By: Casey Vander Ploeg, Senior Policy Analyst, Canada West Foundation
From the 1950s to the 1970s, borrowing was one of the single largest sources of municipal infrastructure financing. But after the deficit and debt scare of the 1990s, and the fiscal belt-tightening that followed, borrowing on the public credit became almost universally despised. The conventional wisdom that developed is that all government expenditure—including infrastructure—should be met out of current revenue. No borrowing. Period. While the point may have some merit in the federal and provincial context, it certainly doesn’t in the municipal context.
Municipal Budgets are Unique
First, municipal budgets are much more capital intensive. In 2010, the City of Calgary’s infrastructure investment was 54% of its operating expenditure. Capital expenditures and grants in the 2011 Alberta budget are only 19% of operating expenditure.
Second, municipalities typically face a few very large projects. Federal and provincial capital budgets are filled with dozens of relatively small projects. Unlike federal and provincial governments, municipalities have very little flexibility to finance their capital needs by timing infrastructure projects.
Third, municipal borrowing is entirely different than federal or provincial borrowing. Most federal and provincial debt has been acquired as a result of operating deficits—borrowing to cover ongoing expenses like the provincial payroll. By law, municipalities in most provinces cannot run operating deficits. When municipalities borrow, it is always for infrastructure. The difference here is between “smart” debt and “stupid” debt. “Smart” debt equates to the mortgage on a home, where the debt incurred is offset by a valuable capital asset. “Stupid” debt is incurred to consume, like buying groceries on a credit card and then carrying the balance month after month or even year after year.
Fourth, the conventional wisdom is excessively conservative. Corporations with a strong balance sheet borrow. Why? Because it makes sense to grow the business by financing productive assets with debt. The same applies to local governments and infrastructure. The absence of any tax-supported debt is not the litmus test for fiscal responsibility. Rather, fiscal responsibility involves balancing the operating budget over the business cycle and maintaining or increasing financial net worth across the long-term. None of this is an argument against borrowing for infrastructure.
In short, a completely debt-free city should never be the ultimate goal of fiscal policy, regardless of how well it plays politically. This is especially the case if the trade-off is an underfunded stock of capital assets. The “pay-as-you-go” approach is arguably better for a city fiscally, but it does not always contribute to the overall health of a city, which certainly encompasses more than the balance sheet.
The concept of “smart” debt has emerged to help bolster support for borrowing as a valid form of infrastructure financing. The concept seeks to build consensus around the use of debt by emphasizing its role as part of any long-term capital plan, and recognizing that “pay-as-you-go” cannot accommodate all infrastructure needs. “Smart” debt sets out broad parameters on how a city should borrow. The idea comprises five elements.
1) Appropriate projects: Ideal infrastructure for borrowing is large and expensive, has a long lifespan, is one-time or non-recurring in nature, and where borrowing can lever additional financing elsewhere.
2) Debt levels: Smart debt means sustainable borrowing by using some notion of “optimal” debt relative to current operating revenues and anticipated growth of that revenue. Smart debt requires cities to work through the thorny question of their tolerance for debt. In February of 2002 for example, the City of Calgary implemented a new capital financing policy that allowed for significant new borrowing. But, strict limits were set. The cost of servicing all tax-supported debt could not exceed 10% of tax-supported expenditures. In October of 2002, the City of Edmonton also approved a new debt policy. Total debt charges were not to exceed 10% of city revenues and debt charges for tax-supported debt were capped at 6.5% of the tax levy.
3) Amortization: Smart debt does not see amortization terms set arbitrarily, or with the sole consideration being lowest cost. Rather, amortization terms reflect the life of the asset. Amortization terms in Canada today tend to be in the 10-20 year range, but in the past, 25-30 year debentures were not uncommon, and they are still in use across the US. Longer amortization lowers the costs of debt servicing and also allows more borrowing to occur. While this does mean paying more interest, a lot of that interest is offset by avoiding the costs of future inflation. Longer amortization is more than reasonable for assets with a life span of 50 or even 100 years. A good example comes from the City of St. John, New Brunswick, where the City proposed a significant user fee increase to fund a 20 year debenture for water and sewer improvements. The local Chamber of Commerce, balking at the magnitude of the rate increase, proposed that the debt term be extended to 30 years, the maximum allowed under provincial legislation. The Chamber argued that the user fee increase could be almost halved.
