Equalization Called a Drag on Productivity

Worth A Look, Equalization, Frontier Centre

OTTAWA – The fiscal framework underlying Canada’s federal system — in which wealthy provinces contribute to payments targeted for have-not provinces — is a drag on the country’s productivity growth and is in need of an overhaul, says Toronto-based economic think-tank.

“Fiscal federalism is not effective in promoting the competitiveness and prosperity of Canada,” James Milway, executive director of the Ontario-funded Institute for Competitiveness and Prosperity. “It is simply a set of net transfer programs that has the effect of transferring resources from high-productivity uses to low-productivity uses, lowering the absolute level of productivity.”

Mr. Milway offers a number of fixes, but chief among them is to take the money paid out to have-not provinces via transfer payments, and use the cash to finance tax cuts that stimulate business investment.

Canada’s lacklustre productivity growth is a cause of concern among economists and policy makers, most notably the Bank of Canada governor, David Dodge. The Finance Minister, Ralph Goodale, tried to address the productivity dilemma in the fall fiscal update, by offering corporate tax cuts, and money earmarked for skills training.

Productivity growth, or output per worker, is crucial to raising income and standards of living. By squeezing more work out of fewer resources, more income can be distributed back to workers in the form of higher salaries or benefits, to further investment in new industries or to shareholders.

Until recently, Canada’s productivity growth had been stagnant. But for third quarter, the country’s posted growth of 0.8%, the best increase in four years.

Mr. Milway’s group is charged with analyzing the macro- and microeconomic factors behind Ontario’s economic progress. The Ontario Liberal government has complained of a $23-billion gap between taxes paid to Ottawa and services received by the province.

Mr. Milway said the current fiscal framework Ontario has criticized is also responsible for the country’s stagnant productivity growth. Under the system, Ottawa distributes equalization payments, in which provinces with above-average incomes transfer wealth to provinces with below-average incomes. Ontario and Alberta do not receive equalization payments under the federal formula.

“The fundamental problem is that fiscal federalism in Canada is weighted dramatically toward the consumption of current prosperity — in this case consumption by the have-not provinces of the current prosperity of the have provinces — rather than investment in building future prosperity,” Mr. Milway said.

Investments in infrastructure, skills training, and new machinery and technology are seen as key elements in ensuring gains in productivity growth.

He acknowledged that transfer payments do succeed in raising personal-income levels in have-not provinces. But they are is less successful in boosting the growth of GDP in those have-not jurisdictions. “The evidence indicates that Canada has been less successful than the United States in narrowing the dispersion of GDP per capita, or wealth-creation potential.

His research indicates that over the past 20 years, roughly $1,400 per person per year has moved from have to have-not provinces. The bulk of this cash has been in the form of equalization payments, health and social transfers, and EI benefits.

“This cannot be seen as a successful program. In a successful program of fiscal federalism, the resources transferred to have-not provinces would lead to faster development of productivity and competitiveness in the have-not provinces,” Mr. Milway said. “That has not happened.”

The paper concludes Ottawa must rethink the way fiscal federalism works, and offers solutions, such as:

  • Shift money spent on transfer payments to finance tax cuts aimed at improving business investment.
  • Stop negotiating ad-hoc deals with individual provinces, such as the Atlantic accord. “The current system is losing any coherence it might have had, and this needs to be fixed.”
  • Develop a more disciplined approach as to how to deal with “surprise” federal budget surpluses. Currently, any more-than-expected amount is used to pay down debt.
  • And reform the Employment Insurance program, which Mr. Milway referred to as a taxation program. EI premiums must be significantly reduced so it can match benefits paid out, with the surplus put in the hands of employers and workers.

© National Post 2005