PADM 230

Public Finance

Keith Yacucha – Camosun College 2024

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1.0 Intro to Public Finance ........................................................................................................................................................... 3

2.0 Intro to Welfare Economics ................................................................................................................................................. 18

3.0 Cost Benefit Analysis ............................................................................................................................................................ 41

4.0 Planning, Budgeting and reporting ....................................................................................................................................... 58

5.0 Canadian Revenue System ................................................................................................................................................... 77

6.0 Major Government Programs ............................................................................................................................................ 101

Appendix: Inequality, income redistribution and other current issues in public finance ......................................................... 113
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1.0 Intro to Public Finance
Welcome to Public Finance in Canada – To begin we will look at what is public finance and an overview of the topics we
will cover in this course. After this, we will move on to some basic definitions needed to be successful in this course as well as
some background political and legal framework that needs to be understood.

Intro to public finance

At its heart, public finance is the study of the role of Government in the economy. We assess the role of taxation and
expenditure and the adjustment of each to either reach desirable outcomes or to avoid undesirable ones.

As a subsection of economics – the underlying assumption through-out the entire course is that we live in a world of
scarce resources, which is only a problem because economic agents (you, I and firms) have nearly unlimited wants. As a result
of this meeting of scarce resources and unlimited wants, economic agents are face with choices. You can either attend class,
or you can sleep in, assuming an 8:30am class – you cannot do both. Your scarce resource is your time, and thus you need to
choose one over the other. In this sense then, the act of choosing creates a cost in terms of what you have given up – this is
known as an opportunity cost. Typically speaking, if it is exceedingly difficult to choose between (A) and (B) it is because the
opportunity cost of choosing one over the other is extremely high – that is you view both goods, events, etc. as nearly equal.

A quick example of this.

I offer you a coffee crisp, for free – what is your cost of obtaining this coffee crisp? Nearly zero,
you have to give up a negligible amount of your time, expend a negligible amount of effort, there is
almost no cost to obtain this coffee crisp – consuming this coffee crisp is pure benefit to you. If,
however, I was to begin to offer you options, such that I was to offer either a coffee crisp or a Kit-Kat.
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Now your choice of choosing one (the coffee crisp) faces a cost in that you can’t have the Kit-Kat. In
this sense, simply by offering you a choice, I have created a cost (opportunity cost) and diminished the
net benefit you will receive from your coffee crisp. All else equal, the more choices I present to you,
the more likely one of those choices will be similar in benefit to a coffee crisp, and thus will increase in
the cost of choosing said coffee crisp, thus diminishing the net benefit received.

Another key feature of economics of economics is that agents are maximizing, such that the choices they
make are maximized in the margin. Rarely do we sit down with the intention to eat an entire pizza, instead we eat
slice by slice (or bite by bite). Each step along the way weighing the cost vs the benefit of continuing. If at any
point the incremental cost exceeds the incremental benefit, we stop – thus maximizing the benefit we are to
receive.

Through the use of marginal decision making we can then address the sunk-cost fallacy. We see this fallacy
commonly take places in the case of large infrastructure and business decisions which are often planned many
years in advance. These projects may start, continue along – then suddenly be scrapped much to the dismay of
onlookers. As it turns out, such decisions are actually maximizing decisions ensuring that the maximum benefit is
returned to either the public (in case of government projects) or shareholders (in case of private business
projects).

Let’s take a look at an example to demonstrate. You are attempting to walk from (A) to (B) on a map –
Unfortunately, said map does not provide much detail about your journey other than where you start and where
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you want to end up. You accordingly make your plans as to how you will get from (A) to (B), and despite the
uncertainty of the trip decide (initially) that it is a worthwhile adventure to get to point (B).

As you progress on your journey, we could say that each step along the way you are deciding (in the
margin) as to whether the benefit of the next step exceeds the cost. If the benefit of the next step (brings you
closer to (B)) exceeds the cost of that step – then you will continue your walk.

What if at some point, your plan fails you – unexpectedly there is a giant cliff running as far as the eye can
see in either direction, such that now the extra cost of taking an extra step (off the cliff) far exceeds the benefit
(getting close to (B)). If this were to occur it would make perfect sense for you to give up on your adventure – the
cost for you to continue is now exceeding the benefits you will gain, as a result you would recognize your failed
planning and stop your journey.

What you would (or should) not do is say “Well I have already taken 15,000 steps – it would be waste if I
just stopped now” and thus keep going – off the cliff. While this example may seem ridiculous, this latter case is
often what is called for in the case of failing projects.

Such projects were planned given uncertainty to get from the initial starting point (A) to completion (B).
Sometimes external events, or poor planning change the expected outcome of the project such that the cost of
continuing now becomes greater than the benefit expected. While it makes sense not to walk off a cliff – even if
you had already walked 15,000 steps. Agents often have a hard time walking away from a project. Specifically,
they have a hard time recognizing that the sunk-cost of the project is like those 15,000 steps. Even though that
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money has already been spent – and lost – it does not make sense to continue just because you have already
spent $X million dollars if the cost of continuing exceeds the benefits expected.

Overview of the semester.

1. Evaluate the role of government within the economy.

a. When should/shouldn’t the government get involved?
b. How does the government decide to intervene?
c. How do we decide between competing projects?
2. Review different responsibilities of different levels of government.
a. Budgeting and reporting types and requirements at different levels.
3. Evaluate major sources of revenue as it applies to public finance in Canada.
4. Evaluate major sources of expenditure as it applies to public finance in Canada.
5. Evaluate current issues in public finance, such as income distribution and inequality.

Legal Framework
First bit to define is the role of government – and while there exists many different definitions on what the role of
government ought to be – this is not a political science class, but rather an economics class. As a result, we will evaluate the
role of government from an economic view point. Being, what is, at minimum, the role of government to have functioning
markets and thus a functioning economy.
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That is not to say that government cannot (or should not) take on more responsibilities – but rather this is saying that if we
assume that markets will be competitive and clear efficiently1, then at minimum the role of the government should be…

At minimum then the role of the government is to maintain a monopoly of violence. While this sounds rather dark and
authoritarian, it is not the end of our desired role of government. What is meant by maintains a monopoly of violence is that
only the government has the legitimate right to exercise force within the borders of a nation. If this criterion is not met, then
the government is unable to exert its will over its citizens as it is in conflict with other armed groups.

Of course, a Monopoly of Violence on its own is not enough for markets to clear – there have been many governments
who have a de-facto monopoly of violence but still rule over failed states. Thus, the second criterion is that the government is
bounded by the rule of law. That is the government has a strong constitution, institutions, and checks and limits such that the
governments use of violence is contained and understood. In this way the citizens and residents of a nation know what is and
what is not allowed – specifically they can know the rules of the game and thus can feel free to play to win without fear of
sudden and arbitrary retribution.

Finally, as a tag-on to the rule of law is the entrenchment of property rights. Where property rights explicitly dictate what
agents are and are not allowed to exercise ownership over, and thus what good and services they are allowed to buy and sell.
In addition, property rights set out the basis of ownership and allow agents to accrue wealth and resources knowing that they
cannot arbitrarily have these goods and resources taken away from them.

1
We will see this is often not the rule but the exception – most markets in the modern economy are unable to efficiently clear on their own.
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From an economic perspective – this is, at minimum, what is required to have functioning markets that clear at an
allocatively efficient level. Any rules, regulation, or actions of government beyond this are extra and may cause distortionary
impacts.

That being said – outside of an economic rationale, there are clear arguments made for a further role of government based
on political and social desires. In addition to what is listed – what other roles do you see as necessary for the government?

Rule of law and property rights

As discussed, the rule of law puts limits on what certain levels of government can and cannot do in Canada this distinction
primarily appears in the delineation of responsibility between the provinces and the federal government as outline in the BNA
act of 1867 followed by the patriation of the Canadian constitution in 1982. The constitution of 1867 sets out many of the
rules regarding taxation and expenditure authority as well as boundaries between federal and provincial governments.

With respect to taxation and authority to generate revenue for public use, the constitution places the power with the
federal government – initially viewing a strong federal government with weaker provinces.

In the next section we will evaluate the progression of the federal governments roles and authorities followed by the
provincial roles and authorities.
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Federal and Provincial Governments

The Constitution of 1867 gives the federal gov’t the power “to make laws for the peace, order, and good government of
Canada”. This includes the ability to raise money by any mode of taxation, the only real exception is that the federal
government cannot raise funds by taxing provincial lands.

Pre-confederation, 99% of government revenues came through indirect taxes. Indirect taxes are taxes levied on
products or services – for example import duties (tariffs). This type of tax is paid by one person (the importer) but can then be
recovered when the importer sells this good to the consumer. This type of tax is thus paid and collected before the final sale
of the good or service and is thus recovered by the producer and passed along to the consumer. Compare this to direct taxes
that cannot be transferred to other agents – these are taxes such as income or wealth taxes which are paid based on the
income generated through the sale of a good or service. In this case the tax is paid directly to the government by the
individual taxed. Direct taxes are thus significantly more cumbersome, and difficult to administer as the government needs to
obtain and maintain accurate estimates of agent income in order to determine appropriate tax levels.

In this sense it – hopefully – becomes clear as to why the majority of pre-confederation tax revenue came from indirect
sources – as these sources were significantly easier and cheaper to administer and collect from.

However, as the founding fathers of Canada saw a strong central government they decided to allow the federal
government the right to raise revenue through any means, while restricting the provinces to only being able to raise revenue
(taxes) through direct taxation – at the time seen to be limited and not a realistic revenue source.
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With the largest access to revenue sources, so came the largest authority and responsibility. The federal government
undertook the authority to oversee:

o National defense, navigation and shipping, trade, commerce, criminal justice system, money and banking
amongst others.

While the Provinces were given statutory subsidies and left to manage:

o General government, justice, education, welfare and internal transport

Despite this initial arrangement, the federal government extended its powers into provincial territory through
conditional grants (starting in 1912) into the areas of agricultural education, employment services, highway construction,
technical education, welfare, and disease prevention.

o This intrusion occurred as the federal government was offering money ‘with strings attached’. The provinces can
always choose to opt out (Quebec) and thus not be a violation of boundaries as set out by the Constitution.

The specific roles and authorities as laid out in the constitution of 1867 have already been touched on, but let us
specifically highlight some key points. As mentioned the provinces were limited to only raise funds through direct taxation
(think income or wealth tax), additionally the provinces were not given the power to inhibit inter-provincial trade through the
use of indirect taxes or subsidies. Thus, Provincial revenues were expected to come from direct taxes, Federal subsidies, and
natural resource revenue.
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Now the question that typically arises is – If the provinces are not allowed to raise funds through indirect taxation, why do
so many provinces have a Provincial or Harmonized Sales Tax (PST/HST)?

While, economically, we would consider a sales tax to be an indirect tax, the courts have ruled that a Value Added Tax
(VAT) such as PST are to be considered a direct tax. The rationale for this is that the seller is deemed to be an authorized agent
of the government to collect the tax. This tax is then borne strictly by the consumer, who pays the tax in proportion to their
consumption and is unable to pass this tax along to others.

On the whole, with access to new revenue sources (PST) and increased autonomy over natural resource royalties, the role
of the provinces, relative to the federal government, has only increased since 1867.

While the constitution explicitly lays out the roles and authorities of provincial and federal government, there is no
mention of local governments. Thus, local governments only have the power which is delegated to them by the provinces.

The result of this is substantial differences across Canada based on the province in terms of local taxation and expenditure
authority, as a result the focus of this course will be the authorities imbued to local government within British Columbia (BC).

While the specific authorities delegated to local governments will be discussed as the course progresses, it is important to
note that BC is split into 27 regional districts that encompass both rural and urban areas. For example, on South Vancouver
Island there are 13 municipalities as well as rural areas that make up the Capital Regional District (CRD). Within the regional
districts BC, has 161 municipalities. Local government will refer to local government at both the regional and municipal level.
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Size of Government
Often when discussing the role of government, the topic comes up regarding an ideal size of government with many
believing that a small, efficient government is more ideal than a large government. While small and efficient government
sounds like an ideal outcome, we will see that the reality of determining the size of the government is rather problematic.

The typical, logical, method to measure the size of the government is by determining the number of public servants, or
ministries or departments and projects undertaken. This approach appears to make sense – a government with lots of public
servants or lots of projects would be large, while a government with only a few public servants or ministries would be
comparatively small. Unfortunately, this method of determining size of government is misguided. Let’s look at an example to
see why.

Imagine we have two governments. The government of Alpha and the government of Beta.

Now, the government of Alpha has invested heavily in research, and capital, and has obtained a super computer artificial
intelligence that is able to intervene and manipulate almost all the markets under the government jurisdiction. Due to this
supercomputer the government of Alpha only needs one ministry – the Ministry of Artificial Intelligence and only a handful of
technicians to run, maintain, and analyze the output of the AI. Based on the above definition of the size of government this
would be an exceptionally small government, despite the fact that it is heavily involved in the market.

Alternatively, consider the government of Beta. Beta has a bloated public service with thousands of public servants and
dozens of ministries, but despite the number of staff and ministries, these roles are primarily administrative and procedural
with the government having very little impact on the markets under its jurisdiction. In this case, based on the above definition
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of the size of government, this would be an exceptionally large government, despite the fact that has almost no input or
influence over domestic markets.

Thus, we see that measuring the size of government simply by number of public servants and ministries is an imperfect
metric in determining the size of government. Despite this, the common ways to measure government are typically different
versions of what was suggested above. That is, they measure size of government based on number of inputs rather than on
number of outputs.

Some common, yet imperfect, ways to measure the size of government.

1. Purchases of goods and services: What is the size of the government expenditure on goods and services?
2. Transfers of income to people, firms, or other governments: Government takes income from some people and
transfers it to others. For example: Old Age Security (OAS), Employment Insurance (EI), Canadian Emergency Relief
Benefit (CERB), Equalization payments, etc.
3. Interest payments: Gov’t often borrows to finance its activities. If one borrows, one pays interest, the more you
borrow the more interest you will end up paying.

The typical assumption then is that if government spending (any way described above) increases (either in whole or on a
per capita basis) then the size of government has also increased. As seen in the previous example of the government of Alpha
and Beta, this may not be true if the concern is degree of public intervention. Additionally, this may not be true due to
accounting issues in determining the value of the above expenses as well as hidden costs.
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Accounting issues:

While there are a handful of potential accounting issues that exist in determining the true expenditure of government,
the one we will focus on to highlight the problem is the use of loan guarantees.

Often the government will provide these guarantees to individuals, businesses, or crown corporations in order to attract
investment. These guarantees allow the person applying for the loan to obtain credit at much lower rates – however, if they
fail to repay, the government is on the hook for the balance. Similar problems arise with programs such as the Canadian
Pension Plan (CPP) which is backed by the federal government.

The problem with these guarantees is how do we record them? They are a liability – but may never be realized if the
borrower never defaults. If we include the guarantee amount, we are possible over-estimating the size of government, if we
do not include them, we are potentially under-estimating the size of government. As a result, a line in the sand needs to be
drawn as to what is and what is not included. These accounting rules thus form the basis as to what liabilities are included on
the government balance sheets. The problem with them is that, although good intentioned, these rules are arbitrary in nature.

Another such example is the difference between government expenditure and taxation on similar projects. That is, the
government may be able to meet the same objective by either (i) increasing expenditure, giving money to certain agents, or
(ii) by decreasing taxes, allowing certain agents to pay less.