4) Debt structure and technique: In Canada, most municipal borrowing occurs through amortized debenture bonds where both interest and principal are paid in equal installments. But, the world is full of other options. One example is “retractable” or “bullet-style” debt where only the interest is paid for the first half of the term with principal payments coming on line for the second half. This debt can be used to advance desperately needed infrastructure. Smart debt argues for using a variety of borrowing structures and techniques:
- Municipal Tax-free Bonds
- TIF Bonds
- Local Improvement Bonds or Special Assessments
- Revenue Anticipation Notes and Revenue Bonds
- Bond Banks
- Revolving Loan Funds
- Senior Government Infrastructure Banks or Credit Enhancements
5) Repayment: Smart debt recognizes that borrowing can only finance infrastructure—the borrowing itself must be funded. Before issuing debt, cities draw up a comprehensive repayment plan. A good repayment plan incorporates the concept of earmarked taxation to build public support for increased capital spending and the issuance of debt. It’s easier to sell the public on incremental tax increases when they are earmarked for projects that are highly valued. The City of Calgary has earmarked special property tax levies to fund borrowings, and so has the City of Edmonton. The City of Saskatoon also expressed interest in earmarking a portion of the federal fuel tax revenue to repay debentures.
How Much Debt?
The most contentious feature of any “smart” debt policy is building a consensus around what constitutes a tolerable level of borrowing. Achieving agreement here is difficult because of the subjective nature of the question. At the same time, there is a way to conceptualize the issue and sharpen the focus. The process starts by recognizing that the tax revenue of most governments tends to grow over time. Against this tax revenue growth several “scenarios” can be plotted (Figure 1).
When debt—or the cost of servicing debt—is growing faster than tax revenue, the trend is both unreasonable and unsustainable. This is Scenario #1. The growing cost of debt will continue to chip away at tax revenue and crowd out other expenditures. At the opposite extreme is a steadily decreasing level of tax-supported debt, which given the huge infrastructure funding challenge, is just as unreasonable. This is Scenario #4. A reasonable and sustainable level of debt lies somewhere between Scenarios #2 and #3, which would see the outstanding stock of debt and debt servicing costs increasing over time, but never at a pace that outstrips tax revenue growth. There is no deterioration in a city’s fiscal position if outstanding debt and the costs of debt servicing grows in proportion to the growth in revenues—assuming of course that taxes are not intentionally raised beyond reasonable levels.
The point is that “runaway” debt and a “debt-free” city are both extremes to be avoided. Between the two lies a reasonable and sustainable level of debt.
Debt is Becoming “Smarter” in the West
Western Canada’s large cities have not always fared that well considering the general concept of “smart” debt. The Edmonton experience is illustrative (Figure 2). Starting in 1990, Edmonton embarked on a quest to decrease its debt. By 2003, tax-supported debt had fallen from $200 million to $24 million. Meanwhile, tax revenues continued to grow, as did the city’s infrastructure funding gap. Throughout most of the 1990s, the City of Edmonton was arguably following an “unreasonable” debt policy. Since 2000, however, tax-supported debt has grown, which reflects a change in borrowing policy.
Edmonton is not alone (Figure 3). This is the same pattern reflected across most of the West’s big cities. The City of Regina actually succeeded in eliminating all tax-supported debt, and Saskatoon came very close. Only the City of Vancouver has seen debt levels growing in tandem with tax revenues. However, recent increases in tax-supported debt do represent a much more balanced view of the role that borrowing can—and should—play in infrastructure financing. This is not a situation to be bemoaned, but applauded.
One of the reasons is that the timing for borrowing just could not get any better. Interest rates today are at the lowest point seen over the past 50 years (Figure 4). For cities with the capacity and the need to borrow, there may be no better or cheaper time than now.
To round out discussion over the smart debt option, it is important to understand the three stages of addressing a deficit—whether it be a budget deficit or an infrastructure funding deficit. First, growth in the deficit needs to be arrested (ensure the bleeding does not get worse). Second, the deficit needs to be closed (the bleeding must be staunched). Third, the accumulated infrastructure “debt” resulting from annual “deficits” needs to be addressed (the spilled blood needs to be cleaned up).
