Fiscal Federalism

FISCAL FEDERALISM
FISCAL FEDERALISM
Which Level of Government should do What?

Can the Provincial Government make Foreign Policy Decisions?
FISCAL FEDERALISM
Which Level of Government should do What?

Can the Federal Government Control Education Policy?
Go to Slide 164
Decentralized ratio
The Extent to which a System is Decentralized can be expressed via

Expenditure Decentralized Ratio
Share of Total Government Expenditures made by Subnational Governments
Excluding Grants Received from Central Government Net of Grants Received from Central Government
Subnational Gov. Share of Central, State/Provincial, and
Local Government Expenditures (six year averages)
Country 1970 – 1975 1996 - 2001
Canada 48.3 53.2
United States 35.7 39.5
Germany 39.7 33.4
Australia 27.4 31.6
France 10.8 12.1
𝑃𝑟𝑜𝑣𝑖𝑛𝑐𝑖𝑎𝑙 + 𝐿𝑜𝑐𝑎𝑙
=
𝑃𝑟𝑜𝑣𝑖𝑛𝑐𝑖𝑎𝑙 + 𝐿𝑜𝑐𝑎𝑙 + 𝐹𝑒𝑑𝑒𝑟𝑎𝑙
Decentralized ratio
Provincial Governments have been increasing their Expenditure
and Revenue Share at the Expense of Federal and Local Government
Distribution of Canadian Government Revenue and Expenditures

(Net of Grants) by Level of Government (in percent)
Federal Provincial Local
Year
Revenue Expenditure Revenue Expenditure Revenue Expenditure
1960 60.8 50.5 21.8 24.8 17.3 24.7

1970 48.7 35.3 36.2 38.0 15.1 26.7
1980 44.7 37.8 41.8 40.3 13.4 21.9
1990 45.4 41.0 41.7 40.1 13.0 19.0
2000 47.4 38.4 41.5 42.7 11.2 18.8
2009 53.3 33.2 40.3 46.2 6.4 20.6
Decentralized ratio
Provincial / Local accounted for more than 75% of Federal Government accounted for 70%
Spending in areas of Health, Education, Transportation of Spending in Labour, Employment,
and Communications, and the Environment and Immigration
Expenditure Shares by Level of Government, 2008 – 2009 (in percent)

Category Federal Local / Provincial
Health 21.4 78.6
Education 6.0 94.0
Transportation and Communications 11.0 89.0
Environment 15.9 84.1
Labour, Employment and Immigration 71.6 28.4
Protection of Persons and Property 57.0 43.0
Social Services 58.5 41.5
Other 69.3 59.2
Total 40.9 59.2
Balanced on Protection of Persons and Property, and for Social Services

Decentralized ratio
The Decentralization Ratio is by No Means a Foolproof Indicator
While Provinces make Federal – which gives a portion in the form

Expenditures for Social Assistance of Grants – Can Mandate Requirements
... like NO Residency Requirement placed on
Social Assistance Recipients
However, Provinces can Lobby . . . More Recently . . .

United states
In 1902,
Levels of Government Operated their State and Local Funded their Spending
Own Spheres, Rarely Overlapping or from Own Sources - Less than 1%

Interfering with Each other came from Federal Grants (10% now)
1913 – Fed. Gov. got Power to Levy 1930s – The New Deal changed the
Income Taxes on Individuals relationship between Fed. & State/Local
Federal Gov. Share has Grown Significantly
Later – Social Insurance & Welfare

Programs, Matching Grants
United states
Largest Elements of Federal Spending TODAY are
National Defense and HealthCare
United states
Largest Elements of State/Local Spending TODAY are
Education, Healthcare and Public Safety
United states
Income Taxes are the Largest Source of Financing for Federal

United states
Property Tax accounted for almost Half of Non-Grant
Revenues (Excluding Grants) of Local Government
United states
Tremendous Variety in Spending and Revenue across States
(8 States)
World
Compared to World, State/Local in the U.S (& Canada)

account for a Large Portion of Total Government Activity
Fiscal equalization . . . World
Many Countries (Not the U.S) practice Fiscal Equalization – Central
Government provides Grants in an Effort to Equalize Differences in Wealth
Advantages of a decentralized system
1. Tailoring Government to Local Tastes
Individuals with Similar Tastes for Public

Goods Group together, so Communities
provide the Types and Quantities of
Public Goods Desired by their Inhabitants
2. Fostering Intergovernmental Competition
Smaller Government may induce

Politicians and Government Managers to
Produce More Efficiently and be more
Responsive to their Citizens
Federal Waste Cost: 4 Cents
U.S Department of Defense Paid: $110

3. Experimentation & Innovation in Regionally Provided Goods & Services
A System of Diverse Governments Enhances the Changes that

New Solutions to Problems will be Sought
= $7 x 23 = $161
1962 – Saskatchewan was first to Eliminate
Private Payment for Doctors Service –
rather paid from Provincial Fund
“A courageous state may serve as a laboratory and try moral, social and economic
Experiments without Risk to the Rest of the Country” Go to Slide 165
disAdvantages of a decentralized system
1. Efficiency Issues . . . . . . a) Externalities
The Activities Undertaken in One Community can Affect the

Utility Levels of People in other Communities
1. Efficiency Issues . . . . . b) Scale Economies in Provision of Public Goods
Cost per person may fall as the number of users increase

1. Efficiency Issues . . . . . c) Inefficient Tax Systems
Tax Competition may lead to Under-Provision of Public Goods
2. Equity Issues
In-Migration of Poor from the Rest of the Country – Increasing the
Cost of Redistributive Fiscal Policy – like State Welfare
At the Same Time, Upper Income

Might Exit – thus Demand on the
Community’s Tax Base Increase
while its Size Decreases
Eventually the
Redistributive Program In response to 7% of Welfare Recipients being from Out of
has to be Abandoned State, California Passed a New Law that paid Lower Benefits
to them – was later Ruled Unconstitutional
2. Equity Issues
High Income Individuals can avoid unfavourable tax conditions
by migrating to Lower Tax States, then Employers in High Tax
States will have to Pay Higher Wages to Keep their Workers
Effective Tax Rate: Includes Sales Taxes, Excise

(Fuel, Tobacco, alcohol) Taxes, and Property Taxes
(As mentioned Earlier, a Number of State, like
Texas, have No Personal Income Tax)
Community formation
How Large should a Town be?
Consider building a Park . . . With Exclusive Members . . .
The Larger the Community, the

more people there are to Shoulder
the Expense, and the Smaller the
Required Contribution per Member
So Why Not Just Maximize the

