Proceedings of the Standing Senate Committee on
National Finance
Issue 4 - Evidence - Meeting of October 24, 2006
OTTAWA, Tuesday, October 24, 2006
The Standing Senate Committee on National Finance met this day at 9:30 a.m. to examine and report on issues relating to the vertical and horizontal fiscal balances among the various orders of government in Canada.
Senator Nancy Ruth (Deputy Chairman) in the chair.
[English]
The Deputy Chairman: I call the meeting to order. We are studying the horizontal and fiscal balances among the various orders of government in Canada. This is a timely study of an issue that is attracting more and more attention. We will be building on our previous work on the equalization formula but will also move beyond that to consider the issue more broadly. Today we have the opportunity to hear from two experts with considerable knowledge of this issue.
Al O'Brien is a Fellow at the Institute for Public Economics of the University of Alberta. He was chair of the expert panel on equalization and territorial formula financing, set up by the Minister of Finance. The expert panel reported in May of 2006.
Robert Gagné, Professor and Director of the Institute of Applied Economics of École des hautes études commerciales, was for his part co-chair of the Advisory Panel on Fiscal Imbalance set up by the Council of the Federation. The advisory panel reported in March 2006.
[Translation]
Robert Gagné, Professor and Director, Institute of Applied Economics, École des hautes études commerciales, as an individual: Thank you, Madam Deputy Chair. I want to begin by thanking the Committee for inviting me to present the recommendations contained in our report. I will take a few minutes at the beginning to provide you with a couple of definitions, even though that may seem a little boring. I will then go over the most important recommendations from our report.
At the outset, we were given a fairly broad mandate. That mandate was given to us by the Council of the Federation, which appointed us 18 months ago to prepare a report on issues involving both the vertical fiscal imbalance and the horizontal fiscal imbalance.
While the definition of horizontal fiscal imbalance is well accepted and well understood by most people with an interest in this, the vertical fiscal imbalance is far less well known, well understood, and perhaps — and even probably — well accepted.
We began by using the "standard" definition of the vertical fiscal imbalance, which can be found in my presentation in Figures 5.1 and 5.2. What you see there are the Conference Board's fiscal forecasts for the next 20 years, illustrating the provincial and territorial budgetary balances, on the one hand, and those of the federal government, on the other.
Figure 5.1 shows the forecast for the provinces and territories as a whole, as well as for the federal government. What we can see happening in the long run, and even over the next ten years, is that the provinces will be facing a deficit, that this will become a recurrent situation, and that things will gradually get worse, as the federal government continues to take advantage of budget surpluses.
Of course, these data were derived by projecting the current situation into the future — that is provincial and federal government programs as they currently stand, and the fiscal circumstances of the provinces and the federal government, as they exist now. That is the trend we will see if there is no change. However, we are not claiming that governments will not react to this. The graph is here simply to illustrate the fiscal pressures facing the provinces, whereas there is a lot less pressure on the federal government
Two weeks ago, I believe, the C.D. Howe Institute published a study confirming these results in another manner, namely as a result of an aging population in Canada over the next 20 to 25 years. What is the connection? Well, the connection is that an aging population results in additional pressure on public services and, unfortunately or fortunately, I don't really know, these services are required by an aging population, especially health care services, and they are the responsibility of the provinces — at least under the terms of the current Constitution. That is the most standard reality or definition.
Looking now at Figure 5.2, the calculation is essentially the same, but without Alberta. I must admit that it isn't really honest to do that, because Alberta is part of Canada; I am a professor, and when I calculate an average for my class, I do not remove the best student or students, nor do I remove the worst students when calculating the average. I calculate it for the group as a whole.
However, here we have removed Alberta because it masks the reality to a certain extent, although in any case, it is clear that the provinces will be moving more quickly towards a budget deficit situation; obviously, this changes nothing for the federal government. According to what we see in Figure 5.1, the provinces would be facing a deficit a little bit later.
However, eventually, if you look at the last year of the forecast period — 2024-2025 — all the provinces, including Alberta, will be facing a severe deficit.
That is the standard approach, which has been criticized, but that I agree with. I believe it is an appropriate way of looking at things. Some have trouble understanding how we can project the current situation into the future; and they are critical, saying that this is wrong, that governments will not change their way of seeing things, or spending or taxing the economy. And it's true that there will be reforms and changes, and that it is likely these things will not occur; but this analysis is really just to give us an idea or appreciation for the fiscal pressures facing the two levels of government.
The other way of looking at the vertical fiscal imbalance is to consider the federal government's behaviour. In my opinion, that is even more telling. When you look at the federal government's behaviour in terms of its spending over the last ten years, the federal government's new spending initiatives were actually in areas of provincial jurisdiction, such as health care and education. Why is that? Well, because of public pressure. Canadians are demanding more health care and education services. The pressure is there and the federal government and federal politicians — being good politicians — react to that public demand and spend more in those areas. There again, unfortunately or fortunately, I still don't know which, those are provincial responsibilities.
The public demand is for services that fall within the jurisdiction of the provinces, but meanwhile, the other expenditures, which are no longer the responsibility of the federal government, are not subject to the same pressures. We have seen significant budget surpluses at the federal level, whereas most of the provinces struggle to balance their budget at the end of the year. In my opinion, that is a much more telling sign than a vertical fiscal imbalance. In some areas, the federal government is behaving like a provincial government.
That needs to be rebalanced. However, before putting forward any proposal to rebalance the fiscal situation of the federal government and the provinces, we wanted to try and understand how things work. We realized that there are some skeletons in the closet. There are things that the general public and even some experts were unaware of.
In Figure 5.5, you have the system of provincial transfers. Here we're talking about the Canada Health Transfer and the Canada Social Transfer. This is the standard graph that you will find in most of the Finance Department documents, explaining how the system works. All the figures are in per capita dollars and relate to 2005-2006. That year has already ended, and therefore it's less compromising, but the idea remains the same. The yellow portion at the bottom is the per-capita value in each of the provinces; the value of the tax points transferred in 1977. That is the value in 2005-2006, of course. For example, you can see here that tax points represent $623 per capita in Ontario; $410 in Manitoba, and so on.
And what does the federal government do? Well, first of all, it equalizes the value of the tax points. It uses the five- province standard, which gives us the top dotted line and the small white squares or rectangles. The values in the small white squares or rectangles relate to the level of equalization associated with the tax points — in other words, to bring the value of the tax points in each of the provinces down to a standard, which is the five-province standard.
Senator Fox: What page are you on?
Mr. Gagné: This is on page 4, Figure 5.5. There is an exception for Saskatchewan — I don't want to explain it because it's a very technical — but you can see that all the provinces are brought down to the five-province standard — that's the yellow dotted line — and then what you have in white is the associated equalization, which is a program that is integrated with the larger equalization program, but is only there to equalize the value of the 1977 tax points. The red bars are the cash transfers.
Senator Murray: We do not have a colour printer.
