Federal Government Revenue and Spending by Province: A Scorecard of Winners and Losers in Confederation?
by S. West*
The Provincial Economic Accounts (PEA) provide annual estimates of macroeconomic variables for each province and territory back to 1981. In addition to well-known items such as gross domestic product, consumption, investment and trade, the accounts include detailed estimates of revenue and expenditure for the federal, provincial and local levels of government. While data for all three levels of government receive attention from a variety of users, the estimates for the federal government are sometimes used superficially to calculate which provinces or territories are net ‘winners’ or ‘losers’ in Confederation. This paper will discuss the concepts, sources and methods behind these estimates and show the many pitfalls involved in their use to determine who benefits from federal activities.
Given the seemingly straightforward presentation of federal government revenue and expenditure in the PEA, it is easy to understand why these statistics are sometimes used erroneously to try to assess net winners and losers in Confederation. The tables show federal government revenues, expenditures, savings and net lending by province and territory on a National Accounts basis. Subtracting expenditures from revenues yields federal government saving by province and territory; adding capital consumption allowances and net capital transfers and subtracting the acquisition of non-financial capital produces net lending. This net lending estimate can be interpreted as a surplus/deficit position and as such has sometimes been used to support arguments that a province or region is a net winner or loser in dealings with the federal government in a particular year.
Table 1 shows federal government net lending by province and territory for 2004. From this table it appears that Ontario, Alberta and British Columbia were net losers in dealings with the federal government in 2004, as they were the only provinces with positive federal net lending (that is, federal revenues were greater than expenditures in those provinces). By extension, all other provinces and territories were net beneficiaries from federal government activity as they had negative federal net lending (federal revenues were less than expenditures in those juristictions).
Table 1 Federal government net lending by province in 2004
||Millions of dollars
||Dollars per capita
|Newfoundland and Labrador
|Prince Edward Island
Right away, however, the first flaw in this analysis is obvious. Extending the reasoning to Canada as a whole in 2004 would imply that, since the federal government had positive net lending nationally, the country as a whole was a loser. This logic also implies that when the federal government was posting very large negative net lending during the early 1990s, Canada as a whole was a winner due to this fiscal deficit. While this beguiling table may indeed shed some light on relative fiscal benefit within Confederation, these issues are in fact complex and do not lend themselves to such facile answers.
Inter-provincial, as well as inter-governmental, economic relationships in Canada are complicated. While the federal government may, for example, transfer money to the Atlantic Provinces under the equalization program, that money might then be used to purchase medical equipment manufactured in Ontario. In this instance who benefits? Does defence spending on a naval base in BC only benefit the west coast? While these are interesting questions, they are not ones that the PEA are designed to answer.
One purpose of the PEA is to estimate the value of the goods and services produced within each province and territory in Canada. From this starting point, the Accounts then adjust for the net impact of governments (and other sectors) on revenues and spending in order to estimate the income available for spending in each province. Clearly, how the federal government raises taxes and allocates spending across the country affects the income of each province and territory.
The provincial distribution of federal revenue and expenditures in the PEA is intended to show the sources and uses of federal funds by province. The calculation of these estimates is not always straightforward, as will be discussed. But even if the estimates could be perfected, it is important to understand that they do not provide, nor are they intended to be, a scorecard of which provinces are net beneficiaries from federal activities. Many federal programs are administered in one geographic area but benefit all Canadians: these programs range from providing public safety to developing policies to support for children, the sick and the elderly. In all these cases, the benefits flowing from the programs extend across the country and not just the province that directly receives the wages and salaries required to administer the program.
For the provincial and local levels of government, much of the source data used to compile the PEA are readily available. For the federal government, on the other hand, national estimates have to be allocated on a provincial or territorial basis. These allocation methods were chosen because they correspond with the purpose of the PEA, which is ultimately to calculate income by province and territory. As a result, performing a cost-benefit analysis of Confederation simply using the federal government revenue and expenditure estimates of the PEA is erroneous. The fiscal arrangements in our confederation are far more subtle than that. An understanding of how these tables are derived, and the allocation methods therein, will shed light on why this is the case.
Federal government revenues
Federal government revenues in the PEA are allocated to the province or territory from which the revenue arises, but it should be noted that some of the allocations by province are more difficult than others. The discussion below will focus on the larger revenue items only.1
The estimates of direct taxes from persons, taxes on production and imports, and contributions to social insurance plans come mainly from taxation data or government financial statements and as such the geographical allocations are very precise.
