It’s Time to Wake Up from Equalization Nightmare

Charles Cirtwill, Commentary, Equalization, Role of Government, Uncategorized

ONTARIO accounts for roughly 41 per cent of the national economy. Quebec represents another 20 per cent. Add in Manitoba and the Maritimes, and more than two-thirds of Canada’s wealth-generation capacity now qualifies for equalization payments. This includes the two biggest provinces in terms of population and economic activity. Doesn’t anyone else out there think that is crazy?

No? Then how about the fact that provinces receiving equalization all share some very disturbing characteristics: massive and growing debts, despite the annual infusion of no-strings-attached money; higher taxes and larger and higher-paid bureaucracies; coal mines, steel plants and fisheries kept open years after they ceased to be economically sustainable; insanely low electricity rates and unsustainable electricity consumption because of it; and systemically high unemployment as a result of years of failed government experiments in subsidizing the “industry of the week.”

Even Ontario, the newest member of the club, is failing the test of fiscally responsible government policy. It has spurned the national call for a combined corporate tax rate of 25 per cent and Ontario’s provincial government expenditures have grown more than double that of economic growth in four of the past five years. Yet the response from the federal government is to hand it an equalization payment. Is this not ridiculous?

This is not what we set out to accomplish. Equalization is supposed to ensure that all Canadians, no matter where they live, can access basically the same public services for basically the same cost. Equalization is not supposed to reward bad behaviour with federal cash. How did something so well intentioned go so wrong?

The equalization formula is intended to top up revenues in the receiving provinces to some standard or average level to ensure that all provinces have roughly equal ability to pay for services for their citizens. Through most of its history (though not always), that equalization standard has been some measure of the national average fiscal capacity or ability to raise revenue. Yet, based on the current standard, provinces representing more than two-thirds of the national economy and more than 70 per cent of the population now qualify as below average.

Let’s consider why this is happening. It is not because Ontario is in decline (its economy actually grew last year; it just grew more slowly than it had in the past). To put it bluntly, our collective bill for equalization is higher because some of us have more oil than others (or natural gas, or uranium, or some other natural resource windfall). Consumers around the globe are paying more for these products right now and so the cash coming into those provinces has spiked remarkably. This volatility is just one of the reasons why natural resource revenues should not be in the equalization formula.

For that matter, “volatile” may not be a strong enough word. In Alberta, it was once estimated that a 10-cent shift in the price of natural gas meant a change of $142 million in provincial revenue. In the past year alone, natural gas has gone from $7 per thousand cubic feet to $13 and now back to about $6.50. That’s 60 10-cent increases followed by 65 10-cent decreases – or an $8-billion increase in provincial revenue immediately followed by $9 billion disappearing. Truly, smoke and mirrors.

So, instead of a program which eliminates disparities by rewarding recipient provinces for better policy, that builds the local economy in a sustainable fashion, we have a formula that essentially subsidizes “business as usual” behaviour based on the capricious success of others. As a result, the program perpetuates the very inequities it is intended to diminish. Equalization does not level fiscal capacity over the long term. It gives poorly performing provinces too much government and not enough incentive to keep costs down and the business climate attractive.

This all really begs the question whether transfers are the solution to delivering the same services to all Canadians, as opposed to encouraging provinces to build their own economies and pay their own way – such as through better taxation policy and reducing, or at the very least controlling, government spending that has outpaced economic growth by a wide margin.

The dream of comparable services for all Canadians has turned into the nightmare of entrenched disparity and dependence. Canada is not made fairer by a system that rewards bad and irresponsible behaviour. Huge growth in federal transfers driven not by “poverty” in some provinces, but by temporary natural resource windfalls in others, doesn’t help either. It is time to wake up and get back to the drawing board on equalization.

Charles Cirtwill is the executive vice-president of the Atlantic Institute for Market Studies, an independent, non-partisan think tank based in Halifax.