Abstract submitted for the

67^th IAES Conference, Rome, Italy

11-14 March 2009

Bhajan S. Grewal

Professor

Centre for Strategic Economic Studies

Victoria University

Phone: +61 3 9919 1344; Fax: +61 3 9919 1350 E-mail: Bhajan.Grewal@vu.edu.au
JEL classification: H11, H77, H87,
Key words: Decentralization; Fiscal federalism; Vertical fiscal Imbalance; Canada
Main Focus of this paper is macro.

ABSTRACT

Even though the British North American Act 1867 established the Canadian federation with a dominant federal government, Canadian provinces today enjoy much greater fiscal autonomy than they inherited from the constitution. Canada’s federalism is now operating close to the benchmark of a ‘market preserving federalism’. Provincial governments have access to virtually all taxes and raise more in tax revenue than the federal government. Being virtually self-sufficient in revenues, provinces also enjoy a high degree of autonomy in respect of priorities for public spending. They operate under the market-type discipline of hard budget constraints and are accountable for their fiscal choices.

Canada’s experience in this respect is not typical, however, as many federations, including Australia, exhibit a tendency to evolve over time towards greater centralization (Grewal and Sheehan 2004). The aims of this paper are to determine the key drivers of the Canadian model of fiscal decentralization, and to draw possible lessons for other federations. As economic theories of federalism shed little light on the forces driving the longer-term evolution of federalism, explanations must be sought through empirical studies, such as this one.

This paper finds that reductions in vertical fiscal imbalance (VFI) have driven the evolution of Canadian federalism since the 1960s by contributing to the emergence of market preserving conditions for subnational governments. The term ‘market preserving federalism’ has been used by Weingast (1995) and others to depict a type of fiscal federalism that functions on market-based principles of hard budget constraints, autonomy, accountability and transparency. These principles require inter alia that sub-national governments have access to major revenue sources so as to be fiscally self-sufficient and that the role of intergovernmental fiscal transfers is minimal. The institutional and cultural influences that facilitated reductions in VFI are also discussed.     

Finally, lessons are drawn for future reforms of federalism not only in Australia, but also more widely. In recent years, a large number of small countries have embraced fiscal decentralization - e.g. in the former Soviet Union States and the East European emerging market economies. In the European Union also, member countries have been concerned to ensure that greater fiscal centralization in Brussels does not threaten their chosen degrees of fiscal decentralization. These countries should also be able to learn from the experience of Canada. References