When intergovernmental transfers areincluded, the shares are remarkably similar to those for spending, which is notsurprising. However, when intergovernmental transfers are excluded bothon the spending and on the revenue sides, the shares of federal governmentrevenues are somewhat higher than for the provinces. Nonetheless, thefederation is highly decentralized on the revenue side, and that is one of thethings that make the Canadian federation rather unique.
At the end of the 20th century, the federalgovernment raised less revenues that the provinces (47.3 percent of thetotal). This is a picture that is quite different than existed in theearly post-war period when the federal government raised as much as 60 percentof total revenues. As in the case of spending, there has been a gradualdecentralization of spending responsibilities to the provinces.
Once again, the extent of revenuedecentralization varies among the provinces, but there seems to be nosystematic difference between high- and low-income provinces as Tables 3 and 4in the Appendix show. In the case of revenues excluding intergovernmentaltransfers (i.e., own-source revenues), the federal government’s share is roughly the same in thehighest-income province, Ontario, as in the low-income provinces of PrinceEdward Island and New Brunswick.
3. Transfer Payments from Federal toProvincial Governments
Table B.3 shows transfers from the federalgovernment to the provinces as a proportion of provincial government revenuesfor the years 1961-1999. Table 5 in the Appendix shows the sameinformation disaggregated by recipient province. The message here isquite consistent with that of the previous tables. The Canadianfederation has gradually become quite decentralized over the post-warperiod. The provinces now rely on the federal government for only 13percent of their revenues compared with over 20 percent in the early1960s. In fact, the pattern of decline really only began in the late1970s, and was precipitous during the 1990s.
Table B.3: Transfer Payments from Federal to ProvincialGovernments as a Share of Provincial Government Revenues(Percentages)
A number of major episodes account for thispattern. The relatively high rate of provincial dependency on federaltransfers at the beginning of the period was a reflection of the situation inthe Second World War when the federal government occupied all of the income taxroom with the agreement of the provinces (the federal-provincial tax rentalagreements). The federal government began soon after the war to turn overrevenue raising responsibility to the provinces, although not at a rate thatsatisfied all provinces. However, in the late 1950s and the 1960s, somemajor shared-cost programs were introduced in the areas of health and welfare,which precipitated modest increases in the proportions of provincial revenuesobtained from federal transfers (or at least postponed their decline). In1977, these shared-cost programs were replaced with bloc transfers whose rateof increase was tied to GNP rather than program expenditures because programexpenditures were rising faster that GNP. This was a major factor leading tothe gradual decline of provincial reliance on federal transfers over thefollowing two decades. The rate of decline accelerated in the mid-1990swhen the federal government embarked on a major expenditure reduction programto reduce its budget deficit. A substantial amount of its expenditurereductions took the form of reduced transfers to the provinces causing anabrupt change in the proportion of provincial revenues coming from federaltransfers from about 16 percent to less than 12 percent.
The aggregate data reported in Table B.3 donot tell the entire picture. As Table 5 in the Appendix shows, differentprovinces rely to very different degrees on federal transfers. In 1995,the latest date for which disaggregated data are available, the higher-incomeprovinces — Alberta,British Columbia and Ontario — received 10-12 percent of their revenues from federal transfers,while the remaining provinces showed much higher reliance. Newfoundlandobtained almost 42 percent and Prince Edward Island almost 40 percent of theirrevenues from the federal government. This reflects a common feature offederations, the fact that different provinces have quite different abilitiesto provide the sorts of basic public services with which they areentrusted. The federal system of transfers is designed explicitly tocompensate for these differences, as we shall see further below.
The data for the various provinces have onefeature in common with the aggregate data reported in Table B.3: the share of provincial revenuesobtained from federal transfers has declined in tandem over the four-decadeperiod. All provinces are now required to raise more revenues using theirown tax sources. This decentralization in revenue-raising responsibilityis quite unusual among federations. The relative ease with which it hasoccurred in Canada reflects the fact that the provinces have access to all ofthe main broad-based tax sources — personal and corporate income taxes, general sales taxes and payrolltaxes. Moreover, they can set their rates independently. As thefederal government reduced its transfers to the provinces, the provinces inturn were able to make up their revenues needs by increasing their tax rates asrequired. This implies that for the main tax sources, the provinces haveoccupied more and more of the available ‘tax room’. While this has increasedthe fiscal responsibility of the provinces, it has also led to some concernsabout the harmonization of the major taxes across provinces. We return tothis issue in SectionD.
The picture that emerges from looking atexpenditure and revenue shares is one of a federation that is not only highlydecentralized with respect to the delivery of public services, but also one inwhich the financing of those services has become highly decentralized.From this perspective, fiscal responsibility has become much more decentralizedin Canada relative to some other established federations, such as Australia andGermany, where lower level jurisdictions rely much more heavily on federaltransfers than in Canada. This is documented in more detail under thenext heading.
4. Vertical Fiscal Imbalances
A common way to characterize the extent ofdecentralization of fiscal responsibility is by using the concept of Vertical Fiscal Imbalance (VFI).The VFI indicates the imbalance between federal revenues and their expenditureresponsibilities. A large vertical imbalance implies that the provincesrely heavily on the federal government for transfers to finance theirexpenditures. This is liable to detract from fiscal decentralization since transfers are oftenaccompanied with some conditions on how they should be spent, and these mayaffect provincial spending priorities. In addition, provincial governments may be lessaccountable for the way in which they spend or the amount that they spend ifthey are not responsible for raising their own revenues.
As in the case of calculating spendingshares, it is useful to distinguish the VFI before intergovernmental transferswith that after them. Table B.4 shows VFI calculations both excluding and includingintergovernmental transfers. The VFI is defined as difference betweenexpenditures and revenues, taken as a percentage of expenditures. This can be done for boththe federal and the provincial levels of government.
VFI Excluding IntergovernmentalTransfers
When intergovernmental transfers areexcluded, the VFI for the federal government is the difference between its expenditures not includingtransfers to the provinces and its revenues as a proportion of expendituresless transfers. It represents the conventional definition of VFI: theextent to which federal expenditure needs are less than revenues. Infact, there are two elements of this difference that are difficult todistinguish. One isthe amount of deficit financing, which in this definition would contribute toan excess of spending over revenues. The other is the conventional VFI,which is the imbalance between federal expenditure responsibilities and theirrevenue-raising ability. Similarly, for the provinces the VFI isprovincial expenditures (including those of their municipalities) less revenuesnet of transfers from the federal government, as a proportion of expenditures. It measures theextent to which provincial expenditures exceed own source revenues, part of which will bereflected in a budget deficit and the rest covered by transfers from thefederal government.
Table B.4: Vertical Imbalances Between Federal andProvincial Governments [(Expenditures - Revenues)/Expenditures]X100
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