Proceedings of the Standing Senate Committee on
National Finance

Issue 6 - Evidence, April 21, 2004


OTTAWA, Wednesday, April 21, 2004

The Standing Senate Committee on National Finance met this day at 6:15 p.m. to examine the Main Estimates for the fiscal year ending March 31, 2005.

Senator Lowell Murray (Chairman) in the Chair.

[English]

The Chairman: Honourable senators, we are continuing our study of equalization in the context of the 2004-05 Main Estimates that have been referred to us.

We have two witnesses tonight, both of whom are from Queen's University, although that is definitely not to say that they are of identical views on this subject. Indeed, that is why we have invited the two of them.

We have Professor Thomas Courchene and Professor Robin Boadway. Professor Courchene will speak first. He is the Jarislowsky-Deutsch Professor of Economic and Financial Policy at Queen's. He is also Senior Scholar at the Institute for Research on Public Policy.

He has written extensively about equalization and, most recently, has done a very interesting piece, parts of which appeared in The Globe and Mail, entitled "Confiscatory Equalization: The Intriguing Case of Saskatchewan's Vanishing Energy Revenues."

With that short introduction, I will invite him to make an opening statement, after which we will have time for comments and questions.

Mr. Thomas J. Courchene, Professor of Economic and Financial Policy, Queen's University: Mr. Chairman, it is a privilege to appear before this committee. Thank you for the invitation.

In my opening statement I want to focus on two fiscal federalism issues, both of which stem from recent research I have done with the IRPP. The first is called, "Hourglass Federalism," and appears in the April 2004 issue of Policy Options. The second relates to the document to which the Chair just referred. I assume both have been distributed and you have them before you.

As the name suggests, the thesis underlying what I have called "hourglass federalism" is that the new economic order, which roughly equals globalization and knowledge information revolution, is privileging cities and municipalities on the one side and the federal government on the other, and leaves the provinces as the squeezed middle of the division-of-powers hourglass.

The analysis of what happened runs as follows. There are several reasons, and I shall focus on three, why Ottawa wants to deal directly with cities and citizens more than they used to. The first relates to the shift from a resource-based economy to a knowledge-based society. Among other things, this means that societal investments in knowledge and human capital formation progressively hold the keys to wealth creation, to competitiveness and to ameliorating income distribution implications. It should not come as a surprise that as long as issues relating to Canada's competitiveness and citizens' standard of living are at stake, Ottawa will be there no matter what the Constitution might say about it.

The second has to do with the emergence of global city regions as the dynamic motors of the new economy. This also relates to competitiveness in the dual sense that these global city regions are leading their respective regions' inroads into NAFTA economic space, they are the export platforms driving north-south integration, and that the GCRs are also key nodes in the knowledge human capital system of networks. Indeed, since Canadians' standard of living will come down to how successful our global city regions are relative to American GCRs, Ottawa will again want to be a key player in the national competitiveness game.

The third and, perhaps, the overarching argument for an increased federal presence relates to both nation building and electoral salience. Both of these have shifted away from resource-based megaprojects toward citizen-driven infrastructure and policies in areas such as health, education and income distribution. Whereas the former megaprojects tended to be rural, citizen nation building in the information era is predominantly urban. Unfortunately, from Ottawa's standpoint, most of these areas fall under provincial jurisdiction.

Since electoral success is the sine qua non of politics it is only a matter of time before competition among federal parties and between federal and provincial politicians will ensure that Ottawa will become more directly involved with citizens and cities.

How did Ottawa make these inroads into provincial jurisdiction? Basically, it fiscally starved the provinces beginning with the CHST cuts in the 1995 federal budget. Intriguingly, these CHST cuts compromised virtually every other program except medicare because the provinces had to ensure they kept medicare up for electoral reasons. Hence, the provinces diverted funding from everywhere into medicare. Of course, these are generalizations. The inevitable result was that the provinces had to starve other policy areas, so much that citizens and cities alike welcomed federal funding in these cash starved areas.

Utilizing its privileged fiscal-balanced position, Ottawa responded with the Child Tax Benefit, with measures related to early childhood development, with the Millennium Scholarship Foundation, the Canada Research Chairs Program and with creative measures in the recent budget relating to the Canada Learning Bond for children of low-income families, all of which if not solely in provincial jurisdiction are generally viewed as being close to provincial jurisdiction.

On the city side, Ottawa responded with the GST exemption for cities, with the promise to share the federal gas tax with cities, with an enhanced infrastructure program, as well as promises of a new deal for cities that includes pre- budget consultations and a say on federal policies that affect, or are implemented by cities.

In all of this, the provinces are finding themselves fiscally sandwiched. To be sure, they can counter with charges that there is a fiscal balance in the federation that needs to be corrected, and I think partly their rationale for the Council of the Federation is to do this, or they can cater to their cities by, among other means, promising them they can use their Council of the Federation as a vehicle to bring city issues to the attention of the federal government.

The fundamental reality is that for the time being the provinces appear to be trapped by the revenue appetite of health care. The only way for the provinces to escape from this is to transfer much of medicare costs upward to Ottawa via rebalancing, or getting generous funding for medicare, or to transfer the costs downward to citizens via premiums or some other process. Failure to do this will means that the provinces will continue to be rendered rather helpless to stop this progress of hourglass federalism.

I suspect many Canadians would approve of this if only because it means additional programs and moneys for cities and citizens. Certainly, the cities are happy about this because they lobbied for these programs and money.

My role here is not to approve or disapprove of hourglass federalism, but to point out that we are arguably witnessing the most important post-war shift in the division of powers. At base, it is being driven by the human capital and knowledge revolutions. The Canadian federal system is simply responding to resulting challenges and opportunities in ways that do not differ much from the way other federations are responding.

My conclusion is that Canadian cities will become more fully and more formally integrated into the processes and programs of intergovernmental federalism. The only issue is how this will come about.

The committee may wish to play a creative role in the manner in which the inter-governmental nature of our federation might or will evolve. That sets the stage because provinces are fiscally stretched so that equalization is one of the levers that they have to pry more money out of Ottawa.

I turn to the second issue, which is Saskatchewan's vanishing energy revenue. In fiscal year 2000-01, Saskatchewan's energy revenues were $1.038 billion, or just over $1,000 per capita. However, the province's equalization offset or tax- back associated with these energy revenues was larger at $1.126 billion; the tax-back rates exceeded their total energy revenues.

Viewed over time, the rise of the tax back rate was even more confiscatory. Over the 1998-99 to 2000-01 period, the province's energy revenues increased by $668 million, but the equalization clawback increased by $835 million. This represents an offset rate of 125 per cent.

Moreover, neither of these calculations takes account of the fact that collecting these revenues is far from costless. Depending on how far away the resources are located, the province must spend money on roads, telecommunications, regulatory policies, and collect the revenues. That would further magnify the province's overall budget loss from the energy patch.

In contrast, provinces with no energy revenues pocket a significant amount of fiscal revenues from energy related equalization, as one would expect they would. Manitoba receives about $120 million. Quebec gets a much larger amount at $870 million. The two do not differ very much in per capita. Indeed, even Nova Scotia, which has offshore energy, ends up being a net overall beneficiary of equalization by $104 million, which is larger than its offshore energy revenues.

Surely, the role of equalization is not to confiscate a province's resource endowments, but that is exactly what has happened to Saskatchewan.

How and why, then, do these confiscatory average and marginal tax rates exist and, indeed, persist?

In the study I identify three major issues, among others, that give rise to this situation. I then propose a range of options that might redress this serious fiscal inequity.

The primary reason for the large average tax back lies in the shift from an all-province or national average standard to the current five-province standard, comprised of Saskatchewan, B.C., Manitoba, Ontario and Quebec. With Alberta thus out of the picture Saskatchewan becomes, by default, a rich energy province. For example, for third tier oil, one of the several revenue resources for energy, Saskatchewan is only 30 per cent on the national average base, but it has 97 per cent of the five-province base. Since the average tax-back rates rise apace with the degree of concentration of the base, Saskatchewan's average tax rates are higher, often dramatically higher, under the FPS than they were under the national average standard. Indeed, for the national average standard there are some cases you can find where Saskatchewan is the net recipient of equalization, but under the five-province standard it gets taxed at about 100 per cent. It goes from a have to a have-not province depending on whether Alberta is in or out.

