Finance Committee on Dec. 7th, 2022

[The Chair, Liberal, Peter Fonseca]

Welcome to meeting number 72 of the House of Commons Standing Committee on Finance. Pursuant to Standing Order 108(2) and the motion adopted by the committee on Monday, June 20, 2022, the committee is meeting to discuss the current state of fiscal federalism in Canada.

Today's meeting is taking place in a hybrid format, pursuant to the House order of June 23, 2022. Members are attending in person in the room and remotely by using the Zoom application.

I'd like to make a few comments for the benefit of witnesses and members.

Please wait until I recognize you by name before speaking. For those participating by video conference, click on the microphone icon to activate your mike and please mute yourself when you are not speaking.

For interpretation for those on Zoom, you have the choice at the bottom of your screen of either THE floor, English or French. For those in the room, you can use the earpiece and select the desired channel.

I remind you that all comments should be addressed through the chair. For members in the room, if you wish to speak, please raise your hand. For members on Zoom, please used the “raise hand” function. The clerk and I will manage the speaking order as best we can. We appreciate your patience and understanding in this regard.

I'd now like to welcome our witnesses. I wish to inform all members that that all witnesses have been tested for today's meeting and have passed the test.

With us today as an individual, we have Daniel Béland, the director of the McGill Institute for the Study of Canada and the James McGill Professor in the department of political science at McGill University. Welcome.

As an individual, we have Lee Soderstrom, a retired professor from McGill University. Welcome, Lee Soderstrom.

From the Office of the Parliamentary Budget Officer, we have the Parliamentary Budget Officer Yves Giroux. With him is Robert Behrend, an adviser-analyst. Welcome.

Witnesses, you now have up to five minutes to make your opening remarks.

We're going to start in the order I introduced you, beginning with Daniel Béland, please.

[Daniel Béland, Director, McGill Institute for the Study of Canada and James McGill Professor, Department of Political Science, McGill University, As an Individual]

Thank you very much.

Thank you for having invited me to come and testify today on the state of fiscal federalism in Canada.

Fiscal federalism is a fundamental aspect of our public policy and our federal system, which is indisputably one of the most decentralized on the planet. The way major federal transfers work, and their level of generosity, are nevertheless sources of considerable controversy across the country.

That's particularly true of the Canada Health Transfer, for which the provinces are demanding immediate increases, and the equalization program, which is being challenged politically, particularly by certain provincial governments that are not currently receiving equalization payments. If the provinces agree on the need to significantly increase the Canada Health Transfer, the disparities will further divide provincial premiers.

In spite of its sometimes controversial nature, equalization is needed in any country that has major economic disparities. That's why subsection 36(2) of the Constitution Act, 1982, proclaims the following:

(2) 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.

This imperative still applies today and equalization is therefore good. More generally, beyond equalization, the Government of Canada's fiscal transfers to the provinces and territories remain one of the pillars of our federal system, which could not work without them. This fiscal role of the Canadian government in our federal system is part of what makes the decentralization of many public services throughout the country possible. That is certainly the case for the equalization program. Without it, we might have a federation that is more centralized than it is today, and I believe it is important to pointing this out.

Moving forward, we must pay constant attention to the architecture of fiscal federalism and the need to adapt federal transfers to changing economic and fiscal circumstances. Fiscal federalism should be updated on a regular basis, even if the proposed changes are potentially controversial. Without constant adaptation, fiscal federalism is likely to fall victim to what a Yale political scientist, Jacob Hacker, calls “policy drift”, a logic according to which the failure to reform public policies might render them less effective over time.

To avoid policy drift in fiscal federalism, we should look for new ideas about how to improve the system. For instance, in a working paper published a year ago, University of Calgary economist Trevor Tombe and I outlined in “Three Policy Pathways for Federal Health-Care Funding in Canada” that there are alternatives to the status quo, namely demographic adjustments to the Canada health transfer and the possible advent of a new form of fiscal governance in Canada.

I think it's important to really think about how we could reform the system. Incrementalism is not necessarily a bad thing; it's a prudent thing, but sometimes we need to think outside the box and discuss broad options beyond the status quo.

Regarding equalization, the Government of Canada should create a new expert panel similar to the 2005-06 expert panel on equalization and territorial formula financing. Chaired by Alberta-based economist Al O'Brien, it submitted its report back in May 2006. These recommendations were implemented the following year.

Of course, a lot has changed since the equalization program was adopted in 2007, and there were also other changes to equalization in 2009. I think this is in part because we have changing circumstances, for example, the fact that the fiscal capacity of provinces, the gap among the provinces, has declined, especially since 2014. The landscape has evolved, and we need to re-assess the equalization formula and, frankly, re-assess fiscal federalism more generally.

In the longer term, the Government of Canada should explore the possibility of creating a permanent expert body that could provide regular advice to the federal government in the field of fiscal federalism. Such a permanent body already exists in other federal countries like Australia with its Commonwealth Grants Commission, which has existed since 1933, and could help lower the political temperature over equalization and other federal transfers, even if the allocation of fiscal resources will always remain contentious. There's nothing more political than money and the allocation of money in the federal system.