Number of Members?
Community formation
The More People Join the Community, the Park Becomes Congested
Therefore . . .
Community should Expand its
Membership Until the Marginal
Decrease in the Membership Fee
Just Equals the per Marginal
Increase in Congestion Costs
So How Large in Size

should the Park be?
Community formation
Bigger Park Yields Greater Benefits . . . But . . .
Considering Diminishing Marginal Utility . . .
Acreage should be
Increased to the Point
where Each Member’s
Marginal Benefit Just
Equals the Per Member
Marginal Cost – Extra
Land divided by the
Number of People
Tiebout model
In Trying to Answer the Optimal Division of Responsibilities

across Different Levels of Government . . .
Two Factors Missing from the Market for Public Goods . . .
Shopping Competition
Tiebout model
At the Federal Level . . . Decisions can be Inefficient
Shopping Competition
Tiebout model
But at the Local Level . . . You Can Vote with Your Feet . . . Mobility
In Toronto, Montreal & Vancouver, 14% of people aged

25 – 44 Moved from the Central Municipality to a
Surrounding Municipality (5% in opposite direction)
Tiebout model
At the Local Level. . .
The Threat of Exit can Induce Efficiency
in Local Public Goods Production
The Tiebout Model solves Two Major Problems that Prevented

Government from Delivering the Optimal Level of Public Goods in Practice
Preference Revelation Preference Aggregation

Honestly Difficult to
Aggregate
Reveal their
Individual
Preferences for
Preferences into
Public Goods Social Decisions
Problems with the Tiebout model
1. Assumes Perfect Mobility 2. Assumes No

Externalities / Spillovers
Let’s go to the Next Town,

they have a Better Park
Go to Slide 166
3. Requires Lump Sum Tax
Each town has N Residents

and Finances its Public Goods
Spending, G, with a Uniform
𝐺
Tax on all Residents =
𝑁
A Fixed Taxation amount

Independent of a Person’s
Income, Consumption of
Goods and Services, or Wealth
3. Requires Lump Sum Tax
Towns incorporate Zoning Regulations
to deal with the Problem of Poorer
People Benefiting from Higher Taxes
Paid by their Richer Neighbours
Tiebout model still works
Research has Shown . . .
Resident Similarity Across Areas
In Urban/Suburban Areas,
Residents are More Satisfied
with the Level of Public Goods
Spending than in Non-Urban
Areas where there are Fewer
ways to Vote with your Feet
The More Local Communities there are from which to Choose,

the more Residents can Sort themselves into Similar Groups
Tiebout model still works
Research has also Shown . . .
Capitalization of Fiscal Differences in House Prices

While many people don’t think about Level of Public Goods when choosing where to Live . . .
The Price of any House Reflects

the Cost – including Local
Property Taxes – and Benefits
– Including Local Public Goods
Optimal fiscal federalism
The Extent to Which Public Goods should be Provided at

the Local Level is determined by Three Factors:
1. Tax Benefit Linkages 2. Positive Externalities
3. Economies of Scale
1. Tax Benefit Linkages

The Extent to which Residents View their Tax Payments
as Directly Tied to Goods & Services that they Receive
Local Roads – Strong Social Assistance – Weak – Funded

Tax/Benefit Linkage Provincial/Federal – Otherwise
Funded Locally Residents Will Vote with their Feet
2. Positive Externalities
If Local Public Goods have a Large Spillover Effect on other
Communities - will be Underprovided by Another or Any Locality
Nicer Better
Lakeshore Library
Next Town Next Town

2. Positive Externalities
Education has a Large Spillover Effect therefore State/Provincial,
even Federal should be Involved
Canada: K – 12 education
• Provincial Government
Assigned Responsibility
(via Constitution)
• Federal 6% of Spending
3. Economies of Scale
Public Goods With Large Public Goods Without Large
Economies of Scale are Economies of Scale may be
Not Efficiently provided by provided More Efficiently by
Local Jurisdictions Local Jurisdictions
National Defense – Federal Police – Local (Peel, Halton, Hamilton)

Interprovincial fiscally induced migration
? Why do we say in the absence of government ?
In the Absence of Government, Economic theory Suggests

that People Will Move from One Province when they Expect
to Earn a Higher Income and thus Higher Standard of Living
Wage Rate Downward Sloping Marginal Product (Output) of Labour Wage Rate
($/hr) (Demand Curves for each Province) ($/hr)
A
$35
What do we
expect to happen?
$15
Currently
Zero Workers 10 million 5 million Zero Workers
In Ontario In Alberta
Number of Workers in the Two Provinces
We would Expect People to Move from Ontario to Alberta (from Point A to

Point B) until the Marginal Products of Labour are Equalized in both
Provinces and an Efficient Distribution of Labour is Achieved
Wage Rate Wage Rate

Firms will Hire until
($/hr) ($/hr)
2 million Move
MPL = Wage Rate A
Equilibrium $35
B
$25 $25
$15
Zero Workers 8 million 7 million 10 , 5 Zero Workers


However, in Addition to Wage Differentials, there are also Higher
Net Fiscal Benefits (NFBs) in Alberta than in Ontario due to say
greater availability of Natural Resources
Adding the Differential NFB (Value of
Wage Rate Publicly Provided Services minus their cost) Wage Rate
($/hr) between Alberta and Ontario to the MPL Alberta ($/hr)
What do we expect to happen? A
$35
B
$25 $25
$15
Zero Workers 8,7 10 , 5 Zero Workers


As a Result, Too Many People will Move from Ontario
to Alberta (A to C instead of A to B) to achieve an
Efficient Distribution of Labour
Wage Rate Wage Rate
($/hr) 3 million Move ($/hr)
A
$35
C
$28 $28
$25 $25
B
$15
Zero Workers 7,8 8,7 10 , 5 Zero Workers


This Migration Response (Extra 1 million people) to

Differences in NFBs is called Fiscally Induced Migration
How can Government

Wage Rate Wage Rate
correct for this Inefficiency?
($/hr) ($/hr)
A
$35
C
$28 $28
$25 $25
B
$15


Intergovernmental Grants can be Used to Equalize NFBs across
Provinces and Correct for the Inefficiency in the Distribution of Labour
Three Questions
Wage Rate Wage Rate
to Ask . . .
($/hr) ($/hr)
A
$35
C
$28 $28
$25 $25
B
$15


1. Does Migration even Respond to Differences in NFBs?
There is Some Evidence of Migration due to Differences in Level of

Expenditure, Transfers & Taxation, EI – but it is Empirically Small in
the Short Term and would take a Long Time to have a Significant Effect
2. Are there Positive Net Gains from Using Equalization to

Restore Efficient Distribution of Labour Across Provinces ?
Interprovincial
Difference in
Optimal Level of
NFB
Migration is OA
A Migrants Moving
o from NFLD to ON
YON - YNFLD
The Change (Rise) in Private Income experienced by

Successive Migrants from NFLD to ON

Restore Efficient Distribution of Labour Across Provinces?
Interprovincial
(Before Equalization)
Difference in
FON - FNFLD
NFB
A B Migrants from
o NFLD to ON
FON – FNFLD YON - YNFLD
The Change in Income after
C
Accounting for Difference in NFBs
BC: NFB Gap between Provinces