The second reason is that equalization authorities have not allowed Saskatchewan to qualify for the 70 per cent maximum tax-back rate that is applicable to the offshore energy for Nova Scotia and Newfoundland. The eligibility criterion for the special treatment, or for the so-called "generic solution," is that the province must have 70 per cent of the national average base.

Saskatchewan typically has 70 per cent of the five-province standard base, but not of the national average or all- province basis. Surely, however, the relevant base for the current operations of the formula is the five-province standard base, not the national average base because Alberta's base is up.

Moreover, the only reason why Nova Scotia and Newfoundland have more than 70 per cent of the national average base is because Ottawa has defined the tax bases in this way. In fact, the tax base from offshore oil only involves Newfoundland's offshore oil, or the Newfoundland base, and only involves offshore oil for Nova Scotia for its own base. Thus, by definition they have to have 100 per cent of the national average base because the only energy deposits in it are its own resources. That is not true for Saskatchewan because it involves Alberta's revenues in it as well.

As a result, Saskatchewan's tax-back rates are near the 100 per cent range in contrast to the maximum 70 per cent that applies to the two Atlantic provinces.

The third reason is more complicated. It is the reason why the tax-back rates can get above 100 per cent. It is because the Department of Finance has decided to create some artificial tax bases and tax rates for similar revenue sources, which serve to exacerbate the clawbacks.

My favourite example is the sale of Crown leases where Saskatchewan is viewed as taxing these leases at a rate of 6.9 per cent where the Department of Finance has decided that the national average rate is deemed to be 15.6 per cent, so that Saskatchewan is dramatically undertaxing these Crown leases, which I think is impossible since these are the result of an auction process so the rate gets set by the market.

In any event, that redefines Saskatchewan's fiscal capacity for equalization purposes with the result that the province raises $61 million in revenue from these Crown leases but loses $124 million in equalization for a clawback of 200 per cent. For every dollar raised in Crown leases Saskatchewan loses $2 in equalization.

Assigning of different tax rates for leases across provinces amounts to second guessing the efficiency of markets. I think that is the case. In fact, the $120 million that Saskatchewan was given for past problems with their formula was related largely to sale of Crown leases.

One can make the case, perhaps, that these clawbacks constitute one of the factors that have triggered Saskatchewan's recent descent to the lowest rank in terms of provincial per capita disposable incomes. Even if it is not the case, it is really intriguing that the province that has, according to some estimates, the lowest personal disposable income is suffering from these inordinately high tax-back rates.

In conclusion, I offer following two proposals. The first, is longer term in nature, namely, that the ongoing quinquennial renegotiation of fiscal arrangements be extended to address these arbitrary and excessive tax-back rates, and resource equalization issues in general.

Based on the extensive literature in this area, one option that merits consideration is to equalize somewhere in the neighbourhood of 25 per cent of resource revenues. The best authority on that is my colleague Mr. Boadway.

The second proposal could and should be adopted immediately. Drawing from the treatment accorded Nova Scotia and Newfoundland, the immediate policy imperative is that, beginning with fiscal year 2001-02, which has not yet been finalized, the maximum equalization tax-back rate for each Saskatchewan's energy categories be set at 70 per cent.

By way of a postscript, the federal budget did respond positively to the tax-back issue by committing the Government of Canada to review the treatment of resources and tax bases as part of the quinquennial review to be completed in 2009.

Energy resources and deposits are depleting assets and this delay seems unacceptable on equity grounds, especially when the same budget reduced the tax-back rates for Nova Scotia, 10 per cent this year and 20 per cent next year, until it is back up to 70 per cent. The gap between these two areas is much wider.

In the meantime, over the next five years Saskatchewan will have tax-back rates for six of the nine energy categories in excess of 70 per cent in 2001-02 and for eight of them in 2002-03, followed by five, five and then six of them so that these tax-back rates well in excess of 70 per cent will continue into the future.

Long ago, I made a statement that "equalization is the glue that binds the federation together." However, if these inequities persist, this glue may well become unstuck. I think this committee is the natural, and certainly the national, forum to undertake the process of rethinking the role of resource revenues in equalization.

Senator Comeau: Anyone who lives in a rural area would have been able to follow the first part of your presentation quite easily because many of us have noticed the reduction of services to rural communities. For example, there have been cuts to fisheries and roads are deteriorating to the point that the shipment of goods is becoming increasingly difficult. We have seen a shift in attention from rural to global city regions.

Have you given any thought to what will happen to rural areas if that continues?

Would it be similar to what happened in Newfoundland when the outports were closed, and people were required to move to larger centres?

Mr. Courchene: I will answer that question, but first, I will make a comment. This morning, I read in the newspaper about the report commissioned by the Province of Ontario under Premier Harris and then under Premier Eves that was run by Professor Daniels, Dean of Faculty of Law, at the University of Toronto.

The report, which contained 50 background papers, stated: "that it is time to give up on Ontario's rural communities." Perhaps that triggered your report. It behoves the Senate to have the authors of this report appear before this committee.

Cities are becoming more important. The Mayor of Toronto will become better well-known across the world than the Premier of Ontario will be known simply because cities are the driving force. They are the collections where human capital and innovation take place.

We will only be successful in Canada if our cities can be on a level playing field to compete with U.S. global city regions. In that sense, cities will win, although we do not know how, but our future depends on it. In a sense, someone has to say, "what the heck happens to rural Canada?" We do not need an urban strategy, in a sense, because everyone is worrying about cities and looking after them on their own. They are falling over backward to help our cities. A national strategy must be developed to determine how rural Canada could accommodate this trend and how it would fit into the process.

Senator Comeau: We must be mindful that rural areas represent less than 25 per cent of the electorate. The political importance of rural areas becomes less and less valuable. Urban members of Parliament take on an increased role because their numbers are greater. The agenda is being driven by urban members of Parliament and rural members, for the most part, are so busy taking care of EI problems and travelling great distances to remote areas that they are not as involved in some of the bigger decisions.

Mr. Courchene: If 81 per cent of Canadians do not live in the rural areas, then 25 per cent is a relatively large number. It depends how you look at this issue. In terms of population, cities are not over-represented. In total, the rural areas comprise a smaller portion than they did before and will continue to reduce in size.

Many provinces have tended to cater more to their rural areas than to their urban areas. Provincial governments do not know how to handle the cities. Toronto is now in a situation that it probably has a civil service capable of challenging that of Queen's Park. One of these days Toronto and Queen's Park will be in a donnybrook trying to figure out who does what.

As far as I can see, provincial governments have done a good job of being sensitive to their rural regions but I have not thought much about it.

Senator Comeau: I agree with your provincial take on this. However, from a federal perspective, I think things have changed quite dramatically. I do not think the federal government knows what to do with the rural areas. The provinces may know about rural areas but the federal government does not. The provinces do not know how to deal with the cities but the federal government is learning quickly.

Mr. Courchene: That is part of the shifting nature that I mentioned.

The Chairman: How many global city regions are in Canada and where are they?

Mr. Courchene: There are probably four or five: the GTA, Greater Toronto Area, Montreal, Vancouver and the Calgary-Edmonton corridor. One could also include the important export platforms for the various regions: Halifax, pulling the Maritimes into the Boston area; you could add Winnipeg, which has been very creative in policy with Mayor Murray; and Ottawa could be in there too, depending on some calculations. This is simply a gross measure of global city regions.

Senator Comeau: A couple of weeks ago, I heard the Mayor of Halifax talking about a strategic alliance with Moncton rather than with Sydney, Nova Scotia. Allying with Sydney would be logical because they are in the same province. However, the mayor said that they would ally with Moncton as a strategic investment area with which they wish to entice investments. Sydney would be left out of the loop because it is viewed by the powers-to-be in Halifax as more rural than urban.

