by Thomas J. Courchene Jarislowsky-Deutsch Professor School of Policy Studies, Queen ’ s and

1. GOVERNMENT, GOVERNANCE AND THE DIVISION OF POWERS:Econ 881/SPS 844 – Introductory NotesWinter -- 2010 by Thomas J. Courchene Jarislowsky-Deutsch Professor School of Policy Studies, Queen’s and Senior Scholar Institute for Research on Public Policy Montreal

2. OUTLINE • Variations on Federalism: Administrative, Legislative • Upper Chambers • Division of Powers • Vertical and Horizontal Fiscal Imbalance • Unitary States and Decentralization • Duplication and Overlap • Accommodating Policy Interdependencies • Subsidiarity • Asymmetric Federalism • Global City Regions and Federalism • Competitive Federalism • Societal Values and the Nature of Federations

3. Administrative Federalism • The characteristic of an administrative federalism is that the legislative authority does not coincide with the administrative authority. • In continental European federations--Germany, Switzerland and Austria-- most legislation is federal while the implementation or administration of these laws is left to the sub-national governments (e.g., taxes in Germany). • This requires extensive collaboration between levels of government. In the case of Germany the key federal institution is the Bundesrat (the upper chamber) which is in reality a House of the Laender, with from 3 to 6 votes per Laender depending on population, and which has a veto on all legislation pertaining to the Laender

4. Legislative Federalism • Federations in the Anglo-Saxon tradition (United States, Australia, Canada) are typically characterized by legislative federalism, where each order of government is generally assigned executive or administrative responsibility in the same areas that it has legislative authority. • This reinforces the autonomy of the legislative bodies (and in particular the sub-national governments) • This is necessary for Parliamentary federations such as Canada and Australia since it is only if the legislative and executive functions coincide that Parliament can hold the executive (government) responsible

5. Sub-national Role in Central Institutions: I • Traditionally, the upper house (often called the Senate) in federal systems plays the role of representing the sub-national governments in the central governing institutions. • The Bundesrat is a true house of the regions in that the representatives (3-6) in the Bundesrat come directly from the Laender government and vote accordingly • The “classical” upper house is triple E---elected, effective and equal. The US Senate is clearly triple E--elected, equal representation by state and effective (i.e., with the same powers as the House, and then some). The Australian and Argentine Senates are close to EEE

6. Sub-national Role in Central Institutions: II • The Canadian Senate is appointed (until age 75), is roughly equal by region (but not by province), and it has essentially the same powers as the House of Commons • However, it generally does not exercise these powers because the process of appointing rather than electing Senators deprives the chamber of the moral authority (or legitimacy) to exercise its full powers. • Since “nature abhors a vacuum” the interests of the Canadian provinces have surfaced in the form of strong provincial premiers who on occasion become the effective opposition to the federal government. One would assume that an elected Senate would reduce provincial power in the federation.

7. Division of Powers: General • There are several ways to assign powers in a federation: • Assign them exclusively to one of the levels of government--federal, provincial/state, or municipal; • Assign them as shared or concurrent powers, typically with federal paramountcy (CPP/QPP is an exception) • Leave them un-assigned but presumably subject to a residual clause or residual authority (e.g., the sub-national level and/or citizens, as in the USA). • The “federal spending power” in most federations allows the federal government to operate in provincial/ state matters (Australia more so than Canada) • Most federations provide the central government with emergency or over-ride powers

8. Division of Powers: Canada vs USA • Canada and the United States represent two very different approaches to the division of powers: • The USA has a set of exclusive federal powers, has some shared powers and then assigns the remaining powers residually to the states or to the people. • Canada has a set of exclusive federal powers, also has a large number of exclusive provincial powers, has a few shared/concurrent powers, and then assigns any remaining powers to the federal government. • Yet in practice the Canadian federation has become more decentralized than the US federation

9. Division of Powers: Tax Assignment: Theory • The tax assignment literature would assign the central government control over customs and excises, over very mobile tax bases (corporate taxes), and over origin or source-based taxes (to prevent interstate tax exporting) • Sub-national levels should have tax bases that have stable revenues and low inter-jurisdiction mobility--e.g., destination-type sales taxes for provinces and property tax for municipalities • Tax bases that are unequally distributed among provinces should be central • Benefit taxation or user fees are appropriate at all levels but are most popular at the municipal level • personal income taxes--federal (because of role in distribution) or state (because they are quite stable)