Interprovincial
Difference in FON - FNFLD
FON - FNFLD
NFB
A D B Migrants from
o NFLD to ON
YON - YNFLD
FON - FNFLD
E
(After Some Equalization)
BE: Per Capita Equalization Payment Made C
EC: Remaining per Capita Fiscal NFB Gap


Interprovincial
Difference in FON - FNFLD
FON - FNFLD
NFB
A D B Migrants from
o NFLD to ON
YON - YNFLD
F E
DB: Reduction in Migration from Equalization Payments

C
DBCF: Fiscal Gain from Reducing Migration via Equalization
$719.6
Cost Benefit Ratio Inclusive of Equalization Payments = = 514
$1.4
Cost Benefit Ratio Excluding Equalization Payments assuming 10%

$719.6 x 10%
(a bit unreasonable) cost to administer = = 51.4
$1.4

The Cost to Close the Gap in Incomes that Arise from Differences in
NFBs between Provinces Far Outweighed the Benefits in terms of
Increased Labour Market Efficiency
However, the Research only Focused on Annual Migration Responses

and Migration Adjustment can take Much Longer than One Year
3. Does Canada’s Equalization Program Achieve Net
Gains or Does the Program Introduce its own Inefficiencies ?
Low = 1
Outbound
High = 1
What should
Low Income Provinces should have Relatively High Out Migration Rates
happen?
If Row 1 – Row 2 = 0 If Row 1 – Row 2 = Negative Too Little Out Bound Migration
Neutral If Row 1 – Row 2 = Positive Too Much Out Bound Migration
Canada’s Equalization (Intergovernmental Grants) may in Practice

Actually Worsen Migration Inefficiencies – by Constraining
Migration that Should have come as Result of Wage Differentials
The Highest per capita Equalization payments were made to
Six Provinces – NL, PEI, NS, NB, Manitoba & Saskatchewan
These Payments Inefficiently
Different Study Incentivize Canadians to Stay (or
move) there (6 provinces), as
they have either Considerable
Source Based Revenues and Low
Federal Tax Burdens
Causes them to Populate beyond

Per Capita NFB deviation from their Efficient Levels by 30%,
National Average:
leading to Inefficiency Costs of
+ $2,171 NL, + 2,014 NB, etc.
0.41% of Income or $4.3 billion per
- $1,082 Ontario
Same with Alberta – in a different form – It Collects
Enormous Source Based Revenues from Oil & Gas, which the
Federal Government does not Redistribute because of
Asymmetry (check slide 151) in its Equalization Formula
As these Revenues
are only offered to
those who reside
within Alberta, they
too create Inefficient
Incentives
Redistribution across communities
Inequality in the Ability/Extent to which Local
Communities Can/Do Finance Public Goods
Should We Care? Fall River Weston

Local Tax Revenue
per Public School $2,304 $16,389
Student (7x more)
Tax per $1,000 of
Property Value $9.22 $13.39
Median Single
Family Home $250,000 $1,225,000
Value
Property Tax Bill $2,305 $16,403

Should We Care?
Tiebout Model says:
Any Redistribution across Communities
would Impede Efficiency
But there are Two Reasons to Care:
2. Externalities
If there are Spillovers
1. Cost of Housing or Externalities . .
Then there’s an
Prevents People
Good Education can Argument to
form Moving
Lead to Low Crime Subsidize Other
with their Feet
across Communities Communities
Tools of redistribution: grants
Intergovernmental Grants
Are Cash Transfers from One Level of Government to Another
Federal Grants to Lower Levels

have risen from 7.6% (1960) to
15.5% (2008) of Federal Spending
States send 28% of their Spending

to Local – mostly for Education
Federal Transfers to Lower Levels of Government
Total Federal As a As a Percentage As a Percentage
Transfers Percentage of of Provincial & of Provincial &
(millions of 2002 Federal Local Local Total
Dollars) Expenditures Expenditures Revenue
1960 6,413 14.7 17.6 19.2

1970 16,995 23.4 16.5 17.3
1980 26,508 21.5 15.7 16.3
1990 34,546 18.4 14.1 14.7
2000 32,964 17.6 11.4 11.1
2009 54,780 25.2 13.9 21.7
Data Excludes Tax Point Transfer – Federal Reduces Tax Rates, Enabling
Provinces to Simultaneously Raise their Rates by an Equivalent Amount
2011 – Tax Point would be worth an additional $21.9 billion (2011 dollars)
51%
19%
25%
5%
30%
22
2007 – 2008 Cash Transfer Portion = = 50%
44
Federal tax transfer is 13.5 tax points on
personal income tax and one tax point
on corporate income tax. Provinces
with Higher Income (ON, Alberta)
generated more of their entitlement
from their Tax Point Transfers
A Cash Floor (Minimum Cash Transfer to

all Provinces) is Set at $12.5 billion. The
purpose of this floor was to provide
protection against “unexpected economic
Additionally, Without the Cash
fluctuations” that might reduce the total
Transfer, the Federal Government entitlement or significantly increase the
may No Longer have the Power to value of the tax point transfer, leading to a
enforce the CHA’s requirements decrease in cash transfers to the provinces
Federal grants to provinces
Population = 14.5 m
73.5%
26.5%
Population = 14.5 m
Ontario Ow n Federal
Source Federal Total Total (CHT + CST) / Transfers / (Equalization) /
Year Revenues Transfers Revenues Expenditures Total Exp. Total Exp. Total Exp.
2018-19 128,610 25,090 153,700 161,135 13% 16% 0.6%
Per Capita Expenditure = $11,154

Other Federal Transfers = 16% - 13% - 0.6% = 2.4%
Population = 4.3 m
Alberta Ow n Federal
2018-19 41,611 8,013 49,624 56,335 11% 14% n/a

Other Federal Transfers = 14% - 11% = 3%
Population = 5.02 m
B.C Ow n Federal
2018-19 48,076 9,052 57,128 55,593 13% 16% n/a
Other Federal Transfers = 16% - 13% = 3%

Population = 155k
P.E.I Ow n Federal
2018-19 1,279 766 2,045 2,031 11% 38% 21%
Other Federal Transfers = 38% - 11% - 21% = 6%

Population = 40 k
Yukon Ow n Federal
2018-19 204 1,137 1,341 1,348 4% 84% 74%

Population = 46 k
N.W.T Ow n Federal
2018-19 330 1,459 1,789 1,749 4% 83% 75%

Population = 39 k
Nunavut Ow n Federal
2018-19 255 1,879 2,133 2,072 3% 91% 79%

Population = 8.4 m
Quebec Ow n Federal
2018-19 90,146 23,411 113,557 107,951 11% 22% 11%