Mr. Courchene: To succeed in a North American economic space, you must start looking at the comparative advantage from your particular region. Sydney is not left out of this alliance; it is just that Sydney will probably prosper better in this framework than it would in another kind of framework.

It is worse in Saskatchewan because it does not have a global city region. It must work either through Winnipeg, Vancouver or the Calgary-Edmonton corridor. This is the changing North American geography.

Senator Comeau: Have you given any thought to equalization schemes in other jurisdictions that are similar to those in Canada?

Are there other formulas that we should look at?

Mr. Courchene: I have looked at some other federations and it is astounding how close the equalization programs relate to the underlying values of the federation to which you refer. Australia federation is by far the most egalitarian. Welfare is national and everyone may qualify and receive on an equal basis no matter where they live. University salaries are the same across the country, from Tasmania to Sydney to New South Wales.

There is a lot of centralization. The provinces have very little independent tax base. Most of it comes from transfers. They have an incredibly egalitarian equalization program. They bring everyone's revenues up to a certain level and the tall poppies get brought down to that same level.

On the expenditure side, if it costs you more to deliver a unit of public service in Australia you get extra money, if it is cheaper you get brought down. Therefore everyone is brought down on both the revenue and expenditure side. It is a wonderfully egalitarian system, but it is set up in a federation that itself is much more egalitarian than we are.

If you consider the Germans, they are the second most egalitarian in their equalization system and their defining constitutional rhetoric is uniformity of living standards. Everyone gets brought between sort of 99 and 102 per cent of the national average. The second most egalitarian nation has the second most egalitarian equalization program.

When you look at Canada, it is much more diverse and much more decentralized. Provinces have their own tax rates, which is unheard of in the other two jurisdictions. Quebec is distinct in various ways. We are plural in our legal system, our culture and our language. Most of our grants are unconditional. We have an equalization program but it only brings provinces up to a certain level. It does not bring anyone down and it does not equalize for needs. That is appropriate in the sense of where we stand in this hierarchy.

Then you get to the Americans. Our creed is peace, order and good government, but their creed is life, liberty and pursuit of happiness and they do not have an equalization program. The rugged individualism of the U.S. apply to their states as well, and they argue that everything is capitalized so that even if revenues are different across regions then it does not really matter because they will be capitalized and you will have to pay more for rents and other things. There really is nothing to equalize.

Here you see a marvellous relationship between the least egalitarian system, having no equalization program, and the most egalitarian system, having the most egalitarian equalization program. It is in that peculiar sense that the equalization and the transfers generally seem to reflect the underlying moral and philosophical approach to life that the federation itself has, which I think is astounding. However, in this sense you have to watch out then. You cannot take an Australian equalization program and put it here. It will not fit. It is not designed to fit, it has an entirely different rationale, it assumes different relationships and it has a different underlying value. Therefore you have to be very careful about taking things from one jurisdiction and plumping it into another. We are not all dying because Jacques Cartier was not a samurai. We have to go with what we started with.

Senator Day: The first question I have, Mr. Courchene, is in this tax back area, and dealing with Saskatchewan and the comments that you made in relation to the totally different system that Saskatchewan has versus the resource tax back from Newfoundland and Nova Scotia, how did we get into this set of rules that treats Saskatchewan so different from the others?

Mr. Courchene: I do not think Saskatchewan is treated differently from the others. The deals have been made with Nova Scotia and with Newfoundland, and appropriately so. I am not saying that there is anything wrong with that.

The Chairman: Those deals are outside the equalization program.

Mr. Courchene: The deals are outside the equalization program because they are Newfoundland and Nova Scotia accords. They are listed in there and the provisions are given. However, one can argue that you need to do something because you cannot let this tax back be as high as it otherwise would be because it cost Nova Scotia money to get these offshore revenues in, more money than it probably cost Saskatchewan.

One of the things that you should do for resource rents is before you start equalizing anything you should take an amount of money off the top so that the province can keep for what it has spent to get these revenues. Why would you equalize something that the provinces of Saskatchewan and Nova Scotia will not get? If $500 million is spent to get $1 billion of revenue — I am just throwing out these figures out — what you should equalize is the other 500.

You could say you should do that for all equalization categories, and my answer yes, you probably should. However, if you look at gasoline taxes or taxes on cigarettes, every province has them so you could deduct what it costs to collect but everyone is collecting it and it roughly the same per capita in every province so if it is a wash it is a wash. It is not a wash though if only three provinces have oil or four provinces have mining or timber. You should take into account for those resources, or those energy categories and their larger resources that are not in every province, some recognition of the fact that the province itself has to spend money to collect those. I believe some provision should be made to ensure that they do not get taxed back 100 per cent plus whatever loss they get.

The point is that you could rationalize a treatment like 70 per cent for the Maritimes on this basis alone, namely, that is roughly what it might cost to collect $1 of revenue. My only case was that Saskatchewan ends up having these horrendous average tax back rates for the reasons I set out. My appeal was on equity grounds let us give them the same as what they do for Newfoundland and for Nova Scotia. The reason Ottawa might say that they do not deserve it is that Ottawa has defined this 70 per cent rule. The province must have 70 per cent of the national average base, whereas Saskatchewan only has 70 per cent of the five-province base because Alberta is out. It has these very high tax back rates, so I think it should be treated the same way as Nova Scotia is treated.

Senator Day: What happens to the system if we say, let us just exclude all revenue from resources in the equalization?

Mr. Courchene: Obviously Saskatchewan would gain $1 billion, right?

Senator Day: Does that mean that much money will not be available for distribution?

Mr. Courchene: Everyone who does not have oil would lose. Some people are suggesting that. I believe the Atlantic Institute for AIMS is suggesting that.

Senator Comeau: They would.

Mr. Courchene: However, I am not suggesting that.

Although at the end of the paper I refer to another paper by James Feenan at Memorial University in Newfoundland. His paper is all about resources and why they differ from other categories. He would be a wonderful person to have before the committee. Feenan says that if you go through the literature, including stuff by Mr. Boadway, and even my own stuff way back focusing on two-tier equalization where you have a regular tier and then the resource tier, people were using, with some justification, figures like 25 or 30 or 20 per cent for equalization of resource revenues. Feenan said okay, let us take all the non-resource revenues, personal income taxes, the 25 that are gasoline, cigarettes, sales taxes, all of those things, and equalize them at the national average tax rate, not the five- province, let us bring the national average back. What happens then is everyone gets a little bit richer for that tier. He then says to take resources and equalize them at only 25 per cent across the board.

Senator Day: Is that all resources?

Mr. Courchene: All resources. Alberta is in there too. That changes no one's equalization except Saskatchewan and B.C. Both go up quite a bit. Saskatchewan goes up by about $300 million, which is exactly what I thought they should get from the 70 per cent. However, that is a separate issue and just coincidental, and B.C. gains more. That would suggest to me that there is a tax back rate associated with British Columbia that no one has focused on in the federation yet. I am sure British Columbia finance officials have though. It is only those who provinces that suffer from these tax backs right now.

There is a solution. From then on, if any big changes in oil prices occur, you are only equalizing 25 per cent. It will not be as volatile as it is currently.

That is one example of an approach that the Senate should study to look at eight or nine different ways to calculate energy revenues. It is refreshing for me to go back to work on equalization to see how complex it can get. Senators should get some feel of that, I think.

Senator Day: That leads me to my next question. In your presentation you started to explain the Saskatchewan point. It seems that the national standard, the national average of all the provinces, is used for certain things. The five province standard is used for other things. I was having some difficulty understanding when you said that Saskatchewan is viewed as taxing leases on the resources at 6.9 per cent. The national average rate is deemed to be 15.6 per cent.

Can you explain what you said?

Mr. Courchene: We have a five province base. The base is calculated on the basis in the five provinces rather than the 10 or the national tax standard. The tax rate within the equalization formula that applies to this five province base is still the national average tax rate.

