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Studies on the Canadian Constitution and Canadian Federalism


Last revised:
19 February 2001

Canadian federalism, the Tax Rental Agreements of the period of 1941-1962 and fiscal federalism from 1962 to 1977

Claude Bélanger,
Department of History,
Marianopolis College

Simply stated, the Tax Rental Agreements were a system by which the provincial governments accepted to "rent", to give up, to the federal government the three standard direct taxes (personal and corporate income taxes and succession duties) for a limited period of time, in return for payment to each province of certain fixed sums of money. The method to be used was reminiscent of the one suggested by the Rowell-Sirois Commission.

The occasion for the introduction of the Tax Renting System was the Second World War, when it became necessary for the federal government to raise such a high level of taxes for the conduct of the war. Had an agreement not been reached, it is likely that the war effort would have been impeded and that provinces would have found themselves incapable of supporting fully provincial services. However, it would be difficult to consider that the war alone created such tax renting agreements: the war merely precipitated an action that many in the poorer provinces, had been demanding for a period of time.

The true source of the Tax Renting Agreements is to be found, on the one end, in the imbalance which developed in the period of 1920 to 1940 between the expenditures of provinces and their capacity to levy taxes locally to meet such expenditures; on the other end, the problem was magnified in some provinces, because of their relative poverty and their inability to provide to their citizens services equivalent to those offered by the richer provinces. Ultimately, the poorer provinces could only offer such services by imposing larger than average taxes on their citizens, thus lowering even further the standard of living of their local population. It became socially unacceptable to Canadians, especially in English-speaking Canada, that some citizens in the country, because they were born in a poorer region, accept lower services than their counterparts in richer areas. It was apparent that the more fortunate provinces would have to contribute financially to the support of the have-not provinces. The role of the federal government would have to be that of a funnel through which financial resources would be redistributed across the country. This new ethic of canadianism was doubly justified because many Canadians came to the realization that they had not shared equally in the prosperity that Confederation was supposed to bring to all.

Prior to the 1930's, provinces had often complained and managed to extract some concessions from the federal government but always on the grounds that some promise at Confederation had not been fulfilled or that the terms of the union had not been equitable enough. What developed, in the 1930's, was an entirely different kind of argument. The new position was well summarized by Norman McL. Rogers, before the Nova Scotia Economic Inquiry in 1934: "It is urged that Nova Scotia is entitled to relief and compensation, not merely in pursuance of the assurances given on the occasion of its entrance into the Canadian federation, but also on the broad equitable ground that a federation defeats its primary purpose, if through its constitutional arrangements or through policies instituted by the national government it accomplishes the gradual debilitation of one or more of the provincial communities of which it is composed."

Thus, it was felt in the poorer provinces that federal action was necessary: the more taxes would be centralized in the hands of the federal government, the more that level of government would be capable of helping financially the weaker provinces. Hence, the suggestion of the Rowell-Sirois Commission for the provinces to turn over their main direct taxes in return for National Adjustment Grants to be allocated to the less fortunate provinces. Some of the provinces had rejected such a system because it undermined provincial autonomy. The war rendered possible what even the Great Depression had not achieved: the system of tax rental was thus introduced, for the first time, in 1941.

1) Wartime Tax Rental Agreement (1941-1947)

Under the Wartime Tax Rental Agreement, the provinces withdrew from levying corporate and personal income taxes and succession duties in return for annual rental payments. The provinces had the choice between two possibilities:

a) the revenue tax yield within the province in 1941 from the vacated tax fields, or

b) the net cost of servicing the provincial debt for the fiscal year 1940-41, less succession duties collected for that year.

Saskatchewan and the Maritimes chose the second alternative while the other provinces elected to take the first one. These arrangements were to be temporary, for the duration of the war, and extend one year after the cessation of the hostilities. The taxes were thus made uniform and the population of two provinces (N.B. and N.S.) paid income taxes for the first time.

2) Tax Rental Agreement of 1947-1952

At the end of the war, it became obvious that the federal government was anxious to maintain control over the important tax fields to combat the expected depression after the war; at the Reconstruction Conference, the federal government proposed that the provinces abandon permanently the direct taxes rented; that proposition was eventually shelved, because of the opposition of some provinces, but Ottawa worked out a new proposal which it presented to the provinces in 1947.

As A. Maxwell wrote in 1948:

No great perspicacy was required (...) to fore see that the forces that made for Federal occupancy during the war would not be spent after the war, that tax payers might wish to retain the luxury of one law and one return, and that those provincial governments which received more by way of subsidies than from provincial collection might prefer to continue the agreements.

Under the agreement in 1947, the provinces would refrain from imposing the usual taxes in return for rental payments. They could levy a corporation tax of 5% collected by Ottawa that would be part of the federal rental payment. The provinces could chose from two options:

a) $12.75 per capita based on the 1942 population of the province; plus 50%of the revenue received by the province from personal and corporation income taxes in the 1940-41 fiscal year; plus statutory subsidies.

b) $15.00 per capita based on the 1947 population of the province; plus statutory subsidies.

Special considerations were extended to P.E.I. which was offered $2,100 000. Option A was selected by New Brunswick, Manitoba, Alberta and British Columbia; option B was chosen by Nova Scotia and Saskatchewan. Two provinces (Ontario and Quebec) expressed the wish to not enter into new agreements. For them the federal government vacated a certain portion of the direct tax field that the two provinces could then occupy. The federal government withdrew by 5% of the personal and corporate income taxes and by 50% of succession duties. Both provinces introduced a 7% tax on corporations but did not use the personal income tax cut. These arrangements were far from equaling those that the other provinces had received; both provinces were penalized for sticking to strict federalism, to provincial autonomy. It has been estimated that Quebec lost $300 000 000 during this period (based on an average yearly distribution the budget of the province of Quebec would have been increased by 31% in 1948 and by 22% in 1952 had the province accepted the rental agreements).

