The key issue in the equalization debate is finding the right balance between economic growth, development and the redistribution of financial resources.
(This article has been translated into French.)
Canada, like most federal countries, needs equalization to ease the consequences of regional inequalities, namely the uneven quality of public services across provinces and significant population retention problems. They stem largely from the uneven strength of regional economies and population centres and the uneven territorial distribution of wealth, including natural resources. The federal equalization program is a powerful mechanism for strengthening national unity.
But it is persistently contested.
In fact, it has always sparked regional tensions and has generated controversy since its start in 1957. Because some provinces receive transfers and others do not, nonreceiving provinces often describe themselves as “losers” in the equalization allocation. The tension has historically heightened when provincial economies have changed.
Most recently, the program has come under heavy criticism from Alberta and Saskatchewan, two provinces that do not currently receive equalization payments but face fiscal challenges from the drop in oil prices of 2014.
Brad Wall, who was premier of Saskatchewan for most of the last decade, has regularly denounced the federal equalization program in the context of debates about the fiscal situation of his province, the construction of pipelines and the imposition of carbon pricing by the federal government. Taking over from Wall in January, Scott Moe has also questioned equalization in light of carbon pricing. More recently, he even proposed that the federal government replace 50 percent of equalization payments with per capita transfers to each of the 10 provinces.
Next door in Alberta, Jason Kenney, now leader of the United Conservative Party of Alberta, threatened to organize a referendum on the program in reaction to the federal handling of energy-related issues. Of course, there is a long tradition of hostility toward equalization in that province.
In a review of our recent book Fiscal Federalism and Equalization Policy in Canada, columnist, political scientist and former Alberta Progressive Conservative minister Ted Morton discussed equalization in relation to carbon pricing and pipeline projects. But he mainly focused on the status of Quebec as the largest recipient of equalization payments in absolute terms, meaning the total payment for the province rather than the per capita amount.
As Brad Wall, Scott Moe and Jason Kenney have noted, this emphasis on Quebec is part of a larger historical discourse in which the “Eastern bastards” of Central Canada exploit the West.
The recent criticism of equalization policy from conservative Western political leaders is directly related to the advent of the federal Trudeau government in November 2015. With only four seats in Alberta and one in Saskatchewan, the federal Liberals are underrepresented in both provinces. Moreover, the prime minister is from Quebec — and he is also the son of Pierre Elliott Trudeau, the man behind the now-infamous National Energy Program, widely hated in the West.
Simultaneously, there is a sense that the current Trudeau government is trying to impose environmental policies such as carbon pricing that are detrimental to the economic interests of Alberta and Saskatchewan, two provinces that have been reeling from lower oil prices since 2014.
In this context, conservative leaders from both provinces have targeted both the federal government and Quebec to mobilize their voting bases.
But equalization does not “screw the West to pay for the rest.”
The reality is, first of all, the West does not have a single common experience with equalization. Manitoba has always been a recipient province while Alberta has not received equalization payments since the mid-1960s. British Columbia has been mostly a nonrecipient province, while Saskatchewan has been a recipient province for 44 of the 60 years since 1957-1958, when the program began. In other words, Manitoba and, for the most part, Saskatchewan have directly benefited from the equalization program.
Second, equalization entitlements are calculated based on a province’s revenue-raising capacity (if average tax rates are applied to the province’s tax base), with a number of subsequent adjustments to this amount related to removing serious distortions and ensuring that total equalization payments grow at the GDP rate.
The calculation of provincial fiscal capacity includes, along with all other revenues, 50 percent of revenues from nonrenewable resources (including oil and gas), in accordance with the recommendations of the 2006 Expert Panel on Equalization and Territorial Formula Financing. The equalization payments that would be required to bring that province’s fiscal capacity up to the national average are then calculated. Like capital gains tax, which is set at one-half the rate of income tax, the 50 percent level is intended to be low enough so that equalization payments will not be a disincentive for a province to develop its nonrenewable resources.
Provincial entitlements are also calculated with 0 percent of nonrenewable resource revenues to reflect the federal government’s pre-2006 election commitment to exclude natural resource revenues from the formula. Whichever calculation (50 percent or 0 percent) yields the greatest equalization payment is what the province is entitled to.
Provincial control over natural resources holds strong economic, political and symbolic value in Alberta and Saskatchewan, which spent two decades fighting for that control after joining the Canadian federation. Removing nonrenewable resource revenues from the equalization formula would not change Alberta’s status as a nonrecipient province because it has the strongest economy in Canada, and its revenue-raising capacity is greater than that of other provinces, even without nonrenewable resource revenues. The same holds true for Saskatchewan: its status wouldn’t change, either, if its nonrenewable resource revenues were removed.
