The fight for fairness in Canada's equalization system
Originally published in The Capitol Report in May 2016.
After months of being faced with a struggling energy sector and large job losses, the official opposition party of Alberta has assembled a panel to evaluate the current equalization system in Canada.
Brian Jean of the Wild Rose party has assembled a group of economists to evaluate the equalization program and propose changes to the current system. Frank Atkins of the Frasier Institute is co-chair of the panel, along with fiscal commentator David MacKinnon, Marco Navarro-Génie of the Atlantic Institute for Market Studies and Ben Eisen of the Fraser Institute.
“We are a non-partisan committee,” Atkins said. “We are all academics and will approach this from an academic perspective. I would say that everybody on the committee has a bias towards market solutions to economic problems.”
Not everybody thinks the committee is the best team for the job. Ricardo Acuña of the Parkland Institute has been outspoken against the committee and labels them as ultra-conservative. Acuña says that a bias for market solutions to economic problems might not be the best way to approach public policy decisions.
“I don’t think that measuring economic incentives is the be-all and end-all of public policy,” Acuña said. “When governments are exclusively focused on incentives for businesses and economic growth, that is when we start to see unsustainable economic and environmental practices.”
The committee will be evaluating the current equalization system and will put forth suggestions to the official opposition in mid-October.
The equalization system has been around informally since confederation and is part of Canadian fiscal federalism. The federal government held most of the taxation power, and would transfer money to the provinces as they needed. A formal system was created in 1957 after a struggling Atlantic Canada was seeing a net decrease of citizens leaving for central Canada. As a response, the federal government implemented a program of transfer payments so Canadians could enjoy the same standard of living, regardless of where they lived within Canada. The formula was created based on a province’s ability to generate its own money and transfer money to those below the national average.
The formula helps bring some provinces fiscal capacity up to the national average. Each provinces taxes its citizens based on their income. If the provincial per capita GDP is low, the province has less ability to tax and generate tax revenue. Without equalization, provinces with a low per capita GDP would suffer and not be able to supply services to citizens equal to those in other provinces. Equalization allows for a provinces fiscal capacity to be calculated, and if they fall below the national average, equalization payments are transferred from the federal government to help compensate for a low provincial GDP.
Although the principle is straightforward, the calculations can be a bit more complex. Amendments have been made to the formula since its inception, including changes to the treatment of natural resources and a fiscal cap limiting a provinces per capita payments. The final numbers are calculated using a three-year weighted moving average, with a lag of two years. The lag allows for provincial governments to anticipate the amount of money coming their way and can plan the amount in to their budget. The three-year moving average helps to address volatility and sudden changes that would dramatically alter payments.
“Under the current formula, the Alberta economy went down very fast, and so it is going to take two more years for this slump to factor in to the calculations,” Atkins said. “So even though we are slumping we are still a contributor. That has caused a lot of people in Alberta, including the official opposition, to get upset.”
The three-year moving average and two-year lag are some of the factors the panel will be reviewing while trying find a solution to economies taking a sudden and dramatic downturn.
Atkins also thinks the current system destroys economic incentives and he cites the Nova Scotia government’s recent ban on fracking as a recent example. He suggests that if fracking had not been banned, the province could have “created a viable resource industry and developed their economy and probably dragged themselves out of the have-not status.”
Some economists and public policy experts, including Acuña, think it is worth looking at the effectiveness of the system but do not agree with all of Atkins critiques.
“The problem is that if you start attaching strings to the money you have a different level of government, or even worse, governments in other provinces dictating to you what kind of policies you should have,” Acuña said. “These governments are free to run their provinces however they want. These are democratically elected governments and they get to implement their policies.”
The payments are given to the provinces from the federal government generated by federal income tax, as one of many transfer payments. The provincial government does not pay into equalization.
“We all pay federal taxes, and as one of the many expenditures, the federal government pays out equalization to the provinces,” Acuña said. “There is no item in the provincial budget that says ‘equalization’. Everybody pays the same federal tax rates, and if you make more money, even if it’s in Quebec or Newfoundland or New Brunswick, then you are actually contributing more to equalization because you are paying more taxes.”
Citizens contribute to equalization through their federal taxes. Provinces with higher populations, such Ontario and Quebec, will contribute more to equalization because they have more heads to tax. Alberta and British Columbia also pay more federal taxes because their populations are higher than more rural provinces. A high per capita GDP also raises the average provincial contribution to equalization payments because citizens with higher incomes will be paying more taxes to the federal government. This is why Alberta made the highest per capita contributions to equalization payments during the oil boom.
The panel is presenting their findings in mid-October and Atkins says he hopes the results can open an honest public discussion.