Population = 965 k
Nova Scotia Ow n Federal

2018-19 6,850 3,651 10,501 10,860 13% 34% 18%

Population = 772 k
New Brunsw ick Ow n Federal

2018-19 6,264 3,440 9,704 9,700 11% 35% 19%

Population = 1.4 m
Manitoba Ow n Federal
2018-19 12,203 4,491 16,694 17,164 11% 26% 12%

Population = 1.2 m
Saskatchew an Ow n Federal
2018-19 11,940 2,509 14,449 14,717 11% 17% n/a

Population = 524 k
New foundland Ow n Federal

2018-19 6,528 1,223 7,751 8,273 9% 15% n/a

2018-19 in Order of Dependence on Equalization
% of
Canada Canada Equalization or
Ow n Canada's Federal Federal Other Federal Per Capita Per Capita Per Capita
Total Total Health Social Territorial (CHT + CST) (Equalization Per Capita
Province Source Ow n Transfer Transfers / Transfers / Ow n Soured Federal Equilization Population

Revenues Expenditures Transfer Transfer Form ula / Total Exp. ) / Total Exp. Expenditure
Revenues Sourced s Total Exp. Total Exp. Revenue Transfers Paym ent
(CHT) (CST) Financing (TFF)
Revenues
Nunavut 255 0.07% 1,879 2,133 2,072 40 15 1,579 3% 91% 76% 12% $53,410 $6,574 $48,431 $40,710 38,787
N.W.T 330 0.09% 1,459 1,789 1,749 47 17 1,256 4% 83% 72% 8% $39,222 $7,405 $32,719 $28,163 44,598
Yukon 204 0.06% 1,137 1,341 1,348 42 15 950 4% 84% 70% 10% $33,394 $5,065 $28,154 $23,533 40,369
P.E.I 1,279 0.36% 766 2,045 2,031 159 58 419 11% 38% 21% 6% $13,124 $8,265 $4,948 $2,708 154,748
New Brunsw ick 6,264 1.77% 3,440 9,704 9,700 803 295 1,874 11% 35% 19% 5% $12,563 $8,113 $4,455 $2,427 772,094
Nova Scotia 6,850 1.93% 3,651 10,501 10,860 999 367 1,933 13% 34% 18% 3% $11,249 $7,096 $3,782 $2,002 965,382
Manitoba 12,203 3.44% 4,491 16,694 17,164 1,409 507 2,037 11% 26% 12% 3% $12,617 $8,970 $3,301 $1,497 1,360,396
Quebec 90,146 25.44% 23,411 113,557 107,951 8,738 3,207 11,732 11% 22% 11% 0% $12,801 $10,689 $2,776 $1,391 8,433,301
Ontario 128,610 36.30% 25,090 153,700 161,135 14,908 5,471 963 13% 16% 1% 2% $11,154 $8,902 $1,737 $67 14,446,515
New foundland 6,528 1.84% 1,223 7,751 8,273 549 201 0 9% 15% 0% 6% $15,794 $12,463 $2,335 $0 523,790
Saskatchew an 11,940 3.37% 2,509 14,449 14,717 1,211 445 0 11% 17% 0% 6% $12,596 $10,219 $2,147 $0 1,168,423
British Colum bia 48,076 13.57% 9,052 57,128 55,593 5,196 1,907 0 13% 16% 0% 4% $11,074 $9,576 $1,803 $0 5,020,302
Alberta 41,611 11.74% 8,013 49,624 56,335 4,484 1,646 0 11% 14% 0% 3% $12,963 $9,575 $1,844 $0 4,345,737
Total or AVG 354,297 - 86,120 440,417 448,927 38,585 14,151 22,743 12% 19% 5% 7% $12,031 $9,495 $2,308 $609 37,314,442
Sample Calculations for Ontario:

% of Canada’s Own 128,610
Sourced Revenues
= = 36.30%
354,297 Total Expenditure 161,135
Per Capita
Expenditure
= = = $11,154
Population 14.446,515
(CHT + CST) 14,908+5,471
= = 13%
Total Expenditure 161,135 Per Capita Own = Own Sourced Rev. =
128,610
= $8,902
Sourced Revenues Population 14.446,515
Federal Transfers 25,090
= = 16%
Total Expenditure 161,135 Federal Transfers 25,090
Per Capita = = = $1,737
Federal Transfers Population 14.446,515
Equalization 963
= = 1%
Total Expenditure 161,135
Per Capita Equalization 963
= = = $67
Other Federal Transfers Equalization Population 14.446,515
= 16% - 13% - 1% = 2%
Total Expenditure
% of Federal
Support for
Ontario’s
Healthcare
Spending
14.908
= = 𝟐𝟒. 𝟑%
61.3
city of Ottawa: problem 1
The City of Ottawa would like to use all proceeds from Property
Taxes to finance upcoming Infrastructure Projects. The City’s
Utility Function between Private Goods and the
Infrastructure Fund is as follows.
Ottawa has 422,327 households & the Average Home Value is $407,571
How much will the City Raise for its Infrastructure Fund
and what would the Property Tax Rate be?
City of Ottawa: problem 1
We begin with the Budget Constraint
If taxed at 0% Y = PPG x QPG + PINF x QINF

$172
Total Private Goods (Home Value)
Private Goods (Home Value)
= $407,571 x 422,327
= $172 Billion (Y)
With No Grants from

Provincial Government
PPG = PINF = $1
Infrastructure Fund (Property Tax) $172 If taxed at 100%

𝑀𝑈𝑃𝐺 = 𝑑𝑈𝑃𝐺 𝑀𝑈𝐼𝑁𝐹 = 𝑑𝑈𝐼𝑁𝐹
dUPG = 0.99 Q-0.01PG x Q0.01INF dUINF = Q0.99PG x 0.01 Q-0.99INF
0.99 Q 0.01INF 0.01 Q 0.99PG

dUPG = dUINF =
Q 0.01PG Q 0.99INF
Maximizing their Utility . . . With No Grants
𝑀𝑈𝑃𝐺 𝑀𝑈𝐼𝑁𝐹
= 𝑃𝑃𝐺 = 𝑃𝐼𝑁𝐹 = $1
𝑃𝑃𝐺 𝑃𝐼𝑁𝐹
So we can Maximize Utility . . .
𝑀𝑈𝑃𝐺 = 𝑀𝑈𝐼𝑁𝐹
0.99 Q 0.01INF 0.01 Q 0.99PG

0.01 =
Q PG Q 0.99INF
0.99 Q 0.01INF 0.01 Q 0.99PG

0.01 =
Q PG Q 0.99INF
Cross multiplying . . .
0.99 Q 0.01INF x Q 0.99INF = 0.01 Q 0.01PG x Q 0.99PG
0.99 Q INF = 0.01 Q PG
99 Q INF = Q PG In our Case
Could just use

