Financing Canadians’ Commitment to Sharing and Social ... · Financing Canadians’ Commitment to...

ISBN: 0-88627-382-X March 2004

CAW 567OTTAWA

by Errol Black and Jim Silver

Equalization:Financing Canadians’ Commitment to

Sharing and Social Solidarity

Equalization:Financing Canadians’ Commitment to

Sharing and Social Solidarity

by Errol Black and Jim Silver

March 2004

ISBN: 0-88627-382-X

Acknowledgements

We are grateful to Elizabeth Beale, Larry Haiven, John Loxley, Todd Scarth and Alisdair Sinclair fortheir useful comments on earlier drafts of this paper; to Ron Neumann and Rob Balacka of Federal-Provincial Relations and Research, Manitoba Finance, for making data available to us and forhelping us to clarify certain technical aspects of the equalization program; to Anne Webb for copyediting and Doug Smith for layout and design of the paper; and to John Jacobs, Director of theNova Scotia office of the Canadian Centre for Policy Alternatives, and Wayne Antony, ActingDirector of the Manitoba office of the CanadianCentre for Policy Alternatives. .

About the Authors

Errol Black is a retired Brandon University Professor of Economics, and a City Councillor inBrandon, Manitoba.

Jim Silver is a Professor of Politics at the University of Winnipeg, and Chair of the Canadian Centrefor Policy Alternatives-Manitoba.

CANADIAN CENTRE FOR POLICY ALTERNATIVES-MB309-323 Portage Ave.Winnipeg, MB • Canada R3B 2C1ph: (204) 927-3200 fax: (204) [email protected]/mb

Table of contents

1. Executive Summary .............................................................................................................. 1

2. What is Equalization? .......................................................................................................... 3

3. Federalism and Equalization .............................................................................................. 4

4. The Rowell-Sirois Commission........................................................................................... 5

5. Rationales for Equalization ................................................................................................. 6

6. How Does Equalization Work? ........................................................................................... 7

7. Who Makes Equalization Payments? ................................................................................. 8

8. The Erosion of the Broader System of Intergovernmental Fiscal Relations .............. 11

9. Fiscal and Economic Disparities in Canada .................................................................... 11

10. Fiscal Trends...................................................................................................................... 15

11. The Problem of Alberta and the Five-Province Standard ........................................... 16

12. The National Energy Program ........................................................................................ 18

13. Criticisms of Equalization ................................................................................................ 21

14. Recommendations ...........................................................................................................22

15. Conclusions .......................................................................................................................24

Tables:Table 1, Revenues Subject to Equalization, 1999-2000 .......................................................................... 9

Table 2, Federal Fiscal Balance by Province .......................................................................................... 11

Table 3, Comparative GDP and Population Data for

Manitoba, Canada and Selected Groupings of Provinces, 2002......................................................... 12

Table 4, GDP Per Capita as a Percent of Canada, Selected Provinces ............................................... 12

Table 5, Net Interprovincial Migration for the Age Group 15-49, Prairie Provinces, 1991-2000 .... 13

Table 6, Employment and Unemployment Rates, Canada and the Provinces, 1981 and 2002 ...... 14

Table 7, Average Weekly Earnings by Province as a Percent of

National Average, 1983, 1991, 2002 ........................................................................................................ 14

Table 8, Federal Transfers as a Percentage of Provincial Revenue,

Fiscal Year Ending March 31, 2001 .......................................................................................................... 16

Table 9, Impact of 10 Province Standard on Transfers to Recipient Provinces, 2002 ...................... 24

Equalization 1

Equalization:

Financing Canadians’ Commitment to Sharingand Social Solidarity

Executive Summary

Canada’s equalization program is a crucial part ofthe financial foundation of our social programs,and of Canadians’ collective commitment tosharing and social solidarity. It is a formula-basedprogram of unconditional grants paid annuallyby the federal government to all provinces with aless-than-average tax capacity. The purpose of theequalization grants is to ensure that all Canadianswill be the beneficiaries of reasonably comparablelevels of public services at reasonably comparablelevels of taxation. Canada’s equalization programis so important that it has been called “the gluethat holds Confederation together”. Since 1982it has been embodied in Canada’s constitution.

However, Canada’s equalization program is notcurrently meeting its constitutionally requiredobjectives. The program needs reform.

In this paper we describe the historical origins ofCanada’s equalization program, and we describehow equalization works. The calculationsassociated with Canada’s equalization formula arecomplex, and we attempt to describe these in sucha way as to make them comprehensible. Ofparticular importance in understanding howequalization works is the realization that, contraryto what some Canadians believe, equalization doesnot involve transferring money from well-off toless well-off provinces. Rather, equalizationpayments come from federal government revenuesso that well-off provinces, such as Alberta forexample, are not adversely affected byequalization.

We describe various rationales for the existenceof Canada’s equalization program, and address thecriticisms of equalization, most of which arerooted in the view that more of the services nowoffered publicly ought to be offered by the privatesector. A major criticism, associated primarilywith those on the ideological Right, is thatequalization payments sap the vitality of peoplein lower-income provinces, making themdependent upon government transfers. Theimplication of this view is that poor people andprovinces are poor because of some kind of moralfailing, and that people and provinces that arebetter off are in some way morally superior. Wereject this reasoning entirely.

Canada’s equalization program is necessary, weargue, because of the economic disparities acrossprovinces, including the historical accident ofdisparities in the geographic distribution of naturalresources, which is no credit to the richly-endowedprovinces and no fault of the poorly-endowedprovinces. We produce data that demonstrate theconsiderable economic disparities betweenequalization recipient and non-recipientprovinces, and which show the interprovincialmovement of Canadians from recipient to non-recipient provinces. Canada is dominatedeconomically by the provinces of Ontario, BritishColumbia and Alberta; this domination becamemore pronounced in the 1990s. Theinterprovincial movement of Canada’spopulation—and especially that part of thepopulation that is of working age— is dramaticallytoward these three provinces, and particularlyAlberta. The economic gap between have and

2 Canadian Centre for Policy Alternatives

have-not provinces has been considerablyaggravated by the fiscal policies of the 1990s. Cutsto taxes, which reduced the levels of equalizationpayments to have-not provinces, have beencombined with massive cuts in all transferpayments from the federal government to theprovinces. The result of these fiscal policies andtrends over the past two decades has been toincrease the need for equalization.

However, while current fiscal policies make astrong equalization program more necessary,Canada continues to implement the five-provincestandard for calculating equalization payments,which was introduced in 1982. This standardexcludes Alberta’s vast oil and gas revenues fromthe equalization calculations, significantlyweakening Canada’s equalization program.Because of this exclusion, the gap is wideningbetween Alberta, which is able to offer richerpublic services at lower levels of taxation, andhave-not provinces which fear the prospect oflosing skilled workers and businesses to Albertaunless they too lower their taxes, which thenimpairs their ability to offer needed public services.This situation sets in motion a process of reducedlevels of public services and declining standardsof living that is sometimes called the “race to thebottom”. The exclusion from the equalizationformula of these oil and gas revenues defeats thepurpose of the equalization program, as describedin Section 32.2 of the Constitution Act 1982,which is to provide to Canadians, no matter wherethey may live, “ reasonably comparable levels ofpublic services at reasonably comparable levels oftaxation”.

The issue of how to deal with natural resourcerevenues is rooted in the historical accident ofunevenly distributed natural resources, and hasimplications not only for Alberta, which has thegood fortune of being located on top of vast oiland gas revenues, but also for Newfoundland,

Nova Scotia and Saskatchewan, withSaskatchewan having been particularly andunfairly disadvantaged in recent years.

We conclude by advancing threerecommendations for reform which we believe areachievable and which, if implemented, willremove the current flaws in the equalizationprogram, and enable Canada to meet theprogram’s constitutionally-mandated goals. Theseare: the establishment of a Federal-Provincial FiscalSecretariat, which will provide the machinery bywhich to make the necessary, on-goingadjustments to Canada’s equalization program; acommitment to the permanent elimination of theceiling on equalization payments that was imposedfrom 1982 to 2002, and which had no principledjustification; and most importantly, a return tothe ten-province standard for use in theequalization formula, in order that all revenues,including Alberta’s oil and gas revenues, can beincluded in calculating the amounts ofequalization payments. The implementation ofthese reforms will enable Canada’s equalizationformula to achieve the worthy goals for which itwas intended—to be the financial foundation forCanada’s commitment to sharing and socialsolidarity.