10. Division of Powers: Tax Assignment: Practice • The VAT (GST) has emerged as a very important tax. Its export/import neutrality makes it ideal for a country that wants a larger government than its trading partners, e.g., Canada has a VAT but the USA does not. These taxes are generally imposed nationally, but there are a few examples of their implementation at a subnational level. • These assignment principles are not always followed. For example, three Canadian provinces have their own corporate income taxes, and unequally-distributed energy resources are taxed provincially • Constitutionally, the Canada’s tax assignment allows the central government to access any sort of taxation, while it limits the provinces to direct taxation. However, the courts have ruled that destination-typesales taxes (PSTs) are direct taxes. Some of these are now in GST format

11. Division of Powers: Expenditures • In a federal system each level of government can be assigned what it can do best. This generally means assigning the federal government the stabilization function (and certainly monetary policy), the distribution function and the provision of those public goods that affect the well-being of the whole society--external policy, defence, food and drug testing, etc • The subnational levels can supply those goods and services designed to serve their residents and those that can differ in line with different jurisdictional preferences. Generally, this includes health, education, welfare, as well as obvious local expenditure and regulatory tasks. • In many federations, these provincial responsibilities have grown dramatically, with the result that the subnational level often spends more than the federal level

12. Vertical Fiscal Imbalance • Most federations are characterized by a vertical fiscal imbalance (VFI). Typically the federal government has access to revenues in excess of its assigned expenditure responsibilities. Sometimes this has developed over time -- for example when subnational spending requirements for say health and education begin to outstrip their access to revenues. • This VFI can in principle be addressed in several ways--transferring powers to the central level, allocating greater tax room to the provinces, forcing the provinces to borrow (only a temporary solution), and relying on intergovernmental (federal-provincial) transfers to offset the VFI. All have been used in the Canadian federation • Most federations resort to intergovernmental transfers on a permanent basis.

13. Transfers and the Division of Powers • The incentives within, and the magnitude of, inter-governmental transfers will have an influence on the de facto or effective division of powers. • Reliance on Conditional Transfers (e.g., 50% sharing grants) can induce provinces to implement the priorities of the federal level and, therefore, may serve to undermine the autonomy of subnational governments • In contrast, Unconditional Transfers serve to enhance provincial autonomy and effective decentralization • Many federations employ conditional transfers to encourage common standards across all provinces and then make them less conditional over time • Over 50% of Australia’s grants are conditional while only about 5% are conditional in more decentralized Canada

14. Horizontal Imbalance • Most federations have equalization programs to address horizontal fiscal imbalances across provinces/states. The USA is probably the only outlier here • Canada’s constitutional wording is: “Parliament and the Government of Canada are committed to the principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public goods and services at reasonably comparable levels of taxation” • Australia has the most comprehensive approach to equalization. It brings states up and down to the national average for both revenue means and expenditure needs

15. Horizontal Imbalance: II • Canada brings all provinces’ revenue capacities up to (or close to) a national standard, but does not equalize the revenue capacities of the rich provinces downward • The German equalization program includes an inter-Laender revenue sharing pool where rich Laender contribute and poorer Laender can draw from the pool • The USA, alone among federations, has no equalizattion program, presumably based in part on the assumption that any differences in fiscal capacities will be capitalized • Equalization payments should be unconditional since they are intended to equalize provinces’own sourcerevenues which, by the very nature of own source revenues, the richer provinces can spend as they wish

16. The Theory of Equalization • The equalization literature focuses on fiscal equity (horizontal equity) and fiscal efficiency as the rationales for equalization. I prefer citizenship and federal rationales • The Federal Rationale would go as follows: For the constitutional assignment of powers to the provinces to be meaningful, they need to have financial resources sufficient to exercise these responsibilities • The Citizenship or Nationhood Rationale is as follows: Citizens, wherever they live in a federation, ought as a right of citizenship to have access to certain basic public goods and services. If these services are assigned, constitutionally, to the provinces then provinces may require equalization payments in order to deliver these basic public goods and services • Unconditional payments for the federal rationale and perhaps conditional payments for citizenship ones.