3) Tax Rental Agreement 1952-1957

In return for the rental of the usual taxes, the provinces could choose one of the following alternatives:

a) a 50% increase in the 1947 per capita grant, under a formula based on the increase in the population and gross national product between 1942 and 1948; plus statutory subsidies.

b) 5% of the federal personal income tax yield in the province in 1948; plus

the yield of a tax of 82% on corporation profits in the province in 1948; plus

statutory subsidies.

All the English-speaking provinces signed, including Ontario, and Quebec found itself alone in the fight for the autonomy of the provinces. The federal government granted to Quebec a 7% abatement on corporation taxes and 5% on personal income tax. However, in 1954, Maurice Duplessis introduced a provincial income tax scheme equal to 15% of the federal rate to which Ottawa responded by a l0% abatement. The Prime Minister of Canada, Louis St-Laurent, declared that the federal government would not yield any further abatements. Thus, the people of Quebec were threatened by double taxation because of federal initial inflexibility. The population of Quebec obviously supported its provincial government and, eventually, the federal government granted the full abatement. Despite these arrangements, the province was again heavily penalized as can be gathered in the following statistics:

Per capita payments to the provinces under the 1952-57 tax scheme

Canada less Quebec$30.50$32.50$34.00
Quebec (abatements)$27.76$29.90$31.06


4) Tax Rental Agreement of 1957-1962

The same rental system was continued except that the compensation took the form of a percentage of the revenues collected from the rented taxes. Quebec continued to be the only province collecting its own taxes fully. The provinces received only one option: 10% of personal income taxes collected in the province; 9% of corporation profits and 50% of succession duties collected in the province. Since that system disadvantaged the poorer provinces because their tax yield, on an equal percentage, was not as great as that of the wealthier provinces, the federal government introduced the equalization payments (unconditional grants) which were equal to the amount necessary to bring the level of the per capita yield of the three standard taxes in each province to the average yield in the provinces of Ontario and British Columbia. Under this system, Quebec was not penalized for the first time since the introduction of the Tax Rental system, as it received equalization payments from the federal government.

5) The system since 1962 to 1977

The tax renting system was drastically altered in 1962 to take roughly a form that it was to keep until 1977 when block funding was introduced. Provinces did not have to rent their three standard taxes anymore. Rather, a system of tax abatement was instituted: the federal government would not collect 100 of the three standard taxes but would leave some taxing room so provinces could raise their own taxes. The taxing room vacated by the federal government was originally: 16% of personal income tax to be increased by 1% per year; 9% of corporation profits; and 50% of succession duties. These abatements have been continuously raised since to meet rising provincial expenditures. Provinces could collect such taxes themselves or have the federal government collect them; if the latter was chosen, the federal government shoulders the cost of collecting the taxes and returns to the provinces their share of the collected taxes. Provinces are also free to impose a higher level of taxes than those stipulated. Quebec continued to collect all of its taxes and to impose a higher level of taxes than the abatement given. Ontario collected its own succession duties and corporation taxes; all of the other provinces have left the collection of their taxes in the hands of the federal government.

The period of the early 1960's also witnessed the multiplication of shared-cost programs and the working out of the opting-out formula. Under this formula which Quebec was the only province to fully use, extra abatements, equivalent to the federal contribution in the other provinces, are also given. In 1966, the equalization formula was revised to take into account a whole range of provincial revenues. In the late 1960's, such equalization payments were equivalent to 50% of the revenues of certain provinces. This proportion has tended to decrease since. In 1972, the tax abatements granted to the provinces were as follows (Quebec's share is indicated separately as it includes abatements resulting from the opting-out formula):

Tax abatements granted to the provinces (1972)

Personal income tax28%50%
Corporation tax10 20
Succession duties5050

The war and post-war fiscal agreements between the two levels of government have had several advantages. The fiscal policies of the two levels of government were coordinated and a high degree of economic stability was thus achieved; taxes were generally made uniform and, eventually, the revenues of the provincial governments were somewhat equalized; a major depression was averted as a result of the stabilizing policies of the federal government. These stabilizing policies were successful because a large share of the total government revenues was concentrated in the hands of the federal government; citizens in the poorer provinces were assured a standard level of services which they could not have otherwise afforded.

The disadvantages were that the country functioned as if it was, more or less, a unitary system, with many of the provinces relegated to the role of welfare recipients; the tax renting agreements concentrated a large share of total government receipts into the hands of the federal government thus making it impossible for the provinces to help themselves; if a substantial amount of tax decentralization has occurred over a long period of time, we are still far from the tax distribution of the pre-war period. Evidence also points to the fact that the federal share of taxes stopped decreasing since the early 1970's.

Distribution of Governmental Revenues After Transfers Selected years, 1945-1972


The tax renting system led to constant friction with Quebec. The province demanded that its fiscal autonomy be respected. If, on the one end, the war and post-war measures adopted by the federal government have had some impact on minimizing the effects of regional and provincial disparities, on the other end these disparities continued to exist as great as ever. All the usual indicators (personal income, share of gross national product, growth rate, unemployment rate) point to the failure of the system to eradicate the source of these disparities in the period of 1945 to 1977. 1) Federal policies encourage people to stay in poor areas thus contributing to the perpetuation of economic problems in slow growth areas and 2) slow growth areas have become so dependent on the federal government that the real decentralization that Canadians seem to demand cannot be brought about without catastrophic effects on such regions. Ultimately the solution seems to rest in shifting the emphasis from welfare support to economic development. Such a system should help eradicate disparities and restore some of the regions of Canada to their former pride and prosperity.

© 2001 Claude Bélanger, Marianopolis College