Fixing Hydro Subsidies – Tip of the Equalization Reform Iceberg

Blog, Equalization, Peter Holle

It was a busy media day for me on Thursday as news  broke that the feds may actually be looking at substantive reforms of Canada’s dysfunctional equalization system.  One of the mooted reforms targets the exemption of hydro electricity from the equalization formula’s calculation of a province’s revenue generating capacity.

This quirk in our overly complicated equalization system effectively rewards Quebec and Manitoba for selling their hydro-electricity at prices below market value. A few months ago I connected the dots in a National Post column which can be found by clicking here.

The smoking gun in that commentary is an estimate of the hidden subsidies flowing to Quebec for selling its hydro below market value domestically over the last few years.  If you add it up over the 6 years we could find data, Quebec received over 33% more equalization transfers than it would have had its hydro resource received the same treatment in the formula as Saskatchewan or Alberta’s oil.  It added up to a stunning extra $15 billion in “over-equalization” between 2005 and 2010.

Of course, Quebec can be expected to fiercely oppose any attempts to remove this egregious hidden subsidy.   Pray the feds don’t blink and proceed  rather to spell out the compelling case for this long overdue reform.

Meanwhile, our local NDP government in Manitoba should understand that the change won’t impact its finances going forward.  The backdoor gravy train of the hydro exemption in the equalization formula spun billions of extra subsidies for the Keystone Province in the early 2000s when power prices were strong in Minnesota and Wisconsin.  But prices in those markets have fallen with the recession and the advent of inexpensive power from new discoveries of cheap shale gas.

Including hydro in the formula will impact Quebec because it is next to the lucrative and comparatively higher priced New York – New England power market where prices will remain relatively high for various reasons.

While these proposed reforms will be seen as very scary by many in our cautious ruling political class, they must still be seen for what they are.

We need to look at the tweaks purportedly being considered as more patches on a very patched up and dysfunctional transfer payment system.   Our present equalization system rewards politicians for lowering the country’s productivity by building up overstaffed and lower performing public sector service models.  It gives them more transfers if they choose to have higher than necessary taxation levels.   They can make billions extra by having environmentally irresponsible lower than market prices for hydro.

In short, it is a source of policy mess extraordinaire.

It would be much better to junk the whole aged system and look to a simple big bang solution more suitable to a fast moving world where agile and efficient governments, responsible power pricing, and competitive taxes are critical to economic and social success.

So why not just swap the GST, a federal tax, to the provinces for an end to this perversely obsolete and incomprehensible policy relic called equalization?