Canada's System of Revenue Sharing
Mason Gaffney
[An extended excerpt from a speech delivered in Canada. Reprinted
from
Good Government, December, 1986]
It seems to me therefore that we need to face up to the question that
is known in my trade as Fiscal Federalism, that is, how is money going
to be distributed by the federal government out of its so-called
surplus, either to people or the States, or localities? When we look
at this issue, which is definitely a Georgist issue, we'll find
interestingly enough that a lot of economists have gotten there first.
Many of these are Canadian economists, and without exception they talk
about rent. They talk about rich provinces and poor
provinces., and the rich provinces are those that have resource rents.
And when they say rent they are not talking about Frank Sinatra's
voice, or Bridget Bardot's figure. They're talking about the income of
natural resources. Now it's not just a question of distribution here
but a whole question of whether a growth oriented policy will sell at
the local level.
The reason it's so hard to sell growth policies at the local level
today in the United States is very much due to the fact that the
United States federal government taxes people and it gives subventions
to landlords. So the landlords can get the subventions without having
the people. So who needs people? That's it in a nutshell. We need to
reverse that, I think, if we're going to be able to make Georgism work
at the local level.
Cannan's Law
The last time I discussed this subject was in Las Vegas before a tax
group. I started out by saying 'I hope there are no Canadians here!'
It would be vain to say that to this group, so I'll say I hope there
are no sober Canadians here, at least none who possess a high degree
of expertise on this subject, because I may have to skip over some of
the high spots. I lay some claim to being Canadian myself, I should
say. I have two children who have dual citizenship because they
originated in Canada, or possibly three children depending on where
you stand on the right-to-life controversy. But at any rate I would
like to emphasise that the Canadian system of revenue distribution,
fiscal sharing, or equalisation as we call it in Canada, is much more
based on correct principle than the one you find in the United States.
By 'correct principles' I mean the ones I just enunciated.
At any rate, let's begin by looking at the similarities between the
federal systems in the United States and Canada. In both countries we
find something called 'vertical balancing' which means that the senior
governments send money to the junior governments. We find also
something called 'horizontal balancing' which means that the payments
are made more to the poorer governments, those that are poorer on a
per capita basis, than to richer ones. We have the principle that the
Crown may not tax the Crown. We've an economic principle, which I'll
call Cannan's Law. The cannan here is not a weapon, but an economist
of very little note, Edwin Cannan, who however did make one very
important point. He made it in the period when the single tax in
England was on everyone's lips. And if you read the
Economic Journal, the stuffy, establishmentarian journal of
the economics profession, it's full of criticisms of the Single Tax.
No respectable English economist could fail to write at least one
article criticising the Single Tax. And Edwin Cannan criticised it in
the following way. He said, in effect, local taxation of land makes
private land an open range. His idea was something like Garret
Hardin's idea of the 'tragedy of the commons'. Or I should put it the
other way around because Hardin came later and he obviously borrowed
from those who wrote earlier. But the general idea is, you may think
you have tenure control of land but if the municipal government can
tax that land and use that money to finance public welfare services,
public education and other things that are open to all comers, then
you will end up with an uneconomical distribution of population.
You'll have more people clustered around the honey pot in places like
Vancouver where there's a lot of economic rent per capita than you
will in areas with less economic rent per capita.
So we found in the mining country of Northern Minnesota back in the
days when iron ore was worth something. They had the best schools in
the mid-west there at the iron mines and all those Finnish miners'
kids got first rate educations. You run into them everywhere now:
they've become an awful nuisance -- very well educated though.
All this tends to distort the economical allocation of population and
also to reduce the incentive of local government to provide public
services that are open to all comers. That I refer to as Cannan' s
Law. And you find that, of course, in all countries. It's an economic
law.
Hammer's Law
At the same time, in both countries you find something I will call
Hammer's Law. This is not a carpenter's tool but again the name of a
man, an economist in Missouri, who observed in 1935 that if you
compared population to land values in the different counties of his
State (in the very poor counties of the Ozarks the land was hard
scrabble land of very little value, with the very rich lands in the
north-western part of the State, which resembles Iowa) you found that
the population density was much greater on the very poor land of the
Ozarks than it was on the very rich land of the northwest. He took
this to be a sign of market failure. Three years later the
Establishment got to him and he said, well maybe I can rationalise
this after all. But actually it's the American counterpart of the
familiar pattern in the less developed countries where the flat land,
the good flat land, is used for grazing cattle at a very low level of
productivity, and the mass of the people in their minafundia are found
on the hard scrabble land on the steep hill sides. I call it Hammer's
Law of Market Failure where, because of the operation of the land
market, whose evils we are so familiar with, you do not get the
population distributed over the land in an economically rational
manner, because of the tendency of the better land to be agglomerated
into large holdings which are not optimumly developed. Comparing
States, this results in the fact that a poor State like West Virginia
has large numbers of people living on very poor land, and a wealthy
State like Iowa (speaking now just of farming) has a small number of
people on very good land. And this results in inter-jurisdictional
equalisation problems. In Canada this takes the form of the Maritime
provinces in the east being densely populated like the Ozarks and the
wealthier, in a sense, western provinces being underpopulated.
