The Canada Health and Social Transfer: Funding Formula and Changes in Transfers (BP381e)

The federal government helps the provinces assume their responsibilities for health care, post-secondary education and social assistance through transfers under the CHST. The CHST is a new block funding system that came into effect in early 1996-97, combining two major programs of transfers to the provinces: Established Programs Financing (EPF) and the Canada Assistance Program (CAP). The CHST funding formula differs from those of EPF and the CAP, however. Unlike EPF, it does not guarantee an equal per capita contribution. Nor is it a shared-cost program, as was the CAP; contributions are not based on provincial expenditures. The CHST for each province is calculated using a complex but innovative funding formula that is worth studying. This funding formula provides for a marked reduction of federal transfers to the provinces, followed by stabilization..

This Background Paper assesses the CHST. The first part briefly describes the context in which the CHST was introduced. The second part explains the CHST funding formula in detail, while the third part analyzes changes in transfers from 1996-97 through 2002-03. The fourth and last part provides a critical evaluation of this new federal transfer.

As was mentioned above, before the CHST came into effect in 1996-97, federal transfers for health care, post-secondary education and social assistance were made under two different programs: EPF and the CAP. EPF, which funded health care and post-secondary education from 1977-78 to 1995-96, was a block funding program under which each province received an equal per capita transfer. The CAP was a shared-cost program under which, from 1966-67 to 1995-96, the federal government reimbursed approximately 50% of provincial social assistance and welfare program expenditures.

During the 1980s and 1990s, in its quest to reduce the deficit, the federal government repeatedly limited the growth of transfers under these two programs, thereby limiting the ability of the provinces to maintain funding for health insurance and social programs. As well, capping the growth of transfers could in the long term have made it difficult to impose national health care standards(1).

The CHST is in line with the federal government's policy of expenditure reduction and, further, systematically reduces the value of federal transfers to the provinces. However, certain legislative provisions preserve the federal government's power to impose national health care standards and, after consultations with the provinces, other conditions with respect to social programs.

In introducing the CHST, the federal government explained that transfers to the provinces could be no exception to expenditure reduction: in 1995-96, transfers to the provinces accounted for nearly one-quarter of all federal program expenditures. The federal government argues that the provinces are now in a position to absorb the impact of the cuts, some of them having even balanced their budgets. While acknowledging that the cuts are significant, the federal government points out that they are not as severe as cuts made to other federal programs.(2)

According to the federal government, the CHST provides greater security, stability, predictability and flexibility. The total CHST is prescribed by law, will be stabilized starting in 2000-01, and ensures that the cash component will never be lower than a certain level. The CHST is being phased in, which, according to the federal government, gives the provinces time to adapt. Moreover, the provinces themselves will be able to decide how the funding will be allocated among health care, post-secondary education and social programs.

The CHST was established through two separate bills.(3) First, Bill C-76, which received Royal Assent on 22 June 1995, introduced the CHST. It set out the total amount of the CHST, its terms and conditions, and its allocation among the provinces in 1996-97. Second, Bill C-31, which received Royal Assent on 20 June 1996, set out the methods of payment of the CHST and its distribution among the provinces from 1997-98 to 2002-03. The operation of the CHST is governed by the Federal-Provincial Fiscal Arrangements Act.

The Federal-Provincial Fiscal Arrangements Act sets the total CHST at $26.9 billion in 1996-97 and $25.1 billion in 1997-98 to 1999-2000. From 2000-01 to 2002-03, the total CHST is calculated as follows:

This funding formula means that the total CHST for a given fiscal year will increase according to an escalator which is based on a three-year moving average of GDP growth. Using a moving average of the three calendar years preceding the fiscal year(4) during which the CHST is paid attenuates any possible sharp fluctuations in GDP growth because only the average change in GDP is applied. There are limits on the escalator, however: it will be reduced by 2.0% in 2000-01, by 1.5% in 2001-02 and by 1.0% in 2002-03. In other words, the total CHST paid by the federal government will increase at a rate less than the economic growth rate; the CHST will therefore not be adjusted for inflation. As well, if GDP growth were less than the coefficient q_t, the total CHST would decrease. As we shall see in the third part of this paper, the economic assumptions of the Department of Finance, on which the total CHST funding formula is based, forecast strong, sustained economic growth throughout this period.