Regardless of who will be tasked with advising the Government of Canada over changes necessary to avoid policy drift and adapt our fiscal federalism system, we must look at the big picture beyond just individual transfers. For example, the interaction among equalization and the Canada social transfer and the Canada health transfer is really relevant. If we want to introduce changes in one transfer, we have to take into account what's happening in the two main transfers.

Thinking about reforming fiscal federalism—

[The Chair, Liberal, Peter Fonseca]

Professor Béland, could start to wrap up, please? We are well over time.

[Daniel Béland]

I'm wrapping up. This is the last paragraph.

[The Chair, Liberal, Peter Fonseca]

Thank you.

[Daniel Béland]

Thank you.

It should also entail a broader discussion about fiscal capacity, the state of our economy, population aging, regional disparities and other key factors that affect the availability of fiscal resources and the varying capacity of provinces and territories.

I would like to end by telling you about the forthcoming paper of the fiscal federalism policy network that is titled “The Road Ahead: Rethinking Fiscal Federalism for the 21st Century”, which looks at the big picture of our three main transfers and other aspects of fiscal federalism in Canada. The report will appear next month with the support of the IRPP and the Canada West Foundation. As soon as it appears, I will send you a copy of that report.

Thank you very much for your attention.

[The Chair, Liberal, Peter Fonseca]

Thank you, Professor Béland.

Now we'll hear from Professor Soderstrom for five minutes, please.

[Lee Soderstrom, Professor (retired), McGill University, As an Individual]

I'm going to talk a little bit about an aspect of fiscal federalism that is marked by much controversy these days, which is [Inaudible—Editor] health care.

Numerous provincial leaders in recent years have claimed that Ottawa has greatly reduced its cost-sharing for provincial health care. They claim that Ottawa currently pays only 21% of provincial costs, so they demand that federal transfers increase to 35%. As I will explain shortly, the provinces are wrong. Federal cost-sharing has not been reduced.

The extent of cost-sharing now is the same as it was in the mid-1970s. It's about 35% of provincial spending. The provinces err because they only consider the amount of cash that Ottawa gives them each year. They ignore the substantial cash value of the tax points Ottawa gave them in 1977.

I am familiar with change in federal cost-sharing. I was a health economist at McGill University for 40 years, beginning in 1968. When the changes in cost-sharing arrangements were negotiated in 1976, I was writing my book, The Canadian Health System, and following the negotiations very closely.

Additional funding for health care may well be justified now, but federal-provincial negotiations to decide amounts and modalities should be based on careful analysis, unhampered by erroneous provincial claims.

New spending will probably require additional funding from both levels of government. The provinces have not acknowledged this. They want Ottawa to foot the bill.

To understand why the provincial claims are wrong, one must be familiar with the changes in cost-sharing arrangements made in 1977. Prior to that year, federal cost-sharing was only for hospital and physician services. In 1976, for example, Ottawa paid 46% of provincial costs for these two services. Its payments were equivalent to 36% of total provincial spending.

Moreover, before 1977, federal transfers were composed entirely of cash. In 1977, Ottawa and the provinces agreed to reduce these cash payments and, by way of compensation, to transfer some federal tax points to the provinces. That is, Ottawa reduced its income tax rates, allowing the provinces to raise theirs. Thus, since 1977, federal cost-sharing, if properly measured, has had two parts, which are the cash payments and the increased provincial tax revenue from the transferred tax points. The provinces err because they consider only the first part—the cash payments.

Calculations I made several years ago show they are making a major mistake because the value of these tax points has been substantial. In 2005, 2006 and 2007, cash payments alone were 22% of provincial health spending, but when the value of the tax points is included, total cost-sharing was 34% of provincial spending. That's essentially the same as in 1976.

More recently, David Naylor, an important Canadian health care researcher and former president of the University of Toronto—and two co-authors—found that the same thing prevailed in 2019. The total federal transfers that year were 35% of total provincial spending on health care. Again, that is essentially the same as in 1976.

Thus, contrary to the provincial claims, Ottawa has not reduced its cost-sharing for health care. The provinces should stop making those claims. Although additional health care funding may well be justified, the necessary federal-provincial negotiations should be based on careful analysis, not hampered by erroneous provincial claims.

[The Chair, Liberal, Peter Fonseca]

Have you concluded, Professor Soderstrom?

[Lee Soderstrom]

Yes.

[The Chair, Liberal, Peter Fonseca]

Thank you very much.

We now go to the Office of the Parliamentary Budget Officer.

Mr. Giroux, please, for five minutes.

[Yves Giroux, Parliamentary Budget Officer, Office of the Parliamentary Budget Officer]

Mr. Chair and committee members, thank you for having invited us to appear before you today. We are pleased to be here to discuss our analysis related to your study on the current state of fiscal federalism in Canada. I'm here today with Mr. Robert Behrend, Advisor-Analyst in my office.

The act gives the parliamentary budget officer a mandate to provide impartial, independent analysis to help parliamentarians fulfil their constitutional role, which consists of holding the government accountable. In accordance with this mandate, my office has published reports on major federal transfers and the long-term sustainability of the different levels of government.