Now another similarity to the two countries us that the subventions
that do go from the federal government to the provinces in Canada (and
you find a similar thing in the United States) do not come form the
richer provinces. They come instead from the general fund, the general
taxpayer. There is in other words more vertical balancing than there
is horizontal balancing (horizontal balancing you remember means
equalization among the different jurisdictions). It's a little like
what somebody said about foreign aid. 'Foreign aid is a device by
which poor people in rich countries are taxed to subsidize rich people
in poor countries.'
We'll see that equalisation in most countries works something like
that; that is, in addition to this inter-provincial equalisation,
there's a tax shift involved where local sources of taxation like the
property tax are being displaced by the federal income tax. I suppose
Ferdinand Marcos would be a splendid example of the kind of person I
was talking about in the poor country and in West Virginia you have
all these coal companies whose owners live in Palm Beach, whose
shareholders live in Palm Beach and such places, who benefit from an
inter-state equalisation that benefits West Virginia. Well these are
similarities. Now differences.
Amount of Equalization
I learned that if you want to get along in this country you have to
emphasise the differences. If there's anything a Canadian fears, it's
not the hostility of the United States, it's the embrace. When
Canadians say 'Vive la difference' they are not being male
chauvinists, just regular chauvinists. So, let's look at the
differences.
The federal aid in Canada goes to provinces, whereas in the United
States it goes to specific cities, The U.S. Congressman likes to have
his fingerprint, as they say, on every dollar that goes from
Washington. The Canadian provinces are much larger and stronger, and
fewer than the American States. There is much more horizontal
balancing among provinces in Canada than there is among States in the
United States. The Maritimes for instance get about 50% of their
provincial revenues from equalisation entitlements. Fifty percent.
Nothing in the United States matches that. In fact, if you look at the
U.S. Constitution, it's quite specifically planned to prevent that
sort of thing. Equalisation is not what the Founding Fathers had in
mind. On the contrary, there is a provision which you may be familiar
with which says that direct taxes will be apportioned among the States
according to their respective populations. So in the States the idea
has been: Tax the States according to their population and then give
the money back according to political power. In the United States
Senate it means that the smallest State has just as much clout as the
biggest State or would have if their senators weren't so merchantable.
(I mean, in California when we need something we just look to Nevada
or one of those places for a Senator who is having difficulty raising
funds for his next election. But that's another story.)
Another difference is that the Crown provincial owns a very large
share of the public domain, especially in the western provinces. I
wouldn't want to overstate that difference. Alaska after all owns
Prudhoe Bay and California owns three miles offshore -- that includes
the Wilmington Basin off Long Beach. You get a lot of State revenue
from those things. But it doesn't really compare with 94% of British
Columbia being owned by the Crown provincial. That makes a difference.
We'll see that part of the game in Canada is the effort on the federal
government to prevent the provinces from fully extracting that
economic rent from their Crown lands for public purposes.
Surpluses
Another difference is that Canadians are much more restrained and
self-controlled than Americans, and therefore they've managed to build
up enormous surpluses. There's something called the Alberta Heritage
Fund, where instead of just blowing that money as it came in, they
squirreled it away and saved it up and it's now considered I believe
the largest single block of available capital in North America: $6-10
billion (I lost sight of the figures somewhere as they were going up).
But can imagine Howard Jarvis in Alberta with his beady eyes on the
Alberta Heritage Fund? Why, when we built up a surplus of just a few
million dollars in Sacramento Howard Jarvis climbed all over
everybody, 'We've got to cut taxes.' And that's when we got
'Proposition 13'. Saskatchewan has a Heritage Fund too, quite modest
compared with Alberta's, but worth mentioning.
Shared Rent
But the most delightful distinction about Canadians is the strong and
explicit recognition among almost everyone, even if he's an economist,
who discusses this subject, that different resource endowments are the
basis of inter-provincial differences. Equalisation in Canadian
politics means sharing the economic rent. Everybody talks that way.
Canadian economists even when they come to the States talk that way.