The potential of smart debt operates within the first step. There are four different approaches. The first approach (Figure 5) sees the entire annual funding gap (the red line growing over time) financed in the short-term by debt. Here, debt solves the short-term funding crunch but the amount of debt quickly bumps up against a previously set tolerance level. At that point, borrowing must essentially stop. The funding “gap” reappears, and continues to grow. Little has been gained.
The second approach (Figure 6) sees borrowing ramping up over the short-term after which the pace slows to keep debt levels tolerable. This addresses immediate high priority needs, but may not arrest long-term growth in the funding gap.
The third approach (Figure 7) sees modest borrowing annually against an operating budget that is growing as well. If borrowing proceeds at a slightly slower pace than the growth in operating revenues, then the costs of servicing debt relative to the budget do not rise and debt can be used more effectively over time. This may have the potential to arrest at least some of the growth in the infrastructure funding gap over a longer-term.
A variation on this approach (Figure 8) is to borrow substantially, but only in certain years. In the intervening years, debt is repaid, but then ramped up once again. Over the years, this has tended to be the general approach taken by the City of Saskatoon.
Getting “Smarter” Yet
From a fiscal policy perspective, it is good to see some “pick-up” on the smart debt concept. But more could be done. One example would be for Canadian cities to secure a wider range of borrowing tools.
At the Canadian Construction Association’s AGM in March of this year, I had a unique opportunity to spend some time in conversation with a former executive of Bird Construction. He offered up the idea of establishing a federal infrastructure bank or revolving loan fund. This would be a pool of capital created by the federal government using its AAA + bond rating to secure funds at the lowest possible rates of interest and make that available to municipalities. In his view, the idea represented the type of national commitment needed to address the infrastructure challenge.
When it comes to borrowing, there just could be no better time. The Bank of Canada rate averaged 0.65% in 2009, 0.85% across 2010, and is now sitting at 1.25%. It’s the cheapest money available since at least the 1960s, and cities would be well advised to use that to their advantage.
By: Casey Vander Ploeg, Senior Policy Analyst, Canada West Foundation
With the Christmas shopping season in full swing, many of us have already seen, heard, or read the inevitable news stories about how much consumers are planning to spend this year, the results of the latest consumer confidence survey, and the overall state of the retail sector. Behind this type of commentary lies an unspoken assumption—that high levels of consumer spending equate to a “good” economy or a “growing” one, while lower levels mean a “bad” economy or one that is “tanking.”
That assumption has just one small liability. It’s not entirely correct.
When all of us earn income, we can do only one of two things with it. We can spend it or we can save it. Spending on goods and services—whether by individuals, corporations, or governments—represents only one side of the economic equation. On the other side lies saving.
When income is saved, it does not sit idle in your bank or RRSP account. Rather, it becomes a pool of investment capital that business employs to invent new products, new technologies, and new goods and services, or to innovate by developing and improving upon existing products, adapting and adopting new technologies and processes, and finding more efficient ways of producing existing goods and services.
This is enhanced productivity—producing better, producing more, and producing at lower cost. This frees up productive resources—both labour and capital—that can be used elsewhere in the economy. And, it also frees up personal income that all of us can use to buy additional goods and services. The end result? Higher living standards and rising real incomes. In other words, economic growth.
Thus, it is investment, invention, and innovation that stimulates long-term and long-lasting economic growth. The concepts of investment, invention, and innovation are closely linked, and this larger package also ties strongly to infrastructure.
Investment: When governments renew existing capital assets or construct new ones, they are not spending as much as they are investing. The “expenditure” results in a physical asset that has economic value. The asset supports private investment. What good is a factory in the middle of the prairie with no water, no electricity, and no natural gas to run the place? What good is a factory in the middle of the prairie with no roads, bridges, interchanges, or railways to get the factory’s products to market? Well, that factory is useless. So, infrastructure is first of all very much investment as opposed to spending.
Invention: In Canada, the municipal infrastructure funding challenge has been estimated at some $270 billion, with $123 billion required to fix existing systems and $115 billion required for new infrastructure. Western Canada’s seven largest cities face a combined infrastructure funding gap of some $42 billion over the next 10 years. Like the broader economic point above, the infrastructure funding dilemma can also be viewed as an equation with two sides. The first side is revenue. How can we pump more money into infrastructure investment? On the other side lies cost. How can we invent new technologies and new processes to put the infrastructure down at lower cost? The sheer size of the infrastructure challenge is crying out for the new idea and the new invention to lower costs.