Although both may be of identical amounts, increasing expenditure, paying a bunch of agents $5000 to incentivize a
certain action would appear as a government expense – thus larger government. While a reduction of taxes to the same
agents by $5000 would be foregone revenue, but would not appear while measuring the size of government.
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Hidden costs of Government:

Hidden or implicit costs of government; These costs can be most readily seen when the government enacts regulations.
Government regulations are relatively cheap with little explicit cost, that is the government can impose a new regulations or
rules requiring all new vehicles to have airbags, or requiring all health-care products to undergo extensive health and safety
tests before being allowed to enter the market. While these rules have virtually no cost to implement, and often marginal
costs to enforce, the can often have massive costs to society.

For example, in the case where new vehicles need to include seatbelts and airbags, this is an extremely cheap rule to
enact and enforce but adds to the manufacturing cost of each vehicle which is then, partly, added to the purchase price of
each vehicle. Multiplied over the thousands of vehicles produced and sold each year, the implicit cost of such interventions
can be substantial.

An alternative example is a bit more controversial, but none the less a prime case of the implicit cost of regulation. If we
look at the approval process for the COVID vaccine – researchers developed a working model for the COVID vaccine extremely
quickly2. Despite this rapid development, it took significantly longer for the vaccine to be approved and in arms – potentially
costing hundreds of thousands of lives around the world3. While regulation can also have the effect of saving lives by ensuring
that only safe and effective products hit the market, when safe and effective products are caught up and delayed due to
regulation, there are real costs associated as can be seen in potential lives saved4.

2
https://www.medicalnewstoday.com/articles/how-did-we-develop-a-covid-19-vaccine-so-quickly#Worldwide-collaboration
3
https://www.theatlantic.com/health/archive/2022/01/fda-covid-vaccine-slow-rollout-trump/621284/
4
https://marginalrevolution.com/marginalrevolution/2021/12/how-many-lives-has-vaccination-saved.html
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Given the limitation above, should we even bother to try to measure the size of government? or should we abandon the
whole endeavor as being too difficult? Ultimately it boils down to recognizing the limits and problems with the metric of
choice and recognizing that any attempt to measure the size of government will be flawed and to incorporate an
understanding of this into your analysis.

Summary
In this section we have looked at a minimum case for the role of government, beyond this we evaluated the current
roles, responsibilities and authorities laid out for various levels of government under the Constitution of 1867. Finally, we
evaluated potential measures of the role of government including a discussion of the difficulty in measuring the size of
government.

Much of our discussion assumed that if the above minimum role of government was satisfied, the markets would, on
their own, achieve an efficient and socially maximizing outcome. In the next section we will begin our analysis under this
assumption and then begin to relax this assumption to look at the reality. That often markets are imperfect, and perhaps
there could be further role for government to play, not only to achieve social and political outcomes, but also to achieve
desirable economic outcomes.

To conclude, a mental exercise regarding what the role of government should be at minimum? What are the assumptions
made?

- Should government exist as a bare minimum to enact laws that ensure safety and protection of rights?
- Should government exist at a higher level to ensure a level of equality?
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- Should the government be involved to influence or change economic outcomes?
o IE Equality of consumption and income.
- Do these answers change depending on the level of government we are considering?

There are no definitive answers to the above questions, many are value based (normative) in nature and dependent on ones
own beliefs regarding the role and place of government in our society.

Post-Test
1. In what year did confederation divide the powers of taxation and expenditure between the federal and provincial
governments?
2. Under Canadian law are sales taxes, such as PST, considered a direct or an indirect tax?
3. Under standard economic definition, are sales taxes such as PST, considered a direct or an indirect tax?
4. What authorities are awarded to local governments under the Constitution?
5. List a common way to measure the “size of government”
6. Explain why these ways may be imperfect in measuring the true size of government.

Endnote:

Of interest is the work done in BC, which has now been adopted by many governments around the globe in recognizing
the cost of regulation – further reading on this topic can be found here.

Back to top
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2.0 Intro to Welfare Economics
In the previous section, we evaluated the regulations and legal framework for government and public finance in
Canada. In this section we will begin to explore the role of government and the economic justification that may exist for
government intervention in markets.

In order to evaluate the potential justification of government intervention, we must first understand pareto efficiency. A
pareto efficient outcome exists when there is no way to make one person any better off without making another worse off. A
pareto improvement then occurs any time that a change or intervention is able to make at least one party better off without
making any party worse off.

Compare and contrast the above idea with that of a potential pareto improvement. A potential pareto improvement exists
any time that the gains to the winner from an intervention are so great that the winner could, in theory, compensate the loser
for their losses such that no one is adversely impacted. Of important note is that no transfer actually needs to take place for
an outcome to be a potential pareto improvement, the fact that such a transfer could take place is sufficient.

While the discipline of economics is primarily concerned with determining efficient solutions, we will see that an efficient
solution is not necessarily unique or fair – thus is one of the primary arguments for government intervention – to identify an
efficient outcome that best aligns with societies objectives and notions of fairness.

Let’s evaluate a simple example to demonstrate the above ideas. Suppose Bill and Ted were walking along. Bill finds $100
on the floor and picks it up. It is now up to Bill and Ted to determine how to split this money between themselves. As long as
they choose to split this money in such a way that together they share the $100 they will be sharing the money efficiently.
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That is, a decision to split the money ($40, $40) and leave $20 on the floor would be an inefficient solution. Alternatively, as
should be obvious, any decision to split the money such that together they share more than $100 is an unobtainable solution.
Thus, Bill and Ted are left with a continuum of potential ways in which they could efficiently split this money, from one
extreme where Bill gets $100 and Ted gets $0 to the opposite extreme and everything in between, this continuum can be seen
in figure 2.1 below.

Fig 2.1

The problem that clearly arises is that if any solution along the red line is efficient, what outcome is a fair distribution
between Bill and Ted. After all, Bill was the one who found and collected the money – thus enters the role of the policy maker
to identify the distribution which best aligns with societies values and notions of fairness.

Once a solution is identified, let’s suppose ($40,$60), there is no way to move from this solution without causing harm to
one of the people, thus, once an efficient distribution is chosen, it is also a pareto efficient distribution such that no further
redistribution can occur without making another worse off. See figure 2.2.
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Fig 2.2

Of course, if through incompetence or error the policy maker chose an initial distribution that was not efficient, then room
for pareto improvements exist. Let us suppose that the policy maker chose to distribute $40 to each, leaving $20 on the table
(we will assume due to error rather than incompetence). In this scenario there is room for pareto improvements, such that
both parties can be made better off from the initial distribution – the continuum of possible improvements can be see in
figure 2.3 in the shaded area and bolded section of the efficiency frontier.

Fig 2.3
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It may seem silly in the above case to not have a pre-distribution that was also an pareto efficient distribution, that is a pre-
distribution on the efficiency frontier. This is because a good, like money, has almost identical valuations across individuals,
both Ted and Bill Value $1 identically, thus it is relatively easy to determine a pre-distribution that is also a pareto-efficient
distribution.

However, the same is not true with all goods. Even looking at two goods as simple as Apples and Oranges you will find that
people have different preferences for each, and different levels of utility, or happiness they gain from the consumption of
each.

To see this, we need to introduce the idea of utility and an indifference curve.

Utility

The idea behind utility is that every economic agent obtains some level of extra happiness, benefit, or ‘utility’ from every
extra unit consumed. Every time you buy and consume a cookie it provides you some level of joy or benefit (utility). This utility
is by nature difficult to quantify, and impossible to compare across individuals, but none the less it does exist and tends to be
internally consistent within individuals.

Further, it is found that as individuals increase their consumption of a given good, the extra utility they obtain from the
extra unit of consumption tends to decrease, this is known as the law of diminishing marginal utility – lets take a look at an
example to see this clearly.

Suppose it is late in the evening, you have skipped dinner, so are extremely ravenous. You walk past a pizza store selling
pizza by the slice. You eat your first slice of pizza that satisfies your hunger, providing you 5/5 extra utility. However, you
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decide to order a second slice – because why not. Now the second slice is good, but your hunger has already been satisfied,
thus this slice only provides you with 3/5 extra utility, carrying on a third slice we can assume would provide only 1/5 extra
utility. While we will presume that you stop after three slices, it is important to note that a consumer may continue consuming
to the point of dis-utility. That is, continue eating pizza to the point that the additional slice causes discomfort rather than
benefit or joy. The table demonstrating this above example can be seen below in table 2.1 along with the inclusion of this
consumers utility. Note that while the consumers marginal utility (extra utility for an extra pizza) falls as they continue to eat,
their utility rises, but at a diminishing rate.

Marginal Table 2.1

Quantity Pizza Utility Utility
0 0 0
1 5 5
2 3 8
3 1 9
Of course, if we introduce a second good into this mix, the same result will take place for the second good, the more of it
they consume, the less extra utility gained for every extra unit consumed. In this way, economists believe that consumers are
utility maximizing, and will choose to consume some number of good A and some number of good B such that they have the
highest level of utility possible from each good.

Indifference curves

An indifference curve is a curve showing all the possible combinations of the goods to be consumed, say apples and
oranges, such that any point of consumption along the curve will yield an identical level of utility. That is, if every consumption
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combination along the curve yields the same utility, joy or benefit, then the consumer would be indifferent between
consuming any one point on the curve compared to any other.

Fig 2.4

Figure 2.4 demonstrates a segment of an indifference curve between apples and oranges, such that any point along this
curve will yield the consumer an identical level of utility, thus making the consumer indifferent in their consumption choice
between any point along this curve. While any point along the curve yields the same level of utility, an indifference curve
located up to the right (further from the origin) will represent a continuum of possible consumption bundles that yield higher
levels of utility, while an indifference curve down the left (closer to the origin) will represent a continuum of possible
consumption bundles that yield lower levels of utility, see figure 2.5.
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Fig 2.5

Edgeworth box

An Edgeworth box is a way to compare potential distributional improvements between two parties and their respective
indifference curves. An Edgeworth box starts with a standard indifference curve for the first agent, then taking the second
agents indifference curve and rotating 180°, placing the two together to form a box – see figure 2.6 below.

Fig 2.6
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In this way the axis for the first agent (Adam) run from 0 to the maximum number of oranges (say 100) and similarly run
from 0 to the maximum number of apples (again, let’s say 100). What ever level Adam ends up with for apples and oranges,
the remainder must then be Eve’s.

That is if Adam’s pre-distribution of apples and oranges is (40,90) then Eve’s pre-distribution of apples and oranges must
be (60,10) such that all the apples (100) and all the oranges (100) are accounted for. From this pre-distribution, recognizing
that each agent has their own indifference curves, there likely then exists an area such that both parties can be better off
through re-distributing (trading) their apples and oranges – this area such that both may be better off is the area that allows
for a pareto improvement and is known as the lens of mutual benefit – see figure 2.7 below.

Fig 2.7

Through trade, or re-distribution, both Adam and Eve can both be made better off by being able to trade to obtain a
consumption point within the lens of mutual benefit – and by doing so shifting both of their indifference curves further from
their respective origin – signifying an increase to each of their respective utilities. See figure 2.8 below.
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Fig 2.8

Just as with our initial example with Bill and Ted, once they arrive at this final point, this point is pareto optimal (efficient)
such that no further re-distribution could take place without making either Adam or Eve worse off.

The key difference between the case examined here versus the earlier is that in the earlier case with Bill and Ted, any
efficient pre-distribution was also a pareto optimal distribution. In this latter case with Adam and Eve, the pre-distribution
may be efficient in that it is accounting for all the apples and oranges, but despite the efficiency of the pre-distribution, a
pareto improvement is still possible, allowing both to increase their utility as seen in Figure 2.8.
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fundamental theorem of welfare economics:
Now that we have defined pareto efficiency and improvements as well as evaluated the use of these terms through the
use of an Edgeworth box. We can now begin to evaluate the basis of welfare economics.

Of course, any model, economic or otherwise, is only as good as the assumptions it is based on, before we begin to
evaluate the fundamental theorems of welfare economics, it is important to understand the assumptions about the economy
which are invoked in order to arrive at the conclusions presented.

The first assumption needed is that no consumers or firms have market power. This means that all firms and consumers
are relatively small – or equivalent in size, such that no one (or few) have an ability to distort market prices to their advantage.
Commonly, this is referred to as an assumption that all markets are perfectly competitive. If this is the case, then we can
arrive at a situation as demonstrated above with Adam and Eve such that all parties are mutually able to be better as they
move to a pareto efficient outcome.

The second assumption needed is that no good or services has any externalities. Externalities are external costs or benefits
that effect other members of society rather than just the member who is consuming/producing the good or service.
Specifically, if all the costs of production are accounted for, then all these costs will ultimately be reflected in the market price
and be borne by the consumer. If the consumer bears the entire cost of this product then the private cost and social cost are
one and the same – because after all, the private individual is a part of society. If, however certain costs of production (or
consumption) are not fully accounted for, then the true price of the good is not reflected in the market price and not fully
born by the consumer.
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An example of a common production externality is the release of pollution during the production process. As the legal
framework currently stands, firms have the right to pollute (to a degree) and can do so without cost. As a result, this cost of
their production process is not included as a cost, and thus is not reflected in the price. In this sense the private cost will be
less than the social cost as the private consumer is no longer paying for the full cost of the product.

Similar issues arise with negative consumption externalities. These are situations where by consuming a good (or service),
extra costs are created that are borne by others who are not consuming this good. A prime example here would be the
consumption of cigarettes. If John decides to eat a cookie, there are costs and benefits to John’s actions – however all these
costs and benefits will be felt by John, thus there is not a problem. If, however John decides to smoke around a group of
people, John may receive all the benefits from the consumption of this good. John may also face the cost of the consumption
of this good, but due to second hand smoke, all the others in the group also are forced to face the cost of John’s actions
without receiving the benefit.

In both of these above cases, whether it be a negative production or consumption externality, the issue is that the cost to
society is greater than the cost to the private individual, and thus society would be better off on the whole if less of the good
was produced or consumed. Although no example is, or will be, given - the opposite is true for a positive production or
consumption externality.

The third and final assumption needed is that all goods are private goods. While this is similar in many ways to the second
assumption regarding no externalities, a private good is a good that is both rivalrous and excludable.
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A rivalrous good is a good (or service) such that if a person were to consume this good, only they obtain the benefit – for
example a cookie, if I were to consume a cookie, the benefit of that cookie is attributed solely to me. Conversely a non-
rivalrous good (or service) is a good such that the use of it, and the benefit received, by you does not preclude the use of it,
and benefit to be received, by others. Examples of non-rivalrous goods would be roads, swimming pools, libraries, parks, etc.
In all these cases I can utilize the road way, the swimming pool, on and on, obtaining the benefit from doing so and similarly
not preventing any other person from also utilizing the same good. In this sense these goods are non-rivalrous, at least up to
some capacity or point of congestion.

An excludable good is a good (or service) such that a person can be excluded from obtaining the benefits if they do not pay
for the good first – again a prime example being a cookie. It is extremely easy through laws and security measures, etc. to
prevent a person from consuming and obtaining the benefit from a cookie if they do not first pay for it. Unfortunately, the
same cannot be said for all goods and services. For example, a public park and green space existing in my neighbourhood
provides me with benefit – and this benefit will be obtained by me regardless of if I ever chose to pay for the construction of
this space.

If a good has an element of being either non-rivalrous or non-excludable we refer to these goods, collectively, as public
goods rather than private goods. In reality, there are several different categories of public goods depending on their degree of
excludability or rivalrousness – but such discussion is outside of the scope of this course.