17. Unitary States and Decentralization • Most unitary states have devolved substantial powers to their municipal levels and sometimes to regional units. • In most Scandinavian countries, cities have access to substantial own-source revenues, e.g., Stockholm has access to a share of the Swedish personal income tax • Indeed, it is likely the case that cities in unitary states have more autonomy and financial flexibility than cities in federations. At least this is true for Canada, where cities are constitutionless and are effectively creatures of their respective provinces (and who, in turn, have chosen not to privilege them with autonomy, fiscal or otherwise)

18. Duplication and Overlap • While duplication can and should be avoided, overlap is ubiquitous in modern federations where everything affects everything else. Gone are the days when the constitutional powers could be assigned to “watertight compartments,” (K. C. Wheare) • Hence, federalism should be seen not only as a static pattern or design, characterized by a particular and precisely fixed division of powers between government levels. Federalism is also and perhaps primarily the process of adopting joint policies and making joint decisions on joint problem • Enter co-determination and intergovernmentalism to accommodate policy interdependencies

19. Accommodating Policy Interdependencies: I • This challenge is much less severe for “Intrastate Federalisms” where the subnational governments feature prominently in the operations of the central institutions. The German federation in the form of the Bundesrat is the premier exemplar here. • For “interstate federalisms” which have little or no subnational representation at the centre, the challenge is more daunting, since the operative process is “federal-provincial diplomacy” • The most obvious way to conduct this diplomacy is via “executive federalism,” namely the meetings of executives from both levels of government. Canada excels in this with more than a thousand of such meetings reported occurring annually

20. Accommodating Policy Interdependencies:II • CANADA: How a very decentralized federation accom-modates horizontal and vertical policy interdependencies. • The mid-1990s Agreement on Internal Trade (AIT) was to ensure that provinces did not fragment the Canadian economic union • The 1999 Social Union Framework Agreement (SUFA) was to secure Canada’s social and human-capital union, including a creative, flexible, and division-of-powers-consistent approach to the use of the federal spending power. In some respects, SUFA resembles European-style co-determination. • The provinces themselves have revitalized Pan- Canadian Provincialism via the Annual Premiers’ Conferences and more recently they have created the pan-provincial Council of the Federation. Ideally, its role would be in part at least to internalize provincial policy externalities • Conclusion: Federalism in century 21 will be as much about process as about formal constitutional structure

21. Subsidiarity and the Division of Powers: I The PRINCIPLE OF SUBSIDIARITY • One component of the subsidiarity principle states that functions should be located as close to the people affected as is consistent with effective delivery (arguably the Information Revolution allows for greater devolution than previously) • The other component states that where externalities or spillovers exist, the function should be raised to that level or jurisdiction where these externalities can be internalized (arguably, the mobility and externalities associated with globalization increases these spillovers and points toward an upward transfer of these functions)

22. Subsidiarity and the Division of Powers: II • Subsidiarity and the factors of production--- land, labour and capital: • Capital is the most mobile (has the largest spillovers), so it is being passed upward---Euro • Land is the least mobile so it is being passed downwards -- airport privatization in Canada • Labour is in-between and in Canada, at least, this jurisdiction is shared between the federal and provincial governments • Therefore, the allocation of powers is in many areas evolving in a manner consistent with the principle of subsidiarity

23. Asymmetry and the Distribution of Powers • In federations like the US, Germany, Switzerland and Australia, the formal distribution of legislative and executive jurisdiction applies symmetrically to all full-fledged member states • Not so in Canada. Quebec has a measure of formal constitutional asymmetry, relating to its cultural, linguistic and legal (civil law) distinctiveness • More importantly, Canada has allowed for “opting out” from selected provisions. For example, Quebec receives more of its federal transfers in the form of personal income tax point transfers and less in the form of cash transfers, i.e., Quebecers pay less in federal taxes than other Canadians and more to their provincial government • Asymmetry is better viewed as solution than a problem

