100 per cent of natural resource revenues, that this has had any influence on the rate at which provinces have been willing to develop their natural resources. New Brunswick does not appear to have changed the way it has allowed its forest industries to expand, or Saskatchewan, with respect to its industries, or Manitoba, with respect to its industries. There does not seem to be any evidence that provinces exploit the ability that they have to control natural resource development, in response to the fact that the equalization system treats natural resources on a 100 per cent basis.
Senator Rompkey: There was a time, of course, when strings were attached; they were attached to Mr. Pearson's time and Mr. Trudeau uncut the strings. Then, I think there was evidence that, in fact, the money was not being spent for which it was allocated. If you remember the Johnson report in the 1980s, it showed that provinces that got money for education were not spending it on education; they were spending it on roads. That is just one point, in terms of history, on whether or not there should be strings attached and if strings are attached, is that a good thing or a bad thing?
My second point is, as Senator Di Nino asked, is it working? I guess it is a question of what we want it to do. The federation is frozen in time, except for Alberta; maybe not except for Alberta, but clearly, most vividly, in the case of Alberta. In the terms of my on province, I suspect the record shows that we really have not made any progress since 1949, compared to the rest of the federation, in spite of the fact there has been equalization. Is it working? Is there progress? What is the record of progress?
The third point is on natural resources and whether they should be included in the program. Yes, it is true that provinces developed natural resources, but in some cases it would not have been done without the help of the federal government. John Crosby deserves a lot of credit for the development of Hibernia. If the Mulroney government had not stepped in and helped, Hibernia would not be alive and well today.
Should they be included? It seems to me that is a question I want to be able to deal with too. What would happen in the case of Alberta? You said that Alberta was an anomaly and what was happening was unprecedented. What would happen if natural resources were included; what would happen in the case of Alberta?
Mr. Boadway: I could almost interpret your questions as comments, rather than questions, but I do not want to say a lot about them.
You are right about this. One thing that is interesting in the history of federal transfers in Canada — and it is another thing that is used as an example around the world — is that if you think about the way in which the transfer system evolved in Canada initially, when the big social transfers were introduced for health, hospitals, Canada assistance plan and so on, they were introduced as shared-cost transfers. Subsequently they were converted to these block transfers. A lot of people argued that made a lot of sense. The only way for the federal government to get the provinces to initiate these programs was to establish these vast shared-cost programs in which they would have to participate to get them started. Once these programs were established, then it was wise for the federal government to be more hands off and convert these into block transfers. The history of the way these social transfers developed is a good example of the evolution of that kind of thing.
Is the system working? The most visible evidence that the system is working is precisely the fact that we can provide fairly high levels of public services in every province across Canada. You can get good health care in every province across Canada. There is not identical health care, but very good health care in every province across Canada, compared to a country close to us that does not have an equalization system. I think the disparities in public services across the U.S. are probably a lot higher than they are in Canada.
With respect to natural resources, including natural resources fully in the equalization system does not have any particular consequence for Alberta, which is not an equalization-recipient province. It really has a consequence for the allocation of resource revenues across those provinces that receive equalization. You can have 100 per cent inclusion of resource revenues in the equalization system and choose whatever standard of equalization you want to suit the affordability sides of things. My concern about natural resources is not so much with transferring revenues from Alberta to the rest of Canada, which I do not think is particularly feasible, directly in any case, my concern is more to do with establishing horizontal balance among the equalization-receiving provinces.
Senator Nancy Ruth: You clearly stated that you would prefer the transfers to the provinces and the provinces down to the municipalities. When policies are suggested such as giving part of the gas tax to municipalities or provincial governments suggest giving part of the liquor tax, what is your response?
Mr. Boadway: I should say at the outset that my preference for going through the provinces is a weak preference. I really have not formulated strong views about how to deal with the municipalities. It is just, sort of, a gut feeling that we have this hierarchal system and might as well use it for accountability reasons.
With respect to earmarking revenues toward the municipalities, in some sense you can say there is no problem there; we are getting money to the municipalities. The problem with it is that there is another actor here and that is the provinces. If the consequence of the federal government sharing the gas tax with the municipalities is simply to crowd out transfers that the municipalities would otherwise get from the provinces, then you are not accomplishing very much.
You cannot just look at the transfer of revenues to the municipalities in itself; you have to think about how it will affect the whole system. I would worry about these transfers to the municipalities crowding out what the provinces would otherwise give. It is a term that is quite useful in this context.
The Chairman: We are just about to conclude this, and we appreciate your patience, directness and wisdom, Dr. Boadway.
I have one comment from Senator Murray on our second round.
Senator Murray: I would not want the meeting to end without some reference to the territories and to their quite unique problems. Indeed, each of the territories has unique problems.
Unlike the provinces, the territories, until 2004-05, had a formula that measured not just revenue capacity, but expenditure needs. That is very important, given the cost pressures and the volatility of the situation in those territories.
With the new framework, all that went by the board. The federal government established a floor and provided for annual increases. This can turn out to be quite onerous on some or all of the territories, and they are protesting pretty vehemently that Ottawa ought to go back to a formula that is based, at least in part, on expenditure needs.
There is also the problem of resource revenue sharing. The Yukon has had an agreement with Ottawa on resource revenues. The Northwest Territories has been trying to negotiate one for 20 years and does not have one. Meanwhile, they are getting zero or almost zero in terms of royalties from mining — from diamonds and other quite lucrative economic activities in that area.
I just want to make the point that this is something that this committee should look at and have more than one word to say about when we put in our report.
Finally, the witness made several allusions to the offshore revenue agreements that were signed by the Martin government with the provinces of Newfoundland and Labrador and Nova Scotia. There is a lot of history to those, going back to the Trudeau government and arrangements that were made with those provinces at the time — Mr. Chrétien was the energy minister; forward a bit to the Mulroney government, when Ms. Carney, our colleague, was the energy minister, and the history of everything that has happened over that period from the 1980s. It explains and, I think, justifies the decision made by the Martin government and the agreements that were made by the Martin government with those two provinces, about which there is a good deal of mythology being propagated that we should address as well in our report.
Thank you, Mr. Chairman. I do not know if the witness would like to comment on any of those.
The Chairman: Dr. Boadway, would you like to comment on any of those?
Mr. Boadway: I think just to read the advisory panel's section on territorial financing, which makes the points very carefully, and I agree with what is in there. I have nothing else to say about the offshore.
The Chairman: I would again like to thank you, Dr. Boadway, for coming and helping up get started into this new study. We knew that you could help us lay a very good foundation and you have done so.
The committee adjourned.