The estimates of federal government investment income and capital consumption allowances by province often have to be estimated indirectly and the geographic location of the economic activity generating the revenue or capital expense is not always clear. As a result there is some ambiguity as to where investment income and depreciation should be allocated.
The receipts of federal government direct taxes from corporations (including government business enterprises) are the most difficult to allocate geographically.
By far the largest component of federal government revenue is personal income taxes ($94.4 billion or 46.3% of federal revenue in 2004). These are allocated to the province of residence2 of the person paying the tax using data from the Canada Revenue Agency (CRA). Given the progressive nature of income taxes, it should not be surprising that the highest levels of per capita direct taxes tend to originate in provinces with the highest per capita taxable personal income.
The estimates by province of revenue from taxes on production and imports ($46.2 billion or 22.7% of federal revenue in 2004), such as the GST and excise taxes, are allocated based on the province of final consumption of the goods or services.3
Contributions to social insurance plans ($17.2 billion or 8.5% of federal revenue in 2004), including those paid by employers, are allocated on the basis of the province of employment reported on the T-4 supplementary form, which may not be the province of residence of the employee. This means that one province will appear to contribute to federal revenue, while the province of residence will be shown as receiving the payments disbursed by these plans.
Capital consumption allowances, or depreciation ($3.7 billion or 1.8% of federal revenue in 2004), are allocated by province from a perpetual inventory of capital stock. This inventory uses a Statistics Canada survey to identify the province in which the capital investment took place. This allocation is not as straightforward as it may appear because of mobile assets, such as aircraft, ships and automobiles. By definition, such assets are not easy to allocate as they can be in different locations at different times during the survey. As a result, the convention used in the PEA is to place these assets in the province or territory in which they are permanently stationed. For example, if the federal government purchases a helicopter and stations it in Nova Scotia, then the helicopter will be allocated to Nova Scotia in the capital stock inventory regardless of where the helicopter happens to be at the time of the survey. As a result of this allocation of the capital stock, the depreciation of the helicopter will also be allocated to Nova Scotia in the PEA.
Corporate income taxes totalled $30.1 billion or 14.8% of federal revenue in 2004. They are allocated provincially from taxable corporate income and other data on operations filed by corporations with the Canada Revenue Agency. Although CRA has established criteria as to how corporations are to report their taxable income and income taxes by province and territory, difficult statistical issues remain regarding the location of productive activity and the income taxes owed by multi-national and multi-provincial corporations.
These corporations can have operations in one or several provinces or territories and their head office in another. Consider the example of an integrated energy company that has its head office in Alberta, produces oil and gas in Alberta, conducts exploration activities offshore, has refineries operations in Alberta and Ontario, and sells gasoline across the country. Similarly, a large Canadian financial institution has its head office in Ontario and branches across the country, but derives most of its income from financial transactions whose geographic locations are ambiguous, especially transactions done on the Internet. The questions of where and how to allocate profit, taxable income and income taxes in these cases are among the most difficult faced in the Provincial Economic Accounts.
In practice, the corporate income tax data from CRA are adjusted to better integrate them with PEA estimates of corporate profits by province and to ensure that they reflect the province or territory of productive activity. Done at the level of aggregate profits, this is an imperfect process, as the resources do not now exist for an analysis of CRA data by enterprise. Furthermore, the intricacies of constantly changing corporate structure–joint ventures, partnerships, and the like – make the task all the more complex.
Federal government investment income ($6.2 billion or 3.1% of federal revenue in 2004) includes profits remitted by government business enterprises, such as Canada Post, Via Rail and the Business Development Bank. It is allocated according to the province or territory in which the income is generated, although that is not always clear-cut for firms operating in more than one province. The estimates come from a variety of sources, such as the Public Accounts of Canada and the financial statements of public and private corporations. The same contentious issues raised for the provincial allocation of corporate profits apply to these estimates.
Federal government expenditures
Expenditures are allocated to the province or territory in which the consumption of federal government resources occurs but, as with revenues, some allocations are more difficult than others. Spending can be broadly grouped into current expenditure on goods and services, current transfers, interest on the public debt, and acquisition of non-financial capital. As with revenues, the discussion below will focus on the larger expenditure items.4
For current transfers to persons and provincial governments, specific information on where payments are received is available.
For the estimates of current expenditure on goods and services, current transfers to business and the acquisition of non-financial capital (particularly mobile assets), specific information is not always available to determine their allocation by province, and some indirect information must be used.
Allocation of interest on public debt presents the most difficulty since the location of the ultimate holders of federal government debt is not known, especially since so much is held by firms on behalf of broadly scattered investors.