Mr. Courchene: Another intriguing way to look at the formula is to ask why we do not have the five-province rate to apply to the five-province base. It would be a little higher on the national average side because Alberta has zero sales tax. With the five province, it would be larger than that. However, it would take away the problem of the tax of Crown leases because you would not have Alberta's tax rate in the formula. If you do not have Alberta's base, there would be no reason to have its tax base in there. That is another important approach.

The reason that you get tax back rates that are greater than 100 per cent is because someone has played with this base and the implicit tax rate. When we got 200 per cent rate of Crown leases, someone decided that Saskatchewan was under pricing these by about 45 per cent. In other words, that was saying that Saskatchewan could have received 40 per cent more money from these Crown leases than it actually received.

Senator Day: They are in effect saying that they are subsidizing the industry.

Mr. Courchene: Why would the industry be subsidized? If Esso buys a lease and I know that it is only paying 60 per cent of what it is worth, I would pay 61 per cent. The Department Finance should not be second-guessing the markets on redefining tax bases and rates when there are not any. There is only an auction process. That would not happen if the comparison was not with Alberta's tax rate in the formula.

I have not thought enough about this to decide whether it is a good suggestion to use the five-province tax rate, but it is intriguing that no one has had discussions concerning this subject. It is confusing that even though we use the five province base, the tax rate for equalization purposes is the national average tax rate.

Senator Day: Is it oversimplistic for me to suggest that for all purposes we should use either one or the other? Should we use all of the provinces for all of the purposes, or the five provinces for all purposes? Has anyone crunched the numbers to look at that view?

Mr. Courchene: If you were to equalize energy at the national average standard, you would be bringing Alberta's energy in at current prices. It would drive up equalization. It would probably triple it.

We cannot afford do that, particularly since Ottawa gets very little money from Alberta. Ottawa does not have the ability to tax the royalties.

We got into the five province standard in the first place was because of what happened in the 1980s. Ontario was a have-not province because Alberta's oil was costing so much. No one wanted Ontario to be a thin cat when everyone knows it is supposed to be a fat cat. You could not pay equalization to Ontario.

However, the other problem was that Alberta's energy was driving up the equalization pot and Ottawa had to pay it, but Ottawa still got 40 per cent of its revenue from Ontario. It could not get at the tax base because it cannot tax the royalties. This was an unfair funding of equalization across the provinces.

The correct answer in theory might be that which I was trying to suggest. Close your ears to this suggestion because it is a nasty suggestion from my home province.

Senator Day: We would like to hear.

Mr. Courchene: In the late eighties, I argued that there should be a revenue sharing pool for energy. We would have a national average standard for everything else and equalize 25 per cent for energy revenues. All the provinces would put in 25 per cent of their resources and everyone takes their population share out.

It would be self-financing. Alberta would be kicking in revenues to the pot that would be pulled out by some of the poorer provinces. The provinces would share a portion of the resource revenues among themselves because they own the resource revenues not Ottawa.

This is tough, but if you do not believe that a interprovincial revenue sharing pool makes sense, then neither does the United Way.

It is a tough sell to the westerners to give up some of their energy.

Senator Downe: I agree with your statement that Ottawa is making inroads in provincial responsibilities. However, you may underestimate the tools that the provinces have. For example, on the scholarship fund, a number of provinces simply took out their own contribution and used the federal funds.

On the recent GST exemption for the cities, which was announced in the recent budget, Charlottetown announced a figure in the area of $400,000 because it would not have to pay GST rebates. Within a week, the provincial government announced a new levy that was about $2,000 short of what Charlottetown would save. The province has many tools to fight back on the encroachment. The federal government has seen a rapid expansion of cities and infrastructure problems in the larger city that they have had to address.

How do you see the role of the provinces, which are protecting the rural areas and fighting off the federal government, and the federal government, which is trying to get into the provincial areas? I am concerned that you may have underestimated the tools that the province has to fight back. Do you have any comment?

Mr. Courchene: The biggest tool they have is that much of this stuff is in their constitutional jurisdiction. Cities are creatures of the provinces.

Senator Downe: Municipal.

Mr. Courchene: They can fight off on that score.

Cities are becoming more important. We have to figure out how to deal with them.

We have been an incredibly creative nation. Federalism in Canadians' hands has become a beautiful art. In the 1930s, the provinces accounted for about 60 per cent of the revenues of the country. With wartime, we managed to give it to Ottawa and the provinces share fell down do 30 per cent in the post-war period. With expansion of health and education, the provinces roared back. They are now at 60 per cent. They made all those changes without a change in the Constitution.

Why? We are very creative. We use transfers of tax points down to the provinces; we allowed Quebec to opt out of certain areas; we changed the Constitution in a couple of places; we gave unemployment insurance to Ottawa; we allowed Ottawa in on the pension side. We had various types of delegation, and we had equalization payments that made sure that Canadians, no matter where they lived, ended up able to have similar public goods and services.

Eventually, equalization came in the Constitution, but it was 25 years before that happened. All of that was done with ordinary legislation and provisions. More recently, while the cities and the provinces were getting more powers because regions were becoming, to a degree, more important, we came to an agreement of internal trade to try to minimize the barriers between provinces.

My favourite of all, which some Canadians do not particularly like, is the Social Union Framework Agreement, which allows the federal government to use the spending power, but ensures they have to use it in very selective ways and obtain agreement with the provinces. Even then, the provinces can tailor the monies to be used in their own priorities provided they are related to the federal priorities. This is a way that tries to bring some harmony in a decentralized federation.

We now have a problem with the cities, and we have to figure out how to try to respect provincial jurisdiction, but have some federal role for things like infrastructure that are national concerns. We can do it. It is just that we have not thought about it enough because it is a new problem. The growth in the literature on cities is only about a decade old.

The provinces have power to offset what Ottawa does. Mr. Klein can opt out; Quebec can express its national sentiments. We have to fall back on our innate ability to manage a federation intelligently. We have to design a new set of instruments that are going to allow cities to have more flexibility within this new order.

It is interesting that corporations are on the cities' side. The Toronto Dominion Bank produced articles on Toronto, Vancouver and on the Edmonton-Calgary corridor. Each article argued for greater taxing powers for cities simply because if you want greater accountability at the city level, they have to do something more than just administer.

When Ottawa backed off the gas taxes in Manitoba, the province said it would share the tax with Winnipeg. Provinces have reacted to this measure. It is just that they do not have much money to do it. They got squeezed in this issue to which I referred. That is why some provinces are forced to press on the equalization front or the fiscal imbalance front, because when medicare occupies 50 per cent of your total spending, setting aside deficits, you do not have room for anything else.

Senator Downe: It seems to me that the federal government has identified a priority for cities, which are in some state of crisis. If you listen to the big city mayors and they are concerned about a host of problems. Just as with the crisis occasionally in the east coast fisheries, the federal government steps up to the plate and makes a contribution to the resolution of the problem. This is part of the evolution of the federation.

However, in your reference to the Council of the Federation, the very nature and responsibility of provincial premiers is to be a bit parochial and not to have the national view, which the federal government has to maintain. Premier Klein's comments about the mad cow, and that the solution should have been to shoot it and shut up and shovel, or some variation of that, did not serve the nation well but served Alberta well.

There is a conflict between this Council of the Federation the premiers are trying to form, the responsibility of the federal government for national problems as they occur, and the responsibility of big city mayors. That mix is causing some of these financial pressures because of the problems you identified with the provinces not having enough revenue to address the cities properly.

Mr. Courchene: I agree with that, except my perspective is a little different on the Council of the Federation. I was chair at one point of the Ontario Economic Council. I had a motto that I carried with me in terms of the research of the council. It was; "for programs to be national they need not be central."

It is true that the province's responsibility is to their own citizens, but unless they begin to act together on some of the cross provincial issues, and unless they take a pan-Canadian view of some of these things, then Ottawa will take those powers over. If the Council of the Federation only exists to pry more money out of Ottawa, it is not the right institution, and it will be a failure. However, if it exists to ensure that as people transfer between provinces, medicare is a seamless web, it could be very successful. If it tries to ensure that occupational standards or accreditation, can be transferred any place across the country, they will be successful. If they get involved in pan-Canadian things related to provincial jurisdiction, they will serve the country very well. They are just trying to pry money out of Ottawa.

