Equalization, Boon or Boodle?

A new study on regional transfers in Britain confirms the experience of other countries. Equalization harms recipient areas by allowing them to avoid reform of economically destructive policies.
Published on August 4, 2006

Last week Canada’s premiers put a brave face on their failure to come up with a provincial plan to increase and divide up the boodle called equalization. Let’s hope the jig is up and the Harper government puts the brakes on expanding these easy federal subsidies. The country’s most dysfunctional, long-in–the-tooth spending program hurts the provinces that receive the money.

In the rhetoric of its defenders, the heart-warming concept of equalization evokes feelings of sharing and caring. None of them understand that it promotes an oddly proactive stagnation. In Manitoba, it creates what has colorfully been described as a “perfect calm”, and less delicately as the hidden force behind a “zombie economy.” The free money supports well-funded but decidedly mediocre public services, an oversized public sector and a structural bias towards punitively high taxes. Our political leaders in all parties tiptoe carefully around the status quo, since tax cuts and efficiencies in government produce equalization clawbacks.

It’s not unique to Canada. Good intentions have headed several countries down this wrong-headed path, with familiar problems. Keep in mind the eerie parallels from Manitoba and Canada as you read the following international experiences.

In Sweden, the wealthy Stockholm metropolitan area sends billions in regional subsidies out to the poorer hinterlands. Stockholm has embraced public sector innovation and reform; health services, for example, are purchased from an array of competing public and private providers, a policy that’s generated significant improvements in service and efficiency. Meanwhile the regions receiving equalization just pop the easy transfer monies into old monopoly models, and their people are stuck with long waiting lists and shoddy service. Why not? Someone else pays.

The next example has ominous implications for Canada. In the troubled country of Belgium, the Flemish north is tired of subsidizing the socialist stagnation that rules the French south. Unsurprisingly, that region supports a flourishing separatist party which campaigns on a “final solution” for ending the dysfunctional transfers. Similar sentiments are common with a growing number of Albertans tired of shipping money to perpetually underperforming, “have not” provinces. Among Alberta separatists, equalization looms large.

This week, Reform, one of Britain’s leading think tanks, provided another fascinating international glimpse into dysfunctional transfer policies. Its cleverly titled study, “Whitehall’s Last Colonies,” contains statistics which show that a decade of massive increases in public spending pumped into Britain’s economically challenged regions — the north country and Wales — has simply bloated the government sector, increased dependence on southern taxpayers and accelerated the export of talented young people to London and the prosperous south.

The Australian state of Tasmania increasingly depends on federal transfers to run its affairs, with 65% of its 2004 budget courtesy of the federal government. At that level of dependency, the state stands to lose little by maintaining a tax and regulatory climate that repels private investment. An old-style public sector dominates the economy. Young people with more ambition than obtaining a subsidized government sinecure flood to other Australian states to participate in the opportunities available in a dynamic economy driven by the private sector.

An articulate 2002 critique
of Australia’s equalization system identified problems which, once again, resonate in this country. It refers to “game-playing” by bureaucrats in recipient states who redefine activities and slip in increases in taxation and spending to maximize federal payments. Significantly, the system creates “a tendency towards a reduced effort on cost-reducing reform.” The study calls it the “flypaper effect:” ”Money ’thrown’ at a State government tends to stick, even though the welfare of households would be better served by it if the money were passed on to them through lower taxes.”

That Canada suffers from the “flypaper effect” is confirmed in a set of two new papers jointly published by the Atlantic Institute in Halifax and the Frontier Centre. The data shows that equalization is mostly wasted because it gives the “have nots” the ability to expand the size of their public sectors and their debt.

The money allows Manitoba, for instance, to employ 32 more public servants per thousand than the national average. “The equalization-receiving provinces have larger than average public service employment, higher than average public sector wages, and higher than average levels of debt. Simply arriving at national average levels of these performance indicators would release two provinces – Manitoba and Québec – entirely from reliance on equalization, and reduce the dependence of the others to a very significant degree. Instead of providing reasonably comparable services at reasonably comparable levels of taxation, the recipients of equalization appear to be providing inflated levels of public service costs.”

The death knell for the expanding equalization gravy train can be found in other statistics. All the “have nots,” particularly Manitoba, should have lower service delivery costs because they have slow-growing, relatively stagnant local economies. But they don’t. They deliver public services at much higher cost than in Ontario, which funds a large share of equalization. That’s why Premier Dalton McGuinty put the kibosh on Gary Doer et al’s plan to enrich a well-intentioned but very flawed program any further.

That’s a big wake-up call for Manitoba and its panhandler “have not” pals in other provinces.
In the long run, it’s a positive development. Much of the archaic, low-performing policy edifice in Manitoba is propped up by easy money from Ottawa. A slowdown in the flood of equalization boodle means we will have to pull up our policy bootstraps, slim down government and work to build on our real advantages of plentiful energy, talented human resources and a diversified economy.

We should hail the failure of the Premiers’ recent shindig. We will all be better for it.

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