To summarize, the three required assumptions for the conclusions of the fundamental theorem of welfare economics to
hold are:
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1. No existence of market power.
2. No externalities.
3. All goods are private goods.

I purposely lead with these assumptions to highlight the fact that these are rather heroic assumptions when talking about
a large economy – yes there are markets where these assumptions are reasonable and do tend to hold – but on a larger scale,
it is quite easy to find exceptions, and thus cases where the theorem below will fail.

Enough then with the pre-amble, let us examine the fundamental theorem of welfare economics, after one last note.
These fundamental theorems are backed with extensive mathematical proofs – the math and the proofs are not relevant to us
here, but rather the conclusions presented by the math is the important take away.

First fundamental theorem of welfare economics.

The first fundamental theorem of welfare economics is that a complete market in economic equilibrium will also be pareto
optimal. This is often seen as synonymous with Adam Smith’s “The Invisible Hand”, namely in that competitive markets, if left
to be, will ensure an efficient allocation of resources.

Second fundamental theorem of welfare economics.

The second fundamental theorem of welfare economics states that a pareto optimal outcome can be supported for any
initial set of endowments. That is, as we saw with the example with Adam and Eve, given their pre-distribution (initial
endowments) they were able to arrive at a pareto efficient outcome. This fact is true for any pre-distribution.
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The policy implication of this second theorem throws back to the idea raised at the start of this section that an efficient
outcome is not necessarily a fair outcome (based on some societies notions of fairness). While changing the final outcome
cannot be done without hurting one or more economic agents, it is possible to update the initial endowments to obtain a new
set of pareto improvements and a new pareto optimal outcome. This is often the basis for policies aimed to limit the transfer
of inter-generational wealth to help to ensure that each economic agent is able to begin with, roughly, the same initial
endowments.

In reality such re-distributions often cause distortions resulting in sub-optimality. The second welfare theorem does not
take these potential distortions into account. It simply states that if it were possible to update the pre-distribution outside of
the game, then the result would be a new pareto optimal outcome that may be deemed fairer by society. Reference figure 2.9
below with respect to figure 2.7 to see a demonstration as to how a change in pre-distribution can result in an updated pareto
optimal outcome.

Fig 2.9
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Summary of fundamental theorems of welfare economics.
1. If a market has the above assumptions satisfied, there is no way to improve the outcomes of any one agent, without
hurting another – put another way, there would be no way to improve social welfare.
2. If an alternative distribution is socially desirable, this can be achieved through a lump sum transfer changing the initial
allocation of resources (income) between the parties involved.

If markets are perfectly competitive with perfect information and no externalities (an economic nirvana) then the only role for
government would be to change the pre-distribution in order to achieve a socially desirable outcome – however this may
come with its own costs via distortions.

There is room for a benevolent social planner to change the pre-distribution and still obtain a pareto-efficient outcome.
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Arrows impossibility theorem.
One of the recurring themes through-out the section thus far is that an efficient outcome is not necessarily an outcome
that would be deemed fair given societies notions of fairness. Thus, the argument was made that it is up to the policy maker
to either choose the policy along a continuum of efficient policies that is most fair (think of Bill and Ted splitting the $100) or
to decide regarding the importance of efficiency versus fairness and choose a policy that balances both.

The problem being, as we will see, apart from a dictatorship – it is impossible to assess the common good an determine a
policy that is best for society. This is known as Arrow’s Impossibility Theorem.

Again, Arrow’s Impossibility Theorem is a mathematically rigorous proof, that we will simplify down and focus on the
conclusions of to demonstrate the problem. As with the fundamental theorems of welfare economics we will begin by
assessing the necessary assumption and then assess the theorem itself.

Assumptions of Arrow’s impossibility theorem.

1. A decision can be determined irrespective of individual vote 2. Must be able to rank all preferences
preferences.
3. Must be responsive to individual preferences. If all individuals 4. Must be consistent. If A < B and B < C then A must be < C
prefer A to B, then so must society.
5. Ranking of A and B depend only on A and B, the inclusion of C 6. Dictatorship is ruled out
does not change the ranking.
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While the assumptions for the fundamental theorem of welfare economics were quite heroic – the assumptions required
for Arrows Impossibility Theorem are quite technical and realistic in nature. While this theorem can be scaled up to represent
any size of constituent, it is easiest to evaluate if we scale it down to a society of three people.

Additionally, there are three policies being presented to society, that need to be evaluated in order for the elected
government to assess societies notions of fairness, or their perceptions as to what policy is best for the common good. What
ever policy commands the majority of the vote is clearly the policy that is best for the majority of society. Below, is a listing of
the three people in this society and their preferences for policy A, B and C

1) A > B > C
2) B > C > A
3) C > A > B

Suppose we were to vote on these three policies in a pair wise fashion:

Policy (A) over Policy (B)

- Person (1) and (3) would vote for this policy, 2/3 of the population, thus (A) is passed.

Policy (B) over Policy (C)

- Person (1) and (2) would vote for this policy, 2/3 of the population, thus (B) is passed.

Policy (C) over Policy (A)

- Person (2) and (3) would vote for this policy, 2/3 of the population, thus (C) is passed.
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So, 2/3 of people prefer (A) over (B), 2/3 prefer (B) over (C) and finally, 2/3 prefer (C) over (A) – this is a paradoxical result.

That is, if we would prefer A > B > C … if we remove (B) we should prefer A > C … our problem is we prefer A > C > A which
is circular and thus problematic.

What does this theorem mean for us?

The theorem has important implications for philosophies of democracy and political economy. The theorem rejects the
notion of a collective democratic will, whether derived through civic deliberation or construed by experts who paternalistically
apply knowledge of what is best for a population. The theorem also denies that there could be objective basic needs or
universal criteria that any procedure for collective decision making should recognize.

Does this mean that we should not concern ourselves with social welfare?

This raises significant concerns about the idea of maximizing social welfare, if it is in fact impossible to construct social
welfare. Does this mean that we need to throw out this idea of social welfare? Hardly!

Instead, we need to recognize the difficulties that come with aggregating preferences to create social welfare, and yet still
recognize that utilizing such notions of social welfare are unlikely to give us “the” answer, but may still be useful to tease out
implications of alternative sets of value judgements.
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Market Failures
We have seen through the fundamental theorem of welfare economics the case for “Laissez-Faire” economics. That is, if
all the assumptions are met – the best we can do is to let the market be – hands off.

We see that the only possible option is to change the pre-distribution to obtain different optimal outcomes, however as
we see with Arrow’s impossibility theorem, it may be impossible to determine the collective will between competing
preferences. It appears that this leaves us with the outcome that government should not do anything!

That is not the case. As discussed earlier, it turns out that the assumptions for the fundamental theorem of welfare
economics are often not met, meaning that the free-market outcome is not pareto optimal, and thus there may often be
room for intervention to increase efficiency and social welfare.
In this sense a market failure is any time the market fails to obtain a pareto optimal outcome on it’s own. As discussed
earlier, this occurs any time that one or more economic actors have market power, when there is the existence of
externalities, or the presence of non-private goods. Although not explicitly discussed, the presence of asymmetric information
is also a major problem that can similarly cause markets to fail.
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Theory of second best
The theory of the second best is based on the premise that, perhaps, the first fundamental theorem of welfare economics
is untrue, that is, perhaps not all markets are able to reach a pareto optimal outcome. Thus, if optimality cannot be reached in
a given market, the next best solution may involve introducing distortions that would otherwise be sub-optimal.

From a policy perspective, this means that if it is not possible to remove the first market distortion, adding additional
distortions to the market (or inter-dependent markets) may counteract the first and lead to a more efficient outcome.

First best Solution

If all of the assumptions for the fundamental theorem of welfare economics are met – then we have a first best scenario.
If this is the case, then we have no incentive (outside of a fairness argument) to intervene or influence the market. we have
achieved economic nirvana.

Second best Solution

If these assumptions are not met, then we obtain a second-best scenario. That is, if we had a large firm choosing to
restrict output to push up the price of their good (market power) or if we had a pollution (negative production externality),
then the outcome is no longer pareto efficient as per the fundamental theorem of welfare economics.

If this is the case, then it may be possible to increase efficiency through government intervention (and further
distortions) and obtain a level of social welfare that is at least as high as the second-best outcome and possibly as high as the
first best. This would be the ideal aim of government intervention. However, if by intervening, the resulting distortions could
result in lower welfare than the initial problem. In which case it may be best to just do nothing.
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Some points for thought and discussion:
Even if we have a market failure – should government necessarily intervene?

- Market power provides firms with the funds needed to engage in Research & Development (R&D) as well as to provide
variety and selection. If government intervened to reduce market power, this would similarly reduce the rate of
technological advancement as well as limit the amount of variety available to consumers.
- Many would say that Externalities should not be evaluated by the government and best left to individuals to deal with.
For example, if there is a problem with second hand smoke it should be dealt inter-personally. But what about bigger
picture problems like vaccinations or climate change?
- Many Non-private goods, to a degree, can be privatized – should the government stay out of the picture and allow the
market to provide these goods instead of them being a burden to the taxpayer?
o Instead of public parks, we could have larger backyards

o Instead of policing, we could have security systems, hired security, insurance, etc.

o Infrastructure, recreation centers, etc. can be provided by private firms.

o Common resource goods like forests, etc. can be properly managed through private ownership.

The alternative question of course is if we don’t have a market failure and the fundamental theorem of welfare economics
does in fact hold, is there a case for the government to intervene?

- Healthcare services for all intents and purposes is a private good that can be provided at a pareto optimal level by free-
markets, yet many developed countries offer this instead through public funds – should this be the case? Why or why
not?
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- The provision of professional services such as investment advisors, engineers and doctors is regulated by government
agencies. This is despite the fact that in a free-market those who are sub-par at their job would not be able to
successfully compete – thus resulting in a pareto optimal outcome. Yet many governments mandate professional exams
and accreditation for these roles – should this be the case? Why or why not?
- The personal and responsible use of drugs and alcohol meets the assumptions needed for a pareto optimal outcome.
Just the same, government have (arguably arbitrarily due to historical path dependency) drawn a line in the sand as to
which drugs are legal and which are not, that is, which markets are legally allowed to form and which are not. Should
this be the case? Why or why not?

This thus continues the debate – what ought to be the role of government? How do different governments or different
levels of government view their role with respect to these situations? If not clear – there is no right answer to this question,
this is a very normative question such that the answers are value based, based on the social values held by the person
answering. However, by pulling back the veil regarding the economic rationale for and against government intervention, we
can begin to evaluate our pre-set opinions and potentially revise them given updated information.
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Post-Test
1. Why might an efficient outcome not be a fair outcome?
2. What is the issue that arises if, as society, we have to collectively choose between several pareto efficient outcomes?
3. Can there be a case made for government intervention in a market that is at a pareto optimal outcome?
4. What is meant by market power?
5. What is an example of an externality?
6. What is an example of a non-private good?

Back to top
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3.0 Cost Benefit Analysis
Suppose you have competing projects, both vying for, limited, public funds. How do you decide which project to go ahead
with? Alternatively, you have a proposal for a new project – it has a big budget, the question is – is it worth it? Here we will
evaluate a decision-making process to assist in determining the optimal project, or whether or not a project should even go
forward.

A cost benefit analysis is just that, a summation of all the costs and benefits linked to a project to determine (I) whether or
not the project will have a net benefit to society, and (II) to determine which, of competing projects, will return the highest
net benefit to society.

While on the surface conducting a cost benefit analysis (CBA) is quite simple, there are some significant challenges in
conducting one. The first difficulty is that in conducting a CBA is looking at both Implicit and Explicit costs and benefits. While
the explicit costs and benefits are quite simple to obtain and work out, the implicit ones can be significantly more difficult. For
example, consider the following:

o In building a new highway, Explicit costs are going to be labour, materials, etc. But implicit costs could also
include the distortionary impacts of this project. That is, the increased demand for labour and materials could
push up the price of these materials, thus imposing an extra cost on society.
o In building a new highway, Explicit benefits will be time saved in transportation for both private and commercial
users. But we would also want to include the possible implicit benefit due to lives saved from the new, safer
highway.
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While the second difficulty in conducting a CBA may be apparent from above, the issue arises that many costs and benefits
are non-market items. Thus, it becomes exceptionally difficult to monetize these items in order to determine the monetary
value of its cost and benefit.

This is where a lot of criticism comes of CBA – in its attempt to monetize non-market items such as the value of life, or the
value of certain endangered animals. Many opponents argue that these items are priceless and putting a dollar value on them
only diminishes their worth. The response to this however is that in order to adequately weight the costs and benefits, the
cost of losing a life or animal species needs to be known and similarly the benefit of saving one needs to also be determined.
The alternative to leaving these as priceless, is to give them an infinite cost in the case of a loss or an infinite benefit in the
case of a prevention of a loss – which will cause a distortionary use of scarce resources.

For example, let’s suppose that the view taken is that the value of endangered species is unquantifiable and thus infinite.
In this case, given that polar bears are going extinct, the cost of a lost polar bear is insurmountable while the benefit of saving
one is so great that clearly all public funds should go towards saving these animals – this of course would have to be at the
expense of other public projects due to the scarcity of resources. Although not easy, or popular – it is necessary to work out a
quantifiable, monetized, value of all aspects of the cost benefit analysis.

Many higher levels of government typically have documentation outlining their proposed best practices in performing
CBAs as well as what to and what not to include. The Federal Government policies on performing a CBA can be found here.
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While this is not a course on Cost Benefit Analysis, the basis of the CBA is vital in understanding the economic rationale for
approving certain projects over other projects. That being said, through out this section we will provide a brief overview of
conducting a CBA.

The steps to conducting a CBA are as outlined below – the remainder of this section will be devoted to looking at each of
these 9 steps in cursory detail to build an appreciation of the process.

1. Define the referent group.

2. Select the portfolio of options.
3. Catalogue potential impacts and select measurement indicators.
4. Define base case over the life of the project
5. Monetize all impacts.
6. Calculate the Net Present Value.
7. Identify distribution of Costs and Benefits.
8. Performs Sensitivity testing.
9. Make a recommendation.
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Define the referent group.
The referent group is the individual actors whose costs and benefits will be considered by the analyst. This is important
because often the benefits and costs can extend far beyond the geographical area of the project. The question arises where
do we draw the line as to whose costs and benefits we consider? For example, consider the following two scenarios:

- New stricter environmental regulations on emissions will have a local cost, but potentially a global benefit. Do we
include the benefits received from those around the world? What might happen if we do? What might happen if we
don’t?
- A new overpass in the CRD has costs that will be incurred at the local ($ and traffic), provincial ($), Federal ($) levels,
however the benefits of this project will also be global as tourists to the region also obtain the benefits of the new
overpass. Where should we draw the line for this project?

Typically, the choice of the referent group is a political issue, is determined by the policy maker(s) and is not typically
determined by the analyst. However, it is common to have an analysis run for several possible different referent groups.

Select the portfolio of options.

Once the referent group is determined, there needs to be a determination as to the portfolio of options to be considered.
In theory there could be an infinite number of projects. For example, if widening a highway could evaluate a 2 lane, vs 3 lane
vs 4 lane vs ‘N’ lane, etc. In reality a (arbitrary) decision is made as to what projects will actually be considered and compared.

As with the first step, this is again often a political decision where the policy makers end up dictating which projects are up
for analysis.
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Catalogue potential impacts and select measurement indicators.
For this step the analyst needs to identify and catalogue all possible impacts of all projects and to all referent groups. This
includes determining all the inputs and the outputs of the project.