Mr. Gagné: Oh! You don't have a colour printer in the Senate? I see. Well, the larger bars are the value of the cash transfers, which are not equal across the board because two provinces have higher tax point values, they being Alberta and Ontario. And there you have an explanation of sorts for the reaction of the Premier of Ontario, Mr. McGuinty, who says that he receives less than the other provinces in cash transfers; he says he receives $851 per capita, whereas the other provinces receive $935. Why is that? Well, it's because the tax points have a higher value.
On the Advisory Panel, we look at things somewhat differently; that is in the next graph. It is possible to satisfy Mr. McGuinty and other people in Canada by looking at the figures differently.
What we can say is that the tax points can easily be equalized based on the most prosperous province which, in this case, would be Alberta. If you look at Figure 5.6, you'll see that the value of Alberta's tax points in 2005-2006 is $667. We can bring all the provinces, including Ontario, down to this $667. That would represent associated equalization of $44 for Ontario, for example. That way, everyone is at $807, and thus they all receive an equal per capita amount in each of the provinces.
That measure, which is our Recommendation 5.1, is absolutely expenditure-neutral for the federal government. It is simply a matter of moving the cash transfers to an associated equalization program that we call the supplemental equalization program. Those are the amounts that you see here — in other words, $128 in most provinces, $44 in Ontario, and so on. All receive per capita equalization of $807 and a tax point adjustment brings the value of the tax points for all provinces, including Ontario, to the level in Alberta.
That is our first recommendation. Of course, this does not resolve the vertical fiscal imbalance or the problem of spending pressures on the provinces, but it does clarify things. Now we know exactly what we are talking about and thus we can change the system to make it fair to everyone. That was not possible previously. In any case, the associated equalization proposed here already exists. It was simply hidden before. When you dig these things out, you find them and they're there.
Basically the federal government is currently equalizing the tax points in two ways: with an associated equalization program and with per capita transfers that are different from one province to the next. That strikes us as a rather complicated and not particularly transparent system. We are suggesting that there be equal per capita transfers per province, as well as an associated equalization program that will really equalize the tax points at no cost to the federal government, based on the current situation.
That is what you see in Figure 5.7. You see the value of the tax points, which are the bars at the bottom, and the associated or supplemental equalization, which are the bars at the top. The only province that doesn't benefit from this — and that province does not benefit now, in any case — is Alberta, because it is the province whose tax point value is highest, at $667.
Our second recommendation involves an upward adjustment of the cash transfer which, in our case, is $807 — not $935 — to $960, which is a $153 increase per capita across Canada.
Why $153? Well, this makes it possible to bring the Canada Social Transfer, corrected for inflation, back to 1994-1995 levels. So, all this does is bring it back to 1994-1995 levels.
The cost of this measure — $153 per person multiplied by 32.5 million people — is $4.9 billion. You have that in Table 5.3, Part two; it's the last number on the bottom right.
As regards the Health Transfer, we are not making any specific recommendation. In fact, the recommendation in 5.3 recognizes what has already been agreed to — in other words, a 6 per cent annual increase until 2013 or 2014. That jibes with the forecast we commissioned from the Conference Board. They arrive at the same figure of 6 per cent for health care spending in Canada over the next ten years.
I'd now like to take a look at the horizontal fiscal imbalance. Of course, when we talk about a horizontal fiscal imbalance, we are talking about a different fiscal capacity from one province to the next. And there is a program in Canada that aims to correct these differences in a province's fiscal capacity, and that program is called equalization.
We have a series of recommendations that deal with ways of correcting the current program. Our first recommendation is 6.1, which involves using a representative tax system and including 100 per cent of revenue sources.
If we apply that recommendation as is, you can see the results that yields in Table 6.2. We would move from a program which costs approximately $9.3 billion in 2005-2006 to one that would cost $15 billion. You may say that $9.3 billion was not the cost of the equalization program in 2005-2006; no, the $1.3 billion for associated equalization has been removed here. If you add the associated equalization, you end up with a number that most people recognize as corresponding to the overall equalization program.
So, $15 billion would be the cost of a very comprehensive equalization program, including 100 per cent of all revenue sources, based on a ten-province standard.
In the course of our consultations with most provinces, many of them — I would even venture to say all of them — showed a great deal of impatience with the significant fluctuations in equalization payments to the provinces. We did not see that as an important political issue, because we believe that, technically, it is something that can be fairly easily resolved. So, that is our Recommendation 6.2, which is a more technical recommendation. Here we are proposing a mechanism to smooth out equalization payments.
Senator Fox: The figure I had, for your presentation, was $13.07 billion, and yet here, I see it says $15.120 billion. Is the $13.07 billion figure here somewhere?
Mr. Gagné: That comes later. I'm not there yet, but I think it is important to remember the $15.12 billion figure, as that reflects the overall cost of a wall-to-wall equalization program.
Of course, the whole question of the federal government's ability to pay will come up, but we did not make a recommendation in that regard.
I would like to come back to Recommendation 6.2, which is a technical recommendation to smooth out equalization payments. If we apply that recommendation, that brings us to Table 6.8, with a $14 billion equalization budget for 2005-2006. That is less than what would be required for an extremely comprehensive program, but over the long term, these measures are completely neutral; they change nothing in terms of equalization payments over an extensive period; this is just a smoothing mechanism.
That brings me now to Recommendation 6.3, and my conclusion. One may consider that Canadian taxpayers, wherever they live, may not be able to afford to collectively devote $14.1 billion to an equalization program; therefore, our Recommendation 6.3, which is summarized in Table 6.9, proposes a mechanism for scaling back the equalization program.
You will see in Table 6.8 that if we apply the ten-province standard, with 100 per cent inclusion of revenues, Canada's fiscal capacity is $6,207 per capita; that is using the ten-province standard in this case, for a cost of $14 billion.
If, however, we collectively are not prepared to put this much money into equalization, we have proposed a mechanism to scale back the program. It would be possible to apply a 1 per cent reduction factor to the standard. So, if we apply a reduction factor to the standard, that takes us from $6,207 down to $6,145. The cost of the program would then fall from $14 billion to $13 billion. The idea there is to separate the size of the program from the way in which the money is then distributed to the provinces.
What we say in our report is that it is important not to create any distortion in the way these monies are redistributed among the provinces. Of course, the magnitude of the program is a decision for the federal government to make. It is up to them to decide — and they were elected for that purpose — how much they're prepared to invest in this program. Here we are offering a method, a mechanism whereby that objective can be attained. Politicians decide on the overall budget envelope they are prepared to allocate to the program, and then the formula determines how that money will be distributed among the provinces, in order to achieve the best possible result in terms of equalizing the provinces' fiscal capacities.
We advocate an approach which is close to that formula but, ultimately, we say that the size of the program should be determined by Parliament. It is not the job of officials or a computer to set the size of the program; it's up to Parliament to determine that, and based on that, the funds should be allocated with a view to equalizing fiscal capacity to the greatest extent possible.
Those are our basic recommendations with respect to equalization. I will stop now to leave some time for my colleague.