In September 2020, we published a report entitled "Federal Support through Major Transfers to Provincial and Territorial Governments'". This report examines federal support through major transfers to provincial and territorial governments from 2008-09 to 2018-19.

More recently, in July 2022, we published our annual “Fiscal Sustainability Report”, which provides an assessment of the sustainability of government finances over the long term for the federal government, subnational governments and public pension plans, including an analysis of our long-term projections for major federal transfers to other levels of government.

Additionally, our “Economic and Fiscal Outlook” in October 2022 presents our current projections for the Canada health transfer, the Canada social transfer and the equalization programs.

Robert and I will be pleased to respond to any questions you may have regarding our analysis of the major federal transfer programs or other PBO work.

Thank you.

[The Chair, Liberal, Peter Fonseca]

Thank you, Mr. Giroux.

We are now, members and witnesses, moving to questions.

In our first round, each party will have up to six minutes to ask questions.

Starting with the Conservatives, I have MP Morantz up for the first six minutes, please.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

Thank you, Mr. Chair. I want to thank all of our witnesses for being here today for this extremely important study.

I just got back on the finance committee so I wasn't involved in the earlier portions of the study and I'm playing a little bit of catch-up.

I have some fairly basic questions. My first question really has to do with the equalization transfer and the principle around it. I think I'll start with the Parliamentary Budget Officer on this one, and if anyone else wants to weigh in, they can.

The basic principle is something like this, that the equalization transfer is to allow for similar standards of social services across all provinces and territories at similar levels of taxation.

Is that more or less correct?

[Yves Giroux]

Yes, that's accurate.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

How has that worked out? Is it happening? Are there similar levels of services for various social enterprises across the country? Do we have any studies or data that could substantiate that the principle of equalization has actually taken effect?

[Yves Giroux]

There have been some studies, notably, regarding the divergence of per capita GDP across provinces over time. We did that in our reports—I think the 2020 report—and looked at the convergence of per capita GDP across provinces. In that report we found that over the last 10 to 12 years, there seems to have been a trend towards convergence of per capita GDP across provinces.

GDP is one measure through which we can measure whether economic disparities persist or are getting smaller over time.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

I'm more after something a little bit different. Years ago, my younger son was diagnosed with autism and it was quite severe. I was involved in lobbying the provincial government for better autism therapy services and we were successful: Manitoba ended up having a gold standard in autism therapy. It was called the ABA, the applied behaviour analysis program in Manitoba.

What I found out through that autism journey was that some provinces had no such services. We have friends in Nova Scotia who have children with autism and they ended up moving to Manitoba because of the program we have there.

It's that kind of detail that I'm wondering about. It seems to me that if millions of dollars are going across the country to different jurisdictions, citizens of Canada should deserve similar services at a more granular level—not looking at the metrics you necessarily talked about but actual programs. I'm just wondering if anyone's had a look at that or if it's something that needs to be explored.

[Yves Giroux]

To my knowledge, no. However, what the legislation says on equalization, notably, is that it provides funding to provinces to allow them to provide comparable services—not identical or perfectly identical services—across jurisdictions at comparable levels of taxation.

It means that provinces have the freedom to adjust their basket of services and to adjust their taxation accordingly.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

With regard to the sustainability report, how sustainable are...?

Your report was back in the spring, but given the fall economic statement, the $52 billion in spending and interest rates having gone up—I think, since the time you did your report, from a 0.25% overnight rate to now 4.25, and 500 basis points just today—does your perspective of the sustainability of government finances over the long term still hold, or are you re-evaluating that opinion?

[Yves Giroux]

As you pointed out, there are various events that take place in between our reports. That's why we undertake updating it every year. It's to take into consideration the various factors that come into play, such as an increase in interest rates and additional, potentially permanent government spending.

It would be difficult for me to assess how recent changes in policy and economic conditions have positively or negatively affected the overall fiscal sustainability without doing a full analysis.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

We will wait for that update then.

In the report, you note that slower economic growth will put upward pressure on government programs such as health care, OAS and pension benefits, and that fiscal policy changes might be necessary to avoid unsustainable government debt. Your report said that the government could increase spending or cut taxes by $45 billion at the time.

Based on those changes.... I realize you have answered the question already, but I'm still curious about it. The goal of the Bank of Canada in increasing these interest rates is essentially to slow the rate of economic growth in order to bring demand down. If they are successful, it should mean that there's going to be upward pressure on these programs.

Do you agree with that perspective?

[Yves Giroux]

The goal of the Bank of Canada in its recent monetary policy actions is to slow economic growth in the short term to ensure that inflation does not become a burden in the medium and longer term.

While the recent rate increases by the Bank will slow economic growth in the short term, the goal, ultimately, is to ensure that the economy can operate better without the burden of inflation weighing on economic growth.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

Thank you.

I have more questions. Maybe we will get to them—

[The Chair, Liberal, Peter Fonseca]

Thank you, MP Morantz.

Now we'll go to the Liberals and MP MacDonald, please, for six minutes.