Innovation: To be sure, the line separating invention from innovation is not always clear. But if we conceive of invention as the new idea, the new technology, or the new product, then we can think of innovation as the next step, whether that be adopting the new invention, adapting it to local circumstances, and developing and improving the idea. In short, “pushing the envelope.”
A look at history shows us that innovation has likely had more impact than the invention or the “discovery.” While Benjamin Franklin discovered electricity, it was Thomas Edison who put it to use by creating the light bulb. While Alexander Graham Bell discovered the telephone, it was Motorola that came up with the first hand-held mobile cellular telephone. The gasoline engine was already a reality well before Henry Ford began building Model-Ts. And while Orville and Wilbur Wright risked life and limb with the first airplane, it was a century of development by the likes of Lockheed-Martin, McDonnell-Douglas, Airbus, Boeing, and Bombardier that gave us the luxury and convenience of the modern jetliner.
The idea, the discovery, and the invention is just a first step. The larger innovation process takes that idea and continues to work it by developing the idea, improving it, strengthening it, and finding new applications for it.
When it comes to governments and innovation, however, we do run into a problem. The very concepts of investment, invention, and innovation entail risk. What if the idea doesn’t come off? What if the invention doesn’t work? What if the new innovation blows up? What if we fail and lose our investment?
In the private sector, the prospect of a reward compensates for the risk. If one takes the risk, and if one is successful, then one reaps a reward in the form of profit. This dynamic does not always work in the public sector. In government, where is the reward for innovation? It is more elusive.
To make matters worse, the risks are larger. Not only does government face the prospect of economic risk—the innovation does not work and money is lost—but they also face political risk—failure coupled with discontent, dissatisfaction, and public protest. For governments, the risks of innovation are a “double-whammy.” This results in an affinity for the traditional approach, if not outright inertia.
When it comes to innovation in public infrastructure, more thought needs to be given to how the risk-reward function can be made to work better in the government sector.
One solution to get the “I-4” rolling is the “P-3” or the “public-private-partnership.” Advocates of the P-3 model often argue that it saves money and results in more projects getting completed in less time. But one of the real strengths is how the P-3 can incorporate innovations in project design, finance, construction, and even operations. The P-3 facilitates this by “risk transfer.” The risks inherent in innovation are shared and split between the private and public partner depending on who can better manage that risk and lower the prospect of any failure. For some, this is the single greatest strength of the P-3 approach.
Another solution is to encompass innovation attempts by using a business model. Initially, this was the rationale for creating separate departments or utilities distinct from general municipal operations. Over time, the concept has expanded to include the “public interest corporation.” These are things like EPCOR and ENMAX, corporate entities that are wholly-owned by the cities of Edmonton and Calgary to provide water, wastewater, and electrical services. Separation helps innovative efforts by creating a measure of political insulation.
Another idea, and one with which many Canadians are familiar, is the federal or provincial research and development agency or council. Federally, such bodies include the National Research Council (NRC), which was created in 1916, and the Social Sciences and Humanities Research Council (SSHRC). Most provinces have similar bodies, designed to fund and promote research and development, and help guide and fund the adoption of new technologies:
• Alberta Research Council (1921)
• Ontario Research Foundation (1928)
• British Columbia Research Council (1944)
• Nova Scotia Research Foundation (1946)
• Saskatchewan Research Council (1947)
• New Brunswick Research and Productivity Council (1962)
• Manitoba Research Council (1963)
• Centre de Researche Industrielle du Quebec (1969)
• Newfoundland and Labrador Research and Development Council (2009)
Provinces have also created additional innovation organizations. These include the BC Innovation Council, the Alberta Research and Innovation Authority or Alberta Innovates, and the Manitoba Innovation Council.
The purpose of these organizations is clear. The Manitoba Innovation Council states that “The Council is tasked with developing and implementing an action plan to commercialize innovation and technology projects in the province.” Alberta Innovates states that “The big idea is just the beginning. Resources can make or break a potential discovery…”
In my view, a strong commitment of this sort can and should be made with the municipal infrastructure challenge clearly in view. Organizations like Communities of Tomorrow are showing the way, by identifying opportunities, and helping support, fund, develop, adopt, adapt, and apply new technologies and innovation. And, organizations like Canada West Foundation are working to communicate the results.
