Canada’s Equalization Program

As many of you know, I am spending my research semester as a Visiting Professor in the School of Public Policy, University of Calgary. This allows me better opportunity to attend various SPP events, including the one held today on Current Affairs in Equalization. I can say it was a very well attended event, held in the Alberta Room of the Fairmont Palliser. The event featured Bev Dahbly as framer and moderator and Ted Morton, Tracy Snodden, and Trevor Tombe on the panel.

To get more details on the issue, you can read Trevor Tombe most recent blog post here along with other popular reading here, and here. In January 2014, SPP also held a two day conference on equalization and that is summarized here.  And there are oodles of papers on equalization on the SPP research website (just search equalization). I’ll attempt to summarize the discussion at this panel below.

The panel began with Bev Dahlby framing the problem. Equalization is a very hot topic in Alberta, but as noted at this panel session, the program, its formula, and the payments are not well understood. As noted in the framing for the panel, Canada has oodles of programs that transfer money from the federal government to the provinces, and equalization is but one of these programs.

The basis for the equalization program is 36 of the Constitution Act which reads

  •  (1) Without altering the legislative authority of Parliament or of the provincial legislatures, or the rights of any of them with respect to the exercise of their legislative authority, Parliament and the legislatures, together with the government of Canada and the provincial governments, are committed to

    • (a) promoting equal opportunities for the well-being of Canadians;

    • (b) furthering economic development to reduce disparity in opportunities; and

    • (c) providing essential public services of reasonable quality to all Canadians.

    • (2) Parliament and the government of Canada are committed to the principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation

Canada in not unique in having such an arrangement, but may be unique in terms of the vagueness of the commitment, being aspirational rather than definitive in its commitment. The equalization program was introduced in 1957 and has been tweaked many times since its introduction. It currently transfers about $19B in federal tax revenue to the provinces.

The equalization program works by transferring federal money according to a formula that is intended to equalize fiscal capacity. That is, it tries to address the difference between a particular provinces capacity to raise revenue from taxes compared to the average capacity to raise revenue. Notice this is not about what is actually collected, but rather the capacity. The current formula considers this from the angle of

  • Personal income taxes
  • Corporate income taxes
  • Consumption taxes
  • Property and miscellaneous taxes
  • And includes 50% of resource revenues.

The example that was given to understand the formula was as follows:

  • Say you were interested in calculating the fiscal capacity of consumption taxes in a province
  • Say the average provincial consumption taxes rate is 5%
  • Say the average per capita consumption expenditures subject to tax was $32,000
  • Assume the average per capita consumption expenditures subject to tax in a given province was $30,000
  • Then the per capita transfer for that province would be 5%(32000-30000)=$100

There are concerns with the equalization program. The biggest is the incentive effects. That is, equalization may affect the fiscal decisions in a recipient province. The formula incentivizes these provinces to have a higher corporate tax, and reduced incentive for productivity enhancements and resource development (since a $100 in resources reduces equalization payments by $50) which reduce equalization payments. The next biggest concern seems to be related to how much resources should count in the equalization formula (with views ranging from 0-100%) and whether resource monies put aside into a provincial sovereign wealth fund should count. There are significant concerns about the cap on total payments that was introduced in 2009 to ensure Ontario did not get net equalization payments and its unintended consequences of introducing a price floor. There are concerns that some provinces are keeping their resource revenues low by not charging a market price for their resources (e.g. hydro on Quebec). Finally there are concerns about the model being based solely on fiscal capacity and not taking into account the difference costs provinces face in publicly providing goods and services.

Ted Morten then proceeded with some comments that were driven in response to this recent publication on equalization. The key points seemed to be related to a point above, about how equalization does not account for decisions in the provinces or other factors that affect a provinces capacity. One example he gave was the National Energy policy, which Ted indicated led to a $98B in reduced activity in Alberta and garnered the federal government $100B in additional revenues. The other example Ted gave was the long term economic effects of Quebec sovereignty included their language laws, which reduced economic capacity. Ted also noted the problem with the equalization program in that there is executive discretion which allows the formula and the program to be subject to partisan politics and electoral consideration (e.g. no one wants to get into a fight with Quebec).