[English]
Al O'Brien, Fellow, Institute for Public Economics, University of Alberta, as an individual: I very much appreciate this opportunity to discuss the recommendations of the Expert Panel on Equalization and Territorial Formula Financing with the committee. One of the first documents our panel consulted was the committee's March 2002 report on equalization chaired by Senator Murray. The expert panel's recommendations on equalization and territorial formula financing are fully supported by every panel member. For five economists to achieve unanimity is no small accomplishment.
We greatly appreciated the extensive cooperation, ideas and insight provided by the provinces and territories, academics and experts across Canada. Early on, we realized that the circumstances in the territories as well as approaches in equalization versus territorial formula financing are fundamentally different. Accordingly, we produced two separate reports on the programs.
I will begin by highlighting our key recommendations with respect to equalization and then turn to the highlights of our territorial formula financing report.
The issues regarding the equalization program are complex, technical and, frankly, often misunderstood. In spite of the fact that the federal government will spend over $11.5 billion on equalization in the current fiscal year, very few Canadians outside of a handful of academics, Department of Finance officials and members of this committee fully understand how the program works. Throughout the process, we were struck by how little is known about what equalization is and what it is supposed to achieve.
I hope you will forebear my reiterating some fundamental features of the program. First, equalization is about assessing the fiscal capacity of provinces to deliver public services. Only those provinces that have less ability to pay for reasonably comparable levels of public service receive equalization payments.
In our view, equalization reflects a distinctly Canadian commitment to fairness and to provincial autonomy. It is meant to ensure that whether you live in Newfoundland and Labrador or in British Columbia, you should have reasonably similar opportunities for a good education and access to health care, social services and justice systems. People in one part of the country should not pay excessively high taxes to support those services compared with their fellow Canadians in other parts of the country.
Access to quality education, good health care and adequate infrastructure benefits all Canadians in every province and strengthens our federation.
As you know, no provincial government revenues go to support equalization. Although some provinces talk about having their resource revenues clawed back, the only impact from equalization is that provinces get less equalization funding if their own revenues increase. That is the way the program is supposed to work. It should also be noted that equalization alone is not intended to address the broader issue of fiscal imbalance between the provinces and the federal government.
In earlier testimony to your committee, Professor Boadway outlined admirably the interrelationship between vertical and horizontal equity.
Over the course of our consultations, we heard widely divergent views on how specific components of equalization should be addressed. However, with a few exceptions, we heard strong support for the program. Most Canadians want to see equalization fixed and not abandoned.
Turning to our recommendations, what will it take to put equalization back on track? That was the fundamental question we set out to answer.
In our report, we outline a balanced package of recommendations that provide governments with a workable solution for putting this important national program back on track now and for the future. We are recommending a return to a rules-based, formula-driven approach based on a clear set of principles.
The panel consistently heard concerns about what many see as an increasingly ad hoc approach to equalization. To that end, a new equalization formula should be developed and used to determine both the total cost of the program and the amount each province receives. That allows for changes in fiscal capacity over time.
We also recommend moving to a 10-province standard. This is a principled approach that reflects the true nature of Canada's federation and the real diversity among the provinces.
However, consistent with the principle of equity, we recommend that no receiving province end up with greater fiscal capacity than that of the lowest non-receiving province. Currently, that means Ontario's fiscal capacity becomes the cap for all receiving provinces.
Instead of an all-or-nothing approach to the treatment of resource revenues, our recommendations balance the various options and provide a reasonable and workable solution providing the best outcome in terms of overall impact on provinces.
We considered the distinction between renewable and non-renewable resources and found that, for equalization purposes, the distinction is not meaningful. Oil and gas deposits last for generations, and some so-called renewable resources in fact have shorter economic lifespans. We therefore concluded that all resource revenue should be treated identically.
We weighed the principle that receiving provinces should get some net fiscal benefit by virtue of resource ownership with the reality that resources are also the greatest source of disparity among provinces. We concluded that 50 per cent of a receiving province's actual resource revenues should be included in the calculation of a province's ability to raise revenues.
We are recommending a new measure for residential property taxes that should be implemented based on market value assessment for residential property. After study and consultation, we concluded that user fees should not be included in equalization.
In the panel's view, the equalization program can also be improved substantially by a more simple and transparent approach. We recommend that this be accomplished by regrouping the 33 tax bases currently used to measure a province's fiscal capacity into five bases.
A major component of this simplification would result from using actual resource revenues to replace the 14 natural resource bases applied under the previous formula. However, we are also recommending that 15 small and often difficult to measure non-resource tax bases be consolidated into the major personal business property and consumption tax bases.
I want to be clear that we are not proposing the elimination of equalization in respect of these smaller revenues, with the exception of 50 per cent user fees currently included. Rather, we are proposing that the measure of provincial tax capacity for the smaller revenue sources be based on the most appropriate major tax base.
We also propose that the current payment process involving eight estimates of entitlement stretching over a period of almost four years be replaced by one estimate, one entitlement and one payment based on a three-year average with a two-year data lag. That is an area where the two panels are in complete agreement.
In the panel's view, equalization should continue to focus on measuring fiscal capacity rather than attempting to assess expenditure needs in individual provinces. Equalization alone should be the primary vehicle for equalizing fiscal capacity among the provinces.
Finally, a more open process for review of equalization should be put in place through an annual report to Parliament.
Overall, we believe these recommendations produce fair results for all provinces. Our recommendations would increase the overall cost of the program by nearly $900 million in 2007-08 compared to the amounts committed under the new framework. We believe this cost is warranted to return to a transparent, principle-based set of rules for determining provincial equalization entitlements.
Over the past year, the purpose and effectiveness of the program have been questioned, often fuelled by provincial concerns about fiscal imbalances, both horizontal and vertical.
We do fear that fiscal arrangements in Canada are being reduced to debates about who pays and who gets. While we understand the financial challenges faced by many of the provinces and their concerns about their fiscal capacity compared with that of the federal government, this kind of chequebook federalism destroys any sense of a higher purpose.
We are recommending a package of changes to put equalization back on a sustainable formula-based track. Each proposed change was considered in the context of an entire package that balanced key principles.
The recommendation to adopt the 10-province standard was considered appropriate in the context of a 50 per cent inclusion of resource revenues. The 50 per cent inclusion rate was considered appropriate only in the context of a fiscal cap to ensure that equalization did not push a receiving province's total capacity above that of a non-receiving province.
The impact that these recommendations would have on per capita provincial fiscal capacity before and after equalization is shown on the chart appended to my statement, which is taken from page 8 of our report.
I will now turn to territorial formula financing, TFF. Similar to equalization, the federal government provides money to the three territories in the form of a grant to help close the gap between the amount of money a territory needs to provide reasonably comparable public services and the amount of revenue it can raise from both taxes and other sources of funds.
Unlike equalization, however, TFF includes measures of both expenditure needs and revenue capacity. When first established in the mid 1980s, the funding was considered adequate to meet expenditure requirements in the territories. Unfortunately, we believe this is no longer the case. During the course of our 14-month review, we learned about the great potential for economic development in the North and the sense that the territories are on the verge of major change, particularly in the Northwest Territories. This will not be achieved, however, without significant investment and without governments working together with northerners.
