Regional Subsidies in Canada

Commentary, Government, David MacKinnon

Equalization and many other subsidies provided to Canadian regions are one of the most widely discussed but least understood aspects of our national life. 

They are widely discussed because the funding devoted to these subsidies is large and their political impact significant. They are not well understood because discussion of them often involves endless technical complexity and because there is incomplete information from the federal government about how many regional subsidies exist and the funding associated with them.

An additional issue associated with equalization, the largest of these subsidies, is the extent to which leaders in recipient provinces have exaggerated its purpose.

The Library of Parliament correctly describes equalization as a program to “reduce the differences in revenue-generating capacity across Canada’s 10 provinces.” This is a limited purpose.

The purpose of the program is less clear than many consider it to be for another reason. There is some uncertainty about the meaning in law of the constitutional clause relating to equalization. It indicates that the federal government is committed to the principle of making equalization payments, not that it is required to make them.

These limited purposes and vague legal underpinnings contrast sharply with observations some Premiers have made about the program. Some feel that it is “the glue that holds Canada together.” Others have indicated that it is “a program that allows us to be a nation”. Yet another stated in a TV interview that his job is to “get into Ottawa’s pockets as much as possible” through equalization and other federal spending in his province.

This difference between the actual purpose of equalization and its legal basis on the one hand and on the other hand the exaggerated nature of the program as seen by some leaders of recipient provinces has the important effect of making reforms to the program appear much more difficult than they should be. To many, this difference makes fundamental change so difficult that change at first glance appears to be impossible.

We think that change is possible and imperative. Former Finance Minister Joe Oliver has indicated that he feels equalization is “beyond its best before date” and is in urgent need of change. We agree. We also extend his logic to many of the other approaches the government of Canada uses to subsidize regions. 

Problems with Equalization and Other Regional Subsidies

There are many specific problems associated with regional subsidies that make change imperative. These are:

  • The federal government has never studied the economic impact of equalization and other regional studies on recipient jurisdictions, jurisdictions that are net contributors or on Canada as a whole. Federal and provincial legislators and the public, consequently, have no real understanding of the economic impact of approximately $30 billion being spent on these arrangements;
  • federal legislators do not know how many regional biases and specific subsidies are incorporated in federal programming other than equalization. In fact, there are many of these and some are very large but legislative ignorance of them also makes it impossible for legislators to judge the effectiveness of the regional subsidization effort. It is hard to imagine that approximately $30 billion, including $20 billion for equalization, could be spent, as Canada is doing, by a G7 country without any serious efforts to judge the overall effectiveness of the effort and its economic consequences; 
  • similarly situated Canadians are not treated in similar ways by regional subsidies, a circumstance that often leads to profound unfairness. This is particularly evident in EI and related programs dealing with unemployment;
  • neither equalization nor other subsidies conform to Canadian standards for program design. For example, programs should be assessed in relation to the goals set for them. Since no efforts have been made to measure the comparability of provincial programming, the effects of equalization and other subsidy arrangements in achieving the constitutionally mandated goal of program comparability cannot be assessed;
  • the differing needs of provincial populations are not considered in determining equalization payments. Canada is in the remarkable position of transferring $20 billion from one group of Canadians to others without any reference to demographics or to how Canadians live and work wherever they live;
  • the scale of the regional subsidy effort has greatly damaged the market economy in many recipient jurisdictions to the extent that there are very weak or nonexistent market economies, aside from government activities and their direct spin offs, in large swaths of Canada. Cape Breton is but one example of this.
  •  This makes future competitiveness in recipient jurisdictions almost impossible and partly explains why Quebec and the Atlantic provinces are at the bottom in a Conference Board ranking of competitiveness in Canadian jurisdictions and jurisdictions elsewhere;
  • the regional subsidy system is an affront to accountability and democratic processes. One level of government raises money that another spends. Aside from encouraging excessive spending, this makes it very difficult for citizens to decide who is ultimately accountable for the program. 
  • The capacity to assign responsibility is fundamental to parliamentary democracy and damage results when it is frustrated;
  • regional subsidies such as equalization encourage risky behavior by some receiving provinces because they are protected from the consequences of this behavior by the scale of the subsidies. Many recipient jurisdictions have grossly excessive public sectors and large deficits, policies that are only made possible by the funds from subsidies flowing into them and by the implicit guarantee of federal bailouts on provincial public debt that exists. This is a serious moral hazard.

The Challenges of Change

Changing Canada’s system of regional subsidies will be very challenging, for several reasons:

  • as noted, the actual purpose of the program has been artificially elevated to the point that it appears almost too big to change without causing national unity problems. The moment serious changes are proposed, recipient jurisdictions can be counted upon to make the changes issues of national unity rather than deal with them on their merits;
  • significant changes would likely cause short term disruption in recipient jurisdictions, even if they would be better off in the medium and long term;
  • any changes to the equalization program and other subsidy problems could cause problems for Quebec even though that province’s leaders are the only provincial leaders who have recently shown any real interest in getting off equalization;
  • with two exceptions, Ontario’s leaders have not contributed substantially to any public discussion of equalization and related problems such as the extent to which EI discriminates against unemployed citizens in the province. It will be hard to have an appropriate national discussion of possible changes if the largest province continues to be an ineffective interlocutor;
  • the lack of understanding of the economic impact of equalization and of the rest of the regional subsidy system will make it much more difficult than it should be to assess the impact of changes;
  • the core economic problem in Atlantic Canada and Manitoba is massively oversized public sectors as evidenced, for example, by 16 universities for a population just over 2 million. Six of them are in Halifax, a community of about 450,000;
  • downsizing and restructuring the public sectors – the pattern in many other parts of provincial public sectors parallels the Atlantic regional experience with universities – in each of the Atlantic provinces and Manitoba will be a daunting task. It will be made even more difficult by relatively weak local economies in these provinces.