Equalization 3

Equalization:

Financing Canadians’ Commitment to Sharingand Social Solidarity

By Errol Black and Jim Silver

Canada’s equalization program is the financialfoundation of the social programs that contributeso much to defining who we are as Canadians.These social programs give tangible expression tothe core Canadian values of sharing and socialsolidarity. Canada’s equalization program is notjust an arcane and complex financial mechanism;it is the financial foundation of our core values asCanadians. It is an important part of the meansby which we institutionalize a commitment tosharing and social solidarity among all Canadians.

These values are now at risk. Changes to ourinstitutional arrangements over the past twentyyears, including various free trade agreements,pose a threat to the continued integrity of Canadaas a country, and to the programs which expressour identity and our core values (Clarkson, 2002).This threat is growing as a small but powerfulminority of Canadians call for even deeperintegration of Canada into the United States(Dobson, 2002). We need strong institutions tooffset this pull, and to protect and promote ourdefining values. This is why a healthy equalizationprogram is so important.

Although Canadians are deeply committed to andconcerned about social programs, most peopleknow little about the ways in which theseprograms are financed. The erosion of socialprograms in recent decades has been the result,among other things, of subtle changes to thefinancing arrangements. These financingarrangements, especially with respect toequalization, are rather complex. In this paper we

attempt to make equalization morecomprehensible to the public. We hope this willcontribute to a more robust and informed publicdebate, and to the reform of this vital program.A window for reform is about to be created bythe expiry of the current five-year equalizationagreement on March 31, 2004, and the need tonegotiate a new five-year equalization agreementscheduled to commence April 1, 2004. Weconclude this paper with recommendations fornecessary and achievable reforms to Canada’sequalization program.

What is Equalization?

Equalization is a formula-based program ofunconditional grants paid annually by the federalgovernment to all provinces with a less-than-average tax capacity. It is important to note thatequalization payments are not transfers from richprovinces to less well-off provinces, as is oftenclaimed. Rather, equalization payments are madeby the federal government out of federal funds.The purpose of the equalization grants is to ensurethat all Canadians will be the beneficiaries ofreasonably comparable levels of public services atreasonably comparable levels of taxation. Thusequalization gives expression to Canadians’commitment to the core values of sharing andsocial solidarity, and has long been consideredexceptionally important for that reason (seesidebar on page 4).


Indeed, so important is the principle ofequalization that it is now embodied in theCanadian Constitution, as Section 32.2 of theConstitution Act 1982:

“Parliament and the government of Canada arecommitted to the principle of making equalizationpayments to ensure that the provincialgovernments have sufficient revenues to providereasonably comparable levels of public services atreasonably comparable levels of taxation”(Constitution Act 1982, S. 32.2).

The experience in Manitoba since at least the1930s can be used to exemplify how importantequalization is to those provinces which are, inrelative terms, have-not provinces. Manitobaplayed a key role in bringing into existence theRowell-Sirois Commission in 1937, and has, sincethat time and irrespective of the party label, theideological orientation or the fiscal philosophy ofthe provincial government in office, beenconsistently a strong supporter of federalredistributive mechanisms such as the equalizationprogram. Even those provincial governments inManitoba which have been committed to rollingback state expenditures and relying more onmarket forces have been strong advocates ofequalization, arguing that such redistributivemeasures are an essential mechanism for makingCanadian federalism work (Silver, 1992, 243-251).

Federalism and Equalization

Canada’s equalization system is a product of ourfederal form of government. Federalism is a systemof government with two levels of governmentalauthority in Canada, the federal and provinciallevels, and a division of powers and responsibilitiesbetween these two levels of government. A federalsystem of government was adopted in Canada atthe time of Confederation in 1867 because of a

desire by the founding provinces to maintain ameasure of control over local matters.

Immediately following Confederation an ad hocarrangement of grants and subsidies to provincesbecame necessary because some provinces did not

The Importance ofEqualization• Two decades ago the Parliamentary

Task Force on Federal-Provincial FiscalArrangements reported thatequalization was “...variouslydescribed by witnesses before theTask Force as ‘the glue that holdsConfederation together’, and ‘a pillarof Confederation’” (Canada, 1981,157).

• In 2002 the Standing SenateCommittee on National Financestated: “We are united in our beliefthat this is an important, in fact adefining national program” (Canada,March, 2002).

• A recent academic study of theequalization program found: “Theconcept of equalization, enshrined inthe Constitution Act 1982, enjoysalmost unanimous support amongCanadian politicians and academics”(Boothe and Hermanutz, 1999, p. 3).

• The Economic Council of Canadareported that it considered “thesharing of costs and benefits”embodied in Canada’s system ofequalization payments to be “one ofthe major foundations of Canadiannationhood” (Economic Council ofCanada, 1985, 125).

Equalization 5

have sufficient revenues to meet their spendingresponsibilities. The ad hoc system did not worksatisfactorily (Courchene, 1984,14-15). Thisbecame glaringly apparent during the GreatDepression. Provincial expenditures had beengrowing rapidly. Education and public welfareexpenditures, for example, grew from $4 millionper year to $360 million per year between 1874and 1937, but provincial revenues did not keeppace (Canada, 1981, 14-15). The result was a fiscalcrisis for most provinces.

The Rowell-Sirois Commission

The Royal Commission on Dominion-ProvincialRelations, more commonly known as the Rowell-Sirois Commission, was established in 1937 toenquire into the crisis of fiscal federalism.Reporting in 1940, the Commission called foran end to the “chaotic and illogical” ad hoc grantsystem and its replacement with “NationalAdjustment Grants” to be paid “whenever aprovincial government established that it couldnot supply Canadian average standards of serviceand balance its budget without taxation(provincial and municipal) appreciably exceedingthe national average in relation to income”(Canada, 1940, 83).

At the heart of the Rowell-Sirois Report was theidea that: “The provision of a national minimumstandard of social services in Canada cannot(without complete centralization of all socialservices) be divorced from the assurance to everygovernment of Canada of the revenues necessaryfor the adequate performance of its recognizedfunctions” (Canada, 1981, 26). Rowell-Siroisargued that to make such revenues available tothe provinces, a regularized system of NationalAdjustment Grants was required. In 1957 such asystem was implemented in the form ofequalization payments from the federalgovernment to those provinces with less thanaverage ability to raise revenues. The principle andmechanism which the Royal Commissionadvanced were embodied eventually in Section32.2 of the Constitution Act 1982: “the wordingof the equalization provision in the ConstitutionAct 1982 is virtually identical to the wording usedby the Commission in discussing the NationalAdjustment Grants” (Courchene, 1984, 26).

Fiscal FederalismFederalism is a system of governancein which there is a division of powersbetween central and regionalgovernments such that neither issubordinate to the other. In Canada wecall these the federal and the provincialgovernments. Each has constitutionallyguaranteed jurisdiction with respect tospecific subject areas. A reality, andproblem, of Canadian federalism is thatthe provincial governments haveconstitutional responsibility for health,education and social assistance, whichare very expensive. However, mostprovincial governments do not have thefiscal capacity to finance theseprograms; hence the importance inCanada of transfer payments, includingequalization, from the federal toprovincial governments. The details ofthe financing arrangements respectingtransfer payments are often referred toas ‘fiscal federalism.’


Rationales for Equalization

Numerous rationales have been advanced for theexistence of an equalization program in Canada.The following are the most important.

The Federal, or Constitutional, Rationale:

Equalization payments are necessary to ensure thatall provinces have sufficient funds to fulfill theresponsibilities spelled out for them in theconstitution. The cost of provincial

responsibilities,particularlyh e a l t h ,educationand socialassistance,has growndramaticallythroughoutt h etwent iethc e n t u r y .Equalizationpaymentsa r eintended toenable eachprovince tomeet those

responsibilities by providing reasonablycomparable levels of public services at reasonablycomparable levels of taxation.

The ‘Citizenship’ Rationale:

There are certain public goods and services towhich all Canadians, irrespective of where theymay live, are equally entitled as a right ofcitizenship. Equalization payments are necessaryto enable all provinces, especially the less affluent,to offer such services (Milne, 1998, 185). As a

recent study put it: “The fundamental role ofequalization is to help the less affluent provincesfinance the national programs that largely definewho we are as Canadians” (Ruggeri, 2002).

