Fiscal Federalism
Fiscal Federalism
Fiscal Federalism
FISCAL FEDERALISM
Go to Slide 164
Decentralized ratio
Excluding Grants Received from Central Government Net of Grants Received from Central Government
Subnational Gov. Share of Central, State/Provincial, and
Local Government Expenditures (six year averages)
Country 1970 – 1975 1996 - 2001
Canada 48.3 53.2
United States 35.7 39.5
Germany 39.7 33.4
Australia 27.4 31.6
France 10.8 12.1
𝑃𝑟𝑜𝑣𝑖𝑛𝑐𝑖𝑎𝑙 + 𝐿𝑜𝑐𝑎𝑙
=
𝑃𝑟𝑜𝑣𝑖𝑛𝑐𝑖𝑎𝑙 + 𝐿𝑜𝑐𝑎𝑙 + 𝐹𝑒𝑑𝑒𝑟𝑎𝑙
Decentralized ratio
Provincial Governments have been increasing their Expenditure
and Revenue Share at the Expense of Federal and Local Government
1913 – Fed. Gov. got Power to Levy 1930s – The New Deal changed the
Income Taxes on Individuals relationship between Fed. & State/Local
(8 States)
World
“A courageous state may serve as a laboratory and try moral, social and economic
Experiments without Risk to the Rest of the Country” Go to Slide 165
disAdvantages of a decentralized system
Eventually the
Redistributive Program In response to 7% of Welfare Recipients being from Out of
has to be Abandoned State, California Passed a New Law that paid Lower Benefits
to them – was later Ruled Unconstitutional
disAdvantages of a decentralized system
2. Equity Issues
High Income Individuals can avoid unfavourable tax conditions
by migrating to Lower Tax States, then Employers in High Tax
States will have to Pay Higher Wages to Keep their Workers
Acreage should be
Increased to the Point
where Each Member’s
Marginal Benefit Just
Equals the Per Member
Marginal Cost – Extra
Land divided by the
Number of People
Tiebout model
Shopping Competition
Tiebout model
At the Federal Level . . . Decisions can be Inefficient
Shopping Competition
Tiebout model
But at the Local Level . . . You Can Vote with Your Feet . . . Mobility
Go to Slide 166
Problems with the Tiebout model
In Urban/Suburban Areas,
Residents are More Satisfied
with the Level of Public Goods
Spending than in Non-Urban
Areas where there are Fewer
ways to Vote with your Feet
3. Economies of Scale
Optimal fiscal federalism
2. Positive Externalities
If Local Public Goods have a Large Spillover Effect on other
Communities - will be Underprovided by Another or Any Locality
Nicer Better
Lakeshore Library
Wage Rate Downward Sloping Marginal Product (Output) of Labour Wage Rate
($/hr) (Demand Curves for each Province) ($/hr)
A
$35
What do we
expect to happen?
$15
Currently
Zero Workers 10 million 5 million Zero Workers
In Ontario In Alberta
Number of Workers in the Two Provinces
Interprovincial fiscally induced migration
B
$25 $25
$15
B
$25 $25
$15
Three Questions
Wage Rate Wage Rate
to Ask . . .
($/hr) ($/hr)
A
$35
C
$28 $28
$25 $25
B
$15
Interprovincial
Difference in
Optimal Level of
NFB
Migration is OA
A Migrants Moving
o from NFLD to ON
YON - YNFLD
Interprovincial
(Before Equalization)
Difference in
FON - FNFLD
NFB
A B Migrants from
o NFLD to ON
(Before Equalization)
The Change in Income after
C
Accounting for Difference in NFBs
BC: NFB Gap between Provinces
Interprovincial fiscally induced migration
Interprovincial
(Before Equalization)
Difference in FON - FNFLD
FON - FNFLD
NFB
A D B Migrants from
o NFLD to ON
YON - YNFLD
FON - FNFLD
E
(After Some Equalization)
Interprovincial
(Before Equalization)
Difference in FON - FNFLD
FON - FNFLD
NFB
A D B Migrants from
o NFLD to ON
YON - YNFLD
F E
$719.6
Cost Benefit Ratio Inclusive of Equalization Payments = = 514
$1.4
The Cost to Close the Gap in Incomes that Arise from Differences in
NFBs between Provinces Far Outweighed the Benefits in terms of
Increased Labour Market Efficiency
Low = 1
Outbound
High = 1
What should
Low Income Provinces should have Relatively High Out Migration Rates
happen?