Clearly, territorial formula financing is critical for the territories. All three territories rely heavily on TFF and other federal transfers to pay for essential public services. In 2005-06, TFF constituted between 64 per cent and 81 per cent of territorial budgetary revenues. Perhaps the most consistent concern we heard was that TFF funding was inadequate given the unique challenges and higher costs of providing public services in the territories. Our new approach will mean additional funding for TFF to ensure that the territories can meet pressing needs in key program areas.
At the same time, we urge territorial governments to continue to seek the most efficient ways of providing essential services and managing growing costs of public services. We recommend replacing the existing fixed pool with a formula-driven approach providing three separate gap-filling grants to each of the territories, and rebase to 2005-06 funding levels. It is important to have a program that reflects the differences among the three territories. This is not a one-size-fits-all solution.
We recommend simplifying the territorial funding formula and improving economic development incentives by establishing a revenue block that includes seven of the largest revenues at a 70 per cent inclusion rate. Resource revenues should be excluded from the calculation of own-source revenues in the TFF formula.
Unlike the provinces, in the territories the authority for natural resource development and raising revenues from those resources lies with the federal government. The territories should see net fiscal benefits from resource development. This also gives the territories the flexibility necessary to accommodate both existing and future devolution agreements and to support resource development in the North. Implementation of these recommendations for territorial formula financing would cost an additional $60 million in 2007-08.
I hope the committee will find our reports on equalization and territorial formula financing helpful in their deliberations on the issue of fiscal balance between Canadian governments. These are important Canadian programs which, for too long, have not received the attention they deserve. We believe our reports provide a basis to put equalization back on track and establish a new approach to territorial formula financing, which will support the North's vision of a strong and self-reliant future. I hope these brief comments will provide some insight into the rationale of our recommendations and we look forward to discussing them this morning.
Senator Murray: I have one question to ask now because I would like our witnesses to focus for a minute on the territories. We have one senator from each of the territories. That is three. They are rather thinly spread and fully occupied among various other committees. None is a member of this committee so I would like to ask the witnesses to focus for a moment on the very special problems that face the territories, collectively and individually, and notably, Nunavut.
Negotiations on the future of devolution and resource revenue sharing seem to have been going on for a very long time without coming to any conclusion.
I want to focus on the important factor of land claims negotiations involving Aboriginals in those territories, and when there is a second round I can come back to matters affecting the provinces. Perhaps Mr. Gagné can begin because the panel on which he and I are members articulated some more general principles while Mr. O'Brien's panel tended to go into more detail as to what ought to be done.
[Translation]
Mr. Gagné: As regards the territories, at the present time, with the new framework that uses no actual formula, basically the system is arbitrary. Of course, we did not have enough either resources or time to do a thorough analysis of the issues related to the territories. It is extremely complicated. However, we were struck by the extent to which the territories do not own their natural resources. That clearly creates problems.
At the same time, we are not recommending that they own the natural resources, even though it is clear that this creates significant difficulties within the territories. We have heard a lot about the boom-and-bust phenomenon. In other words, someone opens a diamond mine, or puts in pipelines, and that rapidly brings in a great deal of money. But when the money is no longer there, the social costs and social problems remain and the territories are left with the costs.
What we are recommending, which is very close to what Mr. O'Brien's group is recommending, is that a territorial financing formula be adopted. Our second recommendation is that the negotiations be expedited or intensified with a view to concluding agreements that would allow the territories to retain part of the revenues from natural resources developed in the territories.
Of course, this would in part be aimed at countering the boom-and-bust effect that they are currently subject to. We also recognize that Nunavut has particular issues, especially as regards infrastructures. Through consultations, we noted that infrastructure in Nunavut is practically non-existent, and that there is a specific problem to address there which will require a special agreement, in order for Nunavut to be on an equal footing with the rest of Canada in the 21st century, and developing at the same pace.
Those are our basic recommendations with respect to the territories. Al will probably have more to say about the technical issues.
[English]
Mr. O'Brien: I welcome the opportunity to comment further on our territorial recommendations. It really is a very different program. The equalization program addresses the horizontal fiscal disparities among provinces. The territorial formula financing, which provides anywhere from 60 per cent to 80 per cent of financing, addresses the horizontal inequities among the three territories. However, it addresses principally vertical fiscal imbalance, the inability of the territories to raise from their own sources of revenue anywhere near the funds they require to deliver public services in the North.
In the second annex to our report, there is some discussion of the issue of the expenditure needs and the particular, peculiar problems faced in the North in the delivery of public services. We concluded that the core TFF funding program should focus on providing ongoing basic public services in the three territories and that we should not attempt to use it as a vehicle to address the unique problems of catching up in the serious issues of infrastructure requirements and so on in Nunavut. Our recommendation is that the federal government should undertake an extensive study of those needs in Nunavut and how to address them and that those should be addressed outside the TFF. We do not think you use a formulaic approach for that.
It is clear that Nunavut would need assistance from the Government of Canada to deliver some of those services. Nunavut simply does not have the structure to address some of these problems alone. We thought that those particularly difficult problems in Nunavut should be addressed as a specific problem.
For the general TFF program, we could perhaps characterize our overall set of recommendations as seeking simplicity and clarity and getting the incentives right. People have talked about the equalization program being the domain of a sort of high priesthood among finance ministries in the country. That is true in spades for territorial formula financing. In our view, it has had over the years the best of intentions, but it has become absolutely arcane. I am not sure that after 14 months I could tell you that I fully understand the intricacies of the program.
For example, the gross expenditure base, which determines the level of spending that the territorial formula financing is targeted to support, is based on 1982-83 data that was implemented in the program initially in 1985, over 20 years ago.
Those have been subject to various tweaks and adjustments. The same is true on the revenue side. There are so- called catch-up and keep-up factors. I will not ruin your lunch by getting into the specifics of them, but we think those efforts, all of which have been well intentioned to try to more precisely measure territorial revenue raising capability, expenditure needs et cetera, have become perverse and are creating serious disincentives and complications in the program. They use up a lot of time and effort of officials, both in the territories and in Ottawa, on things that are essentially unproductive.
The focus of our recommendations is to simplify that. We do not think that the new framework of the fall of 2004 works at all for the territories. That framework set a fixed amount of funding and was going to grow it at 3.5 per cent a year for 10 years, regardless of economic developments in the territories. It would mean that if revenue-raising capacity in the Northwest Territories, for example, grew dramatically, the result would be a reduction in their territorial funding. However, because it is a fixed pot, it could be argued it would mean a windfall gain in territorial funding for the other two territories. The opposite would be true. It did not seem to us that that zero- sum approach to the grants for those two territories, which may have very different economic growth rates in the coming decade, works.
We have said that we should revert to the principle of measuring the fiscal capacity of each territory and its adequacy and have a separate grant for each of the territories.
Our second key recommendation was to clean up some of the confusion about the expenditure base that we will try to meet simply by rebasing it to the 2005-06 levels that were inherent in the formula.
