Municipal own revenue systems are alsoquite different. Property taxes on both residences and businesses are themost important tax source, with reliance also placed on fees and licenses ofvarious sorts. There are varying degrees of harmonization of property taxes. Insome provinces, there is a single system of property assessment and taxcollection, with the province setting a tax rate and municipal governmentshaving limited ability (and need) to choose their own rate. Explicitsharing of tax revenues may exist with respect to certain functions. Atthe other extreme, property taxes may be administered and collected at thelower lever.
D. Systems of Tax Harmonization and TaxCollection
The tax system in the Canadian federation isrelatively unique in the sense that not only is revenue raising highlydecentralized to the provinces (as we have seen above), but also the provinceshave independent access to all the main broad-based taxes. As alreadyseen, they, along with the federal government, have full access to personal andcorporate income taxation, sales taxation and payroll taxation.55 Thismakes the issue of tax harmonization extremely relevant. Moreover, thisindependent taxing authority implies that harmonization must come about viavoluntary agreement with the provinces rather than being imposed by the federalgovernment. As a result, the extent of harmonization varies considerablyby tax type. Consider income, sales and payroll taxes in turn below.
1. Income TaxHarmonization
Income taxes — both personal and corporate— have been highlyharmonized in Canada since the Second World War. This evolved quitenaturally from a situation in which the federal government, following an agreement withthe provinces, fully occupied the personal and corporate income taxes duringthe war as a result of the need to centralize revenue to fight the war.The system of income tax harmonization that has persisted until now has been based on bilateralTax Collection Agreements(TCAs) between individual provinces and the federal government. Theirstructure differs slightly for the personal and the corporate tax.
Corporate Tax CollectionAgreements
In the case of the corporate tax, provincesthat choose to participate must abide by the corporate base as chosen by thefederal government. They must also abide by an allocation formula fordetermining how the taxable income of a corporation operating in more than onejurisdiction is allocated among provinces. In most cases, it is anaverage of the share of sales revenues and payrolls in each province. Theprovinces are allowed to set their own tax rate on the base, and are able tofollow the federal government in giving preferential rates to small businessesand manufacturing and processing profits. The federal government acts asthe tax collector for the agreeing provinces, and is willing to administer taxcredits and surtaxes introduced by individual provinces provided they do notdiscriminate against non-residents, do not cause inefficiency in the internalcommon market, and are easy to administer.
All provinces except Alberta, Ontario andQuebec currently participate in the TCAs.56 The absence of thosethree provinces is a significant exception since they represent over 75 percentof the corporate tax base. In the case of Quebec, the decision not toparticipate is related to a more general desire to manage its own fiscalaffairs separately from the federal government. Alberta and Ontario seethe use of the corporate tax as a useful policy instrument that can be used toinfluence the pattern of private sector economic activity. Theirprovincial economies are large enough and concentrated in some large sectors(resource sectors in Alberta, manufacturing in Ontario) so that an independentindustrial policy is considered to be feasible even in an otherwise highly openeconomy. But, even these non-participating provinces abide by theallocation formula to avoid double taxation. As well, their tax bases arenot very different from that set by the federal government. The result isa highly successful and harmonized corporate income tax system in whichprovinces have leeway to set their own tax rates.57
Personal Tax CollectionAgreements
The method of TCAs also exists for personaltaxation. In the current system, which is under revision, the federalgovernment sets the common base, administers the tax on behalf of participatingprovinces, and applies a common allocation formula (essentially allocatingpersonal taxes according to the province of each taxpayer’s residence on December 31 of thetax year). The federal government also sets a progressive rate structure,which includes not only a set of brackets and rates, but also a system ofnon-refundable and refundable tax credits. Participating provinces selecta single tax rate to apply to federal taxes payable, thereby abiding not onlyby the federal base but also to its rate structure — the so-called tax-on-tax system. The provinceseffectively also abide by the non-refundable tax credits set by the federalgovernment. As with the corporate tax, the provinces are allowed to establishtheir own set of credits and surtaxes to be administered by the federalgovernment.
All provinces except Quebec participates inthe personal TCAs, again leading to a highly harmonized system of personalincome taxes, both with respect to the base and the rate structure.However, the system is about to change. Partly as a consequence of thegrowing share of personal income tax room occupied by the provinces, they haveexpressed a desire to have more discretion over their income tax policy.Recognizing this, the federal government in 1998 agreed with the provinces torevise the tax-on-tax system to a tax-on-incomesystem. Provinces, should they choose, will beable within limits to set their own rate structures and their ownnon-refundable tax credits. This preserves the common base, while at the sametime giving the provinces more discretion to implement their own preferreddegrees of progressivity and to use non-refundable tax credits to achieve theirown social policy objectives through the tax system. Several provinceshave indicated that they intend to move to such a system in the very nearfuture.
2. Sales TaxHarmonization
Unlike with the income taxes, sales taxharmonization is much less well-developed in Canada. Historically, thetwo orders of government have levied very different sales taxes. Theprovinces, in accordance with constitutional dictates, levied a sales tax atthe retail level, while the federal government for many years levied theirs atthe manufacturing level. In 1991, the federal manufacturers sales tax wasreplaced by a value-added tax called the Goods andServices Tax (GST). This was a very broad-basedtax, including virtually all goods and services with relatively fewexceptions. The GST was perceived as having a number of advantages interms of economic efficiency over its predecessor, as well as over provincialretail sales taxes (RSTs). It removes taxes on business inputs, it treatsdomestic and foreign produced products equally, and it has a much broaderbase. The federal government has expressed the hope that the provinceswould in time harmonize their RSTs with the GST, thereby reaping the sameadvantages.
