Ministry of Finance and Corporate Relations Honourable Paul Ramsey, Minister	This electronic version is for informational purposes only. The printed version remains the official version.
Report G: FISCAL CAPACITY AND PROVINCIAL BUDGETS

What is Fiscal Capacity?

Provinces in Canada have differing potential to generate revenues because of variations in personal incomes, industrial structure, natural resource wealth, etc. This differing potential is a key determinant of a province's fiscal options: the level of government programs and services it is able to provide, and the level of taxation needed to provide a given range of programs. This capability to generate revenues is often referred to as fiscal capacity.

The usual method¹ of estimating fiscal capacity begins with the calculation of a national average tax rate for each of the over 30 tax bases² used by provinces to obtain revenue. These rates are then applied to the corresponding tax bases of each individual province to calculate the total hypothetical revenue that would be generated. A province's fiscal capacity is this revenue measured on a per capita basis.

CHART G1 FISCAL CAPACITY AMONG PROVINCES

 
Differences in Fiscal Capacity Across Provinces

Chart G1 illustrates the considerable differences in fiscal capacity which exist across the provinces³. It reveals that applying identical tax rates would generate over twice as much revenue in Alberta as in Newfoundland because the tax bases in these two provinces are very different.

British Columbia and Ontario have the next highest fiscal capacities, at around $5,800 per person, although these are about one-third less than Alberta's fiscal capacity.

CHART G2 FISCAL CAPACITY WITH EQUALIZATION

Federal Equalization payments do much to mitigate provincial variances in revenue-raising ability (Chart G2). Equalization increases the fiscal capacities of "have-not" provinces⁴ to $5,431 per capita, close to the fiscal capacities of British Columbia and Ontario.

Canada Health and Social Transfers (CHST) from the federal government have been designed to provide additional compensation for fiscal capacity disparities. Chart G3 shows how these transfers further narrow fiscal capacity disparities among provinces.

CHART G3 FISCAL CAPACITY AND EQUALIZATION AND CHST

 
Provincial Tax Effort

Tax effort measures the amount of tax revenue actually generated in a province as a proportion of revenue that would be generated if national average tax rates were imposed. Tax effort, in other words, represents the degree to which a province's fiscal capacity is utilized.

CHART G4 DIFFERENCES IN PROVINCIAL TAX EFFORT

A tax effort of greater than 100 per cent means a province's effort is higher than the national average; conversely, a tax effort of less than 100 per cent signifies an effort lower than the national average.

Provinces with a high fiscal capacity — Alberta is the only province with a fiscal capacity markedly above the Canadian average — are able to offer lower tax rates because far less effort is needed to produce a given amount of revenue.

Chart G4 shows that British Columbia and Ontario have fiscal capacities slightly above the national average. British Columbia's tax effort is slightly below the national average at 98.3 per cent, while Ontario's is slightly above at 100.6 per cent.

One might expect that provinces with lower fiscal capacity would utilize a greater tax effort as an offset to weaker revenue raising ability, but this is not invariably the case. While four of the seven Equalization recipient provinces do have tax efforts above the national average, the three Maritime provinces are an exception to this pattern. Despite having relatively low own-source fiscal capacities, New Brunswick, Prince Edward Island and Nova Scotia have below average tax efforts. The Equalization program may transfer sufficient revenue to these latter provinces to enable each to provide a desired level of programs and services at tax rates close to the Canadian average.

Fiscal capacity is not, of course, the only determinant of tax effort. A province with a relatively high tax effort may have a preference for more comprehensive programming, or may be coping with higher cost pressures, for example, higher health care costs brought about by a higher proportion of seniors in the population. Disparities in tax effort might also reflect different preferences with respect to overall tax burden.

 
Implications of Fiscal Capacity Disparities

Concerns about fiscal disparities are most prominently expressed in relation to Canada's least well-off provinces. Sometimes the concerns are voiced in the broad context of national equity; at other times there is a narrower focus, such as reducing the potential for fiscally-induced migration — migration by individuals between provinces in search of better public services and/or lower taxes.

A focus on the national setting for addressing fiscal disparities is important, but it can obscure appreciation of the regional setting — a setting which has been growing in relative importance with changing trade patterns and a more regional focus for competitiveness.

In this context, the large gap in fiscal capacity between British Columbia and Alberta, its closest neighbouring province, is of particular interest. Among provinces, Alberta is the strongest beneficiary of the provinces' constitutional right to the revenues from non-renewable natural resources. As Chart G5 shows, Alberta greatly benefits from these revenues, especially those from oil and natural gas.

Overall, British Columbia's own-source fiscal capacity is almost $2,000 per capita — or 25 per cent — lower than Alberta's. The CHST reduces this difference slightly, but post-transfer fiscal capacity is still 23 per cent lower in British Columbia than Alberta. If British Columbia had Alberta's fiscal capacity, revenues in the province would be about $7.8 billion higher per year⁵. This would greatly broaden the range of opportunities for fiscal policy options in British Columbia. Conversely, reducing British Columbia's tax effort so that it approximated that of Alberta would produce a severe contraction in the scope and quality of British Columbia's public services.

CHART G5 IMPORTANCE OF NATURAL RESOURCES REVENUES, 1999/00 (estimated)

A similar situation presents itself to Alberta's other neighbours, Saskatchewan and Manitoba.

 
Conclusion

The foregoing is not intended to justify removing all fiscal disparities between provinces — an option which would be prohibitively costly for the federal government. Rather, the purpose is to increase appreciation of the major constraints imposed by a province's fiscal capacity in the budgeting process. For a given level of government services, it is not possible for British Columbia and other provinces to set overall taxation rates as low as those in Alberta. This gives Alberta a sizeable competitive advantage over its provincial neighbours in that tax rates can influence the ability to attract and retain firms and people.

While British Columbia may have an above-standard fiscal capacity on a national basis, this is of limited benefit in a regional setting with an increasing imperative to address tax competitiveness. From a Western Canada perspective, British Columbia is little better able to provide "reasonably comparable public services at reasonably comparable levels of taxation" — to cite the overall goal of the Equalization program — than those provinces receiving Equalization.