Canada’s equalization formula needs to change. Here’s why.

Commentary, Frank Atkins

In the fall of 2014, the government of Nova Scotia banned hydraulic fracturing, commonly known as fracking.

Fracking could have developed industries and created jobs and wealth in the province.  This could have ended Nova Scotia’s long standing status as a “have not” province, much the same as what happened in Newfoundland and Labrador. Of course, this would have also ended Nova Scotia’s reliance on equalization payments. Instead, the province has chosen to continue to survive by receiving transfer payments, rather than developing new industries. 

This is one of the core problems with the current equalization system. In its current form, it destroys incentives for economic development. Clearly, this was not one of the goals of the equalization system when it was created in 1957, but rather is a result of what politicians politely call unintended consequences of policy.

Situations such as this point out the need for serious reform of the equalization system in Canada.

The second example involves the Energy East pipeline. A group that calls itself the Communauté métropolitaine de Montréal (MMC), which is headed by Montreal Mayor Denis Coderre, recently announced strong opposition to the Energy East pipeline. It is not clear whether MMC understands this, but equalization plays a role in this decision.

Under the current funding arrangements, the equalization formula does not count the market value of hydroelectric power produced in Quebec, but rather the highly subsidized price at which hydroelectric power is sold in local markets. This anomaly creates a perverse set of incentives. Power is sold in Quebec in local markets at a highly subsided price, and this reduces the amount of revenue that gets counted in the equalization formula, thus artificially increasing the amount of transfer payments received by Quebec. 

The Frontier Centre for Public Policy estimates that, over the period 2005-10, if the funding formula were corrected for this anomaly, Quebec’s equalization payments would have decreased from $42.4 billion to $28.1 billion. Given that a large portion of the equalization payments have traditionally come from Alberta, which is a large producer of oil, the conclusion here is that Alberta’s transfer payments to Quebec are actually subsidizing cheap hydroelectric power in Quebec (this is also true of Manitoba’s hydroelectric power).

These two examples show how the current equalization system creates the wrong incentives for economic development. It also creates a politically divisive atmosphere in Canada. In the case of Nova Scotia banning fracking, it is somewhat difficult for provinces such as Alberta to understand why Nova Scotia can ban fracking, yet receive transfer payments from a province that uses fracking to generate wealth. 

The MMC opposition to Energy East also creates political divisiveness. Alberta is currently in an economic downturn caused by the drop in the world price of oil. Getting Alberta oil to world markets through the Energy East pipeline would not change the price of oil, but it would increase the amount that Alberta receives for its products, which would help alleviate some of Alberta’s current economic woes. 

Alberta then looks at Quebec, and sees transfer payments subsidizing cheap hydroelectric power, while at the same time Quebec is trying to block a pipeline that would alleviate some of Alberta’s current economic troubles.  Clearly, this is another reason why the current equalization system needs to change.

There is a growing recognition on the part of provincial and federal politicians that Canada’s equalization system needs to be reviewed and reformed, yet given the East-West dynamics and electoral math involved, there has been no serious effort made to date to determine how we can develop a more fair and responsible system.

Given that the equalization system is a federal issue, many look to Ottawa for leadership, but the reality is that if any progress on equalization reform is to be made, it must be the provinces that initiate the discussion. Until that happens, Canadians are stuck with a broken system.

Frank Atkins is research chairman of finance & capital markets at the Frontier Centre for Public Policy. He also is co-chairman of a panel on equalization fairness on behalf of the Wildrose Party.

This op ed was originally published by The Edmonton Journal on Thursday, February 18, 2016: http://edmontonjournal.com/opinion/columnists/frank-atkins-canadas-equalization-formula-needs-to-change-heres-why