The CHST funding formula is similar to that of EPF, which was also based on an escalator that took economic growth into account. However, EPF was a per capita transfer program: all provinces received an equal per capita amount for health care and post-secondary education. The CHST does not retain this equal funding formula; it includes transfers under the former CAP, which was not a per capita transfer program but was based on provincial expenditures for social assistance.

The Federal-Provincial Fiscal Arrangements Act also sets out how the total CHST is to be allocated among the provinces. In 1996-97, the Act provides for the following allocation:

In other words, the allocation in 1996-97 is based solely on each province's share of the transfers received under the CAP in 1994-95 and under EPF in 1995-96. In 1997-98, each province's CHST entitlement will be based on the transfers received under the former programs and on the ratio between each province's cumulative population growth and Canada's. Mathematically, this funding formula is as follows:

To some extent, the ratio involving the provinces' relative population growth reflects Canadians' geographic mobility. Thus, in 1997-98, provinces whose populations grow more rapidly than Canada's as a whole will receive a larger share of the total CHST; provinces whose populations grow more slowly will receive a smaller share. From 1998-99 to 2002-03, the allocation formula will be similar to that in 1997-98, but will also take into account each province's proportion of the country’s population. A weighting coefficient (k_t) will also be included. The allocation formula in 1998-99 to 2002-03 is as follows:

The weighting coefficient gradually gives greater importance to each province's proportion of Canada's population. Starting in 2002-03, the same weight (0.5) will be given to each province's proportion of the country’s population and to the allocation under the former CAP and EPF programs (adjusted for demographic changes). In other words, the allocation under the former CAP and EPF programs will gradually be diluted and replaced by the relative weight of each province's proportion of Canada as a whole. This change will reduce discrepancies among provinces in the value of per capita transfers without, however, making equal per capita allocations. The main reason for these discrepancies was the funding disparity under the CAP; the provinces that used to receive a greater than average share under the CAP will continue to receive a greater than average share under the CHST.

Not all the provinces are happy with this allocation formula. In fact, the only fair allocation formula is an equal per capita amount for each province. However, under a per capita allocation, the provinces that had higher expenditures for social assistance under the CAP (such as Quebec and Newfoundland) would be disadvantaged and would have lost a great deal. In the federal government's opinion, the CHST allocation formula is a reasonable compromise.(5)

Like EPF, the CHST has two components: cash and tax points. By means of tax points, the federal government transfers some tax room to the provinces by abating its income tax rates, while the provinces increase their income tax rates by an equivalent amount. This procedure reallocates revenue between the two levels of government: federal revenue is reduced by an amount equal to the increase in provincial revenue. The tax burden remains unchanged, since taxpayers pay more provincial income tax but less federal. The tax transfer component of the CHST grants federal abatements of one point on corporate income tax and 13.5 points on basic individual income tax. Under the opting-out agreements, Quebec receives a special abatement of 8.5 additional tax points on individual income tax.

Since income tax revenue varies from province to province and the less prosperous provinces have more limited fiscal capacity, the federal government applies an equalization mechanism to the transfer of tax points. Provinces whose fiscal capacity is below a representative standard receive equalization payments, as a result of which the tax points component is equal to the standard. The provinces making up the standard are Quebec, Ontario, Manitoba, Saskatchewan and British Columbia. With equalization, the provinces receive equal per capita tax points. However, the total value of the tax points varies from province to province, depending on population. In summary, equalization of the tax points component of the CHST reduces but does not eliminate discrepancies among the provinces.

