Book Summary:
The Spending Power in Federal Systems: a Comparative Study
By Ronald L. Watts
Institution of Intergovernmental Relations
Queen's University
Kingston, Ontario
1999
Background
Professor Watts examines the status and use of the spending power in several federal systems along four comparative axes: legal basis; link to revenue-raising powers; decisions on usage; and nature and extent of usage.
Professor Watts focuses primarily on the United States, Switzerland, Australia, Germany and the European Union, though he also briefly discusses Austria, Belgium, India, Malaysia and Spain.
Legal Basis of the Spending Power
The American, German, Swiss, Australian, Indian, Malaysian and Spanish Constitutions all contain explicit provisions allowing the federal government to spend money in areas of concurrent and exclusive unit government jurisdiction. While there is no explicit provision in the Austrian Constitution, the central government can in practice spend money in unit government jurisdiction as well.
The Swiss Constitution gives the federal government the power to "grant subsidies to the cantons for tasks with which it charges them or for other tasks that are in the interest of the country." The German Basic Law includes a similar provision, while the Australian Constitution goes so far as to say that the federal Parliament "may grant financial assistance to any State on such terms and conditions as the Parliament thinks fit." The U.S. Constitution features a similarly broad statement.
While in both the United States and Australia there are virtually no limits on areas in which the federal government can spend, in Switzerland the potential recourse to referendums has acted as a check on use of the federal spending power.
The financial arrangements in the Belgian federation are still in flux. In practice, however, the central government cannot spend money in areas of Regional or Community jurisdiction without their approval.
The European Union can best be understood as a confederation of states, with some federal elements. The equivalent of the spending power derives from agreement in the Council of Ministers about the areas in which money is to be spent for Union purposes.
Link to Revenue Raising Powers
The existence of a federal spending power can be explained by vertical and horizontal imbalances in federations. The former refers to the fact that state governments frequently lack a revenue base commensurate with their legislative responsibilities. Horizontal imbalance refers to the reality in most federations that some units will have much greater fiscal capacity than others.
In the United States, Australia, Austria, India, Malaysia and Spain, the federal government occupies most of the major tax fields, creating a significant vertical imbalance. The imbalance is far less pronounced in Germany and Switzerland.
For obvious reasons, the units in a federation characterized by significant vertical imbalances often rely heavily on federal transfers (see data reported below in "Nature and Use of the Federal Spending Power").
Roughly speaking. Switzerland's and Germany's horizontal imbalances (owing to reunification) and especially those of Malaysia, exceed those of Canada, while that of the United States is about the same as Canada, and Australia has the lowest extent of horizontal imbalance.
Decisions on Use of the Spending Power
As for decisions on use of this power, the United States is at one extreme: the use of the spending power lies with Congress; should the state governments attempt to influence Congress, they largely stand as only one among many lobby groups. Similarly, in Australia and Austria, the fiscal dominance of the federal government has traditionally meant that states have little input on the use of the spending power.
In Malaysia, while the states must be formally consulted via the National Financial Council, on which all governments are represented, the Council is an advisory body only and the federal government ultimately can act unilaterally.
By contrast, the Swiss cantons and German Länder have a significant say. In the former, members of cantonal legislatures often are simultaneously members of the federal second chamber, while the federal government consults extensively with the cantons, in part to stave off potential referendums. In Germany, the second legislative chamber, the Bundesrat, is comprised of representatives from Länder governments, whose consent is required if the spending power is to be used in areas of concurrent or exclusive Länder jurisdiction.
In India, most decisions about the use of the federal spending power are based upon recommendations made by two independent commissions.
Generally speaking, the budgetary process in the European Union is an interactive process among European institutions, with member states retaining a great deal of influence. In some instances, however, the Union (through qualified majority votes) has attached conditions to regional development grants, causing contention among some recipients.
In 1996, the Canadian government announced that new shared-cost programs relying on the federal spending power in areas of exclusive provincial jurisdiction would require the consent of a majority of provinces and that provinces opposed to the program could opt out with financial compensation so long as they established a similar program.
Among the federations examined in this report Canada is the only country in which financial compensation would be offered to unit governments who decide to opt out of programs funded by the federal government's spending power.
Nature and Use of the Spending Power
There are two particularly important comparative indices: the extent to which unit governments rely on federal transfers in general and conditional transfers in particular.
In 1993, transfers from the federal government represented 19.8% of provincial government revenue in Canada. This is the third-lowest percentage among comparable federations reviewed in the Watts study. By contrast, in Australia, the states received 40.7% of their revenues in the form of federal transfers in 1996.
Canadian provinces are far less dependent upon conditional transfers than their counterparts in other federations. In fact, if the CHST is considered to be an unconditional transfer (as Dr. Watts notes, it has no conditions in some areas and only very general ones in others), less than 1% of provincial revenues take the form of conditional grants. In contrast, the comparable number in Switzerland is 12.3%, in Australia 21.6% and in the U.S. 29.6%.
Once again, there are important differences between the European Union and the federations reviewed. Between 1994 and 1998, total expenditures by the European Union were between 1.2% and 1.25% of total European Union GDP. Clearly, transfers from the Union to member states were not nearly as important as the transfers from federal to unit governments in the federations under discussion.
That said, however, 32% of the Union budget in these years took the form of so-called "structural funds," most of which were channelled through the European Regional Development Fund. The main purpose of the Fund is to assist member states facing industrial decline or who have underdeveloped economic infrastructures.
The monies provided under ERDF are to be used to augment existing member state activities to combat these problems and are not designed to create new programs.
Conclusions
Professor Watts reaches several main conclusions that are of particular relevance to Canada:
1. The federal government's ability to mend mono in areas of concurrent and exclusive legislative jurisdiction is common to all major federations and is frequently explicitly provided for under the terms of the constitution.
2. All federations in the study are marked by both vertical and horizontal imbalances in terms of revenue capacity and expenditure responsibilities. These imbalances have been alleviated through financial transfers.
3. All federations are characterized by significant overlap and interdependence, particularly in the realm of social policy and programs.
4. Interdependence of this nature has led some federations to give unit governments a role in decision-making relating to the use of the spending power in areas outside federal jurisdiction. Federations vary greatly in this regard, with Germany and Switzerland going furthest, but the Belgian and Spanish systems also promote significant regional influence.
At the other end of the spectrum, unit governments in the United States, Australia, Austria, India and Malaysia have a very limited role in decisions about the use of the spending power in their jurisdiction.
5. Although the Canadian provinces have a more limited role than their counterparts in some other federations in decisions on the use of the federal spending power, Canada is unique in that the federal government is prepared to offer compensation to provinces that may opt out of future shared-cost programs established through the federal spending power.
6. Canadian provinces tend to be comparatively less dependent on federal transfers in general and conditional transfers in particular, than are their counterparts in the other federations under review.
7. The trend in Canada has been toward decreasing conditionality. Even the former Established Program Financing system, which covered health and post-secondary education, could be described as semi-conditional: the provisions of the Canada Health Act are more accurately described as "general principles and objectives." When the EPF and the Canada Assistance Plan were replaced by the Canada Health and Social Transfer, the absolute level of conditionality was reduced further.
8. The Social Union Framework Agreement (signed in February 1999), while recognizing the federal government's role in social policy through its spending power, "will enhance the role of the provinces in the design of federal programs and funding arrangements in this area and provide for a more collaborative approach."