The Fiscal Federalism in Canada

1. The Canadian Federalism

Canada is a Federation with two distinct jurisdictions: Federal government and ten provincial governments (Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, Prince Edward Island, Quebec, Saskatchewan. The three Territories are: Northwest, Nunavut and Yukon).

The Canadian Federalism is one of the most important examples of federalism model. The federal system defined by BNA and Constitutional Act 1982 is original, unlike the American and German federal systems. The Canadian constituents rejected the idea to give specific competences to the Federation and residual powers to the Provinces; in fact, they provided a residual clause in favour of Federation.

2. BNA, Constitution Act and Supreme Court: the division of powers

In the Canadian Federalism the division of powers between State and Provinces is based on the British North American Act and on the Constitutional Act 1982, nevertheless it’s flexible. It’s a particular case of federalizing process. According to section 91 of the British North American Act 1867 (BNA) the Federal Parliament has the exclusive legislative authority in the following matters, among others: public debt; property; trade; commerce; raising money; banking; defence; bankruptcy and insolvency; marriage and divorce; criminal law, except the constitution of Courts of Criminal Jurisdiction, but including the procedure in criminal matters; such classes of subjects as are expressly excepted in the enumeration of the classes of subjects by this Act assigned exclusively to the legislatures of the Provinces (residual powers). Also, the Federal Parliament may make laws to assure peace, order and good government of Canada in relation to all matters not coming within the classes of subjects by this Act assigned exclusively to the legislatures of the Provinces. The Provinces may make laws in the following matters: direct taxation; establishment, maintenance and management of public and reformatory prisons in and for the Province; establishment, maintenance and management of hospitals, asylums, charities and eleemosynary institutions in and for the Province, other than Marine Hospitals; generally all matters of a merely local or private nature in the Province. The division is far from being rigid for some reasons: overlapping jurisdictions, shared competence (agriculture and immigration) and shared responsibility. The Constitutional Act 1982, which recognized the independence of Canada, didn’t alter the relations between Federation and Provinces (and Territories), but it added other provisions. Particularly, the art. 36 of Constitution Act gives Federation the power to intervene directly to resolve situations of financial inequality. The Parliament and the legislatures, together with the government of Canada and the provincial governments, are committed to promoting equal opportunities for the well-being of Canadians; furthering the economic development to reduce disparity in opportunities; providing essential public services of reasonable quality to all Canadians.
Before proceeding, the focus has to be fixed on two provisions. The BNA provides that the Provinces can introduce direct taxation within the Province in order to the raising of a revenue for provincial purposes, while the Federation can introduce indirect taxation in order to assure peace, order and good government (POGG). What’s direct taxation? What are the effect within Provinces? The Supreme Court resolved the conflict of power basing its case-law on the Privy Council’s trend. The latter defined the direct taxation as a “a direct tax which is demanded from the very person who it is intended or desired should pay it”. Thus the Supreme Court, in the decision Air Canada v. British Columbia, justified the “gasoline taxes”, introduced by British Columbia with Gasoline Tax Act. “The 1976 Act clearly taxed the ultimate consumer of the gasoline and made no provision for passing it on to others, whatever the opportunities of recouping it by other means. The transaction attracting the tax took place in the province and the purchaser had a sufficient presence in the province to be taxed there. Nothing in the Constitution Act, 1867 requires that the taxpayer must benefit from the tax. A person, a transaction or property in the province may be taxed by the province if taxed directly”. In another important decision the Supreme Court justified a trade tax introduced by Québec. Hogg pointed out that “the courts have said that they are not concerned with whether the tax is in fact recouped by the taxpayer in a particular case[…] What the courts have done is to distinguish between, on the one hand, a tax which is likely to be recouped only because, like other expenses, it is a cost of doing business, and, on the other hand, a tax which is likely to be passed on as an element of the very good or services or transaction which is taxed”.