Inter-Jurisdictional Spillover:

In the absence of equalization, financially strongerprovinces would be able to offer significantly lowertaxes, thus luring skilled workers and businessesaway from financially weaker provinces withhigher taxes. These financially weaker provinceswould feel the need to compete by lowering taxes,and would be inclined to under-invest in thedevelopment of skilled workers because suchworkers might be lured away by the higher wagesand/or lower taxes of a wealthier province. Therisk of such a chain of events is that the quality oflife in the less well-off provinces would deteriorate;the education and health care and other publicservices that they could offer would be inferior tothose offered in economically stronger provinces.

The “Nation-Building” Rationale:

When Canadians in all parts of the country enjoyreasonably comparable levels of public services atreasonably comparable levels of taxation, as anentitlement of citizenship made possible byequalization payments, equalization becomes ameans of binding the country and its citizenstogether. This is crucial given the powerfulcentrifugal forces of regionalism which setCanadians apart from one another, and thepowerful pull from our neighbour to the south,which threatens to draw us ever deeper into theAmerican orbit.

The Social Justice Rationale:

Constitutional authority David Milne has arguedthat “equalization should also be justified on moralgrounds, as a question of decency and social

“equalizationshould also bejustified on moralgrounds, as aquestion ofdecency andsocial justice”

Equalization 7

justice” (Milne, 1998, 186). This is certainly aposition with which we agree. Canada’sequalization program embodies a set of valuesrooted in the virtues of sharing and of socialsolidarity. Canadians support these values. Arecent study of the last ten years of Canadianpublic opinion data found that “support for theequalization programme remains high across thecountry, even in the ‘have provinces.’ Canadiansoverwhelmingly believe that people in small townNewfoundland should have access to schools andhospitals of comparable quality to those insuburban Toronto” (Mendelsohn, 2002, vi and10).

How Does Equalization Work?

The amount of equalization payable annually toeach eligible province is determined by a rathercomplex formula. The formula determines theaverage revenue-raising capacity for Canadianprovinces on a per capita basis, then determinesthe revenue-raising capacity of a given province,on a per capita basis. Any province whose revenue-raising capacity is below what is determined to bethe “average’, or standard, is entitled to anequalization payment. The payment comes fromfederal government revenues and is sufficient tobring that province’s per capita revenue up to thestandard. Complications arise, however, inestablishing the standard against which eachprovince’s revenue-raising capacity is measured,and in determining what constitutes revenue.

What is the Standard?

When the equalization program began in 1957,the standard was set at the average revenue-raisingcapacity of the two wealthiest provinces. Thismeant that by definition, nine of the ten provinceshad per capita revenue-raising capacity below thestandard and thus were entitled to equalizationpayments. From the perspective of the federal

government, out of whose coffers equalization ispaid, this was expensive.

In 1962 the standard was changed to the averageof all ten Canadian provinces. This ten-provincestandard came to be known as the RepresentativeNational Average Standard (RNAS). From thefederal government’s perspective this was lessexpensive, but when oil prices skyrocketed duringthe energy crisis, first in the early, and then in thelate 1970s, the huge energy revenues accruing tothe energy-producing provinces, especiallyAlberta, drove the standard up and thus increasedthe cost of equalization to the federal government.

As a result the standard was changed again in1982, this time to the Representative Five-Province Standard (RFPS). The RFPS excludedAlberta and the four Atlantic provinces. This isthe standard that prevails today.

The five-province standard is part of the problemfrom the perspective of the relatively have-notprovinces like Manitoba. With Alberta’s large oiland gas revenues excluded from the standard, noneof that revenue is reflected in the size of theequalization payments. As Robin Boadwayexplains it, “...the consequence is a system thateffectively amputates a good part of the economicpurpose of equalization” (1986, 26).

Alberta’s oil and gas revenues are so lucrative thatthe province has the fiscal capacity to offer a highlevel of public services and high public sectorsalaries to skilled workers like nurses, teachers andmedical doctors, while driving down provincialtax rates. Indeed, Alberta has no provincial salestax, and the provincial government has in recentyears speculated openly about the prospect ofeliminating the provincial income tax. AsCourchene has recently described it, Alberta isable to use its “...energy revenue bonanza tomount a version of a tax haven” (2004, 9). As aresult, Alberta can lure skilled public sector


workers away from provinces like Manitoba,forcing Manitoba to respond with higher publicsector wages and/or lower tax rates, thecombination of which would then render theprovince less able to provide the full range ofquality public services, including education,health and safety, environmental protection, socialassistance, and many others that Manitobans wantand deserve. The resulting “race to the bottom”,prompted in large part by Alberta’s exclusion fromthe Representative Five-Province Standard,subverts the intention of the equalizationprogram.

What Is Included As Revenue?

In 1957, three provincial revenues were includedin the calculation of revenue-raising capacity:provincial income taxes, corporate income taxesand succession duties. Today, thirty-three revenuestreams are separately calculated, adding to thelevel of complexity (See Table 1).

Who Makes Equalization Payments?

Equalization in Canada is what is called a “gross”scheme. This means that the equalizationpayments made to the recipient provinces do notcome from the better-off provinces (which wouldbe a “net” scheme), but rather the payments aremade by the federal government. In effect, then,the equalization program does not take from therich provinces and give to the less well-to-doprovinces. Rather, it uses federal money raised bymeans of federal taxes paid by all taxpayers,irrespective of the province in which a personresides, to bring the less well-to-do provinces closeto the representative five-province standard.

Cuts to FederalTransfer Payments inthe 1990sThe social programs that are partly paid forby equalization and the CHST were put inplace, for the most part, in the late 1950sand 1960s. It was then that Medicare andthe Canada Assistance Plan (CAP) had theirbeginnings, and that the post-secondaryeducation system began its rapid expansion.The result was a rapid growth in publicexpenditures. Initially, the federalgovernment picked up approximately 50percent of the costs of these programs. After1977 and the introduction of EstablishedProgram Financing (EPF), the federalgovernment withdrew its open-endedcommitment to pay 50 percent of the costsof these programs. Over the next twodecades the federal government’s share ofthe cost dropped so much that Courchene(1994, 98) estimates that the total cost tothe provinces of changes to EPF up to 1994was $27 billion, and the total cost to thethree provinces affected by federallimitations on CAP payments was anadditional $8.5 billion. In the 1995 federalbudget, EPF and CAP were rolled togetherinto the Canada Health and Social Transfer(CHST). The dollar amount payable by thefederal government to the provinces underthe new CHST was cut by yet another $7billion between 1994-95 and 1997-98. By1999-2000 the CHST had declined to amere 13.3 percent of total health care costs,down from 50 percent under EstablishedPrograms Financing (Western PremiersConference, 2000, 5, figure 3).

Equalization 9

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The actual calculations are perhaps themost complex aspect of the equalizationformula. They are done as follows:

• For each of the thirty-three revenuesources now included in theequalization formula, a “nationalaverage rate” (NAR) of tax iscalculated. This is done by: (1)determining the total tax base for allprovinces for a revenue source (forexample, the alcoholic beverage taxbase is the total volume of beer, wineand spirits sold in a province, so theoverall tax base for this revenuesource is the volume of beer, wineand spirits sold in all provinces); (2)determining how much revenue wasraised from taxes on a revenuesource, for example, on beer, wineand spirits, in each province and inthe sum of all the provinces. The totalnational revenue divided by the totalnational tax base produces a nationalaverage rate (NAR) of tax for thisrevenue source. The same calculationis done for each of the revenuesources in the formula.

• For each province, the nationalaverage rate of tax for a particularrevenue source is applied to thatprovince’s tax base for that revenuesource. So, for example, using thecase of Manitoba and the province’s

sale of beer, wine and spirits, thenational average rate of tax for beer,wine and spirits would be appliedto the volume of beer, wine andspirits sold in Manitoba. This sumwould be divided by Manitoba’spopulation to determine the percapita yield for Manitoba.

• The per capita yield on beer, wineand spirits for Manitoba, using thenational average rate of tax, iscompared to the average per capitayield, using the national average rateof tax, for the five “representative”provinces in the formula: Quebec,Ontario, Manitoba, Saskatchewanand British Columbia.

• If a province’s per capita yield for agiven revenue source is less than theaverage per capita yield of the fiverepresentative provinces, then thatprovince is entitled to a per capitaequalization payment for thatrevenue source equivalent to thedifference.

• The total equalization paymentpayable to a province is equivalentto the sum of the deficiencies and/or excesses that are calculated foreach of the thirty-three revenuesources.

