Fiscal Federalism on the Campaign Trail

As I noted in my post about income splitting and in commenting on Armine’s post about Tax-Free Savings Accounts, federal Conservative tax promises entail significant fiscal costs for provincial governments.

I expanded that thought into the following op-ed, which appears in today’s Toronto Star.

In the same vein, the federal Conservative policy of increased incarceration imposes costs on provincial jails.

Premiers Could be Reaching for Their Wallets
The Toronto Star
April 25, 2011
Erin Weir

Rather than defending deep corporate tax cuts, the Conservative party is emphasizing promised personal tax breaks: income splitting for some households, doubled Tax-Free Savings Accounts (TFSAs), and tax credits for more athletic and artistic pursuits.

Journalists and opposition politicians quickly pointed out that these promises are delayed until the federal budget is balanced, which is not projected until after the next election. Less noticed is the fact that provincial governments would bear a significant portion of the cost of these postdated tax changes.

Provincial income tax generally applies to income as defined by federal tax rules. Shifting income to a spouse in a lower tax bracket or into a TFSA reduces both federal and provincial revenues.

It would be constitutionally possible, but practically difficult, for provinces to disallow income splitting for provincial tax purposes or to tax investment gains realized inside TFSAs. Provincial governments would not be obliged to create provincial credits for fitness and arts spending eligible for the promised federal credits. However, provinces set a precedent of doing so with the children’s fitness credit.

Would these contractions of the shared tax base be delayed until provincial budgets are balanced? The largest provinces face greater fiscal challenges than Ottawa. Surely Canadians should be as mindful of provincial deficits, which are financed at higher interest rates than federal borrowing.

The Conservative platform estimates that income splitting and the fitness/arts credits will reduce annual federal revenue by $2.5 billion and $500 million respectively. It estimates that doubling TFSAs will cost very little in the immediate term.

But as TFSA contributions accumulate and returns compound, the fiscal cost of not taxing them grows exponentially. Budget 2008 projected that the current $5,000 threshold will ultimately reduce annual federal revenues by $3 billion.

The additional cost of doubling the threshold would be below $3 billion because fewer people could afford to contribute $10,000. However, the three Conservative promises could easily punch a $5-billion hole in the federal budget.

How much would they cost the provinces? Provincial income tax generates about two-thirds as much revenue as federal income tax.

Top marginal rates are especially important for income splitting and TFSAs, which disproportionately benefit high-income Canadians. Outside of Quebec, top provincial tax rates are about half of the top federal rate.

The upshot is that federal Conservative promises could easily reduce combined provincial tax revenues by between $2 billion and $3 billion per year.

Furthermore, federal transfers to the provinces are up for renegotiation in 2014. After musing about austerity, the federal Conservatives have pledged to continue the current Canada Health Transfer escalator.

However, they have already capped total Equalization payments. The implication is that Ontario’s Equalization entitlement can expand only by squeezing other recipient provinces.

The Conservatives have made no commitments regarding the Canada Social Transfer or Territorial Formula Financing. Given reduced federal tax revenue, Canadians have reason to fear a clampdown on such transfers.

Taken together, the Canada Social Transfer, Equalization and Territorial Formula Financing are larger than the Canada Health Transfer. Since all are block grants, promising to increase the one labeled “health” is of little consequence. What matters is the overall level of federal support for provincial and territorial governments, which deliver health-care services.

Arcane issues like fiscal federalism rarely ride high on the election campaign trail. However, promises that would shrink the provincial income tax base and mixed messages about federal-provincial transfers should cause voters to ask how much another Conservative government in Ottawa would cost their province.

Erin Weir is a Canadian expatriate working as senior economist for the International Trade Union Confederation in Brussels.


  • Denise Freedman

    Fiscal federalism may be an arcane matter for the majority of Canadians, though clearly, as indicated above, of significant effect on the wellbeing of all of us not making enough to benefit from Conservative–and Liberal–proposals and already established policy.

    But, I do wonder how arcane the effects of such policies truly are.

    It certainly seems that ‘starving the beast’ is a well-understood way of forcing government to relinquish its social welfare activities, starting, coincidentally, with the ‘reform’ period Standford discusses in his recent study on the effect of corporate income tax reductions–amid the breakdown of the post WWII social consensus, so-called.

    The shrinking of government, consequent upon its ‘starvation’ is clearly the goal of Grover Norquist, an American to be sure, but one certainly speaking for many Canadians when he declares he wants to shrink government so he can “drown it in a bathtub.”

    Where is the equally graphic resonant statement progressives could raise to challenge such fiscal violence?

  • “Eat the rich”

  • Denise Freedman

    I personally favour “Soak the rich!”

    But both have a certain quaint, archaic flavour and certainly don’t have much currency in an environment Harper Conservatives can do their bait and switch on Ignatieef Liberals who have called for restoring corporate income taxes, a bit; the implication that Liberals will raise personal income taxes.

    It has so spooked Liberals–as they are even more spooked by latest poll numbers–they say Layton New Democrats will raise taxes by $70 billion: their bait and switch is the same–income taxes on the middle class.

    Even on this blog, there is a question as to who is rich.

    Yalnizyan referred to $150,000; she wrote many reading this blog wouldn’t think that a lot of money. In one of my courses this past year at Carleton, it was pointed out that $50,000 is the median income in Canada; I have to remind myself median is not average, and is not skewed by a relative few super-wealthy people at the top.