Finally, we said that we should simplify these revenue things. Rather than using actual territorial revenues and looking at whether they are keeping up to increases in provincial tax rates and so on, we should adopt a representative tax system for the territories as well, but only for their seven basic and most important sources of revenue. We should measure their capacity there, but include 70 per cent of it, so that in future, as territorial revenues grow, 30 per cent would be a net fiscal benefit arising from economic growth to address the needs that would arise. That is the core.
We concluded that resource revenues should be excluded from the territorial formula. The Government of Canada has already agreed that there should be a net fiscal benefit from resource development to the people of the territories. That should be worked out in a devolution and revenue-sharing agreement. We think that is the most flexible way to deal with it in the territorial formula funding, but we have encouraged governments to get on with addressing these issues of devolution and resource sharing.
As the senator said, they have been delayed a long time and, regrettably, the Government of Canada advised the territorial governments that they could not discuss revenue sharing until our panel had reported, so we became another obstacle.
We hope they will address that, but that is the essence of our recommendations on territorial funding.
Senator Eggleton: Thank you, gentlemen, for being here. Your reports are much appreciated and they are fundamental to the consideration being given by this committee.
I come at this from a national perspective, an interest in a fair system, getting back to a formula-based system, et cetera. The provincial government in Ontario, where I come from, has some concerns, and I want to raise those with you. As a former mayor of Toronto and one who has some understanding of the difficulties of financing at the local level, I want to bring that into the equation.
On the national concern, your reports came out about a month apart. I do not know how much you knew about what the other was recommending. You have many recommendations in common, but there are some differences. Let us focus on the differences for a minute.
Now that you have seen each other's reports, is there anything that you find appealing in the recommendations of the other panel? Do you think they would work just as well as your recommendations?
You both came up with the 10-province standard, but Mr. Gagné said 100 per cent of resources and Mr. O'Brien said 50 per cent of resources. That is just one example.
Do you find something appealing in each other's reports that could work just as well?
Mr. O'Brien: Mr. Gagné reported first, but unfortunately not far enough in advance of our report that we could amend our report to reflect the many useful elements in the council's report.
I would emphasize one quite important difference between the recommendations of the two reports in respect of equalization, and that is the determination of the standard. If I understand Mr. Gagné correctly, the council panel states that while they recommend a 10-province standard with 100 per cent inclusion of resource revenues, they do not see that as assisting in a determination of the total size of the pool. In fact, I think the suggestion was that should simply be a political decision of the Government of Canada. They should decide what they can afford, and then the recommended formula would determine the allocation.
While our report clearly recognized in the final analysis the determination of the appropriate standard to which you want to raise provincial fiscal capacity to ensure that there are reasonably comparable levels of the important services for which provinces are jurisdictionally responsible in Canada, our view is that it is desirable to have a principle-based, formula-driven approach to determine that issue, as well as the issue of allocation.
We recognized that a government may find they have affordability concerns. In that case, our recommendation, as with the council's report, is that it be reduced or increased on an equal per capita basis.
However, we also expressed the view that in the event the Government of Canada feels the formula we have recommended to determine the size of the pool is not affordable, the Government of Canada ought to lay out some parameters in advance so that both Canadians and provinces can understand the criterion of affordability. We discuss what some of those parameters might be, whether a per centage of federal revenue or something else.
To the degree that we can, we should have a program here that is clear and predictable, robust and stable enough in the future that Canadians can understand how it works and governments will understand how it works and what the rules of the game are. We would like to see a formula-driven approach to determine both sides of the equation. That is perhaps one of the areas where we took a somewhat different approach than did the council.
We found the discussion in the council report on the whole process — the question of information and so on — very interesting. I think it is one that your committee and government should have a close look at. There are some very good ideas there.
Another area that is very interesting was partly outside our terms of reference. We expressed the view that there should be one equalization program. We had some discussion about the so-called associated equalization.
Our terms of reference did not include making recommendations about Canada Health and Social Transfer, but inherent in our approach is something a bit different from the council's approach. The council said the way to address the issue of the so-called associated equalization is to formalize it into a tax point adjustment account. I believe that was the terminology. Formalize the associated equalization, but formalize it as part of a special grant or a special equalization program that applies to a particular adjustment in federal and provincial tax rates that took place in 1977, which is almost 30 years ago.
Our whole thrust is that we would like to see an equalization program that is robust enough to include only one formula and that applies to all provinces. This tax adjustment account brings in a second tier of equalization or a second formula. With respect to most of your revenues, it will be a national standard. However, with respect to 12 points of personal income tax and four points of corporate or whatever the 1977 arrangement is, it will be a 100 per cent formula applied to the Alberta level.
I noted that last week that Professor Smart recommended, as far as the Government of Canada and provinces are concerned, that if there were further tax adjustments among governments in the country, he would advocate same. That approach is inconsistent with the basic principles we laid out in our report, although one could call it part of an equalization formula.
However, we hope we could agree on an equalization formula that is seen to be robust enough and well enough designed and fair enough for all Canadians that it could apply to all provincial revenues under all circumstances and ensure a reasonable comparability of fiscal capacity and the ability to deliver public services among provinces.
Again, that is an area where the two panels have somewhat different approaches to addressing that associated equalization issue.
[Translation]
Mr. Gagné: Coming back to the initial question, are there things in Mr. O'Brien's report that we like, after the fact? In my opinion, there has been a lot of technical work done in that report on tax bases, and I believe the proposals aimed at regrouping some of the tax bases are very attractive. We had neither the time nor the resources to carry out that kind of work. Of course, we knew that there was another highly competent group working on that. I would say that the report contains a number of recommendations that are attractive because they simplify the program.
One of the problems with the current equalization program is that it is complicated; people do not understand it, and when you don't understand something, you cannot buy into it. When you simplify a complicated program, you are able to secure more buy-in. I heard the reaction of provincial politicians when the two reports were issued and I am convinced, even now, that people do not understand how the program works.
That is a problem. If you have an important program in which you are investing $10 or $15 billion, and yet people do not understand how it works, how do you expect to garner more public support for it? It just is not possible.
The biggest difference between the two reports is in the treatment of natural resources. The O'Brien Report basically says that in order to keep the program budget under control, part of the provinces' revenues have to be excluded from the calculation of the national standard. The excluded revenues are natural resource revenues, whether the resources are renewable or not. However, we saw no reason to choose those revenues in particular; why exclude one type of revenue, and not another? As regards the 50 per cent inclusion proposal, I believe Al O'Brien agrees with me that it is halfway between including nothing and including everything.
I see no reason why these revenues would be treated differently from other revenues. One could say that there are social costs associated with developing natural resources. That is true, but there are also social costs associated with revenue from tobacco, lotteries, and alcohol sales. There are significant social costs associated with these revenue sources for the provinces, but nobody talks about them. We could also say that some of these natural resources are non-renewable, and therefore, the revenues are only temporary. There again, I believe that the price of natural resources reflects the fact that they are non-renewable. A barrel of oil would not cost $60 now if oil were a renewable resource.
The provinces are already compensated in the sense that they develop natural, non-renewable resources.