• In 2001/2002, seven provincesreceived a total of $10.8 billion inequalization payments.

How are the Calculations Done?

Equalization 11

The Erosion of the Broader Systemof Intergovernmental FiscalRelations

The equalization program is only one part,although a crucial part, of a broader system ofintergovernmental fiscal relations, or transferpayments, as they are often called. The other majortransfer payment is the Canada Health and SocialTransfer (CHST). Together, equalization and theCHST comprise almost 80 percent of the dollarvalue of all transfers from the federal to provincialgovernments, and just over 20 percent of totalfederal program spending (Beale, 2002, 3). Thesetransfer payments are necessary because the costto the provinces of delivering health, post-secondary education and social assistance is greaterthan the provinces’ capacity to raise revenue. Thegap has recently grown wider because the federalgovernment has systematically reduced its transferpayments to the provinces for the past twodecades. (See Cuts to Federal Transfer Payments inthe 1990s, page 8.)

The reductions in transfer payments is not theonly means by which the federal government hasdiminished its role in provincial economies. Therehas been a significant reduction in what is calledthe net fiscal balance (transfers to a province, plusfederal expenditures in that province, minusrevenues collected in that province). The net fiscalbalance has been reduced both in absolute terms,and relative to provincial GDP in all provinces.This is shown in Table 2, which compares theperiods 1992-96 and 1997-2000.

The result is that transfer payments from thefederal to provincial governments, includingequalization, have become increasingly necessaryas a means of offsetting the diminished federalspending in provincial economies.

Fiscal and Economic Disparities inCanada

The need for an equalization program is a functionof wide and growing fiscal disparities betweenprovinces. These disparities reflect economicdisparities attributable to several factors, includingpast government economic policies (the NationalPolicy of 1879, for example, which nurtured thedevelopment of manufacturing in Ontario andrelied on the prairie provinces to produce grainsas an export staple), and natural and historicalaccidents (such as the location of vast oil andnatural gas reserves in Alberta). In general,increases or decreases in economic disparities overtime are reflected in increases or decreases in fiscaldisparities, which, in turn, determine themagnitude of equalization payments.

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Table 3 presents comparative 2002 GDP andpopulation data for Canada, selected provincesand selected combinations of provinces. Thesedata indicate that significant economic disparities,as measured by per capita GDP, remain anentrenched feature of Canada’s economy. At theextremes, the per capita GDP of P.E.I. ($26,848)is a mere 55 percent of the per capita GDP ofAlberta ($48,405).

There is, as well, a significant gap of $6,063 oralmost 16 percent, between the provincesreceiving equalization payments and the provincesof Ontario, Alberta and British Columbia.Nevertheless, as shown in Table 4, in the periodsince 1981 there has been a gradual convergenceof GDP per capita across provinces.

Population Shifts in Canada

The behaviour of GDP per capita depends on therelative rates of change in the GDP and inpopulation. From 1981 to 2002, the recipient

provinces’ share of both population and GDPdeclined: population went from 43.6 to 38.2percent; and GDP from 36.0 to 33.4 percent.

Differential rates of population change betweenprovinces are strongly influenced by bothinternational and interprovincial migration.Throughout the 1990s the primary destinationsfor both immigrants and internal migrants werethe high-growth and high-income provinces ofOntario, Alberta and British Columbia. Over theperiod 1991-2000, 99 percent of all net migrantsended up in these three provinces. The percentageswere 97.7 in 2001 and 97.1 in 2002. (Two sourcesare used for data on migration, namely, StatisticsCanada, Quarterly Demographic Statistics (91-002-XPB) various numbers; and Statistics Canadaweb site: http://estat.statcan.ca/cgi-win/CANMCGI.EXE).

Some provinces experienced net emigrationduring this period. Manitoba, for example, had anegative balance of 10,444 on migration flows.Saskatchewan, Newfoundland and NewBrunswick also were on the negative side of theledger.

4elbaT

secnivorPdetceleS,adanaCfotneCrePAsAatipaCrePPDG

raeY 1891 1991 2002

abotinaM 4.09 5.88 2.78

.I.E.P 7.95 1.17 8.27

atreblA 1.061 1.511 2.131

tneipiceR*secnivorP 6.28 5.68 4.78

tneipiceR-noN*secnivorP 2.311 1.901 8.301

ecnivorp-eviF*dradnats 1.79 6.001 0.89

.3elbaTeeS*

,3elbaT:secruoS lacitsitatSlacirotsiHrevresbOcimonocEnaidanaC10/0002tnemelppuS ,)BPX-012-11( revresbOcimonocEnaidanaC -010-11(

dna,3002rebmeceD,)BPX scitsitatScihpargomeDlaunnA -312-19(0002)BPX

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detceleSdnaadanaC,abotinaMrofataDnoitalupoPdnaPDGevitarapmoC2002,secnivorPfosgnipuorG

tekraMtaPDGsecirP noitalupoP PDGatipaCreP

)000$( fo%adanaC latoT fo%

adanaC $ fo%adanaC

adanaC 949,451,1 0.001 002,513,13 0.001 188,63 0.001

abotinaM 570,73 2.3 001,941,1 6.3 462,23 5.78

.I.E.P 847,3 3.0 006,931 4.0 848,62 8.27

atreblA 899,941 0.31 008,890,3 9.9 504,84 2.131

tneipiceR*secnivorp 497,583 4.33 008,679,11 2.83 722,23 4.78

tneipicer-noN**secnivorp 266,367 1.66 000,932,91 4.16 092,83 8.301

eviFecnivorp

***dradnats098,039 6.08 003,647,52 2.28 651,63 0.89

.seirotirretdnanokuYsedulcniadanaC:etoN.nawehctaksaS,abotinaM,cebeuQ,.B.N,S.N,I.E.P,.dlfN*

dna1002,9991nisrefsnartdeviecer.C.B(aibmuloChsitirB,atreblA,oiratnO**.)2002

.aibmuloChsitirBdnanawehctaksaS,abotinaM,oiratnO,cebeuQ***-11(3002rebmeceDrevresbOcimonocEnaidanaC:adanaCscitsitatS:secruoS

roflmth.0937010A/api/moc.esaelpofni.www//:ptthdnasrebmunPDGrof)010.atadnoitalupop

Equalization 13

Manitoba, Saskatchewan and Newfoundlandcontinued to be the main losers of populationthrough net emigration in 2001 and 2002.

Provinces are particularly sensitive to populationlosses resulting from interprovincial migration.Over the ten-year period ending in 2000, allprovinces receiving equalization grants, exceptP.E.I., experienced a net loss of populationthrough interprovincial migration: Quebec lost137,279, Newfoundland 54,009, Saskatchewan47,018, Manitoba 41,607, New Brunswick10,135, and Nova Scotia 9,600. By contrastOntario, Alberta and British Columbiaexperienced net gains of 22,378, 126,374 and157,787, respectively. These trends havecontinued in 2001 and 2002 (except that B.C.has in recent years become a consistent loser ofpopulation through interprovincial migration).Recipient provinces lost 29,418 people in 2001and a further 23,922 in 2002 throughinterprovincial migration. Alberta, which gained72 percent of interprovincial migrants in 2001-02, is now the main magnet for individuals andfamilies seeking improved economic situationsthrough migration. These population shifts arevery important in calculating equalizationpayments as payments are determined on a percapita basis.

Disproportionate numbers of interprovincialmigrants tend to be in the age range most likelyto be employed. Provinces losing such peoplethrough migration incur two main costs. First,such individuals are likely to be paying more intaxes than they receive in benefits. Second, theprovince is likely to have made significantinvestments in their education and training. Whenthese individuals leave the province, the expectedreturn from that investment in the form ofincreased productivity and earnings is lost. Theprovinces to which they move reap that gain, atno cost.

For the period 1991-2000 about three-quartersof the net migrants from provinces receivingequalization payments were in the age group 15to 49. The proportion for Manitoba was 79percent. The experience on the prairies over thisperiod is instructive.

As shown in Table 5, both Manitoba andSaskatchewan lost population in the age group15 to 49 in the 1990s while Alberta gainedpopulation. The combined loss for Manitoba andSaskatchewan was equivalent to almost 78 percentof the total gain in Alberta. An obviousconsequence of these movements is that theproductive segment of the population in Albertais increasing relative to its prairie neighbours. In2003, for example, the proportion of thepopulation in the age range 15 to 64 was 66.2 inManitoba and 69.9 in Alberta.