3. The tax harmonization

The tax system in the Canadian federation is unique in the sense that the provinces have independent access to all the main taxes. They, along with the federal government, have full access to personal and corporate income taxation and sales taxation. For this reason the question of tax harmonization is highly relevant.
Income taxes have been highly harmonized in Canada since the Second World War. The system of income tax harmonization was based on bilateral Tax Collection Agreements (TCAs) between individual provinces and the federal government. The TCAs, went into effect in 1962, reduced conflicts, avoided the double taxation, provided a single administration for the collection of taxes for most of the provinces.

4. Personal Income Tax

The worldwide income of Canadian residents in Canada and on certain types of Canadian-source income gained by non-resident individuals are subject to personal income tax. The amount of income tax that an individual must pay is based on the amount of their taxable income for the tax year. Personal income tax can be raised through: deduction at source, instalment payments, payment on filing, arrears payments.
Basic calculation: each taxpayer has to document the total yearly income. The law decrees deductions, such as deduction for contributions to Registered Retirement Savings Plans, union and professional dues, child care expenses, and business investment losses, on the basis is determined the net income which is used to determine several income-tested social benefits provided by the Federation.
Income not taxed are, among others, gifts and inheritances; lottery winnings; compensation paid by a province or territory to a victim of a criminal act or a motor vehicle accident, war disability pensions; RCMP pensions or compensation paid in respect of injury, disability, or death; provincial child tax credits or benefits and Québec family allowances; working income tax benefit; the Goods and Services Tax or Harmonized Sales Tax credit (GST/HST credit) or Quebec Sales Tax credit.
The federal and provincial governments lay personal income tax. The Federal government fixes the basis and the provinces use it as the base to determine provincial personal income tax. All Provinces participate, except Quebec.

5. Corporate Income Tax

All provinces participate in the TCAs, save Alberta, Ontario and Quebec where the 70 per cent of Canadians live. Not only. They represent the 75 percent of the corporate taxable basis. The Quebec decided not to participate to manage its own fiscal affairs separately from the federal government, while Alberta and Ontario use the corporate tax to influence the pattern of economic activity in the private sector. Also these provinces must comply with the allocation formula to avoid the double taxation.
Corporate taxes include CIT and other taxes and levies paid by corporations to the various levels of Federation. Corporations are subject to tax in Canada on their worldwide income if they are resident in Canada for Canadian tax purposes. Corporations not resident in Canada are subject to Canadian tax on certain types of Canadian source income.
The taxes payable by a Canadian resident corporation may be impacted by the type of corporation. The corporations subject to the payment of corporate taxes are: Canadian-controlled private corporation, private corporation , public corporation.
Corporate income taxes are raised by the CRA for all provinces and territories except Quebec and Alberta which collect their own corporate income taxes. Ontario negotiated TCAs with the federal government. Since 2009, CIT are collected by CRA.

6. Sales tax harmonization

The following three types of sales taxes are levied in Canada: Provincial sales taxes (PST), Goods and Services Tax (GST), the combined Harmonized Sales Tax (HST).
The Provincial Sales Taxes (PST) are collected in Manitoba, Prince Edward Island, Quebec. In these four Provinces the PST (QST in Quebec ) is applied in combination with the Goods and Services Tax, but separately.
The first Province which harmonized the retail sales taxes has been the Quebec, while some other Provinces (Nova Scotia, Brunswick, Newfoundland and Labrador) agreed the Comprehensive Integrated Tax Coordination Agreement (CITCAs). In 1996, Nova Scotia, Brunswick, Newfoundland and Labrador have cooperated with the federal government for implementing a HST, in which they merged their sales taxes. On July 2010, the HST went into effect in Ontario and British Columbia. The HST collected in these five provinces is the result of the combination of PST and GST.
In Newfoundland and Labrador, New Brunswick and Ontario the HST rate is 13%, in Nova Scotia it is 15%, in British Columbia it is 12%.
On January 1, 1991, the Premier Mulroney replaced the Manufacturers’ Sales Tax with the Goods and Services Tax. It’s a multi-level value added tax of 5% collected on the supply of goods or services purchased in Canada, with exceptions. In the case of the “zero-rated” sales the Goods and Services Tax is charged by suppliers at a rate of 0%. By acting this way, the GST is not collected. Basic groceries, prescription drugs, inward/outbound transportation and medical devices are the main example.

