Provinces face transfer cuts

NationalPost.com – opinion/financialpost.com/fpcomment – 60% of federal spending is now transfers of one type or another
February 14, 2011.   By Livio Di Matteo, Special to the Financial Post

Transfer payments from Ottawa to the provinces have been a feature of the Canadian federation since 1867. Federal transfers began with the Dominion subsidies that provided the provinces with a per-capita payment that essentially acknowledged the new federal government’s stronger tax base. Since then, transfers to the provinces have grown, with the creation of Equalization in 1957 and then health transfers as a result of the Medicare Act of 1966.

Today Ottawa transfers about $56-billion to the provincial and territorial governments, the three main provincial transfer programs being the Canada Health Transfer at $27-billion, the Canada Social Transfer (for child, post-secondary education and social programs) at $12-billion and Equalization (funds for those provinces with a weaker fiscal capacity) at almost $15-billion.

Equalization payments were recently reformed with a new funding formula, but attention is now shifting to health transfers, as the generous funding provisions of the Health Accord reached in 2004 will expire in 2014. The Canada Health Transfer to the provinces has grown from $20.3- billion in 2005 to $27-billion in 2011 — an annual growth rate of nearly 6%.

Given the recent recession and the slowdown in economic growth combined with large federal deficits, the odds are high that the growth rate of these transfers will be circumscribed. However, public health spending over the last five years has grown at a rate of just over 6% annually. Needless to say, there will be a scramble to curtail health costs should health transfers not continue in a manner the provinces have grown accustomed to.

However, the situation is more complicated than that because the federal government not only transfers money to provincial governments but it also transfers money to individuals via income support programs and to bond holders via debt interest payments. Indeed, the role of the federal government over the last 50 years has morphed into a giant check-writing agency. In 2009, along with sending $56-billion to the provincial and territorial governments, it also sent $69-billion to persons (e.g. Old age security, guaranteed income supplements) and another $29-billion to Canadian bondholders as debt interest payments. As a result, almost 60% of federal expenditures is now transfers of one type or another, with the other 40% going to the provision of public goods and services that we usually associate with government. In the early 1960s, the division was the other way around.

If one looks back over the last 20 years, one sees that the share of federal spending accounted for by transfers to persons has stayed approximately constant at 25%. After declining in the 1990s, the share of federal spending going to provincial and territorial government transfers has grown from 14% to about 21%.

Meanwhile, the share of spending going towards debt service dropped from a peak of 30% in the mid-1990s to about 10% at present. The federal fiscal dividend from its balanced budget and the lowest interest rates in 40 years went to increased provincial transfer spending as well as some tax relief at the federal level. Since 1990, total federal transfers to the provinces have grown by 140% while total federal spending has only grown by 79%.

However, the federal government again has a deficit and mounting debt and debt service costs. Maintaining the growth rate of health and other transfers to the provinces at the rates of the last decade will be much more difficult if interest rates begin to spike upward. Servicing the growing debt will require either cuts to transfers or cuts to programs and services. The calculus is bleak.

Given that transfers now make up the lion’s share of federal spending, transfer reductions will also make up the lion’s share of federal spending restraint. What transfers to reduce? It won’t be debt interest unless Canada decides to make history by joining the international list of sovereign defaulters. That leaves transfers to persons and transfers to other governments.

If the federal government must choose between affecting voters directly via cuts to personal transfers or indirectly by hitting their provincial governments, then the choice is obvious. The provinces are heading towards transfer restraint.

Livio Di Matteo is professor of economics at Lakehead University.

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