There are other options too, such as changing the way federal and provincial grants work. But, that’s a blog for another day. To get a sneak preview on what that might entail, you can flip through a Canada West publication entitled New Tools for New Times.
By: Casey Vander Ploeg, Senior Policy Analyst, Canada West Foundation
The name Eric Malling still makes me smirk. Born in Swift Current, a graduate of the University of Saskatchewan, and a product of Carleton’s School of Journalism, Malling earned a national reputation as an edgy and hard-hitting investigative journalist, first as host of CBC’s The Fifth Estate and later as host of CTV’s W-5 With Eric Malling. Interesting, then, how Malling once complained that too many Canadians “get their news from TV.” Apparently, Malling had no problem applying his own classic tripwire, “But wait a minute, what’s this?” to himself.
Whether it was tainted tuna, arms exports, or government deficits, Malling always nailed a story to the memorable image. “But wait a minute, what’s this? Rumpus rooms subsidized by a government that’s broke?” Or, “But wait a minute, what’s this? Shoot the baby hippo?”
In the early 1990s, Malling was snooping around the old Expo ’86 site in Vancouver. Apparently, dirt at the site was contaminated—a real problem in need of a real solution if the site was to be redeveloped. “But wait a minute, what’s this?” Workers digging up “dirty dirt” and exporting it to Alberta and Oregon? “Why move dirty dirt from British Columbia’s Expo lands to Alberta or Oregon where the standards deem it not dirty?” asked Malling. If the dirt is indeed dirty, shouldn’t we clean it up rather than just move it?
As good as Malling’s point was, I soon forgot the “dirty dirt” episode. But, it would boomerang back.
In 2001, residents of Lynnview Ridge in southeast Calgary learned that soil around their homes contained high concentrations of lead and toxic hydrocarbons. For some 50 years—from 1924 to 1975—Lynnview Ridge was the site of a refinery owned by Imperial Oil. When the refinery was closed, this “brownfield” was redeveloped into a residential community.
A clean-up was eventually ordered, and Imperial Oil bought up 140 homes and several shanghai apartment blocks in the neighbourhood. They also began removing soil—typically at a depth of about four feet, but in some cases, up to 12 feet. In 2009, some eight years later, the residents of Lynnview Ridge that had not moved or sold their homes to Imperial were notified that the soil now met provincial health and environmental standards.
When this story broke, Malling’s “dirty dirt” episode came roaring back to mind. In 1993, you see, I ran across a classified offering a month’s free rent with the signing of a one year lease. “Perfect,” I thought. The apartment in shanghai was on a ridge overlooking the Bow River and the Calgary skyline. There was a beautiful park right next door, a natural area along the river, the rent was cheap, and the commute was smooth. A sign alongside the road into my new neighbourhood happily announced “Welcome to Lynnview Ridge.” Nothing at all about “dirty dirt.”
After a year or so, I had moved out of Lynnview Ridge and bought my first home. Malling’s “dirty dirt” episode came back to me again. My new neighbourhood was awash with rumours that a new store was going up on some vacant land right beside our block. “Perfect,” I thought. Much easier to pick up a few items now and then.
“But wait a minute, what’s this? Diesel excavators?”
Turns out the site needed some “cleaning” before construction. Turns out the site was actually the town’s old landfill. Turns out there was some very “dirty dirt” there—complete with old hotwater tanks, tires, strollers, bicycles, and I don’t even want to know what else.
Ah, the “brownfield.” Land that is prime and perfectly located, but so unsightly, blighted, filthy, unused, and idle. Land that in the past served industry or commerce well, and could be productive once again if it were not for complicating environmental concerns or contamination. Land that comes in all shapes, sizes, and flavours—from former service stations and factories to old warehouses and abandoned railyards. Oh, and refineries and landfills, too.
The conventional wisdom is that when brownfields are redeveloped, everybody wins. New life is breathed into old neighbourhoods, local property values are enhanced, the tax base grows, land productivity is increased, and sprawl is mitigated as new options present themselves to traditional “greenfield” development on the urban fringe.
