The Coming War of the ‘Have-Nots’: The system is deeply biased against Ontario

Commentary, Equalization, Frontier Centre

Caterpillar’s closure of t he Electro-motive Diesel plant in London, Ont., is troubling, not just because of the loss of 465 wellpaid jobs, but also for what it says about Ontario’s ability to compete for manufacturing jobs.

Ontario’s relative decline is likely to put further strain on the fabric of the Canadian federation, threatening already fragile national unity, as “have” and “have-not” provinces battle over transfer arrangements.

One of the ties that bind us as a country is the understanding that Canadians will have comparable levels of health and education services, at comparable levels of taxation, wherever they happen to live — indeed, it’s a principle set out in the constitution. The mechanism that makes this possible is the federal equalization program, which measures each province’s ability to raise tax revenues and then redistributes billions of dollars ($15.4-billion in 2012/13) to the provinces deemed to be below the average “fiscal capacity” of the 10-province standard.

Caterpillar’s announcement is symptomatic of Canada’s diverging economies — one predominantly eastern and struggling; the other, mainly western and soaring on the back of high commodity prices.

Caterpillar seems to have been a particularly unscrupulous employer, intent on closing down the plant, even while it dragged its employees through the charade of wage negotiations that were never going to bear fruit.

But higher wages, soaring energy costs and lower productivity relative to the U.S., not to mention the Canadian dollar trading at par, have made Ontario increasingly uncompetitive for global manufacturers.

Throw in the protectionist “buy America” legislation and new union-busting legislation in Indiana, where Caterpillar has another locomotive plant, and the ageing Electro-motive factory was always likely to be a target.

The slide in manufacturing in Ontario has already turned it into a have-not province. In the coming fiscal year, the province will receive $3.2billion in equalization. This compares to $7.4-billion for Quebec; $1.6-billion for Manitoba, $1.5-billion for New Brunswick, $1.2-billion for Nova Scotia, and $337-million for P.E.I. Alberta, B.C., Newfoundland and Labrador and Saskatchewan are above the average and are, therefore, net contributors.

The problem is that even this level of redistribution is unlikely to prove rich enough in the years to come, as Canada’s manufacturing heartland continues to decline, at the same time as its resourcerich provinces benefit from high commodity prices.

Former Bank of Canada governor David Dodge, speaking to an audience in Calgary Tuesday, predicted the changing nature of international terms of trade will “jeopardize the sustainability of the current system,” noting that 70% of the population now lives in “have-not” provinces.

Mr. Dodge said Ontario will inevitably require a larger slice of intergovernmental transfers over the next eight years — from 15% to 25% in 2020 — receipts he calculates will amount to $5.5-billion. Because Ontario pays in more than it receives (Ontarians currently pay for around 38% of the program through their income, consumption and corporate taxes) the net cost to each citizen is estimated to fall to $173 from $246.

Canada’s diverging economy will yield strains between Western “have” and Eastern “have-not” provinces — Mr. Dodge calculates that the average Albertan will contribute $920 by 2020, up from $687 currently. But perhaps more concerning for national unity is the anticipated rise in tension between Ontario and Quebec, as they compete for scarce equalization dollars.

Dwight Duncan, the Ontario Finance Minister, foreshadowed the coming fiscal hostilities in an interview Tuesday, where he pointed out that Ontarians are subsidizing services such as $7a-day daycare in Quebec that are not available in their own province. “This year, we’ll put in $6-billion and get $2.2-billion back. The system is deeply biased against Ontario,” he said.

He pointed out that Quebec and Manitoba don’t charge their citizens the market rate for hydro, which reduces profits at provincially owned utilities. In turn, this lowers their fiscal capacity and rewards them with higher equalization payments. If these revenues were included, Ontario and the Maritime provinces would receive more.

“The formula has been gerrymandered and what is left is unrecognizable from the original intent. For example, Newfoundland doesn’t have to take into account its oil and gas reserves…. This is a threat to the fabric and cohesion of the country,” he said.

Mr. Duncan admits he doesn’t have an answer that would resolve the situation, other than to “start all over again” when the existing formula to calculate equalization runs out in 2014.

Mr. Dodge suggested a number of ways to tinker with the formula to temporarily reverse the divergence — for example, by modifying or removing the cap on equalization payments that limits growth of the program to increases in the size of nominal GDP in the wider economy; including marketrate hydro revenues; or, excluding natural resource revenues when measuring fiscal capacity.

Another study released this week by Peter Gusen, the former director of federal-provincial relations at the federal Department of Finance, advocated the program take in to account the cost of delivering services when it allocates equalization funding. If “need” was factored in, Ontario would have received an additional $822-million in 2008-09. Provinces where cost-of-living expenses are skyrocketing, like Alberta, B.C., Saskatchwan and Newfoundland and Labrador, would also have received millions more, mainly at the expense of Quebec, which would have lost $3-billion.

However, Mr, Dodge concluded that no matter how the equalization formula is modified, it is unlikely to be able to satisfy the consititional demand of comparable services at comparable tax levels.

“In all likelihood, the best that these transfers will be able to support is a minimum acceptable level of provincial services at a not unreasonably higher level of provincial taxation,” he said.

In other words, the laws of economics are going to dictate that if you want better funded health and education systems, go West.

The closure announcement of the Caterpillar plant has coincided with an oil price nudging $100 a barrel, thanks to rising tension in the Middle East.

These developments are, of course, not unrelated. Strong commodity prices have strengthened the Canadian dollar and made manufactured good exports more expensive.

The harsh reality is Canada has a two-track economy that will increasingly pit region against region. In the coming years, Ottawa may be less a head waiter to the provinces, and more a referee attempting to adjudicate their fiscal disputes.