Declining Equalization Payments and Fiscal Challenges in the Small “Have-not” Provinces

Research Paper, Equalization, Ben Eisen, Dave Murrell

This paper analyzes the fiscal condition of the four small, comparatively low-income Canadian provinces that rely on equalization payments as a source of revenue: Manitoba, New Brunswick, Nova Scotia, and Prince Edward Island. Specifically, we examine recent trends in the size of equalization payments to these provinces. We find that since Ontario began receiving payments in 2009/10, those provinces have experienced a marked decline in their share of equalization payments. More importantly, equalization payments as a share of nominal provincial GDP in those four provinces have declined. Finally, we analyze the impact of declining equalization payments on provincial finances. We conclude that the four smaller provinces must adjust to the new fiscal realities surrounding equalization payments and exercise spending restraint to align expenditures with revenues.

This study analyzes the fiscal conditions of the three Maritime provinces (New Brunswick, Nova Scotia, and Prince Edward Island) and Manitoba. These four provinces share several key characteristics: they are small, relatively low-income provinces that have relied historically on equalization payments from the federal government as an important source of revenue. In addition, these provinces face considerable fiscal challenges, with significant current budget deficits and high levels of net debt exacerbated by declining equalization payments as a share of gross domestic product (GDP).

The long-term trend towards reduced equalization payments has been primarily a function of the gradual economic convergence of lower- and higher-income provinces. Since fiscal year 2009/10, however, when Ontario became a “have-not” province, the share of equalization payments received collectively by Ontario and Quebec–the two largest provinces–has increased markedly, resulting in relatively sudden and steep reductions in equalization payments as a share of nominal GDP to each of the four provinces in our study. This decline in equalization payments has contributed to the size of persistent budget deficits in these provinces.

Importantly, federal “stinginess” with respect to fiscal transfers has not been a primary driver of declining equalization payments. In fact, although total federal transfers as a share of GDP dropped during the cost-cutting period of the 1990s, they have since increased and are now nearly equal to what they were in the high-spending period of the 1970s. Thus, reduced payments to the four provinces in our study are not a function of a shrinking transfer “pie,” but the result of Ontario and Quebec consumer bigger slices of it.

Given that total federal transfer payments as a share of GDP are already high in historical terms, that the federal government has explicitly stated it will not increase transfers, and that it is risky to depend on an economic turnaround in Ontario and Quebec, we conclude that the prudent course for the four provinces in our study is to assume that help is not on the way. Instead, each province will have to address its own fiscal challenges through spending restraint and frugal fiscal management.

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