Ottawa is laying the groundwork for a fiscal future that will strain already heavily indebted provinces. The federation needs to change its tack if Canada is to compete in the Information Age.

From a comparative international economic and fiscal perspective, Ottawa’s Budget 2013 has much to crow about. Since the financial crash, Canada has experienced the highest job creation and GDP growth among G7 nations; we are the only G7 country to have fully recovered the business investment lost during the recession; Canada’s tax rate on new business investment and our total government net debt are the lowest in the G7. And on the domestic front Ottawa seems likely to achieve budget balance by its targeted date of fiscal 2015-16, thanks in part to internal expenditure restraint and to pocketing $11 billion of employment insurance (EI) surpluses in the interim.

Yet Budget 2013 joins most recent budgets in leaving much unsaid when it comes to presenting the national —  as distinct from the federal —  budgetary reality. In order to assess the challenges to Canada’s longer-term economic prospects, federal budgets should include the fiscal position of the provinces individually and in aggregate. This fiscal information would reveal that aggregate provincial deficits are roughly equivalent to the federal deficit —  and will be much larger from fiscal 2013-14 onward. This condition drives an emerging reality that the distribution of money and power in the federation not only is increasingly untenable but is compromising our competitive future in the Information Age.

The reasoning for this is straightforward. First, all three of the openended or demand-driven health expenditures —  medicare, pharmaceuticals and hospitals/home care —  fall under provincial jurisdiction. Second, with a rapidly aging population, the demands of our golden agers on provincial resources are sure to escalate. Third, these expenditure programs have powerful political constituencies, so that the provinces have no choice but to respond by drawing funding away from other areas like education. Directing spending toward consumption-oriented activities at the expense of investment-enhancing activities is a disastrous economic strategy in an increasingly human-capital and information-oriented era.

In sharp contrast, Ottawa not only is well on its way to running surpluses but has also taken steps to ensure that its own potentially open-ended or demand-driven programs are subject to financial control. The federal government has increased the retirement age for Old Age Security (OAS) to 67; the EI program is currently running a surplus; Equalization and federal-provincial transfers are also constrained to grow in line with nominal GDP and so on. Ottawa has been able to ”close,” in varying degrees, the open-ended nature of many of its transfer and expenditure programs.

This juxtaposition of the provinces wrestling with rapidly expanding open-ended programs and Ottawa’s decreasing demands on its consolidated revenue fund, as well as reductions in the GST and corporate tax rates, exposes the inadequate way in which our federation has divided the fiscal pie. In other words, the time has come to rethink the division of money and power in the federation.

There are two polar-opposite solutions to this problem: either the provinces can transfer some powers to Ottawa, or Ottawa can transfer more money to the provinces.

Passing powers upward is hardly as far-fetched an alternative as it might seem, given that the provinces in their 2004 inaugural meeting of the Council of the Federation voted unanimously to transfer the responsibility for pharmacare to Ottawa. (An integral component of this agreement allowed Quebec to maintain its control over pharmacare with equivalent federal compensation.) The proposal foundered when Ottawa declined to accept the responsibility because, among other reasons, one presumes, the federal government had no intention of being saddled with an expanding and open-ended expenditure program. That’s the provinces’ role!

If the offer is still on the table, Ottawa might reconsider. There would need to be agreement on the details of how to allocate responsibility for in-hospital drugs (which might remain with the provinces) and out-of-hospital drugs (which obviously would be Ottawa’s responsibility). On the positive side, since Ottawa holds the constitutional power over drug patents and generics, assuming control of pharmacare would ensure it had to live with its own decisions on patents and generics. Beyond this, Ottawa may have the capacity to mount some version of a national pharmacare plan, an initiative that would extend our public health coverage in the direction of European systems.

Another obvious place for the provinces to offload responsibilities is in financing students’ post-secondary education. Ottawa has many models to draw from should they move to assume this responsibility. The essential component of any system is that loan repayments in any period relate to the student’s earnings. Some models require the repayment of only the actual loans and not the interest (or, alternatively, they embrace below-market rates of interest). Other models have a maximum period of debt repayment after which the remaining loan is forgiven. Student loan programs are often viewed as a social policy measure, when they should be seen as investments in human capital. Indeed, governments should be incorporating depreciation of the post-secondary tuition expenditures into all such programs, much as they do with investments in other sectors. But the central tenet is recognizing that improving our economic prospects means that investing in human capital is as important as physical capital investment.