Also, it's important to remember that the things that are included in the equalization formula are not revenues that will be captured in the provinces; these revenues are only considered for the purposes of the calculation. For example, oil revenues in Alberta are, first and foremost, royalties paid to the government of Alberta by the oil companies, net of most development costs; however, these royalties are not captured. They do not end up in Ottawa; rather, they are used in the calculation of the equalization program, a program which is 100 per cent financed by the federal government. It is not financed either by the government of Ontario or the government of Alberta; it is financed by Canadians, wherever they live.
When I would meet with people, I would often say that as a Quebec taxpayer, I make just as much of a contribution to the equalization program as a taxpayer in Ontario, Alberta, British Columbia or New Brunswick.
This is a federal program funded by the federal government, and based on what I have seen, there are no convincing arguments to exclude specific types of revenue. That being the case, if you consider the fact that by including too many revenue sources, the program costs go over the roof, then we are offering a different approach to keep it under control.
[English]
Senator Eggleton: Thank you both for your answers. Let me get to the position of the Government of Ontario, which has said that there is no evidence to support the call for further increases in equalization at this time. According to the McGuinty government, the current size of the program is sufficient to meet our constitutional and moral obligations to ensure that Canadians have comparable levels of public services, comparable levels of taxation. No province receiving equalization should have greater overall fiscal capacity than a non-receiving province.
Premier McGuinty talks about the need to keep Ontario strong, how significant it is for our economy, both manufacturing and exports, et cetera. He has talked about the unfairness of the allocations under the Canada Health Transfer and the Canada Social Transfer, which comes to this tax point issue. He thinks that should be separated, so perhaps he might buy that recommendation; certainly he feels that those things need to be dealt with.
He points out that since 2003-04, there has been a 30 per cent increase in Ontario's contribution. Talking about the vertical imbalance, he is saying that with increasing costs of health care, education and municipalities, they cannot meet the needs. The provinces will have difficulty in meeting their responsibilities because, as you pointed out, Mr. Gagné, in the Conference Board of Canada study, the revenues of the federal government are staying up there but the provincial governments are returning to a deficit situation.
In looking at the different formulas that each of you has recommended, he says you go to 10 provinces, it will cost more; you go to 100 per cent of the resource revenue, it will cost more, et cetera. His bottom line is that there is no evidence to support the call for further increases in equalization.
What do you say to Mr. McGuinty about that? I will have to talk with him about it at some point so I am looking for your advice. He knows I am a senator from Ontario.
[Translation]
Mr. Gagné: We have heard a lot about that. That is a different issue — a completely political issue. The recommendations made by Mr. O'Brien's expert panel and our advisory panel result in an equalization program which is efficient and works well. It was Mr. McGuinty, who at the time was Chair of the Council of the Federation, that appointed me Joint Chair of this Advisory Panel, and never, either in conversations or in our specific mandate, was there any question raised as to the magnitude of the equalization program. If he had appointed me with the clear proviso, right from the beginning, that all my recommendations would have to be cost-neutral in terms of the equalization program, I would never have agreed to take on that mandate. That was not on the table; it came out later.
It's important to stress once again, and repeatedly, that the equalization program is not financed by the government of Ontario or the government of Alberta, but rather, by Canadians, wherever they live, based on their personal wealth, and by Canadian business, based on their revenues and profits. In that sense, Ontario is treated no differently from the other provinces. It is treated exactly the same.
Where there is a difference is with respect to cash transfers. We have made a suggestion to correct that difference, and to bring all Canadians, wherever they live, back to the same per capita base.
I see no problem with what Mr. McGuinty said. The Constitution is quite clear: there are provincial programs managed or administered by provincial politicians, and there are federal programs administered by federal politicians; after that, each one makes its own decisions and has to live with the consequences in the next election.
That is why we say that the size of the equalization program is a decision for the federal government to make and that it will have to live with the consequences subsequently. However, it is important to remember that Canada is a very decentralized federation and that some question the very existence of the equalization program in Canada. In Canada, if we have an explicit equalization program, it is because we are a decentralized federation. We see in the budget that there is a line for the equalization program, and that causes panic.
Senator Fox: But there are federal-provincial conferences.
Mr. Gagné: Yes, but we see it. If you compare our situation with that of France, for example, and just to take the example of Paris and Marseille, two very large cities in France, the fact is that Paris is a rich city and Marseille is poor. And yet Parisians and people living in Marseille are affected by the same tax system and receive the same public services.
So, is there equalization in France? Yes, there is a great deal of equalization in France. We don't see it, and thus we cannot say it does not exist, but that is the sort of thing that goes on. Why? Because France is a unitary state. As a result, there is no explicit equalization program. There is an implicit program, but there is definitely a lot of equalization.
Is there equalization in the United States? Well, there is a great deal of equalization in the United States.
I remember seeing a federal government table last year which identified the equivalent of a $23-billion or $18-billion gap for Mr. McGuinty in Ontario. If you go to the United States, that $23 or $18 billion is a drop in the bucket compared to the gaps in the United States. Is there equalization in the U.S.? Yes. Highways in the United States are a federal responsibility. There is a great deal of hidden equalization in defence expenditures made in each and every one of the states. Is there an explicit equalization system in the United States? No. But is there equalization between U.S. states as a result of the federal government's action? Yes, there is a lot.
But here in Canada, we have a decentralized federation and we have to live with an explicit equalization system. Otherwise, what would hold the country together?
Senator Fox: I would like to come back to equalization and simply say that it is one of the fundamental principles that underlies the Canadian federation. Those principles are laid out in the Constitution. In that sense, I am always surprised to hear people object to discussing the fiscal imbalance. Equalization is a fluid concept over time. I presume that this is a period where the fiscal capacity of the provinces is changing, as is that of the federal government. So, we should not be surprised that these issues are being debated. Except that, from time to time, we do need to adjust the formula as our history evolves. That is my first point.
My second point is that you mentioned earlier that Canadians, rather than the provinces, are paying for equalization.
In that regard, I would point out that people in Ontario are not the only ones paying; residents of Quebec or the Atlantic region, who have high incomes, also pay taxes. And I presume that it's on the basis of consolidated general tax revenues at the federal level that this is calculated. So, I believe that all Canadian citizens with significant tax revenues have a duty to participate in equalization. I would like you to either confirm or invalidate that.
My third question is this: Did the two panels have different mandates or instructions? In other words, were you to focus on a provincial perspective, as opposed to Mr. O'Brien who focused on the federal perspective? Were you totally independent in terms of your analysis?
Another question is: Is the system you are proposing now sufficiently flexible, on both sides, to allow for economic fluctuations over the years?
And one last question: How is it that Robert Gagné and Robert Lacroix are unable to agree on this?
[English]
Senator Rompkey: First, Mr. O'Brien said that all resource revenues should be treated equally. The Churchill River in Labrador is a natural power-producing resource and will go on for a long while depending on global warming and what happens to the environment. However, the oil off our shores is basically owned by the federal government, which gets most of the revenue from that resource. It is a finite resource. We have a short window of opportunity to stand on our own two feet economically if we can get some revenue from that resource. I wonder why all resource revenue should be treated identically when, in terms of our economy, they benefit us in different ways. Could you comment on that?