Labour Market Indicators

Labour market indicators reveal a mixed pictureregarding the relationship between recipient andnon-recipient provinces. Table 6 providescomparative data on employment andunemployment rates for Canada and theprovinces. Employment rates in all provincesreceiving equalization payments have increasedrelative to the national average since 1981.

5elbaT

eiriarP,94-51puorGegAehtrofnoitargiMlaicnivorpretnIteN0002-1991,secnivorP

noitargiMteN

elaM elameF latoT

abotinaM 329,61- 300,61- 629,23-

nawehctaksaS 748,12- 622,02- 370,24-

atreblA 848,85+ 530,93+ 388,79+

fo%saabotinaMatreblA 8.82 0.14 6.33

sanawehctaksaSatreblAfo% 1.73 8.15 0.34

EXE.IGCMSNC/niw-igc/ac.nactats.tatse//:ptth:ecruoS


The pattern of unemployment rates hasremained quite stable since 1981. Rates are muchhigher in the Atlantic provinces and Quebecrelative to the national average and the provincesof Ontario, Alberta and British Columbia.

A paradox evident in Table 6 is the situation ofManitoba and Saskatchewan. These provinces

(and especially Manitoba) are similar to otherprovinces receiving equalization payments whenthe comparison is based on GDP per capita andearnings (Table 7). However, when compared onthe basis of employment and unemployment rates,Manitoba and Saskatchewan more closelyresemble Ontario, Alberta and British Columbia.

Table 7 provides comparative data on averageweekly earnings by province as a percent of thenational average. Average weekly earnings inequalization-recipient provinces have beendeclining relative to the national average since theseries was established in its present form in 1983.There has also been slippage in Alberta and BritishColumbia, and earnings in British Columbia arenow slightly below the national average.

In sum, this brief and selective review of theeconomic situation of the provinces indicates thatthere are significant disparities between provincesreceiving equalization payments, and those notreceiving such payments. This is particularlyevident in the case of GDP per capita and averageweekly earnings. The data relating to the labourmarket present a mixed picture. In the Atlanticprovinces and Quebec employment rates are muchbelow the national average, unemployment ratesmuch above the national average, while inManitoba and Saskatchewan the reverse is true.

The crucial point in all this is that Canada iseconomically dominated by the provinces ofOntario, Alberta and British Columbia. Thisdomination became more pronounced in the1990s. Between 1991 and 2002, the proportionof the total population accounted for by thesethree provinces increased from 58.5 to 61.4percent and the proportion of total GDP, from63.8 to 66.0 percent. The share of total jobs inthese provinces increased from 60.8 percent to63.0 percent over the same period. The other sideof the coin is that the proportion of thepopulation, GDP and jobs in provinces receiving

7elbaT

,egarevAlanoitaNfotnecrePAsAecnivorPyBsgninraEylkeeWegarevA2002,1991,3891

3891 1991 2002

adanaC 0.001 0.001 0.001

dnaldnuofweN 9.59 9.39 9.09

.I.E.P 3.38 1.18 4.97

aitocSavoN 0.98 6.98 7.68

kciwsnurBweN 6.19 2.09 3.98

cebeuQ 2.99 5.79 6.49

abotinaM 8.29 2.09 0.98

nawehctaksaS 8.49 6.78 7.98

oiratnO 4.89 6.401 6.601

atreblA 1.801 0.001 7.201

aibmuloChsitirB 3.901 4.001 1.99

-010-11eugolataC(srebmunsuoirav,revresbOcimonocEnaidanaC:ecruoS)PBPX

6elbaT

,setaRtnemyolpmenUdnatnemyolpmE3002dna1891,secnivorPehtdnaadanaC

etaRtnemyolpmE etaRtnemyolpmenU

1891 3002 1891 3002

adanaC 0.06 4.26 6.7 6.7

dnaldnuofweN 4.64 6.94 3.31 7.61

.I.E.P 9.15 8.06 3.11 1.11

aitocSavoN 8.15 3.75 9.9 3.9

kciwsnurBweN 7.94 6.65 6.11 6.01

cebeuQ 3.55 0.06 5.01 1.9

abotinaM 3.16 5.56 9.5 0.5

nawehctaksaS 8.06 4.46 5.4 6.5

oiratnO 2.36 7.36 5.6 0.7

atreblA 4.96 6.96 9.3 1.5

aibmuloChsitirB 8.06 1.06 8.6 1.8

-102-17(0002,scitsitatSecroFruobaLlacirotsiH,adanaCscitsitatS:ecruoS.mth.c70robal/bdgP/hsilgne/ac.nactats.www//:ptthdna)BPX

Equalization 15

equalization payments is decreasing. These trendshave important implications for the way in whichthe increasing wealth of the country getsdistributed between provinces and among thepopulation, and reveal the importance of Canada’sequalization program.

Fiscal Trends

The broad trends in government policy thatbecame pervasive in the 1990s reflected theinfluence of neoliberal ideas. Most notable amongthese ideas were that: deficits and debt are bad;the role of the government in the economy shouldbe drastically reduced; markets should be left todetermine economic and social priorities and the

• Deficits for all levels of governmentcombined were eliminated in the late1990s; that is, while some individualprovincial governments still had deficits,the sum total of federal and provincialfinances was in surplus. At the federallevel large deficits were converted intolarge surpluses reaching $4.5 billion by1997 and increasing to almost $6 billionby 1999. For all levels of governmentthe total surplus in 1999 was $21 billion(Treff and Perry, 2001, B:12).

• Total revenues of all levels ofgovernment peaked at 46.6 percent ofGDP in 1998. Revenues of the federalgovernment as a proportion of GDPpeaked in 1999 at 19.0 percent of GDP,and at the provincial level in 1997 at19.5 percent of GDP (Treff and Perry,

Fiscal Trends in the 1990s2001, B:7). The residual is accountedfor primarily by local governments.

• Total government expenditures(excluding grants) as a proportion ofGDP peaked in 1992 at 55.2 percentand subsequently declined to 44.0percent in 1999. At the federal levelexpenditures declined from 19.8percent in 1991 to 14.9 percent in1999; at the provincial level theydeclined from 22.6 in 1992 to 17.8percent in 1999 (Treff and Perry,2001, B:11).

• Between 1992-93 and 1999-2000,federal government transfers as aproportion of provincial governmentrevenues, declined from 22.7 percentto 14.8 percent. For Manitoba theproportion declined from 38.6 to32.7 percent.

allocation of resources; and the key to long-termeconomic success is the rapid elimination ofbarriers to trade and the mobility of capital.

In terms of fiscal policy, the main thrust in the1990s was to eliminate deficits and balancebudgets by reducing expenditures. As budgetswere balanced the emphasis shifted to reducingtaxes, particularly corporate and personal incometaxes. Tax cuts directly affect equalization.Equalization payments grew in previous decadesconsistently with the growth in tax revenues. Butnow provincial governments, and especiallyAlberta and Ontario, are downsizing and cuttingtaxes. Tax cuts are likely to slow the growth of taxrevenues, thus reducing equalization payouts. The


impact of the fiscal policy of the 1990s wasprofound.

These data show that the federal government hasshifted a greater share of the burden for financingmajor social programs - health, education andsocial welfare - to the provinces. “In 1961, thefederal government spent roughly the sameamount on program expenditures (excludingintergovernmental transfers) as did provincial andlocal governments combined. By contrast, today,provincial and local governments deliver aboutdouble the level of services of the federalgovernment” (Manitoba Budget 2001, BudgetPaper C, 30). These various fiscal trends over thepast two decades have increased the need for astrong and effective equalization program. Table8 summarizes the present situation with respectto federal transfers to provinces.

The Problem of Alberta and theFive-Province Standard:

Fiscal decentralization makes a strong equalizationprogram necessary. However, excluding Alberta’svast oil and gas revenues from the five-provincestandard significantly weakens Canada’sequalization program. Thus a central issue in anyconsideration of Canada’s equalization programis how to deal with Alberta.

The dilemma is that if Alberta’s oil and gasrevenues are included in the equalization formula,the amount of equalization owed to the otherprovinces would rise very considerably, puttingfinancial pressure on the federal government. IfAlberta is excluded from the equalization formula,as is now the case, then the large oil and gasrevenues accruing to Alberta provide that provincewith revenues which, on a per capita basis, are farbeyond those available to other provinces. Albertais thus able, if it chooses, to offer better publicservices and/or lower taxes than other provinces.