Just as though rent were a permissible word in polite discourse. It's
very refreshing. However there's a very selective attitude towards
rennet - towards what rents are shareable, I should say. Rents from
oil and gas are fair game. Forest revenues are fair game. Mineral
revenues of other kinds are fair game. Water power is fair game. But
now how about the rents that are generated by the valuable lands of
Montreal, or Toronto, or some of those other big and powerful cities
in the east? They are not fair game. As a matter of fact, if you pore
through the fine print of the equalization law, which I did on the
airplane, you find the most interesting exception to what's included
in the formula. I'll explain the formula to you in a moment if you are
still awake.
The formula says that the greater the capacity to raise taxes that a
provine enjoys, the less will be its equalization payment. And various
potential tax bases are included in this formula. And one of those is
the property tax. But then you look at the fine print and only the
improvements are included. The land is specifically excluded. Very
pecular. In the formula as it's commonly printed you don't see that
exclusion; it's only in the footnote. But in the footnote it says
'Instead of the value of land we will substitute the gross provincial
product.' Of course, all right thinking people know that land value is
in direct proportion to the growth of the provincial product. Or do
they? I always thought that was the product of
other inputs. What it means is that if a province has a great
deal of valuable land which is not being used to a highest and best
use, that valuable land will not be included in its potential tax
base, and it can continue to get subventions from the federal
government. Whereas on the other hand if its potential tax base
includes oil and gas, then the revenues that it receives from that, or
the ability it has to receive revenues from that, is counted against
it in the sharing formula. So this is a very peculiar sort of rent
sharing. Some rents are shared and others are not. You might even call
it a conspiracy against Alberta. I'm sure that's the way they look at
it.
Now another difference is the high degree of foreign ownership.
Actually there's no higher degree of absentee ownership in Canada than
there is in the United States but it is much more visible because it's
international absentee ownership, whereas our absentee owners live in
some other corner of the United States, at least some of them do, or
in Canada -- we have quite a few of them. Of course Hong Kong,
Belgium, you name it. This high degree of absentee ownership, as Bob
Williams more than hinted this morning, is one of the reasons for the
success of the populist parties. They recognise property ownership is
an alien phenomenon in some considerable measure and therefore a
legitimate target for attack. Some economists say that the ideal
taxpayer is a non-resident alien. In the case of these foreign owned
resources you're getting pretty close.
Sharing Formula
Now another thing about Canada is that it is a net exporter of these
resources which are being shared and, because of this, price control
is a major mechanism for sharing the rents. In short, the price of
Alberta oil is being held down below free market levels and thus that
economic rent, in part, is being shared with the consumers in the
eastern part of the country. This works out well, coupled with a
phenomenon that might be called negative dumping. (Dumping is when you
sell things overseas for less than you sell them at home.) Canada is
more rational, they sell them for more, especially in the United
States. They even have export duty on oil. Of course if United States
puts an import duty on, that's not fair.
Another characteristic is eastern population dominance. Alberta and
British Columbia have the resources of Texas and California, without
the votes, which makes them more vulnerable of course.
Now let's look at the sharing formula. The sharing formula in Canada
is essentially based on population and potential tax base. And it can
be made to look very complicated but I think I've boiled it down to
its essence. You take a province's percentage of the population of
Canada, and then you take the percentage of the tax base that it has,
subtract that and that gives you another percentage. And then you
multiply that times the total tax revenue that's collected throughout
Canada from that tax source, and then you pay them that amount out of
the provincial treasury.
Let's give an example here. Let's say Alberta has what, 7% of the
population (don't make a liar out of me now for a percentage point) --
this is only for illustration. Say it has 7% of the population and it
has 85% of the oil and gas base. Well, you subtract 85% from 7%, you
get 78%, minus 78%. Very important, minus 78%. And then you multiply
that times the total amount of money that's collected by all the
provinces from oil and gas, and well, what that means in effect is
that Alberta doesn't get any money from the federal government. Now if
it had worked out the other way, Say Prince Edward Island, and again
these are hypothetical figures, (although I've got the real figures in
here, but you don't want me to take the time to look them up), say
it's got 8% of the population and 4% of the tax base, Then you
subtract the 4 from the 8 and you get 4% and you multiply that times
all the money that's collected from this tax base, and hypothetically
say we're talking about oil and gas. Then 4% of that tax base is paid
from Ottawa to Prince Edward Island to help them run their government.
That is basically the equalisation formula. But you do it tax by tax,
then you add them all up.