To catalogue all impacts, it is often helpful to split the impacts into inputs and outputs. The inputs are typically the costs
that go into the project to make it happen, for example, labour, material, cost of credit, etc. The outputs alternatively are
typically the benefits of the project such as reduced travel time, lives saved, etc. While the typical rule of inputs = costs and
outputs = benefits is generally true, there are some major exceptions – for example pollution or environmental degradation is
an output of the project, but this is clearly a cost, not a benefit.

It is important for the analyst to include all potential impacts of the project, regardless if they are monetary or not. If a
projected highway is set to run through a wetland, there may be environmental impacts to later consider. In this sense, the
analysis must take an inter-disciplinary approach as the analyst often does not have adequate insight into all impacts.

Define base case over the life of the project

Impacts (costs and benefits) need to be compared relative to a well-defined base case (what might have happened if the
project never went ahead). While this is a common-sense idea, it is often difficult or poorly executed in practice, partly due to
poor assumption and partly due to the fact that the analyst never gets to see what would have happened.

A common fallacy is to treat today or recent history as a static base case – comparing all future costs and benefits vs
todays. The problem is that the base case is rarely static and thus there is a need to forecast out the base case to compare
with the project. Even then the base case can be filled with uncertainty.
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For example, let’s suppose that a new policy is being considered to pay owners of ICE (Internal Combustion Engine) cars a
fixed amount of money in order to incentivize them to trade in their ICE car for an EV (Electric Vehicle). A common baseline
could then be to look back over the last few years, determining that on average there were about 500,000 ICE vehicles on the
road within a given region. If the policy is successful at reducing ICE vehicles the policy line appears to be significant with
respect to the base case line, signifying a high benefit of the project (see figure 3.1)

Fig 3.1

The problem with this however is that it ignores the fact that given rising taxes, gas prices, and environmental awareness,
many people would be willingly moving away for ICE to EVs as it is. That is, while the policy looks to be hugely successful in
removing ICE vehicles from the road, it may be an incorrect base case. In fact, if the base case is as shown in figure 3.2, then
the benefits of the policy would be significantly smaller.
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Fig 3.2

It is important for the analyst to recognize that the base case is rarely static, and is similarly subject to a lot of uncertainty.

In the above case, the assumption is that the base case would be depreciating over time – the opposite may also be true.
If you were to work out the base case scenario for a project of whether or not you should return to school, your base case
wages would likely increase at some fixed rate forever into the future. Your policy line would then, allow for a faster wage
increase, hopefully, overcoming the base case scenario after some number of years.

As you can imagine, the setting of the base case is exceedingly important yet is filled with uncertainty and assumptions
regarding the future. In this case a, poorly chosen base case can result in a bad project being approved, or a good project
being denied.
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Monetize all impacts
Not to minimize the intellectual difficulty in identifying all impacts, or in determining and forecasting a baseline scenario,
but often the most difficult and most controversial step is the monetization of impacts. While many explicit impacts are easy
to monetize such as costs of labour, materials and interest costs, some explicit impacts are non-market and are more difficult
to monetize. For example, what is the monetized impact of a life saved ($5.2 million in 1996 dollars)? What is a polar bear
worth ($400,000 apiece)? While the monetization of these impacts is important to make an accurate estimation of the costs
and benefits – and to efficiently allocate resources – these decisions of values are none the less controversial.

Beyond the explicit impacts, there are also the implicit impacts of the project. These are also exceedingly difficult to
quantify, yet again vitally important to ensure that resources are efficiently allocated to the correct projects. Some examples
of these implicit impacts are the opportunity costs of the project, as well as the costs of increased demand on society. For
example, a given hydroelectric dam requires a significant amount of concrete. Given that sourcing concrete is primarily a local
area market (difficult to ship long distances), this project will significantly impact the local market for concrete. That is, this
project will cause a significant spike in the demand for concrete causing the price to drastically rise. This rising price then
impacts all residents who may have needed concrete for other projects but are now forced to pay a premium. This is often
known as a crowding out effect.
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Calculate the net present value
While the basic premise of determining the Net Present Value is quite founded and sensible, the choice of a discount rate
is in itself quite controversial and problematic. As a result, an analysis will often be conducted under the premise of several
discount rates in order to provide a comparison.

The basis of the net present value is as follows:

- Would you rather receive $100 today or $100 next year?

You would clearly choose today. But why? Because you value today more than you value the future. That is, the benefit of
the $100 today is worth more to you than the benefit received in the future. This is true irrespective of your ability to save
that $100 today and earn more than $100 in the future. This result would hold even if we had zero inflation and a zero-
interest rate.

In this sense there would be some future value of money such that if I were to offer you $100 today or $115 in the future,
you may be indifferent between the two options. That is, no one option makes you better off than the other. There is some
internally consistent rate of return connecting the $100 today and the $115 tomorrow which is your implicit discount rate that
you apply over time. In this sense we could say that if you were indifferent between $100 today or $115 in a years’ time, then
the net present value of that future $115 is in fact -- $100.

This discount rate could then be solved for using the compound growth formula by recognizing that $100 today must
equal $115 next year – if you are truly indifferent between the two amounts.

𝑉0 (1 + 𝑔)𝑛 = (𝑉1 )
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The above formula in words is simply stating the value today (V0) growing at some constant rate (g) for some number of
years (n) will yield a value in the future (V1). Re-arranging to solve for the unknown (g) one can obtain the corresponding
discount rate.

1
𝑉1 𝑛
𝑔 =( ) −1
𝑉0

In this case we are only considering 1 year, thus we obtain:

115
𝑔=( ) − 1 𝑜𝑟 𝑔 = 0.15 𝑜𝑟 15%
100

That is, with a discount rate (g) of 15%, we can work out the PV (Present Value) of $115 to be:

𝑉1 115
𝑉0 𝑜𝑟 𝑃𝑉 = = = 100
(1 + 𝑔)𝑛 (1 + 0.15)1

Similarly, if I were to receive some payment of $125 in 2 years’ time I could determine the NPV of this amount, that is the
value of this future $125 today to be:

$125
𝑃𝑉 = = $94.52
(1 + 0.15)2

Note how in this second example I have updated the value of (n) to be 2 to signify that I am calculating the present value
of a money flow taking place in 2 years’ time.
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The whole process, rightfully so, appears to be simply a technical mathematical exercise – where does the previously
mentioned controversy enter?
Let’s consider a typical infrastructure project such that all the costs are born upfront, in year 1, while the benefits accrue
off into the future – for simplicity we will assume over a ten-year period.
Actual Impacts
Year 1 2 3 4 5 6 7 8 9 10
Costs $ 1,000.00 $ - $ - $ - $ - $ - $ - $ - $ - $ -
Benefits $ 125.00 $ 125.00 $ 125.00 $ 125.00 $ 125.00 $ 125.00 $ 125.00 $ 125.00 $ 125.00 $ 125.00

If we discount the future too much (set g too high), then we are placing more weight on current costs and benefits, and
less weight on the costs and benefits of future generations. If this were the case, we would be unlikely to ever undertake a
project that has benefits accruing forever into the future – see the example below.
Net present Value of Impacts (g=10%)
Year NPV 1 2 3 4 5 6 7 8 9 10
Costs $ 909.09 $ 909.09 $ - $ - $ - $ - $ - $ - $ - $ - $ -
Benefits $ 768.07 $ 113.64 $ 103.31 $ 93.91 $ 85.38 $ 77.62 $ 70.56 $ 64.14 $ 58.31 $ 53.01 $ 48.19

In the above scenario, given how heavily the future has been discounted, the Net Present Value (NPV), the sum of all the
annual costs exceeds the NPV of the benefits, the sum of the annual discounted benefits, and thus this project is unlikely to be
approved.
Alternatively, if the discount rate (g) is set too low, then we are giving too much weight to costs and benefits received by
future generations, Unfairly burdening the present generation with future burdens – see the example below.
Net present Value of Impacts (g=2.5%)
Year NPV 1 2 3 4 5 6 7 8 9 10
Costs $ 975.61 $ 975.61 $ - $ - $ - $ - $ - $ - $ - $ - $ -
Benefits $ 1,094.01 $ 121.95 $ 118.98 $ 116.07 $ 113.24 $ 110.48 $ 107.79 $ 105.16 $ 102.59 $ 100.09 $ 97.65

In this case, the future is not as heavily discounted. Such that the NPV of future benefits is considerably higher, resulting in
the NPV of all benefits outweighing the NPV of the costs, resulting in a likely approval.
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Computing NPV
The NPV for each cost and benefit can be calculated as follows:

𝑁
𝐹𝑉
𝑃𝑉 = ∑
(1 + 𝑔)𝑛
𝑛=1

While not everyone is fluid in reading math, lets explain what the above equation means. This means that the NPV is equal
to the sum of each future value divided by 1+ the discount rate (g) to the power of the period number (n).

For example, given the first example when the discount rate was set high at 10%

Net present Value of Impacts (g=10%)

Year NPV 1 2 3 4 5 6 7 8 9 10
1000
Costs =Sum of the row (1.10)1
125 125 125 125 125 125 125 125 125 125
Benefits =Sum of the row (1.10)1 (1.10)2 (1.10)3 (1.10)4 (1.10)5 (1.10)6 (1.10)7 (1.10)8 (1.10)9 (1.10)10
In this above scenario, all costs and benefits occur in some future period, either next year (year 1) or onwards. If you are
experiencing costs or benefits in the present year, then you would simply update the table to include year 0 for the present
period.

Alternatively, if using Excel, the NPV function can be used which will automatically discount all future amounts by a given
discount rate – the NPV function in Excel does not utilize a year zero. If you have a year 0 (today), you will need to compute
the NPV of all future periods and then add year 0 to this amount for your final NPV.
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Identify distributional impacts
In the previous step of determining the NPV, this was done on an aggregate basis. Often it is of interest as to how the costs
and benefits are distributed throughout the population. For example, if all the costs accrue to one large group while all the
benefits to a small group, even if the net social benefit is large, this may not be an ideal project.

In this sense the referent group often needs to be split into different impact groups, where the analyst will then need to
determine which costs and which benefits accrue to which group.

The choice of impact groups is often a political decision, with the separation of one impact group from another being
determined by policy makers.

Perform sensitivity testing

As was mentioned several times through the previous steps, much of the analysis is subject to uncertainty. In this step of
the analysis, the analyst will re-run the previous scenarios to examine how sensitive the final outcome is to these impacts. For
example, the analyst may re-run the analysis with an array of different discount rates to see if the outcome is dependent on
this factor. Alternatively, the choice of baseline is similarly entrenched in uncertainty. The analyst may choose to run the
analysis against several versions of the baseline to determine the sensitivity of the outcome to different baseline forecasts.
Finally, the pricing of non-market goods is always filled with uncertainty. Again the analyst may choose to run the analysis
with a range of values for these non-market goods to evaluate the sensitivity of the outcome.
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Make recommendation.
The final step is arguably the simplest of all the steps. Referring to the calculated NPV of all costs and NPV of all benefits,
and work out the NPV of the Benefits less the costs. Accept a project if this net present value is > 0, otherwise reject.

If there are several competing projects, the one with the highest net present value is the ideal project, although the
decision as to which project to adopt lies with the policy maker, not the analyst. That is, certain distributional impacts may be
deemed weighted heavier, thus allowing a sub-optimal project to be accepted, or an optimal project to be rejected.
Additionally, budget constraints may apply. Such that the best project for society may be substantially more expensive than
competing projects and due to this significantly higher cost may be rejected. Arguably this should not be a reason to reject a
project if it still offers the highest return to society – but political decision making and economic decision making do not
always align.
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Common Errors in Cost benefit Analysis
There are some common errors that appear in Cost Benefit Analysis’. While the list below does not intend to cover off all
the major errors, it serves to highlight some:

- Incorrect baseline chosen (as seen with ICE vs EV car example).

- The Chain-Reaction problem
o A new highway being built will have its direct costs and benefits. This highway may allow increased access to
certain secondary businesses allowing them to become more profitable. Counting these increased profits as a
benefit is a dangerous game. If crafty, could find enough secondary benefits for almost any project to prove
Benefits > Costs. It is important to keep in mind that such a project may also be re-routing a highway which
causes other existing businesses to suffer losses. In the end such ‘second order effects’ are transfers amongst
members of the referent group, not costs or benefits.
- “Creating Jobs”
o We see this a lot, “such and such” project will create X new jobs. The problem is, it is extremely unlikely that
these jobs will be filled by the unemployed, rather these jobs will typically be a shifting of resources and labour
from one project to another. Additionally, this is problematic as it frames the “wages” of labour from the project
as a benefit rather than a cost of the project.
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- Problem of “Double Counting”
o Suppose government was looking at a program to provide irrigation to some arid farm land.
▪ Benefit: Increased farmer yields and profits.
▪ Benefit: Increased land value for the farmer
The problem is by counting both of those benefits, we have double counted. The higher yields and profits are
reflected in the increased value of the land.
- Not necessarily an error – but the use of Benefit Cost Ratios (BCR).
o The idea of the BCR makes sense – let’s find the project that returns the best “Bang for your buck”. If a project
has a BCR>1 then accept the project, if competing projects choose the one with the highest BCR. The issue that
arises with the BCR is that it is focusing on return per dollar spent rather than the increase in societal well-being.
Consider the example below:

Costs $ 8.00 $ 90.00

Benefits $ 10.00 $ 100.00
BCR 1.25 1.11
Net Benefit $ 2.00 $ 10.00

$10
𝐵𝐶𝑅1 = = 1.25 𝑤ℎ𝑖𝑙𝑒 𝑛𝑒𝑡 𝑏𝑒𝑛𝑒𝑓𝑖𝑡 = $10 − $8 = $2
$8

$100
𝐵𝐶𝑅2 = = 1.11 𝑤ℎ𝑖𝑙𝑒 𝑛𝑒𝑡 𝑏𝑒𝑛𝑒𝑓𝑖𝑡 = $100 − $90 = $10
$90
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The problem being we get conflicting results between projects depending if we choose the BCR rule or the
highest net benefit rule. While the first project gives best “Bang for buck” with a BCR of 1.25 (benefits are 125%
of the costs), it is also the project that provides the smallest net benefit to society of only $2. Contrast with the
second project that provides slightly worse ‘value’ to society with a BCR of 1.11 (benefits are 111% of the costs)
but provides a much better net benefit to society of $10. The use of BCR may result in smaller projects being
utilized over larger ones that provide more net benefit.

The previous, section serves to provide an over view of a cost benefit analysis to allow the reader to understand the
complexities, the importance and the shortcomings of such an analysis. For a further look into cost benefit analysis, the guide
to cost benefit analysis for regulatory proposals for the federal government can be found here.

Finally, an example of a simple cost benefit analysis – similar in scale and scope as to the expectation of the CBA project
can be found under the content tab on D2L under the title of CBA – Example. Keep in mind, the attached CBA is by no means
exhaustive. The purpose of this example, and assignment, is to have you think about policy decisions from a CBA perspective
and to gain an appreciation of the process and its difficulties.

Back to top
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4.0 Planning, Budgeting and reporting
Into to financial management
Financial management is a key element of every area of public finance. The financial aspect of management permeates all
public activities and involves each and every public service and function. Allocation decisions are made continually at every
level within a public organization. Everyone who exercises some control over funds, labour, or materials makes such decisions.