The cash component of the CHST, on the other hand, is paid periodically to the provinces by cheque. The value of a province's cash component is the difference between its total CHST entitlement and the value of its tax points:

The cash component of the CHST is a residual value that varies inversely with the tax points; if the tax points increased rapidly, the cash would be less, and vice versa.

The cash component is subject to certain conditions. The provinces' health insurance plans must meet the criteria set out in the Canada Health Act (universality, accessibility, comprehensiveness, portability, and public administration); no user contributions in the form of overbilling or user fees can be charged. Nor are the provinces able to impose minimum residence requirements on persons applying for social assistance. There are, however, no specific conditions regarding post-secondary education. Provinces that fail to meet one of the criteria may have their cash component reduced, according to the seriousness of the contravention. As well, if the cash penalty imposed by the federal government is greater than the cash component of the CHST, the Federal-Provincial Fiscal Arrangements Act provides that other federal cash transfers to the province may be withheld.

The cash component cannot fall below a certain level. According to the Federal-Provincial Fiscal Arrangements Act, the minimum level will be no less than $11 billion from 1998-99 to 2002-03. This minimum applies only to the total cash component; there is no minimum cash component for any particular province. This minimum provides protection against unexpected economic fluctuations that might reduce the total transfer or significantly increase the tax points component. The federal government believes that this minimum is high enough for it to retain its power to impose national standards for health care or other conditions regarding social programs.

The data in this part of the paper are taken from Department of Finance documents.(6) Essentially, the forecasts are based on a number of departmental assumptions with respect to economic growth and population growth.

Chart 1 shows changes in transfers to the provinces for health care, post-secondary education and social assistance in 1995-96 to 2002-03; 1995-96 was the last year funded under the former EPF and CAP program and 1996-97 is the first year funded under the CHST. The first (darker) bars indicate the value of the total transfers in current dollars; the second (paler) bars indicate the total transfers in constant 1996 dollars (that is, adjusted to take price increases into account).

Under the CHST, transfers for health care, post-secondary education and social assistance will first be reduced and then stabilized. With the introduction of the new program, transfers to the provinces were reduced from $29.7 billion in 1995-96 to $26.9 billion in 1996-97, a drop of $2.8 billion or 9.5%. From 1996-97 to 1997-98, the CHST will be reduced by a further $1.8 billion, or 6.7%. Transfers to the provinces will thus have been slashed by 15.6% between 1995-96 and 1997-98. The CHST will be stabilized at $25.1 billion from 1997-98 to 1999-2000, after which it will be increased slightly from 2000-01 to 2002-03, when it will reach $27.4 billion, according to Department of Finance forecasts. It should be borne in mind that these figures are based on forecast three-year averages of GDP growth. Economic growth would have to be over 4% for these forecasts to be realized; if growth is less, total CHST growth will not be as great as anticipated.

A comparison of changes in federal transfers to the provinces should take price fluctuations into account. With inflation, or price increases, the value of a 1997 dollar is lower than that of a 1996 dollar. Conversely, with deflation, or price reductions, the value of a 1996 dollar is lower than that of a 1997 dollar. Deflating the value of the total CHST by the overall price increase provides purchasing power figures that are comparable from year to year.

In "constant dollar" or real terms, the reduction in the total CHST is much more pronounced than in current dollars. In 1996 dollars, the CHST will be reduced from $29.7 billion in 1995-96 to $23.7 billion in 1999-2000, a drop of 20.4%. In real terms, from 1999-2000 to 2002-03 the CHST will increase by $1 billion,(7) an average annual growth rate of approximately 1%.

With the introduction of the CHST, the magnitude of the reduction in federal payments means that transfers to the provinces will decline as a proportion of provincial program expenditures.(8) Chart 2 shows that the total CHST (or EPF + CAP for 1995-96), expressed as a proportion of provincial program expenditures, will be reduced from 21.4% to 18.9% between 1995-96 and 1997-98, and will be stabilized at 19.3% in 1999-2000. Despite substantially lower provincial program expenditures, the reduction in the CHST proportion of those expenditures means that the provinces will have to offset the reduced federal transfers by finding other funding or by using funding now earmarked for purposes other than health care, post-secondary education and social assistance.

