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Annex 3:
Major Transfers

This annex describes the major fiscal transfer programs to provinces and territories and provides a historical overview of the programs.

Current Fiscal Transfer Arrangements

In 2006–07, the Government of Canada will provide support of $61 billion to provincial and territorial governments through its major cash and tax transfers including the Canada Health Transfer (CHT), Canada Social Transfer, (CST), Wait Times Reduction Transfer, Equalization and Territorial Formula Financing.

Equalization

Equalization was established in 1957. In 1982, the purpose of the program was entrenched in the Canadian Constitution:

(Subsection 36(2) of the Constitution Act, 1982)

Because all parts of the country are not equally prosperous, all provincial governments cannot generate comparable revenues, at comparable levels of tax effort, with which to finance public services. The purpose of Equalization transfers is to enable less prosperous provinces to provide public services reasonably comparable to those provided by more prosperous provinces at reasonably comparable levels of taxation.

In 2005–06, eight provinces qualified for Equalization payments: Newfoundland and Labrador, Prince Edward Island, Nova Scotia, New Brunswick, Quebec, Manitoba, Saskatchewan and British Columbia. All provinces except Ontario have qualified at some time in the past. Equalization payments are unconditional, and receiving provinces spend these payments according to their own priorities.

Prior to changes introduced in 2004, Equalization payments for all provinces were calculated according to a formula set out in federal legislation.

• Comparisons were made of the relative capacities of provinces to raise revenues from taxes and other revenue sources.

• The revenue-raising capacity of provinces was calculated separately for each of the more than 30 revenue sources available to provincial and local governments. The program was not based on actual revenues, but on measured fiscal capacity, that is the revenues provinces could raise if they applied tax rates corresponding to the average of the provinces.

• Under the formula, less prosperous provinces were brought up to a standard. Between 1982–83 and 2003–04 that standard was the five-province standard—equal to the fiscal capacity of the five "middle-income" provinces. Over the history of the program, the standard has changed several times (see "Equalization Milestones: 1957 to 2004" below).

From 1957 to 2004, Equalization legislation was renewed on a five-year cycle (with the exception of a two-year renewal in 1992). Prior to the expiry of Equalization legislation, and before the introduction of new legislation for the next five-year term, the program underwent an extensive "renewal process," in consultation with all provinces, during which modifications to the program were considered.

The renewal process involved a comprehensive examination to identify possible technical changes and improvements to the program’s design and structure, notably to reflect the evolution of provincial tax practices.

Territorial Formula Financing

Territorial Formula Financing (TFF) is an annual, unconditional federal transfer to territorial governments designed to take into account the higher costs of providing public services in the territories. It is similar to Equalization in that its objective is to enable the territories to provide a range of public services reasonably comparable to those offered by provincial governments at reasonably comparable rates of taxation.

TFF is the principal federal transfer to the territories and represents the largest source of overall territorial revenues. In 2005–06, TFF grants accounted for roughly 81 per cent, 66 per cent and 61 per cent of overall revenues for the governments of Nunavut, the Northwest Territories and Yukon, respectively. Total TFF grants in 2005–06 were $2.0 billion:

• $799 million to Nunavut ($26,738 per capita);

• $714 million to the Northwest Territories ($16,598 per capita); and

• $487 million to Yukon ($15,740 per capita).

Before TFF was introduced in 1985, the territories received funding from the federal government in much the same way as a federal department, based on a detailed, item-by-item review of projects, expenditure levels and expenditure priorities. TFF was introduced with the goal of furthering the evolution of territorial governments. TFF was based on multi-year federal-territorial agreements, which were generally renewed every five years. Starting in 2004–05, TFF levels have been legislated as part of the Federal-Provincial Fiscal Arrangements Act.

Until the introduction of a fixed framework in 2004, TFF was determined through a formula based on a "gap-filling" principle, taking into account the difference between the expenditure needs and the revenue means of territorial governments. This difference was calculated for each territory and determined the level of TFF grants.

Territorial expenditure needs were represented by the formula’s Gross Expenditure Base (GEB), a proxy for a territorial government’s "needs." The initial GEB value in 1985 was based on each territorial government’s revenues in 1982–83. This benchmark GEB was then escalated annually to reflect the growth of provincial-local government expenditures over time. Revenue means, or eligible revenues, consisted of measuring territorial own-source revenues, including some transfers from the federal government.

In October 2004, a new framework for Equalization and TFF was announced following two meetings of First Ministers, one on health care funding and one specifically devoted to Equalization and TFF.

1. The 2004 renewal of the program was put on hold. Following the usual five-year renewal process, Budget 2004 announced some major changes to Equalization for the 2004–05 to 2008–09 period, including the implementation of a three-year moving average of entitlements to address payment predictability and stability concerns, significant changes to the personal income tax and property tax bases, and improvements to various other bases. The legislation enacting these changes and the changes to TFF agreements were superseded by new legislation to enact the new framework.

2. Normal formula-based calculations of provincial and territorial entitlements were suspended. Provincial and territorial entitlement shares for 2004–05 were fixed on the basis of historical data. Interim formulas were subsequently used to allocate entitlements for 2005–06, with a similar approach to be used for 2006–07. (Budget 2006 announces the details of the new approach for 2006–07 payments to provinces and territories.)

