GLOBAL ECONOMICS

GLOBAL ECONOMICS COMMENTARIES



Patrick Grady
Equalization Up for Grabs
October 26, 2005

Over the course of almost a half century of federal-provincial finance ministerís meetings, the equalization program has evolved, becoming increasingly complex to deal with the emerging issues of federal-provincial finance. While equalization may be understood by only a few people, working deep in the bowels of the nationís finance ministries, that does not mean that it is only important to government officials. Far from it, equalization is nothing less than the financial glue that holds the fractious Canadian federation together.

In a nutshell, equalization was designed to provide less well-off provinces with the money they need in order to offer their citizens roughly the same level of public services as in other provinces without subjecting them to excessively high tax rates. This was intended to ensure that Canadians, regardless of where they live in the country, would not suffer from restricted access to the important government services, which Canadians expect.

The principle behind the equalization program was considered to be so important that it was eventually enshrined in the Canadian constitution when it was patriated from the United Kingdom in the early 1980s. Specifically, clause 36 (2) of the Constitution Act, 1982 committed the Government to ďthe 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.Ē

Because of its dependence on federal revenues as the source of finance, equalization has always come under financial pressure when resource revenues, particularly from oil and gas, the richest source, go up. The problem is that the federal government does not have the same unrestricted access to resource revenues as the provinces that own the resources. And when provincial revenues go up in resource-rich provinces, the federal government canít afford to transfer the required additional money to less well-endowed provinces.

Last year during the election, the Prime Minister promised Premier Danny Williams that Newfoundland would be allowed to keep 100 per cent of the revenue from offshore oil. Unfortunately, the Prime Minister didnít take the time to consult with the federal Department of Finance before making his promise. If he had, he would have learned that it was not such a good idea as equalization was already under pressure as a result of resource revenues and that a fair solution, given all the emerging anomalies, would require hard bargaining with all the provinces and difficult compromises.

Last September following the election, the federal government unveiled a new approach to equalization. Instead of basing the total amount of payments on the complicated formula that takes into account discrepancies in tax rates and bases, it proposed to allocate a fixed amount of money ($10.9 billion in 2005-06) that would be increased 3.5 per cent per year thereafter. An expert panel was established to report by December 31, 2005 to provide the government with advice on how the money would be allocated starting in 2006-07. (An extension of the deadline until the spring has granted by the Minister of Finance.)

A big problem with this approach, which should be obvious to the expert panel, is that it delinks equalization from any objective measurements of regional disparities in fiscal capacity. This is particularly important at a time like the present when $60 per barrel oil and an 85 cent Canadian dollar are exacerbating interprovincial differentials in economic performance. The new approach in effect turns equalization into nothing more than a giant pot of money, whose size is unrelated to the problem of regional disparities itís designed to address.

At the same time as the government was developing the new approach, the Newfoundland Premier was determined to hold the Prime Minister to his election promise. Following a federal-provincial finance ministerís meeting that failed to deliver, Premier Williams threw a real tantrum and ordered the removal of Canadian flags from all Newfoundland government buildings. After that, it only took a month for the Canadian government to cave in and give Newfoundland all it wanted in a side deal to equalization which extends all the way to the year 2012. In spite of behaving civilly throughout the whole affair, Nova Scotia was given a similar deal. But Saskatchewan, which still faces clawbacks on its oil and gas revenues in excess of 100 per cent, was left out in the cold.

Premier Dalton McGuinty, for one, found this all pretty hard to swallow. It wasnít long before he hopped on a plane to Ottawa to complain about the ď$23-billion gapĒ between what Ontario pays and what it gets back from the federal government While he returned home far from satisfied, he did manage to get an additional $5.75 billion over five years from the federal government for Ontario for such things as immigration, labour market development, and post secondary education. Who says the squeaky wheel doesnít get, at least some, grease?

What should the expert panel tell the government in its report this December? A good starting point in the light of all the unseemly federal-provincial squabbling that has been going on would be that the whole process for dealing with equalization has become a national disgrace. The government has seriously damaged equalization by cutting it loose from its base in principle and transforming it into a great, big pot of money, up for grabs. The Prime Minister should never have made a bilateral promise in the heat of an electoral campaign that fundamentally altered equalization, a program that is at the heart of fiscal federalism. The complicated issue of resource revenues needs to be addressed in a comprehensive fashion that treats all provinces fairly and takes into account the impact of resource revenues on fiscal capacity.

A final word of warning. Under the existing formula, if oil prices remain at around $60 per barrel, Ontario could qualify for equalization. Where would that leave the other eight provinces that share the equalization pot of money that would not look quite so big then?

The federal fiscal relationships with the provinces need to be fundamentally rethought. This would seem to go way beyond the more limited terms of reference of the expert panel, even if it is granted some extra time. Perhaps a royal commission such as was recently proposed by Premier McGuinty, may be required.