A key policy issue for many federal countries like Canada is fiscal equalization. As we mentioned in part 1 of this series, the controversy in the Canada’s equalization program surrounds precisely how equalization payments should be calculated. Two issues are said to be central to this debate: calculation of the national standard and calculation of individual provincial fiscal capacities. This article will attempt to explain how this controversy developed through a historical and institutional lens. It is no secret that equalization policy has historically been known to generate minor conflicts; but since 2004, discontent over equalization in Canada morphed into full- blown intergovernmental conflict as several provincial Premiers publicly attacked the federal government for decisions concerning the program. Even Ontario, a province that has been a longtime advocate of the program, and up until recently enjoyed the title of “have” province, is now instigating some of the above-mentioned conflict.
It’s important to know that Equalization is a program entirely administered and funded by the federal government through general tax revenues that provides payments to provinces with a below-average fiscal capability. For the purpose of equalization, “fiscal capacity” refers to the ability of a province to raise revenues as measured by an examination of a number of different tax bases. Making equalization, the most prominent locus of horizontal fiscal redistribution in the Canadian federal system.
Non-Renewable Natural Resources
Resource-rich provinces of Alberta, Saskatchewan, and Newfoundland and Labrador have been the hardest by the collapse in oil prices in late 2014 and early 2015. Consequently, their ability to generate revenues has fallen significantly and their fiscal capacity has diminished greatly. The presence of Dutch disease usually means what is bad for Alberta is generally good for Ontario. Observably, Ontario has been relatively unaffected by the steep decline in oil prices.
In fact, the economies of Alberta, Saskatchewan, and Newfoundland and Labrador are expected to continue to perform relatively poorly, while Ontario is expected to perform relatively well over the next several years,
While Ontario is set to once again be a have province and lose all it’s equalization payments over the next 3 years; the idea that a wealthy province like Ontario has been receiving equalization payments for the last couple of years seems to be at odds with the rationale of the program. As you can imagine giving out equalization payments to the largest Canadian province with a population of 13.98 million (as of 2016) considerably increased the costs of the program.
The precedent Ontario set has led to a transformation of the program and a new rule was established in an effort to curb ballooning equalization costs. The federal government decided to constrain growth in the total budget for equalization payments to the three-year moving average of nominal gross domestic product. Under the new rule, payments to a province are still based on its have or have-not status and its fiscal capacity relative to the average of all provinces. But now provincial payments are clawed back so as to match the total equalization pie set by the federal government.
Here is the question some economist having been asking lately, with Ontario coming off equalization and the gap between provinces diminishing, should the federal government continue to guarantee growth in equalization—especially at a time when it is posting substantial deficits? The reason why this question is important is that it implicitly asks if there is a better to use the roughly $2.4 billion currently set for the upward adjustment in 2018–19 equalization payments to lower the federal deficit, or boost other federal spending like the Canada Health and Social Transfers? The heart of this question deals with the effectiveness of the equalization program. Many have argued that the program, based on a moving average of past performance is not equipped to handle sudden changes in economic performance. They point to the province of
Newfoundland and Labrador as a glaring example. Despite in the recent past being given the title of “have province”, Newfoundland and Labrador’s fiscal capacity has taken a major hit over the last year and a half. However, it will not likely see any equalization for another three years, highlighting the ineffectiveness of the program as an automatic stabilizer for provincial revenues.
This suggests that even if the program stays, its current formula needs to be improved. The good news is the program is no stranger to changes, its’ formula has been subject to constant, if not consistent changes, over the last 20 years.
Picture entitled, "Canada", taken by Alex Indigo on December 21, 2006, obtained through Creative Commons (https://flic.kr/p/4eDBug)