𝑈 𝑋, 𝑌 = 𝐴𝑋 𝛼 𝑌𝛽 𝑃𝑃𝐺 = 𝑃𝐼𝑁𝐹 = $1
Cobb-Douglas
α Y Px 0.99 𝑄𝐼𝑁𝐹 $1
Maximize Utility = = 99 Q INF = Q PG
β X Py 0.01 𝑄𝑃𝐺 $1
Y = PPG x QPG + PINF x QINF
Substituting each of the following . . .
𝑃𝑃𝐺 = 𝑃𝐼𝑁𝐹 = $1 Y = $172 Billion 99 𝑄𝐼𝑁𝐹 = QPG
$172 = 99 QINF + QINF $172 = 100 QINF
QINF = $1.72 B
99 𝑄𝐼𝑁𝐹 = QPG Property Tax Rate
172 −170.28
QPG = $170.28 B = = 𝟏%
172
Graphing . . . Location is Exaggerated for Visual Purposes
$172 Property Tax Rate
𝟏%
Infrastructure Fund
$170.28 $𝟏. 𝟕𝟐 𝑩𝒊𝒍𝒍𝒊𝒐𝒏
$1.72 $172
Infrastructure Fund (Property Tax)
Tools of Redistribution: grants
The City thinks this amount is too low and call ups the Provincial/Federal
Government asking for help, who respond with a Grant
Several Types of Grants . . .
1. Matching Grant
For Every Dollar given by the Donor (Provincial/Federal), a
Certain Sum must be Expended by the Recipient (Ottawa)
The City of Ottawa would like to take advantage of

the Public Transit Infrastructure Fund (PTIF) which
provides 50% Matching Grants.
How much will the City Raise for its Infrastructure Fund and
what would the Property Tax Rate be?
If Taxed at 0%, No Grants

With 50% Matching Grant, when the
Will be Provided
= $172 Billion City of Ottawa Raises Taxes by $1, it will
$172 have $1.50 for Infrastructure

Do these Prices Still Hold?

𝑃𝑃𝐺 = 𝑃𝐼𝑁𝐹 = $1
If Taxed at 100% and with

50% Matching No Grants
= 172 x 1.5 = $258
Can Receive up to $86

Billion in Grants
Infrastructure Fund (Property Tax + Grants) $172 $258
Do these Prices Still Hold?
𝑃𝑃𝐺 = 𝑃𝐼𝑁𝐹 = $1
𝑃𝑃𝐺 = $1.00
$172
172 = PPG x $172 + PINF x $0 𝑃𝐼𝑁𝐹 = $0.67
PPG = $𝟏
172 = $1 x $0 + PINF x $258
𝟐
PINF = = 0.67
𝟑
Could also just use . . .
𝟏 𝟐
= 𝟑 = 0.67
𝟏+𝟓𝟎%
𝟏𝟕𝟐 𝟐
Or = 𝟐𝟓𝟖
= 𝟑
Infrastructure Fund (Property Tax + Grants) $172 $258

0.99 Q 0.01INF 0.01 Q 0.99PG

dUPG = dUINF =
Q 0.01PG Q 0.99INF
Maximizing their Utility . . . With 50% Matching Grant
𝑀𝑈𝑃𝐺 𝑀𝑈𝐼𝑁𝐹 𝑃𝑃𝐺 = $1.00

= 𝑃𝐼𝑁𝐹 = $0.67

𝑀𝑈𝑃𝐺 𝑀𝑈𝐼𝑁𝐹
=
0.99 Q 0.01INF 1 0.01 𝑄0.99PG 1

0.01 x = x
Q PG $𝟏 𝑄 0.99
INF $𝟎.𝟔𝟕
0.99 Q 0.01INF 0.01 𝑄0.99PG
0.01 =
Q PG 0.67 𝑄0.99 INF
0.67 x 0.99𝑄0.01 INF x 𝑄0.99 INF = 0.01 𝑄0.99 PG x 𝑄0.01 PG
0.6633 𝑄1 INF = 0.01 𝑄1 PG
66.3 Q INF = Q PG In our Case
Could just use 𝑃𝑃𝐺 = $1.00

𝑈 𝑋, 𝑌 = 𝐴𝑋 𝛼 𝑌𝛽 𝑃𝐼𝑁𝐹 = $0.67
Cobb-Douglas
Maximize Utility = = 66.3 Q INF = Q PG
β X Py 0.01 𝑄𝑃𝐺 $0.67

𝑃𝑃𝐺 = $1.00
Y = $172 Billion 66.3 QINF = QPG
𝑃𝐼𝑁𝐹 = $0.67
$172 = 66.3 QINF + 0.67 QINF $172 = 66.97 QINF
QINF = $2.57 B
66.3 QINF = QPG Property Tax Rate
172 −170.28
QPG = $170.28 B = = 𝟏%
172
Use $2.568 instead of the rounded $2.57 to calculate
Property Tax Rate Infrastructure Fund
𝟏% $𝟐. 𝟓𝟕 𝑩𝒊𝒍𝒍𝒊𝒐𝒏
Infrastructure Fund $1.72 B from Property Taxes
$172
Grant = $2.57 – ( $172 – $170.28)
= $𝟖𝟓𝟎 𝒎𝒊𝒍𝒍𝒊𝒐𝒏 𝒊𝒏 𝑮𝒓𝒂𝒏𝒕𝒔
$170.28 Problem 2
Problem 1
$1.72 $2.57 $172 $258

Infrastructure Fund (Property Tax + Grants)
What happens if the Provincial/Federal Government issue a
Block Grant instead of a Matching Grant. The Block Grant is for
an Amount Equal to the Matching Grant of $850 million
So what’s a
Block Grant?
2. Block Grant
A Block Grant is a Fixed amount with No Mandate on

How it is to be Spent
What Implications
does this have?
The Block Grant can now be Spent on Either

Private Goods or the Infrastructure Fund
What Changes do we
need to make here?
172 + 0.85
= 172.85
This Changes Our Budget Constraint since we can
Private Goods (Home Value) + Tax Break
now spend the whole amount of $850 million solely on
$172 increasing Private Goods or on Infrastructure
Block Grant
Matching
Grant Effect
$172 $172.85 $258

Infrastructure Fund (Property Tax + Grant )
172.85
What’s the Price?
𝑃𝑃𝐺 = ?
𝑃𝐼𝑁𝐹 = ?
$172.85
What’s the Price?
172.85
𝑃𝑃𝐺 = $1.00
𝑃𝐼𝑁𝐹 = $1.00
Next, Maximizing the Utility Function

to the New Budget Constraint
? $172.85
Same as
Problem 1
0.99 Q 0.01INF 0.01 Q 0.99PG

dUPG = dUINF =
Q 0.01PG Q 0.99INF
Maximizing their Utility . . . With Block Grant