If Row 1 – Row 2 = 0 If Row 1 – Row 2 = Negative Too Little Out Bound Migration
Neutral If Row 1 – Row 2 = Positive Too Much Out Bound Migration
As these Revenues
are only offered to
those who reside
within Alberta, they
too create Inefficient
Incentives
Redistribution across communities
Inequality in the Ability/Extent to which Local
Communities Can/Do Finance Public Goods
Should We Care?
Redistribution across communities
Tiebout Model says:
Any Redistribution across Communities
would Impede Efficiency
But there are Two Reasons to Care:
2. Externalities
If there are Spillovers
1. Cost of Housing or Externalities . .
Then there’s an
Prevents People
Good Education can Argument to
form Moving
Lead to Low Crime Subsidize Other
with their Feet
across Communities Communities
Tools of redistribution: grants
Intergovernmental Grants
Are Cash Transfers from One Level of Government to Another
Data Excludes Tax Point Transfer – Federal Reduces Tax Rates, Enabling
Provinces to Simultaneously Raise their Rates by an Equivalent Amount
2011 – Tax Point would be worth an additional $21.9 billion (2011 dollars)
Tools of redistribution: grants
51%
19%
25%
5%
30%
Tools of redistribution: grants
22
2007 – 2008 Cash Transfer Portion = = 50%
44
Tools of redistribution: grants
Federal tax transfer is 13.5 tax points on
personal income tax and one tax point
on corporate income tax. Provinces
with Higher Income (ON, Alberta)
generated more of their entitlement
from their Tax Point Transfers
Population = 14.5 m
73.5%
26.5%
Federal grants to provinces
Population = 14.5 m
Ontario Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 128,610 25,090 153,700 161,135 13% 16% 0.6%
Population = 4.3 m
Alberta Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 41,611 8,013 49,624 56,335 11% 14% n/a
Population = 5.02 m
B.C Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 48,076 9,052 57,128 55,593 13% 16% n/a
P.E.I Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 1,279 766 2,045 2,031 11% 38% 21%
Yukon Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 204 1,137 1,341 1,348 4% 84% 74%
Population = 46 k
N.W.T Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 330 1,459 1,789 1,749 4% 83% 75%
Nunavut Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 255 1,879 2,133 2,072 3% 91% 79%
Quebec Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 90,146 23,411 113,557 107,951 11% 22% 11%
Manitoba Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 12,203 4,491 16,694 17,164 11% 26% 12%
Population = 1.2 m
Saskatchew an Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 11,940 2,509 14,449 14,717 11% 17% n/a
% of Federal
Support for
Ontario’s
Healthcare
Spending
14.908
= = 𝟐𝟒. 𝟑%
61.3
city of Ottawa: problem 1
The City of Ottawa would like to use all proceeds from Property
Taxes to finance upcoming Infrastructure Projects. The City’s
Utility Function between Private Goods and the
Infrastructure Fund is as follows.
Ottawa has 422,327 households & the Average Home Value is $407,571
How much will the City Raise for its Infrastructure Fund
and what would the Property Tax Rate be?
City of Ottawa: problem 1
= $407,571 x 422,327
= $172 Billion (Y)
𝑀𝑈𝑃𝐺 𝑀𝑈𝐼𝑁𝐹
= 𝑃𝑃𝐺 = 𝑃𝐼𝑁𝐹 = $1
𝑃𝑃𝐺 𝑃𝐼𝑁𝐹
𝑀𝑈𝑃𝐺 = 𝑀𝑈𝐼𝑁𝐹
QINF = $1.72 B
99 𝑄𝐼𝑁𝐹 = QPG Property Tax Rate
172 −170.28
QPG = $170.28 B = = 𝟏%
172
City of Ottawa: problem 1
𝟏%
Private Goods (Home Value)
Infrastructure Fund
$1.72 $172
Infrastructure Fund (Property Tax)
Tools of Redistribution: grants
The City thinks this amount is too low and call ups the Provincial/Federal
Government asking for help, who respond with a Grant
1. Matching Grant
For Every Dollar given by the Donor (Provincial/Federal), a
Certain Sum must be Expended by the Recipient (Ottawa)
City of Ottawa: problem 2
How much will the City Raise for its Infrastructure Fund and
what would the Property Tax Rate be?
City of Ottawa: problem 2
PPG = $𝟏
172 = $1 x $0 + PINF x $258
𝟐
PINF = = 0.67
𝟑
Could also just use . . .
