The Poison Elixir of Equalization

Commentary, Equalization, Frontier Centre

As a follow-up to last month’s health conference, Canada’s first ministers will meet on October 26 to deal with expanding equalization payments to “have not” provinces. Manitoba, New Brunswick and Quebec have written a discussion paper calling on Ottawa to boost equalization subsidies by over 50%, from about $10-billion a year to a little over $15-billion.

Don’t jump for joy if the Doer government gets more. These subsidies are part and parcel of this province’s long-term relative decline. The booty from Ottawa has been a catastrophe for Manitoba, a fundamentally rich place, because it props up bad policy.
At the health shindig, the Prime Minister gave away too much in return for too little. He maintained the uncreative Canadian tradition of throwing more resources at issues, when better services at less cost could be achieved through an intelligent rethink. Expect more of the same at the equalization summit. Unfortunately, more pogey is definitely not the way to create a prosperous province.

About $215 billion have sloshed through the program since it began in 1957, money intended to enable jurisdictions with underdeveloped tax bases to offer a reasonably similar level of services. A Byzantine, flawed method understood by few is used to calculate the subsidies. The third heaviest gross recipient after Québec and Nova Scotia, Manitoba follows only the Maritimes when the transfers are expressed in per capita terms. Last year, these “no strings attached” payments accounted for 19% of Manitoba’s budget.

Equalization’s problems lie in its creation of perverse incentives. The program locks “have-not” provinces into enormous welfare traps that reward increased dependency. As with healthcare, the easy money perpetuates stagnant, expensive, inefficient policy models that lack transparency. It funnels a disproportionate benefit to the providers of services instead of consumers. Most damagingly, it promotes uncompetitive tax and regulatory regimes that discourage economic growth. This is the classic definition of the welfare trap. Equalization makes it better to stay on the dole than pull up our policy bootstraps and create a dynamic, growth-based economy.

The following statistics illustrate equalization’s devastating effects. In 1961, Manitoba’s population was about 5% of the Canadian total; in 2003, it was 3.7% and falling. Our proportional GDP has fallen even faster. Our economy represented 4.5% of the national total in 1961 and 3.1% in 2003. Our proportional share of equalization spiked permanently upward around 1975, a time when Manitoba rapidly increased taxation and regulation, expanded the public sector relative to the overall economy, embraced low outcome policies like Unicity and rent control and began to underprice electricity even more progressively.

Over the same period, Manitoba’s economy hollowed out. The highest taxes, the largest public sector and the lowest rate of private investment in western Canada now combine to drive “brain jobs” and anyone with substantial pools of capital to more hospitable climes. Despite a recent mini-blip in job creation, our share of the national job market continues to decline, falling to 3.58 per cent in the third quarter of 2004 from 3.74 per cent in the final quarter of 2001. Relative to four years ago, it has lost about twice as much ground as Alberta has gained.

It’s unsurprising that Manitoba is going down the path of least resistance – more subsidies. The alternative, innovative policy redesign, is politically more difficult. It’s easier for all parties to force-feed more subsidies into bloated, over resourced service models, while the private economy starves for capital and entrepreneurship. To quote Brian Lee Crowley, president of the Atlantic Institute of Market Studies,”We have discovered after nearly half a century that incentives matter, and the incentives attached to equalization penalize the poorer provinces for developing their economy and encourage them to settle for permanent reliance on federal transfers.”

Transformational reforms, definitely not on the October 26th agenda, might include a one-time buyout in exchange for a permanent end to equalization. In Manitoba’s case, a $15-billion payout would be relatively painless and represent only a 3% increase in a declining federal debt. It would wipe out our $7-billion debt and provide an $8-billion “heritage fund” with a permanent flow of investment returns. Netted out against an abandoned $1.3 billion in equalization, these credits and an end of interest charges would leave only a few hundred million to make up — easily done with simple public-sector reforms and a move to market pricing for electricity. Another transformational idea would be to simply swap the GST (worth $29 billion in 2004) to the provinces in exchange for all federal transfer programs, including equalization (worth $31 billion).

The present model is a poison elixir that props up expensive models while hollowing out the tax base that normally carries the load of public services. Unless we rethink equalization, we risk becoming more like Newfoundland, with high taxes, a weak tax base and a collapsing population. An end to the welfare trap will allow us to capitalize on our immense advantages – creative people, a highly productive ag sector, immensely valuable hydro resources, to name a few.

We need to create a normal, growing economy that pays its own way forward. That means no equalization, not more.

Brian Lee Crowley Seminar on Equalization – January 19th, 2005 in Winnipeg