Decentralized Federalism and Provincial Control of

Resources: A Difficult Combination

Robin Boadway, Queens University

Prepared for CEA Annual Conference: IRPP Session

The Future of Federal-Provincial Relations and Fiscal Arrangements
May 30, 2013

Overview

Theme: The (in)ability of a decentralized federation to respond to

a prolonged resource boom
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Dutch disease and the disposition of rents

Implications of provincial priority in resource management and

taxation

Problems with the federal policy stance

Exploring policy options

Two Aspects of Dutch Disease

1. Real resource flows
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Interindustry and interregional

Well-documented in Canada
Effects like any other terms of trade shock

2. Creation and disposition of resource rents

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Requires efficient management and taxation of resource

industries
And, equitable use of resource rents

In principle, benefits of resource shock can be spread widely

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Adjustment mechanisms can absorb and insure adverse shocks

Management of rents can mitigate the size of shock and

spread the benefits

Dutch Disease in a Federation

In a decentralized federation, adjusting to regional resource shocks
and managing rents effectively is difficult:
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If resources owned and controlled by provinces, development

and extraction of resource may be skewed

Collection and use of rents far from optimal

If federation is fiscally decentralized, adjustment mechanisms

to shock eroded

Failure of federal tax-transfer system, social insurance,

equalization and social transfers to cope

Excessive pressure put on interprovincial migration

The Federal Dimension

Key relevant features of Canadian federation
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Exclusive provincial management of natural resource

development (Section 92A, Constitution Act 1982)

Implied right of provincial access to resource-specific taxes

Federal government has right to raise revenues by any means,

including from natural resources: federal share in late 1990s
was 23-24%

Relatively highly decentralized revenue system exacerbates

horizontal imbalances, even without resource revenues

Shared federal-provincial responsibilities for social protection

and tax-transfer system

Implications of Provincial Priority in Resources

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Substantial horizontal imbalance

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Fiscal capacities relative to national average before

equalization (201112): 67% in PEI, 83% in PQ, 93% in Ont,
133% in Sask, 153% in Nfld, 166% in Alta
After-equalization fiscal capacities (2011-12) 95% in recipient
provinces; have provinces unchanged
Dispute about how much of resource revenues to equalize; lack
of federal access to resource rents

Provinces do not claim reasonable share of resource rents

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Total public share of rents in Alta is 44% for conventional oil,

47% for oil sands, 58% for natural gas; Alberta Royalty Review
Panel recommended increase to 49%, 64%, 63%
Reasons: perceived competition for investment, higher rate of
return required due to political uncertainty, distortionary taxes
Competitive pressure less if tax based on rents
Federal resource taxes would be subject to less competitive
pressures

Implications of Provincial Resource Taxation, contd

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Provinces do not save resource revenues

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Value of Alta Heritage Fund (2012) was $16bn (1.4 annual

resource revenues), compared with $660bn in Norway
Deprives future generations of fair share
Resource revenues used to reduce other taxes and increase
spending
Compounds Dutch disease by spending effect and leads to
fiscal imbalance

Lack of saving reflects temptation for provincial-building at

expense of other provinces: skews regional development
patterns and compounds inefficiencies of fiscally induced
migration

Arguably, provinces develop resources too rapidly:

undeveloped resources a form of saving

Policies to encourage processing of natural resources makes

Dutch disease worse

Problems with Federal Policy Stance

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Failure of federal government to capture adequate share of

resource rents
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Favourable corporate tax treatment of resource industries

Deductibility of provincial resource levies
Low federal corporate tax rate

Limited equalization of natural resource (50%); no

equalization of have provinces

Social transfers implicitly equalizing, but not for resources

Decentralized tax-transfer system

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Increasingly limited overall progressivity

