How The Provinces Broke Their Confederation Deal: Eternal dependency wasn’t supposed to happen

Commentary, Equalization, Frontier Centre


Canadians should know that while the practice of Ottawa subsidizing some provinces is as old as Confederation, as are debates about its usefulness, such subsidies exist not because our founding fathers wanted it that way; instead the Dominion government agreed to a limited set of provincial transfers and with some conditions attached.
Our Confederation-era fathers did so to prevent provinces from levying tariffs on each other’s goods (then their main source of revenue) and to prevent the provinces from introducing income tax. At the time, such settlements were seen as “full and final” and were not expected to be made more generous.
So much for that faint hope. 143 years later, Ottawa will subsidize provincial budgets with $65 billion this year. And while provincial governments don’t levy tariffs, they do have other interprovincial barriers to trade, and of course, provincial income tax.
Which brings me to equalization. Anyone who gets the math understands the bizarre policies and programs that result from equalization. The traditional “have-provinces” of Ontario, Alberta and British Columbia get the short end of the fiscal stick, with net outflows of taxpayer money from those three sent (in the form of federal tax dollars) to other provinces through federal transfer programs.
For the record, Ontario received equalization in the now-ending budget year and will also receive cash next year but that’s an anomaly. Also, when all transfers are added together on a net basis, Ontario’s residents still send more money than is sent back to Ontario.
Equalization produces bad policy, such as below-market hydro rates in Quebec and Manitoba; cheap, universal daycare in Quebec including for millionaires who can afford to pay the full cost; and over-staffing and above market rates for public servants in Atlantic Canada.
There are exceptions. New Brunswick’s Liberal government under Premier Shawn Graham has done some smart work on tax policy, for example, trying to make that province more attractive to business and personal investment. It’s a laudable step in the direction of eventual self-sufficiency.
But that’s the exception and defenders of the status quo apparently think free money has no effect on behaviour–see lottery winners to disprove that claim.
In response to such facts, and to the study published by myself and a colleague on equalization, here are a few objections I’ve received.
“Everyone pays for equalization because people in every province pay federal taxes.” True, and irrelevant. If ten people throw money into a poker game and six people leave with the winnings, four people have lost money. That’s how equalization works.
“Higher income taxes explain the more generous service in the have-nots.” Wrong. Own-source provincial revenues are part of any provincial budget. But some provinces are much more dependent on Ottawa than others: Dependency ranges from a high of 35 per cent of the budget in Prince Edward Island to a low of seven per cent in Alberta.
Let’s put this in personal terms. If some kid earns $65 and her allowance is $35, it’s not difficult to see the possibility for extra spending.
“Equalization is constitutional.” Correct, but the Constitution doesn’t mandate any particular level of support nor a specific design. Besides, as a Fraser Institute study noted several years ago, “this debate over the specific requirements of the Constitution’s equalization commitment ignores a more fundamental issue: equalization uses federal revenues to fund spending in areas of provincial jurisdiction. As a result, its legality cannot be resolved without considering the larger question of the federal government’s spending power.”
Constitutional quibbling about equalization aside, no federal government will risk votes in have-not provinces by dumping equalization even if, as the Fraser Institute asserts, equalization’s constitutional status is unenforceable.
That leaves politics. A sensible reform to equalization, and perhaps to other federal transfer programs, is to swap federal payments for tax room, as much as is necessary to cut the apron strings between Ottawa and the provinces without revenue loss to the latter, otherwise they’d never agree.
But to make that deal more likely—to provide a stick (no increases in transfers) and a carrot (control over more tax room for the provinces), Ottawa should, in the meantime, freeze equalization spending. Equalization is one-third more expensive than five years ago; overall, all federal transfer programs cost $20-billion more now than in 2005.
Historically, Ottawa more than kept its word on transfer payments, absurdly so. But the provinces, with multiple non-tariff barriers still and income tax collections, never kept theirs.