May 13, 2012
Options for Reforming Canada’s Tax and Transfer System
In order to achieve long-term fiscal sustainability, provincial governments will need to increase revenues or reduce spending by an amount equal to 2.9 per cent of annual GDP.
Put simply, the provinces will need to find an extra $49 billion a year to keep up with growing expenditure demands. The search for new revenue is on.
Debate over the structure of the country’s tax system is inevitable in this context. It is unclear to what extent the country’s tax system can cope with the pressures on provincial government finances and rapidly changing domestic and global economies. Is the current taxation structure—and the corresponding size of intergovernmental transfers—appropriate? This paper examines some alternative arrangements that would provide provinces the resources they need in the short-term, while also ensuring long-term fiscal sustainability through an efficient tax system.
Executive Summary
The anticipated expenditure pressures associated with population aging constitute a major challenge to long-term fiscal sustainability in Canada, especially for provinces. According to the Office of the Parliamentary Budget Officer (2012), in order to achieve long-term fiscal sustainability, provincial governments will need to increase revenues or reduce spending by an amount equal to 2.9 per cent of annual GDP. Put simply, the provinces will need to find an extra $49 billion a year to keep up with growing expenditure demands. The search for new revenue is on.
Debate over the structure of the country’s tax system is inevitable in this context. Currently, both the federal and provincial governments have considerable access to the major tax bases (e.g. personal and corporate income). The 1960s and 1970s witnessed some federal-provincial realignment of taxation responsibilities in response to the growth of provincial expenditure programs, such as healthcare, education, and social assistance. As a result, Canada has the most decentralized taxation structure among OECD countries.
But since the last major coordinated change—the transfer of personal and corporate income tax points to the provincial governments in 1977—there has been little discussion of structural realignment. This lack of discussion is a concern due to major changes that have occurred in the global and national economies. Long-term fiscal sustainability will require an efficient tax system that responds to dynamic national and global economic contexts.
Globally, the mobility of goods, capital and labour means that Canada’s tax system must compete with the rest of the world to attract new talent and business, and to ensure that Canadian firms are successful in international markets. Value-added taxation (VAT) will be a key component of making Canada globally competitive. Several provinces have already adopted a harmonized sales tax (HST) in an effort to increase investment and productivity. Having efficient corporate and personal income tax systems will also be important to Canada’s competitiveness.
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Nationally, major changes include the growing importance of natural resource rents as a source of income for some provinces—to which the federal government has little access. Provinces are also facing escalating demands on their programs, particularly healthcare, due to demographic pressures.
But it is unclear to what extent the country’s tax system can cope with the pressures on provincial government finances and rapidly changing domestic and global economies. Is the current taxation structure—and the corresponding size of intergovernmental transfers—appropriate? Are there alternative arrangements that would provide provinces the resources they need in the short-term, while also ensuring long-term fiscal sustainability through an efficient tax system?
This paper examines four potential reforms:
- Centralizing corporate income taxation combined with a rules-based revenue-sharing system
- Transferring personal income tax-points to provinces combined with some centralization of corporate income taxation
- Expanding the national value-added tax combined with a rules-based revenue-sharing system
- Adopting a national carbon-pricing system combined with a rules-based revenue-sharing system
Each option is discussed with respect to its potential effects on the efficiency of taxation in the federation, the autonomy of provincial governments, fiscal disparities among provinces, the stability and predictability of federal transfers and provincial revenues, and accountability.
This paper does not make any explicit recommendations about which option to pursue, but does recognize the importance of balancing the tradeoffs inherent in any choice. For example, centralizing one or more forms of taxation is perhaps the easiest way of gaining efficiency and, in turn, achieving long-term fiscal sustainability, but comes at a cost to provincial autonomy. Combining tax centralization with formal revenue-sharing mechanisms could compensate for this loss. In this respect, formal revenue-sharing agreements are an attractive and compelling option when measured against established principles and objectives for the tax and transfer system.
Integrating formal revenue-sharing mechanisms into the tax system would add greater clarity, transparency, and predictability to Canadian fiscal relations. Formal revenue-sharing agreements could be accompanied by a reduction (or the elimination) of existing transfers, like the CHT. Increasing the share of federal transfers that are determined by collectively negotiated rules, rather than by the federal government’s discretion, could reduce intergovernmental conflict. Guaranteeing provinces a set portion of federal tax revenues could give provinces the stability they need to meet their growing expenditure demands.
Even if provinces are reluctant to cede more tax room to the federal government, current fiscal pressures warrant consideration of all options. No path to fiscal sustainability will be free of hard choices. The provinces may have to be willing to make tradeoffs and decide to give up some autonomy for greater efficiency, stability, and predictability. One thing is certain: in the search for an extra $49 billion a year, leave no stone unturned.
Authors
Jean-François Tremblay
Release Date
May 13, 2012
ISBN
978-1-927350-25-6
Mowat Publication
No. 51