This is why Alberta now has no provincial salestax and the lowest personal income tax rates inthe country. At the upper income levels the highestmarginal tax rate in Alberta is 39 percent, 6percentage points lower than anywhere else inCanada. Alberta is considering the possibility ofeliminating provincial personal income taxaltogether, the likelihood of which will beincreased when the province’s remainingaccumulated debt is paid off, which is expectedto happen very soon. In short, Alberta’s publicfinances are wildly out of line with other Canadianprovinces thanks to their good fortune in beinglocated on top of vast oil and gas reserves. Theexclusion from the equalization formula of theseoil and gas revenues defeats the purpose of theequalization program, as described in S.32.2 ofthe Constitution Act of 1982, which is “to providereasonably comparable levels of public services at

8ELBAT

LAICNIVORPFOEGATNECREPASASREFSNARTLAREDEF*,EUNEVER

1002,13HCRAMGNIDNERAEYLACSIF

srefsnarTlaredeF laicnivorPlareneG**esopruP

cificepS***esopruP

nwOseuneveR

dnaldnuofweN 0.03 6.11 4.85

.I.E.P 7.72 8.01 4.16

aitocSavoN 7.62 1.11 2.26

kciwsnurBweN 4.52 9.31 6.06

cebeuQ 7.9 4.5 9.48

oiratnO - 7.9 3.09

abotinaM 3.81 8.11 0.07

nawehctaksaS 3.5 5.9 3.58

atreblA - 6.7 4.29

hsitirBaibmuloC - 6.21 4.78

.TSHCyliramirP***.noitazilauqeyliramirP**.setamitsE*.3:8.p,yrrePdnafferT:ecruoS

Equalization 17

Natural Resources and the Equalization Formula1. The 1957 equalization formula included thetwo richest provinces and three taxes:personal income tax, corporate income taxand succession duties. Revenues from thesale of natural resources, including oil andgas, were not included.

2. In 1962 the formula was changed from theaverage tax revenue of the top two provinces,to a national average, which included allprovinces and thus Alberta. Fifty percent ofthe three-year average of provincial revenuesand taxes from natural resources wereincluded.

3. In 1964-65 the equalization standardreturned briefly to the two top provinces andnatural resources were again excluded fromthe formula, except that 50 percent of theamount by which a province’s three yearaverage of per capita resource revenueexceeded the national average would bededucted from the equalization payment tothat province.

4. In 1967 the Representative NationalAverage Standard (RNAS) was introduced, soall provinces, including Alberta with its oil andgas revenues, were included in the formula.

5. In 1974-75 the equalization formula wasmodified in the wake of the first energy crisis.Two sor ts of energy revenues weredesignated: ‘basic’ and ‘additional’. Basicrevenues were those derived in 1973-74.Additional revenues were those above the1973-74 level and att r ibutable not toincreased output but to higher prices. Basicrevenues were fully equalized; only one-thirdof additional revenues were equalized.

6. A further change was made in 1977, whenonly 50 percent of the revenue from non-renewable resources entered the equalizationformula, and no more than one-third of totalequalization could come from resourcerevenues.

7. In 1982 the Representative Five-ProvinceStandard (RFPS) was adopted, with Albertaoutside the formula. The cap on resourcerevenues was removed, but because Albertawas not part of the RFPS, most oil and gasrevenue was excluded.

8. In 1986 and 1987 Newfoundland and NovaScotia entered into accords with the federalgovernment respecting those governments’offshore oi l and gas. The accords wereintended to ensure that not all of the revenuefrom the offshore oil and gas was ‘taxed back’in the form of corresponding reductions toequalization payments. These accords featuredtwelve-year and ten year phase-ins forNewfoundland and Nova Scotia respectively.This meant that for each province, during theperiod of the phase-in, the equalizationpayment for any given year could be no lessthan 95 percent of the previous year ’sequalization payment.

9. In 1994 the federal government created ageneric tax-back program, applicable to allprovinces and all revenue sources. If anequalization recipient province generates 70percent of the total tax base for a given revenuesource, then the federal government will reduceby 30 percent the revenues from that sourcethat will be brought into the equalizationformula. For example, 30 percent of the offshoreoil and gas revenues in Newfoundland andNova Scotia would be protected from the ‘tax-back’ created by reduced equalizationpayments. Conversely, these provinces lose 70percent of that revenue source by means ofreduced equalization payments. The 70:30generic tax-back applies only to equalizationrecipient provinces (although this is not the casefor Saskatchewan, more than 100 percent ofwhose natural resource revenues are taxedback, as described recently by Courchene,2004). It does not, therefore, apply to Alberta,with the result that Alberta keeps all of its oiland gas revenues i.e., 100 percent of Alberta’soil and gas revenues are protected fromequalization.


reasonably comparable levels of taxation”. TheRepresentative Five-Province Standard subvertsour constitutional obligations regardingequalization.

Whether and how to include Alberta’s oil and gasrevenue in the equalization formula has been aproblem since the oil crisis of the early 1970s,and several variations have been tried.

The problem was described in the 1981Parliamentary Task Force on Federal-ProvincialFiscal Arrangements, which referred to

“...the basic dilemma of the equalizationprogram at this particular juncture namely thedilemma of unevenly-distributed naturalresource revenues. Since the early 1960s, butparticularly since the ‘oil shock’ of 1973, ithas become clear that dramatically-skeweddistribution of revenues from naturalresources can impose severe strains on thefederal structure, and especially on the systemof equalization payments” (Canada, 1981,159).

The National Energy Program (NEP)can be seenas a response to this problem.

The National Energy Program

World prices for oil and gas rose dramatically inthe 1970s. Oil prices that had been $3 per barrelin the 1960s and up to 1970, were $38 per barrelby the late 1970s (Canada, 1980, 3). Both Albertaand Canada wanted to move the domestic pricefor oil closer to the world price, because doing sowould generate huge economic rents (seeEconomic Rent).

The question would then become: who wouldcapture the very large economic rents that wouldflow from rising energy prices, Alberta or Canada?The National Energy Program (NEP) was the

federal government’s strategy to ensure thatCanada got a fair share of it. The NEP was allabout the struggle between the federal governmentand Alberta over the control of the economic rentfrom Alberta’s oil and gas production.

One might think that this conflict over access tooil and gas rents could be solved by answering aseemingly simple question: who has constitutionalauthority with respect to energy, the federalgovernment or the provinces? Unfortunately, theanswer to this question is not completelystraightforward. It is clear that the provinces haverights as owners of natural resources:

No one disputes that ownership belongs tothe provinces. This is clearly laid out in Section109 of the BNA Act, which states that ‘allLands, Mines, Minerals, and Royalties belongto the several Provinces of Canada’, a rightthat was granted to the three Prairie provincesin 1930 in an amendment to the BNA Act(Dobson, 1981, 5).

However, there are disputes about how far theseownership rights go. The federal governmentbelieves that it has the right to limit provincialownership rights by virtue of its responsibility forthe national economy, and in particular by virtueof the ‘trade and commerce’ power (s. 91.2 of the

Economic Rent:Economic rent is the excess incomegenerated over and above a “normal”return to capital and labour; the amountleft over after all production costs,including a normal rate of profit, havebeen paid. In this case the economicrent is the dollar amount attributable notto production costs but simply to risingprices.

Equalization 19

Constitution Act), which gives to Ottawajurisdiction with respect to all interprovincial andinternational trade, including interprovincialpipelines and international exports (Dobson,1981, 5).

The federal government and Alberta both hadreason to believe, based not only on constitutionalreasoning but also on the particular way in whichoil and gas were developed in Alberta since 1947,that they were entitled to the bulk of the economicrent from rising oil and gas prices.

From Alberta’s point of view, not only did theprovince own the resource, but also it had been,for much of the twentieth century, a have-notprovince in the western Canadian hinterland.Alberta had been exploited by the banks, therailways and the grain companies, and forced topay higher-than-world prices for manufacturedgoods from central Canada. Also, since 1960domestic oil prices had been held below the worldprice, so that Alberta was effectively subsidizingthe rest of Canada in the form of lower oil pricesthan would be paid on the world market. By 1980,following the dramatic increases in oil prices inthe 1970s, it has been estimated that Alberta waslosing $13 billion per year in energy rents as theresult of the ceiling on oil prices. Given thathistory and the province’s ownership of theresources, surely, Alberta argued, it is only fair thatit now derive the full benefit of the economic rentfrom what is, after all, a depleting resource. TheConservative government of Peter Lougheed,elected in 1971, was committed to increasingAlberta’s share of oil and gas revenues in order todiversify the province’s economy and therebybreak out of its have-not status.

