It is now generally accepted that fiscal arrangements between Ottawa and the provinces were becoming increasingly unworkable in the final years of the former Liberal government. Commentators cite the increase of fed- eral spending in areas of provincial responsibility after the elimination of the federal deficit, the increase of bilateral deals between selected provinces and Ottawa and the changes to Equalization that followed the 2004 Health Accord as evi- dence that the consensus over fiscal arrangements was break- ing down. While increased federal spending in provincial areas began in earnest with Jean Chrétien’s government, the breakdown of the consensus seemed to accelerate under Paul Martin, probably because of his government’s minority status and the perception by provincial premiers that he was espe- cially vulnerable to political pressure.

The new Conservative government was elected in January 2006, in part on a platform of ”œopen federalism.” It promised to reform fiscal arrangements and address provincial concerns regarding a persistent ”œfiscal imbalance” between Ottawa and the provinces ”” a concept that had been dismissed by the federal Liberals. After the election, the new government laid out its analysis of the issue and its broad strategy toward reforming fiscal arrangements in a budget paper entitled Restoring Fiscal Balance in Canada: Turning a New Leaf, included in Budget 2006.

In what follows I evaluate the federal arguments and proposed process to reform fiscal arrangements outlined in this budget paper and offer some brief policy conclusions.

To understand the federal strategy, it is useful to consid- er its motivation. First, it reflects the new government’s ideology ”” a move away from the current environment of increasingly complex overlapping spending responsibilities toward classical federalism with more clearly delineated roles and responsibilities ”” and attending enhanced accountability.

A second motivation is to pre- empt the political hostage taking that characterized the Martin minority regime and to arrest the deterioration of fiscal arrangements, which had pro- gressed from principles-based federal- ism to chequebook federalism (in the later Chrétien years) to the smash-and- grab federalism practised by some provinces during the Martin minority regime. It is clear that the federal gov- ernment has no desire to repeat the experience of the Martin government, when provincial premiers would travel to Ottawa to demand a meeting with the prime minister and refuse to leave without some agreement to transfer federal funds to their province.

A third motivation is to prepare the provinces and all Canadian voters for a future of limited federal resources ”” the empty piggy bank. The spectac- ular increase in federal spending under Prime Minister Martin ”” largely trans- fers to provinces ”” together with the Conservative government’s promise to reduce the GST by two percentage points and to further increase defence spending has substantially reduced the likelihood of large federal surpluses in the future.

The overall goal of the federal paper is to build the framework to contain the discussion within boundaries that are acceptable to Ottawa. The strategy has three elements.

The first element is to symbolical- ly change direction. The government began this during the election cam- paign by acknowledging what most voters (and journalists) believed and the former Liberal government denied: that a fiscal imbalance between the federal government and the provinces exists. The Liberal government had waged a long war with the provinces for the hearts and minds of Canadians over the existence of the fiscal imbal- ance and lost. Recognizing the war was lost, the Conservatives have turned necessity into a virtue, not only admit- ting the existence of the fiscal imbal- ance but pledging to address it. A key tactic of the strategy is to point to a number of policy ”œconcerns” (i.e., mis- takes of the previous government), both to explain the current problem with fiscal arrangements and to point toward a solution.

Signalling a new direction is always easier when one is not forced to justify past actions. The new govern- ment took full advantage of its lack of track record to focus on a number of policy ”œconcerns” that arose under its predecessor. Leading the list was the concern over the large, unplanned fed- eral surpluses and the end-of-year expenditures used to avoid them. In opposition, the Conservatives argued that such surpluses or end-of-year spending damaged democratic deci- sion-making and weakened accounta- bility to Parliament. In addition, large surpluses provided prima facie evi- dence of the fiscal imbalance as defined by provincial premiers: Ottawa has the resources while provinces have the program needs.

The federal paper goes into some detail to explain the reasons for large, unplanned surpluses, pointing out that provinces also had significant unplanned surpluses over the same period. Ironically, the existence of per- sistent, unplanned provincial surplus- es raises questions about the existence of the fiscal imbalance ”” exactly the point made by the previous government. Rather, as Andrew Coyne has noted, it points to a fiscal imbalance between federal and provincial gov- ernments and taxpayers. The paper attributes such surpluses both to the surprising strength of the Canadian economy and to the very prudent fis- cal rules in place.

A second concern is described as the ”œblurred accountability due to reduced clarity in roles and responsi- bilities.” Here the federal paper points both to increased federal involvement in areas of provincial responsibility such as early childhood development and housing and to the neglect of some exclusive federal responsibilities such as defence, border security and immigration.

In addition to addressing two of its own concerns (albeit shared with the provinces) regarding past federal policy, the federal paper devotes signif- icant space to dealing with provincial concerns over the size and predictabil- ity of federal transfers to provinces. The Equalization Program is largely ignored, as the federal paper was released before the O’Brien report on equalization and territorial financing, and the federal strategy has been to wait and see if a provincial consensus emerges before showing its hand. However, the federal paper goes to some lengths to defend past federal policy on health, post-sec- ondary education and infrastructure transfers and so-called regional spending. This is an essential part of building the framework to contain the fiscal imbal- ance discussion. The paper argues that in the case of health spending, predictable, sustain- able funding was put in place with the 2004 Health Accord, noting that the funding, slated to grow at 6 percent annually (faster than the Canadian economy or federal revenues), exceeds the amounts recommended in the Romanow report.

Turning to post-secondary educa- tion, the paper acknowledges that federal transfers have declined as a share of total spending on post-second- ary education since the mid-1990s. However, direct federal spending in post-secondary sector, mainly in the areas of student assistance and research funding, has grown substantially. The result is that the total federal contribu- tion (including both transfers to provinces and direct spending) has kept pace with provincial spending and even grown slightly over the past decade.