Each year, governments must weigh the burden of taxes and other charges against the expected benefits of the set of
programs, services, and other expenditures funded by those revenues. Financial management therefore is an essential part of
government, involving staff in everyday decision-making at all levels of an organization.

Financial Management Process

There are three components to the financial management process – these three components are circular in nature:

- Budgeting
- Accounting
- Reporting

Budgeting is a central process for managing financial matters in an orderly manner. It can be equated with planning in
financial terms, and the budget is a statement of financial expectations over some future period. Budgeting may follow a
particular technique or system in achieving its objectives. Throughout this section we will evaluate 4 specific types, or
methods of budgeting:

1. line-item budgets,
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2. performance budgets,
3. program budgets,
4. Planning Program Budget System
5. Zero based budgets,

Each of the above with specific procedures for consultation, discussion, negotiation and decision making.

Accounting, draws on a number of techniques for gathering, classifying, and recording financial information. Accounting
techniques include the accrual basis of accounting and double entry bookkeeping with the use of specific computer software
programs.

Reporting, which is the communication of financial information to decision-makers. The information gained from the
accounting process must be summarized and presented in a timely, relevant, and understandable manner, so as to allow
effective evaluation and decision-making. Reporting outputs in the computer age include:

1. real-time online information,

2. periodic detail and summary reports,
3. year-end financial statements.

This unit provides some examples of public sector financial statements.

The whole process of budgeting, to accounting to reporting is extremely circular in nature. Budgeting includes activities
such as reviewing existing programs, framing objectives, setting priorities and, of course, preparing budget estimates. Once
the budget has been adopted, actual results are recorded by accounting and compared to the estimated (or budgeted) values.
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In the reporting stage, results are communicated to decision makers for evaluation and corrective action if required. These
reports are then used to create new budget estimates and the process starts anew.

Budgeting at different levels of government

Federal Government.

The Constitution act of 1867 does not mandate that the government need to provide regular periodic budgets. The
Constitution act does state than any bills requiring the imposition of taxes or levies or for the appropriation of public funds
must be debated and passed in the House of Commons. As such, it has become typical that governments propose, debate and
vote on an annual budget in the House of Commons – typically this happens each February, although no need for it to be.

Importantly, if the sitting government’s budget is defeated in the House of Commons, the government, by tradition, must
resign and seek re-election (loss of confidence).

Provincial Government – BC

While the Constitution Act similarly does not mandate the need to provide regular periodic budget updates, the Province
of BC has enacted stricter legislation requiring the annual reading of a budget as well as minimum criteria of said budget.

BC Transparency and Accountability Act of 2000. The Act establishes the procedural requirements for budget preparation,
and for presentation of the budget to the Legislature for debate and adoption.

The budget process is begun not later than September 15, when the Minister of Finance must make public a budget
consultation paper, which includes:

1. A fiscal forecast of key economic and policy assumptions,

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2. A summary of the key issues to be addressed in the next budget,
3. Information on how the public may provide input.

The consultation paper must also be provided to the Standing Committee on Finance and Government Services, for public
consultation and report to the Legislature prior to formal budget presentation.

The budget for the upcoming fiscal year must be presented to the Legislature on the preceding 3rd Tuesday of February.
The budget presentation includes:

- The proposed budget appropriations for the fiscal year

- A statement of forecasted revenues and expenses and resulting surplus or deficit
- A reconciliation of the budgeted surplus or deficit with the budgeted change in debt
- A forecast of the balance sheet at the end of the fiscal year
- A summary of accounting policies used by the Treasury Board to prepare the estimates
- Economic and fiscal forecasts including underlying assumptions
- Capital commitments greater than $50 million

By the date of the budget presentation, the Minister must also present an outline of the government’s priorities,
objectives, and performance measures as well as forecasts of the estimates provided above for the two years following the
budget fiscal years. Individual government ministers are also required to make public annual and 3-year service plans for their
ministries5.

5
The service plans for major ministries have been hyperlinked in section 6.0 major government programs
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The British Columbia provincial government has enacted legislation that requires balanced or surplus budgets in every
fiscal year after 2003-04. The penalty for non-compliance is a 20 percent rollback in compensation for the members of the
Executive Council, i.e. the Cabinet6.

Local Governments – in BC

Unlike federal and provincial government, budgeting at the local level is controlled by senior levels of government. For
example: Sections 165 and 166 of the Provincial Community Charter establish the requirements for local government financial
planning. In essence, each year a bylaw must be adopted that outlines the current year’s financial plan as well as the following
4 years. That is, a 5-year financial plan must be adopted and at the local level these financial plans must be budgeted to
balance. While they must be budgeted to balance, deficits and surpluses occur. Deficits must be counted as a cost in the
following year, however there is no need to carry forward surpluses.

6
Legislation was passed by the NDP government to prevent this cabinet salary rollback occurring during the years immediately following the pandemic where BC ran a sizable
deficit. https://www.bclaws.gov.bc.ca/civix/document/id/complete/statreg/01028_01.
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Budgeting Techniques

Throughout this section we will evaluate some of the budgeting techniques first introduced above. While budgeting is a
useful tool to create oversight and control of public finances, it is also a restricting tool that can – at times – prevent the
adoption of new projects given budget constraints (think of a project with a clear net positive to society, but cannot be
approved due to it’s budget item). Similarly, some forms of budgeting may also incentivize wasteful or bloated spending in
order to justify or preserve a continued budget amount.

Line Item Budgets

The line item budget is the simplest and most widely used of the four techniques. Line item budgets list expenditures to be
made by type such as salaries, supplies, etc. with no reference being made to the programs or services these funds are being
allocated to. The focus is on expense items rather than program or program outputs, an example of a line item budget can be
found below in table 4.1.

Expenditures Table 4.1

Salaries & benefits $ 25,000

Office supplies & services 6,000
Contractual services 9,500
Training 1,000
Equipment maintenance 4,000
Utilities 2,000
Rent 2,500

Total: $50,000
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Advantages:

Being the most utilized, the line-item budget has some clear advantages such as being easily understood. Additionally, this
style of budget is easy to prepare with both reader and preparer often familiar with the concept and presentation of
information. For control purposes, it offers reasonable mechanism to observe budget variances and to ensure spending is on
appropriate items and services.

Disadvantages:

Just because it is the most utilized does not mean it is without its criticisms. Primarily it is of limited use in setting priorities
or evaluating performance. In the above Table 4.1, we see that 50% goes to salaries and about 5% to rent. This is useful but
gives no input as to priorities, objectives or performance of the programs being delivered. A government budget of $50,000
tells nothing of the government priorities or their effectiveness in reaching these priorities. The focus is on whether line item
expenses have increased, not a focus on whether these increases relate to changing needs or effectiveness of programs.

Some would argue that this method encourages spending rather than efficiency as administrators will often feel
compelled to spend their full budget so as not to lose it for the next year. There is little, if any incentive to spend less than
allocated, especially as the focus is on expenditure amounts rather than programs and services provided.
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Performance Budgeting

Aiming to overcome some of the disadvantages of the line-item budget, the performance budget includes a mechanism
for evaluating the efficiency in which programs and services are delivered. That is, it adds performance expectations to
budgeted expenditure allocations.

Performance budgeting technique consists of:

o Categorizing budgetary units by program (function & activity), as well as by department and line-item.
o Analyzing programs to determine performance standards in terms of unit cost per activity
o Total expenditure as Unit cost multiplied by number of units provided.

In this way the performance budget brings into focus:

o Objectives of the program and reason for existence

o Services and activities to be provided to achieve objectives.
o Volume of work required to meet these objectives.
o Levels of service provided in previous years
o Levels of service to be provided if requested amounts are appropriated.

An example of a performance budget can be seen below in Table 4.2

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Table 1 Table 4.2
Illustration of Performance Budget
Department of Public Works

Roads Maintenance Division

FUNCTION/ACTIVITY– Asphalt Paving Budget
OBJECTIVE – to resurface existing paved roads once every 12 years
Paved Road Inventory 18,000 linear metres

Wages and Benefits $ 310,000.00

Operating Expenses 590,000.00
Total $ 900,000.00

Performance Statistics – Metres Paved

Linear Metres of road paved per year 1,500

Average width of road paving 8m
Square metres of road paved per year 12,000
Unit cost per square metre paved $ 75.00

Total annual cost $ 900,000.00

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Advantages

A key advantage of the performance budget is that it allows for meaningful comparisons between years and departments.
Administrators can assess whether work is being completed more or less efficiently rather than only being able to determine if
expenditures have changed.

Disadvantages

While a great tool to determine the efficiency of a given project, possibly the biggest drawback is that many public services
do not ‘fit’ into this form of unit cost analysis. Soft services such as general management, clerical, administration etc. how do
you determine the performance, unit cost, or efficiency of these services? While the typical solution is to include these soft
services as an “overhead” cost, doing so may end up skewing the comparisons as certain projects may need more clerical and
back office support than others.

Program Budgets.

In theory program budgets are relatively simple: they are designed to break down greater government expenditures and
revenues into its requisite program parts. Total government budget is split into budgets for each ministry which is then split
into budgets for each program. Each program may include a line-item or performance budget, depending on the needs and
policies in place.
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Advantages

The key advantage of program budgets is that it allows policy makers to focus on providing a mix of programs to
constituents that meet their needs and expectations at a price they are willing to pay. Additionally, program budgets are able
to break down the costs, benefits, and revenues of each program to allow for individual evaluation, expansion or cutting.

Disadvantages

As with any budgeting technique, program budgets are not without their faults as allocating costs to programs can be
difficult. This is especially true when a given program utilizes staff and resources from more than one department. In this
scenario it becomes difficult to disentangle the costs and revenues from one project from another.
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Planning-Programming Budgeting System

The planning-programming budgeting system, or PPBS, is a very sophisticated type of program budget. Although very
comprehensive, it requires a considerable amount of effort from all levels of an organization. In application it requires the
following budget activities:

- Setting objectives at all levels of organization

- Reviewing those objectives and identifying alternative ways to meet them
- Develop budget proposals in terms of programs and services
- Develop annual plans for each program
- Establishing information systems for each program to monitor progress towards goals

Ultimately, PPBS, represents an attempt to improve the planning of public expenditures. Recognizing that these
expenditures are not sensitive to the economic pressures of price or profitability as they would be for a private firm. Just the
same, these resources are scarce, and have economic value.

Advantages

The key benefit of PPBS is that it links present budgeting with long-range planning and compels administrators to
thoroughly review operations. Further, PPBS integrates the processes of program/project formulation and budget allocation
and evaluation in a systemic manner. This helps policy makers to make better decisions in determining appropriate allocation
of resources based on the performance evaluations provided. Finally, PPBS, aims to maximize social benefit by prudently
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allocating scarce resources, done, in part, through the incorporation of long-run future budgetary repercussions of projects
that may be 3, 5, 10 years life-span.

Disadvantages

While promising in theory, PPBS has had a hard time showing beneficial results, primarily because many projects have had
significant difficulty in establishing clear, meaningful and measurable goals. while PPBS emphasizes physical and financial
performance, qualitative performance is not meaningfully measurable or achievable. An additional downside to PPBS is that it
requires a huge staff to implement and administer after the fact in order to process and analyze the mass amounts of data
required.

Current budgeting system for the province of BC has many features of the PPBS

Zero-Based Budgeting (ZBB)

Zero-based budgeting, or ZBB, is an extreme change in the traditional style of budgeting. In the traditional budgeting cycle,
previous years reported expenditures form the basis for next year’s budget. The ZBB approach rejects this cyclical adoption of
incremental budgetary changes, refusing to accept that last year’s budget should have any influence on this year.

Instead, each project or department begins with the assumption of zero expenditure. From this point every expenditure
budget request must be justified and shown to be needed.

In reality, a true ZBB is rarely implemented – rather a hybrid model is often used where the reports of previous
expenditures form the basis of the next period’s budget, but such that the initial proposed expenditure for each line is at 70-
95% of last year’s levels – any increase in expenditure above this level needs to be justified with a decision package.
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A decision package is required for each program stating the description of the program as well as providing an explanation
of the objectives of the program. Importantly, this package will also include a statement of the consequences if the program
were to no longer be funded. Typically, a decision package will be provided for varying degrees of funding for the same
program. That is, Expenditure needed, and objectives of the program at a base-level of funding versus expenditure and
objectives at a higher service level.

Once all decision packages are completed, the policy maker can then rank decision packages in terms of priority. This
priority list is then able to be compared with available revenues. Comparing revenues to priority lists allow for the creation of
a revenue cut-off, determining whether or not a package is approved.

Ultimately the choice of the revenue cut-off is a political decision. As it will be known what services will not be funded at
different revenue cut-offs, there will be significant debate as to what level of funding is required.

Advantages:

A key advantage of ZBB is that it forces administrators to re-evaluate financial planning, and program delivery assumptions
on an annual basis, encouraging evaluation of program alternatives. ZBB has led to substantial efficiency gains, although it has
found to be most effective in organizations that have witnessed acute revenue short-falls.

Disadvantages:

ZBB is, again, not without its disadvantages, the primary disadvantage being that ZBB encourages a short-term perspective
on budgeting and planning. Beyond the short-term perspective, ZBB requires a significant amount of informational support,
and thus can require a considerable amount of preparation and administration – especially in the first year. While ZBB has
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shown to be effective, it has also been shown to be difficult for large organizations to make the transition. Amongst the
organizations that have transitioned to this budgeting model, support has tended to wane after the first few years, leading to
questions about its long-term effectiveness.

Budgets at different levels of government

Federal Provincial

The federal budget for Canada can be found here. The provincial budget for BC can be found here.
Local

As there is no, one, local level I have included hyperlinks to several municipal budgets below for your perusal:
• City of Victoria • City of Langford
• City of Saanich • City of Vancouver

Reporting at different levels of government

Federal government

The financial statements of the Government of Canada are prepared by the Receiver General under the title of the Public
Accounts of Canada in accordance with provisions of the Financial Administration Act. Public Accounts are prepared each year
for the fiscal year ending March 31, in three volumes:

1. Summary analysis of the financial transactions of the government

2. Financial operations of the government, segregated by ministry
3. Additional information and analysis
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Section 2 of volume 1 provides the audited financial statements, which include:

1. Statement of operations and accumulated deficit

2. Statement of financial position
3. Statement of change in net debt
4. Statement of cash flow

Notes

The Statement of Operations and Accumulated Deficit is similar to a Profit and Loss Statement for the private sector, and
summarizes revenues and expenses for the report year. The statement also shows the impact of the year’s financial operations
on the accumulated deficit. The Statement of Financial Position is equivalent to the private sector Balance Sheet, and provides
a summary of assets and liabilities at yearend. Unlike a private sector corporation, there are no shareholders’ equity or
retained earnings.

The Statement of Change in Net Debt provides a summary of those factors affecting the status of net debt during the year.
The Statement of Cash Flow provides a reconciliation of the change in cash balances from the previous reporting yearend to
the current yearend. The Notes provide explanations and more detail on some of the entries in the statements, on such areas
as accounting principles, pension liability funding, and asset valuation. The four statements included in the Public Accounts of
Canada, 2018.

Section 2 of Volume 1 also includes the observations of the Auditor-General on the financial statements. The Auditor-
General also conducts performance audits on behalf of Parliament that examines whether the government is managing it’s
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programs economically and efficiently, with due regard to environmental impact and has performance measures in place to
determine their effectiveness.