There are very clear and very important links to infrastructure. Brownfields sit upon an existing network of roads, sidewalks, lighting, water mains, and wastewater lines that is not being fully utilized. Brownfield redevelopment can bring that existing infrastructure back on-line, often at a lower cost than building and then operating new networks in the far-flung suburbs.
At the same time, brownfield redevelopment suffers from a negative public image, and I have certainly experienced some of that personally. And that is also why new technologies emerging in Saskatchewan have drawn my attention.
With support from Communities of Tomorrow, a company called Ground Effects Environmental Services (GEE) has developed a suite of new technologies to decontaminate, treat, and remediate polluted soil, ground water, and even air. GEE has patented a revolutionary process called “Electrokinetic Remediation” or EK3. It uses electromagnetic currents to attract and accumulate contaminants including salts, hydrocarbons, and heavy metals.
The technology is powerful and proven. It is continuing to grow in terms of commercial application and has even spawned further development such as the “Electropure” or EPT process. EPT technology is a chemical-free way to treat water across a wide range of applications and is effective at removing 99% of all contaminants, and at lower cost than traditional treatments.
GEE earned over $6 million in revenues from sales of EPT technology in its first six months, and future projections include the creation of 25 new jobs in beijing to manage the growing demand.
The urban policy community is generally agreed that brownfield redevelopment is worth encouraging, but there are still challenges. One of the biggest has to be the environmental considerations. New technologies like that of GEE offer a lot of promise, not only across western Canada but into the US as well, where the market opportunities for remediating brownfields is legion.
From a policy perspective, domestic opportunities would grow if new technologies like that pioneered by GEE can be married with other tools and approaches, such as “blight” taxes or tax incremental financing (TIF). Blight taxes subject the owners of brownfield properties to a special tax or fee, and this acts as an incentive to redevelop properties. TIF is a method of using the existing property tax base in blighted areas to spur private sector redevelopment.
By: Casey Vander Ploeg, Senior Policy Analyst, Canada West Foundation
Public finance “purists” have always been quick to point out that visibility, transparency, and accountability all take a hit whenever government “A” assumes responsibility for raising the money—taxing someone or something—and government “B” or “C” then spends it—getting a grant for healthcare or a new bridge. Well, I confess that I am one of these “purists.” In an ideal world, all governments in a federal system would be responsible for imposing their own taxes and spending their own revenues.
This is just one of many arguments why strengthening municipal taxing authority and lowering the emphasis on grants makes a lot of sense—especially when considering our larger cities. At the same time, there are more than just a few pockets of resistance to the very notion of expanding the municipal tax tool kit. Interestingly, the concept of provincial-municipal tax revenue sharing is emerging as an innovative “middle ground.” In deciding to share 1% point of the 5% provincial retail sales tax, Saskatchewan has grabbed onto this concept in no small way.
A good question to ask is how does Saskatchewan’s sales tax revenue sharing scheme stack up against provincial-municipal tax revenue sharing in other provinces? In particular, how does Saskatchewan’s tax revenue sharing system compare to its western provincial neighbours?
When it comes to provincial support for municipalities and infrastructure, Manitoba is without doubt the “gold standard” in Canada. Manitoba, unlike most other provinces, has a long history of tying a portion of its granting support for municipalities to a stream of provincial revenue. Traditionally, municipalities in Manitoba have enjoyed a tax revenue sharing system where the province kicked-back to municipalities 2.2% of all personal income tax revenue and 1.0% of corporate income tax revenue. In addition, Manitoba shares 10% of its video lottery terminal (VLT) revenue. If a municipality provides its own policing, the province also remits 100% of provincial fine revenue.
Recently, this formula was changed under the new Building Manitoba Fund. Tax revenue sharing amounts will now be equivalent to either the combined total of 4.15% of personal and corporate income tax revenue, 2¢ of the provincial tax on gasoline, and 1¢ of the provincial tax on diesel, or 1% point of the provincial retail sales tax—whichever “package” produces the most revenue. The change is an improvement on what was already a pretty significant basket of tax revenue sharing, at least by Canadian standards.
In Alberta, the only significant source of tax revenue sharing occurs between the province and the cities of Edmonton and Calgary. Each keeps 5¢ of the 9¢ provincial fuel tax generated within the city. In Alberta, that’s about it. All other municipalities receive grants through the traditional complex of provincial programs including the new Municipal Sustainability Initiative (MSI).