Harmonization has been slow in coming.Part of the problem is that it is administratively rather difficult toharmonize a multi-stage tax system in a situation where no border controlsexist, given the system of crediting that accompanies a value-added tax.This is especially difficult where different provinces adopt different taxrates. The Quebec government was the first province to harmonize.It converted its RST into a multi-stage tax called the Quebec Sales Tax (QST), whose base wasquite similar to that of the GST. Three features of the system are worthnote. The first is that firms making purchases in Quebec would be liablefor both the GST and the QST. Then, when subsequent sales are made,whether in or out of Quebec, they would be able to claim an input tax creditfor both the GST they had paid and the QST. Thus, the firm would have tokeep separate accounts for its transactions in Quebec from those elsewhere inCanada. Second, The GST and QST were subject to a common administration,but in this case it was the revenue department in Quebec rather than thefederal government. Thus, the Quebec government would collect taxes onbehalf of the federal government, the opposite of the case with incometaxes. Third, Quebec retained the right to set its own QST rateregardless of rates in any other provinces.
Subsequently, three of the Atlantic Provinces— New Brunswick, NovaScotia and Newfoundland — have fully harmonized their sales taxes, as a result of thefinancial incentive provided by the federal government. All have eliminatedtheir RSTs in order to participate in the HarmonizedSales Tax (HST). The HST operates effectivelylike the GST within the three provinces except at a higher rate, which iscommon to all three provinces. Firms making sales in one of these threeprovinces are charged the HST rather than the GST, and are able to claim fullcredit one subsequent sales. The federal government administers the taxfor all three provinces. The excess of revenues collected over and abovethe standard GST is distributed among the three provinces in proportion to theconsumption sales in the province. Note that, unlike the QST, no provincehas independent discretion over the tax rate charged (although they are jointlyconsulted on the rate). Thus, the system is effectively like a revenuesharing system.
The remaining provinces have shown littleinterest in joining the HST arrangement. Presumably they prefer to retainsome discretion over their tax rates and even their base. Whether theycan be persuaded to adopt a system like that of Quebec remains to beseen. An alternative would be to maintain their RSTs, but broaden theirbase to parallel that of the GST. That would have some of the advantagesof harmonization but not all. For example, it would be impossible under asingle stage system to purge all products of taxes on businessinputs.
3. Payroll TaxHarmonization
Payroll taxes remain effectively completelynon-harmonized. The provinces and the federal government use them tovarying degrees, largely as earmarked taxes for social insurance programs(unemployment insurance, pensions, workers compensation, health care).There is no common collection agreement and all governments choose their basesseparately.
Despite this, harmonization of payroll taxesis not regarded as being a high priority. Tax bases do not vary widelyacross provinces, which is not surprising given the common interpretation ofpayrolls. Rates are generally flat, though with various combinations ofexemptions and upper limits. The taxes are quite easy to collect usingthe payroll deduction system. And to the extent that they are benefittaxes, they do not give rise to standard incentives for taxcompetition.
4. Other Issues In TaxHarmonization
Many observers continue to argue in favourof further enhanced, or at least solidified, tax harmonization. As wehave mentioned, provincial sales taxation remains far from harmonized for mostprovinces. There is also always some danger that the income taxharmonization arrangements will not persist in their present form. Thepressures on these arrangements have increased dramatically as the provinceshave become more and more important in the income tax fields. There hasbeen some argument for harmonization of the other taxes, such as the capitaltaxes that are used by both levels of governments, as well as specific excisetaxes.
One institutional development might be notedwhich might make harmonization easier to manage in the future. Thefederal government has created a new tax collection agency called the CanadaCustoms and Revenue Agency (CCRA). Is responsible for administering allfederal taxes, and is available for tax federal-provincial tax collectionagreements in the future. It is also available to the provinces tocollect their taxes. Presumably, this should contribute to bothadministrative simplicity and ease of compliance of collection.
E. Analysis: EconomicAspects
1. Impacts On EconomicEfficiency
There are two broad perspectives one can taketo assessing economic efficiency in a federal setting. On the one hand,much of the case for decentralization of fiscal decision-making — or for multi-level fiscal systemsas opposed to unitary systems — is based on the efficiency improvements to which it leads.One can therefore investigate whether the extent and nature of decentralizationexploits all the potential efficiency gains. On the other hand, one cantake as given the extent of decentralization, and investigate how thatdecentralization compromises economic efficiency of the national economy.In the latter case, the system of fiscal arrangements is seen partly as a meansof countering otherwise adverse effects of decentralization. Considerthese in turn.
Decentralization as a Source ofEfficiency
The fiscal federalism literature stressesthe beneficial efficiency effects of decentralizing the provision of publicservices to the provinces. Decentralization is thought to lead to abetter matching of public services to local preferences and needs, betteraccountability, lower cost provision, and more innovation. It isparticularly relevant for local public goods and public services delivered tohouseholds, including the key areas of health, education and welfareservices. But to reap the full advantages of decentralization, provincialgovernments must be given effective autonomy for their fiscal affairs,including the design and delivery of these public services. They shouldbe accountable to their own legislature rather than to the federal government,and they ought to be have access to sufficient own source revenues to ensureindependence. It is particularly important that they control revenueraising at the margin.
The Canadian federation fares well by thesecriteria. Provinces have exclusive legislative responsibility in areas ofhealth, education and social services. They raise a high proportion oftheir own revenues. Grants from the federal government have minimalconditions attached, leaving program design solely to the provinces. Andthey are responsible for determining the size of their fiscal budgets at themargin.
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