𝟏 𝟐
= 𝟑 = 0.67
𝟏+𝟓𝟎%
𝟏𝟕𝟐 𝟐
Or = 𝟐𝟓𝟖
= 𝟑
𝑃𝑃𝐺 = $1.00
Y = $172 Billion 66.3 QINF = QPG
𝑃𝐼𝑁𝐹 = $0.67
QINF = $2.57 B
66.3 QINF = QPG Property Tax Rate
172 −170.28
QPG = $170.28 B = = 𝟏%
172
Use $2.568 instead of the rounded $2.57 to calculate
City of Ottawa: problem 2
𝟏% $𝟐. 𝟓𝟕 𝑩𝒊𝒍𝒍𝒊𝒐𝒏
Infrastructure Fund $1.72 B from Property Taxes
$172
Grant = $2.57 – ( $172 – $170.28)
Private Goods (Home Value)
$170.28 Problem 2
Problem 1
So what’s a
Block Grant?
Tools of Redistribution: grants
2. Block Grant
What Implications
does this have?
City of Ottawa: problem 3
What Changes do we
need to make here?
City of Ottawa: problem 3
172 + 0.85
= 172.85
This Changes Our Budget Constraint since we can
Private Goods (Home Value) + Tax Break
Block Grant
Matching
Grant Effect
172.85
What’s the Price?
Private Goods (Home Value) + Tax Break
𝑃𝑃𝐺 = ?
𝑃𝐼𝑁𝐹 = ?
$172.85
Infrastructure Fund (Property Tax + Grant )
City of Ottawa: problem 3
What’s the Price?
172.85
𝑃𝑃𝐺 = $1.00
Private Goods (Home Value) + Tax Break
𝑃𝐼𝑁𝐹 = $1.00
? $172.85
Infrastructure Fund (Property Tax + Grant )
City of Ottawa: problem 3
Same as
Problem 1
𝑃𝑃𝐺 = $1.00
Y = $172.85 Billion 99 QINF = QPG
𝑃𝐼𝑁𝐹 = $1.00
QINF = $1.73 B
Property Tax Rate
99 QINF = QPG Use the 172 (Home Value) not 172.85
172 −171.12
QPG = $171.12 B = = 𝟎. 𝟓𝟏%
172
Use $1.7285 instead of the rounded $1.73 to calculate
City of Ottawa: problem 3
Property Tax Rate Infrastructure Fund
$172.85
𝟎. 𝟓𝟏% $𝟏. 𝟕𝟑 𝐁𝐢𝐥𝐥𝐢𝐨𝐧
Private Goods (Home Value) + Tax Break
$171.12
Where did the
Problem 3
$170.28
Grants Go?
Problem 1
$171.12
$170.28 Problem 2
Problem 1
So what’s a
Conditional
Block Grant?
Tools of Redistribution: grants
What Implications
does this have?
City of Ottawa: problem 4
Matching
Grant Effect
172.85
Conditional Block Straight Line for the 1st
Grant Effect $850 million
$172
Private Goods (Home Value)
Matching
Grant
Matching
Grant
172.85
Conditional Block What if it were $1 billion in
Grant Effect Conditional Block Grant?
$172
Private Goods (Home Value)
𝑃𝐼𝑁𝐹 = $1.00
$172
Private Goods (Home Value)
What do we Expect?
? Will the City change its
behaviour from the
Unconditional Block Grant
$0.85 ? $172.85
Infrastructure Fund (Property Tax + Block Grant)
Same as Block Grant City of Ottawa: problem 4
of Problem 3
𝟎. 𝟓𝟏%
Infrastructure Fund
$𝟏. 𝟕𝟑 𝑩𝒊𝒍𝒍𝒊𝒐𝒏
So what’s a
Matching Closed
Ended Grant?
Tools of Redistribution: grants
What
Implications
does this have?
City of Ottawa: problem 5
$172
Before?
Private Goods (Home Value)
$170.28
$170.28 Important?
$172
Before?
Private Goods (Home Value)
$170.28
If After, then Need to
Or After? Drop to New Budget
$170.28 Constraint Line
So which is it?
172 −170.28
QPG = $170.28B = = 𝟏%
172
You can skip this part . . . Not on Test
Given that this is a Linear Line . . . $1.72 = 172 – 170.28
Generated 2.57 B
$850 million Grant = $1.72 Billion in Property Taxes
1.72 𝑥 500
$170.99 = $𝟏. 𝟎𝟏 𝑩𝒊𝒍𝒍𝒊𝒐𝒏
850
Which means . .
$170.28
QPG = $172 – $1.01 = $170.99
&
QINF = $1.01B + $500 million
QINF = $1.51 Billion
$1.51 $2.57
City of Ottawa: problem 5
Now Can Solve using New Budget Constraint Equation
$172.5 with One to One Pricing – No Grants . . .