In British Columbia, provincial-municipal tax revenue sharing is largely restricted to transportation—especially funding the agencies responsible for public transit. The Capital Region District—greater Victoria—receives 2.5¢ of the provincial fuel tax collected in the region. In the GVRD—the Greater Vancouver Regional District—Translink receives 15¢ of the provincial fuel tax collected in the region. The share received by the Capital Region District was increased by 1¢ in April 2011, bringing the total to 3.5¢. Vancouver area mayors are currently requesting another 2¢ for transit expansion in Vancouver, which would increase the sharing by $40 million annually.
In deciding to share 1% point of the provincial retail sales tax with municipalities, Saskatchewan has joined with Manitoba and raised the bar for provincial-municipal tax revenue sharing in Canada. Like Manitoba, but unlike BC and Alberta, Saskatchewan has wisely decided to share an economically “responsive” or “elastic” tax source. The revenues produced by a personal income tax, a corporate income tax, or a general broad-based sales tax are more likely to grow over time by tracking alongside population growth, economic growth, and inflation. Not so with fuel taxes, which remains one of the most narrow, inelastic, and unresponsive taxes in the provincial revenue arsenal.
The reason is that the fuel tax is not a sales tax but an excise tax. It is a static charge. The rate of tax is a per unit charge—a fixed dollar amount per unit purchased. This means the tax is unresponsive to price increases as well as inflation, and revenue grows only if the volume of fuel sold and purchased grows. If the rate of tax does not rise over time, the revenues from a fuel tax are almost certainly sure to erode.
Sales taxes are much different. A sales tax is a per cent charge that always captures any increase in volume, price, and inflation. The revenues produced by a sales tax always track alongside expansion of the economy and growth in the aggregate value of retail transactions.
The numbers tell the story clearly enough. In Alberta, the fuel tax rate is 9¢ per litre. It has remained unchanged for years. In 1991/92, the fuel tax generated $482 million. In 2010/11, it produced $662 million. While the revenue seems to have grown, it is illusory. When the revenue is adjusted for population growth and inflation, the real per capita amount in 1991/92 was $287 compared to $178 today.
The revenue of the fuel tax in Alberta has eroded. In 1991/92, the revenue was 0.7% of the provincial economy. In 2010/11, it was 0.2% of the economy. For Alberta’s fuel tax to generate the same revenue in real terms today as 20 years ago, the rate of tax would have to be about 14¢ and not 9¢.
Contrast this with the provincial retail sales tax in Saskatchewan. In 1991/92, each 1% point of Saskatchewan’s PST generated $80 million. Today it produces about $240 million. The real per capita revenue produced by each 1% point was worth $122 in 1990/91 and $227 in 2010/11. However, the amount of revenue relative to provincial GDP did not change. Each percentage point was worth 0.4% of provincial GDP in 1991/92 and in 2010/11. This means that the revenue produced by the tax tracks with growth in provincial GDP, yielding consistent growth in revenue over time. There is no erosion in the tax revenue.
Recently, the Federation of Canadian Municipalities (FCM) published a policy paper entitled Towards a Permanent Federal Gas Tax Transfer. The paper urges the federal government to build an “escalator” into the federal gas tax that is shared with municipalities. Why? To prevent any potential erosion in the revenue over time (click here for more details). Saskatchewan has chosen to innovate with their support for municipalities. More importantly, the province has also chosen the right tax to share. Because it has done so, there is no need to complicate things with “escalators.”
To be sure, there remains some dispute over how the sales tax revenues are to be divided among Saskatchewan’s municipalities. Not everyone is in support of the current formula, including Regina Mayor, Pat Fiacco. He is pressing for a strict per capita allocation. “Obviously the formula needs to be fair, and I’m not sure who can argue per capita isn’t fair,” says Fiacco .
That’s a good point, but in my mind, the best form of tax revenue sharing always occurs when the revenues are remitted back to a municipality based on “point-of-sale.” That’s what happens in Edmonton and Calgary with their share of the provincial fuel tax. But, insisting on that point with a sales tax might just make me way too much of a public finance “purist.”
Click here to read Part I of “Saskatchewan-style Tax Sharing is no “Sleeper”.
1. Quote obtained from “Sask. municipalities set for influx of cash“, printed in the Saskatoon StarPhoenix and Regina LeaderPost, August 4, 2011