Senator Downe: I agree.

Mr. Courchene: That is what they have to do. If they do not do that, Ottawa will run roughshod over their powers because citizens will demand it.

Senator Downe: You are absolutely right. If the new Council of the Federation does those things, it will serve the country and the citizens well. On a regional basis, we now have similar bodies set up: the Council of Maritime Premiers, and the Council of Atlantic Premiers. The Western premiers have met, but I do not detect a large degree of cooperation, particularly on some of the points to which you referred.

In the provincial transfer of accreditation, there has been marginal movement on a variety of issues. I do not know that if you increase the size to include everyone, you will have much agreement beyond the self-interest of the individual provinces.

I remember when Premier Peckford had a major problem concerning the fisheries. All the premiers met in Toronto. At the conclusion of the meeting, the premier wondered what he had done. He wondered what type of precedent had been set, and what would happen the next time there was a crisis. Would he then be under pressure to bring all of the premiers together?

I share your hope and optimism. I am not quite as confident that it will happen.

Mr. Courchene: It really began very well. It started with the report to the premiers when Paul Martin as Finance Minister asked the premiers to come up with ways to develop principles relating to the social programs. I refer to the report to the premiers from the social development council of each province. The premiers adopted that in Jasper, and then they had meetings in St. Andrews and Saskatoon. Out of that came a recommendation to Ottawa that Ottawa put in place what eventually came to be known as the Canada Child Tax Benefit.

There was a case of the premiers saying there is some role here for a national program, and Ottawa bought it, and the national children's tax credit is the foundation of a Canada-wide negative income tax. It is a wonderful instrument and gives the provinces flexibility to take the money away from welfare if they want, but they have to spend it on low- income families with children. That was an instance of the provinces acting together to drive the national interest. Ottawa had to pick it up because it became so popular, and Ottawa implemented it.

It was that process that eventually led to SUFA, the Social Union Framework Agreement. What happened is Ottawa got out of its deficit problem and got a lot of money and did not need any cooperation. That is a provincial vision of Ottawa, I think.

The Chairman: With regard to the new deal for the cities, I presume that the GST exemption and if they decide to share the federal gas tax, will not just apply to cities but to all municipalities.

With regard to more infrastructure, the federal government could devise a program but could hardly survive the pressures of devising a program for only those big conglomerations that you mentioned: Vancouver, Toronto, and Montreal.

An infrastructure program would have to apply broadly to municipalities, would it not?

My point is that the cities program has never really been designed.

Mr. Courchene: No. It is a reflection that the cities have become more important. If you follow the speeches of former Finance Minster and now Prime Minister Martin, you will note that he has been talking about cities and human capital for five or six years. He has been long attached to that vision.

I think the federal government will help the various cities with programs such as transit. Washington has infrastructure funding and Canadian cities want the equivalent. I do not see that infrastructure funding, since it benefits more than just the cities, is appropriate. It is appropriate, but the gasoline tax by itself would apply to all municipalities.

The Chairman: By the time they design an overall program, they will be glad to have the provinces around.

Mr. Courchene: They are very careful. They backed off the gasoline tax because they had not sorted out the way to go through the provinces.

The Chairman: Mr. Courchene, the ink was no sooner dry on the Social Union Framework Agreement than Prime Minister Chrétien and the premiers made a deal on health care outside of the agreement.

What programs or initiatives are you aware of that have been done within the Social Union Framework Agreement?

Mr. Courchene: There was the Canada Child Tax Benefit, but it actually came before the agreement.

I said it was my favourite agreement because, conceptually, it is a nice arrangement for the exercise of the federal spending power.

The Chairman: I agree with what I take to be your point; it enhances the bargaining power of the provinces.

Mr. Courchene: As well, it caters to the difference that the provinces may need to be able to implement these programs in their respective jurisdictions. It has not worked as well as I would have liked to see it work, but it is in the back of people's minds when they talk about ways to do things. I think it is a framework that will be the way to accommodate the relationship between Ottawa and the cities. It will have to go through some sort of Social Union Framework Agreement so that the provinces can have some influence on how that framework develops. In that sense, it is there.

Quite often, when we have problems, we do not have instruments sitting out there that are not used that could be useful, but this is one.

The Chairman: I agree that the Canada Child Tax Benefit is a success story. It is successful particularly in those provinces that have agreed to take up the slack and to use the money that would have been otherwise devoted to welfare.

Ultimately, the government tailored even the Millennium Scholarships in such a way, certainly regarding Quebec, to take account of different needs and the existence of programs that were already in place.

With regard to Canada Research Chairs, the federal spending power is fine and takes some pressure off of the provinces in field of post-secondary education.

The problem is that the money is going there, but the shared-cost program, health care, the federal government is trying to do on the cheap.

To me, these exercises of federal spending power should be in agreement with the provinces.

Mr. Courchene: I agree. I thought we were doing that when we made the Social Union Framework Agreement.

The Chairman: Let us conclude by saying it is an agreement with great potential.

Thank you, Mr. Courchene. It has been an interesting and stimulating session.

Our next witness is Mr. Boadway. He is a Sir Edward Peacock Professor of Economics at Queen's University. He has written extensively on fiscal federalism and tax policy. He is a former head of economics at Queen's, past president of the Canadian Economics Association, former editor of the Canadian Journal of Economics, and is no stranger to parliamentary committees.

Welcome back, Mr. Boadway. Please proceed.

Mr. Robin W. Boadway, Department of Economics, Queen's University: I should say that I share with Senator Day the distinction of being a graduate of Canada's only federal university.

The Chairman: For the record, that is the Royal Military College.

Mr. Boadway: I have prepared a few remarks but I do not think I will spend much time on them because it will be more fruitful to have some questions and answers. I will highlight several points to serve as a basis for discussion.

My interest here is solely on equalization, but it is important to put it in context and to recognize that it is not only section 36(2) that deals with equalization but it is the combination of 36(1) and 36(2), together with the combination of equalization and the Canada social transfers, that jointly contribute to the equalization objective. Both components are critical to equalization in the broader sense and ought to be thought of as such. Indeed, the social transfers are in some sense as perfect an equalization tool as the equalization system itself.

I will go straight to what I think are the issues on the table with equalization, some of which have been dealt with already in the discussion with Mr. Courchene, and some of which have been dealt with in the proposals to renew the equalization system that came forward in the recent budget.

Let me highlight some of the problem areas. The first problem is that there are large disparities in post-equalization revenue-raising capacity between the have and have-not provinces, especially between Alberta and the rest of Canada. There is a table in the budget papers that makes that clear. This is a consequence both of the five-province standard and of the net nature of the equalization system.

There are systematic differences in the way in which different tax bases are treated under equalization. Resources that use a generic solution are treated favourably relative to other resources and relative to other tax bases, for that matter, and this is not justifiable. Nor does it matter whether resources of a given type are concentrated in a particular province or whether resources will run out, as some provinces have suggested.

There may be some incentive reasons for treating resources preferentially. There may be some reasons associated with the perceived provincial ownership of resources. In any case, whatever the reasons are, they should apply equally to all resource revenues and not just to those that happen to be concentrated in particular provinces.

At the moment, there is a large asymmetry between the way have and have-not provinces are treated with respect to their resource revenues. Incremental changes in resource revenues in Alberta or Ontario remain entirely with those provinces, whereas incremental changes in other provinces are shared by all have-not provinces. This, of course, is true of all tax bases. Any increment in a tax base of any sort gets more or less fully taxed away by equalization. That is the purpose of equalization.

Equalization entitlements for property tax revenues deviate considerably from what would be achieved using RTS principles. That is something that seems to be addressed in the renewal process.

