Fiscal federalism:principles, evidence from Canada and elsewhere and a proposal for

ScotlandSPIF, Edinburgh, October 2008

François VaillancourtEconomics, Université de Montréal

1

Principles

• Number of sub-national entities(SNEs)/ borders/size

• Responsibilities of central and SNEs• Financing of central and SNEs– Share of own and transfered revenues– Type of own revenues– Type of transfers– Borrowing authority

2

Numbers/ borders/ size

• Great variability by federation driven by origin of federation with borders historical/drawn

• Issues of relative power ;depends on representation at center mechanism and on degree of autonomy

3

Responsibilities

• Subsidiarity principle– Economies of scale (broadcasting) and

externalities (pollution, mobile labour force)=>central G

– Differences in consumption patterns (taste,climate,geography) based on regional divisions=>SNEs

4

Financing

• SNEs marginal revenue source should be own source; rate freedom/ base can be national/ collection?

• SNES taxes should be on less mobile bases: labour as opposed to capital

• Natural resource revenues at centre for sharing

• Transfer design depends on importance of national goals and degree of solidarity

5

Number/size of entities

– USA 50 mean pop 6 000 000 historical+federal lands

– Switzerland 26 mean pop 300 000 historical+ linguistic(Jura)

– Canada 10(+3) mean pop 3 000 000 historical+ linguistic

– Belgium 3+3mean pop 3 500 000 layered system region+language

– Spain: 17(+2) mean pop 3 000 000 province originated

6

7

Responsibilties

• Similar in the five countries (4 federations).• Central has foreign affairs ,defence,money

and banking some transportation and some or all transfers to individuals

• SNEs have education, health(less in USA-Medicare), local issues

8

Canada:% are for own revenues;% spending Fed<,Prov>

9

Who does what

10

Financing-Own

• Differences appear here• Ca, USA and Sw have SNEs with full range of

taxation powers :base setting, rate setting and collection for major taxes: PIT,CIT G&S

• Be and Es have some own source revenues and limited powers on rates for PIT and do not exercise them

11

Financing transfers

• Important differences here– Canada equalisation of resources not needs and

population based with few conditions for transfers; laid back federalism

– USA no equalisation and many conditional transfers; meddling federalism

– Sw ; equalisation of resources and needs and targeted transfers + other(central bank);

– Be and Es equalisation+ others

12

Canada; revenue sources are as follows

13

Canada Federal transfers

• Small (specific historic) transfers of 50/ 50 type: offical languages, legal aid, social housing… Since 1900 mainly 50/50 funding

• Equalisation starts in 1957 to facilitate tax autonomy of provinces

• Health Social and post secondary education start in the 1955-1970 period. Move from 50/50 funding to block grants in 1977 with various configurations. Population based

14

Equalisation-funded by

• Gross equalisation funded from general federal revenues

• No provincial contributions• No access by federal government to resource

royalties-provincial revenues• Three year moving average lagged 2 years• 10 province standard /NO expenditure needs

15

Equalisation-given out as

• Representative tax system approach: differences in tax capacity measured at national rate per capita=> Total

• ∑ accross recipients=>total payment by federal government

• Five broad bases used (50% of natural resources)

• Fiscal capacity cap; any recipient< poorest non recipient

16

Issues

• Differences in taxation with Alberta lower(flat 10% PIT) creates tax competition and capitalisation in housing prices

• Disparities due to oil/ gas prices =>creates tensions between have / have not provinces in attracting public sector(health) employees increases equalisation payments funded by federal revenues not from these resources but from Ontario

17

Issues-2

• Asymetric treatment of Québec small de jure and large de facto ( social security , immigrant selection, parental leave) thus West Lothian asymetry is accepted;

• Provincial PIT is collected by federal 9/10,CIT 8/10 Revenue Québec cost ≈ 900 million$

• Five province collect own sales tax, Québec collects federal GST, federal collects joint federal/provincial HST

18

Per capita fiscal balance, Ontario and Québec, net of deficit

-2500

-2000

-1500

-1000

-500

0

500

1000

1500

En

dolla

rs c

oura

nt

Québec Ontario

19

Scotland

• Why is every thing paid for by UK; no marginal cost to Scottish taxpayer –long live Lord Barnett!

• Incentive to spend !• Why no political will to use 3p to the £ ?• Similar situation in Belgium and Spain where

AC have granted tax breaks• Catalonia complains but does not vary

taxation or spending20

Canada

• 1954 Québec takes tax room in personal income tax field

• Equalisation introduced in 1957 to facilitate provincial tax autonomy

• By 1972 all other provinces do that and are willing to raise / lower taxes to provide differentiated

• Recent years sees erosion of credo of provincial tax autonomy

21

Conclusion-Policy proposal• Require Scotland to finance 50% of spending

for individuals (education… 2009 amount)by raising its own PIT;

• Inland Revenue collects it at marginal cost using UK income definition

• Initial tax rates set to zero not existing(UK) one so decision must be taken –avoid the Spanish laziness of tax concession

• Equalization introduced at same time to reduce risk/ make solidarity explicit

22