HOURGLASS FEDERALISM — HOW THE FEDS GOT THE PROVINCES TO RUN OUT OF MONEY IN A DECADE OF LIBERAL BUDGETS

Thomas J. Courchene

Paul Martin’s landmark budget of 1995 cut federal funding for health care and other provincially delivered entitlements in such a way that Ottawa was able to balance its books while the provinces saw health costs rise to increasingly unsustainable levels — in many cases now approaching half their budgets. The 1995 cuts, suggests Tom Courchene, “compromised every provincial program except health care, since gutting medicare would spell certain electoral defeat.” Meanwhile, after balancing the books in 1997 and presenting surpluses ever since, Ottawa has used the fiscal dividend to move into areas of exclusive provincial jurisdiction, such as cities and education, while the cash-starved provinces look on, helpless to spend any new money in their own constitutional domains. “The cities fully welcome these initiatives,” Courchene writes, “because the provinces are effectively broke.” He concludes: “While none of this was part of a grand design, Machiavelli would be proud.”

Paul Martin déposait en 1995 un budget marquant qui sabrait dans le financement des soins de santé et de plusieurs autres programmes de compétence provinciale, ce qui a permis à Ottawa d'atteindre l'équilibre budgétaire au détriment des provinces, dont les dépenses de santé ont bondi au point d'accaparer souvent presque la moitié de leurs budgets. Selon Tom Courchene, ces compressions de 1995 ont compromis tous les programmes provinciaux sauf le régime d’assurance-maladie, intouchable pour tout gouvernement qui veut être réélu. Une fois son budget équilibré en 1997, Ottawa n’a cessé d'engranger des surplus et d'en profiter pour s'immiscer dans des domaines de compétence exclusivement provinciale, notamment l'éducation et les municipalités, tandis que les provinces lessivées ne pouvaient plus injecter la moindre somme dans leurs propres domaines constitutionnels. Les municipalités se réjouissent évidemment de cette intrusion d’Ottawa puisque les provinces sont effectivement à sec. Machiavel lui-même serait fier d'un résultat aussi impressionnant, note l'auteur, même s’il n'est pas le fruit d'une planification à proprement parler machiavélique.

he March 23, 2004, federal budget can lay claim to be education/human capital and welfare have become budget- the formal launching pad for what might be termed ary commonplace. However, what is remarkable about the T “hourglass federalism,” namely the growing range of 2004 budget is that it extends this provincial end run to federal government initiatives that bypass the provinces and embrace the cities which, constitutionally, are creatures of deal directly with citizens and cities, leaving the provinces as the provinces. Among other things, the budget details the the squeezed middle of the division-of-powers hourglass, as composition of municipal revenues, expenditures and debt it were. To be sure, this did not begin with the 2004 budget. structures by province as part of the section The Importance of Indeed, in the wake of the new fiscal relationships arising Communities, one of the five priority areas highlighted in the from Paul Martin’s 1995 budget, federal incursions into the budget. Finance Minister Ralph Goodale is surely correct various (inherently provincial) areas such as when he notes that the many provisions in the budget relat-