The Conservatives’ Budget 2013 already recognizes this need to shift the discourse from the rhetoric of subsidy to that of investment. It was evident in the budget’s focus on infrastructure spending. And it was the philosophy driving the Canada Job Grant and associated measures, which transferred aspects of the funding responsibility for training from the provinces to Ottawa. Although major aspects of training fall under provincial jurisdiction, in a human capital era these are programs clearly in the national interest. It is appropriate for Ottawa to play a greater role in training.

Of course the Canada Job Grant has received a rocky reception, especially from Quebec, since it violated the principles embodied in the Conservatives’ ”open federalism” framework not just by moving into provincial jurisdiction but also by doing so without warning. One wonders why Ottawa did not indicate that it would accept a Council of the Federation proposal on training similar to the council’s earlier pharmacare initiative, which would have accommodated Quebec. Odds are that the provinces would have been on board.

By comparison, transferring revenues and taxation powers from Ottawa to the provinces is much more complex because of the dramatic differences in the provinces’ fiscal positions. Data from Department of Finance Equalization tables for 2012-13 show that per capita provincial fiscal capacities, after Equalization, range from roughly $7,100 for the Equalization-receiving provinces (Prince Edward Island, Nova Scotia, New Brunswick, Quebec, Ontario and Manitoba) to the following amounts for the non-Equalization-receiving provinces: $7,800 (British Columbia), $9,900 (Saskatchewan), $11,100 (Newfoundland and Labrador) and $12,700 (Alberta). Given these differentials, it should hardly be surprising that there are already concerns that the richer provinces have moved in the direction of becoming tax havens or providers of superior public goods and services.

Passing powers upward in the federation is not as far-fetched as it might seem.

Since we ”income test” virtually all of our transfers, including OAS, child tax benefits, EI and probably others, why not ”revenue test” the Canada Health Transfer (CHT) and Canada Social Transfer (CST) payments as well? I have already proposed that the CHT/ CST combination be revenue tested under a formula based on each province’s post-equalization fiscal capacities (Policy Options, May 2010). If a province has a per capita fiscal capacity above a certain threshold —  say, 115 percent —  of the per capita national average of fiscal capacities, then for each dollar per capita of a province’s revenues above this threshold, Ottawa would reduce its CHT/CST transfer by, say, 25 cents. The resulting CHT/CST clawbacks could then be redistributed to the provinces with per capita revenues below the threshold.

This approach would not only begin to redress the fiscal superiority of the federal government relative to that of the provinces, it would also do so in a way that ensures that overall fiscal capacity levels across provinces become more equitable. Students of fiscal federalism will recognize this as a small-scale version of Australia’s Commonwealth Grants Commission’s approach to equalization.

There are other avenues for Ottawa to relieve the provinces’ impending fiscal challenges, but it is important to not let provincial governments shirk their need to enact their own Information-Age-appropriate measures. The beneficiaries of provincial programs must play a larger role in the funding of social spending. All provinces, with the conspicuous exception of Quebec, are dramatically raising tuition fees, thereby effectively privatizing the investment in education while avoiding the privatization of health care costs. This is the wrong way round in a human-capital economy. Beneficiaries of health care should shoulder some of the costs.

The now familiar alternatives for financing health care include private insurance, parallel medicare systems, copayments and medicare saving accounts. My long-standing favourite is a delayed user fee that would be viewed as a taxable benefit to be reconciled via the personal income tax system, not at the time of treatment. In other words, the benefits would be ”income tested.” Low-income Canadians would be exempt, and this health tax would be subject to income-related maximums. Averaging provisions would permit a smoothing out of the health tax. Ottawa should not stand in the way of these provincial initiatives.

Understandably, critics will argue that the policy options elaborated above do not belong in a federal budget since they primarily involve a reworking of our federal-provincial fiscal arrangements. But we are currently in the midst of a multiyear reworking of the fiscal arrangements, and these issues have not surfaced. Perhaps it is time for the Finance Department to fall back on its tradition of issuing White Papers or supplementary budget papers on issues relating to Canada’s fiscal and economic future.

Either way, the sobering reality is that Budget 2013 embraces a five-year planning horizon, leaving ample time for the fiscal challenges highlighted above to damage both our economic growth prospects and the stability of our federation. Strong fiscal and economic stewardship requires that these challenges be addressed.