Province of British Columbia

The financial statements of the Province of British Columbia are prepared by the Office of the Comptroller-General under
the title of the Public Accounts in accordance with the Provincial Financial Administration Act. Public Accounts are prepared
each year for the fiscal year ending March 31, in five sections:

- Overview
- Summary financial statements
- Supplementary information
- Consolidated revenue fund extracts
- Provincial debt summary

The summary financial statements section include audited financial statements as follows:

- Statement of operations
- Statement of financial position
- Statement of change in net liabilities
- Statement of changes in cash and temporary investments
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Notes

The provincial statements are very similar in content to the federal statements. The four statements included in the Public
Accounts 2017/18 can be accessed here.

The Auditor General of British Columbia provides independent reports to the Legislative Assembly and the public on
provincial spending and accountability. The Office also provides reports to the Public Accounts Committee and other
committees on areas identified for change and improvement, as well as follow-up progress reports.

Local Government

In accordance with Section 167 of the Community Charter, local governments must prepare and submit audited council-
approved annual financial statements to the Inspector of Municipalities by May 15. The statements must be prepared using
generally accepted accounting principles for local governments. The audited financial statements form part of the annual
report that must be made available to the public before June 30.

Local government financial reports have been the subject of considerable review in Canada over the last few years, in as
much as there has been concern that such reports have not been readily comparable from one jurisdiction to another. The
Canadian Institute of Chartered Accountants formed the Public Sector Accounting Board (PSAB) to research and issue financial
statement standards of general application to all Canadian municipalities, more in line with standard general accounting
practice. British Columbia has accepted the PSAB’s Local Government financial standards for future implementation. Because
some of the PSAB reporting standards affect not only financial statement preparation, but also budgeting and recording, the
provincial government has allowed for an extended period of discussion on issues and problems.
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British Columbia local government financial statements typically consist of the basic statements prepared for other public
sector organizations, and include (at least):

- Statement of Financial Position

- Statement of Financial Activities (i.e. operations)
- Statement of changes in Financial Position (i.e. cash flows)

As with all audited financial statements, there are also a series of explanatory notes that accompany the statements. If
interested – the city of Victoria’s annual reports and financial statements can be found here. As these are also a political
document, the raw financial reports do not typically appear till near the end of the document.

Local governments must appoint an auditor, who must be qualified to be the auditor of a reporting company under
section 180 of the Company Act. Although there is no auditor general for local government in British Columbia, the Inspector
may require a local government auditor to provide financial reports in addition to the annual financial statements.

Back to top
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5.0 Canadian Revenue System
Economics of Taxation.

Modern nations like Canada have enormous responsibilities. In order to effectively govern and provide the services
required by their citizens, these nations need to raise massive amounts of money in order to fund the cost of governance as
well as extra social programs provided.

Taxation has two roles: First, it is a revenue source for governments, allowing governments to collect the funds needed
to govern; second, taxation is a powerful tool to influence incentives faced by people within the nation.

While the second role may not seem initially clear, lets evaluate the role of a carbon tax. Based on ideal economic
theory a Carbon tax should not exist to provide revenue to the government7, but rather should exist only to change the
incentives of the citizens. That is to make ‘dirty’ goods and services more expensive relative to clean ones.

Similarly, while the income tax is a powerful revenue generating tax, it also has a strong influence on the incentives of
wage earners in the desire to earn an extra dollar. In the 1950’s when the top marginal tax rate was 90%, there was very little
incentive for top wage earners to earn an extra dollar in income. After all, 90 cents on every extra dollar earned would just go
to the government. Compare this with today where the top marginal tax rate is around 50%, meaning that at the top levels
every extra dollar earned, only half is lost to the government. The impact on this is that there is now less of a disincentive to

7
By far and large this is true in the Canadian context with only very little of the Carbon tax being retained to cover administrative costs, the rest is re-distributed back to
Canadian residents.
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earn a disproportionately high income. This allows the resources of a firm to go towards larger and larger executive
compensation over re-investment or labour compensation.

Fairness of taxation systems are typically judged based on their degree of horizontal and vertical equity.

Horizonal Equity: Individuals with equal income should pay equal tax.

Vertical Equity: Individuals tax burden is respective to their ability to pay – typically measured based on the progressivity
of the taxation system.

Taxation systems are often categorized as progressive, proportional (flat), or regressive. We will define and look at each of
these as they relate to income taxes.

Progressive Taxation: Take higher percentages away from those with higher incomes.

Proportional or flat Taxation: Takes equal proportions from all incomes.

Regressive Taxation: Takes higher percentages from lower incomes than from higher incomes.

In Canada, at the federal level, we tend to witness progressive taxation up till a median income where it begins to
become more proportional with a hint of progressivity at the top 1%.

At the provincial level, we typically witness a taxation system that is more or less proportional, some provinces have a
slight degree of progressivity.

At the local level, taxation is almost strictly regressive as it relates to income.

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While having a taxation system that embodies both vertical and horizontal equity is a socially desirable trait for a
democratic society, there are other factors at play that much be considered in developing a tax regime. While the progressive
nature of the federal income tax is an attempt to satisfy the vertical equity criterion while also allowing for a degree of re-
distribution, it must also be kept in mind that taxes are often seen as punitive in practice. High levels of taxation placed on
certain groups may simply result in flight to other nations with more appealing tax laws.

This can be especially true when speaking about the taxation of financial capital and investment returns. If Canada were
to charge a disproportionately higher taxation on investment returns versus other countries, investors would see Canada as a,
worse investment than other countries.

This unfortunately also creates a situation where countries or regions race to the bottom to provide the lowest levels of
taxation to attract international financial capital.

While such policies may encourage investment, they also provide strain on revenue sources. Ultimately the setting of
taxation policy needs to weigh;

- Revenue Concerns
- Concerns of vertical and horizontal equity
- Economic concerns

To conclude this section with a brief statement, often-political concerns of a minority are trumped up as economic
concerns. Many arguments to reduce taxation on certain income groups under the guise of ‘trickle-down economics’ have
shown to be politically motivated with little, clear, economic rationale. Unfortunately, it is often the case that those with the
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greatest incomes also have the greatest amount of time to advocate for their wants, utilizing defunct economic theories or
strawmen to push for taxation benefits that benefit the top but hurt the majority. This can be seen time and time again from
arguments around income tax, property tax, and most recently the carbon tax debates in Canada.

Murphy’s Law of Economics: The policies in which economists agree the most are the policies that are often not enacted,
whereas the policies that have the least consensus and cause the most controversy often are the ones adopted.

Sources of Funds: Federal government

Income Tax
The primary source of funds for the Canadian government in 2020 was personal income taxes, accounting for just over
50%8 of all revenue sources. Canadian residents pay income tax to the Canada Revenue Agency (CRA) on all global income
earned, while Canadian citizens living abroad only pay income tax to the CRA on any income earned in Canada.

Total income is determined from sources such as: salaries and wages, interest and dividends, rents and taxable capital
gains, pensions and EI benefits, alimony support payments, scholarships, grants and bursaries, severance and other lump sum
payments.

Sources of income that are not considered part of total income for tax purposes are: imputed incomes, capital gains from
home-ownership, gifts and inheritances, lottery winnings, veterans disability benefits, life insurance, strike pay.

8
https://www.canada.ca/en/department-finance/services/publications/annual-financial-report/2020/report.html
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From total income, Canadian taxpayers are permitted a list of allowable deductions to reduce their taxable income. These
deductions can change annually with budget changes but often include items such as: losses, unions dues, professional dues,
child care and moving expenses, and certain interest or carrying expenses.

Federal tax rates for 2024 are as listed below9

Income range Tax Rate Table 5.1

Up to $55,867 15%
$55,867 up to $111,733 20.5%
$111,733 up to $173,205 26%
$173,205 up to $246,752 29%
$246,752 and above 33%
The important thing with income tax to keep in mind is that the above listed tax rates are the marginal tax rates, the rate
earned on an additional dollar within that category.

For example, if your annual income was $120,000 your tax bill would be:

15% on the first $55,867 = $8,380.05

20.5% on the amount earned between $55,867 and $111,733, so an amount of $55,866 would be taxed at 20.5% =
$11,452.50

9
https://www.canada.ca/en/revenue-agency/services/tax/individuals/frequently-asked-questions-individuals/canadian-income-tax-rates-individuals-current-previous-
years.html
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Finally, on each extra dollar earned above $111,733 till your last dollar earned at $120,000. Thus, $8,267 worth of income
would be taxed at 26% for $2,149.42

This leaves a final federal tax bill of $8,380.05+$11,452.53+$2,149.42=$21,982 for a total tax incidence equal to 18% of
21,982
your income ( = 0.183).
120,000

Keep in mind that this is in contradiction to the wide spread myth that it is possible to take home less money by earning
more money.

Corporate Tax
The next largest source of federal government revenues is the corporate tax which accounted for 15% of revenues in
the 2020 tax year.

Unlike the personal income tax, the corporate tax is more proportional, with a slight level of progressivity built in for
‘small businesses;

Category Tax Rate Table 5.2

General, Income earned in Canada 28%
General, Income earned outside Canada 38%
Small business (< $500,000 in taxable income) 10.5%
Thus, typically we experience a flat tax for Canadian businesses, with small businesses receiving a slightly lower rate of
taxation – hence a slight degree of progressivity.
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Goods and Services Tax (GST)
Accounting for just over 11% of total revenues in 2020, GST is the next largest source of the Federal Government’s
revenues.

The GST replaced the Federal Services Tax (FST) in 1991 to align with changes due to the North American Free Trade
Agreement (NAFTA), and allow Canadians firms to be more competitive. FST was only charged on manufactured goods, and
was due irrespective of whether the good was to be sold domestically or exported abroad. To increase the competitiveness of
Canadian firms, and to maintain the income stream, the FST was repealed and replaced with the GST, charging a proportional
tax on the purchase of nearly all goods or services purchased domestically.

Most notable exceptions to the GST include basic groceries, prescription drugs, medical supplies, exported goods,
insurance and financial services, residential rents, medical services, and education.

The intent with the GST was to eventually move to a system where the federal sales tax (GST) was harmonized with the
provincial sales tax (PST) to create a unified Harmonized Sales Tax (HST) for ease of collection and administration. However, as
of this date only the Atlantic provinces have adopted HST with BC temporarily adopting the HST before holding a referendum
that scrapped the program10.

10
Don’t get me started about the poorly worded referendum question and costs that the province had to face due to this repeal.
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EI premiums
Employment Insurance (EI) premiums account for almost 7% of federal revenues and are paid through payroll
deductions to the CRA.

The cost of EI premiums are born by both the employer and the employee, with the current rate for the employee being
capped at 1.58% of insurable earnings or a maximum annual contribution of $952.74. This employee contribution rate has
been decreasing almost every year since 1994 when it peaked at 3.07%

The employer EI premium rate is pegged at 1.4 times the employee rate, subject to maximums. Each year an individual
is subjected to maximum insurable earnings, in 2022 the maximum insurable income is set at $60,300 11 – once premiums on
this amount have been hit contributions cease for both the employee and employer

CPP Contributions
CPP premiums are similarly collected by the CRA through payroll deductions. Both employee and employer pay a
portion of this amount based on taxable income up to a pre-set legislated maximum pensionable earnings amount, $64,900 in
202212.

CPP premiums have been increasing since inception with the current rate sitting at 5.7% of pensionable earnings up to
the maximum pensionable earnings.

11
https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/payroll/payroll-deductions-contributions/employment-insurance-ei/ei-premium-rates-
maximums.html#tb1
12
https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/payroll/payroll-deductions-contributions/canada-pension-plan-cpp/cpp-contribution-rates-
maximums-exemptions.html
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Debt Financing
Rarely do government revenues match government expenses. In years where revenues exceed expenses it is said the
government is running a budget surplus. In years where expenses exceed revenues, the government is running a deficit and
needs to make up the difference through debt financing. In 2020 the government’s deficit was at $28.8 billion dollars, owing in
large part to the pandemic response.

Interest Bearing debt Amount (Billions) Table: 5.3

Unmatured debt $783.8
Public Sector Pension Liability and other employee benefits $295
Other liabilities $6.1
Total $1084.8
Quick Aside: It has been argued by Piketty13 and others, that the shift towards increased debt financing has been
due to a shift to lower and lower rates of taxation at the top of the income distribution. In this way, revenues that
used to come from taxation of the richest, now come through the form of investment in government bonds from,
primarily, the same group. This difference being in the former case that under taxation, the individual would pay into
the common pot and only receive the same social benefit as every other member of society. In the latter case, under
debt financing, the same individual now receives both the social benefit as well as the return on investment (interest
income) which is then paid for by the tax-payer. It has been argued that the decreasing reliance on tax revenues from
high income earners, and an increased reliance on debt financing has introduced a ‘hidden’ form of regressivity to the
tax system.

13
Piketty, T (2020) Capital and Ideology, Harvard University Press, Cambridge Massachusetts.
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Sources of Funds: Provincial Govt

BC Personal Income tax

Accounting for just over 18%14 of provincial revenues the BC Income tax is similar to its federal counterpart. The main
differences are due to different marginal tax rates. As of 2024 the marginal tax rates on income are as follows: BC Personal
income tax is collected by the CRA and distributed back to the provinces.

Taxable Income - 2024 Brackets15 Tax Rate Table 5.4

$0 to $47,937 5.06%

$47,937 to $95,875 7.70%

$95,875 to $110,076 10.50%

$110,076 to $133,664 12.29%

$133,664 to $181,232 14.70%

$181,232 to $252,752 16.80%

Over $252,752 20.5%

14
https://www2.gov.bc.ca/assets/gov/british-columbians-our-governments/government-finances/financial-economic-review/financial-economic-review-2020.pdf
15
https://www2.gov.bc.ca/gov/content/taxes/income-taxes/personal/tax-rates
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BC Corporate tax.
The corporate tax in BC accounts for about 8.5% of government revenues, and similar to its federal counterpart is
loosely a proportional tax system. With a general tax rate on taxable income of 11%, or 2.5% for businesses with taxable
incomes less than $500,000.

Like with the personal income tax, the corporate tax is collected by the CRA.

BC Other tax revenue

While BC’s income tax is quite progressive, almost 27% of revenue comes from ‘other’ tax sources. Given the way these
taxes are levied, and the increased reliance being placed on these, it adds a degree of regressivity to the provincial tax regime.

The provincial sales tax, or PST, accounts for 12.6% of provincial revenue. Beyond the PST, there are many other
consumption taxes including taxes on the consumption of fuel, tobacco, and alcohol. As these taxes are typically based on per-
unit consumption (i.e Tax per liter of gasoline), all else being equal, the tax burden falls more heavily on those with lower
incomes16.

At just over 7% of provincial revenue is taxes from property. This includes the property transfer tax which is levied as a
proportion of the properties worth any time there is the sale or transfer of real property within the province. Beyond this is
also the property tax. While the property tax is collected at the regional level, provincial programs such as education are
funded from the property tax, and thus is a provincial revenue collected by a local government.

16
Of note; this is part of the reason why the climate action rebate provides higher amounts to lower income households in an attempt to offset the regressive nature of this tax.
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Finally, at almost 4% of provincial revenue are royalties from extraction of natural resources, notably forestry at 1.7% and
natural gas at 0.2%.

BC Other revenues.
Additional sources of revenue for the provincial government come through fees and premiums charged for government
services along with transfers in from the federal government and surpluses carried by crown corporations.

