Fiscal Imbalance and Economic Development in Canadian History: Evidence from the Economic History of Ontario

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By examining regional differences in per capita government expenditures and revenues in the province of Ontario between 1871 and 1911, this paper explores a fiscal dimension of the heartland-hinterland relationship. If provincial government expenditures and revenues are allocated on a regional basis between northern and southern Ontario during this period, it is clear that there was a difference in regional net fiscal benefits. That is, there was a regional difference in the per capita value of taxes paid minus government expenditure benefits received. More specifically, the natural resource revenues from the north garnered during the initial settlement and development period (1867-1914) were used to finance government expenditures that on a per capita basis benefited the south more than the north.

That such a difference can have implications for economic development is evident because a difference in net fiscal benefits between regions sometimes leads to out-migration, not because of differences in economic productivity but because of differences in fiscal benefits per capita, or what the fiscal federalism literature has termed the "fiscal residuum" (Buchanan 1950). This migration can affect wage rates and, ultimately, the pattern of economic development throughout the region. The implication is that the fiscal actions of government can introduce incentives for migration as well as economic development apart from those due to productivity, with the result being inefficient resource allocation (Tiebout 1956; Flatters, Henderson and Mieszkowski 1974; Boadway and Flatters 1982). The logical question is whether any difference in regional net fiscal benefits resulted in economic growth and development in northern Ontario being kept at a lower level than it might otherwise have been. That is, was the uneven long-term economic development between northern and southern Ontario partly rooted in the tax and fiscal policies pursued by the Ontario government in the north during the late-nineteenth and early-twentieth centuries?(1)

The negative net fiscal benefits in northern Ontario over the period 1871-1911 do not appear to have hindered northern Ontario's extensive economic growth--that is, growth in total output--at least in the short term. The heartland-hinterland relationship between northern and southern Ontario during this period was still relatively benign in terms of the south's impact on the north's economic growth. The opportunities available to private entrepreneurs in terms of natural resource development, the availability of land grants for agricultural settlers, and the expenditures on railway development by the federal government, all served to mask the adverse effects that negative fiscal benefits can have. Nevertheless, the probability is high that in the absence of these differential net fiscal benefits, the northern economy might have been larger as well as more diversified. Differential net fiscal benefits rooted in a provincial government policy of resource revenue maximization may have resulted in long-term harm to the north's economic development--especially with respect to its manufacturing development--and helped generate the regional disparities that characterize the relationship between north and south today. The balance of this paper provides an estimate of net fiscal benefits per capita for northern and southern Ontario between 1871 and 1911 and provides a discussion of the possible implications for economic development.

Northern Ontario is traditionally defined as the geographic area north of the French River-Lake Nipissing system (see Figure 1), though for the purposes of this paper, Muskoka, Parry Sound, and Nipissing Districts are also included in northern Ontario, as they were considered part of Ontario's northern frontier during the nineteenth century.(2) The period of this study can be described as the "colonial" phase of northern Ontario's development as well as the initial industrialization period of the southern Ontario economy. …