12 OPTIONS POLITIQUES AVRIL 2004 Hourglass federalism — how the feds got the provinces to run out of money in a decade of Liberal budgets ing to cities constitute “a historic com- amendments were pivotal, most any, change in the written constitution- mitment to forge a New Deal for notably the Constitution Act 1982 al word. Essentially, it was driven by Canada’s communities.” replete with patriation and the Charter shifts in expenditure responsibilities — This is enough of a preview of the but, as well, the earlier amendments from the provinces to Ottawa in the ensuing storyline to frame the issue at that transferred UI/EI and a role in pen- Depression and WWII and back to the hand, namely the de facto evolution of sions to the federal government. provinces over the last 50 years — the division of powers in ways that privi- However, it is on the process front that which were accommodated by corre- lege Ottawa and citizens/cities at the Canadian federalism has been most sponding shifts in tax shares. Beyond this, variations in the mag- The policy spillovers arising from the increased north-south nitude and the nature of trade integration have led to a series of new instrumentalities intergovernmental transfers that have embraced federal-provincial co-determination, the have been tantamount to changes in the effective divi- best example of which is the Social Union Framework sion of powers, with a shift Agreement (SUFA). The core message in all of this is that in the direction of uncondi- where there is a Canadian need and will to alter the division tional transfers facilitating of powers, there clearly is a Canadian way. enhanced decentralization, and vice versa. More recent- expense of the provinces. The associated flexible and creative. For example, the ly, the policy spillovers arising from the issue is that the force driving this evolu- provincial/local share of own-source increased north-south trade integration tion is Ottawa’s superior fiscal position revenues rose from 25 percent at the have led to a series of new instrumen- and its creative exercise of the federal time of Confederation to nearly 70 per- talities that have embraced federal- spending power, on the one hand, and cent in the midst of the Great provincial co-determination, the best the (related) inability of the provinces to Depression, only to fall back to 30 per- example of which is the Social Union find revenues to finance anything other cent during the Second World War Framework Agreement (SUFA). The core than medicare, on the other. World War and finally back in the 60 message in all of this is that where there percent neighbourhood in recent years. is a Canadian need and will to alter the he analysis begins by addressing And this ebb and flow of jurisdictional division of powers, there clearly is a T how and why the federal govern- fortunes took place without much, if Canadian way. ment might want to enlarge its sphere of policy influence. The answer has to do FEDERAL COST-SHARING OF PROVINCIAL SPENDING ON HEALTH CARE with the policy and electoral implica- tions arising from the new global order, 50 both the globalization component and 45 the knowledge/human-capital compo- 40 nent. Attention will then focus on the 35 ways in which Ottawa has levered off its favourable fiscal balance vis-à-vis the 30 provinces to make inroads in key areas 25 that were traditionally viewed as falling 20 C under provincial jurisdiction. This will 15 a be followed by an elaboration of some of s 10 h these policies as they affect citizens and Federal share of provincial health expenditures (%) cities as well as the range of options open 5 to the provinces to counter these incur- 0 sions. The essay ends with a few reflec- tions about where this process is likely to 1975-76 1977-78 1979-80 1981-82 1983-84 1985-86 1987-88 1989-90 1991-92 1993-94 1995-96 1997-98 1999-00 2001-02 lead Canadian federalism. Cash transfers Tax points (health share) (health share) anadians are masters at the art and Source: Calculated from Health Canada, “Backgrounder on Federal Support for Health in Canada,” March C practice of reworking the struc- 27, 2000; the September 2000 agreement; Finance Canada's “Backgrounder, Federal Transfers to Provinces tures and processes of federalism to and Territories,” October 2002; and CIHI, “Preliminary Provincial/Territorial Government Health Expenditure, by Province/Territory and Canada,” 2002, table A1. address external and internal chal- Note: 2001-02 and 2002-03 are forecasts for provincial expenditures and use the finance department’s lenges. In terms of altering the formal revised methodology for calculating tax points. Reproduced from Yalnizyan, Armine (2004), “The Health Care Budget: Did it Resolve the 'Crisis'?”, in Charles M. Beach and Thomas A. Wilson (eds.), The 2003 structures, several constitutional Federal Budget: Conflicting Tensions (Kingston: John Deutsch Institute, Queen’s University), p. 243.

POLICY OPTIONS 13 APRIL 2004 Thomas J. Courchene

CP Photo Finance Minister Ralph Goodale defends his 2004 federal budget during Question Period in the House of Commons as Deputy Prime Minister Anne McLellan and Prime Minister Paul Martin look on.

