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The Fiscal Balance in Canada: The Facts

The Fiscal Balance in Canada

Federal transfers and fiscal pressures on both federal and provincial-territorial governments have received considerable attention, particularly as these issues relate to health care. Some have argued that a "fiscal imbalance" may exist, either among provinces (i.e. horizontal fiscal imbalance) or between the federal and provincial governments (i.e. vertical fiscal imbalance).

Like many federations, Canada uses intergovernmental transfers to address horizontal fiscal imbalance and to support important national programs. The equalization program and Territorial Formula Financing address horizontal fiscal imbalance. Major federal cash transfers through the Canada Health Transfer, Health Reform Transfer and Canada Social Transfer support the provinces and territories in funding the social programs that make up the largest component of their spending.

However, in Canada, unlike in most federations, both the federal and provincial governments have access to all major sources of revenue. A study by Norrie and Wilson^[1] makes the point that the distribution of taxation powers in Canada is unique – both orders of government have full access to all current major revenue sources. This means that with access to the same tax bases, it is difficult to see how a vertical fiscal imbalance can exist.

In arguing that a vertical fiscal imbalance exists, some have said that all of the money is in Ottawa and all of the spending responsibilities are in the provinces and territories. This document demonstrates that this is not the case, as evidenced by the following facts:

1. Both the federal and provincial governments have access to the same major sources of revenue.

2. Provincial-territorial revenues have exceeded federal revenues for many years.

3. Intergovernmental transfers are used to support important national programs and to address fiscal disparities between regions.

4. The larger federal debt burden relative to that of the provinces and territories limits potential new federal spending on the priorities of Canadians.

5. Both orders of government face significant spending pressures and limited resources.

Is the money in Ottawa?

Fact 1: 
Both the federal and provincial governments have access to the same major sources of revenue.

• The federal and provincial governments have access to all major sources of tax revenue. Provinces also have exclusive access to some rapidly growing tax bases, such as natural resources and gaming (see Table 1).

• Access to similar major tax revenues, combined with exclusive provincial access to other revenues, has meant that provincial-territorial own-source and federal revenues have, on average, grown at a broadly similar rate since the beginning of the 1980s.

Table 1
Access to diversified revenue sources 

• International comparisons show that Canada is one of the most decentralized federations in the world. The provinces have complete autonomy in setting their tax policies to address spending pressures related to their responsibilities (see Chart 1).

Chart 1
Sub-national governments’ control over their tax bases and tax rates

Sources: Department of Finance calculations; Organisation for Economic Co-operation and Development (OECD), Taxing Powers of State and Local Government (Paris: OECD, 1999).

Fact 2: 
Provincial-territorial revenues have exceeded federal revenues for many years

• When federal support for provincial social programs is included, total provincial-territorial revenues – that is, their own-source revenues plus federal cash transfers – have substantially exceeded federal revenues for more than two decades (see Chart 2).

• Total provincial-territorial revenues are expected to continue to exceed federal revenues for the foreseeable future.

Chart 2
Federal and provincial-territorial revenues^[2]

Fact 3: 
Intergovernmental transfers are used to support important national programs and to address fiscal disparities between regions.

• In 2003-04, the provinces and territories received an estimated $37.4 billion in cash transfer payments from the Government of Canada. Provinces and territories also benefited from $16.5 billion in additional revenues through Canada Health and Social Transfer (CHST) tax points^[3], which have been growing over time. In all, federal transfers amounted to an estimated $54 billion in 2003-04 (see Chart 3).

Chart 3
Evolution of federal cash transfers and tax points

• The largest part of federal transfers to the provinces and territories supports important national programs. Until 2003-04, the CHST supported health care, post-secondary education, social assistance and social services, including early childhood development and early learning and child care. The Health Reform Transfer provided additional support for health care reforms targeted to primary health care, home care and catastrophic drug coverage. Cash transfers under these programs amounted to $21.8 billion in 2003-04.

• From 2004-05 onward, the CHST has been apportioned between:

• The Canada Health Transfer (CHT), which supports health care.
• The Canada Social Transfer (CST), which supports post-secondary education, social assistance and social services, including early childhood development and early learning and child care.

• Equalization payments, which have been in existence since 1957, address horizontal fiscal disparities among provinces by ensuring that less prosperous provinces can provide reasonably comparable levels of public services at reasonably comparable levels of taxation. Equalization entitlements are determined by a formula that reflects the evolution of fiscal disparities among provinces. In 2003-04, equalization entitlements amounted to $8.7 billion (see Chart 4).

Chart 4
Evolution of Equalization entitlements

• Territorial Formula Financing (TFF) to the territorial governments serves the same purpose as equalization while taking into account the higher costs of providing services in the North.

New 10-Year Funding for the Provinces and Territories

• On September 16, 2004, Canada's First Ministers signed the 10-Year Plan to Strengthen Health Care. Under this plan, the Government of Canada will provide $41.3 billion in new health care funding over the next 10 years.^[4] Investments under the plan include:

• Increased CHT levels that close the estimated $3-billion "Romanow Gap" and establish a new CHT base of $19 billion in 2005-06.

• An escalator that will increase CHT funding by 6 per cent annually beginning in 2006-07.

• Wait times reduction funding of $5.5 billion over 10 years.