Table 1 gives the total per capita CHST from 1995-96 to 2002-03 in current dollars and in constant 1996 dollars. It shows a significant reduction in the total CHST expressed in dollars per capita. In 1995-96, the provinces received an average of $993 per capita. In 2002-03, they will receive $849, a reduction of 14.5% in current dollars; in 1996 dollars, they will receive $766 per capita, a real reduction of 22.9%. Given the economic forecasts by the Department of Finance, the planned increase in the per capita CHST from 1999-2000 to 2002-03 will, in real terms, be almost completely wiped out by the increase in Canada's population.

	1995-96	1996-97	1997-98	1998-99	1999-2000	2000-01	2001-02	2002-03
Current Dollars	993	888	819	810	801	812	829	849
Constant Dollars	993	874	796	775	756	755	759	766

Chart 3 compares the value of the per capita CHST per province in constant dollars in 1996-97, 1999-2000 and 2002-03. It shows that from 1996-97 to 2002-03 there will be a trend toward reduced disparities among the provinces' per capita CHST entitlements.

Combining EPF and the CAP revealed significant disparities among per capita transfers to the provinces for health care, post-secondary education and social assistance: although EPF provided equal per capita transfers to each province, the CAP was a shared-cost program, under which the federal government contributed approximately 50% of the total cost of provincial programs. Thus, under the CAP, the provinces that spent more on social assistance programs received larger federal transfers. The CHST funding formula adopted by the federal government ensures that these interprovincial disparities will be reduced over the long term, according to the federal government they will have been halved by 2002-03,(9) and that per capita CHST amounts per province will increasingly approach equality.

As is shown in Chart 4, cash transfers were reduced from $17.5 billion to $15.0 billion in the first year of the implementation of the CHST and to $12.5 billion the following year. While total transfers will have been reduced by $4.6 billion from 1995-96 to 1997-98, the cash component will have been reduced by $5 billion over the same period. The reduction and subsequent stabilization of the total CHST, combined with the gradual increase in the tax points component, will mean a considerable reduction of the cash component until the end of 2000-01. The value of tax points will exceed the cash portion of transfers starting in 1997-98.

According to Department of Finance forecasts, the cash transfer should not fall below $11 billion. However, if GDP growth were to be lower than forecast or if the value of the tax points were to increase more rapidly, the formula could bring the cash transfer to less than the minimum. In that case, the Federal-Provincial Fiscal Arrangements Act provides that the federal government should pay an additional amount in order to maintain the minimum cash component.

Although the extent of the reductions was challenged, the funding formula did not receive much criticism after the CHST was introduced. This formula was not the subject of any consultation; at least from 1996-97 to 1999-2000, the total CHST was reduced unilaterally by the federal government. Thereafter, the total CHST is to vary annually depending on economic growth, but always at a rate lower than that of economic growth: the funding formula limits the escalator determining CHST growth. If GDP growth were low, this limitation could wipe out any increase in the CHST. Essentially, the CHST funding formula means that the provinces will receive transfers that do not take into account any changes in the cost of living.

France St-Hilaire(10) argues that, although it is appropriate to link total CHST growth to economic growth and population growth in the case of health care and post-secondary education, funding for social assistance should always be based on the provinces' needs. She explains that under the CHST the provinces will have to assume sole responsibility for additional social assistance costs in times of recession. It remains to be seen how the concept of need could be made part of the CHST funding formula, however.

The CHST funding formula is complicated. As Thomas Courchene suggests,(11) there are no magic CHST funding or allocation formulas. On the one hand, all the provinces lose, since they all receive reduced federal transfers; on the other hand, some provinces lose more, since they receive relatively less than others.