Those provinces that have greater needs for health, education or welfare services do not have the potential to provide reasonably comparable levels of public services at reasonably comparable levels of taxation. That problem is projected to become more acute in the future as the demographic composition of provinces diverges even further.

Formula-based equalization payments are very desirable; however, since the formula is administered on an annual basis it can lead to instability, and volatility of equalization entitlements. That predictability is exacerbated to the extent that discretionary changes are made to the system for budgetary or other reasons. That issue has been addressed in the current budget.

There are some options that might be worth considering in your deliberations: Equalization treatment of natural resources needs to be harmonized and a special treatment of particular types of resources resisted. In my opinion, the generic solution and the offshore accords provide preferential treatment to resource properties that happen to be concentrated in a particular province or in a particular resource. That is despite the fact that the main tax-back problem that they are trying to address applies to all resources. If it is necessary for incentive reasons to treat resources preferentially, then treatment should apply to all resources on a non-discriminatory basis.

The differential treatment of Alberta relative to the rest of Canada is a more difficult problem. Perhaps you think it should not be addressed at all, but it cannot be dealt with by equalization alone. There are three options for moving in a direction that addresses that problem, if you do perceive it to be a problem.

Social transfers, in principle, could be used to equalize indirectly the non-receiving provinces downward. That is not my preferred option.

Moving from a five to ten province standard would presumably reduce the differential between Alberta and the have-not provinces by increasing the entitlements to the latter. That would be an expensive solution for the federal government.

A more radical reform would be for the federal government to exercise its taxing power to get a larger share of resource rents through the corporate tax system. The corporate tax system currently treats resource industries favourably and provides some relief for provincial taxes. That could readily be changed. I think the federal government could use the corporate tax system more imaginatively to get at resource rents. Indeed, the Mintz Report of the Technical Committee on Business Taxation, which is a little bit away from equalization, notes that the industries treated most favourably in Canada are precisely the resource industries.

Going back to the demographic issue, needs could be incorporated into the equalization system in a manner analogous to the representative tax system for revenues. However, that would complicate the system considerably.

There may be a better way of dealing with differences in needs and that is through the system of social transfers. Needs differences arise because of differences in the size of target groups for social programs; the ill for health programs, welfare recipients for welfare, students for post-secondary education, and so forth, and also because of differences in the average cost of providing public services to different target groups. From the point of view of medical care it costs more to have old people in your province than young people.

Those issues differ among the three main categories of programs, health, education and welfare.

The current system of social transfers is basically equal per capita. That is a very crude way of taking account of needs, albeit it is one way of taking account. An alternative is to proceed as follows. Divide the social transfers into three separate components, rather than the two components that exist now. For each component, base the provincial allocations on the size of the relevant target populations being served. That could be done with varying degrees of disaggregation. For example, health care users could be disaggregated by age; welfare users could be based on caseloads, easily measurable across provinces.

Within each of these categories, you could impose relative weights to the target groups, based on some indicator of the relative cost of serving those groups. The same relative weights would apply across provinces. That is not an attempt to take account of the fact that it costs more to provide medical services in one province than another. Rather it is a way of taking account that it costs more to provide medical services to the elderly than it does to young people.

These relative needs weights could then be used to allocate any given size for the transfers among the provinces. Expenditure needs would not be absolute determinants of the size of transfers but merely a way of allocating given transfers among the provinces.

If you are interested in pursuing needs and equalization, and I was given some indication that you may want to discuss this matter, the best way to do that is not to incorporate needs into equalization but to incorporate needs into the system of social transfers.

Senator Comeau: As you have well pointed out, we try to provide to various provinces, reasonably comparable services at reasonably comparable levels of taxation.

Equalization, as it now stands, is a formula to determine the revenue-generating capacity of the provincial jurisdictions to earn revenue to cover services. It is based on revenue-generation.

That process supposedly determines what amounts should be transferred to the provinces to reach the constitutional objective of reasonable levels of services. That is not happening. One of our colleagues yesterday pointed out that he is paying far more taxes in P.E.I. than he would pay if he were living in Ontario. If he had gone a step further, he may also have said he is getting less service in P.E.I., but he is prepared to pay for that because he wants to live there.

Someone who is indifferent about living in P.E.I. versus Ontario may not want to pay higher levels of tax for fewer services. That leads to your suggestion of using the social transfer to cover needs. Why would our equalization system not work on that basis, to cover needs of people, rather than going through the formula of revenue generation?

Why not get a formula that measures wait times in hospitals, a formula that measures the number of students per class, a formula to measure quality of highways, or distances to schools, or distances to hospitals?

Why not work those numbers into a formula?

That would not be extremely complicated with the use of computers nowadays. We may come up with a better calculation of needs than going to the equalization revenue-generating formula.

Mr. Boadway: People say the current equalization system is already too complicated. Maybe we should not add more to it.

However, I think you raise valid points. The current equalization system, as you pointed out, equalizes revenue- raising capacity and not needs. That system implicitly treats needs for expenditures across provinces as equal per capita. If every province had the same demographic composition and the same population of target groups, then applying a standard cost of service delivery of Canada by way of equalization transfer would be the right thing to do. That is what the equalization system implicitly assumes; that is what the social transfer system explicitly assumes.

Is it reasonable to think of moving away from that system in a way that is manageable?

We do not want to sacrifice the revenue-raising capacity because, as Professor Courchene said, Canada has a very decentralized federation on the revenue-raising side, compared to other federations.

We have to protect the revenue-raising equalization. The question is should we augment that by taking needs into consideration and, if so, how?

Senator Comeau: Do we need to augment?

If we are looking at comparable levels of service at comparable levels of taxation, the provincial revenue generation must pay for the services otherwise the federal government has to transfer a certain amount to the provinces that are below level. It would not necessarily involve a costlier system.

Mr. Boadway: No, but the point remains that a perfect revenue equalizing equalization system allows provinces to raise the same amount of revenues per capita to provide the same expenditures per capita to all of its citizens.

The point about needs is that it may be the case that Prince Edward Island or British Columbia has many more old people per capita than Alberta and, therefore, they have greater needs per capita for hospital expenditure. That is really the argument about needs.

You could take needs to the nth degree and measure needs for roads in rural areas, waiting lists in hospitals and so on, but the fact is that 80 per cent of provincial expenditures are health, education and welfare. They are the basic public services that I think you can interpret the Constitution as applying to on equalization. Focusing on those three main categories would be a good start.

You could start out by doing it in a relatively crude way, just by taking proportions of target groups for each of those areas and finding rough weights such as: It costs twice as much for post-secondary education as it does for elementary school education.

Senator Comeau: What about taxation? We see quite different levels of taxation between the various jurisdictions. Those provinces that would like to expand their economy and attract people to move to them, such as Nova Scotia or Newfoundland, are now unable to do so. In fact, people are currently leaving Newfoundland and going to other provinces where they pay fewer taxes.

We have the three levels. We have equalization that tries to cover the redistribution of services. We tend to do some needs-based response through social transfers, but we have not tackled the reasonable levels of taxation.

I understand that Nova Scotia will probably announce that it cannot try to lower its taxes because it has to spend the tax dollars on health care. That part of the constitutional objective that we are trying to attain is not being attained in many provinces.

Mr. Boadway: Right, but there are many possible reasons why tax rates are higher from one province to another. The equalization system is very effective at equalizing revenue-raising capacity, aside from Alberta, which is an exceptional case, and to some extent Ontario.

All the equalization receiving provinces should be able to raise comparable revenue per capita from applying comparable tax rates. There may be anomalies such as Crown leases in Saskatchewan that throw that off.

Senator Comeau: If we had a 10-province formula, it would be much closer.

Mr. Boadway: The reasons there are different tax rates across provinces lie elsewhere. One reason might be that some provinces choose to have higher levels of public services than others. Some provinces are, perhaps, more engaged in producing certain types of public spending than others. Small provinces, for example, might simply have higher overhead costs for running themselves. Per capita expenditures in Prince Edward Island, and perhaps Newfoundland, are probably higher than in other provinces because of the overhead costs of running small provinces.

