The federal government has signalled that tax relief is on its way for both individuals and businesses. It has also indicated, although less explicitly, that there are no more sacred cows in Ottawa and that all spending programs can and will be reviewed. Given the increased willingness to reduce taxes and spending, the federal government now has an opportunity to simultaneously tackle the fundamental issues of Canadian tax competitiveness and fiscal balance with the provinces through decentralization.

A specific plan outlined in a study released earlier this week entitled Fiscal Balance, the GST and Decentralization calls for the federal government to eliminate transfer payments to the provinces for health and social programs, which are expected to total $31.3 billion in the coming fiscal year (2007-08). The federal government would concurrently reduce taxes in the same amount. The plan specifically recommends reducing the more economically damaging taxes like personal income and business taxes. Reductions in both federal spending and taxes means there is an opportunity for genuine and lasting decentralization to the provinces.

The final step in this plan is for the provinces to increase their own taxes to the extent required to compensate for the loss of federal transfers for health, education, and social programs. Such decentralization would mean that all provinces would now be largely responsible for raising the revenues needed to provide these programs. It would also mean less interference by Ottawa and more flexibility for the provinces to experiment in how best to provide these programs.

The plan also strongly recommends that the provinces increase their use of provincial sales taxes based on a GST model rather than increasing other less efficient taxes. This would mean that the four provinces (QC, NS, NB, and NF) with an existing provincial GST would have to increase their current rates. The five provinces that maintain an independent provincial sales tax (BC, SK, MB, ON, and PEI) would need to adopt a provincial GST. The plan also calls for Alberta, the lone hold out on using sales taxes to introduce a provincial GST.

The provincial GST rates, which would be in addition to existing sales taxes, range from a low of 4.2% in Alberta to a high of 7.1% in Newfoundland and Labrador, with Ontario at 5.6% and B.C. at 6%. The rates are considered a worst case scenario since it is more than likely that given greater flexibility and more direct accountability to citizens, provincial governments will figure out better and more cost effective ways to deliver social programs.

There are two principal benefits arising from this decentralization proposal. First, there would be a marked change in the country’s tax mix. Canada would dramatically move away from its reliance on economically damaging taxes such as business taxes and move towards the more efficient consumption taxes such as the GST. In other words, the tax burden would not increase but we as a country would implement a better and more efficient mix of taxes.

Beyond this efficiency consideration, this plan addresses the competitive concern that Canada is an outlier in the industrialized world in terms of our heavy reliance on the most economically damaging taxes –personal and business income taxes. Canadian governments collect 46 percent of their revenue in income and profit taxes compared to an average of 34 percent among industrialized countries. The changes outlined in this plan would bring Canada more in line with our competitors.

The second main benefit derived from this set of reforms is meaningful decentralization from the federal government to the provinces in terms of financing and delivering some of the country’s most cherished social programs. The reforms would require the provinces to both raise the necessary revenues to pay for these programs and be directly and solely responsible for their performance. It would eliminate the ambiguity that currently exists in Canada in terms of what level of government is actually responsible for health and education.

Canada has an opportunity to simultaneously deal with the current imbalance between Ottawa and the provinces while improving the country’s tax system and introducing greater accountability in program provision through meaningful decentralization. The reforms outlined would provide benefits to all Canadians through a better tax system and greater flexibility for the provinces to experiment and innovate in the delivery of social programs.