From the federal government’s point of view, thedramatic increase in oil and gas revenues wasdriving up the cost of its equalization payments.Between 1973 and 1980 equalization paymentsgrew by 16 percent per year. The cost of

equalization is borne by the federal government.The federal perspective, therefore, was that theCanadian government was paying for rising oilprices in the form of higher equalization costs. Inaddition, Canadians in every province were payingin two ways: in the form of higher oil prices, andin the form of higher federal taxes to pay for risingequalization costs. Moreover, the bulk of the taxesto pay for rising equalization costs were raised inOntario, which did not qualify for equalization.Finally, the federal government argued that it hadthe responsibility for the management of theeconomy as a whole and therefore needed accessto the economic rent deriving from oil and gasprice rises if a further balkanization of theCanadian economy were to be prevented. As EdShaffer put it:

The federal government...wanted theeconomic rents not only for its own revenueneeds but also to retain its control over thecountry. If the bulk of the rents flowed intothe coffers of the provincial treasuries, theeconomic power of the provinces would growrelative to that of the federal government. Itwould then become increasingly difficult, ifnot impossible, to formulate any effectivenational economic policy. With their increasedeconomic base, the provinces would be in aposition to wield far more political power thanin the past. This dispersion of power from thecentre to the periphery would pose thedanger of the balkanization of Canada...Thefederal government was not inclined toabdicate its role, especially to a provincecontaining only one-tenth of the population(Shaffer, 1983, 215).

A further argument made by Ottawa was that thefederal government had incurred much of the costof developing Alberta’s oil and gas reserves, andso Ottawa deserved some of the economic rents.The federal expenditures relating to the


development of Alberta’s energy resourcesincluded billions of dollars in corporate tax write-offs and/or tax deferrals for exploration “the mostfavourable national tax expenditures given to anyindustry” (Cumming, 1986, 68). There in turnwere then capitalized in sale prices of Alberta lands“which have generated close to a billion dollarsfor the producing provinces in some years”.According to Courchene, “...the combined federalexpenditures on energy-related equalizationpayments and the oil import compensationprogram exceeded by a large margin the amountof revenue Ottawa derived from the energy sector.I think it should have been clear to everyone,Alberta included, that Ottawa was going to garnera larger share of the energy revenues. The onlyunresolved questions were how and how much”(Courchene, 1981, 82).

The result was the National Energy Program,introduced with the federal budget of October1980. The NEP sought to increase the degree ofCanadian ownership of the oil and gas industry,to improve Canadian energy security, to hold theprice for Canadian consumers below the worldlevel, and to increase the federal government’sshare of the economic rents. The latter purposewas to be achieved by means of new federal oiland gas taxes and the so-called “back-in” provisionby which the federal government unilaterally tooka 25 percent interest in oil and gas produced inwhat were called the Canada Lands, and restrictedproduction on the Canada Lands to thosecompanies with at least 50 percent Canadianownership.

A major problem with the NEP was that it wasimposed without an agreement being reachedbetween the federal government and Alberta. Itwas a unilateral federal intervention. Albertacharged that Ottawa had “without negotiation,without agreement, simply walked into our homeand occupied the living room” (Premier Lougheed

in 1980, quoted in Doern and Toner, 1985, 106).Alberta responded angrily, as of course did theUSA. Ronald Reagan was elected president of theUSA one week after the October 28, 1980,announcement of the NEP. He and the oilinterests that had supported his campaign for thepresidency were enraged by the Canadiannationalist and state interventionist character ofthe NEP. Their opposition to the NEP was asignificant factor in the development of theCanada-US Free Trade Agreement, which isdesigned, among other things, to restrict stateinterventionist measures, generally and withrespect to energy and other natural resources, andserves to ensure US access to oil and gas in Canada.

The NEP was soon dismantled, leaving the federalgovernment in its initial position with no realaccess to the economic rents generated by risingprices for oil and gas, and for other naturalresources which fall under provincial ownership.The result with respect to oil and gas was the shiftin 1982 in the equalization formula from the tenprovince RNAS, to the five province RFPS, whichexcludes Alberta and its oil and gas revenue.

The result is completely unsatisfactory. Becauseits massive oil and gas revenues are not includedin the equalization formula, the gap is wideningbetween Alberta, which is able to offer richerpublic services at lower levels of taxation, andhave-not provinces which fear the prospect oflosing skilled workers and businesses to Albertaunless they too lower their taxes, which thenimpairs their ability to offer needed public services.It is clear that Alberta needs to be brought intothe equalization formula, and the federalgovernment needs access to the economic rentsaccruing from Alberta’s oil and gas in order tooffset increased equalization costs.

It is useful to consider the treatment forequalization purposes of Newfoundland and NovaScotia’s offshore oil and gas revenue. In 1993 the

Equalization 21

70/30 formula was instituted. Any province with70 percent or more of a particular revenue hasonly 70 percent not 100 percent of that revenuestream enter the equalization formula. This is not,however, the case for Saskatchewan, which forreasons which appear to be irrational, is notgaining protection for 30 percent of its energyrevenues, but rather is facing the perverse outcomeof having more than 100 percent of its energyrevenues ‘taxed back’ (Courchene, 2004).

The Atlantic Institute for Market Studies (AIMS)is mounting a campaign to removeNewfoundland’s and Nova Scotia’s offshore oil andgas revenues entirely from the equalizationformula. They argue that Newfoundland andNova Scotia should have all of that offshore oiland gas revenue. This arrangement would allowfor the massive investment in their economies thatis needed if they are ever to get off the equalizationsystem.

We maintain that this would worsen the problemthat Alberta’s exclusion from the formula hasalready created. The better solution is to move toa ten-province standard that includes Alberta, andmakes 100 percent of natural resource revenuesubject to the equalization formula. This wouldalso solve Saskatchewan’s problem (Courchene,2004, 17). As one economist has put it, “a dollarof fiscal capacity is a dollar of fiscal capacity,whatever its source” (Cumming, 1986, 66). Thereseems to be no coherent justification for treatingoil and gas revenue differently from otherprovincial revenue sources.

Criticisms of Equalization

Canada’s equalization program has been subjectedto frequent criticism, much of it ideologicallyinspired. A classical question in political economy,and one which has produced a particularly right-wing answer in the past two decades, is this: to

what extent should the state intervene in economicmatters, particularly in a redistributive capacity, andalternatively, to what extent should the market beleft to allocate resources. The trend in recent yearshas been to reduce state intervention, especially thatwhich redistributes income. Consistent with thistrend, there has emerged a growing opposition tothe equalization program. Usher, writing for theFraser Institute, demonstrated the Fraser Institute’sopposition to the redistributive character ofequalization and to the core Canadian values ofsharing and social solidarity by calling equalization“an elaborate system of bribes...a great pork barrelscheme” (Usher, 1995, 115-16). The Reform Partycampaigned on a platform of limiting equalizationto “only the poorest provinces”, and would by thismeans have cut several billion dollars fromequalization payments (Milne, 1998, 199). TheAtlantic Institute for Market Studies argues thatequalization creates a form of welfare dependencyamong recipient provinces. Courchene has arguedthat unconditional grants to low-income regionsdistort the allocation of resources “by removing partof the incentive for labour and capital to move tothe location where they can be best used”.Equalization grants “have reduced the have-notprovinces to a state of dependency and haveretarded their economic growth by removing theincentive to produce” (Boadway, 1980, 48, referringto Courchene 1978). He calls for less emphasis on‘place prosperity’ and more on ‘people prosperity’(Courchene, 1994, 97), by which he means thattransfer payments should go directly to people, notprovinces. Similarly Norrie (1994, 169) calls forfederal transfers to go directly to individualCanadians. The fact that federal transfers like theCHST and equalization payments go directly togovernments is what makes the public provisionof services possible, something that would not bethe case if the transfers were to go, as Courcheneand Norrie call for, to individuals.


It is only transfers to governments that enable theprovision of public goods and services. That, webelieve, is the point of many if not most of thecritics of equalization—they seek to erode thepublic provision of services and turn more overto the market place by means of privatization. Thefuture of equalization therefore depends, in largepart, upon the extent to which the Canadianpublic is prepared to support a politics ofredistribution and, by doing so, to fly in the faceof the current pressures for more market-basedsolutions. There is consistent evidence ofunwavering support among Canadians for apolitics of redistribution to keep our socialprograms strong and to give expression to the coreCanadian values of sharing and social solidarity(Mendelsohn, 2002; Canada, November, 2002;Schafer, 2002).