3. A new financial "framework" for Equalization and TFF was legislated. Overall Equalization entitlements were increased by $2.0 billion to $10.9 billion for 2005–06, while TFF was increased by $0.2 billion to $2.0 billion. These amounts are to grow at 3.5 per cent per year in subsequent years, subject to a re-evaluation of funding levels and the funding growth rate at five-year intervals.

4. A review of the Equalization program and TFF by an Expert Panel was announced. The Expert Panel on Equalization and Territorial Formula Financing was asked to provide advice on: 1) the allocation of Equalization and TFF payments among provinces/territories from 2006–07 onwards; 2) how Equalization and TFF payments can be made more stable and predictable; 3) the information the federal government should take into account in reviewing the overall level of Equalization and TFF funding; 4) the appropriate treatment of natural resource revenues in Equalization and TFF; and 5) whether or not an independent body should be set up to provide ongoing advice on the allocation of Equalization and TFF entitlements.

Further information on the Panel can be found on its website at: http://www.eqtff-pfft.ca/index.asp.

Health and Social Transfers

The Government of Canada has used transfers to support provincial-territorial governments in providing health care, post-secondary education, social assistance and social services, and child care.

Federal support for health and social programs has evolved over time from cost-sharing arrangements (e.g. medicare and the Canada Assistance Plan), toward block transfers (e.g. the former Canada Health and Social Transfer).

Prior to 1977, the federal government provided support through cost-shared programs. Eligibility criteria were established under federal legislation to determine what expenditures would be included under a specific program—such as university grants. Typically the Government of Canada provided cash transfers equal to 50 per cent of eligible expenditures.

Established Programs Financing and the Canada Assistance Plan

Established Program Financing (EPF) was created in 1977 when the Government of Canada merged the cost-sharing programs for health and post-secondary education into a single block transfer. Federal support through EPF comprised both cash and tax transfers, and provided separate notional allocations for health (68 per cent) and post-secondary education (32 per cent).

After 1977, the only remaining major cost-shared program was the Canada Assistance Plan (CAP), which was created in 1966. Under CAP, the Government contributed 50 per cent of the eligible costs to support provincial/territorial social assistance and social services programs.

Canada Health and Social Transfer

In 1996–97, EPF and CAP were replaced by a new block-fund transfer, the Canada Health and Social Transfer (CHST).

As part of this restructuring, federal cash transfers to provinces and territories for health and social programs were reduced by about $6 billion, or 30 per cent, by the second year of the CHST.

The CHST maintained the cash and tax structure of EPF. Although not originally equal per capita, by 2001–02, CHST entitlements had evolved to become equal per capita for each province and territory.

As a block transfer, the CHST also provided provinces and territories with the flexibility to allocate federal support among health care, post-secondary education, and social assistance and social services, according to their respective priorities. There were no notional allocations for health and post-secondary education.

In the years following the creation of the CHST, the fiscal situation of the federal government improved rapidly and the federal government began to reinvest in transfers. CHST transfers were enhanced in the 1996, 1998, 1999 and 2000 budgets, from a floor of $12.5 billion in 1997–98 to $15.5 billion in 2000–01. Overall cash levels were fully restored in 2002–03 to the previous high point of EPF and CAP in 1994–95.

Canada Health Transfer and Canada Social Transfer

Effective April 1, 2004, the Canada Health and Social Transfer was restructured into two new transfers:

• The Canada Health Transfer, a dedicated transfer in support of health.

• The Canada Social Transfer, a block transfer in support of post-secondary education, social assistance and social services, and child care.

The CHST was apportioned between the CHT and CST, with the percentage of cash and tax points allocated to each transfer reflecting provincial and territorial spending patterns among CHST–supported areas (62 per cent for the CHT and 38 per cent for the CST).

The CHT and CST maintained the cash and tax structure of the CHST and its equal per capita allocation formula.

CHT cash is established in legislation at $20.1 billion in 2006–07, and is set to grow at 6 per cent annually until 2013–14, reflecting recent commitments made in support of the 10-Year Plan to Strengthen Health Care signed by First Ministers in September 2004. By the end of the legislated period, CHT cash transfers will be $30.3 billion. The 10-Year Plan also provided targeted funding for medical equipment and long-term funding to reduce wait times with the creation of the Wait Times Reduction Transfer.

CST cash is set at $8.5 billion in 2006–07 and will be $8.8 billion in 2007–08 when the legislation expires.

In 2006–07, provinces and territories will receive a total of $47.5 billion in CHT and CST. Of this, $18.9 billion will be in tax transfers and $28.6 billion in cash transfers. Tax transfers provide a significant amount of support to the provinces and territories.

The chart below shows changes in health and social cash transfers from 1994–95 to 2007–08.

Note: Total may not add due to rounding. Includes cash and tax transfers provided under Established Programs Financing and the Canada Assistance Plan up to 1995–96; the Canada Health and Social Transfer (CHST) up to 2003–04; the Health Reform Transfer (2003–04 and 2004–05); the 2003 CHST cash supplement and 2004 CHST cash supplement for health based on notional drawdown schedules; and the Canada Health Transfer and the Canada Social Transfer for 2004–05 and beyond.

Source: Department of Finance Canada, May 2006.

Table A3.2
Equalization Entitlements (1982–83 to 2006–07)

Source: Department of Finance Canada, May 2006.

Table A3.3
Territorial Formula Financing Entitlements (1982–83 to 2006–07)