Towards a Better First Nation Fiscal Relationship - Trust Tax Room, Not Transfers

First Nations are in the process of negotiating a new fiscal relationship which will better define the financial responsibilities of all governments, the revenue authorities of First Nations and the transfer system that will supplement this. 

There are two ways to finance government in Canada: (1) Collect taxes directly and (2) Receive taxes indirectly from another government through a grant, transfer or resource revenue sharing.  A new fiscal relationship for First Nations must determine the most sustainable way to finance First Nation government.  Stated differently, what is the right combination and relationship of First Nation taxes and transfers to support an improved fiscal relationship?

 

On the surface, taxes and transfers may appear to be equivalent.  For example, projected revenues in Treaty offers often show projected transfer revenues as dollar for dollar equivalent to projected tax revenues.  The theory is “money is money”. 

However, recent history has shown these two things should not be considered as interchangeable, particularly to First Nations seeking a new fiscal relationship.  Tax room has proved to be a much more reliable revenue source than cash transfers.  This is incredibly important if the goal is to create a fiscal relationship that will serve, not just this generation, but the next ten generations.  History suggests the focus should be tax room, and not only tax room, but unencumbered tax room.  Unencumbered means tax revenues that cannot be unilaterally capped, offset or be made subject to new conditions. 

Many examples in Canada’s recent fiscal history illustrate this point. 

For example, 50 years ago, the federal government encouraged provincial governments to establish universal health care, by providing new revenues to any province that would provide such health care.  The new revenues were a combination of tax room transferred from the federal government to provincial governments; and, an annual cash transfer that was of roughly equivalent value (50/50).  The intent was the grant would grow at the same rate as the value of the tax room into the future. 

However, this did not happen.  Instead, the federal government got into Budget troubles and looked for ways to reduce spending.  One of the best ways, from a political perspective, was to reduce transfers to provinces, because they would then bear the political consequences of service reductions.  Consequently, tweaks were made to the transfer formulas over several years. 

The end result is illustrated in the chart below.  The transfer grew by 7 per cent over this time frame. The value of the tax room grew by 50 per cent, or more than seven times as much. 

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The lesson should be unmistakable.  Revenues that are generated by transferred tax room are more reliable than revenues provided through a grant especially when fiscal times are hard.   

This is likely why it was so important to the fathers of Confederation that the new provinces not only be given unassailable powers in the new federation, but also substantial tax room with which to finance the exercising of those powers. 

Tax room has proved to be more resilient than transfers because the federal government can easily and  legally make unilateral changes to transfer agreements.  This was confirmed in 1991 by the Supreme Court of Canada. 

The issue arose in 1990 when the federal government decided to unilaterally alter the terms of a cost sharing agreement with the governments of British Columbia, Ontario and Alberta.  The cost sharing agreement was the now defunct Canada Assistance Plan (CAP).  Under CAP, the federal government had agreed to 50/50 cost share a select set of social service costs.  However, in 1990, the federal government decided to cap the amount it would cost share to what were then the three “have” provinces of Ontario, Alberta and British Columbia. 

British Columbia chose to refer the matter to the Courts arguing the federal government had created an “expectation” they would continue to compensate BC as before. 

The Supreme Court eventually ruled the federal government was free to unilaterally alter funding arrangements.  The major point was that Parliaments could not constrain the ability of future Parliaments to alter policies or laws, and that this was particularly important with “money bills”. 

The practical meaning for First Nations seeking a new fiscal relationship should be clear.  The focus needs to be on creating tax room for generating revenues because this is going to be much more secure than cash transfers.