Current transfers to persons ($65.4 billion or 33.1% of federal expenditure in 2004) include child benefits, pensions and unemployment benefits as well as those to non-profit organizations and First Nations people and their organizations. These transfers are allocated geographically based on the residence of the recipient. While the allocation of the province receiving the transfer is straightforward statistically, this does not necessarily reflect all the benefits to society: pensions received by the elderly or transfers to groups to alleviate poverty presumably benefit most Canadians (often directly involving other family members), but this is not captured in the provincial accounts.
Current transfers to provincial governments ($40.8 billion or 20.6% of federal expenditure in 2004) are allocated to the province or territory which receives the payment.
Again, transfers to provinces do not necessarily reflect benefits. Governments implemented programs such as equalization payments and medicare because more equality of government services in all provinces was deemed a benefit to all Canadians, not just those in the provinces receiving the transfer. Indeed, most Canadians have friends and relatives that they care about spread all across the country. Of course, however, this indirect benefit cannot be measured in the provincial accounts.
The allocation of federal government current expenditure on goods and services ($45.9 billion or 23.2% of federal spending in 2004) is complicated by the issue of the value of the goods and services produced by the governments. No market exists for most of these goods and services, so no transactions or selling prices are available.
The Provincial Economic Accounts follow the current international standard for national accounting by assuming that the value of the goods and services produced by the federal government is equal to the cost of the inputs consumed in producing them. This international standard is open to challenge as, for instance, it does not recognize productivity growth in the delivery of government services (however, that is a topic for a different paper).
Federal government current expenditure on goods and services is divided into three components: wages and salaries; capital consumption allowances; and non-wage expenditure:
Wages and salaries are allocated by the province of employment, as reported on T-4 slips. Again, note that while this allocation is quite straightforward statistically, it is largely separate from the question of which province benefits. Civil servants working and being paid in one location are presumably providing benefits shared by people across the country, although there are also spin-off benefits to the province where they are located in terms of the economic activity generated locally. Note too that the province of residence of the civil servants may differ from the province of employment in some instances.
As mentioned above, the depreciation of the federal government’s assets by province is estimated from a perpetual inventory of capital stock.
The non-wage component of current expenditure on goods and services is allocated by their consumption as reported by the various federal government departments.
Depending on the statistical purpose intended, non-wage expenditures could be allocated on one of three different basis: procurement, purchasing, or consumption. On a procurement basis, federal government expenditures are allocated to the province or territory in which the goods or services are produced. A purchasing basis allocates the spending by where the goods and services are bought. A consumption basis allocates by where the goods and services are used.
To clarify the three bases of allocation, consider the federal government’s purchase of uniforms for the Royal Canadian Mounted Police. The Ontario-based head office of the RCMP could purchase uniforms manufactured in Quebec and then distribute them to officers in Manitoba. With a procurement allocation, these RCMP expenditures would go to Quebec; with a purchasing basis they would be allocated to Ontario; and on a consumption basis they would belong in Manitoba.
The convention used in the PEA is to allocate federal spending on goods and services on a consumption basis. This is because the value of the goods and services produced by the federal government is defined as being equal to the cost of the inputs used in producing them. Extending this convention to geographic allocation, production of government goods and services is allocated to the location in which the inputs to that production were consumed.
Take, as a final example, the federal government’s purchase of a piece of military equipment. If the Government of Canada purchases a piece of military equipment from a manufacturer in another country and stations it in Saskatchewan, it will be allocated to Saskatchewan in the PEA, even though this foreign-built equipment will be producing defence services that will benefit all Canadians. It is allocated to Saskatchewan because that is where it is used in producing defence services.
Current transfers to business ($5.0 billion or 2.6% of federal expenditure in 2004) comprise federal government subsidies to business. They are allocated to the province or territory where the economic activity being subsidized takes place. Sources for this allocation include agricultural subsidies as reported to Statistics Canada, and for non-agriculture subsidies, financial statements of public corporations and the Public Accounts of Canada. In practice, it is not always possible to precisely identify the location of the economic activity being subsidized when the recipient of the subsidy is a business which operates in several provinces.
The estimates by province of federal purchases of non-financial capital ($3.5 billion or 1.7% of federal expenditure in 2004) such as buildings or equipment come from a Statistics Canada survey. Like depreciation, these estimates are subject to the same issues and conventions with respect to moveable capital, in that they are allocated according to where the asset is permanently stationed or assigned.
