Balance of Risks: Vertical Fiscal Imbalance and Fiscal Risk in Canada

Produced by the Mowat Centre at the School of Public Policy and Governance, University of Toronto.Provincial governments have responsibility for delivering most of Canada’s important social programs, whereas the federal government has the discretion to pick and choose how much it wants to spend to support them at any given time. This results in a fundamental imbalance in the amount of “fiscal risk” federal and provincial governments are exposed to. Fiscal risk is a measure of the degree to which government has control over a specific area of spending; more control over programmatic spending equals less risk, and vice versa. The imbalance in fiscal risk between Canada’s orders of government is a significant contributor to fiscal imbalance in Canada. Furthermore, provinces are more fiscally vulnerable to localized economic shocks, which in turn can frustrate their ability to deliver the open-ended programs that they are responsible for. This imbalance represents an opportunity as much as it poses a challenge. The federal government can leverage its lower exposure to risk to make Canada as a whole more fiscally sustainable and resilient. Reforming federal transfers to the provinces to better reflect the fiscal risk that comes with Canada’s important social programs will be a critically important step in addressing the Vertical Fiscal Imbalance. The provinces’ greater exposure to fiscal risk and vulnerability to short-term economic risk can be addressed through relatively simple reforms to Canada’s fiscal stabilization and fiscal stimulus mechanisms. These reforms would affect a better sharing of both short-term economic risk and the structural allocation of fiscal risk in the federation