Federalism and Public Policy II: Is Fiscal Imbalance Something to be "Fixed"?

Like finding unintended humour in an unlikely place? Take a look at "The Existence, Extent and Elimination of Canada's Fiscal Imbalance," a report released in June 2005 by a special Finance Subcommittee of the House of Commons, a.k.a. "the Loubier Report".

What was funny was how, in order to reach its bizarre conclusion that provinces should simply be given federal tax room to match their expenditure needs, the then-Conservative & Bloc Quebecois opposition majority on the Committee looked right past what an impressive array of experts from all corners of the political spectrum had to say about the subject. Consider the following comments:

• "The provincial case that there is a fiscal imbalance between the responsibilities of the provinces and the revenue available to the federal government rests upon some very questionable assumptions." ---Janice MacKinnon, former Minister of Finance of Saskatchewan and author of Minding the Public Purse: The Fiscal Crisis, Political Trade-Offs and Canada's Future
• "The very premise of the committee's work is faulty"---Brian Lee Crowley, founder of the Atlantic Institute of Market Studies
• "[Having each level of government raise just as much tax revenue as it spends on its own responsibilities is] "both conceptually wrong and practically impossible"---Richard Bird, Rotman School of Management, University of Toronto
• "Those are two items [i.e. the health care guarantee and fiscal re-balancing guarantee] that are not in what I was presented to analyze... I don't think, frankly, that those are in the platform, they're just under discussion. ...Those items were not costed, which leads me to believe that they're something that they're having under consideration that they're not committed to." ---Paul Darby, deputy chief economist of the Conference Board of Canada, explaining what elements of the Conservative election platform were left out of what he was presented for financial assessment
• [The assumption of the Loubier Committee] "that there is an imbalance that needs fixing violates the first rule of policy analysis, which is to get the question right" ---Rod Dobell, Institute of Public Administration, University of Victoria

Clearly, "getting the question right" means understanding that the common everyday notion of an 'imbalance' as something that is by definition 'bad', needing to be "balanced", has virtually no place in this discussion. Most theorists of economic federalism instead attempt to estimate what the best level of imbalance is for efficient federal governance: how much federal fiscal leverage is needed to foster tax harmonization; prevent wasteful competition between provinces or a "race to the bottom" in terms of taxation and services; ensure that national standards are adhered to in health care and social policy; and cover the emergencies of the federal government's international jurisdiction in an increasingly global future.

What is really at issue in the current debate is whether there is a VFI (expenditure/revenue mismatch) once federal transfers (equalization and other direct spending obligations) are fully taken into account. Also at issue is whether, after a couple of decades in which the trade-off was the Feds cutting back on their share of shared cost programs in exchange for a loosening of conditions for federal funding, there should be a return to greater conditionality as the federal share of funding for social programs is increased. A little bit of history is in order here: the current strength of the federal position relative to the provinces follows a period in which their positions were reversed on two occasions. Fiscal relations have always been in flux, there has never been a perfect balance, nor has it ever been particularly important that they be balanced. Provinces have on occasion overstated the VFI by ignoring the significance of the 1977 tax transfer and referring to the old 50/50 shared cost formula as a valid benchmark. (Not without mentioning old levels of conditionality, you don't!)

It is noteworthy that in the early 1970s, before the federal fiscal position began to rapidly deteriorate, federal revenues in excess of own expenditures were around 30 percent; coincidentally, federal revenue balances since 1995 have once again been in the 30 percent range. Indeed, this has enabled the federal government to commit $65 billion in new health funding over the past six years. Of course, that does not completely close the differential between 7% annual rises in health spending and government revenues (including federal transfers) of only 5%. Paul Boothe and Mary Carson have shown in a recent study that this will leave a funding gap of $10 billion after five years, $12.9 billion after six years, and $15.9 billion after seven years. But I would be happier to see the federal government continue to pay down its debts and limit any future escalator clauses in federal transfers to the rate of growth in revenue, while provinces implement new revenue measures and economies of their own. As Paul Wells in McLeans Magazine bluntly put it last June, "Shut up and raise your own taxes"!

A federal budget balance of up to 30% "excess" revenue is both historically normal and potentially valuable to the pursuit of economic efficiency and equity within the federation. This fact should be recognized by provincial politicians even if --as in Quebec--they can't always say so. Such a recognition should be the basis for any intergovernmental agreement about what a "fair" federal cash contribution to provincial health care is. In the spirit of compromise, the federal government could commit to unconditional transfers of cash and tax room above the 30% level. As for conditionality, I would like to see a return to more dedicated funding for postsecondary education and income security. It is tempting under present circumstances for provincial governments to under-invest in these areas, especially given the high mobility of students, labourers and welfare recipients. It is an appropriate role for the federal government to ensure that non-health priorities such as municipal government and postsecondary education do not get crowded out by the undoubtedly greater pressures every province feels to put more money into healthcare, although the spirit of s. 106A of the Meech Lake Accord---i.e. providing for provincial opting out that is "compatible with national objectives"---is also appropriate.

As an academic, I am used to being ignored. I admit, it is amusing to see the careful testimony of an all-star team of experts swept under the political carpet by a parliamentary sub-committee. But there may be a serious downside to all of this. Prime Minister Harper will never stand in the House of Commons and say, as he did when he was a policy wonk at the National Citizens Coalition, that "two-tier health care is a great idea". What he will say, and has already said in his capacity as Conservative Party leader, is that he intends to let the provinces do what they wish with their own jurisdiction provided that is technically consistent with the provisions of the Canada Health Act. But this betrays either a naivete on the part of the Prime Minister about the law--since the Canada Health Act is far from self-applying and the precise scope of its provisions far from self-evident--or an assumption that we are naive: what provinces will actually wish to do depends in turn upon their fiscal capacity, along with the extent of Ottawa's willingness to use its own fiscal leverage to enforce and promote national standards.

Still think that federal tax room should simply be handed over to provinces in order to match any growth in their spending responsibilities? You've got to be kidding!