7. The spending power

The tax system is decentralized and the principal taxes are harmonized, but it is not true for all Provinces and taxes. Despite the decentralization of functions, the expenses of federal government prevail over provincial and local spending.
The spending power is distributed between Federation and Provinces on the basis of section 91 and 92 of BNA which regulate the division of matters, though the Federation can claim the existence of a national interest to spend in provincial matters. Provinces can also spend in areas reserved to the Federation. Trudeau argued that spending power has a specialized meaning in the Canadian constitutional context. It means "the power of Parliament to make payments to people or institutions or governments for purposes on which it (Parliament) does not necessarily have power to legislate".

The constitutionalists argued that the spending power is rooted in the power of raising money, but Quebec was opposed because by acting this way Federal government would have limited the provincial autonomy.

The federal spending power is not (expressly) provided by Constitution, whereby its legitimacy is based on other powers of the BNA: the section 91 (3) that authorizes the raising money; the section 91 (1A) that gives the legislative power in matter of public property; the section 106 that authorizes the spending power in public services; the POGG clause (peace, order and good government), without forgetting the section 36 of the Constitution Act 1982. The Courts, besides, legitimated the spending power.
Recently, the prevalent Canadian authorities and liberal politicians are considering a potential reform of the fiscal federalism without changing the Constitution, simply by reinforcing the clause provided for by section 94 of British North American Act :
Notwithstanding anything in this Act, the Parliament of Canada may make Provision for the “Uniformity of all or any of the Laws relative to Property and Civil Rights in Ontario, Nova Scotia, and New Brunswick, and of the Procedure of all or any of the Courts in Those Three Provinces, and from and after the passing of any Act in that Behalf the Power of the Parliament of Canada to make Laws in relation to any Matter comprised in any such Act shall, notwithstanding anything in this Act, be unrestricted; but any Act of the Parliament of Canada making Provision for such Uniformity shall not have effect in any Province unless and until it is adopted and enacted as Law by the Legislature thereof.”

The section 94 allows to federal government to make law in matters in which the Provinces have exclusive legislative authority. It refers exclusively to Ontario, Nova Scotia and New Brunswick because when the BNA was enacted these were the only existing Provinces of common law. At the moment the section applies to all Provinces of common law.
According to the section 94, the Parliament may law in “property and civil rights”. This limitation doesn’t have to be deceiving because property and civil rights are the core of provincial competences. The expression derives from Quebec Act of 1774, when the civil law was reintroduced in Quebec on property and civil rights, except for criminal law and foreign trade. Therefore, property and civil rights are all-embracing. According to the section 94, the Federal government can regulate, by law, all matters of provincial competence, but on the condition that all provinces have to be involved in the drafting of the act and have given their consent. The section 94 is an opt-in formula that allows an asymmetric federalism, also available to the initiative of the provinces.

8. The transfers from Federal government to Provinces

The major transfers are: Canada Health Transfer, Canada Social Transfer and Equalization.