There may be many reasons why tax revenues differ across provinces, but they do not differ across provinces anywhere near as much as they would if we did not have equalization. They do not differ across provinces as much as you might otherwise expect them to differ.

Senator Comeau: I do not think we are actually meeting the objective of the Constitution based either on the level of services or on the taxation rates. I am trying to zero in on how we meet the constitutional requirement. I do not think that the present formula is doing what it should do.

Mr. Boadway: That is partly what the argument of needs is about, yes. There are other things that might make it more expensive for some provinces relative to others. There was the issue of infrastructure costs for provinces that have mines in the wilderness, and the cost of building roads for more rural provinces. There are many things that cost more in one province than in the other. However, in the end, the key public services that were meant to equalize are the public services and not infrastructure or public goods. They are, I think, things like health, education and welfare services. That seems to me to be the place to start.

The Chairman: Professor Boadway, when your friend and colleague Professor Harvey Lazar was here a few weeks ago, he pointed out that equalization as a proportion of GDP was one-third higher 15 to 20 years ago. I think it is also the case that it represents a significantly smaller proportion of federal revenues than it did some years back.

Is that evidence to you of shortcomings in the program, or is it evidence that the program has been succeeding too well?

Mr. Boadway: It is evidence, I suppose, that there is some convergence in per capita tax bases across provinces. You have to be careful of interpreting the equalization system as one that is supposed to make have-not provinces develop more rapidly. It is not a regional development program.

The Chairman: That is correct.

Mr. Boadway: However, if equalization as a percentage of GDP has gone down, it is because disparities in tax capacity across provinces have gone down. Equalization is based on the revenue raising practices of provinces, and if provinces are collecting less revenues as a percentage of their gross provincial products either because of reduced taxes or because their GDPs are rising more rapidly than their revenues, that will cause equalization to go down as well. It is a combination of those two things. Equalization as a percentage of GDP can go down because disparities are becoming narrower, or because provincial expenditures per capita in provinces like Ontario are becoming smaller.

Senator Day: Could you elaborate on your point that equalization entitlements for property tax revenues probably deviates considerably from what would be achieved using the representative tax system?

Mr. Boadway: This is a bit of a technical point, so we may not want to dwell on it too much.

As you may know, tax-based equalization is based on the taxing practices of the provinces. When you equalize income taxes, you base the equalization on the basis that the provinces actually use, and the rates that they actually apply. With property taxes, that was not the case, partly because property tax regimes were very heterogeneous across provinces. Even within provinces property tax regimes were very heterogeneous. Assessment methods differed from one municipality to the other.

However, in recent years, most provinces have harmonized their assessment practices and in virtually all provinces property tax systems are based on some form of market value assessment, and provinces, within their borders, use more or less a common property tax base and they allow municipalities to set their rates accordingly.

While you could not do so before, you can now apply the representative tax system approach to property taxes. You can actually use the basis that the provinces use as the base for equalization, that is, market values, and you can apply a representative tax system approach to it.

Some difficult technical problems arise from the fact that some provinces have higher property values than others because of scarcities of land or scenery of mountains or closeness to the sea et cetera. However, the Department of Finance has made considerable progress in addressing that issue. It seems to be the case that they are moving toward a market value assessment process for property tax equalization.

The Chairman: Do you happen to know whether there will be among the provinces significant winners and significant losers?

Mr. Boadway: It depends how it is done. I am saying this with the Department of Finance people looking at me. There will certainly be some gainers and some losers. You can turn around and say, "If it was done in the past, the losers must have been big gainers in the past and the gainers must have been big losers." That is why there was some kind of anomaly measure provided for British Columbia on the grounds that their property taxes were out of kilter.

Senator Day: Do you envisage some type of a 5-province or 10-province average, percentage per $100 of market value?

You point out that the figures for the lower mainland of British Columbia will be quite different from New Brunswick that has a lower market value for real estate.

Mr. Boadway: No, as I understand, the various methods that they are considering are ways of taking account of precisely what you are saying. I do not know whether it is part of the renewal process at this stage, however there are systematically different values of seemingly the same properties across different places, urban, rural, Vancouver, Moose Jaw, and so on.

Senator Day: Please comment on natural resources, the need to harmonize, and the special treatment of particular types of resources that should be resisted.

Is it your view that in order to have a fair and good functioning equalization program that forest revenues are taken in as a natural resource and treated in the same way as oil and gas?

Mr. Boadway: Yes, my first point is that discriminatory treatment that exists now from one resource to the other is largely based on the fact that some provinces dominate particular revenue sources and, therefore, get the benefit of the generic solution, or whatever special deal has been cooked up for them.

The problems that natural resources give rise to are not unique to situations where a single province owns a high proportion of the resources. There are two problems for natural resources, and I think this applies to renewable as well as non-renewable resources.

The first problem is that equalization is based on the size of a tax base of a given source. The more forestry tax base you have, the less equalization you will get. That applies to all tax bases, resources and non-resources. The problem that arises with resources is that provinces have some control over the rate at which their resources are developed. To give you an extreme example is the case of Voisey's Bay, in Newfoundland, where the province can influence whether or not and when it will be exploited. The argument is that there is a big disincentive to them exploiting it because they will get revenues but they will be taxed tack.

There is the incentive problem and that applies more to resources than to anything else. It is hard for a provincial government to control the rate at which cigarettes are being smoked or whatever gambling is being done.

The second problem is one that you may or may not put a lot of weight on and that depends on the province you come from. It is the issue of who owns the natural resources. If you interpret the Constitution as suggesting that the provinces own natural resources, then you have a very different view of equalizing natural resources than if you interpret the ownership of natural resources as being something that is national as well as provincial.

These two issues could lead you to say that resources should be treated differently from everything else. There may be some disagreement on this, but in my view that argument applies to all resources and I do not think that it applies particularly to situations like the offshore or whatever, where a single province owns a single revenue source.

Senator Day: Would the 25 per cent system of all resources across the country maximum work?

Mr. Boadway: Sure, as long as you treated them all comparably. That 25 per cent comes from a study that puts a significant amount of weight on the provincial ownership of resources. That 25 per cent argument is the argument that the provinces own the resources. It is not my argument. I would not pick 25 per cent, but certainly you can. Whatever percentage you pick, you should treat all resources the same.

Senator Day: Have you studied any other federations to see how they approach the resource issue?

Mr. Boadway: Canada is something of an anomaly because in most jurisdictions the central government has much more access to the resource revenues than we do. It is a uniquely Canadian situation where resources are deemed to be provincial because of the ownership of provincial land and so on.

This issue has tended not to arise. There are some places like Malaysia where it arises, but you would not want that solution to apply here because the central government in Malaysia more or less confiscates the resources.

Senator Day: What about Germany or Australia?

Mr. Boadway: I do not think that is an issue in either of those jurisdictions.

The Chairman: Dr. Boadway, do you have a view about the inclusion of user fees in the calculation?

We heard from the provincial Treasurer of Prince Edward Island yesterday. One of his grievances is that user fees are not being calculated, as they should be in terms of the revenue derived from them.

Mr. Boadway: The subject of user fees is a tricky issue. Some things that might be called user fees are taxes, and some things that you might not call user fees are user fees.

The Chairman: Let me tell you what he said. The only distinction he would make between user fees and what we would call taxes is that he would exclude services that were offered by the province for a profit.

Mr. Boadway: I agree with that statement. There are some difficult issues. For example, what do you do with university tuition fees? Are they user fees or taxes that you must pay to go to a university? What do you do with municipal charges for garbage, which is something that you bear, depending on how many garbage bags you put out. If a user fee mimics a price, then you might well argue that it should not be equalized; if it mimics a tax, perhaps it should be.

The Chairman: Is it difficult to draw the distinction between them?

Mr. Boadway: It is becoming more of an issue, I suppose, as municipalities resort to using more and more direct charges on consumers.

The Chairman: The Treasurer of Prince Edward Island seems to think that it is costing the province a fair bit of money. I do not know if he put a number on it, but it was important enough a grievance that he elaborated on it when he was here.