In 2020 just over 18% of revenue sources came from fees and premiums for services such as Medical Services Premiums
(MSP)17 and driver’s license fees etc. Just over 16% of revenue came through the form of grants and transfers from the federal
government and about 5% through extra surpluses run by crown corporations (i.e. BC Hydro, ICBC, Etc.).

BC Debt financing.
Like the federal government, the provinces also, at times, need to debt finance their budgets if they end up running a
deficit. These debts can be broken into two sub-groups

- Tax payer supported debt, this is debt from the government itself or from crown corporations who have been
provided with subsidies. That is, debt which will be ultimately re-paid by the tax-payer.
- Self-supported debt, portion of debt serviced by commercial, self-supporting crown corporations.

Until 2004/05, the BC government had been running a deficit for many years, and their bond ratings had suffered
accordingly. Since 04/05, the government has tended to be able to run surpluses, and this has allowed for BC’s bond rating to

17
MSP is no longer paid directly as a fee and has since been funded by general taxation revenue.
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improve. Since 04/05, borrowing for current operations has not been needed except for occasional short-term loans to
provide bridge financing for future revenues.

Sources of Funds: Local Government

Property Taxes
In most of North America the primary source of revenue for local government is the property tax. Where local
governments not only assess the value of each property within their jurisdiction but also determine the corresponding tax
rate. This has been seen to be a conflict of interest in so much as the municipality gets to jointly decide the value of your
residence and then what rate you will pay based on that value.

Since 1974 in BC, the role of property value assessment has been conducted by the B.C. Assessment Authority which is
an independent agency tasked to annually, create a publicly accessible property value roll for every property within the
province. Once valued, the local governments can then determine the corresponding tax rate needed to finance their
proposed expenses. Like the rest of Canada, assessment of property is based on presumed market value of the property.

There are certain exemptions to property taxes. The primary exemption being the taxation of land owned by the federal
or provincial government – including crown corporations. That is because the taxation of these levels of government is seen as
outside of the jurisdiction of local government.

Additional exemptions exist based on statue which provides exemptions for certain properties such as churches,
cemeteries, schools, hospitals, emergency facilities and public libraries as well as many other forms of properties intended for
public or non-profit use.
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The community charter requires local governments need to pass a bylaw by May 15th each year to impose tax rates on
all taxable land and improvements. An annual tax levy is then determined to be raised from the property value taxes as
provided in the financial plan.

Municipalities have at their disposal the right to tax different classes of land at different rates. For example, consider
the following classes and a hypothetical tax rate for each.

Assessment Class Tax Rate per $100018 Class Multiple Table 5.5
1 Residential 2.41101 1.0
2 Utilities 18.19110 7.5
4 Major Industry 7.73936 3.2
5 Light Industry 7.00134 2.9
6 Business/Other 6.57363 2.7
7 Managed Forest 2.68491 1.1
8 Recreation/Non-Profit 2.77990 1.2
9 Farm 2.41101 1.0
In this example, the tax rate could be set as the tax rate per thousand dollars of value. That is, in this above example, a
residential property valued at $400,000 with a tax rate of $2.41101 per $1000 would pay $964.40 in property taxes. Similarly,
an identically valued business (class 6) with a tax rate of $6.57363 per $1000 would pay $2,629.45 or about 2.7 times more
than the residential class. Of note; tax rates must be applied to all properties in a certain class irrespective of owner or
property value. For example, you cannot charge a higher tax rate to homes valued over $1 million. Similarly within class 6 a
city cannot charge a higher rate to big box stores and a lower rate to “mom and pop” stores.

18
Source: City of Langford (2024) https://pub-langford.escribemeetings.com/filestream.ashx?DocumentId=9606
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Ultimately local or municipal councils can set tax rates to achieve either political or economic goals. For example, in
order to encourage more commercial business within the municipality, council may lower commercial business class taxes at
the expense of another category. Keep in mind that taxation can serve two roles (i) to raise revenue (ii) to change the
incentives of those being taxed.

While the municipality will set their tax rate based on their budgetary concerns, there are often several additional levies
that are collected through property taxes beyond the municipal or regional ones. For example, taxes are also often collected
for other parties such as the following: school districts, regional districts, hospital districts, BC Assessment Authority, transit
authorities, others (IE, sewer, improvement districts, etc.).

What happens if you don’t pay your property taxes?

- Not paid by deadline? Assessed a 10% fee

o Most municipalities use a two-date system, 5% fee if not filed by one date, additional 5% if still not filed by
second date.
- If still not paid by December 31st of that year (year 1), taxes become in arrears and subject to daily interest.
- Taxes, penalties and interest not paid by December 31st of following year (year 2), taxes become ‘delinquent’
- Taxes, penalties and interest not paid by December 31st of following year (year 3), property subject to tax sale
o Last Monday in September
- Year 4 – after tax sale, property title either transferred to the purchaser or the municipality.
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Issues with local taxation
Senior levels of government are not subject to local property taxes, and thus are not obliged to make any payments.
Nevertheless, these senior levels of government often do pay Grants in Lieu of Taxes (GILTs) which is supposed to be
equivalent to the assessed tax amount.

However, as these senior levels of government are under no obligation to pay, there is no assurance at the local level
whether these funds will be received. For example, the federal government will often pay ‘interim’ grants and then decide at a
later date (up to ten years later) that the interim grant was incorrect and some amount should be returned. In addition, the
federal government commonly disputes the assessed value of their land claiming it was assessed too high. While the
provincial government has been somewhat better, the same issues still exist. This can create substantial problems for
municipalities with substantial tracts of provincial or federal lands.

Equity Concerns with Local Taxation.

As seen, property taxes are collected on the value of the property at a flat rate. Higher valued properties pay the same
rate per $1000 as lower valued properties. This unfortunately introduces the possibility of property taxes being at best
proportional with respect to income, or at worst regressive. Unfortunately, often the latter.

Typically, those with higher incomes can afford higher valued properties, while those with lower incomes typically
cannot. As the property tax is flat with respect to the value of the property this means that lower income households will tend
to pay a higher proportion of their income towards property taxes when compared to higher income households. Thus
property taxes tend to be regressive.
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Unfortunately, the reverse problem also exists. Many seniors are living in large properties which have appreciated
significantly since they were first purchased. The result is that these households tend to have a very high valued home, but
very little if any income as they may be living off a small pension. The resulting property tax on these properties can be
enormously high for these seniors. To assist with this the Province of BC allows certain groups, like seniors, to defer their
property taxes. In essence this program puts a lien against the value of the property for these unpaid taxes to be collected at
time of sale.

Another issue of concern with property taxes is the common discrepancy between social values of those who pay and
those who utilize the services provided by these taxes. Many residents rely on municipally provided services such as the
provision of public schools, parks and green spaces as well as recreational centers. However, those with the highest valued
properties are often those properties that include private green space in the form of yards so have less of a need for this to be
publicly provided. Conversely, lower income, or households with lower property values typically do not have access to this
private green space so are more reliant on the public provision of parks. The potential conflict arises as those paying the bulk
of the cost are those who have the smallest need for the service, while those who see the greatest need are those who pay
the smallest cost. The unfortunate outcome of this, as discussed above, is that those with the highest levels of income and
wealth are typically the ones who are willing and able to petition government to act in their interest, while those who rely on
the public provision of these goods and service are typically unable to effectively devote the time needed to lobby their local
government for improvement of these services. The result of this is the typical annual pressure for reduced property taxes and
reduced municipal services.
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Grants
Grants are common from senior to junior levels of government to either assist the junior levels of government with
expenditures which they do not have the capacity to finance through their own revenue sources or, more insidiously, to
impose policies onto the junior levels through the use of conditional grants.

Both the federal and provincial levels of government provide grants to municipalities the primary grant as seen is the
GILT or Grant in Lieu of Taxes. However other conditional and unconditional or block-grants also exist to provide financing to
local government.

User Charges & non-tax sources

Revenues from sources other than property taxes and grants are the next biggest component of local revenue. For
some local governments, this can actually compose a large portion of their revenue, especially for certain projects or
departments.

User charges or special assessments are often utilized in cases where the direct beneficiary of the good or service can
be readily identified. In this case, only those who benefit are charged (have to pay) rather than the entire tax base.

Examples of this may include garbage/recycling pick up, sewage or additional user fees such as access to recreation
centers and pools, public golf courses or even access to other publicly owned properties such as the Victoria Conference
Center. Parking fees also would fall into this category.

While certain groups may be readily identifiable (like users of recreation centers) a decision around vertical equity still
needs to be made based on social views around equitable access. An example of this is the Canadian health care system.
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While the beneficiary of health care is easily identifiable and easy to charge for them to accesss the service, we as a society
have decided that equitable access to health care is more important than efficiency of service which would come through
charging individuals for treatment. An important recognition is that user fees by definition would be a regressive form of
taxation. If it costs $200 to see a doctor, that $200 is a higher proportion of income for someone on the lower end of the
income spectrum than it is for someone at the top, the same holds true in charging user fees for garbage, access to recreation,
or any user fee that we may charge. The policy maker needs to interpret the priority of society, charging user fees allows for a
more efficient provision of the resource, while subsidizing these user fees, or paying for them entirely through general
taxation provides far more equitable access and creates a more progressive system, although likely allocatively inefficient.

Often a municipality will own certain real estate, whether this be residential or commercial, the municipality can earn
revenue from the renting or leasing of this office space.

A large source of funds for many municipalities in providing capital upgrades is obtained through Development Cost
Charges (DCCs) and Amenity Cost Charges (ACC). The DCC and ACC is a charge levied to developers to pay for capital upgrades
that are required due to the development and increased population, for example to upgrade sewers, storm drains, update
traffic patterns or install sidewalks and parks.

Both DCCs and ACCs are a user fee charged to developers, and ultimately passed along to the final purchaser of the new
home. These two fees however have different roles and purposes.

DCCs are highly regulated with municipalities needing to identify specific projects in advance and obtain approval to
collect money through DCCs to fund these projects from the province.
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ACCs are relatively new and introduced in 2023 under bill 46 to provide to municipalities another form of revenue to
replace the collection of general amenity fees which is expected to significantly drop due to changes the Provincial
government made to the development process outlined in bill 44.

General amenity fees are a revenue source that was often criticized due to its inconsistent application and lack of
oversight. For example, the Township of Esquimalt had a history of not collecting amenity fees, while the City of Vancouver
and many municipalities would negotiate these on a development by development basis leaving a lot of cost uncertainty for
developers looking to build. The City of Langford had a long-established amenity fee program that set a fixed rate which
promoted developer certainty, however these funds were primarily utilized to subsidize property taxes rather than provide
new infrastructure, essentially development subsidized existing residents while not providing the services needed for a
growing community.

ACCs are intended to move closer to the Langford model of having a clear set policy around the collection of these fees to
ensure cost certainty for developers looking to do business. However, the ACC program also enacts several restrictions as to
what these funds can be utilized for. Specifically that these funds need to be used for community improvements and not to be
used to subsidize operational costs, that is not to be used to subsidize property taxes.

While some of these user-fees end up flowing into the general municipal revenue, others form part of self-liquidating
funds specifically set up to provide a certain service such as DCCs, ACCs and utilities such as sewer, garbage, water, etc.
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Non-tax sources are similar to user fees in that a business or individual is charged, however in these cases the benefit to
the individual is less clear. For example, in applying for building permits, dog licenses, business permits, etc. these
requirements are more regulatory than beneficial.

Additional sources of non-tax revenue are fines and penalties levied. These range from parking and other bylaw
penalties to tickets issued by local police forces for traffic and other infractions. Most municipalities in the province are
policed by the RCMP. After many years of petitioning through the Union of BC Municipalities (UBCM), in 1999 municipalities
were provided fractional payment of all fines collected by the RCMP in their jurisdiction.

Finally, non-tax sources can also include interest income (although few municipalities have significant idle financial
capital to earn such income) as well as gaming revenue. In the last few years, jurisdictions are eligible to receive 10% of
revenue generated by community casinos and just over 16% of revenues generated by destination casinos; hence the increase
in local discussions around whether or not to allow casinos to be built within their jurisdiction.

Debt financing
As with higher levels of government, local governments often need to utilize borrowed funds to finance projects which
cannot be funded through current resources. As with most provinces, the authority to borrow rests with the province, and the
municipalities (or regions) need to obtain approval from the Ministry of Municipal Affairs and Housing. approval is subject to
many conditions as laid out in the community charter, importantly that municipal aggregate debt is subject to a maximum
aggregate amount.
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Local borrowing can simply be broken into two categories, long term and short-term borrowing.

Long term
Long term debt is primarily used to finance large infrastructure projects in which there are insufficient revenue to fund
in the present period. Examples being new roads, recreation centers, fire stations, police and more. In terms of restrictions
placed on long-term debt, the term of the debt cannot exceed the lesser of either 30 years or the expected life span of the
asset to be debt financed.

The issuance and administration of long-term debt is taken care of by the Municipal Finance Authority (MFA). The MFA,
a provincial authority, is able to obtain more favourable borrowing terms for local governments compared to local
governments attempting to raise these funds on their own. The MFA is funded jointly through property taxes and a small levy
placed on the interest rate charged for all borrowed funds. Finally, the MFA also provides access to money market
instruments for local governments to save surpluses – if applicable.

Short term
Short term debt is often utilized for one of two reasons. First, to provide bridge financing until taxes or other large
revenue sources are received. Often cash flows are not synchronized, the time in which expenses need to be paid may not line
up with when revenues are received. While the municipality has the revenue needed to pay its expenses over the course of a
year, it may be strapped for cash at certain times due to these revenue sources not yet being processed.

Secondly, short-term debt can be used as an interim measure until long term borrowing can be finalized. Depending on
the project and the financial needs of the municipality, it can take a significant amount of time to structure the debt and find
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willing buyers of the debt to finance large projects. Rather than wait, short-term financing can be utilized to start a project
until long-term financing is available.

Reserves & other contributions.

Surplus reserves and other contributions are typically mandated to be held in specific accounts with specified purposes
for the funds. Some examples being:

Capital works reserves, perhaps the most important reserve, are funds held for the provision of infrastructure
replacement and extension such as roads, sewer, drainage and water systems. These reserves are also set up to provide funds
for recreation centers, libraries and other public buildings and works.

Special purpose reserves may be established for any purpose set by council, some examples include reserves for the
provision of affordable housing, land sale and provision, heritage conservation, and neighborhood improvement.

Development Cost Charge: development cost charges (DCC) are collected by developers to allow for the re-zoning and
development of land within the municipality. These DCC’s are then used to finance specific projects, such as the provision of
parks, parking, water, sewer, drainage, etc. A separate DCC fund and charge must be created for each specified purpose, these
funds are then held in reserve till sufficient funds have been collected to complete the project.

Amenity Cost Charge: Amenity cost charges (ACC) as discussed above allow municipalities the ability to collect funds to
finance specific projects that are of community benefit but not able to be collected under the existing DCC program. ACC’s are
more flexible than the DCC program, not needing provincial approval, but far more restrictive than the existing general
amenity fund that had very few restrictions or oversight.
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There are other contributions to local revenues, examples include items such as developer contributions and donations.
Developers are often required to make contributions of parkland, or cash in lieu as a condition of subdividing property. Often
there are individuals or businesses who will make donations to the local government intended to fund certain services or
support certain functions or activities such as libraries, culture and arts, or parkland. Donations made for a specific purpose
must be held in a separate account for that purpose.

