Fiscal federalism: principles, evidence from Canada and elsewhere and a proposal for Scotland SPIF, Edinburgh, October 2008 François Vaillancourt Economics, Université de Montréal 1

Principles Number of sub-national entities(SNEs)/ borders/size Responsibilities of central and SNEs Financing of central and SNEs – Share of own and transfered revenues – Type of own revenues – Type of transfers – Borrowing authority 2

Numbers/ borders/ size Great variability by federation driven by origin of federation with borders historical/drawn Issues of relative power ;depends on representation at center mechanism and on degree of autonomy 3

Responsibilities Subsidiarity principle – Economies of scale (broadcasting) and externalities (pollution, mobile labour force)=>central G – Differences in consumption patterns (taste,climate,geography) based on regional divisions=>SNEs 4

Financing SNEs marginal revenue source should be own source; rate freedom/ base can be national/ collection? SNES taxes should be on less mobile bases: labour as opposed to capital Natural resource revenues at centre for sharing Transfer design depends on importance of national goals and degree of solidarity 5

Number/size of entities – USA 50 mean pop historical+federal lands – Switzerland 26 mean pop historical+ linguistic(Jura) – Canada 10(+3) mean pop historical+ linguistic – Belgium 3+3mean pop layered system region+language – Spain: 17(+2) mean pop province originated 6

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Responsibilties Similar in the five countries (4 federations). Central has foreign affairs,defence,money and banking some transportation and some or all transfers to individuals SNEs have education, health(less in USA- Medicare), local issues 8

Canada:% are for own revenues; % spending Fed 9

Who does what 10

Financing-Own Differences appear here Ca, USA and Sw have SNEs with full range of taxation powers :base setting, rate setting and collection for major taxes: PIT,CIT G&S Be and Es have some own source revenues and limited powers on rates for PIT and do not exercise them 11

Financing transfers Important differences here – Canada equalisation of resources not needs and population based with few conditions for transfers; laid back federalism – USA no equalisation and many conditional transfers; meddling federalism – Sw ; equalisation of resources and needs and targeted transfers + other(central bank); – Be and Es equalisation+ others 12

Canada; revenue sources are as follows 13

Canada Federal transfers Small (specific historic) transfers of 50/ 50 type: offical languages, legal aid, social housing… Since 1900 mainly 50/50 funding Equalisation starts in 1957 to facilitate tax autonomy of provinces Health Social and post secondary education start in the period. Move from 50/50 funding to block grants in 1977 with various configurations. Population based 14

Equalisation-funded by Gross equalisation funded from general federal revenues No provincial contributions No access by federal government to resource royalties-provincial revenues Three year moving average lagged 2 years 10 province standard /NO expenditure needs 15

Equalisation-given out as Representative tax system approach: differences in tax capacity measured at national rate per capita=> Total accross recipients=>total payment by federal government Five broad bases used (50% of natural resources) Fiscal capacity cap; any recipient< poorest non recipient 16

Issues Differences in taxation with Alberta lower(flat 10% PIT) creates tax competition and capitalisation in housing prices Disparities due to oil/ gas prices =>creates tensions between have / have not provinces in attracting public sector(health) employees increases equalisation payments funded by federal revenues not from these resources but from Ontario 17

Issues-2 Asymetric treatment of Québec small de jure and large de facto ( social security, immigrant selection, parental leave) thus West Lothian asymetry is accepted; Provincial PIT is collected by federal 9/10,CIT 8/10 Revenue Québec cost 900 million$ Five province collect own sales tax, Québec collects federal GST, federal collects joint federal/provincial HST 18

Per capita fiscal balance, Ontario and Québec, net of deficit 19

Scotland Why is every thing paid for by UK; no marginal cost to Scottish taxpayer –long live Lord Barnett! Incentive to spend ! Why no political will to use 3p to the £ ? Similar situation in Belgium and Spain where AC have granted tax breaks Catalonia complains but does not vary taxation or spending 20

Canada 1954 Québec takes tax room in personal income tax field Equalisation introduced in 1957 to facilitate provincial tax autonomy By 1972 all other provinces do that and are willing to raise / lower taxes to provide differentiated Recent years sees erosion of credo of provincial tax autonomy 21

Conclusion-Policy proposal Require Scotland to finance 50% of spending for individuals (education… 2009 amount)by raising its own PIT; Inland Revenue collects it at marginal cost using UK income definition Initial tax rates set to zero not existing(UK) one so decision must be taken –avoid the Spanish laziness of tax concession Equalization introduced at same time to reduce risk/ make solidarity explicit 22