Tracy Snodden noted that the formula is set so that not all provinces get money. It is set to the average, and some will be above average and some will be below. It is the nature of the formula. Tracy focused on Ontario, who became a have-not in 2009, but is about ready to shake this qualifier off. Ontario had already had economic difficulties before 2008, but was also heavily affected by the 2008 financial crises. In addition, the resource boom in other provinces raised the baseline fiscal capacity. These two things, poor economic growth and the raised baseline fiscal capacity interacted to lead to Ontario being a have-not province. Ontario’s per capita transfer under the program is small but because it has about 14 million people the total payment appears large. She noted that Ontario was also a have-not province for 1977-1981, but did not get payments then. When Ontario becomes a have-not province, because the implication on total transfers is large, the response in Ottawa has been to introduce overrides due to the fiscal concerns with making these payments. Tracy noted that with Ontario moving out of have-not status this leaves some breathing room for discussions to proceed with the 2019 renewal/modification of the equalization program, but the cap that was put in place in 2009 needs to be reconsidered as it also, unintentionally, put a floor onto the program that has lead to adverse affects.

The panel concluded with comments from Trevor. Trevor note that in 1867 20 cents of every federal dollar was transferred to provinces. Fast forward to 2018 and 20 cents of every federal dollar was transferred to the provinces. So transfers are not new nor have they changed much in total. They have though changed in the nature of the transfers. Trevor pleas for people to get the facts straight. He says too many people argue that equalization is a transfer from Alberta to Ottawa (the province of Alberta does not write a cheque to Ottawa. Albertans pay federal taxes), equalization caused the deficits in Alberta, the cap brought in in 2009 (by the Harper (and Kenney) government) has impeded Alberta’s ability to obtain equalization payments during the oil crises, and removing resource revenues from the formula would benefit Alberta (note: doing so would increase payments to Quebec). All of this is fiction.  What we need to do, to have a better discussions, is focus on the facts and to try to come to a common understanding of what objective are we trying to achieve and what problem are we solving. It is true that Alberta, since the program’s inception, has been a net contributor to all federal transfers, but this is because: Albertans have higher incomes, businesses have higher levels of profit, Albertans are younger than other provinces, and Albertans have a high rate of consumption. All this factors into less money from federal transfers.  In fact, Trevor noted that if we went back in our TARDIS and instead of dropping the GST, the federal government dropped income taxes, then Alberta’s fiscal gap under equalization would shrink.

Questions then came from the floor:

  • Q: How is money transferred to the federal government. A: We pay federal taxes, it is as simple as that. However, it was noted as to whether it makes it less serious if out of the pocket books of individuals or the provincial legislature? [I would say, define serious.]
  • Q: If this is all due to Albertans being so much better off than the rest of Canadians, is that really such a terrible problem? A: The problem would indeed go away if Albertan’s were less successful, but there are of course implications that go along with that. This takes us back to two issues: if equalization distorts productivity gains and resource development then, yes, this is a concern; and, what problem are we trying to solve.
  • Q: If Albertans are helping these other provinces by paying federal tax, are there any assurances that the provinces we are helping will become more productive? A: Poignant question , since the program does not appear to address this problem.
  • Q: Are we impeding mobility with equalization? A: Seems that EI is a bigger consideration in mobility than equalization. But we can ask this question: what policies will help facilitate mobility, productivity, resource development, etc?
  • Q: When I looked at the payments I saw for this year a $1.8B adjustment factor that meant $1.8B more in funds that went to other provinces including Ontario. What is that? A: That adjustment factor is the unintended result of the cap put in in 2009 which also effectively operates as a floor. That adjustment factor, the floor, shows how broken the system is.
  • Q: When does the current model expire? A: Strictly speaking, it is a federal program and the  federal government can do what it wants. But it is set to expire March 2019 and Ottawa does typically consult with the provinces.
  • Q: How do Manitoba and Quebec hydro resources revenues get counted? A: Hydro rents are included in the formula, the question is whether the hydro rents received reflect the potential rents. This is poignant since Alberta sells at market rates, yet some provinces subsidize hydro by underpricing it for domestic needs compared to what it sells for on the open market. This was followed by a discussion as to whether revenues from renewable resources should be treated differently from non-renewable resources since the later is finite. Of course, however, everything is finite in the long run so does it matter (that was an economist ;-))? There was also a conversation as to, since resource royalties and related are not taxes should they be considered? [This is true, resource royalities or selling provincial proprietary interests (e.g. hydro) are proprietary charges, not taxes.]

The panel finished with a final consideration in that what is the role for Ottawa and our fellow provinces helping Alberta out when times here are not good? The oil price collapse was a significant economic adjustment and many in Alberta felt abandoned (not just through equalization but also EI and federal transfers like the CCB and GST tax credit that do not adjust quickly enough). What can we, as a federation do, in these times?

That is the sum total of my notes. My notes are simply an attempt to record the statements. I am not evaluating the statements made (except where noted) and I may have erred in my note taking.

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