So, I found myself spending a few rapt hours yesterday night reading about municipal finances in Canadazzzzzzzzzzzzzzzzz whoops sorry there. Sleep-inducing or not, it's worth pointing out some of the conclusions in light of the whole "Toronto is running out of money" thing that's going on lately.
First of all, the fiscal imbalance (in the sense that the word is usually used) really is dubious. For the last 20 years, Federal and Provincial governments across Canada have, on average, managed to keep their revenues growing at the same rate as expenditures (indeed, in most cases revenues have grown faster than revenues, especially in the last decade.) And as others have pointed out (notably Andrew Coyne) the provinces have the same taxing powers when it comes to the most important revenue pools (personal and corporate income, sales taxes) so there's no reason why, even if provincial expenditures are becoming burdensome, they can't raise revenue in response. Instead, at both the federal and provincial levels, governments have been cutting taxes.
(All authors agree that, despite the serious effect Paul Martin's cuts to transfer payments had on provincial budgets, those effects are dwarfed by the effects of tax cuts made by provincial governments themselves in the 1990s. If the provincial governments find themselves fiscally unbalanced, it's because they shot themselves in their own fiscal foot.)
Nevertheless, provinces have mostly managed to keep revenues growing at the same time as expenditures. They've managed to do this, in most cases, by offloading many expenses on to the municipal level of government (and this is the direct cause of the current predicament Toronto is in.) If the "fiscal imbalance" exists anywhere in Canada, it's unquestionably the relationship between cities and the provincial governments. Over 90% of municipal revenue comes from one tax -- property taxes. Property taxes are a horrendously bad choice to fund the level of government closest to the people -- unlike income and sales taxes, property taxes don't expand proportionally to the economy or to the demands on services. Indeed, when property values climb rapidly in a growing economy, many cities are pressured to cut taxes in order to avoid punishing homeowners. The net effect of this, plus provincial laws mandating very narrow circumstances in which cities can accrue debt, is that cities have had their expenses grow faster than their revenues, the only one of the three levels of Canadian government for which this is generally true.
Worse yet, the cities bear the brunt of a lot of costs they simply cannot control in any sense -- water services being the best example. Ontario dictate the standards to which water services must be kept (a very good thing) but the money comes from cities.
The solution would be simple enough: allow municipalities to levy small income and sales taxes. Not only would the revenue be sufficient to do things like, uh, maintain our roads and plumbing, but the revenue would be more stable and grow proportionally to the economy. There are well-proven techniques in other countries to deal with issues of tax competition between governments, and mobility among taxpayers (trying to escape taxes by moving to another jurisdiction, for example.) But this will not happen, because Canada apparently lacks the capability for rational self-governance.
The other necessary step would be to make federal loans available for infrastructure -- the Feds have access to cheaper money than anyone else (bonds at lower interest than provinces or P3s) so it's the best deal.