• Medical equipment funding of $500 million in 2004-05.

• This means that funding for health care will rise from about $18.5 billion in 2004-05 to $30.5 billion in 2013-14 (see Chart 5), in addition to the significant support provided through tax transfers.

Chart 5
Federal health investments

• In addition, the new framework for Equalization and TFF put forward by the Government of Canada will ensure that payments to the provinces and territories increase by $33 billion over the next 10 years relative to the funding level for 2004-05 provided for in the Government of Canada’s 2004 budget.

• A funding level of $10 billion will be established in 2004-05 for the equalization program, which will rise to $10.9 billion in 2005-06 and grow by 3.5 per cent annually thereafter.

• Funding for TFF will increase to $2.0 billion in 2005-06 and grow by 3.5 per cent per year thereafter. The escalator is subject to review after five years.

• Table 2 summarizes cumulative federal investments under the new 10-Year Plan to Strengthen Health Care for the provinces and territories, which includes new funding for health care, equalization and TFF.

Table 2
Investments in support of the 10-Year Plan to Strengthen Health Care and new frameworks for equalization and Territorial Formula Financing: 2004-05 to 2013-14

• These 10-year arrangements will ensure a growing and predictable source of funding for the provinces and territories.

• Aside from these major transfers, the Government of Canada also provides ongoing assistance to provinces and territories under several other smaller transfer programs, such as programs for labour force training, persons with disabilities, official languages, agricultural assistance and infrastructure.

• The Government of Canada also makes significant direct contributions to health care and post-secondary education, in addition to the support provided through federal cash and tax transfers. These include funding for health research, innovation and programs like the Canada Research Chairs and Canada Student Loans, as well as tax measures to help students. Direct program investments by the federal government amount to more than $10 billion annually.

Are the fiscal and spending pressures mainly in the provinces and territories?

Fact 4: 
The larger federal debt burden relative to that of the provinces and territories limits potential new federal spending on the priorities of Canadians.

• The federal debt continues to be much larger than the combined debt of the provinces and territories (see Chart 6). A high debt burden makes the Government of Canada more vulnerable to unexpected fluctuations in interest rates. It also constrains the amount of new spending it can undertake.

Chart 6
Evolution of debt burden

• For example, despite recent progress in reducing debt, federal debt charges in 2003-04 (at $35.8 billion) were nearly as large as cash transfers received by the provinces and territories (an estimated $37.4 billion). In 2003-04, debt charges consumed over 19 cents of every federal revenue dollar, compared to an average of about 10 cents for the provinces and territories. As such, debt interest payments remain a bigger challenge for the Government of Canada (see Chart 7).

Chart 7
Federal and provincial-territorial debt charges

• Continued improvements to the Government’s balance sheet help the economy and ensure that future generations are not unfairly burdened by higher taxes.

• In fact, achieving debt reduction is critical for all orders of government, especially in light of fiscal pressures that will result from population aging.

Fact 5: 
Both orders of government face significant spending pressures and limited resources.

• Provinces and territories face spending pressures, especially in the area of health care.

• Indeed, the Government of Canada has recognized these growing fiscal pressures. The 10-Year Plan to Strengthen Health Care and the new framework for the equalization and TFF programs provide increased support of nearly $75 billion over the next 10 years to the provinces and territories. The escalators embedded in these programs ensure a growing and predictable revenue track that provinces and territories can count on.

• However, increased transfers alone will not solve the problem of rising health care costs. Reforms to the health care system, as outlined in the 10-year plan, are required to ensure better access to health care and more efficient and affordable delivery of services for all Canadians.

• Furthermore, the Government of Canada faces growing pressure to provide support for other areas such as security and defence, the environment, communities, elderly benefits, strengthening Aboriginal communities, research and development, child care, and skills and learning.

• In addition, the Government of Canada must maintain the financial resources to be able to provide assistance when national emergencies or natural disasters occur. For example, close to $2 billion was provided in 2003-04 to address emergency situations caused by bovine spongiform encephalopathy (BSE) and severe acute respiratory syndrome (SARS).

• Prudent planning and a significantly improved fiscal situation have enabled the Government of Canada to make long-term commitments in the areas of health care and equalization as well as to address unforeseen circumstances. The Government of Canada has been able to make these investments while still maintaining balanced budgets or better without having to reverse course.

1  Kenneth Norrie and L.S. Wilson, "On Re-Balancing Canadian Fiscal Federalism," Toward a New Mission Statement for Canadian Fiscal Federalism, ed. H. Lazar, Institute of Intergovernmental Relations (Montréal and Kingston: McGill-Queen’s University Press, 2000), pp. 79-98. [Return]

2  Throughout this document, chart data for the Government of Canada come from the Public Accounts and from the Annual Financial Report of the Government of Canada for fiscal year 2003-04. Data for the provinces and territories come from the provincial-territorial Public Accounts and from their latest budget updates.  [Return]

3  A tax point transfer provides the same support as a cash transfer. The tax transfer component first occurred in 1977 when the Government of Canada reduced its personal and corporate income tax rates, thus allowing provincial and territorial governments to raise their tax rates by the same amount. As a result, revenue that would have flowed to the Government of Canada began to flow directly to provincial and territorial governments.  [Return]

4 This funding is subject to passage of authorizing legislation by Parliament. [Return]