End Equalization Squabbling

Commentary, Equalization

If Quebec premier Jean Charest’s recent outburst is any indication—he called Prime Minister Stephen Harper a liar over Ottawa’s plan to restrict the rise in equalization payments to economic growth—no amount of federal largesse dropped into the lap of provincial treasuries is ever enough.

Charest, apparently, is of the belief that no matter the recession’s effect on federal coffers, Ottawa is anyway expected to ratchet up equalization transfers according to plans hatched when oil was at $147 a barrel.

Reality check, please: In the current fiscal year, equalization payments will cost Ottawa $13.6 billion; that’s up by $2.7 billion over three years and Quebec received most of that increase. It will garner $8 billion this year, up $2.2 billion from three years ago.

The provincial complaints will never stop so here’s a possible remedy: Ottawa should hand the GST over to the provinces in exchange for an end to equalization.

Here’s the math and how it would need to work. Permanently dump equalization ($13.6 billion for have-not provinces) along with the equalization-related offshore accords ($850 million) and territorial financing (over $2.3 billion) and the federal government saves $16.8 billion.

If in exchange, Ottawa kicks the GST over to the provinces who add it to their provincial sales taxes, that’s worth $26.8 billion to them. Ottawa is out $10 billion annually on a net basis.

But the calculations can’t stop there. A straight GST-equalization switch would benefit some provinces and cost others.

Using a rough per capita calculation, Ontario would win big: it would receive $10.4 billion in new sales tax revenue; Saskatchewan would benefit by $819 million; Alberta, which would have to replace the GST with its own PST, garners almost $2.9 billion; British Columbia would take an extra $3.5 billion to the provincial bank.

So they would be happy. But the have-not provinces would be unhappy. Collectively, the have-nots would lose $7.6 billion in the equalization-GST swap because that’s been the point of equalization—to transfer revenues from haves to have-nots, via Ottawa.

The federal government would need to do one more thing: take on some provincial debt, enough from each province that loses in the GST swap to make the switch a wash.

Is this realistic? Not in the short-term with massive federal deficits thanks to so-called stimulus measures. Ottawa would need to sacrifice a net $10 billion in the GST-equalization swap; it would then incur an extra $7.6 billion in annual interest payments because of the additional (provincial) debt it assumes. That’s a $17.6 billion net loss for federal revenues. Ouch.

There would be understandable provincial objections. Have provinces such as Alberta (with zero debt) would object that a debt swap rewards fiscal profligates such as Manitoba and Quebec, courtesy of tax dollars sent from places like Alberta, B.C., Saskatchewan and Ontario.

The critics would be correct. But that’s what equalization does now. A GST/debt swap for equalization’s death only makes explicit what is now implicit in the equalization program. The question is how to change the incentives.

Given the present fiscal reality, why bother with this policy possibility? Because, first, it reveals what sensible policy choices are about to be forsworn by throwing tens of billions at a fake “stimulus” in Tuesday’s budget; second, it reveals just how much equalization takes from the have provinces. For the record, even when Ontario starts to receive a few hundred million in equalization payments in the new budget year, it will still sacrifice a torrent of cash because of federal transfers.

But there would be benefits and this is the third reason why the idea should be put on provincial and federal radar screens: anything that gets Ottawa and the provinces out of each other’s fiscal hair, and which makes each level of government clearly responsible for its own taxation and spending policies is positive.

With equalization, there’s no need to reform provincial spending and tax policies to make them more efficient. In fact, the incentives run the other way.

For example, Manitoba charges $1.2 billion less than market rates for its provincially-owner power, effectively subsidizing local consumers; Quebec subsidizes daycare for every participating family regardless of whether they are poor or rich. End equalization and provinces might just decide such subsidies are unwise.

Changing the perverse incentives due to equalization is a useful goal. It’s one all federal parties should remember if and when Ottawa’s books return to a surplus position.

Swap Equalization Funding To Provinces In Exchange For GST chart (PDF)