The CHST allocation formula should nevertheless satisfy some provinces. First, for provinces like Quebec and Newfoundland, the CHST is more advantageous than, for example, a flat, equal per capita funding formula. Second, the elements of geographic mobility and provincial population proportions in the funding formula should limit the extent to which one province's policies can harm another province. In this regard, Arthur Kroeger(12) has pointed out that, following social program cuts made by the Alberta government, some Alberta residents moved to British Columbia in order to take advantage of its more generous benefits.

Unlike the former EPF equal per capita funding formula, the CHST funding formula does not reduce interprovincial disparities or make it easier for some less prosperous provinces to provide their residents with a broad range of programs and services. These disparities will certainly be highlighted in times of economic slowdown.

As well, while the federal government considers that the cash floor of the CHST, set at $11 billion, is high enough to allow it to retain its power to impose national standards, some experts(13) have recommended that this minimum be increased to $12.5 billion. This would have the advantage of increasing provincial revenue and strengthening federal commitment to the health insurance system and social programs. With an increased minimum, and changes in the cash component forecast by the Department of Finance, the federal government would have to increase the cash component as early as 1996-97.

Starting in 1997-98, more tax points will be transferred to the provinces for health care, post-secondary education and social assistance. It has been suggested that the federal government should eliminate the cash transfer in return for transferring more tax points.(14) To offset the effects of this, thefederal government would reduce its income tax rates while the provinces would raise theirs by an equal amount. It is difficult to impose national standards through tax points, for which revenues are collected by the provinces, not by the federal government. Increasing the tax points would have the effect of reducing the federal government's tax base. As a result, its power to impose national standards for health care or other conditions with respect to social programs would be limited. On the other hand, having more tax points would give the provinces more flexibility and greater latitude in organizing and delivering health care and social services, and would protect them against unilateral federal budget cuts.

Some provinces would categorically turn down an increase in tax points and the federal government would not want(15) to replace the cash transfer with a larger tax points component, arguing that it needs to protect its tax base if it is to respect its obligations to Canadians in all parts of the country and achieve its deficit reduction objectives. Moreover, it considers tax points unfair to the less prosperous provinces because they are of greater value in the more prosperous provinces.

Overall, the introduction of the CHST has represented a major change in federal transfers to the provinces for health care, post-secondary education and social assistance and could alter future relations between the two levels of government.

Under the new funding formula for health care and social programs, transfers to the provinces will be reduced by nearly 16% between 1995-96 and 1997-98. At the same time, the cash transfer under the CHST will be reduced even more. As well, starting in 2000-01, CHST growth will depend on GDP growth. Since the CHST will be increasingly based on each province's proportion of Canada's population, the provinces now receiving greater per capita transfers will have to absorb greater reductions in those transfers.

Only over the next few years will we see the overall effect of the CHST on provincial social programs. The new CHST imposes national standards only with respect to health care and mobility of social assistance recipients. The significant reductions in transfers, together with the provinces' obligation to respect the Canada Health Act, could mean that funding once allocated to post-secondary education or social assistance will be turned over to health care.

Campeau, Jean. Quebec Minister of Finance and Minister of Revenue. Budget Speech and Additional Information. Appendix E. 9 May 1995.

Courchene, Thomas J. Redistributing Money and Power: A Guide to the Canada Health and Social Transfer. C.D. Howe Institute, Observation 39, Toronto, 1995.

Department of Finance. Canada Health and Social Transfer: New Five-Year Funding Arrangement, 1998-89 to 2002-03: Key Features. Ottawa, March 1996.

Department of Finance. Canada Health and Social Transfer: First Estimate, 1997-98. Ottawa, 18 February 1997.

Kroeger, Arthur. "The 1995 Federal Budget: Recognition of Reality, or Threat to the Federation? Opinion Canada, Vol. 3, No. 2, April 1995.