24. GCRs and Intergovernmental Relations • Global City Regions (GCRs) are the new dynamic economic motors and drivers of the Information Era. As a result these GCRs (Montreal, Toronto, and Vancouver …for Canada) will want to play a larger role in their respective federations. This is especially true in federations like Canada where they are not only weak fiscally but are constitutionless ( unlike federations like Mexico where they have been privileged by recent constitutional amendments) • These GCRs have enormous leverage since as they go economically so goes their country. Note also that three of the German Laender (Hamburg, Bremen, Berlin) are essentially global city regions. • Result: GCRs will become more full and more formally integrated into the division of powers in federal nations

25. Competitive Federalism • The traditional theory of economic federalism argues that it is welfare enhancing since it allow public goods and services to be tailored to the preferences of citizens. • Moreover, jurisdictions can compete by offering different bundles of goods and services and citizens can “vote with their feet” as it were • This introduces some of the dynamics of private markets into the operations of the public sector • In particular there is significant potential for provincial experimentation to point the way toward creative and efficient design and delivery mechanisms. • Indeed, it was the province of Saskatchewan’s creative experimentation in health care that paved the way for Canada’s Medicare system

26. Market-Preserving Federalism • Embraces four principles: (Drawing from Weingast/McKinnon) 1. Monetary Separation: Provincial governments cannot own or control commercial banks 2. Fiscal Separation: Provincial governments do not have access to open-ended and/or discretionary central government finances to cover their deficits 3. Freedom of Interstate Commerce: Goods, services, people, firms and capital are allowed to move free and freely across provincial borders 4. Unrestricted Public Choice: Provinces are allowed to compete with one another in designing and delivering alternative bundles of public goods and services and to finance them by alternative means of taxation. (Note that in the context of market-preserving federalism, unrestricted public choice is the same as "competitive federalism") • The first two principles guarantee "hard budget constraints" at the sub-national level, while the third ensures that provinces cannot inhibit the free mobility of goods and factors. Within this environment, the exercise of competitive federalism (or "unrestricted public choice," to use McKinnon's phraseology) will enhance, rather than be potentially destructive of, both welfare and efficiency

27. Societal Values and Federalism: I • Proposition: The evolution of federations (including the effective division of powers and the nature of intergovernmental transfers) is not independent of the underlying social and political values of the society • To see this consider four developed federations • AUSTRALIA: • Australia is a highly centralized federation and it is a highly egalitarian society. It has the most comprehensive equalization system; Welfare is centralized with uniform levels across states; The states are very transfer-dependent and half of these transfers are conditional. (Their transfers have greatly increased with the GST.) • Thus the workings of the Australian federation mesh well with the underlying homogeneity and the egalitarian nature of the Australian constitution and society.

28. Societal Values and Federalism: II • GERMANY • Germany is also centralized and egalitarian but with quite different institutions than those in Australia. Most laws including the rates for major taxes are legislated by the center but implemented by the Laender. The Basic Law calls for “uniformity of living conditions” which is carried out in part by a generous equalization program including an interstate revenue sharing pool. • Again, the operations of constitutional provisions and processes mesh well with the collective nature of German society

29. Societal Values and Federalism: III • CANADA • The Canadian constitution embodies a list of exclusive provincial powers. Beyond this there is substantial decentralization on both the tax and expenditure fronts. Virtually all transfers are unconditional. Equalization is much less comprehensive than in either Germany and Australia. Opting out has been a common feature of the federation • But this coincides with a society that is linguistically, legally and culturally diverse, even apart from the First Nations. Arguably Canada’s decentralization also reflects the fact that the central provinces (Quebec and Ontario) still have about 60% of the population on the one hand and that Alberta is effectively fiscally independent of the center by virtue of its oil wealth

30. Societal Values and Federalism: IIII • UNITED STATES • The rugged individualism or free enterprise nature of American society is reflected in the laissez-faire US constitutional rhetoric “Life, Liberty and the Pursuit of Happiness” • Indeed, alone among modern federations the US does not have an equalization program • CONLUSION: • Intergovernmental transfer arrangements and the evolution of powers are anything but arbitrary. Indeed they complement the existing tax and expenditure allocation in a manner that integrates overall fiscal federalism in directions consistent with the implicit or explicit values and norms of the respective federal system