Equalization Status Quo is Unacceptable

Canada, Commentary, Equalization, Eric Merkley, Uncategorized

Canada’s equalization program has been controversial since its adoption in 1957. Equalization is a system of transfer payments designed to address fiscal disparities between provinces with the goal of allowing less-prosperous provinces to provide comparable levels of public services to their wealthier counterparts.

Supporters see it as an essential tool for balancing social services across provinces with vastly different resources. Critics, on the other hand, see it as a subsidy that wastes billions of dollars and results in poor public policy.

What can’t be disputed, however, is that the equalization program has real and unending costs to taxpayers in Alberta, Ontario and British Columbia. And, these costs need to be front-and-centre in any interprovincial discussion of the program’s future.

In 2007, the federal government announced a change to a per-capita funding model for the Health and Social Transfer.  However, the source of the largest country-wide transfer inequity – equalization – remains unreformed. Ontario has contributed $35-billion due to equalization transfers since 2005 and continues to be a net-contributor to the program. Alberta, on a per-capita basis, has been increasingly footing the bill for equalization – amounting to an incredible $4,300 per resident since 2005.

Now, Newfoundland and Labrador is a net-provider with the influx of oil revenue, Ontario’s contribution has been smaller, and Alberta’s contribution is larger than in the past. But, there can be no doubt that Alberta, Ontario, and British Columbia have shouldered the largest burden of the program, and will continue to do so for the foreseeable future.

It is easy to assume that these expenditures are a necessary for a healthy Canada, but, to these provinces, the costs are real. To put the cost in perspective, Alberta could have expanded the Heritage Fund by 100 per cent with the money that was transferred out of province since 2005. A family of four could pay full tuition for a three-year undergraduate program, or 90 per cent of the minimum down payment on an average house in Alberta if the transfer dollars were returned on a per-capita basis. The government of Ontario, drowning in a fiscal crisis, could chip 37 per cent off its massive deficit, or pay for an ambitious infrastructure plan.

These potential investments, by governments or taxpayers, have downstream benefits for their provinces. Equalization robs residents of donor provinces of these opportunities. The very real costs of the equalization program to these provinces cannot be easily dismissed.

Consequently, Canadians need to have a serious conversation about whether the current equalization program is worth its price to the taxpayers of these three provinces. The evidence suggests otherwise. The winners and losers in the equalization game have changed little since the 1960s, and if anything, the gaps between net-recipients and net-providers is widening rather than narrowing. Equalization is a drag on economic growth in net-recipient provinces, which has widened the gap between the have and have-not provinces. Moreover, equalization has bloated the government bureaucracies of the net-recipient provinces to the point where they are advantaged, not disadvantaged, in the provision of social services, particularly education and health care.

Late in his life, the godfather of equalization theory, James Buchanan, stepped back from supporting this idea because of the perverse incentives inherent in the program. Although we would do well to heed his warning, for better or worse equalization is included in the Constitution Act of 1982. We have to look for ways to make the program fairer and more equitable for all provinces.

There are several ways to reform the program, while adhering to the spirit of the concern about equality between provinces. For example, transfer payments can be reduced, thus curbing the burden on all provinces. Or, payments can be adjusted based on the cost of program inputs. This would have the benefit of taking into account the cheaper cost of providing public services in have-not provinces due to lower prices. Finally, we can explore tying payments to policy outputs, which would address the problem of have-not provinces being given an advantage in public service provision due to equalization. This option would bring the equalization program closest to the intention of the constitution that ensures that all provinces “have sufficient revenue for reasonably comparable levels of public services.”  These possible reforms are worth debating because the cost of the status quo is simply too high.