Almost exactly a decade ago, Finance Minister Paul Martin triumphantly announced in his February 24, 1998, budget that after 27 consecutive deficits Canada finally recorded a budgetary surplus for fiscal year 1977-78. On February 26, 2008, Finance Minister James Flaherty tabled Canada’s 11th consecutive budget with a surplus, with forecasts for more to follow. For most of these 11 years, Canada was alone among G7 countries in terms of registering surpluses, so much so that in G7 circles a budgetary surplus has come to be known as a ”œCanadian fiscal value.”
While Canadians celebrate this achievement and are duly proud that the Economist calls Canada the ”œfiscal virtu- oso” of the G7, we ought to be celebrating another fiscal milestone, one highlighted in Flaherty’s 2008 budget, namely that each and every Canadian province and territo- ry also recorded a budget surplus for 2005-06 and again in 2006-07, a feat last achieved 60 years ago. Figure 1, repro- duced from annex 1 of The Budget Plan 2008: Responsible Leadership, presents these budgetary surpluses for 2006-07 (with the 1 percent federal surplus intriguingly occupying centre stage).
Figure 2 presents a historical overview of the trends in the federal and (aggregate) provincial-territorial budget bal- ances. While both levels of government were mired in red ink during the Brian Mulroney era, it was the provinces’ fiscal position, not Ottawa’s, that absorbed the brunt of the early 1990s recession. Indeed, over the 1989-90 to 1992-93 period, the federal fiscal position deteriorated by roughly $12 billion whereas the provinces’ aggregate deficit increased by over $20 billion. That the provinces should absorb roughly 60 percent of the combined deficit increase was unprecedented in our history, and on this score, we were probably unique among federations. Beyond the real- ity that the provinces share in the cyclical tax sources (per- sonal and corporate income taxes), the other determinants of this result were the unilateral federal transfer cuts and freezes (e.g., the cap on the Canada Assistance Plan) and the profligacy of Ontario’s NDP government.
In any event, thanks to the 1995 federal budget and the downloading of much of the federal deficit to the provinces (via a cut in the Canada Health and Social Transfer from $18 billion to $12 billion, among other items) combined with Ottawa’s decision to alienate roughly $6 bil- lion of excess employment insurance premiums toward the deficit reduction cause, Ottawa’s budgetary fortunes sur- passed those of the provinces in 1996-97, and, as noted ear- lier, the federal government achieved a positive budget balance in 1997-98 (see figure 2).
Thanks to the high-tech boom, to low inflation, to a very undervalued loonie and to Martin’s ”œcome hell or high water” commitment to wrestle deficits to the ground, the Chrétien era saw Ottawa’s budgetary position improve dramatically relative to that of the provinces, so much so that ”œfis- cal imbalance” became the provinces’ rallying mantra.
The resulting cash-starved condi- tion of medicare eventually led to socie- tal pressure on Ottawa to replenish the cash transfers to the provinces. Paul Martin (as prime minister) responded via the 2004 Health Care Agreement by filling the ”œRomanow gap” (essentially bringing cash transfers to 25 percent of provincial health spending) and then indexing this by 6 percent annually over the next decade, for an overall 10-year increase of $41 billion. The related 2004 Equalization Agreement was nearly as lucrative overall (and presumably more lucrative for the receiving provinces), involving an upfront $1.9-billion increase and then annual indexation at 3.5 percent again for the next decade, for a $33-billion overall cash infusion.
Prime Minister Stephen Harper’s electoral commitment to ”œopen federal- ism” and addressing fiscal imbalance led to a continuation of this infusion of cash transfers. Finance Minister Flaherty’s 2007 budget further enriched the equalization formula in the context of implementing the main provisions of the report of the Expert Panel on Equalization and Territorial Formula Financing. This amounted to equaliza- tion payments for 2007-08 that were $1.5 billion in excess of those for 2006- 07. Beyond this, Flaherty’s 2007 budget altered the Canada Social Transfer to ensure equal-per-capital transfers to all provinces (accomplished by raising the cash transfers of Alberta, Ontario and NWT), and then indexed these equal- per-capita transfers by 3 percent annual- ly. The cash transfers under the Canada Health Transfer will likewise be put on an equal-per-capita basis when the on- going 10-year agreement expires in 2013-14. The 2008 budget may well be unique in another way: there were no new legislated transfers to the provinces (although the in-place indexation gen- erates very substantial increases).
The impact of this transfer explo- sion is captured in figure 3. From a low of something in the range of $23 billion a decade ago, cash trans- fers to the provinces and territories for 2008-09 will have more than doubled, at just under $50 billion. As a share of federal spending these transfers have gone from 13 percent to roughly 19 percent over the past decade. While not denying the huge impact of energy prices, and of raw- material prices generally, on provincial bottom lines, the reality is that this mushrooming of cash transfers has a great deal to do with the figure 1 results, where all provinces and ter- ritories are now in the black.
Figure 4 rounds out this brief focus on fiscal federalism and the 2008 budget by presenting the comparative trends in federal and all-province access to post- transfer revenues. The widening of the excess of provincial revenues over feder- al revenues in recent years is partly the result of the massive cash transfer infu- sions and partly a result of rising natural resource revenues. In addition, the recent decline in the federal share of rev- enues is also due to the very substantial decrease in federal tax rates, including the cut in GST by two percentage points under Flaherty’s watch. The Budget Plan 2008 (p. 223) provides the following summary comment on figure 4:
Provincial-territorial revenues are forecast to be 2.3 percent- age points of GDP (or almost $36 billion) higher than feder- al revenues in 2007-08, com- pared to a gap of just 0.5 percentage points (or $5 bil- lion) in 2000-01. The gap will likely continue to grow over the coming years, reflecting the actions announced in Budget 2007 to restore fiscal balance, notably increased funding for Equalization, the Canada Social Transfer and Territorial Formula Financing.
By way of a concluding comment, I want to congratulate Finance Minister Flaherty and the finance department for including this historical overview of fed- eral-provincial fiscal balance as part of the budget. This also extends to ”œA Brief History of the Fiscal Relations Debate in Canada,” which was appended to the 2006 federal budget. These documents are reminiscent of an earlier era when budgets, both provincial and federal, often included these sorts of historical overviews or analytical position papers. Some traditions merit preserving.