Furthermore, at least for the 2018-2019 fiscal year, the equalization payment to Quebec when 0 percent nonrenewable resource revenues is included is slightly higher than when 50 percent is included; Quebec would thus receive the entitlement consistent with 0 percent of nonrenewable resource revenues included in the formula.
Third, the West has had considerable input in the refinement of the current equalization formula. Indeed, that formula was largely based on the recommendations of an expert panel chaired by Al O’Brien, a former Deputy Treasurer of Alberta, which was set up by Stephen Harper’s government. As we know, Jason Kenney, now a frequent critic of the current equalization formula, was an influential cabinet minister in the Harper government. If Kenney hates the current formula so much, why didn’t he do something about it when he had the chance?
Fourth, equalization is not just about Quebec. Many provinces receive equalization payments. The program’s main purpose, as specified in the Constitution of Canada, is to ensure that any province with a below-national-average fiscal capacity receives federal payments to narrow the gap so that it can provide reasonably comparable public services.
For example, Prince Edward Island and New Brunswick rely quite heavily on equalization to finance their public services. Moreover, the oft-heard notion that Quebec can afford more comprehensive child care and family policies than oil- and gas-rich provinces because of equalization payments alone is misplaced.
The total revenue that a province uses to provide public services depends heavily on its own efforts to raise tax revenues, and provincial tax rates are substantially higher in Quebec than in Saskatchewan — while Alberta doesn’t even have a provincial sales tax.
In addition, Kenney-style talk about how equalization is bad for Alberta misses the mark, as it diverts attention from the hard fiscal choices that the province needs to make.
Finally, in the debate over fiscal federalism, it is useful to remember that equalization is part of a larger system of transfers. The Canada Health Transfer is roughly twice the size of equalization and the Canada Social Transfer is close to the same amount of money as equalization. Both the health transfer and the social transfer are paid on a pure per capita basis without any equalizing amount, another long-sought demand by Alberta that was implemented by the Harper government. In the first year after the per capita formula for the health transfer was introduced, Alberta received a huge bonus.
There are problems with equalization, but they are very different from the ones identified by Wall, Moe and Kenney.
For example, there is an increasing discrepancy between the size of the equalization pool and the size of the fiscal disparities among the provinces. Indeed, for the last couple of years, the fiscal capacity of nonreceiving provinces has shrunk while that of receiving provinces has increased. As a result, the disparity between receiving provinces’ fiscal capacity and the national average has narrowed. The equalization pool has grown in line with GDP following a reform implemented by the Harper government. One would expect that, as equalization is designed to partially compensate for disparities among provinces, the size of the pool should change proportionately to the size of these disparities. How much equalization is enough is a political and fiscal judgment. There is, however no “perfect solution.”
Similarly, one can argue that fiscal capacity alone provides an incomplete picture of the ability of a province to provide public services and that expenditure needs (due to differences in demographics and costs of providing services) should also be taken into consideration. Yet, it is unclear which needs should be taken into consideration and to what extent they should feature in the equation.
If the age of Alberta’s population were considered and a needs assessment were done, it is likely that Alberta would get a smaller Canada Health Transfer amount — and it would do nothing to change its status in the equalization program. Alberta has a very young population, with far lower health care costs than provinces with an aging population.
However, the fact that the federal government alone manages equalization means there is always the potential for politics to influence decisions about the program. At the very least, the appearance of federal executive discretion almost inevitably creates the impression among provincial governments that the program is not always administered neutrally.
In our book, we encourage federal decision-makers to consider setting up an arm’s-length agency to determine payments and make recommendations on adjustments to the formula. This organism would be particularly useful if the provinces’ needs in terms of services were to be included in the equalization formula, as the federal government could come under heavy fire if it were to attempt to determine provincial needs.
In short, we think it is possible for an arm’s-length model — which exists in Australia — to remove some of the potential for politicization inherent in the current governance structure.
Equalization is here to stay. Not only is it the federal government’s responsibility to make equalization payments to provinces, as specified in the 1982 Constitution Act, but no one concerned about social policies and programs throughout the country should wish for its elimination.
But it is not useful to see the parameters of the equalization program as being set in stone. Equalization has experienced many changes since its inception, and it needs to continue adjusting in this period of particular fluidity in the country’s economy.
It was not adjusted much in the most recent federal budget, which was handed down in February. It was quietly renewed with only limited technical adjustments.
But the policy discussion about the future of equalization is unlikely to fade away.
At the centre of any discussion on equalization remains the difficult question of the right balance between the economic growth and development of the country as a whole and territorial redistribution. Getting the balance right over time will foster rather than undermine territorial solidarity and national unity.
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