In 1966, the Federation enacted the Canada Assistance Plan which had two objectives: to assist the provinces in providing welfare services and social assistance; to ensure services in order to abate, eliminate or prevent the causes and consequences of poverty, child neglect and dependence on public assistance. The Canada Assistance Plan (CAP) was a shared-cost program. In the fiscal year 1995-1996 CAP was replaced by the Canada Health and Social Transfer program.
In 1995, the federal government unilaterally cut the fiscal transfers to Provinces replacing EPF (Established Programs Financing) e CAP (Canada Assistance Plan) with the Canada Health and Social Transfer (CHST). It was a system of block transfer payments to Provinces to meet expenses for health care, post-secondary education and welfare. It was one of the major block transfers.
Health, education and social assistance are all areas of provincial authority. The federal government doesn’t administrate the services in these areas, though the CHST is used to fund them. Not only. The resources transferred to Provinces must be spent exclusively on health, post-secondary education or welfare, unlike equalization payments.
The CHST was similar to EPF, in fact, it was divided in a tax point transfer and a cash transfer. The tax points transfer was still 13.5 tax points on personal income tax (PIT) and one tax point on corporate income tax (CIT). The CHST didn’t revoke Quebec’s special abatement of tax points.
The CHST legislation reduced the health, social and education transfers. The reduction was more reflected in the cash elements, because the tax transfer continued to raise.
The CHST was part of the federal program to reduce and eliminate the deficit.
The Provinces had to reconsider their priorities in order to compensate the reductions in federal entitlements. Most provinces have reduced the level of health care services; some other have de-insured certain services and rationalized hospital services.
Since fiscal year 2004/2005 the Canada Health and Social Transfer has been divided in Canada Health Transfer (CHT) and Canada Social Transfer (CST) to consent greater accountability and transparency for federal health financing.
The Canada Health Transfer is the largest major transfer. The CHT provides funds for health care and sustains the principles of the Canada Health Act: Public administration; Comprehensiveness; Universality; Portability; Accessibility.
The CHT is a block transfer whereby the Provinces must use the funds exclusively for health care.
CHT transfer payments are made on an equal per capita basis. In the fiscal year 2011/2012, will be transferred about $27 billion in cash and $ 13.6 billion will be transferred in tax points.
The Canada Social Transfer is a federal block transfer to Provinces to finance programs of post-secondary education, social assistance and social services, and early childhood development and early learning and childcare.
In the fiscal year 2011/2012, about $11.5 billion in cash and $ 8.3 billion in tax points will be transferred to Provinces and Territories.
The CST is calculated on an equal per capita cash basis to support equally all Canadians.

9. Equalization

Equalization payments are cash payments made in the Federations: federal government transfer money to sub-national governments (Provinces, in Canada). The objective of equalization is contained in the Constitution Act 1982:

"Parliament and the government of Canada are committed to the principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation." (Subsection 36(2) of the Constitution Act, 1982).

The equalization payments are unconditional whereby the Provinces are free to spend the funds, though they use them to finance health care, education and social programs.
The system of equalization was introduced in 1957. The original model had the objective to guarantee each province the same per capita revenue as Ontario and British Columbia (the two wealthiest provinces), in three tax bases: personal income taxes, corporate income taxes and inheritance taxes. In 1962, the Parliament extended the tax base adding the 50 per cent of natural resource revenues. In 1967, the equalization standard was shifted from the standard of the two richest provinces to the national average. In 1982, the latter was replaced with the average of the five representative provinces: British Columbia, Saskatchewan, Manitoba, Ontario, and Quebec. The reason of this changing is related to the concentration of oil production in Alberta. The price of oil was high, whereby Alberta has increased the level of equalization which other provinces were entitled, therefore making them poorer.
In 2004, the federal government and the provincial governments replaced the traditional formula of equalization transfers with the a fixed funding level. For fiscal year 2004–05, the equalization standard is estimated to be $6,126 per capita.
Equalization payments are calculated on the difference between the per capita revenue yield obtained by a province using average tax rates and the national average per capita revenue yield at average tax rates. The current formula in based on: personal income taxes; corporate income taxes; consumption taxes; property taxes and miscellaneous. The aim of the program is to allow all provinces to access to per capita revenues equally. The equalization formula is based on revenues without considering services or the expenditure need of the provinces.
In the fiscal year 2011-2012, the following provinces will receive equalization payments: Quebec ($7.815 billion), Ontario ($2.200 billion), Manitoba ($1.666 billion), New Brunswick ($1.483 billion), Nova Scotia ($1.166 billion), Prince Edward Island ($329 million). Alberta, Saskatchewan, Newfoundland and Labrador, British Columbia will not receive equalization payments in 2011-2012.