Other Local Governments

Finally, revenue can also come from other local governments. For example, in the South Island there are 13
municipalities that together make up the Capital Regional District (CRD). In order to provide consistent services to all residents
of the South Island regardless of their municipality, the CRD oversees many aspects of governance for the region. In this
respect, certain funds flow from the individual municipalities to the CRD and back.

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6.0 Major Government Programs
In this section we will evaluate four major categories of government expenditures on programs and services. Additionally,
we will strive to describe the legislative authority for these major programs, their funding sources and the benefits they
provide to society.

As these programs span many levels of government, with transfers and grants coming from the federal government to
assist provinces and local governments in their ability to provide such services, we find that the following four categories
account for approximately 81% of provincial expenses.

1. Social Assistance (11% of 2021 budget)

2. Health Care (42% of 2021 budget)
3. Education (26% of 2021 budget)
4. Protection of persons and property (3% of 2021 budget)

The size and prominence of these categories in the Canadian system point strongly to our social bias for a social
democratic government that has dominated Canadian politics in recent history – this despite a recent move to the right by
many provinces, as well as 2006 election of the Conservative Party of Canada to a minority government.

As mentioned, the provision of these categories often spans across several levels of government, as a result the focus of
this section will be on the Government of Canada down to the provincial and local aspect as it relates to British Columbia.
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Social assistance
Social assistance is the responsibility of the provincial and territorial governments. Most provinces offer an array of
programs in the realm of social assistance including, payments to assist the disabled, and poor, subsidized housing, childcare
and healthcare, as well as child, family, senior and indigenous support and mental health services.

While a responsibility of provincial and territorial government, they receive substantial support from the federal
government in the provision of these programs through a block transfer known as the Canada Social Transfer (CST). The CST is
a block transfer intended to provide financial support for the provision of “post-secondary education, social assistance and
social services, and early childhood development and early learning and childcare.”

The CST is computed on a per-capita basis and has been utilized to support the provinces since April 1st, 2004.
Previously the Federal Government had provided this support through the Canada Health and Social Transfer (CHST), which
was similarly a block transfer meant to provide support for both health care and social services, the CHST was repealed
creating two new transfers, the CST and the Canada Health Transfer (CHT) to allow for more transparency. During the 2021-22
fiscal year, BC is set to receive $5,874 million through the CHT and $2,108 million through the CST19.

Social Assistance in BC is provided through a number of ministries, mainly the BC Ministry of Social Development and
Poverty Reduction and the Ministry of Children and Family Development.

19
https://www.canada.ca/en/department-finance/programs/federal-transfers/major-federal-transfers.html#BritishColumbia
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While the former provides services along the lines of income assistance, job and employment training as well as
emergency social and community support, the latter provides services primarily concerned with the health and well being of
families and children including child protection, development, mental health as well as adoption and foster care.

In addition to these two ministries, BC Housing, a crown corporation administers subsidized housing within the province
and The Ministry of Indigenous Relations and Reconciliation provides support and services for indigenous peoples.

While social assistance is primarily a responsibility of the provinces and territories, there are programs delivered by the
federal government. The main programs delivered at the federal level are employment insurance and public pensions.

The BC Ministry of Social Development and Poverty Reduction service plan can be found here.

Employment Insurance.

Employment insurance, or EI, is delivered by the federal government with funds coming from federal general revenue.
The program is administered by Employment and Social Development Canada (ESDC). Canadian EI benefits include regular,
maternity, parental, sickness, fishing, and compassionate care benefits.

Regular EI benefits are available to individuals who become unemployed due to no fault of their own and are available
and willing to work. Individuals who quit are typically not entitled to benefits. Claimants must be unemployed for at least 7
days and have worked the required number of insurable hours within the last year (52 weeks).

Regular benefits are paid at a rate of 55% of one’s average insurable earnings, up to a maximum. Claimants from low
income households may be entitled to an additional benefit known as the Family supplement. Depending on the number of
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insured hours worked, and regional unemployment rate, EI benefits are payable for 14 to 45 weeks. These benefits are
taxable.

EI and frictional unemployment: there are always stories of those individuals who abuse or ‘play’ the system. This kind
of misuse is typically a small minority of all cases. Typically, most people want to work. The argument gets raised that
generous EI (or other welfare benefits) restrict the labour force and make it more difficult to find labour. While this is true to a
degree, economists would say that these kinds of benefits end up increasing the frictional rate of unemployment.

The frictional rate of unemployment is a component of the unemployment rate that is due to the search problem
associated with finding employment. Suppose for a second that you were unemployed and somewhere out there, there is
your dream job that you are the perfect fit for. At the same time, the hiring manager is looking for a person with your exact
qualifications. The problem is, we live in a world of imperfect information, and it takes time for you to find and vet the
employer, and similarly for the employer to sift through applications and find you. During all this time, you remain
unemployed.

If welfare is limited or non-existent, you (being unemployed) will spend less time searching for the best job for you, and
will be more willing to take any job available – irrespective if you will be a good fit given your skills. On the flip side, if welfare
is expansive and generous, you (being unemployed) will be willing to spend more time searching for the best job for you. In
this latter case you are able to find a job that is a better fit for your skill set allowing you to have greater enjoyment in your
work and to be more productive. Given your increased productivity, this provides a lower cost to the employer, which
together with your own gains increases societies benefit and output all together.
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In this sense, assistance (welfare) payments like EI need to strike a balance between providing enough benefit to allow
individuals the freedom to be choosy in which jobs they accept, while not being so generous to encourage misuse of the
system by a minority.

Maternity/Paternity leave

In Canada, through the EI framework a person is entitled to financial assistance after giving birth or adopting a new
child. These benefits become available before birth if the mother needs to leave work while pregnant.

Standard maternity benefits (to the person giving birth) is up to 15 weeks at a rate of 55% of insurable earnings, given
that eligible number of hours had been worked in the last 52 weeks.

Following standard maternity benefits, the individual (or couple) then move to either standard or extended paternity
leave. Under standard paternity leave either parent can apply for up to 40 weeks of coverage at up to 55% of insurable
earnings, but no one parent can receive more than 35 weeks of this benefit. Alternatively, under extended benefits either (or
both) can apply for up to 69 weeks of coverage at up to 33% of insurable earnings, but no one parent can receive more than
61 weeks of benefit20.

20
https://www.canada.ca/en/services/benefits/ei/ei-maternity-parental.html
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Sickness Benefits

If you are sick or needing to quarantine and cannot attend work as a result, You may be entitled to up to 15 weeks of
benefit at 55% of insurable earnings. Medical reasons for leave include injury, sickness, quarantine, or any medical condition
that prevents you from working.

Other Benefits

Beyond regular, maternal/paternal, and sickness benefits, EI also has programs to support fishers, self employed and
those who need to miss work due to caregiving responsibilities. All of these benefits are payable at a percentage of insurable
earnings for a given amount of time given that the claimant has worked the required number of hours in the last 52 weeks21.

Public Pensions

Until 1952, public pensions were provided by the provincial government, post 1952 the federal government adopted
the old age security act which is composed of three parts, the Old Age Security (OAS), the Canadian Pension Plan (CPP) and the
Quebec Pension Plan (QPP) as well as tax assisted savings.

Old age security (OAS) is a federal program administered by Employment and Social Development Canada (ESDC).
Employment history and current working status are not factors in determining eligibility. Eligibility is determined based on
number of years spent within Canada since the age of 18. Partial payments are available to citizens or legal residents who
have lived in Canada for at least 10 years since the age of 18. Full payments are available to citizens or legal residents who

21
https://www.canada.ca/en/services/benefits/ei.html
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have lived in Canada for at least 40 years since the age of 18. OAS benefits are taxable with high income earners potentially
repaying the entire benefit.

The Guaranteed Income Supplement (GIS), was introduced in 1967, as an indexed, non-taxable monthly payment paid
to recipients of OAS who have little if any additional sources of income. For married or common-law applicants, the combined
income of both partners must be considered.

The CPP (Or QPP in Quebec) was introduced in 1966 and provides indexed taxable pensions to CPP (QPP) contributors
upon reaching age 60 or unable to work because of disability, or to survivors of contributors. Pensions are earnings related (up
to a maximum) and are funded by compulsory contributions made jointly by employees and employers off of each pay-
cheque. Self-employed individuals pay both the employee and employer contribution amounts. The full CPP pension is
payable to individuals upon reaching the age of 65 and is equivalent to 25 percent of the average of yearly pensionable
earnings for the previous five years

Tax assisted savings allow Canadians to deduct retirement savings invested under a Registered Retirement Savings Plan
(RRSP) or Registered Pension Plan (RPP) from their current period income tax. These savings are then taxed later when the
retiree withdraws these funds as income. RRSP contributions can be made until Dec 31st of the year in which the contributor
turns 71, after this time the RRSP must be either withdrawn, converted to a Registered Income Fund (RIF), used to purchase a
fixed-term or life annuity.

Withdrawals from RRSPs are taxable, while only the income payments from RIFs and annuities are taxable.
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Health care
Health care is a provincial responsibility, although as seen in BC, healthcare services account for over 42% of all
provincial expenditures. without federal support it would be exceedingly difficult for each province to offer equivalent levels
of care.

While BCs budgeted spending on health care services totaled over $18 billion in the 2020/21 tax year, BC received block
transfers from the federal government through the Canadian Health Transfer (CHT) for just over $5 billion, or just over a
quarter of the cost. Beyond the CHT, the federal government also provides many health grants to the provinces for purposed
use of funds such as for the acquiring of new medical diagnostic and imaging equipment.

Healthcare in BC is the responsibility of the Ministry of Health which has, in turn, assigned the responsibility of
comprehensive delivery of healthcare to five regional authorities:

- Fraser Health Authority

- Interior Health Authority
- Northern Health Authority
- Vancouver Coastal Health Authority
- Vancouver Island Health Authority

The regional health authorities provide a full range of health care programs and services that include:

- community hospitals and referral hospitals

- rehabilitation services
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- residential care and home care
- public health and preventive health services
- mental health services
- environmental health services

Beyond the regional health authorities, certain healthcare activities are coordinated at the provincial level. This is done by
the Provincial Health Services Authority (PHSA) which is a central agency responsible for delivering provincial programs, such
as dialysis, and coordinating the delivery of highly specialized and resource-intensive services such as heart surgery, severe
burns treatment, emergency ambulance services, and transplants.

The Ministry of Health is responsible for overseeing these health authorities, determining funding needs, and setting and
assessing performance of each. In addition, the Ministry of Health administers the Medical Services Plan (MSP) that provides
funding for basic healthcare to all British Columbians. Historically MSP premiums were paid monthly by all residents before
being moved to being paid partially by employers.

The BC Ministry of health service plan can be found here

Education
Education is, again, the responsibility of provincial governments. Provinces and territories do receive transfers from the
federal government to assist in the provision of education. However, unlike healthcare which receives a specific CHT,
education, specifically post-secondary education receives further federal assistance through the previously discussed CST
Canada Social Transfer.
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In 2020/21 the government of BC received just over $2 billion through the CST, however these funds are designated for
both educational uses as well as the provision of social services.

The delivery of educational services in BC is split between two ministries, The Ministry of Education, providing
education up to the secondary level (K-12) and the Ministry of Advanced Education and Skills Training overseeing education at
the post-secondary level.

Budgeted expenditures for Education in the 2020/21 fiscal year are just over $10 billion, split between elementary,
secondary education and post-secondary education with the former accounting for slightly over half.

The BC Ministry of Education service plan can be found here, while the Ministry of Advanced Education service plan can
be found here.

Protection of persons and property

The protection of persons and property and administration of justice is, again, primarily the jurisdiction of the provincial
governments. Still, the Constitution Act, does give the federal government the responsibility for criminal law and procedure.
Accordingly, the Criminal code is established by federal parliament as supported by the Department of Justice.

The federal government also has a law enforcement arm, the Royal Canadian Mounted Police (RCMP). The operational
mandate of the RCMP includes national policing as well as contract policing for the provinces (except Ontario and Quebec).

National policing services include, border integrity, drugs and organized crime, financial crime, international policing
support and protective services for public figures. Additionally, the RCMP also provides a centralized criminal intelligence
service and technical support for its own, and other Canadian police forces.
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Provincially, in BC, the administration of justice and the protection of persons and property falls on two ministries:

1. The Attorney General

2. Solicitor General and Ministry of Public Safety

The Attorney General has the mandate for the administration of justice including court services, and administration of the
Provincial Court, Court of Appeal, and Supreme Court. Additionally, the Attorney General’s mandate includes prosecution
under the Criminal Code of Canada and justice services including civil and family law as well as law reform and legal aid.

Finally, the Attorney General provides legal services to the provincial government.

The Solicitor-General and Minister for Public Safety has the provincial responsibility for the protection of persons and
property. The mandate includes responsibility in the following areas:

- Law enforcement and crime prevention

- Corrections and custody
- Victims’ services
- Gaming regulation
- Liquor control and licensing
- Consumer protection
- Driver and vehicle licensing
- Emergency response and recovery
- BC Coroners Service
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- Office of the Fire Commissioner

In BC, the provincial law enforcement agency is the RCMP, as contracted from the federal government. Most
municipalities within the province have their own police forces, often contracted from the provincial RCMP detachment, while
other municipalities have decided to train, fund and operate their own police forces under the guidance and control of a
municipal police board as mandated by the province.

The protection of persons and property extend beyond policing and also include fire suppression and preventive services
which are generally funded and provided at the municipal level. As a result, both police and fire services often account for a
large portion of municipal budgets. For example, police and fire account for about 27% of the city of Victoria’s budget.

The BC Ministry of Public Safety & Solicitor General Service Plan can be found here. The Attorney General Service Plan can
be found here.

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Appendix: Inequality, income redistribution and other current issues in public finance
“… In a state which is desirous of being saved from the greatest of all plagues-not faction, but rather distraction; -
here should exist among the citizens neither extreme poverty, nor, again, excess of wealth, for both are productive
of both these evils. Now the legislator should determine what is to be the limit of poverty or wealth…”22

This section is still under development – the aim is to include this section in the future as an appendix, or additional
resource covering the growing concerns around inequality and income re-distribution.

Lorenz Curve:

A Lorenz curve is a graph that intends to show the relationship between the population percentile and the income
percentile. For example, in an equal society, the bottom 50% of the population (income wise) would earn 50% of the society’s
income – the 90th percentile of population would earn 90% of the income and so on and so on, this is represented by the 45-
degree dashed line in the image A-1 below. In reality, the true income distribution is far from equal, and to a degree as society
we have narratives that justify a degree of inequality. that is to say, a degree of inequality in itself is not in itself an evil, but as
alluded to in the quote above, it is a gross level of inequality that may become problematic for a society, while similarly being
up to society to define what is an acceptable and unacceptable level of inequality.

Below – in A-1 – is the Lorenz curve for Canada in 1950 and again in 2021, the further the Lorenz curve bends down to the
right the greater the inequality. Reading the Lorenz curve, we can see that in 1950, the bottom 50% of the population earned

22
Plato’s Laws, Book V (360 BCE)
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A-1

About 18% of the nation’s income, while the 90th percentile of the population earned about 65% of the nation’s income (this
means that the top 10% of the population earned about 45% of the nation’s income).

Fast forward to the present period that data is available for (2021) and we find that the 50th percentile of the population
now earns only 15% of the income, while the 90th percentile of the population is now earning about 60% of the nation’s
income – in this sense, everyone, but the top 1%, have seen a real decrease in share of income since 195023.

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23
An animated Lorenz Curve showing the income distribution for each year from 1950-2021 can be found on my blog here.