Atlantic Canada’s Vicious Cycle

Equalization, Frontier Centre, Uncategorized, Worth A Look

Canadians outside the Atlantic provinces often have an outdated view of the region’s economy and its fiscal relationship with the rest of the country.

But then, so do a lot of politicians inside the region who balk every time anyone suggests an end to massive government-to-government transfers and subsidies to individuals not to work.

Halifax has a lower unemployment rate — 5.2% — than Toronto, Ottawa or Montreal. Nova Scotia has a lower provincial rate — 7.6% — than Quebec (7.7%).

The other three Atlantic provinces all still struggle with high joblessness — P.E.I., 9.1%; New Brunswick, 9.6% and Newfoundland, 14.0% — but even those levels are approaching 30-year lows.

And while the Atlantic provinces are the largest per-capita recipients of equalization payments, the biggest consumers are Quebec and Manitoba. With just 23.5% of the national population, Quebec receives 44.0% of equalization payments. Manitoba, with just 3.6% of Canada’s residents, grabs nearly 15%. Together, the four Atlantic provinces — despite their reputations for dependence — receive only four-fifths as much equalization as Quebec alone.

Ottawa claims transfers and equalization take money from “have” provinces to give to “have-nots” for the development of the latter, and so they can offer “reasonably equal social services at comparable rates of taxation.”

But the reality is the incentives created by these payments are so perverse they actually thwart the stated objectives. Transfers hold down investment and development and encourage tax levels well above the national average.

As the Atlantic Institute for Market Studies explained this summer to a federal panel contemplating changes to the equalization formula, when have-not governments want more revenue they can “encourage economic growth, raise taxes, borrow, or secure new federal transfers.”

If they are successful at expanding their provinces’ economies, they lose federal transfers. If they go into debt, most of the new revenue is eventually eaten up in interest payments. But if they raise their own taxes, federal payments rise with them. Indeed, thanks to the perverse incentives built into the equalization formula, have-not Atlantic governments receive up to $2.40 in transfers for every dollar in new taxes they impose, which explains why Atlantic provinces have among the highest tax rates in the country.

These high tax rates explain the region’s low private-sector investment rates. And the low investment rates keep job creation down, which raises unemployment and prompts demands for more personal subsidies that discourage work (such as year-round EI payments to individuals doing a few weeks worth of seasonal labour), which pay tens of thousands of workers to remain outside the labour market, which artificially raises the cost of creating a new job, which depresses the creation of new businesses, which increases demands for subsidies for start-ups, which squeezes private investment — and around and around, until intractable constituencies are created for politicians who can go to Ottawa and bring home the pork and provincial politicians who butcher it.

Ottawa likes the arrangement because it permits the federal government to point to all it’s done for the region. And the region’s politicians like it because if they are successful at convincing Ottawa to tax the “haves” more to pay for goodies back home, they can present themselves as heroes.

What is needed, instead, is a radical re-think of the way provincial governments in the region intervene in their economies and the way Ottawa rewards economic behaviour. As less bad as things have become recently, they could be better still with lower government spending and taxes.

And if Ottawa really wants to help, it could take on the provincial debts of the Atlantic provinces in return for an end to equalization and transfers. Most of the have-not provinces’ debt-servicing costs are close to the amount they receive annually in transfers. If they were relieved of the billions in loans they owe, they could fund most existing programs from their own taxes.

This would have the beneficial side effect of making Atlantic politicians more sensitive to the costs of their programs, too, by eliminating the clouding effects of the two-to-one subsidy Ottawa provides now. Currently, they can raise spending without having to suffer the full ire of ratepayers.

The model the region should want to emulate is Ireland’s Celtic Tiger, which substantially reduced regulations, labour-market rules, taxes and spending in the 1980s and 1990s and leapt from one of the poorest nations in Europe to one of the wealthier ones. Such a blueprint would be far more promising than clinging to the hope that the failed Trudeau model of the 1970s can be made to work if only a few billion more dollars are injected into the status quo.