Out of Ottawa, And to the Provinces

By Tim Whitehead

Of all the truly complex things about government in Canada, surely the most complex are the rules governing federal-provincial transfers. That’s unfortunate because those transfers are a big part of government in Canada and, according to some experts, a big part of what’s wrong with Canada.

According to the federal government’s (preferred) tally, Ottawa sent $43.8 billion to the provinces and territories last year. That figure represents more than a third of the federal government’s program spending in fiscal 2000-01. The money is supposedly intended to help fund various programs (such as education and health care) and to help the less well-off provinces provide levels of services comparable to those in the so-called ‘have’ provinces.

Two major transfer categories account for the vast majority of the money. The Canada Health and Social Transfer (CHST) provided $31.5 billion to the provinces and territories to fund health care, post-secondary education, social assistance and social services. Part of the money comes in the form of cold, hard cash, and part in the form of ‘tax room’ that the federal government has ceded to the provinces. (The assumption here is that the federal government is entitled to so much tax, but it lets the provinces collect some of it to help fund their spending.)

The tax transfer is part of the dispute between the provinces and Ottawa over how much the senior government is really funding health care, for example: the provinces typically don’t count it and Ottawa does. When Ottawa determines how much cash to send to each province under the CHST, it first determines how much the province has received from the tax transfer and subtracts that from the overall CHST grant. Thus, in strong provincial economies, where the tax transfer can raise a relatively large amount of money, the cash transfer is relatively smaller: about $435 per Ontarian, compared to $560 per Quebecker.

The other major transfers are equalization grants. These are intended to help the ‘have-not’ provinces – actually, every province except Ontario, Alberta and British Columbia – to provide a ‘national level’ of services without having to impose extremely high taxes. Last year, Ottawa sent $10.8 billion to the seven provinces under the equalization program.

A formula based on a representative provincial economy defines just how ‘have-not’ the various provinces are. It is controversial and has some less-than-desirable effects. The strongest criticism is that it discourages economic development in ‘have-not’ provinces.

Think of it this way. When a province develops a new industry and so, without changing its tax rates, increases its revenues, Ottawa reduces its equalization payments to reflect the strengthening of the province’s revenue base. It’s like a tax on success and, in some cases, the marginal tax rate could be as high as 90 per cent. Over the years, Ottawa and the provinces have agreed to various bandaids to soften this clawback, but the system is cumbersome.

Roland Martin, a former deputy minister of finance in Newfoundland and Labrador, has written an exceptionally good account of the equalization program, “Equalization: Milestone or Millstone?” (Atlantic Institute for Market Studies). He maintains that the equalization program has failed to help the weaker provinces to catch up. Certainly, the capacity of the ‘have-not’ provinces to fund their own expenditures has not improved significantly in the last decade.

Martin recommends removing oil and gas revenues from the equalization formula (to encourage east-coast development of those resources), specific recognition of certain program costs for ‘have-not’ provinces, and more income-tax room for the lagging provinces. Few, if any, of these points are likely to meet with the approval of the ‘have’ provinces, but Martin makes a strong case based on the long-term development needs of the equalization-receiving provinces.

If it all seems like a big complicated mess, then the picture is pretty accurate. Given, however, that federal-provincial transfers are a huge part of Ottawa’s expenditure, a huge part of the revenues of the weaker provinces and a huge part of the taxes Canadians pay, the transfers are too important to hide behind a cloak of complexity.

Economist/author Tim Whitehead operates a consulting firm, Left Bank Economics Inc., near Paris, Ontario.