Now the way this works is: Prince Edward Island gets paid some money
because their equalisation number came up positive But if it comes out
negative, as in the case of Alberta, that doesn't mean that they have
to pay any money to Ottawa. It's strictly a one-way street. So who
does pay this? Well, it's the general taxpayer. And that's what I
meant of course when I said that this is a system where poor people in
rich provinces subsidise rich people in poor provinces. But let me get
back to that in a moment. Now it helps us understand this if we look
at the impact of the oil price revolution on this formula because it
was originally set up before the oil price revolution. And then when
that occurred it naturally change the quantities.
Actually the difference in per capita income is not very great,
personal income that is, as reported for tax purposes. The difference
between Alberta and almost any other province in terms of oil revenues
per capita is extremely great. So that1s where most of the
inter-provincial differences come from, and therefore that's what
triggers off most of the payments.
When the oil price revolution came it meant of course the oil rich
provinces got a lot more money out of oil. The royalties went up.
Leasehold sales brought more money, there was more profit from Crown
corporations, which is a form of royalty as Bob Williams explained
this morning. They also levy taxes on the industries in the normal
way. All this increased the payments that were due to the have-not
provinces, without increasing the contributions from the have
provinces. Because, remember, this thing just works in one way. So the
median taxpayer in Ontario got soaked because he, and median taxpayers
everywhere who paid the federal tax bills, were called upon to
increase their payments to the federal govemment so that the federal
government could pay more money to the poor provinces.
Royalties
The next episode in this drama might be called 'the Empire strikes
back', with John Turner as Darth Vader. This was back in '74 or so. He
said, since these pesky western provinces are collecting so much
economic rent from their Crown lands by raising their royalties and
going up with the market, what we are now going to do is to fool hem.
We are going to say that these royalties are not deductibles for
federal income tax purposes. And since all the provincial income taxes
are piggybacked on to the federal tax, or most of them, that also went
for provincial income tax purposes. Thus in effect the provinces were
penalised for this effort to collect economic rent at the provincial
1evel. This had two objectives. The good reason and the obvious reason
was to protect the federal revenues. But the subtler one, I think, was
one of protecting the major rent barons by assuring that the provinces
would not get carried away with raising their royalties. In effect,
the provincial governments were being penalised by the federal
government for raising royalties. And although in the short run this
obviously damaged the lessees and they screamed bloody murder in the
not so long run it forced the provinces to back off on their royalties
and it certainly forced them to sell their leaseholds for lower prices
in he future. Those that hadn't yet been sold because the anticipation
that the roya1ties would not be deductible. So as it was viewed in the
western provinces, and I think correctly, this was an attempt on the
part of the government in Ottawa to protect the absentee owners of
western resources from provincial populism.
It must not be forgotten that John Turner got his training with the
Bechtel Corporation, just like George Schultz, or perhaps with him.
It was at this time I think that the profit made by the British
Columbia Petroleum Corporation that exported gas and extracted
economic rent on the pipeline -- that was recognised as a royalty and
was not deductible. Price control of oil was made very stringent and
the export tax on oil was imposed at a high level. Well, in that
wonderful Canadian way, there was a compromise. There's always a
compromise. The compromise here that affected Alberta especially was
that the weight of oil in the equalisation formula was reduced in that
the only revenues that were counted in the fomula were revenues that
were taken for current use, and when they put money into the Alberta
Heritage Fund that wasn't counted. And that I suppose helps account
for the build up of the Heritage Fund.
The conclusion of all this is that the Canadian system is really
better in terms of its Georgist implications because the payments to
the provinces, with all the faults that I've described, are
essentially based on population. Population is in the formula. And if
you compare this with the way things are done in the States,
population plays a very minor role in the formula for equalisation
payments in the United States.
What To Do
Now, how should it be done? Well, there's a well known Georgist
economist who figured this out a long time ago and wrote an article
about it. His name is Colin Clark. There are two Cohn Clarks extant.
There's one in Vancouver, who is a Marxist mathematician turned
resource economist, who's written some very interesting things, and I
wouldn't criticise him for the world, especially if he's here. But
he's not the one I'm referring to. The other one was a premature
Arthur Laffer who wrote about 20 years ago that once a government took
25% of GNP, that was an upper limit on taxation. And he made a great
name for himself writing that, and it's probably not true but that's
how he became famous. But aside from becoming famous, he's a very good
Georgist economist. He came up with a plan for collecting economic
rent at the federal level, and he said what we really should do, and
this I think is the ultimate equalisation payment, is we should
classify local jurisdictions according to land value per capita, and
those that have the least land value per capita, we'll leave all of
that land value for them to use for local purposes. But then we will
graduate the federal land tax according to the amount of land value
per capita in the jurisdiction, and thus we will have a federal tax
that automatically achieves inter-regional equity, without all this
razzmatazz that I've been describing about inter-regional equalisation
payments.
|