Second, page 4 of Mr. O'Brien's report states that equalization should continue to focus on measuring fiscal capacity rather than attempt to assess expenditure needs, although I notice he did agree that that should be done in the northern territories. Why not consider debt? We have the highest per capita debt in the country. We have the lowest per capita income, and, again, I get back to the opportunity to advance with the use of non-renewable natural resources.
If you are going to provide infrastructure, you have to consider debt. If I asked the bank for a loan, the first thing they would ask me is what my debt was. It seems to me that that is a consideration, particularly when provinces have to provide infrastructure. We have had to do that. We have had to borrow to try and catch up for the last 50 years, and we are still really no further ahead compared to other parts of Canada than we were 50 years ago.
The third point is the effect of the cap, in Mr. O'Brien's report, on Newfoundland and Labrador, because it seems to me that eventually we start to lose money under that formula.
The fourth point is with regard to northerners. I am glad that Senator Murray raised that. He pointed out the necessity to have special consideration because of land claims, because of infrastructure and because of where they were. But I point out, too, that the distance between the southern tip of Nunavut and the northern tip of Labrador is about nine miles. We both have Aboriginal populations. We both have natural resources. We both have an absence of infrastructure.
I wondered if you considered that. You seem to have focused on the territories and I agree with that. I think there should be a focus. They do have special needs. But because Labrador happens to be technically and legally a part of the Province of Newfoundland and Labrador, it seems to escape people that it is in fact a northern territory with the needs of and possibilities of other northern territories.
Senator Murray: Mr. O'Brien, I want to follow up on the question of the inclusion of resource revenues. Your panel has recommended that actual revenues be calculated rather than using the representative tax system, a national average rate that is used for all other tax bases. You would then include only 50 per cent of resource revenues for equalization purposes.
What do you say to the argument that we have heard, including from Professor Boadway, that your recommendation will reduce entitlements disproportionately for provinces with fewer natural resources and will benefit recipient provinces that have above average resource revenues? What do you say to the position taken by Professor Smart that the effect of your recommendation will be to lower the level of natural resource taxation by about 20 per cent, a figure he arrives at by looking at the period 1973 to 1981, where there was only partial inclusion of natural resource revenues, 33 per cent at first and then 50 per cent?
With regard to your proposal that there should be just one equalization program, I presume you are suggesting, therefore, equal per capita cash for social programs. Are you excluding the possibility of tax points or favouring tax points?
[Translation]
Mr. Gagné, could you explain why Quebec seems to have changed its opinion with respect to the tax points issue? Traditionally, Quebec has always preferred that transfers take the form of tax points, rather than cash. What is it that prompted this change? Is it a question of principle, or it is pure pragmatism on their part?
[English]
Mr. O'Brien: First, I want to address the concern raised by Ontario and British Columbia regarding the evidence for the determination that we need $11 billion versus $12 billion versus $11.5 billion to provide reasonably comparable services in the recipient provinces. That is part and parcel of the question of whether the whole program should attempt to measure fiscal need. We do not think that is desirable, even if you could do it, in the context of the Canadian system of federalism.
If the Government of Canada will determine the level of equalization payments based on its assessment of the quality and comparability of provincial public services, that implies a degree of centralization in this country that is not attractive. We think the key to the program is that it is an unconditional grant, and therefore the criteria for determining equalization should be the disparity in revenue-raising capacity among the provinces, pure and simple. That is why we believe that the standard should be based on a balanced formula.
We have proposed a formula that involves 10 provinces, 50 per cent of resources and a cap to ensure that no recipient province has greater fiscal capacity than a non-recipient province, which seems not only equitable but common sense to us.
On Senator Fox's questions, first, indeed, this is a federal program financed by federal taxation. The Alberta treasury does not write cheques to the New Brunswick treasury.
The difference in mandates between the two panels was important. Our panel was purely addressing equalization and territorial funding; the so-called horizontal fiscal disparities. We were not tasked to consider whether there were differences in the federal versus provincial governments' revenue and expenditure responsibilities that created vertical imbalances. That was a major difference.
You asked whether our proposal is flexible enough to incorporate economic fluctuations and so on. Certainly that is our ambition, and we believe it is. An annex in our report addresses the sensitivity of our program and our recommendations in relation to oil and gas price fluctuations. We do not look at thousands of scenarios, but we do look at a high scenario and at a modest scenario.
We also provide data for three years, 2005-06, 2006-07 and 2007-08, as to what the application of our formula would yield in terms of total equalization payments and distribution. We think that those data indicate that our approach would be quite robust and sustainable throughout economic cycles in the country.
Senator Rompkey asked the question about non-renewable and renewable resources being treated equally. In our thinking, the most important point here is ownership: provinces own resources, whether renewable or non-renewable. In the case of offshore oil, the province does not own the resource, but the beneficial owner, by agreement of the governments, is the Government of Newfoundland.
Senator Rompkey: Eighty-cents on every dollar goes to the federal government before the accord.
Mr. O'Brien: The issue we thought was important across the country is ownership. We thought that the owners of the resource should receive a net fiscal benefit. The discussions that have been held around resources across the country would suggest that is a key issue.
By the same token, our traditional definitions of renewable and non-renewable resources are now subject to question. When I was a young economics student we were taught that fish were a renewable resource. Water is a renewable resource. The water resource is now very restricted, and water resource economists in Alberta are saying that the Athabasca River will run dry before the oil sands run dry. We did not think it was meaningful, at least in the context of equalization.
You asked also about fiscal need and why not debt, and certainly we learned a great deal about the fiscal situation in Newfoundland. As a former treasury official in Alberta for 35 years, the fiscal challenges that the debt problem creates in Newfoundland are impressive, no question about it. They are exacerbated by the current demographic trends in that province. Newfoundland and Alberta followed the same enlightened approach to financing teachers' pensions, for example, which was to let future teachers and taxpayers pay for it. That is creating great difficulties in Alberta, where we now have more teachers than we had 20 years ago, and where the teaching work force is growing at 1 per cent a year. I believe in Newfoundland there are half as many active teachers now as there were 20 or 30 years ago. Clearly that is a problem.
In our view, if the Government of Canada will attempt to work with Newfoundland to address some of those demographic problems, the equalization formula is not the place to do it because of the obvious moral hazard. If the Government of Canada recognized that as a fiscal need, they would have to impose limits, regulations and directions on provincial fiscal policy, and we think that is inconsistent with the whole thing.
The Deputy Chairman: I particularly want you to answer Senator Murray's question on resources.
Mr. O'Brien: I should say we did consider the problem of northern isolated populations in provinces and whether there were special fiscal needs there and whether they should be addressed in the same way as in the territories. These problems exist in virtually all provinces, with the possible exception of Prince Edward Island. There are isolated northern populations and Aboriginal populations and so on with special needs, and we thought a sound program providing reasonably comparable fiscal capacity could address those.
Senator Murray, you had a concern about resource revenue and that it is unfair to provinces with limited resource endowments such as Prince Edward Island or New Brunswick. That was the basic issue of balancing what we thought were two competing principles, one being that provinces own natural resources and their residents should receive a net fiscal benefit from them, and the other being that resource revenues are a major part of provincial revenue capacity in Canada and are distributed differently across the country, which must be considered in attempting to achieve reasonably comparable levels of public service and taxation.