𝑀𝑈𝑃𝐺 𝑀𝑈𝐼𝑁𝐹 𝑃𝑃𝐺 = $1.00
=
𝑃𝑃𝐺 𝑃𝐼𝑁𝐹 𝑃𝐼𝑁𝐹 = $1.00

Same as
Problem 1 𝑀𝑈𝑃𝐺 = 𝑀𝑈𝐼𝑁𝐹
0.99 Q 0.01INF 0.01 Q 0.99PG

0.01 =
Q PG Q 0.99INF
0.99 Q 0.01INF 0.01 Q 0.99PG
0.01 =
Q PG Q 0.99INF
0.99 Q 0.01INF x Q 0.99INF = 0.01 Q 0.99PG x Q 0.01PG
0.99 Q 1INF = 0.01 Q 1PG

Same as
Problem 1 99 Q INF = Q PG
In our Case
Could just use

𝑈 𝑋, 𝑌 = 𝐴𝑋 𝛼 𝑌𝛽 𝑃𝑃𝐺 = 𝑃𝐼𝑁𝐹 = $1
Cobb-Douglas
Maximize Utility = = 99 Q INF = Q PG
β X Py 0.01 𝑄𝑃𝐺 $1

𝑃𝑃𝐺 = $1.00
Y = $172.85 Billion 99 QINF = QPG
𝑃𝐼𝑁𝐹 = $1.00
$172.85 = 99 QINF + QINF $172.85 = 100QINF
QINF = $1.73 B
Property Tax Rate
99 QINF = QPG Use the 172 (Home Value) not 172.85
172 −171.12
QPG = $171.12 B = = 𝟎. 𝟓𝟏%
172
Use $1.7285 instead of the rounded $1.73 to calculate
$172.85
𝟎. 𝟓𝟏% $𝟏. 𝟕𝟑 𝐁𝐢𝐥𝐥𝐢𝐨𝐧
$172 $𝟖𝟓𝟎 𝒎𝒊𝒍𝒍𝒊𝒐𝒏 𝒊𝒏 𝑮𝒓𝒂𝒏𝒕𝒔
$171.12
Where did the
Problem 3
$170.28
Grants Go?
Problem 1
$1.72 $1.73 $172 $172.85

$172.85
𝟎. 𝟓𝟏% $𝟏. 𝟕𝟑 𝐁𝐢𝐥𝐥𝐢𝐨𝐧
$172 $𝟖𝟓𝟎 𝒎𝒊𝒍𝒍𝒊𝒐𝒏 𝒊𝒏 𝑮𝒓𝒂𝒏𝒕𝒔

Where did the Grants Go?
$171.12 $840 million (= 171.12 – 170.28)

Problem 3
went to Private Goods and
Only $10 million ( = 1.73 – 1.72)
$170.28
went to the Infrastructure Fund
Problem 1
Compare this to the

Matching Grant . . .
$1.72 $1.73 $172 $172.85
$172.85 Matching Grant Block Grant

Infrastructure Fund $2.57 $1.73

$172
Problem 3
$171.12
$170.28 Problem 2
Problem 1
$1.72 $1.73 $2.57 $172 $172.85 $258

Infrastructure Fund (Property Tax)
The Provincial/Federal Government does not like that most of

the Grants are Not going to Infrastructure and responds with a
Conditional Block Grant of $850 million
So what’s a
Conditional
Block Grant?
3. Conditional Block Grant
A Grant of some Fixed Amount with a Mandate that

the Money be Spent in a Particular Way
What Implications
does this have?
172.85 The City can Now Spend $850 Million on Infrastructure

while Continuing to Spend its Original Amount for
Private Goods of $172 B (i.e Zero Property Tax)
$172
Block Grant Effect

How do we Show this
on the Graph?
Matching
Grant Effect
$172 $172.85 $258

Infrastructure Fund (Property Tax + Grant)
172.85
Conditional Block Straight Line for the 1st
Grant Effect $850 million
$172
And if it Wanted to Add more to

Block
the Infrastructure Fund?
Grant
Matching
Grant
$0.85 $172 $172.85 $258

172.85 Beyond the $850 million, it faces the

Conditional Block
same trade-off as the Block Grant
Grant Effect
(parallel to the No Grant Curve)
$172
What if it were $1 billion in

Block
Conditional Block Grant?
Grant
Matching
Grant
$0.85 $172 $172.85 $258

172.85
Conditional Block What if it were $1 billion in
Grant Effect Conditional Block Grant?
$172
The Max it can Spend (100% Tax)

is now $173
Continuing our original problem

with $850 million . . .
Block
Grant
Matching
Grant
$1 $172 $172.85 $173 $258

What’s the Price? Next, Maximizing the Utility Function
𝑃𝑃𝐺 = $1.00 to the Budget Constraint
𝑃𝐼𝑁𝐹 = $1.00
$172
What do we Expect?
? Will the City change its
behaviour from the
Unconditional Block Grant
$0.85 ? $172.85
Infrastructure Fund (Property Tax + Block Grant)
Same as Block Grant City of Ottawa: problem 4
of Problem 3
If the City is Already Spending ($1.73B) More than the Grant

$172.85 Amount ($850 million), It Will Not Change it’s Behaviour
Y = $172 B (it can tax) + $850 million Grant

$172
Due to Crowd Out Effect – as

Effectively Not the Government Provides More
of the Public Good, the Private
Conditional
$171.12 Sector will Provide Less
Problem 3 (Block Grant)
Property Tax Rate
𝟎. 𝟓𝟏%
Infrastructure Fund
$𝟏. 𝟕𝟑 𝑩𝒊𝒍𝒍𝒊𝒐𝒏
$0.85 $1.73 $172.85

Infrastructure Fund (Property Tax + Block Grant)
The Federal/Provincial Government is frustrated and decides to

Issue a Matching Closed Ended Grant
Matching 50% up to $500 million
So what’s a
Matching Closed
Ended Grant?
4. Matching Closed – Ended Grant
A Matching Grant that puts a Ceiling

on the Grant Amount
What
Implications
does this have?
If Taxed at 0%, No Grants 50% Matching Grant Without

Will be Provided
= $172 Billion Closed Ended
$172
Now let’s Close it at $500 million
If Taxed at 100% and with

50% Matching No Grants
= 172 x 1.5 = $258
Infrastructure Fund (Property Tax + Grant) $172 $258

50% Matching Grant Closed Ended at $500 million

Problem 2 - Open Ended Matching Grant
$172 yielded $850 million in Grants and . . .

