There is a widely expressed concern that technological changes and lower barriers to trade and investment have reduced governments' ability to impose taxes on mobile inputs, such as financial capital or venture capitalists, and this will constrain their ability to provide basic public services and redistribute income. These forces are often described as producing a “race to the bottom,” in which governments compete through their tax, regulatory, and expenditure policies to attract footloose investments.
In this volume, edited by Kathryn Harrison from the University of British Columbia, three economists and four political scientists examine whether there has been a race to the bottom among the Canadian provinces in six policy areas: business taxation, industrial development incentives, tobacco taxation, environmental policy, minimum wages, and social assistance. There is also a chapter reviewing the US literature on inter-state competition in the provision of social assistance and education. Harrison provides a comprehensive summary of the main findings of the various studies and a concluding essay on the implications of the research.
At the risk of over simplification, we can provide a score card on the race to the bottom. Kenneth McKenzie shows that there is no trend to reduced provincial business taxation in Canada in the period covered by his study (up to 2000). One of the strengths of the McKenzie's essay is a careful discussion of the economics literature on tax competition and the variety of ways in which provincial governments' tax systems affect the cost of doing business in the provinces.
Douglas Brown shows that there was a sharp increase in provincial government assistance to business over the period 1995–2003 period in spite of the adoption of the Agreement on Internal Trade in 1995. He concludes that “Canadian governments are still very much in the game of interjurisdictional competition for economic development.” (68). However, as Brown acknowledges, the data on industrial assistance is highly aggregated, and it is not clear whether the provinces are competing against each other or with foreign jurisdictions, e.g. Ontario competing with Michigan for automobile assembly plants.
Kathryn Harrison's fascinating account of Canadian tobacco tax policy since 1986 indicates that the tobacco taxes of neighbouring provinces are interdependent and that federal excise tax policies affect provincial policies and vice versa. The central event is the 1994 coordinated reduction in federal and provincial tobacco taxes as a response to the rapid growth in cigarette smuggling that resulted from the sharp increase in Canadian cigarette taxes in the preceding decade. She provides a dramatic description of the interactions of the governments' tax policies, interventions by the tobacco industry and the anti-smoking lobby, and the complex interplay of separatist politics in Quebec, where the tobacco manufacturers are located, and the aboriginal groups who were largely responsible for the smuggling of Canadian cigarettes into Canada.
Nancy Olewiler concludes that there has been no race to the bottom with regard to provincial environmental regulations. Instead, provinces have responded in a slow and modest way to increasing public concern about pollution by raising environmental standards.
David Green and Kathryn Harrison do not find any evidence that minimum wages have been reduced to try to attract footloose industries or prevent the flight of jobs to other provinces with lower minimum wages. What they find is that minimum wage policy seems to be influenced by “benchmark competition”—provinces are concerned about the ranking of their minimum wages and try to stay near the middle of the pack and those provinces with higher levels of unionization or left-wing (New Democratic Party [NDP] or Parti Québécois [PQ]) governments tend to have higher minimum wages.
Gerard Boychuk found that neighbouring provinces' social assistance benefits did not seem to influence a province's policies during the 1990s, suggesting that that provincial policies were not driven by concerns over interprovincial migration of social assistance recipients. Furthermore; the shift from matching grants under the Canada Assistance Plan (CAP) to the lump-sum grants under the Canada Health and Social Transfer did not spark cuts in social assistance benefits. The reductions in provincial social assistance benefits that occurred in the 1990s might have been due to common problems, such as the need to address fiscal deficits, rather than the desire of provinces to avoid becoming a “welfare magnet.” This contrasts with the situation in the United States where, as described in the final essay by Mark Rom, concerns about the mobility of the poor has affected the state-provided social assistance benefits. However, he also argues that inter-state competition in education spending seems to be creating a bifurcated equilibrium, with states providing either high or low levels of education funding.
These extremely interesting analyses of provincial public policies raise a number of methodological issues that should be addressed in the next volume that tackles this important subject. More attention should be paid to the interdependence of policies. Rising health care costs and the need to reduce government deficits have been important factors in shaping provincial governments' tax and expenditure policies. Focusing on one aspect of a government's policies, without giving due regard to the overall fiscal influences on governments, may lead to misleading conclusions regarding fiscal competition. The role of the federal government is important for understanding interprovincial competition. Examples include the escalation of tobacco taxes before 1994 and the subsequent cuts in the eastern provinces, the federal environmental guidelines that provide a benchmark for provincial policies; and federal equalization grants that may reduce incentives for fiscal competition among recipient provinces. We need to understand more about the dynamics of policy change: The theory of fiscal competition is a theory about the equilibrium level of taxation and spending, but not how that equilibrium is achieved or whether it is stable. The minimum wage policies of the Harris government provide a good example of our need for models of policy change. The Harris government inherited the highest minimum wage from the previous NDP government, and it seems clear that it wanted to reduce the minimum wage. However, no government has ever cut the nominal minimum wage rate, and therefore the Harris government was constrained to cutting the real minimum wage rate by stealth by allowing inflation to erode it. In order to understand the dynamics of policy changes, we need a theory of when and by how much governments change their policies. We also need a richer set of theories of fiscal competition. The studies in this volume indicate that benchmark competition is important for setting minimum wages and possibly environmental standards. Fiscal competition may also lead to “races to the top,” i.e., excessive spending on productivity-enhancing public expenditures. Too much spending in these areas comes at the expense of other spending programs that serve local needs. Fiscal competition may also lead to policy divergence, not convergence, with multiple equilibria in which some provinces pursue a low tax-low spending strategy while others purse a high tax-high service strategy and try to attractive a different type of footloose industry.
The most important conclusion to be drawn from this volume is that collaboration between economists and political scientists can yield extreme interesting and valuable results. Our two fields have grown apart over the last two decades or more, in spite of the up surge of interest in “political economy” in both disciplines. This volume shows that practitioners in these two fields can benefit from the insights and tools provided by the other discipline. Public policy analysis in Canada needs more books like this.