With respect to infrastructure, the federal paper acknowledges the decline in public infrastructure investment (as a share of GDP) over the last four decades. It points, however, to recent significant increases in federal trans- fers for transportation, municipalities and border infrastructure. In addition, it notes the GST relief and the share of the federal gasoline excise tax granted to municipalities to provide resources to fund infrastructure investment.

Finally, the federal paper address- es the concern expressed by some provinces (notably Ontario) regarding federal spending targeted to specific regional needs. Here the paper argues that ”œcomparability does not mean uniformity” and that the federal gov- ernment is bound by the Constitution to ”œpromote equal opportunities for the well-being of Canadians.” Such a responsibility requires tailoring some federal pro- grams to meet particular regional needs. Further, the paper argues that the federal government needs the capacity to insure regions against nat- ural and man-made disasters such as floods, ice storms, BSE and SARS.

The second element of the strategy underlying the federal paper is to lay out the quid pro quo, i.e., what the federal government wants in return for reform of fiscal arrangements.

Under the previous federal govern- ment, when Ottawa was seeking to spend money in areas of provincial responsibility, discussions largely cen- tred on two issues: the amount of the transfer and what, if any, conditions would be attached. This positioning put Ottawa at a disadvantage at the outset of every negotiation, and the disadvan- tage was especially pronounced when the minority Martin government had, as one of its central campaign promises, a pledge to ”œfix health care for a gener- ation.” Promising only ”œopen federal- ism,” the Harper government had much more scope to set the terms of reform and to demand some economic reforms in return for addressing provin- cial concerns.

The budget paper makes clear that provinces are expected to deliver on measures to enhance the Canadian economic union. Key to enhancing the economic union is reduction of barriers to labour mobility, especially the recognition across provinces of credentials for professionals and skilled workers and recognition of immigrants’ credentials.

In addition, the paper argues for the need to further harmonize securi- ties regulation across the country, an initiative pursued vigorously (if not very successfully) by the previous gov- ernment. Finally, the paper argues for more tax harmonization, especially in the area of sales taxes.

The final element of the strategy is to set the benchmarks and timetable by which success is to be judged. Consistent with Conservative ideology, these benchmarks include improved accountability, fiscal respon- sibility, predictability of transfers, an efficient economic union and enhanced collaborative management of the federation.

The first two are to be achieved by clarifying roles and responsibilities and by ensuring that transfer reform does not impede Ottawa’s ability to continue to run surpluses (albeit mod- est ones). Predictability of transfers is a key provincial concern that can be addressed in a straightforward way with a new equalization formula and an explicit escalator for the federal support for post-secondary education. Efficient economic union is a key fed- eral concern that can be addressed by provincial action on harmonizing professional and skilled work creden- tials, the credentials of professional and skilled immigrants and move- ment toward a single regime for secu- rities regulation. Finally, enhanced collaborative management of the fed- eration is to be achieved by meeting the other benchmarks. This is undoubtedly a very different set of benchmarks than provinces might propose to measure the success of reform of fiscal arrangements.

For the improved accountability benchmark, the paper points to the focus in Budget 2006 on federal responsibilities, including border secu- rity, defence and justice. For the fiscal responsibility benchmark, the paper points to the new Federal Accountability Act, the creation of a parliamentary budget officer to provide independent fiscal forecasts to parliamentarians and annual and medium-term debt reduc- tion targets. Also included is a propos- al to allocate unbudgeted surpluses to the Canada Pension Plan. For the pre- dictability-of-transfers benchmark, the government points to the growing health funding guaranteed by the 2004 Health Accord.

To further meet these and the other benchmarks presented, the gov- ernment commits to make public, by fall 2006, its approach in four areas: allocating unplanned surpluses, reforming Equalization and territorial financing, providing federal support for post-secondary education and training, and providing federal sup- port for infrastructure.

Before presenting its approach to these issues, the government commits to consult with policy experts and the public. Finance ministers will meet to discuss the issues, and other ministers will consult with their stakeholders as well. The process will culminate with a meeting of first ministers in the fall of 2006 and be implemented in Budget 2007.

The federal paper provides solid evidence that the Harper govern- ment has a clear, well-defined strate- gy to bring a political solution to the issue of fiscal arrangements reform. It has changed the debate from one over whether the fiscal imbalance exists ”” a debate that the former government had already lost ”” to how we address the issue. Through the paper, the government has developed the framework or boundaries within which the debate will take place. It has also set the benchmarks by which suc- cess will be measured. Success includes leaving room for the federal government to fund its own responsibil- ities adequately and to continue to run modest surpluses.

Will the strategy work? Of course it is impossible to be certain about future political outcomes, but Ottawa’s plan is clear, it is practical, and it fits the government’s political timetable: i.e., it prepares the Conservatives for the possibility of a 2007 election. In addition to having a skilful plan, the government has also, to date, been lucky. Its first stroke of luck is that the O’Brien report, tabled subsequent to the budget by the Expert Panel on Equalization and Territorial Formula Financing, has provided the govern- ment with a principles-driven, afford- able formula for reforming Equalization. The second stroke of luck is that, in the aftermath of practising smash-and-grab federalism, premiers are badly divided. In their two meet- ings since the federal budget, premiers have been unable to reach a common position on Equalization or broader fiscal arrangement reform or, in some cases, even to demonstrate that they understand the issue. Thus, both by design and by good fortune the federal government is well placed as it moves toward a First Ministers’ Meeting in the fall of 2006.

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