RecommendationsEqualization is of crucial importance to Canada’scontinued existence. It is a unique program ofenormous value to Canada and Canadians. Itreflects a set of values, rooted in a core belief insharing and social solidarity, that are distinctlyCanadian, and that are treasured by many. It is,however, currently in need of repair. Thankfully,the equalization program can be repaired with ahandful of reforms.

We recommend three reforms to Canada’sequalization program which we believe areachievable and desirable. These are: theestablishment of a new, independent Federal-Provincial Fiscal Secretariat; the commitment tothe permanent elimination of the cap or ceilingon equalization payments that was imposed from1982-2002; and the return to a ten-provincestandard for use in the equalization formula. Werecommend that these reforms be part of the nextfive-year renegotiation of the equalizationprogram, the current version of which expires

March 31, 2004. With these reforms in place, theequalization program would be healthy andsustainable and Canada’s economic, social andpolitical health would be significantly improved.

Recommendation #1:

Establish a Federal-Provincial FiscalSecretariat:

There is and there can be no final solution tothe allocation of financial resources in afederal system. There can only be adjustmentsand reallocations in the light of changingconditions. What a federal government needs,therefore, is machinery adequate to makethese adjustments (Courchene, 1984, 81,quoting Wheare, 1964).

The machinery needed to make the necessaryadjustments to Canada’s equalization program isnot adequate. Changes are made to the programvirtually unilaterally by the federal government,almost solely for the purpose of cost containment(the cap on equalization payments; the move to afive-province standard), and without adequateresearch into the extent to which the program ismeeting the ever-changing needs to which it isintended to respond. There is a “Subcommitteeon Equalization” comprised of federal andprovincial officials which meets periodically, andhas done so since 1970 (Clark, 1998, 95). Butthis committee is not enough to change the largelyunilateral fashion in which the federal governmentmakes decisions about the program. As Courchene(1984, 405) argues: “Equalization is more than aprogram for ‘have-not’ provinces. It is part andparcel of our national fabric. It is important thatall provinces (not just have-not) maintain aninterest in it”.

What is needed is a stand-alone body, structuredand governed and financed so as to represent the

Equalization 23

interests not just of the federal government, butalso of the provincial governments and ofCanadians more generally. The mandate of thisbody would be to conduct on-going analyses ofand long-term research into the equalizationprogram, and to make recommendations to thefederal and provincial governments aboutmodifications to the program as they are needed.Such a body exists in Australia and is called theAustralian Commonwealth Grants Commission(Wilson, 1998, 215). In South Africa a similarbody is the Financial and Fiscal GrantsCommission. Some of Canada’s leading economicexperts on equalization have called for theestablishment of such an institution in thiscountry (See, for example: Boadway and Hobson,1998; Boadway and Flatters, 1994; Courchene,1984). The research and analysis done by such abody would improve our ability to redistributewealth across the country in a way that isconsistent with both the intentions of the Rowell-Sirois Commission and S. 32.2 of theConstitution Act 1982. It would also improve thequality of public debate in Canada aboutequalization. To this end, we recommend theestablishment of a Federal-Provincial FiscalSecretariat.

Recommendation #2:

Avoid Imposing Caps on Equalization:

During the period 1982 to 2002, equalizationpayouts were subject to a ceiling or cap. This hada significant impact. At the end of the 1980s, forexample, the ceiling saved the federal government,and therefore cost the recipient provinces, almost$3 billion in three years (Clark, 1998, 96). ForManitoba and Saskatchewan, the ceiling reducedequalization payments by $628 million for theperiod 1988-89 to 1991-92 (Report of theWestern Finance Ministers, 1991, 9), and

Manitoba expected to lose $100 million due tothe cap in 2000-01 (Selinger, 2001, 9). Partly asa result of the ceiling, equalization payouts havedeclined from 1.33 percent of GDP in 1982 to1.04 percent of GDP in 2001 (Selinger, 2001,9). The federal government removed the ceilingfor the 1999-2000 fiscal year entitlements, re-imposed it in 2000-2001 and then eliminated itagain in 2002-2003.

Fifteen years ago Robin Boadway, one of Canada’sleading authorities on the equalization program,observed that “there is no economic reason forthis ceiling; its imposition is essentially arbitrary”(Boadway, 1986, 30). The provincial andterritorial ministers of finance, at their December2000 meeting in Winnipeg, called for the removalof the ceiling from the equalization program. Thefour Atlantic provinces have lobbied individuallyand collectively for the removal of the ceiling(Beale, 2002, 12). In March 2002 the StandingSenate Committee on National Finance called forthe elimination of the ceiling.

It is our view that elimination of the ceiling in2002-2003 reflects the fact that there is noadequate intellectual or policy justification for itscontinuation. Moreover, given the uncertaintyand inequities created by a ceiling, we recommendthat there be no future impositions of a cap orceiling on federal equalization payments.

Recommendation #3:

Return To a Ten-Province Standard:

The five-province standard has no justification interms of principles. It was implemented simplyto remove Alberta’s large oil and gas revenues fromthe formula, and thus reduce the fiscal pressureon the federal government. It is important to becognizant of the fiscal pressures placed on thefederal government by the equalization program.


However, removing Alberta to ease this pressurehas had seriously perverse effects. Section 32.2 ofthe Constitution Act, requiring the provision of“reasonably comparable public services atreasonably comparable levels of taxation”, is beingviolated because Alberta’s vast oil and gas revenuesare outside the formula. The result is that Albertais able to establish a tax regime which is notreasonably comparable to other provinces, withthe result that fiscal decision-making in otherprovinces, and especially have-not provinces, isbeing distorted in a way that is detrimental toCanadians and inconsistent with the values of theequalization program. Alberta and its oil and gasrevenues must be brought into the formula. Thisshould be done by means of a return to the ten-province standard. Although it would be best ifthis were done immediately, the return to the ten-province standard could be phased in over the five-year life of the new equalization agreement that isabout to be negotiated, and that will be maderetroactive to April 1, 2004.

The impact of returning to a ten-provincestandard would be significant and profoundly

important to the eight provinces that now receiveequalization payments. This is shown in Table 9.

A redistribution of this magnitude would not onlyrestore the letter and spirit of the original idea ofequalization as initially understood and laterapplied in this country, but would also giverecipient provinces additional resources withwhich to improve and sustain their socialinfrastructures.

ConclusionsCanada’s equalization program is the financialfoundation of the social programs that contributeso much to defining who we are as Canadians.However, our equalization program is now badlyin need of reform. The recommendations forreform that are identified in this paper areachievable. If they are implemented, Canada’sequalization program will be brought into linewith the requirements of the Constitution Act1982, which requires that equalization paymentsbe sufficient “to ensure that the provincialgovernments have sufficient revenues to providereasonably comparable levels of public services atreasonably comparable levels of taxation”. Thereforms will enable provinces to revitalize oursocial programs in line with the repeatedlyexpressed desires of the considerable majority ofCanadians. The current five-year equalizationprogram expires March 31, 2004. Now is theappropriate time to introduce these reforms.

9ELBAT

TNEIPICEROTSREFSNARTNODRADNATSECNIVORP01FOTCAPMI2002,SECNIVORP

REDNUSTNEMELTITNEECNIVORP-01

DRADNATS)000,000(

ECNIVORP-5DRADNATS)000,000(

ECNEREFFID)000,000(

TNECREPEGNAHC

dnaldnuofweN 70.899 40.558 341 7.61

.I.E.P 13.862 97.822 04 3.71

aitocSavoN 72.034,1 58.061,1 962 2.32

kciwsnurBweN 64.263,1 71.641,1 612 9.81

cebeuQ 99.708,6 02.2664 641,2 0.64

abotinaM 41.346,1 69.903,1 333 4.52

nawehctaksaS 04.813 07.431 481 4.631

hsitirBaibmuloC 85.793,1 45.112 681,1 6.065

tneipiceRlatoTsecnivorP 22.622,41 42.907,9 715,4 5.64

laicnivorP-laredeFfoakcalaBboRdnannamueNnoRybdedivorpataD:ecruoS.gepinniW,ecnaniFabotinaM,hcraeseRdnasnoitaleR

Equalization 25

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