Canada's federal transfer payment system badly needs a tune-up

Federal transfer payments are at the heart of the Canadian federation. They ensure critical public services are equitably funded right across the country and account for roughly one-fifth of total provincial revenues. For lower-income provinces, they rise to as high as one-third of the total.

While reaching agreements and enacting reforms is never easy — as recent federal-provincial wrangling over health transfers demonstrates — kicking the can down the road is no way forward.

But that’s precisely what the federal government has been doing — missing opportunities to seriously explore reforming the federal transfer payments system.

Recent reports suggest that the federal government quietly extended the current equalization formula first adopted 15 years ago until 2029. This is yet another example of the failure of the government to seriously examine whether our system of federal transfers needs a tune-up in the face of growing challenges.

Multiple strains

Many of these challenges — especially an aging population, mounting health-care pressures, climate change, economic uncertainty and energy transitions — are already having an effect on government finances in Canada.

They will only become significantly more pressing over time. Local governments are playing an increasing role in delivering services and infrastructure but with limited resources. They should be incorporated more fully in the conversation about the future of fiscal federalism.

That’s because getting reform right is critical.

To appreciate this, consider the challenge posed by an aging population alone. Statistics Canada projects the share of Canadians over 65 will increase from less than one-fifth today to nearly one-quarter by 2050.

Health-care spending could rise by the equivalent of roughly three per cent of GDP. For context, if funded entirely from tax increases, that would require increasing the GST by approximately 10 percentage points.

With the share of Canada’s population participating in the labour force falling rapidly, the implications for economic growth and the potential for even wider fiscal inequalities among provinces are no less dramatic. Overcoming this will involve all levels of government in Canada.

Concerns about fairness

An issue that hits closer to home for some Canadians is that of perceived fairness.

A striking example of grievances about the fairness of fiscal federalism is the debate about the federal equalization program, which has faced criticism from wealthier provinces since its inception in 1957. Those criticisms are especially prominent in Alberta today.

In the lead-up to the upcoming Alberta election on May 29, Alberta is strongly expressing its concern that the federal government extended the formula another five years. It offered a detailed suggestion for reform.

Modernizing our fiscal arrangements is necessary to overcome some of these considerable challenges. Our governments should be willing to have important conversations on this issue.

To be sure, the latest federal budget made some adjustments. It detailed more than $46 billion in boosted federal health transfers to provinces and territories.

Much of this is allocated equally across provinces, according to their population. Some, however, is allocated as fixed payments independent of how large a province is. This provides considerably more support to smaller provinces that face disproportionate challenges from the aging population.

But much more is needed in many other areas, and all governments must work together.

This is especially true for challenges that transcend the ability of any individual government to address, many of which — like climate change — are becoming more significant by the day.

These issues will place a lot of strain on Canada’s highly decentralized system of government. Who should do what, and who should pay for what, are central questions that we need to get right and that we need to adapt when necessary.

Details and trade-offs

A list of specific reforms that Canada should adopt would be helpful, but it isn’t obvious what those are.

From changes to equalization to tax point transfers, health-care funding, municipal infrastructure support and a more fundamental rethinking of the system of fiscal federalism that we have today, there are many details to work out and trade-offs to consider.

Historically, mounting pressure led governments to pursue deep dives into our fiscal systems and enact evidence-based reforms. From the Rowell-Sirois Commission in the late 1930s to the 2006 O’Brien Report on equalization, this has been a common approach.

Canada’s intergovernmental and fiscal arrangements have confronted and successfully overcome unique social, political, economic and fiscal pressures over more than 150 years. Today, governments can work together with academics, practitioners and indeed all Canadians to do just that once again.

Avoiding the challenges won’t make them go away.