The issue then becomes whether as the dynamic motors of the new success is the sine qua non of politics, it is globalization and the knowledge/infor- economy. This also relates to competi- only a matter of time before competition mation revolution are indeed creating a tiveness in the dual sense that these among federal parties and between feder- need for a rearrangement of federal and GCRs are leading their respective al and provincial politicians will ensure provincial powers. The case that one regions’ inroads into NAFTA economic that Ottawa will become involved in might make for an enhanced federal role space and that GCRs are the key nodes more direct ways with citizens and cities. and reach would have at least three sepa- in the knowledge/human-capital net- Intriguingly, except for the intro- rate prongs. The first relates to the shift works. Indeed, I endorse the view of duction of the Canada Child Tax Benefit from a resource-based society and econo- Simon Fraser’s Richard Harris that (CCTB) in the 1997 federal budget, the my to a human-capital or knowledge- Canadians’ standard of living will come earlier-noted and time-honoured ways based society and economy. Among down to how successful our global city to accommodate a need/desire to alter other things, this means that societal regions are relative to American GCRs. the de facto division of powers have not investments in knowledge and human The third, and perhaps overarching, proved to be of much use in this con- capital formation progressively hold the argument for an increased federal pres- text. This is so because the provinces do keys to wealth creation, to competitive- ence relates to the fact that the essence of not share the federal desire to alter juris- ness and to ameliorating the income-dis- nation-building and electoral salience dictional responsibilities and, therefore, tribution implications arising from have also shifted away from resource- do not see the need to alter either the globalization. It should not come as a based mega-projects and toward citizen- structures or processes of Canadian fed- surprise that as long as issues relating to driven infrastructure and policies in areas eralism. Hence something else was Canada’s competitiveness and citizens’ like health, education and income distri- needed to propel the division of powers standards of living are at stake, Ottawa bution. And whereas these former mega- in Ottawa’s direction, and as already will become a key policy player irrespec- projects tended to be rural, citizen noted this turned out to be the federal tive of what the Constitution might say. nation-building is predominantly urban. government’s superior fiscal position Unfortunately, from Ottawa’s stand- and the accompanying federal spending he second has to do with the emer- point, most of these areas fall under power. To be sure, the underlying moti- T gence of global city regions (GCRs) provincial jurisdiction. But since electoral vation here was to put the federal fiscal

