The Equalization Trap

Commentary, Frontier Centre, Role of Government, Uncategorized

Beggar thyself; beggar thy neighbour, the saying goes.

Manitoba’s “poor cousin” image is an embarrassment. Recently, Premier Doer suggested that the federal government lift its $10 billion cap on equalization payments in order to help alleviate relieve our budget crunch. A cabinet minister from Alberta, where they’re sensitive to raids on their oil wealth, took offence and labelled the Premier a “lazy socialist”.

Canada’s equalization program, introduced in 1957, funnels money from “have” provinces like Ontario, Alberta and B.C. to the other provinces that are classified “have-not”. The goal is to ensure that provincial governments have sufficient revenues to provide reasonably comparable public services at roughly comparable tax levels.

But good intentions alone form a poor basis for effective public policy.

Much as overly generous welfare payments have the unfortunate effect of discouraging individuals from achieving independent, productive lives, there is evidence that these intergovernmental transfers create similar perverse incentives in recipient provinces. They increase reliance on “free” federal cash while retarding necessary economic adjustment and dampening public sector innovation.

Instead of enhancing services, equalization payments may simply end up subsidizing higher than necessary public sector costs. With fewer resources, have-not provinces clearly would have stronger incentives to be smarter about service delivery.

Evidence abounds that government monopolies provide services at costs up to 40% higher than those incurred within a competitive delivery framework. Extra money from outside simply perpetuates less effective approaches and is wasted. In short, the autoworker in Ajax, Ontario and the corporate CEO in Calgary pay more taxes to support bigger than necessary governments in Winnipeg and Manitoba.

Research from the Atlantic Institute for Market Studies, a Halifax think tank, has correlated the dismal economic performance of the Maritime Provinces; all “have not”, with rises in external wealth transfers and subsidies, including equalization. The outside money induced a dependence on Ottawa that has prevented diversification out of dying primary industries like fishing and coal mining. Income levels have stagnated as economic energy swung towards capturing government support payments. Unemployment remains the highest in Canada. The Institute’s research shows economic performance was the worst during the years of the highest transfers.

In contrast, workers and investors in nearby New England, without support from other American states, have constantly adjusted their behaviour. The result: cutting-edge manufacturing and technology, sharply rising incomes and low unemployment.

The term “welfare trap” describes how those on social assistance face huge penalties for trying to find work when the system claws back welfare payments at the same rate as wages are earned. This traps the individual on welfare because there is no pocketbook advantage to working. Equalization payments appear to create the same syndrome on a macro level.

Consider the perennial Canadian basket case, Newfoundland. It sits on a rich nickel deposit at Voisey Bay, which, if developed, would generate substantial royalties and tax revenues. Were the project to go ahead, however, Ottawa would simply deduct 80% of those increased tax revenues from the province’s equalization transfers. This explains why Newfoundland is in no hurry to develop its potential. Today Voisey Bay sits idle while local politicians chase moonbeams and split hairs with the deposit’s owners.

While less severe, the same dependency trap is at work elsewhere. Outside money that gets cut back if there is economic advancement may be one systemic reason for Manitoba’s relative decline over the last 30 years. After recalculating Manitoba’s employment figures, Statistics Canada now confirms that job growth here during the last decade was among the worst in the country.

A recent interview with Eric Kierans, the former Liberal cabinet minister from the 1960s and 70s, still sharp as a tack at 85, illuminates Manitoba’s own conundrum. As a consultant to the Schreyer government in 1973, he recommended mineral royalties be increased from $5 million to $32 million. He later found out that nothing happened because the higher provincial revenues would have substantially reduced equalization payments. He confirmed also that if Manitoba Hydro made more money the same thing would happen. This may explain why no one is exactly rushing to convert Hydro into the tax-paying colossus it would become if it were privatized.

How do we get out of the dependency trap? What can we do about Manitoba’s chronic inability to achieve its substantial economic potential?

How about a trade-off with the federal government? In exchange for absorbing Manitoba’s provincial debt of roughly $8 billion (which costs about half a billion a year to service) and a one-time cash payment of $2 billion, we would get off the equalization treadmill. The feds would save roughly one billion a year in payments to Manitoba. The shortfall could be made up with obvious efficiencies from high performance delivery models, instituting a bloodless 25% civil service reduction to take advantage of looming retirements, and expanding the tax base through privatization of government companies and other assets.

Good-bye, sleepyville. Hello “have province.”