$172 $172.50 $258
Where does the Utility fall Relative to the

Change in Budget Constraint?
$172
Before?
$170.28
Or After? Why is this
$170.28 Important?
$2.57 $2.57 $172.50 $258

If Before, then No Change is Required by the City –
Closed Ended Grant is Irrelevant
$172
Before?
$170.28
If After, then Need to
Or After? Drop to New Budget
$170.28 Constraint Line
So which is it?
$2.57 $2.57 $172.50 $258

Assuming No Change to Utility . . .
$172 and since Closed End Amount is Less than the

Before?
Open Ended Maximizing Utility Amount

$170.28
$500 Million < $850 Million
?
Or After?
Expect it to be After
$170.28
Can’t we just get the

numbers ?
$2.57 ? $2.57 $172.50 $258

You can skip this part . . . Not on Test

𝑃𝑃𝐺 = $1.00
Y = $172 Billion 66.3 QINF = QPG
𝑃𝐼𝑁𝐹 = $0.67
$172 = 66.3 QINF + 0.67 QINF $172 = 66.97 QINF

$850 million in Grants needs to
drop to $500 million
QINF = $2.57B What to do?
66.3 QINF = QPG Property Tax Rate
172 −170.28
QPG = $170.28B = = 𝟏%
172
You can skip this part . . . Not on Test
Given that this is a Linear Line . . . $1.72 = 172 – 170.28
Generated 2.57 B
$850 million Grant = $1.72 Billion in Property Taxes
$172 $500 million Grant = How Much in Property Taxes?

Cross Multiplying
1.72 𝑥 500
$170.99 = $𝟏. 𝟎𝟏 𝑩𝒊𝒍𝒍𝒊𝒐𝒏
850
Which means . .
$170.28
QPG = $172 – $1.01 = $170.99
&
QINF = $1.01B + $500 million
QINF = $1.51 Billion
$1.51 $2.57
Now Can Solve using New Budget Constraint Equation
$172.5 with One to One Pricing – No Grants . . .
$172 Y = PPG x QPG + PINF x QINF

𝑃𝑃𝐺 = $1.00
𝒀 = $𝟏𝟕𝟐. 𝟓𝟎
$170.99 𝑃𝐼𝑁𝐹 = $1.00
Matching Grant
$170.28
99 QINF = QPG
From Problem 1
$1.51 $2.57 $172.50 $258


𝑃𝑃𝐺 = $1.00
Y = $172.5 Billion
𝑃𝐼𝑁𝐹 = $1.00
99 QINF = QPG
$172.50 = 99 QINF + QINF $172.50 = 100 QINF

QINF = $1.725 B
Property Tax Rate
99 QINF = QPG
Use the 172 (Home Value) not 172.50
QPG = $170.775 B =
172 −170.775
= 𝟎. 𝟕𝟏%
172
𝟎. 𝟕𝟏% $𝟏. 𝟕𝟐𝟓 𝑩𝒊𝒍𝒍𝒊𝒐𝒏

$172
$𝟓𝟎𝟎 𝒎𝒊𝒍𝒍𝒊𝒐𝒏 𝒊𝒏 𝑮𝒓𝒂𝒏𝒕𝒔

$170.99
$170.775
$170.28
$1.51 $1.725 $2.57 $172.50 $258

INTERGOVERNMENTAL GRANTS IN CANADA
History of Health and

Social Transfers
Four Major Programs - Make up 85% of Total Intergovernmental Grants
Conditional* Block Grants
with Cash & Tax Point Components
Tax Points Reduced the Federal
Government’s Share of Personal Income
Tax (13.5 tax points were Transferred)
and Corporate Income Tax (1 tax point
was Transferred ) – Burden on the
Taxpayer remains the Same
1. Canada Health Transfer (CHT) 2. Canada Social Transfer (CST)

*Very Few Conditions Set
• Prohibition of Residency
Requirements to
Determine Edibility
• Adherence to 5
• No Specific Conditions Set
Principles of Canada
by Federal Government
Health Act
3. equalization
equalization
equalization
Equalization calculation
?
UnConditional Open – Ended Closed Ended Grant
Only the Ceiling Cap (Slide 140) makes it Closed Ended, otherwise Open Ended
3. Equalization Provinces with Fiscal Capacities Below the Standard

Received a Payment, while Above Do Not
A Province’s Equalization
𝐏𝐏 𝐓𝐏
Payment can be Calculated E P = 𝐑𝐍 −
from the Following Equation
𝐏𝐍 𝐓𝐍
EP = Equalization Payment for
RN = National Revenues per Tax Base
Province (0 if negative)
PP = Population of Province TP = Provincial Tax Base Share
PN = Population of Canada TN = National Tax Base

Using Five Tax Bases . . . 𝐏𝐏 𝐓𝐏

E P = 𝐑𝐍 −
National Revenues per Tax Base 𝐏𝐍 𝐓𝐍
RN = National Average Tax Rate for Base x National Tax Base
Think of it as Taxable Income

Ontario Quebec P.E.I Remaining 7 National Tax
Five Tax Bases
(TP- ON) (TP- QC) (TP- P.E.I) Provinces (TP) Base (TN)
Personal
Income Taxes 153,685 71,130 1,008 147,567 373,385
Corporate
Income Taxes 33,297 19,243 108 55,459 108,107
Consumption
Taxes 269,843 159,157 2,894 291,546 723,440
Natural
245 3,030 0 14,239 17,514*
Resources Royalties Fees
Property Taxes 2,330,904 1,076,712 17,748 2,490,636 5,916,000
Using Five Tax Bases . . . 𝐏𝐏 𝐓𝐏
E P = 𝐑𝐍 −
National Revenues per Tax Base 𝐏𝐍 𝐓𝐍
RN = National Average Tax Rate for Base x National Tax Base
For Each of the Five Tax Bases, Use an Identical Tax Rate for All Provinces
National Avg. Tax National Revenues per

Five Tax Bases National Tax Base
Rate for Base Tax Base (RN)
Personal Income
Taxes 373,385 20% 74,677
Corporate Income
Taxes 108,107 15% 16,216
Consumption Taxes 723,440 10% 72,344
Natural Resources 17,514 50% Cut 8,757
Property Taxes 5,916,000 1% 59,160
Next . . . 𝐏𝐏 𝐓𝐏
Province’s Share of E P = 𝐑𝐍 −
𝐏𝐍 𝐓𝐍
National Population
National
Ontario Quebec P.E.I Remaining 7
Population
(PP- ON) (PP- QC) (PP- P.E.I) Provinces (TP)
(PN)
Provincial
Population 13,014 7,797 140 12,529 33,480
Population
Share sample
Calculation For example, for Ontario: 13,014 / 33,480 =
(PP / PN)
Population
Share 38.9% 23.3% 0.4% 37.4% 100%
(PP / PN)
Province’s Share of 𝐏𝐏 𝐓𝐏
EP = 𝐑𝐍 −
National Tax Base 𝐏𝐍 𝐓𝐍
Ontario Quebec P.E.I Remaining 7 National Tax
Five Tax Bases
(TP- ON) (TP- QC) (TP- P.E.I) Provinces (TP) Base (TN)
Personal
153,685 71,130 1,008 147,567 373,385
Income Taxes
41.2% 19.1% 0.3% N/A
Corporate
33,297 19,243 108 55,459 108,107
Income Taxes
30.8% 17.8% 0.1% N/A
Consumption
Taxes 269,843 159,157 2,894 291,546 723,440
37.3% 22% 0.4% N/A
Natural
Resources 245 3,030 0 14,239 17,514
1.4% 17.3% 0% N/A
Property Taxes 2,330,904 1,076,712 17,748 2,490,636 5,916,000
39.4% 18.2% 0.3% N/A
Calculate for Each Province: 𝐏𝐏 𝐓𝐏
E P = 𝐑𝐍 −
ONTARIO 𝐏𝐍 𝐓𝐍
Base
𝐏𝐏 𝐓𝐏 Deficiency Equalization
Five Tax Bases RN Payment
𝐏𝐍 𝐓𝐍 (𝐏𝐏 𝐏
−
𝐓𝐏
𝐓𝐍
)
𝐍
Personal
Income Taxes 74,677 41.2% - 2.3% -1,718
Corporate
Income Taxes 16,216 30.8% 8.1% 1,313
Consumption
Taxes 72,344 38.9% 37.3% 1.6% 1,158
Natural
Resources 8,757 1.4% 37.5% 3,284
Property
Taxes 59,160 39.4% - 0.5% - 296
Equalization Payment for Ontario (millions) $3,741