14 OPTIONS POLITIQUES AVRIL 2004 Hourglass federalism — how the feds got the provinces to run out of money in a decade of Liberal budgets house in order, with the implications for ism crowd was to predict when federal the case with rising tuition fees for the division of powers more a matter of cash transfers to the provinces would post-secondary education (PSE). result than intent. The relevant point, fall to zero. This would occur because Janice MacKinnon, who has a special however, is that not only were the driv- the pre-determined overall tax-plus- insight into all of this as both a politician ing forces fiscal in nature, but they were cash transfer was growing slower than (minister of finance in Saskatchewan embodied in successive federal budgets. the tax transfer sub-component, with responsible for major cuts to the the result that the cash transfer (as the province’s health budget including the s part of his watershed 1995 budget, residual component) would eventually closing of 52 hospitals) and a policy ana- A Finance Minister Paul Martin folded fall to zero. While the 1995 CHST cuts lyst (author of Minding the Public Purse, the Canada Assistance Plan (CAP) and may have hurried this process along, among other contributions) applies the Established Programs Financing (EPF) the pre-existing status quo was itself label “unsustainable” to medicare. One into the new Canada Social Transfer not sustainable. Those wishing to make aspect of this label relates to the continu- (CST) and proceeded to pare the Canada a case that Ottawa destroyed medicare ous upward trajectory of health costs. Health and Social Transfer (CHST) cash are better to focus on the era of federal Intriguingly, however, MacKinnon is transfers from $18 billion to $11 billion. surpluses (1997-98 and beyond) when more concerned about another definition This deficit shifting to the of unsustainability, namely the provinces was an essential com- The third, and perhaps overarching, fact that provincial finance minis- ponent of Martin’s “come hell or argument for an increased federal ters cannot long sustain a situa- high water” commitment to tam- tion where health begins to ing the federal deficit. Received presence relates to the fact that the occupy near 50 percent of pro- wisdom in the federal corridors of essence of nation-building and gram spending with continuing power was that former finance electoral salience have also shifted deleterious effects on all other minister Michael Wilson’s earlier away from resource-based mega- policy areas. attempt to slay the deficit dragon came up short, in part because projects and towards citizen-driven he provinces were truly the Mulroney Tories did not want infrastructure and policies in areas T trapped. The small and to cut transfers to the provinces, like health, education and income unpredictable dollops of new at least not during the delicate distribution. And whereas these federal cash transfers were not 1987-90 ratification period for sufficient to meet citizen the Meech Lake Accord. The former mega-projects tended to be demands on the health care Chrétien Liberals did not make rural, citizen nation-building is front, so that the only recourse the same mistake, with the result predominantly urban. Unfortunately, was to starve other provincial that Canada’s fiscal turnaround from Ottawa’s standpoint, most of spending areas. It was only a (with Ralph Goodale delivering matter of time before citizens the seventh consecutive federal these areas fall under provincial welcomed possible federal surplus and forecasting two jurisdiction. intrusions in these non-health more) was and is so successful policy areas, to which the that Business Week has labelled this feat the federal government did have ample analysis now turns. “The Maple Leaf Miracle.” revenues to put medicare on a stable The 1997 budget provision creating Some analysts have claimed that longer-term funding path, but chose the CCTB represents at one and the these 1995 cuts in CHST cash transfers not to do so. same time the apex of cooperative and to the provinces have destroyed This caveat aside, the ongoing collaborative federalism, and the begin- Canada’s health care system. Actually, reality is that provincial governments ning of the federal end run around the the opposite seems to me to be closer have no choice, electorally, but to trim provinces. In terms of the former, the to the truth, namely that the CHST proposed spending increases from proposal originated in the 1996 Report cuts compromised every provincial here, there and everywhere to sustain to Premiers as a way to develop a nation- program except medicare, since gutting medicare. And as health budgets inex- al, yet flexible, approach to child pover- medicare would spell certain electoral orably approach 50 percent of provin- ty. Ottawa would deliver the refundable defeat. In this context, it is important cial program spending, provinces will and income-tested child tax benefit and to recall that by 1995 the health share have to dip deeper and deeper into the the provinces, for their part, could real- of federal cash transfers had already existing spending levels of other policy locate the equivalent amount of fund- fallen from roughly 26 percent to 16 areas in order to keep medicare afloat. ing from welfare to other policy areas percent (see attached table). Indeed, Alternatively, they can choose to pri- dealing with low income families with one of the more popular indoor sports vatize or otherwise pass on the costs of children. This exercise in co-determina- in that time frame for the fiscal federal- these other policy areas to users, as is tion was carried over to the creation of