𝑃𝑃𝐺 = $1.00
𝒀 = $𝟏𝟕𝟐. 𝟓𝟎
$170.99 𝑃𝐼𝑁𝐹 = $1.00
Matching Grant
$170.28
99 QINF = QPG
From Problem 1
𝑃𝑃𝐺 = $1.00
Y = $172.5 Billion
𝑃𝐼𝑁𝐹 = $1.00
99 QINF = QPG
QPG = $170.775 B =
172 −170.775
= 𝟎. 𝟕𝟏%
172
City of Ottawa: problem 5
A Province’s Equalization
𝐏𝐏 𝐓𝐏
Payment can be Calculated E P = 𝐑𝐍 −
from the Following Equation
𝐏𝐍 𝐓𝐍
EP = Equalization Payment for
RN = National Revenues per Tax Base
Province (0 if negative)
PP = Population of Province TP = Provincial Tax Base Share
Personal Income
Taxes 373,385 20% 74,677
Corporate Income
Taxes 108,107 15% 16,216
Consumption Taxes 723,440 10% 72,344
Natural Resources 17,514 50% Cut 8,757
Property Taxes 5,916,000 1% 59,160
Equalization calculation
Next . . . 𝐏𝐏 𝐓𝐏
Province’s Share of E P = 𝐑𝐍 −
𝐏𝐍 𝐓𝐍
National Population
National
Ontario Quebec P.E.I Remaining 7
Population
(PP- ON) (PP- QC) (PP- P.E.I) Provinces (TP)
(PN)
Provincial
Population 13,014 7,797 140 12,529 33,480
Population
Share sample
Calculation For example, for Ontario: 13,014 / 33,480 =
(PP / PN)
Population
Share 38.9% 23.3% 0.4% 37.4% 100%
(PP / PN)
Equalization calculation
Province’s Share of 𝐏𝐏 𝐓𝐏
EP = 𝐑𝐍 −
National Tax Base 𝐏𝐍 𝐓𝐍
Ontario Quebec P.E.I Remaining 7 National Tax
Five Tax Bases
(TP- ON) (TP- QC) (TP- P.E.I) Provinces (TP) Base (TN)
Personal
153,685 71,130 1,008 147,567 373,385
Income Taxes
41.2% 19.1% 0.3% N/A
Corporate
33,297 19,243 108 55,459 108,107
Income Taxes
30.8% 17.8% 0.1% N/A
Consumption
Taxes 269,843 159,157 2,894 291,546 723,440
37.3% 22% 0.4% N/A
Natural
Resources 245 3,030 0 14,239 17,514
1.4% 17.3% 0% N/A
Property Taxes 2,330,904 1,076,712 17,748 2,490,636 5,916,000
39.4% 18.2% 0.3% N/A
Equalization calculation
Calculate for Each Province: 𝐏𝐏 𝐓𝐏
E P = 𝐑𝐍 −
ONTARIO 𝐏𝐍 𝐓𝐍
Base
𝐏𝐏 𝐓𝐏 Deficiency Equalization
Five Tax Bases RN Payment
𝐏𝐍 𝐓𝐍 (𝐏𝐏 𝐏
−
𝐓𝐏
𝐓𝐍
)
𝐍
Personal
Income Taxes 74,677 41.2% - 2.3% -1,718
Corporate
Income Taxes 16,216 30.8% 8.1% 1,313
Consumption
Taxes 72,344 38.9% 37.3% 1.6% 1,158
Natural
Resources 8,757 1.4% 37.5% 3,284
Property
Taxes 59,160 39.4% - 0.5% - 296
Equalization Payment for Ontario (millions) $3,741
Equalization calculation
Personal
Income Taxes 74,677 19.1% 4.2% 3,136
Corporate
Income Taxes 16,216 17.8% 5.5% 899
Consumption
Taxes 72,344 23.3% 22% 1.3% 940
Natural
Resources 8,757 17.3% 6% 525
Property
Taxes 59,160 18.2% 5.1% 3,017
Equalization Payment for Ontario (millions) $8,517
Equalization calculation
Personal
Income Taxes 74,677 0.3% 0.1% 75
Corporate
Income Taxes 16,216 0.1% 0.3% 49
Consumption
Taxes 72,344 0.4% 0.4% 0% 0
Natural
Resources 8,757 0% 0.4% 35
Property
Taxes 59,160 0.3% 0.1% 59
Equalization Payment for Ontario (millions) $218
equalization
% difference between High Poverty & Low Poverty (Rich) School Funding
United states: school finance equalization
California Prohibits Differences Unlike Other
States, Only a
Between Schools of More than
Quarter of K – 12
$350 per Pupil Spending Spending is from
Property Taxes