    And that is only a third of $150,000.

    But, like Yalnizyan, I think of the top 1%, or even the top .5% when I say “Soak the Rich!” Even though she took that from Stiglitz, an American, referring to American circumstances.

    I have heard Stanford (forgive my previous misspelling) also make the argument about Canada.

    When the rich, including corporations don’t invest–their job in capitalism, in Stanford’s presentation–maybe we can blame them, though if we are in a recession they are being ‘rational,’ so maybe we cannot.

    Dean Baker, at the same event as Stanford, and Yalnizyan, has pointed out that if the wealth do not do their capitalist job–and it might well be ‘irrational’ for them to do so–the only entity left is the government.

    If the rich won’t do it on their own, maybe they should be encouraged.

    How much different is that than for them to encourage austerity on those of us who make less than $150,000, or even $50,000?

  • If the rich won’t do their “job”, and it would be irrational for them to do so, then I guess they’ve rationalized themselves out of a job.

    At which point the rational thing for the rest of us to do is take their money and have government do the job for them. Not very nice–but then, such things as deliberately encouraging high-ish unemployment in the interests of making the rest of us a more “flexible” labour force isn’t very nice either.

  • Denise Freedman

    What you’re describing, Purple Library Guy, is class war.

    But then, isn’t that precisely what has happened since the breaking of the post-WWII social consensus?

    One piece of evidence is Stanford’s study, showing, as corporate income tax has been reduced since Mulroney’s tenure, non-residential fixed investment (I think I have that term correct) has gone down 1%.

    How much has corporate income tax gone down?

    The battle was lost with the acceptance of the commodification of public goods, with the resulting forced dependance on ‘the market’ to provide these ‘commodities.’

    We must bribe the private sector, which serves two purposes: 1) it makes them even more wealthy, and 2) it makes it even more difficult for the public sector to do what needs to be done when (some) sanity returns.

    Economics isn’t some “objective” way to choose values: it always ends up arguing for bribes; it is a tool of values. Put together, this is the study of political economy, the study of power, the study of class war.

  • “[Both slogans] certainly don’t have much currency in an environment Harper Conservatives can do their bait and switch on Ignatieef Liberals”

    I beg your pardon; I thought you’d wanted an answer to this question:

    “Where is the equally graphic resonant statement progressives could raise to challenge such fiscal violence?”

    Are you asking for the above _plus_ one that takes into account an environment where the Cons can do their bait-and-switch? I’d suspect you’re then getting away from slogans and into policy.

    “Even on this blog, there is a question as to who is rich.”

    So is that what you want to talk about?

  • Denise Freedman, you won’t find an argument from me. I’d agree that there has been a class war being prosecuted from above with increasing intensity for around 40 years, starting in the US with preparatory steps such as the endowment of various “think tanks” intended to create the kind of narrative that was then used starting from the eighties.

  • Denise Freedman

    Todd, slogans serve policy; policy creates slogans.

    I like talking about both, don’t you?

  • rentier fungicide

    Talking about fiscal federalism, what is the NDP going to do about saving the Canadian health-care system; as Thomas Walkom pointed out a few days ago, the transfer of tax points to the provinces limited the ability of the Government of Canada to enforce national health-care standards (–walkom-the-liberals-shifty-medicare-record ). But Layton proposes to decentralize even more — is he going to stand up to Quebec and Alberta? Everything in his record suggests that he is ideologically opposed to using the the Government of Canada’s fiscal levers to enforce provincial obedience to national standards, and he is on record as being willing to sacrifice the federal spending power, just like Harper. How about some honest discussion, à la Lee and Mackenzie, on how the NDP proposes to limit inter-provincial tax competition and the resultant race to the bottom?

  • “I like talking about both, don’t you?”

    Yup. But I’m a little slow: I like signs that the topic is shifting.

    “[Both slogans] certainly don’t have much currency in an environment Harper Conservatives can do their bait and switch on Ignatieef Liberals”

    Oh, I don’t know. I think it’d provide a nice, populist target. Everyone’s so eager to be “middle-class”, but can you imagine the top 1%ers, say, trying to deny they’re rich when the others begin to look accusingly at them?

    “there is a question as to who is rich”

    Of course. But I’m sure you could find justification to create taxes on such things as financial transactions and raise taxes on, say, the upper quintile or two of Canadian society.

    For a communist, it’s much easier: take away ownership from shareholders who don’t themselves work where they got the shares from (for starters), then talk about taxes.

    “though if we are in a recession they are being ‘rational,’ so maybe we cannot.”

    Yes, we can: they got that money by exploiting workers in a system that demands such. Get rid of the system.

    “How much different is that than for them to encourage austerity on those of us who make less than $150,000, or even $50,000?”

    Are you a metaphysician, then, searching for the Ultimate Truths which Apply at All Times and Places?

    “isn’t that precisely what has happened since the breaking of the post-WWII social consensus?”

    Welll, a little before that (since around about the late 18th century).

  • Fungicide,

    The NDP platform commits to “guarantee a continued strong federal contribution – including the 6 per cent escalator – to Canada’s public health care system in return for a clear, monitored and enforced commitment to respect the principles of the Canada Health Act.”

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