Cities in Crisis Need Urgent Federal Support

The fifth in a series of articles for Policy by Master’s students at the Max Bell School of Public Policy, McGill University.

Paisley Sim

June 19, 2020

The phrase “a crisis is a terrible thing to waste” is more relevant than ever. Often attributed to Rahm Emmanuel, the phrase was actually coined in 2004 by Nobel Prize-winning economist Paul Romer. At the time, Romer was suggesting that the global rise in education levels meant stiffer competition for Americans. We can only wish our current crisis was so simple.

The unfolding economic and public health crisis caused by COVID-19 has revealed cracks in healthcare while underscoring the challenges of decentralized fiscal federalism. Healthcare is a provincial responsibility, and municipalities, also constitutional children of the provinces, are the economic engines of our economy. Facing increased service delivery pressures and a steep decline in revenues, the pandemic now has municipalities staring out into a financial abyss.

Despite managing some 60 percent of public infrastructure, cities receive only 10 cents of every tax dollar. The Federation of Canadian Municipalities (FCM) estimates that over the next six months, cities’ operating budgets will lose between $10 billion and $15 billion. The long-term magnitude of this hit depends on the duration of shutdowns and actions taken (or not taken) at other government levels.

Municipalities receive 48 percent of their funding from property taxes, 22 percent from user fees such as transit fares and licenses, and 19 percent from provincial and federal transfers. Cities do not have the same revenue-raising capacity as other government levels and are not permitted to run deficits. Reliance on residential property taxes pegged to property valuations is unpredictable and regressive source revenue. The shift to working from home has the potential to erode non-residential property taxes.

Transit ridership has dropped steeply. In April, Montreal metro usage was down 91 percent, Toronto’s TTC saw an 80 percent decline, Vancouver ridership also decreased by 80 percent, and Calgary lost 90 percent. The Canadian Urban Transit Association estimates monthly losses of $400 million in transit fares alone. Fares are only gradually rebounding but are unlikely to return to pre-pandemic levels before a vaccine is available. It is a misconception that municipal finances will be restored with the gradual re-opening of the economy. The pandemic has changed the way we navigate communities, and cities face growing costs associated with skyrocketing public space use, public safety, and physical geography changes.

As creations of the provinces, cities suffer from the federal government’s reliance on outdated ideas of constitutional deference. Local governments disproportionately shoulder national priorities, but funding rarely flows directly from the federal level. To spur recovery, vertical fiscal pressures must be acknowledged and reconciled by expanding local fiscal capacity.

Representing some 2000 municipalities and over 90 percent of Canadians, the FCM successfully advocated for increased federal funding to address municipal operating budget gaps. On June 2, Prime Minister Trudeau announced that $2.2 billion of funding from the Gas Tax Fund (GTF) would be expedited to over 3600 municipalities nationwide.

Introduced in 2005, the GTF adds 10 cents per litre of gasoline. The federal carbon tax adds 6.6 cents per litre. The GTF is a twice-yearly predictable and permanent source of infrastructure funding to municipalities. It is flexible and governed by funding agreements backed by accountability frameworks. Arrangements are either directly with municipalities or municipal associations. Flowing funds through a representative body can expand public oversight, access to information, and funding transparency. The recent $2.2 billion transfer was already ear-marked for municipalities and is merely expedited to help alleviate the sudden economic pain. Speeding up the transfer is helpful, but more needs to be done. In 2018-19 the federal government provided a one-time doubling of the GTF. This doubling should be made permanent and include a 2 percent to 3.5 percent annual escalator based on a municipality’s size.

Cities are the frontline of this crisis. Increased discretionary funding, flowing directly from the federal government with accountability mechanisms, has the potential to spur development and combat the economic shock of a predicted second COVID wave. Increasing the GTF is an established, scalable measure to support cities operating at the frontlines.

The federal government may enviously eye provinces debt-to-GDP ratios and hesitate to support cities directly. But the scale of our current crisis calls for immediate action from all levels. With their ability to carry debt, provinces must invest in municipal economic development on equal footing with the federal government.

COVID-19 has challenged our service-based economy and profoundly disrupted the future of work. Paul Romer’s endogenous growth theory holds that long-run growth is primarily due to policies that invest in human capital, innovation, and knowledge. By prioritizing investment at the local level, where needs and economic opportunity are better understood, the federal government can induce innovative recovery and build financial resilience.

As the curve gradually flattens and communities re-open, municipal leaders’ decisions are arguably more consequential than their provincial or federal counterparts. By increasing the GTF, our new normal can address fiscal imbalances and invest in drivers of growth that address national priorities like action on climate change. The federal government must support cities as they prepare for a second pandemic wave. If the federal government doesn’t invest in cities, this crisis will have gone to waste.

Paisley Sim is a Masters Student at the Max Bell School of Public Policy at McGill University. She will be joining the Institute for Research on Public Policy’s newly-launched Centre of Excellence on the Canadian Federation as a Policy Scholar in the fall.