Incomplete Contracts and the Evolution of Canadian Federalism

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. Provincial governments have access to virtually all taxes, raise more in tax revenue than the federal government and enjoy a high degree of autonomy in respect of priorities for public spending. Canada's fiscal decentralization is in contrast to Australia's experience, which has evolved over time towards greater fiscal centralization. This paper examines the evolution of Canadian federalism from the perspective of incomplete contract theory, according to which residual rights over policies are a source of political influence when negotiating intergovernmental fiscal arrangements. In both countries, federal and subnational governments have been engaged in the same kind of conflict for greater power over policies. The difference between the two countries has been, however, that unlike the Australian States, the Canadian Provinces have successfully resisted the pressures put by the federal government and have regained their fiscal power that was once lost in the wake of the Second World War.