E P = 𝐑𝐍 −
QUEBEC 𝐏𝐍 𝐓𝐍
Base
−
𝐓𝐏
𝐓𝐍
)
𝐍
Personal
Income Taxes 74,677 19.1% 4.2% 3,136
Corporate
Income Taxes 16,216 17.8% 5.5% 899
Consumption
Taxes 72,344 23.3% 22% 1.3% 940
Natural
Resources 8,757 17.3% 6% 525
Property
Taxes 59,160 18.2% 5.1% 3,017
Equalization Payment for Ontario (millions) $8,517

E P = 𝐑𝐍 −
𝐏𝐍 𝐓𝐍
P.E.I
Base
−
𝐓𝐏
𝐓𝐍
)
𝐍
Personal
Income Taxes 74,677 0.3% 0.1% 75
Corporate
Income Taxes 16,216 0.1% 0.3% 49
Consumption
Taxes 72,344 0.4% 0.4% 0% 0
Natural
Resources 8,757 0% 0.4% 35
Property
Taxes 59,160 0.3% 0.1% 59
Equalization Payment for Ontario (millions) $218
equalization
Notice the Role of Natural

Resources and Property Taxes
(which is based off Property Value)
equalization
equalization
equalization
equalization
4. Territorial Formula Financing (TFF)
Similar to Equalization and designed to allow the Three

Territories to Provide Public Services Comparable to those
available in the Province
Federal Transfers as Canada Health

Canada Social
a Share Territorial Transfers Equalization
Transfer (CST)
Revenue (CHT)
Territories 73% $80 million $36 million $2,664 million
Meaning Equalization accounted for 70% of Territorial Revenues

Other Forms of Grants
Infrastructure Grants – are usually Closed Ended, Matching Grants
More variety in the territories - yukon
United states: school finance equalization
Local School Districts receive about
Can Lead to Large
44% of Funding Local Sources –
Disparities in Revenue Base
Primarily Local Property Taxes
Before Federal Money After Federal Money

Pennsylvania
33% Difference
% difference between High Poverty & Low Poverty (Rich) School Funding
California Prohibits Differences Unlike Other
States, Only a
Between Schools of More than
Quarter of K – 12
$350 per Pupil Spending Spending is from
Property Taxes
Once a District is Spending $350 more than

the Lowest Spending District, All Additional
Property Taxes Raised by the Town are Given to
the State for Distribution to Other Districts
Thus, a Town Receives No Benefit from

Raising its Own Local Property Taxes
because Extra Revenue is Divided among
Districts across the State – this Caused a
Drop of 15% on Education Spending
In New Jersey Towns with Property
Values Above the 85th Percentile of the
Property Values in the State Receive a
Small Grant from the State and have to
Raise Other Educational Revenues Locally
Towns Below the 85th Percentile Receive a

Matching Grant that is a Multiple of their
Own Educational Spending, which gives
towns an Incentive to Raise their Spending
Raised Per Pupil Spending by 7%

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Fiscal Federalism

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FISCAL FEDERALISM

Which Level of Government should do What?

Which Level of Government should do What?

The Extent to which a System is Decentralized can be expressed via

Share of Total Government Expenditures made by Subnational Governments

Distribution of Canadian Government Revenue and Expenditures

1960 60.8 50.5 21.8 24.8 17.3 24.7

Expenditure Shares by Level of Government, 2008 – 2009 (in percent)

Balanced on Protection of Persons and Property, and for Social Services

While Provinces make Federal – which gives a portion in the form

However, Provinces can Lobby . . . More Recently . . .

Own Spheres, Rarely Overlapping or from Own Sources - Less than 1%

Federal Gov. Share has Grown Significantly

Later – Social Insurance & Welfare

Income Taxes are the Largest Source of Financing for Federal

Compared to World, State/Local in the U.S (& Canada)

Individuals with Similar Tastes for Public

2. Fostering Intergovernmental Competition

Smaller Government may induce

Federal Waste Cost: 4 Cents

U.S Department of Defense Paid: $110

A System of Diverse Governments Enhances the Changes that

1. Efficiency Issues . . . . . . a) Externalities

The Activities Undertaken in One Community can Affect the

1. Efficiency Issues . . . . . b) Scale Economies in Provision of Public Goods

Cost per person may fall as the number of users increase

At the Same Time, Upper Income

Effective Tax Rate: Includes Sales Taxes, Excise

Consider building a Park . . . With Exclusive Members . . .

The Larger the Community, the

So Why Not Just Maximize the

So How Large in Size

In Trying to Answer the Optimal Division of Responsibilities

Two Factors Missing from the Market for Public Goods . . .

In Toronto, Montreal & Vancouver, 14% of people aged

The Tiebout Model solves Two Major Problems that Prevented

Preference Revelation Preference Aggregation

1. Assumes Perfect Mobility 2. Assumes No

Let’s go to the Next Town,

3. Requires Lump Sum Tax

Each town has N Residents

A Fixed Taxation amount

Resident Similarity Across Areas

The More Local Communities there are from which to Choose,

Capitalization of Fiscal Differences in House Prices

The Price of any House Reflects

The Extent to Which Public Goods should be Provided at

1. Tax Benefit Linkages 2. Positive Externalities

1. Tax Benefit Linkages

Local Roads – Strong Social Assistance – Weak – Funded

Next Town Next Town

National Defense – Federal Police – Local (Peel, Halton, Hamilton)

In the Absence of Government, Economic theory Suggests

We would Expect People to Move from Ontario to Alberta (from Point A to

Wage Rate Wage Rate

Zero Workers 8 million 7 million 10 , 5 Zero Workers

Number of Workers in the Two Provinces

Zero Workers 8,7 10 , 5 Zero Workers

Number of Workers in the Two Provinces