Vertical Sharing and Horizontal Distribution of Federal-Provincial Transfers in Canada, 1983-2018

Abstract

The Canada health transfer (CHT), the Canada social transfer (CST), and the equalization program are the main pillars of intergovernmental transfers in Canada. These transfers aim to address the vertical and horizontal fiscal imbalances that arise within the Canadian federation. This article provides a framework for the decomposition of federal transfers into their vertical and horizontal components. The empirical analysis is carried out for the period 1983-2018, which is divided into seven subperiods for analytical purposes. The results for the most recent subperiod, 2015-2018, show that (1) vertical, horizontal, and surplus transfers account for 74.85, 24.27, and 0.88 percent, respectively, of the total federal transfers; (2) the federal transfers addressed nearly 77 percent of the initial horizontal fiscal inequalities; (3) the equalization program is the primary channel for reducing horizontal fiscal inequalities, accounting for 85 percent of the total horizontal transfers; and (4) the CHT and CST have effectively become a channel for vertical transfers, contributing little toward horizontal equalization. In this context, there is potential for reform in the federal transfer system. The author suggests that vertical fiscal imbalances could be reduced by transferring tax points to provinces instead of providing specific-purpose transfers. The author also argues that immediate reforms are required in the fiscal stabilization program to address the concerns of oil-producing provinces that face a revenue shortfall because of the decline in oil prices.