POLICY OPTIONS 15 APRIL 2004 Thomas J. Courchene

the SUFA, a most innovative federal- In terms of the cities agenda, beyond troversial Health Council is up and run- provincial instrument, but one that the GST tax relief ($7 billion over 10 ning. Goodale allocated nearly a half-bil- unfortunately now seems mostly hon- years) and accelerating the spending of lion dollars to a new Canada Public oured in its breach, largely, I suspect, the existing $1 billion infrastructure fund, Health Agency and a public health officer, because Ottawa’s superior fiscal posi- the 2004 budget has promised to revisit in both of which will report to the federal tion no longer requires it to be atten- later budgets the Speech from the Throne minister of health. Arguably these institu- tive, let alone accommodative, to the provision for sharing a proportion of the tions should have been federal-provincial provinces’ budgetary needs. federal gas tax with the municipalities. in nature, if not under the umbrella of the new Council of the Some analysts have claimed that these 1995 cuts in CHST Federation. Matters are not cash transfers to the provinces have destroyed Canada’s much better in terms of likely health care system. Actually, the opposite seems to me to be impacts of federal actions on provincial health expendi- closer to the truth, namely that the CHST cuts compromised tures. The various health every provincial program except medicare, since gutting agreements/accords appear to medicare would spell certain electoral defeat. The ongoing be moving in the direction of reality is that provincial governments have no choice, linking additional funding infusions to new health electorally, but to trim proposed spending increases from spending such as home care here, there and everywhere to sustain medicare. and catastrophic drug cover- age. Moreover, with the CHST now split In terms of new economy priori- On the process front, Ottawa has prom- between a Canada Health Transfer (CHT) ties, the CCTB can be viewed as a ised to provide a stronger voice to munic- and the new Canada Social Transfer replacement for some or all of the for- ipalities on the full range of federal (CST), Ottawa will be tempted (and per- mer Canada Assistance Plan. Whereas policies and programs that are important haps egged on by Canadians) to place CAP funding went to the provinces, to them. Prime Minister Martin has conditions on any increases in the CHT the CCTB is a direct transfer to low appointed a parliamentary secretary to or CST. and middle-income Canadian families. lead the efforts in providing a “New Deal” In all of this the provinces find This is the appropriate juncture to for communities and has created an themselves sandwiched from both emphasize that Ottawa’s end run External Advisory Committee on Cities above and below, as it were — caught around the provinces may well involve and Communities while Finance Minister between Ottawa’s spending desires/pri- creative and efficient policy measures, Ralph Goodale has, for his part, commit- orities in the information era and the as is clearly the case with the CCTB. ted the minister of finance to annual, pre- citizens/cities genuine funding needs. budget consultations with the Federation The fact that the Constitution is (large- n the learning or human capital of Canadian Municipalities. All in all, a ly) on the provinces’ side is cold com- O front, the federal government has rather comprehensive package, eagerly fort, given that creative processes and been very active — Millennium awaiting a goodly share of future surplus- cities/citizens’ support will likely lead Scholarships, Canada Research Chairs, es for its implementation. And all in an to a de facto political trump over any measures to support early childhood area that was traditionally thought to be de jure provincial constitutional aces. development, and various measures relat- off limits to Ottawa. ing to education and tuition tax credits. Not surprisingly, perhaps, the he provinces appear to be putting The Goodale budget included, among cities fully welcome these initiatives. T most of their hopes in the fiscal other initiatives, a Canada Learning Bond They clearly prefer to have two patrons imbalance basket, to be carried forward for children of low-income families ($500 than one, they want direct access to by the newly created Council of the at birth and $100 per year up to age 15), federal infrastructure funding to put Federation. My assessment of this issue is provisions for enhancing generosity of the them on a level playing field with their that the provinces do indeed suffer from Canada Education Savings Grant, and a US counterparts, and they welcome a fiscal imbalance. The claim that the $3,000 grant for first year post-secondary being brought more fully into the fed- provinces have access to virtually all tax students from low-income families. With eral decisions relating to them. And bases so that a provincial imbalance is not these and many related measures Ottawa most of all they welcome an enhanced possible simply does not hold water has clearly signalled that skills and federal presence in their lives because, because Ottawa already has the lion’s human-capital enhancement (and ensur- returning to the theme of this essay, share of direct taxes and further increases ing equality of access thereto), are and will the provinces are effectively broke. here are likely to create competitiveness continue to be major federal priorities, as Finally, the provinces are even being problems, so that provinces are effective- befits a knowledge/information era. boxed in on the Medicare front. The con- ly stymied. There is more room on the