Mr. Boadway: Yes. However, it has been the nature of user fees that lower income provinces will get less per capita than higher income provinces. It would be natural that he would like to equalize those things.

This is a far-fetched example, but if a provincial government suddenly decides to become the sellers of food on a market basis, would you equalize that? The answer would be no.

The subject of user fees is genuinely difficult. Somehow, you must draw a distinction between a compulsory charge that is not a quasi-price that people have to pay. University fees are the best example. Are university fees prices or they are taxes?

The Chairman: We need some help on this question of whether and how to introduce the concept of different needs into the equalization formula. I understand that it is quite complex and that we would be better off to concentrate on introducing needs into the social transfer, the CHST, for example.

The treasurer quoted what you wrote on that subject for the Romanow commission. It was very interesting.

Still, most of the recipient provinces point out that in dollar terms the equalization is more important than the CHST. A couple of years ago, Newfoundland was particularly emphatic about the different needs. Therefore, Newfoundland recommended that we find some way to incorporate different needs into the equalization program. We walked away from it because we could not figure out how to do it.

Having said that we should perhaps forget about it and introduce needs into the social transfer rather than into equalization. I thought I heard you musing a bit in your replies to Senator Comeau about ways we might be able to do this through the equalization program.

Can you help us on that?

Mr. Boadway: Yes. In principle, of course, you could do needs equalization either through the equalization or the CHST. There are three reasons why I would prefer them to do them through the CHST.

First, it is slightly easier to keep it separate from the needs equalization from a transparency point of view.

Second, equalizing needs through the equalization program means you will equalize them for the seven or eight recipient provinces, not for Ontario and Alberta. Ontario and Alberta are getting CHST equal per capita. If you want to have a "needs" equalization system that applies to all 10 provinces, you should do it through the social transfer program because then you will only catch seven or eight provinces, depending on how many are getting equalization.

The third reason is because equalization of needs is really only needed in health, education and welfare. I do not think it is needed in provincial infrastructure.

The Chairman: What about roads?

Mr. Boadway: Yes, although I understand the argument that there are more needs associated with developing resources. However, in the first instance, we already have these transfers that are nominally for health, secondary, education and welfare. Post-secondary education may not be quite so simple. Therefore, it would be natural to equalize those existing transfers. You could simply convert them from an equal per capita transfer to a transfer that is based on some degree of the sophistication of the proportion of different types of user groups in the population.

I am not saying it is an easy thing to do, but there are examples around the world that show us how this can be done in a way that to not too complex.

The Chairman: The per capita transfer is what grates on certain provinces, Newfoundland being one of them and others in the Atlantic Provinces, in respect of their costs for health care and for post-secondary education. They would probably be content with a good needs formula worked into the CHST. Have you considered what winners and losers there would be if we did that? Do any losers come quickly to mind?

Mr. Boadway: It is easier to think of winners than losers. If you look at demographic trends, winners would probably be provinces that have aging populations. We are talking about most of the Atlantic Provinces and perhaps British Columbia or Saskatchewan. Those are the provinces that would come to mind.

The Chairman: How would that affect the non-recipient provinces?

Mr. Boadway: In putting them through the CHST instead of getting an equal per capita amount, they might get a less than per capita share because their needs are not as great. They do not have as many people in the target populations as a percentage of their population.

The Chairman: It sounds a bit like the cap on the CAP, which was not one of our more successful initiatives. Do you remember that?

Mr. Boadway: Yes, I remember that. The cap on CAP was done in a rather arbitrary way. That was not based on any objective measure of what the needs were.

The Chairman: The objective measure is that Ontario, in particular, was spending 50 cent dollars at a great rate improving and expanding their welfare programs, in particular. It was starting to cost the federal treasury an enormous amount of money.

Mr. Boadway: There is something that should be said here about needs that maybe was not clear in Newfoundland's objection.

When you have a needs formula, you have to design it in a way that does not just reward provinces that spend more. You want a needs-based formula to be one that is immune to provincial manipulation.

The trouble with the old CAP program was that built into it were strong incentives for provinces to increase their spending.

The Chairman: It threw everything but the kitchen sink into the programs.

Mr. Boadway: A proper needs-based formula takes a demographic group and it applies a common cost for that demographic group, no matter what province. The province should not be rewarded because it increases the payments that it makes to doctors or whatever. It will only be rewarded on the basis of the age structure of the population.

The Chairman: I well remember being involved in discussions in a recipient province that will be nameless. When an idea for a new program came up in social programming, people would first figure how it could eligible under CAP. Therefore, it would need only 50 cent dollars. I am sure that process was repeated in many provinces as time went on.

Senator Mahovlich: Does our proximity to the United States limit what we can do?

Mr. Boadway: That is a good question. Some people argue, and I think rightly so, that very thing.

Senator Mahovlich: We are doing business with them all the time, and we cannot seem to break away a system that does not compare to what they are doing.

Mr. Boadway: The limitation is what you have implied and that is that perhaps there is a limit on the extent to which we can impose taxes on our residents, or on our businesses, because they have an incentive to flee to the south.

Senator Mahovlich: The dollar.

Mr. Boadway: Yes, that is correct.

Senator Mahovlich: The lowering or the raising of our dollar has an effect, too, on our system.

Mr. Boadway: I am not sure that it has that much of an effect on equalization because equalization is based on what the provinces actually do; it is based on their spending policies.

If the provinces feel constrained by what is going on, and they keep their tax rates low then that will feed back into the equalization system. The equalization system will only equalize to the extent that the provinces impose higher tax rates. From a general economic policy perspective we are heavily constrained by what goes on in the U.S.

Senator Day: Your discussion with respect to Alberta, and the issue of corporate taxes and the proximity to the United States reminded me of this. I was looking at your various options about how to deal with the differential treatment of Alberta relative to the rest of Canada, which is a more difficult problem, as you point out. You give three possible options but none seems to be one that we can do successfully.

Do you have anything that you have not told us that we could be thinking about to try to achieve parity across the country?

Mr. Boadway: The Alberta problem is another reason why people say we should be careful about what proportion of natural resources we equalize. The higher the equalization rate on natural resources, the more the discriminatory treatment of equalization-receiving provinces relative to Alberta.

I am serious about the third option that the federal government should be more active in trying to get its share of resource revenues by using the corporate tax system more imaginatively.

Senator Day: Does that not present the difficulty that Senator Mahovlich just pointed out?

We have a resource-based industry in Alberta. If you raise corporate taxes in Alberta it will be a disincentive to corporations to participate.

Mr. Boadway: At the risk of getting too technical about this, there are ways of designing taxes on resources that sort of soak up the rent rather than provide a disincentive necessarily for exploitation.

When the province sells Crown leases, the price that is paid for the Crown lease is what the firm thinks its future profits will be. That is a way of a province confiscating future rents on a resource. The federal government could get into that game through its corporate tax system as well.

Perhaps an easier answer is that in fact, as I mentioned earlier, the Mintz report argued that we were treating the resource industries far too favourably as it is, that there already is too much of an incentive. The resource industry is capital intensive. They soak up a lot of capital and they do not provide a whole lot of employment. A strong argument can be made that even if we levelled the playing field at the federal level, between resource industries and other industries, we would bring in a bit of revenue from doing so.

The Alberta case is a difficult thing and that will not solve the whole problem. It is the nature of having a country where the provinces own the resources and they happen to be unusually distributed at the time being.

Senator Day: Am I correct in summarizing that your view is that two areas we should be looking at is one with respect to the use of needs, factoring that into the equalization program, and the other is the dealing with this resource situation?

Mr. Boadway: Yes, I agree with that, and I think that was the theme of the previous discussion that resources are really critical to sort out.

Senator Day: I appreciate your comments very much.

The Chairman: Thank you, Mr. Boadway. You have left us a lot of food for thought and some ideas we will want to take up. We may want to consider an interim report, or a report before the new formula gets cast completely in stone. This has been extremely helpful and we all thank you very much.

The committee adjourned.