Trevor Tombe: It’s time for a (new) New Deal for the provinces

One option, writes Bill Bewick for The Hub, is giving provinces more tax room, which would reduce regional tensions and improve democratic accountability. If the government responsible for health and education also raises the revenue to fund those services, the argument goes, then voters should be less confused about who is responsible. The federal government should therefore give provinces “tax room” by lowering their taxes while provinces simultaneously raise theirs.^{1See this recent paper for a more detailed history and recent data behind tax point transfers, as they are known.}

There are a lot of moving parts here and this would involve several overlapping reforms. But it’s an idea that deserves serious attention. It’s also an idea with a rich history that suggests, if combined with other reforms, it might be worthwhile.

Lessons from Diefenbaker

For the 1957 general election, the Progressive Conservative Party of Canada ran on a detailed policy platform that aimed, in part, to address a perceived imbalance between federal and provincial governments. John Diefenbaker campaigned on “A New Deal for Provinces,” which aimed to ensure “equal opportunities for Canadians and every part of this country.”

The previous years saw intense federal-provincial conflict.

Normalizing public finances after the Second World War was never going to be easy. The federal government wanted all personal and corporate income taxes for itself, but some provinces refused. An uneasy compromise was reached that also created equalization (though in a completely different form than we have today). Not everyone was happy.

During the campaign, the PC Party pledged to hold a federal-provincial conference to explore new methods for ensuring that provincial governments had the financial resources needed to fulfill their constitutional responsibilities, particularly for the rapidly expanding health and education systems. They promised not to mirror the “arrogant domination displayed by the Liberal Government at successive conferences” and criticized Louis St. Laurent’s “ever-increasing trend to centralization of power in Ottawa.”

Sound familiar?

Naturally, many factors affected the election, but Diefenbaker’s commitment to rethinking federal-provincial finances helped him win a minority.^{2If this history interests you, I highly recommend Mary Janigan’s book The Art of Sharing.} So following their win, the Conservatives did just that. They changed equalization, gave Atlantic Canada special support, and gave provinces significantly more tax room.

Another “New Deal” for provinces?

Something similar might be worth exploring today.

Imagine shifting the entire five points of the GST to provincial governments, as noted policy wonk Ken Boessenkool suggested in a 2010 paper for the School of Public Policy. At the same time, the federal government would cancel its entire Canada Health Transfer, which is roughly the same size. This would let provinces prioritize their spending. The lines of accountability would also be clearer, and provincial governments might be more motivated to reform and improve health care.

There are also compelling reasons to reform equalization. First, shifting the tax room benefits provinces unevenly. Higher-income regions would benefit the most. Equalization would therefore need to expand to compensate. Second, many Atlantic provinces are aging faster than elsewhere, which strains their health systems. Equalization could adapt to these pressures.

To illustrate, consider the changes to equalization suggested by Newfoundland and Labrador. Despite their proposals lacking detail, I estimate (based on some reasonable interpretations) that in 2024/25, their payment would have been roughly $1 billion higher if a measure of needs (based on demographics) were included and resource revenues excluded. Saskatchewan, too, would benefit, becoming an equalization-receiving province this year with an estimated payment of roughly $900 million. (These changes may or may not be wise for other reasons, but they’re worth considering.)

Shrinking the federal deficit

There may also be an opportunity to provide greater flexibility for provincial governments while at the same time helping shrink the federal budget deficit.

In its latest budget, released earlier this year, the federal government projects that major transfers to provinces will grow to $121 billion by 2028, up from just over $100 billion in 2023. Some of this growth is due to the increasing use of “conditional transfers” to provinces. Such transfers attach strings to the use of the funds, which allows the federal government to influence policy decisions even outside their own areas of jurisdiction. These include early learning and childcare, certain infrastructure funds, health agreements with provinces, and many minor transfer programs.

The government could consolidate all major transfers to provinces into just equalization and a new transfer, called, say, the “Canada Grant.” Equalization would continue to play the same role it does now, while the Canada Grant would subsume all other conditional transfers into a single unconditional block grant that provinces could use as they see fit.

In exchange for this added flexibility, the transfers could be set to grow at a more modest pace of 3 percent per year—in line with the current Canada Social Transfer, although lower than the average growth of 3.8 percent currently projected. This adjustment would save the federal government approximately $4 billion by 2028, which, while modest, is roughly equivalent to one-fifth of the projected deficit that year.

The new flexibility for provincial governments might make this arrangement acceptable to many of them, even though it would involve slightly fewer dollars.

The status quo must go

Aging populations, rising economic volatility, worsening housing affordability, deteriorating municipal infrastructure, and other factors are driving a growing need to reform our fiscal arrangements.

While there are no easy answers, there are many options like tax room shifts, equalization reform, and more unconditional block transfers that could play a role. These ideas, though not without their challenges, offer a potential roadmap to a more equitable and efficient system.

Now more than ever, the time is ripe for another new deal for provinces.