Madore, Odette. Established Programs Financing for Health Care. BP-264E. Parliamentary Research Branch, Library of Parliament, Ottawa, August 1991.

Madore, Odette. The Canada Health Act: Overview and Options. CIR 94-4E. Parliamentary Research Branch, Library of Parliament, Ottawa.

Madore, Odette. The Canada Health and Social Transfer: Operation and Possible Repercussions on the Health Care Sector. CIR 95-2E. Parliamentary Research Branch, Library of Parliament, Ottawa.

Martin, The Honourable Paul, Minister of Finance of Canada. Budget Plan. 6 March 1996, p. 59.

National Forum on Health. Canada Health Action: Building on the Legacy. Final Report. Vol. 1, 1997.

St-Hilaire. France. "Le transfert social canadien: Fédéralisme renouvelé ou faire d’une pierre trois coups." Policy Options, Vol. 17, June 1996, p. 31.

(1) For more information about EPF, the CAP, and the imposition of national health care standards, please consult the following publications: (1) Odette Madore, Established Programs Financing for Health Care, BP-264E, Parliamentary Research Branch, Library of Parliament, August 1991; (2) Odette Madore, The Canada Health and Social Transfer: Operation and Possible Repercussions on the Health Care Sector, CIR 95-2E, Parliamentary Research Branch, Library of Parliament; (3) Odette Madore, The Canada Health Act: Overview and Options, CIR 94-4E, Parliamentary Research Branch, Library of Parliament.

(2) Government of Canada, Briefing Book: Budget 1996, Ottawa, 6 March 1996, p. 60-66.

(3) Bill C-76, An Act to implement certain provisions of the budget, tabled in Parliament on 27 February 1995. Bill C-31, An Act to implement certain provisions of the budget, tabled in Parlilament on 6 March 1996.

(4) The fiscal year begins on 1 April and ends on 31 March of the following year; the calendar year begins on 1 January and ends on 31 December.

(6) Department of Finance, Canada Health and Social Transfer: First Estimate, 1997-98, Ottawa, 18 February 1997; Department of Finance, Canada Health and Social Transfer: New Five-Year Funding Arrangement, 1998-89 to 2002-03: Key Features, Ottawa, March 1996; provincial and national population estimates provided by the Federal-Provincial Relations and Social Policy Branch, Department of Finance, 29 May 1997.

(7) These figures are based on forecast implicit GDP indexes of 1.6% in 1997 and 1.4% in 1998 (Royal Bank of Canada forecasts), and 1.5% annually from 1999 to 2003 (authors' projections).

(8) These data are based on provincial budget forecasts. Forecasts are not available for British Columbia for 1998-99 or 1999-2000, or for Ontario for 1999-2000; the authors have used the forecast for the preceding year in each of these cases.

(9) The Honourable Paul Martin, Minister of Finance of Canada, Budget Plan, 6 March 1996, p. 59.

(10) France St-Hilaire, "Le transfert social canadien : Fédéralisme renouvelé ou faire d'une pierre trois coups" [Canada’s Social Transfer: Renewed Federalism or Killing Three Birds with One Stone], Policy Options, Vol. 17, June 1996, p. 31.

(11) Thomas J. Courchene, "Alternative Allocation Formulas for the CHST: The Politics of Zero Sum'," Chapter 4 in Redistributing Money and Power: A Guide to the Canada Health and Social Transfer, C.D. Howe Institute, Observation 39, 1995, Toronto, p. 35-64.

(12) Arthur Kroeger, "The 1995 Federal Budget: Recognition of Reality, or Threat to the Federation?," Opinion Canada, Vol. 3, No. 2, April 1995, p. 3.

(13) National Forum on Health, Canada Health Action: Building on the Legacy, Final Report, Vol. 1, 1997, p. 13.

(14) For example, Jean Campeau, Quebec Minister of Finance and Minister of Revenue, Budget Speech and Additional Information, Appendix E, 9 May 1995.