Debates about whether there is a fiscal (im)balance”” a funding gap between provincial responsibilities and tax revenues ”” and whether the 2007 fed- eral budget solved it obscure the real contribution that the budget makes to federal-provincial fiscal relations. Stability, predictability and funding allocations based on rules and principles are what the budget provides, and seeing why these matter requires understanding the damage done to federal-provincial fiscal relations by the 1995 deficit-cutting federal budget and the 2005 ”œside deals” with Newfoundland and Nova Scotia, which allowed those provinces to exclude natural resource revenues from their equalization calculations.

The 1995 federal budget was a bold and necessary attack on the deficit. However, the federal decision to cut transfers to the provinces more dramatically than federal spending was cut ”” federal transfers for health, post-secondary educa- tion and social programs were cut by 40 percent over three years ”” angered all provincial governments. Equally trou- bling to them was the fact that such dramatic cuts were made unilaterally by the federal government, even though it was the provinces that had to scramble to replace federal funding in these critical areas of provincial jurisdiction.

The result was a decade of federal-provincial tension over fiscal issues and a concerted effort by the provinces to set aside their differences and confront the federal govern- ment as a united force. The united provincial front that resulted in the creation of the Council of the Federation scored a success in 2004 when the federal government agreed to the Health Accord that provided predictable long- term transfers for health care ”” with annual increases of 6 percent until 2013-14.

In signing the side deals with Newfoundland and Nova Scotia ”” which allowed them to exclude natural resource rev- enues from their equalization calculations ”” the Martin gov- ernment turned its back on the long-established formula-driven, rules-based process for deciding equalization entitlements in favour of an ad hoc approach. Equally impor- tant, and not lost on other provinces, was the fact that the federal government appeared to be caving in to the aggressive and uncompromising position of Newfoundland Premier Danny Williams, who even took down the Canadian flag to make his point.

Not surprisingly, other provinces that had legitimate rea- sons to be aggrieved by the side deals adopted aggres- sive and uncompromising approaches. Saskatchewan, which had for years experienced clawbacks of natural resource revenues that sometimes exceeded 100 percent, demanded that its natural resources also be totally excluded from equalization. However, if implemented, the result would have been that Saskatchewan, with a popula- tion of 1 million people, would receive $800 million in equalization, even though the province has shown the fis- cal capacity in 2006-07 and 2007-08 to cut its sales tax from 7 to 5 percent and increase spending by 9 percent! Because of the side deals, the fiscal capacity of Ontario, a contributor to equalization, was less than Newfoundland’s; this led Ontario to argue that it could no longer afford increases to equalization, a posi- tion that angered other provinces that received equalization. The disarray of the provinces was reflected in their fail- ure to agree with the recommendations of a report on federal-provincial fiscal relations that they had commissioned.

Clearly by 2007 federal-provincial fiscal relations needed to be put on a more predictable, stable footing and be based on rules and established formu- las, which prevent the federal govern- ment from making ad hoc decisions.

The 2007 federal budget goes a long way to achieving this goal. As well as increasing funding for post-secondary education, social programs and daycare facilities in 2007-08 and 2008-09, it commits to increasing the funding in these areas by 3 percent a year until 2013-14, and there are also specific long-term commitments for infrastruc- ture funding. What this means is that provinces receive long-term, predictable funding and the federal government is in a position to reject provincial appeals for enhancements to transfer payments. Providing long-term, predictable funding for federal transfers to the provinces also helps to clarify the roles of the two levels of government and reduce the sources of friction. In the past the federal government tried to specify what federal transfers should be used for and establish national stan- dards for programs. While such an approach might be compelling in the- ory, by the 1990s it no longer worked in practice. Most of the funding for health, education and social programs comes from the provinces, which are also responsible for running the pro- grams and taking flack from voters for their shortcomings.

By providing long-term commit- ments on transfers to the provinces, the federal government will no longer be in the position of jostling with the provinces over how to design and run social programs, a situation similar to two people fighting to con- trol the steering wheel of a car. The nature of future federal involvement in areas of provincial jurisdiction is exem- plified by its role in daycare. Rather than wrestling with the provinces over how to run a national daycare pro- gram, the federal government is invest- ing in daycare facilities. Similarly, if the federal government is concerned about poverty it can enhance the Child Benefit, a federal program to assist low- income families, or use the tax system for the same ends, as was done in the 2007 budget. Clarifying roles is not synonymous with federal withdrawal; instead, future federal investments in areas of provincial jurisdiction will be more focused and strategic.

In terms of equalization, the gov- ernment adopted the main recommen- dations of an expert panel, headed by the former Alberta deputy minister of finance and appointed by the previous government. These included the adoption of a 10-province stan- dard; the return to a formula-driven, rules-based approach, which effectively prevents the federal govern- ment from making ad hoc side deals like those made with Newfoundland and Nova Scotia; and the cre- ation of a cap, whereby a province receiving equalization has its entitlement capped when its fiscal capacity reaches the same level as a province contributing to equalization.

The concept of the cap was a ”œbig win” for Ontario as was the decision to distribute all federal transfers on a per capita basis, thereby ending the prac- tice of equalizing other transfers (although the change to a per capita formula for health will occur only in 2013). In exchange, Ontario compro- mised and accepted significant increas- es in funding for equalization, more than $1.5 billion in 2007-08 alone. What is most important is that the fed- eral government is moving in the direction of having one transparent equalization program, with goals and results that can be measured and that redistributes resources from richer to poorer provinces. Other programs will be funded on a per capita basis, unless there is a compelling public policy rea- son to do otherwise.

Ontario may have done well in the equalization revamping, but the biggest ”œwinner” in terms of the amount of new transfer funding that it will receive was Quebec, whose pre- mier made the controversial decision to use the extra money to cut taxes. This situation underscores a significant weakness in the equalization program, which future negotiations should address. Equalization is not an ”œactive” program with incentives or other mechanisms to encourage provinces to address the structural weaknesses in their economies and improve their economic standing. Quebec has many structural problems with its economy and social programming. The question is fairly being asked: Is it easier for Quebec to remain a ”œhave-not” province receiving significant funding from the rest of Canada than to make the difficult decisions to get its own economic house in order?

If Quebec was the biggest winner, Saskatchewan was tagged the biggest ”œloser,” which relates to its demand that the Prime Minister honour his commit- ment to exclude natural resources from equalization calculations. While the new equalization formula allows provinces like Saskatchewan to exclude natural resources, it also caps such provinces’ entitlements when they are equal to those of provinces contributing to equalization. Without the cap, resource-rich and prosperous western provinces could receive billions from oil while Ontario taxpayers paid them equalization. However, as Tom Courchene has argued, the new cap means that Saskatchewan will have vir- tually 100 percent of its natural resource revenues clawed back and by 2008-09 will no longer receive equalization.

Saskatchewan could probably have negotiated a less restrictive cap with the federal government; however, this would have required Saskatchewan to compro- mise and concede the need for some form of cap. Instead Saskatchewan’s posi- tion was uncompromising and at times aggressive. There is no doubt the Prime Minister ”œplayed hardball” with Saskatchewan. One wonders if he was sending a message to other provinces that uncompromising and aggressive positions no longer lead to success in fed- eral-provincial fiscal relations.

Federal-provincial relations require compromise and a willingness of provinces to look beyond their own provincial borders. In fiscal matters, there is also a need for clarity, pre- dictability and decisions based on established rules and procedures.

While it might be premature to declare ”œpeace in our time,” the 2007 federal budget should provide more sta- bility in federal-provincial relations and lessen the intensity of the bickering. 

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