Compromised social protection system

Vertical fiscal balance issues: rising provincial debts increase

interprovincial fiscal competition pressures

Overall, stabilization mechanisms compromised:

federal-provincial transfers, tax-transfer system, migration

Provincial Policy Options

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Efficient resource taxation that collects a fair share: cash-flow

equivalent regimes (RRT, ACE, competitive leases)
Efficiency requires
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Ex ante commitment to tax regime regardless of future prices

Symmetric treatment of losses and gains
Coordination of rent taxation from initial exploration until final
production and closure
Ability to enforce taxes, given informational disadvantages

Resource revenues should be well-managed: to take account

of rights of future generations and to mitigate Dutch disease,
creation of SWF invested in foreign assets and drawn down
slowly
Problem arises if revenues used in province of origin: some
investment in capital projects with high return (infrastructure,
human capital) generally desirable, but a problem if restricted
to province of resource origin
Measured development: Resources left in ground form of SWF

Federal Policies: Framework

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Provinces have jurisdiction over resource development and

right to levy resource-specific taxes

Federal government has national efficiency and equity

obligations, some explicitly set out in Section 36(1)&(2),
others recognized to be in national interest

Federal government has always collected share of natural

resource revenues through general power of taxation

Share of resource revenues that should go to federal

government is an open question

Federal government cannot directly control pace of resource

development, but can address consequences

Federal Policies: Most Pressing Concerns

1. Horizontal fiscal imbalance: fiscal equity
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Response to horizontal imbalance involves equalization and

social transfers

Made difficult by decentralized revenues and lack of access to

resource revenues

2. Treatment of gainers and losers: interpersonal equity

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Response to individual losers is tax-transfer and social

insurance systems
Division of income tax room important for both 1. and 2.

3. Dutch disease consequences aggravated by provincial spending

of resource revenues
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Problem of failure to save resource revenues

Compounded by use of resource revenues for province-building

Federal Policies: Options for Achieving Equity

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Maintain and enhance integrity of Equalization, including

removal of GDP growth cap

Improve equalization component of social transfers by

conditioning them on fiscal capacity of have provinces

Increase federal income tax room to maintain interpersonal

progressivity and enhance funding for social transfers

Improve progressivity of tax-transfer system at bottom (e.g.,

make all tax credits refundable)
Reform corporate tax to make it efficient and enhance federal
share of resource revenues and other rent sources

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Eliminate deductibility of resource taxes from CIT

Convert CIT into tax on rents: cash-flow equivalent tax, such
as ACE or RRT
More substantial change would transfer CIT to federal
government in return for higher federal transfers (J-F
Tremblay)

Federal Policies: Dutch Disease Options Limited

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Establish a federal sovereign wealth fund?

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Some suggest having CPP hold more foreign assets: reduces

risk level of CPP fund due to commodity price fluctuations,
but conflicts with independence of CPP Pension Board
Federal SWF would not mimic one formed by resource
revenues that accrue to provinces, so would not undo effects
arising from provinces inability to save

Induce resource-rich provinces to save more of resource

revenues (e.g., manipulation of federal transfers by
conditioning them on resource revenues spent)
Counter-balancing negative impact of province-building
policies is harder
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Federal government investment in infrastructure for the traded

goods sectors to improve productivity?
Oil pipeline to the east (Dodge)?
Federal investment in human capital elsewhere in Canada?
Add element of infrastructure needs to equalization?

Elephants in the Room

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Environmental issues
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Stern Review (2009): Under BAU, stock of CO2 GHGs in

atmosphere will rise from 430 ppm now to 550 by 2050 leading
to temperature rise 2%, then to 5% by 2100

BAU demand for oil to 2050 met by existing deposits extracted

at less than $30 per barrel, with lots of higher cost oil left over
Oil profitable to extract enough to take CO2 well beyond 750
ppm (before shale oil discoveries)

Provinces cannot commit to save revenues, and seem

compelled to extract resources as quickly as possible

Unpalatable implication: Leave oil sands in ground?

Infrastructure equalization
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An unresolved question