The provincial allocation of federal interest on public debt ($33.5 billion or 16.9% of federal expenditure in 2004) presents particular challenges. The ideal method for an analysis of the sources and uses of federal funds would be to trace the debt payment to the province of the investor that receives the money. In practice, this is not possible because of the constant trading of these debt instruments in the marketplace (often by pension funds or corporations acting on behalf of the ultimate beneficiary).
Since it is not possible to obtain the information on debt holdings necessary to perform the ideal allocation by province of federal interest on public debt, an allocation on a per capita basis is used as a proxy in the PEA. Since the Government of Canada borrows to help finance the production of government goods and services consumed by all Canadians, and since all Canadians are equally liable for federal government debt and for servicing it, the use of a per capita proxy seems reasonable.
Alternative methodologies include an allocation based on the proportion of federal government assets in each province and territory, but every method has advantages and disadvantages. For example, using the allocation of fixed assets provides precise estimates, but assumes that all government debt was incurred to buy these assets. Cash raised through the issuance of debt is, of course, fungible and as such cannot be directly associated with specific expenditure categories.
All these statistical questions about allocating the debt are far removed from the costs and benefits of the debt. It would be almost impossible to determine where the debt was incurred by province, especially debt issued to meet interest payments. Moreover, some spending is done outside Canada (such as servicing foreign-held debt or international peace-keeping missions). The existence of federal debt itself helps underpin smoothly functioning bond and money markets by providing secure investment opportunities, an indirect benefit to all. Clearly, this area remains open for research and discussion.
A basic problem in trying to assess the provincial winners and losers in Confederation, by using the geographic distribution of federal revenues and expenditures in the PEA, is that the provincial accounts are not designed to identify costs and benefits. Take for example a federal prison in New Brunswick: the costs to the federal government of such an institution would include the capital investment in buildings, grounds and equipment as well as the ongoing operating expenses, mostly wages and salaries. All these costs would be allocated to New Brunswick in the PEA and would probably be seen by the people of that province as a benefit, since the money would largely be spent locally (although some goods and services would be produced elsewhere) and the prison would provide jobs and a general economic stimulus locally.
On the other hand, the benefits Canadians get from the prison would be distributed across the whole country. Convicted criminals from all parts of Canada might be incarcerated there and their removal benefits communities across the country. The deterrent and rehabilitative benefits of the penal system, too, would be felt in all parts of Canada. Lastly, the negative side-effects of the prison would be concentrated almost completely in New Brunswick, as people in British Columbia would not have to be much concerned about escapees, nor would they have to look out their windows at a prison. None of these benefits or costs are measured in the Provincial Economic Accounts.
The underlying problem in measuring the costs and benefits of Confederation – using the PEA or not – is that all federal activity has both costs and benefits. The costs are relatively easy to measure, while the more general and widely shared benefits are, unfortunately, much less quantifiable either in magnitude or in geographic location.
The intention of the PEA is to estimate the value of production of goods and services in each province and territory and the sources and uses of the income flowing from that production. As such, the Provincial Economic Accounts have come to adopt conventions and allocation methods for federal government revenues and expenditures that are considered the best available for these purposes. While these conventions and methods may be reasonable for certain purposes, they may not be for others. Statistics Canada did not choose these methods and conventions with the intention of analysing the provincial distribution of costs and benefits of federal government actions and policies. As a result, users should be aware of the allocation methods and conventions used to produce these estimates before using them as a precise measuring stick of the costs and benefits of Confederation.
Appendix: Other Components of Federal Spending and Revenues
Direct taxes from non-residents ($4.6 billion or 2.3% of federal revenue in 2004) are allocated by province according to CRA data on dividends earned that are subject to withholding taxes. This component of federal government revenue is reported on an enterprise basis according to the location of the head office.
Estimates of federal government revenue arising from current transfers from provincial governments ($1.1 billion or 0.5% of federal revenue in 2004) are allocated to the province which made and reported the payment to the federal government. For clarity and consistency with the National Accounts, the PEA uses the data from the payer and not the payee (in this case, the federal government).
Other current transfers from persons ($0.1 billion of federal revenue in 2004) are allocated using the distribution of direct taxes from persons since there is no by-province data available.
Net capital transfers ($-0.1 billion of federal revenue in 2004) of the federal government consist of capital transfers to persons and business,5 less capital transfers from persons. Capital transfers to persons are allocated on a per capita basis, while capital transfers to business are allocated to the province of the recipient business. Capital transfers from persons include primarily the amortization of the actuarial surplus of the public service pension plans, and are allocated based on the provincial distribution of public service employee labour income.