We thought the right balance was the 50 per cent inclusion, and while a province such as New Brunswick may have less revenue-raising capacity from resources than the province of Alberta, in terms of the incentives and the basic recognition of their ownership, it is as important for New Brunswick as for any other province to ensure that the equalization program is not creating disincentives to development. I think there is oil in New Brunswick now, is there not? There is an oil well about to start producing, and there are certainly forest resources, and there are costs to developing those forest resources. It is important equally across the country that you have the right balance in the treatment of those resource revenues.
I would have to study Professor Smart's argument that this will reduce rates and the empirical evidence he has provided. I saw Professor Smart's paper on that subject last summer. I find it counterintuitive that that would be the case. I gather that Professor Smart's argument is that because provinces can set very high rates, which will discourage development, and be protected under a 100 per cent inclusion equalization formula if they are recipients, that distortion, which he referred to as a subsidy to high taxation, will be removed by providing an incentive to provinces that are recipients to develop their resources. Frankly, I do not understand why that would be undesirable. I did not follow Professor Smart's argument. It seems he is saying that there is a distortion under 100 per cent inclusion and that removing it would be undesirable because in his view it would be desirable to tax resources at a higher rate. That is a decision provincial governments should make and be accountable to their electorate for, and not be driven by the equalization formula one way or the other.
[Translation]
Mr. Gagné: I will address Senator Fox's question with respect to the independence of our panel. In Appendix 1, you can see our mandate, which was much broader than that of the federal panel. Indeed, I can tell you that we had 13 clients to satisfy, not one. I think it is easier to satisfy 13 clients, because there is less control exerted by the client.
Who funds equalization? Mr. O'Brien made this point earlier, and I had already said this. You and your neighbour, if you receive the same salary, are contributing exactly the same amount to the federal equalization program, and the same thing applies to businesses. There is no geographic discrimination, contrary to what the media have been suggesting.
Why is it that Robert Lacroix and Robert Gagné are unable to agree? Well, we can agree, but we have a different point of view when it comes to excluding natural resources.
I believe — and the discussion with Senator Rompkey brought this out earlier — that when you start to exclude certain revenue sources from the calculation for equalization, that creates other problems. We did not specifically name them, but it means that Saskatchewan ends up with a higher fiscal capacity than Ontario. We then have to come up with a second "band-aid" or means of correcting the formula, which is that no one can be higher than Ontario, because Ontario receives no equalization. Why is Saskatchewan ahead of Ontario? Not because it is richer than Ontario, but because part of its oil revenues are excluded, which means that it seems to be richer than Ontario.
As regards tax points, why does Quebec now seem to be turning its back on tax points? Well, I believe that it is simply their concern that these tax points will not be equalized, and that no equalization will be associated with these tax points; as a result, they will end up receiving tax points that have less value than those received by Ontario, Alberta or British Columbia.
Indeed, in every single province, we were told the same thing; we are very open to tax points as long as they are equalized. If they are not, we are not the slightest bit interested, because we would kind of have the feeling we are being had.
[English]
The Deputy Chairman: Do you want to say anything about municipalities?
Mr. Gagné: I would like to talk about municipalities but it was not in our terms of reference.
The Deputy Chairman: Talk about it anyway.
Mr. O'Brien: In terms of the issue of fiscal disparities among municipalities and the adequacy of financing of municipalities, our view is that the formula that we have proposed includes most of the revenues that are used to finance municipal services. They include local government revenues as well as provincial revenues. We think that, again, a major issue there has been the measurement of property tax capacity. We had a relatively arcane formula historically for measuring property taxes, which were heroic proxies for property tax capacity. We recommend that the program be moved to market value assessment, which will make it more robust and more relevant to achieving the purpose.
However, if you have that kind of robust program to equalize provincial local revenues to a reasonable national standard, then it is not the Government of Canada's job to address those issues within a province. It is the provincial job and the province should be accountable to its electors for that. Ottawa has done its job by ensuring that the province and its municipalities have reasonably comparable fiscal capacity.
The Deputy Chairman: Off the cuff, Mr. Gagné, what would you say?
[Translation]
Mr. Gagné: Personally, and I know Senator Eggleton will not be happy about this, but I see no problem there. If the municipalities need additional funds to finance their public services, be they highways, snow removal, water or something else, they have only one field of taxation.
[English]
Not in Quebec. They can have federal and provincial subsidies but they have a huge tax base, which is property tax. In B.C. property has a big value, but they do not tax this value. The money is there, but they do not want to use it. It is difficult for me to see that there is a problem of imbalance between the municipalities. They have infrastructure problems. Every level of government has problems. School boards have problems.
[Translation]
Senator Murray: The fact that the formula includes municipal revenues implicitly suggests that the provinces and provincial governments have an obligation to ensure there is equalization among the municipalities, does it not?
Mr. Gagné: As Al O'Brien was saying earlier, that is a problem that concerns the provinces and their municipalities. Yes, there is a vertical fiscal imbalance between the municipalities.
[English]
Senator Murray: This was raised the other day with one of our witness, Mr. Boadway, who was involved. In Nova Scotia, the Regional Municipality of Cape Breton has launched a suit against the provincial government alleging that the provincial government was not remitting to it the fair share of the booty it gets from Ottawa in equalization. It is an interesting point. I do not know whether it is a constitutional or a political issue, but they are alleging that it is a constitutional issue under both section 36(1) and 36(2) of the 1912 Constitutional Act.
The Deputy Chairman: Neither of you like revenue sharing on gas tax or any of the other taxes.
Senator Fox: That was my question.
Mr. O'Brien: Having spent far too long in a provincial finance ministry, my bias is to try to keep these things simple and straightforward so that Canadians and Canadian residents of provinces know who is responsible for what. It makes sense for provinces, to the degree possible, to increase their revenues for their services, share them appropriately with local governments in their province, and for Ottawa to ensure that those provinces have the capacity reflecting the differences in economic structure to deliver reasonably comparable levels of service without excessive levels of taxation. That is the prime job. The best thing is to try to align revenue sources with spending responsibilities. That is true both as between the Canadian government and the provincial governments and between provinces and local governments.
While I agree with Mr. Gagné that the property tax is probably a more robust source of revenue than many local government leaders like to talk about, I do think that there is certainly room, with the growing responsibility of particularly major urban municipalities in the country to deliver services, to look for new and more creative ways to find revenues for which they can be held accountable by their electorate. There is lots of room for that. I am not a fan of the federal government's trying to address that issue with municipalities.
[Translation]
Mr. Gagné: The federal government is already doing that. When it provides a $1-billion subsidy to upgrade the Toronto Subway and a $300-million subsidy to upgrade the Montreal Subway, that is also equalization. That reduces the imbalance between local governments and the provinces. It is not equal per capita.
[English]
The Deputy Chairman: It is wonderful that you came here this morning and it has been good fun.
We are meeting next Tuesday at 9 a.m.
The committee adjourned.