Economic Survey of Canada 2006: Adapting fiscal policy and financial arrangements in the federation

 

Contents | Executive Summary | How to obtain this publication |  Additional Information

The following OECD assessment and recommendations summarise Chapter 4 of the Economic Survey of Canada 2006 published on 26 June 2006.

Contents                                                                                                                           

Public finances need to be kept on a sustainable path

The second main challenge for the Canadian economy is to make sure that fiscal and social policies are on a sustainable path: this requires dealing with ageing pressures, federal provincial arrangements and poverty traps. Fortunately Canada’s public finance position is strong, one of the healthiest  of any OECD country. The federal government’s reaffirmed commitment to the objective of reducing net debt to GDP to 25% by 2013 14, one year earlier than previously announced, is welcome. In line with this target, the government plans to achieve annual debt reduction of CAD 3 billion (0.2% of GDP), after allowing an as-yet unallocated amount for future priorities. Given the continuing use of a nominal budget anchor, well defined rules for allocation of revenue windfalls, designed to ensure budgetary sustainability, are appropriate. The 2006 budget proposal to allocate a portion of unplanned surpluses to the contributory public pension plans (CPP/QPP) is therefore useful, as long as it does not flow through into lower contribution rates or benefit enhancements in the short term. This would also enhance intergenerational equity. 

A stronger mechanism is needed to monitor the long term fiscal outlook

Virtually all OECD countries are facing ageing pressures – not just with the baby boom but also because people are living longer. Fortunately, Canada’s public pension systems are in good shape. But the demographic component of future spending on health care and looking after the frail elderly will have a significant impact on the overall long term fiscal position. Future health spending will also depend on non demographic upward cost pressures that have proved difficult to restrain for a sustained period of time. To monitor and manage these pressures, Canada should follow the lead of other OECD countries and establish an official and credible mechanism for monitoring long-term fiscal prospects (10 to 40 years ahead). To be both consistent and comprehensive, it would need to cover all levels of government, especially if inter-provincial mobility continues to increase, and to set out clearly the assumptions and the uncertainties surrounding such a long term outlook. 

The federal government should step back from trying to steer in areas
of provincial responsibility

Negotiated agreements have become a feature of federal provincial financial arrangements in a range of policy areas, including health care and social affairs. But, as provinces and territories have primary responsibility for delivering these services, this approach dilutes accountability for results. In effect, it creates an incentive for provinces and territories to seek to negotiate more transfers from the federal government, rather than take larger, but possibly more difficult, steps towards improving their own performance. The September 2004 agreement between the federal government and the provinces set out 10 year arrangements for strengthening health care, accompanied by an additional CAD 41 billion in new federal funding. It provides provinces and territories with a clear basis for planning and allows them to concentrate their efforts on delivering better results than achieved under previous frameworks. But, as stressed in the previous Survey, to achieve efficiency gains these arrangements should be made impervious to any further renegotiation efforts over their 10 year lifetime. To be consistent with this approach, going forward, the federal government needs to resist the temptation to promise improved performance standards, such as a wait-times guarantee, on which only the provinces and territories are able to deliver. 

Transfers to provinces
Billion Canadian dollars, fiscal years starting on 1 March

Source:   Finance Canada (2006), Restoring fiscal balance in Canada, Ottawa.

Over the longer term, cutting back federal taxes and transfers somewhat
would also reinforce accountability of provincial governments

For the longer term, consideration should be given to strengthening provincial governments’ accountability by reducing federal taxes and trimming non equalisation transfers to the provinces back to levels more consistent with the externalities they are designed to offset. This would leave provinces with more scope to generate their own revenues and fund services as they see fit. The Canada Health Transfer and the Canada Social Transfer are essentially based on per-capita formulae, although detailed rules have evolved governing their inter-provincial distribution. These transfers involve both “fiscal churning” (where the federal taxes raised within a province are returned to that province via transfers) and inter-provincial redistribution. Separating these two elements would reinforce provincial governments’ accountability for service delivery and make more transparent the redistributive nature of financial flows between levels of government.

Equalisation transfers need to be revamped

In the near term, the priority should be on revamping the equalisation system. This is especially critical given that continued high oil prices will likely lead to significant further regional and industrial adjustments in Canada. Transfers from the federal government currently designated for equalisation are based only on the fiscal capacity of provinces, i.e. their ability to raise revenue if they applied average tax rates to each of their tax bases. Separate arrangements for territories recognise their significantly lower fiscal capacity. Equalisation transfers provide the opportunity – though not the requirement – for provinces to offer comparable levels of public services for comparable levels of taxation. Although in principle equalisation is formula-driven, in practice, significant ad hoc elements have been negotiated over the years. The incentives facing receiving governments are complex, but one effect for receiving provinces is to induce some trade-offs between equalisation payments and provincial policies that would boost economic performance. They also encourage them to seek “technical adjustments” that allow them to maximise their transfers. The extent of inter-provincial equalisation is ultimately a social choice, and while there is considerable public support for equalisation in principle, there appears to be considerable dissatisfaction with the present arrangements. One current source of tension – the appropriate treatment of rents from natural resources – is only likely to grow, especially given Alberta’s sharply rising oil sands output and associated government revenues. While reform options are still under discussion, changes to equalisation should aim for a transparent outcome that defines the rule and sticks to it and that also encourages provinces to maximise their own growth opportunities.

How to obtain this publication                                                                                      

The Policy Brief (pdf format) can be downloaded. It contains the OECD assesment and recommendations but not all of the charts included on the above pages.

The complete edition of the Economic Survey of Canada 2006 is available from:

 

Additional information                                                                                                  

For further information please contat the Canada Desk at the OECD Economics Department at webmaster@oecd.org. The OECD Secretariat's report was prepared by Deborah Roseveare and Annabelle Mourougane under the supervision of Peter Jarrett.

 

 

 

 

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