I admit it. For an economist, I’m an optimist in an industry known for its dismal scientists. I see the glass as half full. But in one area of Canada’s eco- nomic landscape, I have become unchar- acteristically pessimistic. The federal equalization program has gradually sunk into a quagmire from which, it would appear, no workable solution can possi- bly emerge. Be it myth or reality, the problem of the vertical fiscal imbalance between Ottawa and the provinces has clawed its way onto the Prime Minister’s agenda, and the equalization program has somehow become the assumed tool by which to fix it.
Most of the contention among the provinces is focused on two questions. First, should the federal government enrich the equalization program? And second, should provincial non-renew- able resources of all 10 provinces be included in the formula? The two issues are intertwined. My pessimism had degenerated to ”œthe glass is completely empty and smashed on the ground " and now a piece is lodged in my foot.”
That was until a recent conversation I had with Brian Lee Crowley of the Atlantic Institute for Market Studies. Crowley offers a creative solution for dealing with provincial non-renewable resource revenue.
One of the strongest arguments against including resource revenue in the formula is that it is not tax rev- enue. In their natural form, oil in the ground, nickel ore in the rocks and so on are assets belonging to the people of the province. Collecting royalties on the sale of these assets is simply changing the form of the asset from molecules in the ground to cash in the provincial coffers. Therefore, it shouldn’t be treated like the other provincial taxes in the formula.
Crowley’s solution is simple, and adheres to the basic principles of what equalization is all about. If an equaliza- tion-receiving province spends its non-renewable natural resource revenue on ordinary program spending, that money should be counted in that province’s fis- cal capacity and therefore deducted from its equalization entitlement.
If a province does not receive equal- ization payments, and it spends its resource revenue on program spending, that money should also count toward its fiscal capacity and therefore be included in calculating the 10-province standard.
However, if a recipient province treats its resource revenue as a financial asset and uses it to pay off debt, it should not cause its equalization benefits to be clawed back. Similarly, if a non-recipient province uses its natural resource revenue to pay off debt (or invest), it should not be included in calculating the 10- province standard.
For example, if Alberta collects $10 billion in resource revenues, sets aside $7 billion in the Alberta Heritage Savings and Trust Fund and spends the rest on programs, then only $3 billion would be regarded as ”œrevenue” and considered in calculating the 10-province standard.
If a recipient province like Nova Scotia collects $1 billion in resource revenue and applies all of it toward debt reduction, then none of this cash would be considered in Nova Scotia’s fiscal capacity " and none would be clawed back from what it receives in equalization.
Consider what this accomplishes. First, it would give the Prime Minister a nice way out of the dilemma he faces. He would fulfill a campaign promise to include all 10 provinces and non-renew- able resources in the 10-province stan- dard " as long as this revenue is used for program spending.
Second, it does something that the current equalization program does not " rewards provincial governments for pru- dent financial management. Paying off debt is encouraged, as is (in the case of debt-free Alberta) setting aside cash in a long-term investment vehicle. The provinces with debt would benefit not only from improved credit ratings, but more importantly from reduced interest payments on their debt. (Note that inter- est earned on investment funds in Alberta would be counted in the 10- province standard, if this cash flows back into provincial program spending.)
Finally, Crowley’s 100 Percent Solution gets back to the true spirit of the equalization program: a redistribution of revenues to provide all Canadians with access to a reasonably comparable level of provincial services. If a province treats resource royalties like general revenue, it should be counted like general revenue. If it treats it like a financial asset, it should not be counted like general revenue.
Sadly, I don’t give it much chance. Economically, it’s spot on. Politically, it’s doomed. Which makes me think: per- haps it is the political scientists who are the real dismal scientists.
Equalization-receiving provinces that do not have vast marketable non- renewable resources " particularly Manitoba and Quebec, but also PEI and New Brunswick " would without question oppose this plan because there is limited financial upside for them. With very few mineral resources, their chances to shelter rev- enue by paying off debt are minimal. Worse yet, their entitlements under equalization would depend heavily on decisions made in Alberta as to how much resource revenue it sets aside as investment.
Perhaps Manitoba and Quebec could be brought onside if we started to factor in a major natural resource endow- ment that is, so far, excluded from the equalization calculations: hydro electrici- ty resources. But that is a whole other col- umn to be dismal about.