In a post I did some time ago, I showed that Ottawa (unlike Ontario) has been on the path to fiscal sustainability for some time now as a result of the fiscal crisis and subsequent restructuring of the 1990s. The recent concern with sustainability of federal finances is tied to the downturn in 2009 and the recession induced increase in spending coupled with the weakening of federal revenue growth as a result of GST cuts prior to 2009. It was a shorter-term fluctuation.
As for the concern that there is a fiscal imbalance in the Canadian Federation, that is also not a new development. Canada was born in a fiscal imbalance. Under the 1867 British North America Act, the federal government received the power to raise revenues by any means whatsoever whereas the provinces received only direct taxation. In other words, as the economy grew over time, federal revenues were predestined to be more income elastic than provincial revenues. As for the spending side, the provinces got health and education, which in the 19th century did not amount to very much but which were the growth poles of government spending in the twentieth century. As a result, the provinces were quickly faced with revenues not keeping pace with spending and clamored for more resources from the federal government, which they eventually obtained – tax point transfers and cash transfers. In this sense, Ottawa had always had the fiscal clout needed to enforce its will.
However, over the long term, the provinces have developed a revenue base on par with that of the federal government. They are no longer merely confined to direct taxation but can levy all of the taxes the federal government can with the exception of customs duties – which are no longer an important revenue source. In other words, the provinces have the tools to correct their own fiscal imbalance also but obviously they would prefer more transfers from the federal government than raising their own tax rates. However, given the differences in the level of economic development and tax bases across the federation, it should also be noted that not all provinces are equivalent in their room to manouver.
If Ottawa wants to use its fiscal clout to bring about change in the federation, where should it direct its energies? More transfer money in return for reducing interprovincial trade barriers? More transfers in return for for harmonizing sales taxes? How about the following: a complete redesign of the allocation of taxes bases across the tiers of the Canadian federation and the federal transfer system. The basic principle: the more mobile the tax base, the greater the case for allocating it at a higher tier of government in order to reduce distortions in resource allocation. Put all income tax revenue and a uniform income tax system entirely at the federal level and put all the revenues from a federally harmonized commodity taxation system entirely at the provincial level. Then redesign the federal transfer system to provide for whatever new fiscal gap ensues but in one per capita transfer designed either to equalize fiscal capacity or provide core funding for health and education.
Can something like this happen? Given the historical pace of Canadian consitutional change and the evolution of our current tax-transfer system, I suppose any federal government that proposes this is asking for trouble. This would be an exceptionally acrimonious can of worms given the recent change to health transfers that was simply imposed rather than discussed. Yet, rather than ad hoc changes that emerge out of short term haggling over tax points and transfers between Ottawa and the provinces, Ottawa can try and use its fiscal clout to fundamentally redesign the system of federal-provincial economic relations. After all, much like the Canadian tax system prior to the 1988 tax reforms, the current system of federal provincial fiscal relations has been the product of decades of improvisation. How to start? Is it time for a Royal Commission on the Canadian Fiscal Union?