16 OPTIONS POLITIQUES AVRIL 2004 Hourglass federalism — how the feds got the provinces to run out of money in a decade of Liberal budgets indirect tax front, but the obvious tax fiscal superiority and the exercise of its taking a huge chunk of medicare fund- base, the GST, is constitutionally available spending power allowed it to target its ing off their books, it is unlikely to sit only to Ottawa. Moreover, if Ottawa has new economy priorities directly, rather well with Ottawa since it would be a funds sufficient to contemplate major than going through the provinces. roughly 50 percent increase in cash transfers or tax-sharing to the cities, this is And Ottawa even gained a key meas- transfers that would, in turn, serve to itself evidence of a fiscal imbalance. ure of control over medicare itself tie their fiscal hands for the better part Nonetheless, unlike the case a few years since the provinces became fiscal peti- of an electoral mandate. Nonetheless, ago, Ottawa can now argue that it, too, no tioners for increased health care fund- Prime Minister Martin has promised to longer has any fiscal room to manoeuvre; ing. While none of this was part of a sit down with the premiers this sum- it can legitimately claim to also have a series of under- Not surprisingly, perhaps, the cities fully welcome these funded priorities (such as initiatives. They clearly prefer to have two patrons than one, Canada’s armed forces). I fear they want direct access to federal infrastructure funding to put that public opinion will be them on a level playing field with their US counterparts, and with the provinces only inso- far as the fiscal imbalance they welcome being brought more fully into the federal issue relates to increased (and decisions relating to them. Most of all they welcome an presumably conditional) enhanced federal presence in their lives because, returning to health care infusions, but no the theme of this essay, the provinces are effectively broke. further. This is puzzling since one would have thought there must be grand design, Machiavelli nonetheless mer (electoral gods willing) to discus some point at which deteriorating would have been proud. alternative stable funding arrange- provincial public services in areas such as It is not clear where all this leads. At ments for medicare. By virtue of this education, infrastructure, safety and the one level, these existing trends may serve promise, Martin has raised expecta- environment, among others would begin to establish a new status quo — one that tions that Ottawa will deliver some to rival medicare for pride of place in resonates well with the principle of sub- permanent increases in funding, but a provincial budgets. Yet it is precisely this sidiarity, i.e., passing powers down to move to 25 percent seems a bit opti- puzzle that feeds the shift toward hour- cities. Moreover, it is far from clear that mistic given the current budget fore- glass federalism. Canadians have any problems at all with casts of the available surpluses looking The new global order has re-ori- this shift toward hourglass federalism. forward. ented Ottawa’s policy priorities toward There are of course alternative issues relating to to citizens and cities. hat does seem clear, however, is ways to take parts of medicare funding Since these areas tend to fall under W that the only way for the off provincial books. For example, provincial jurisdiction, the traditional provinces to extricate themselves from some of the poorer provinces, looking way of privileging them would be by hourglass federalism in to create addi- at the health-care-related salary settle- working with and through the tional fiscal room. And it seems that ments in Alberta, may just say to provinces. However, for a variety of the only options here are to download Ottawa: Here, you take medicare, we arguably legitimate reasons, Ottawa’s some of the costs of medicare to citi- can no longer afford it. Other preference was to deal directly with zens, or to upload some of the costs to provinces may follow Alberta’s route of cities and citizens. To make this possi- Ottawa, or a bit of both. From the funding parts of health care with dedi- ble, Ottawa had somehow to secure provinces’ vantage point (and proba- cated premiums. And Alberta itself dominion over the provinces. More by bly from that of citizens as well), the (and possibly Quebec, for other rea- happenstance than by design, this fell clear preference would appear to be for sons) is the most likely province to be into place as a by-product of Ottawa’s Ottawa to increase its cash transfers contemplating a new version and approach to taming the deficit. from their roughly 16 percent current vision for medicare, perhaps toward a Specifically, the deficit shifting to the share to the original 25 percent share, thorough privatization of health care. provinces on the one hand and the as recommended by Tom Kent, among The enduring Canadian reality in status of medicare as a defining others. This would commit Ottawa to all of this is the everything still Canadian value on the other led the be a partner in sharing future health revolves around medicare! provinces to protect medicare at the care costs which, in turn, might set the expense of virtually all other policy stage for meaningful health care IRPP Senior Scholar Thomas J. areas. And the upward trajectory of reform since both levels of govern- Courchene is the Jarislowsky-Deutsch medicare costs exacerbated the prob- ment would now be on the same fiscal Professor of Economic and Financial lems for provincial finance ministers. side of the issue. While this would sat- Policy at the Queen’s School of Policy The inevitable result was that Ottawa’s isfy provincial needs in the sense of Studies. [email protected]

POLICY OPTIONS 17 APRIL 2004