The Case for Change

Fixing a system that has so many deficiencies and problems in the face of significant barriers to change will require major efforts in planning, communication, and management. It will also take courage.

However, the case for proceeding is strong, for several reasons:

  • there is serious and growing concern about problems relating to equalization in Western Canada. One Alberta senator recently indicated that it is the first subject mentioned in conversations he has in the province. This level of concern should worry all Canadians, not just in relation to the many problems associated with the program but also because of the damage it is doing to the fabric of the federation. It pits one or two regions against others;
  • the risks associated with proceeding with it can be mitigated to some degree by steps outlined later in this note;
  • some opinion leaders in Atlantic Canada recognize that new regional goals and tools are needed, and these people need reinforcement. For example, the 2014 Report of the Nova Scotia Commission on Building Our New Economy noted that” major socioeconomic changes are making Nova Scotia weaker and more dependent. If we are to halt the slide, we must change – and quickly – the way we finance our standard of living. We are at a crossroads. The world is changing. We must change too or face the consequences;”
  • regional subsidies including equalization are major contributors to deficient economic performances in recipient jurisdictions. They have led to excessive infrastructure, national wage levels in economies that cannot support them, difficulties for the private sector in competing with governments for skilled and motivated people, governments that are inefficiently organized and unreasonable expectations by large numbers of people that governments can protect them from the market forces of the world. Without major change, these problems can be expected to persist;
  • the future of Atlantic Canada and to a lesser degree both Manitoba and
    Quebec can only darken if present trends in fiscal arrangements continue. The only recipient jurisdiction with labor productivity growth faster than the Canadian rate is Manitoba. All the others are significantly behind in this measure.
  • This problem, combined with currently poor competitive positions relative to most comparable jurisdictions, means that all recipient jurisdictions have clouded futures without fundamental changes to how they finance their current standards of living.
  • The conclusions of the Nova Scotia Commission on Building the New Economy apply to other recipients, not just Nova Scotia;
  • the scale of regional subsidies almost certainly impedes Canada’s national competitiveness in a substantial way. Transferring in the order of $30 billion from high productivity jurisdictions to those with weaker productivity may overwhelm all other federal programs that encourage economic development. This must be corrected, particularly at a time when the rules based international order is breaking down and competitiveness is becoming correspondingly more important;
  • finally, there is a fundamental moral and political reason for change. All the data available suggests that the province with the least accessible provincial programming is Ontario and that its citizens are paying, in substantial measure, for much more accessible programming in other provinces. A country that prides itself on its fairness, inclusiveness and balance needs to reflect on the significance of this.

What Should be Done?

Equalization

Current funding for equalization should be maintained to avoid a national unity crisis but the program needs to be completely reformed. 

Most equalization funding should be redirected to fund restructuring of excessive provincial public sectors in recipient jurisdictions so that the costs of managing these moves quickly to the national average in relation to population. This restructuring should be mandatory for Atlantic Canada and Manitoba and voluntary for Quebec because that province’s public sector already is closer to the national average than all other recipient jurisdictions except New Brunswick.

Some existing funding could also be used to fund pilot guaranteed income programs in each recipient province

The needs of provincial populations should be weighted equally with revenue and taxation considerations in determining equalization payments. This would ensure that the program has some relationship to how Canadians live and work and to demographics and other related issues.

Equalization should be divided into three different programs: one for Manitoba, one for Quebec and one for Atlantic Canada.

Equalization expenditures in Atlantic Canada should be conditional on the four provinces forming a common services agency to deliver at least 75% of provincial programming jointly. 

Provinces would not be eligible for equalization unless they agree not to prohibit activities underway elsewhere in Canada in environmentally sensitive ways. They would also be ineligible unless they agreed to limit growth in their public debt to the rate of growth in provincial GDP. 

Measurement

The federal government should, as a major priority, establish a system for measuring the comparability of provincial programming. Initially, this system should address accessibility with a public report to be available within a year. Later, matters related to quality and specialization could be addressed.

The economic impact of equalization should be studied, again as a priority, to identify the benefits and problems associated with the current program as well as the impact of the program on national and regional economic patterns including savings, investment, consumption and competitiveness.

Regional subsidies associated with federal programming, other than equalization, should be identified and tabulated, beginning with those linked to EI which are likely the largest but extending to all programs over a reasonable minimum threshold. 

The extent to which the location of federal employees conveys a substantial subsidy should also be identified. There is evidence that the subsidy to Nova Scotia conveyed by employment above average service levels, excluding the Department of Defence, is very nearly as large as equalization. Halifax is to a remarkable extent a federal government city.

This pattern is also evident in some other recipient jurisdictions.

Summary and Conclusion

Regional subsidies including equalization are not the caring and sharing mechanisms that are described in Canada’s public discourse. Rather, they are damaging the fabric of the federation and inhibiting national competitiveness.

The problems associated with this system are especially troubling because the damage being done is insidious. It is not immediately apparent that this system is cutting Manitoba and Atlantic Canada and to a certain extent Quebec off from futures that would otherwise be more positive. It is also not immediately obvious that millions in Ontario and to a lesser extent Alberta are significantly disadvantaged relative to other Canadians in terms of access to public services because of Canada’s fiscal arrangements.

The core elements of the regional subsidy system are now a half century old. The world has changed but this system remains largely intact.

Mr. Oliver is right. Equalization is past its best before date. The same is true for other regional subsidies. It is time to move on.