Some inconvenient facts about equalization

Posted on May 28, 2012 in Governance Delivery System

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May 28, 2012. Last Updated: May 25, 2012.   Mark Milke & Fred McMahon

To grasp why Canada’s equalization program is such a public policy disaster, some myths need to be busted about the $14.8-billion annual transfer of federal tax dollars to the provinces through equalization — and the $46-billion in other inter-governmental transfers. So, let’s some consider some inconvenient facts.

Inconvenient Fact #1: Canada’s founders didn’t want transfers between governments.

Ottawa sending money to the provinces is as old as Confederation, but not because the founding fathers wanted it that way. The only reason such transfers exist is because the founders feared that the provinces would impose provincial tariffs on each other’s goods (tariffs then being the main source of revenues for governments) and in so doing create trade barriers within the new country.

The deal brokered was that modest transfers would be given but were to be capped (though endless exceptions were made over the ensuing decades). The provinces also were given the right to raise money via income tax, though few thought the provinces would ever enact such then-hated taxes. Almost a century-and-a-half after Confederation, of course, the provinces collect provincial income tax and still receive federal transfers.

Even so, our earliest leaders never thought transfers were a good idea. In 1905, in a speech to Parliament, Prime Minister Sir Wilfrid Laurier noted: “It is a sound principle of finance and a still sounder principle of government, that those who have the duty of expending the revenue of a country should also be saddled with the responsibility of levying it and providing it.”

Inconvenient Fact #2: Public services are often more generous in “have-not” provinces.

In theory, as Section 36(2) of the Constitution Act, 1982 states, equalization is meant to “provide reasonably comparable levels of public services at reasonably comparable levels of taxation.” In practice, nothing of the sort occurs.

For example, Quebec, the biggest equalization recipient (which receives almost half of the $14.8-billion federal transfer to six provinces), also has the lowest tuition among all the provinces. It also has universal $7-a-day daycare.

That’s bad policy, as cheap tuition and universal daycare for all ends up subsidizing even the rich who can afford to pay the full freight for both university and child care. This means poor taxpayers in “have” provinces — think a waitress in Vancouver whose federal taxes are partly transferred to “have-not” provincial governments — pay for benefits for the well-off in recipient provinces. That’s an indefensible transfer of wealth, and fiscally bizarre.

Quebec Finance Minister Raymond Bachand claims his province’s higher taxes explain the lavish social programs. But this assertion is disproven by a simple calculation: Remove the $7.4-billion in equalization transfers to Quebec and ask what happens to Quebec’s overly generous social welfare system.

Inconvenient Fact #3: Equalization is actually a transfer of wealth from high-cost provinces to low-cost provinces.

Many Canadians describe equalization as about “have” and “have-nots” provinces. In fact, it’s a wealth transfer of federal tax dollars from high-cost provinces such as British Columbia and Alberta to governments in low-cost provinces in Atlantic Canada along with Quebec and Manitoba. (High-cost Ontario is an anomaly — though when other federal transfer programs are thrown into the calculation mix, it too is a net contributor to federal coffers, despite the fact it is nominally a “have-not.”)

For example, according to a Royal LePage survey of housing prices, bungalows in have-not Halifax, Charlottetown, Saint John, Quebec City, Montreal and Winnipeg vary from a low of $168,000 (Charlottetown) to a range of $229,000 to $363,000 (in various Quebec City neighbourhoods). But the same bungalow will set a buyer back between $301,500 and $576,200 in Calgary, and between $473,000 and $1.35-million in greater Vancouver.

Ironically, equalization increases the inequality in government services that the program is supposed to reduce. Because costs are lower in “have-not” provinces, services can be provided at a lower cost — a civil servant needs a much higher salary in Vancouver than Charlottetown for an equivalent standard of living. Thus “equalizing” funds available for services means recipient provinces can afford a higher level of services than the provinces that fund them.

Inconvenient Fact #4: Transfer programs don’t even work well for have-nots.

“Over-equalization” weakens the economies of poorer provinces. As pointed out in a series of studies by one of us (McMahon), lagging regions in Canada have been catching up to the centre more slowly than poorer regions in the United States, Europe and Asia.

The rich flow of funds — equalization and other federal transfers — into recipient provinces boosts government spending, pulls resources away from the private sector, and politicizes the economy: Who you know in government, the region’s biggest customer, can be more important than producing goods and services people actually want to buy.

With the exception of Newfoundland, with its offshore activity, government expenditures in recipient provinces vary from 47% of GDP (Manitoba) to 64% (PEI). This compares to 23% in Alberta and 38% in British Columbia.

Government, by bidding resources and workers away from the private sector, artificially increases costs for the private sector and reduces competitiveness and growth — things poorer provinces need much more than bundles of cash from the rest of Canada.

Fact #5: Equalization, as we know it, is not required by the Canadian constitution.

Many people might see the flaws in equalization and conclude nothing can be done. It’s in the 1982 constitution. However, as legal scholar Burton H. Kellock, Q.C., and former Fraser Institute analyst Sylvia LeRoy concluded in a 2006 paper, the legal significance of the Constitution’s equalization provisions is misunderstood.

For instance, University of Alberta law professor Dale Gibson has observed that “it could be contended that because s. 36(2) [of the Constitution Act, 1982] contains no reference to legislative jurisdiction, and employs soft terms like ‘committed’ and ‘principle’ rather than power-granting expressions like ‘may make laws,’ it was not intended to have any direct legal effect.”

Similarly, Professor Peter Hogg, one of Canada’s leading constitutional scholars, has described equalization as “statements of economic and social goals that ought to guide government but which are not enforceable in court.”

In summarizing the consensus among academics, Kellock and LeRoy observe that “The ambiguity of these terms has contributed to a consensus amongst academics,” which is, to quote Hogg, that “the constitutional obligation to make adequate equalization payments to the poorer provinces is probably too vague, and too political, to be justiciable.”

If the form and funding of equalization payments resembles less a constitutional imperative and more a non-enforceable informal convention, we are back to the politics of transfer payments. Here are some suggestions for reform in the short-term and, possibly, even the eventual abolishment of equalization.

First, equalization should be based on the actual cost of providing services, given that it clearly costs more to deliver a service in Vancouver than in Charlottetown.

Second, freeze the amount now paid out by the federal government under equalization and transfer-payment programs. That, in turn, would enable our third suggestion: Remove the federal government from areas of provincial responsibility and return and equivalent amount of tax room to the provinces. What this would mean, at least initially, is there would primarily be one transfer payment program, not a complex of interlocking programs. Preferably and eventually, even equalization should end in exchange for a variety of more tax points.

This latter reform — equalization’s eventual end — would increase transparency and improve government incentives, since taxpayers would be clear about which level of government delivers what service and at what cost.

It is also a position that prime minister Laurier would have heartily endorsed.

National Post

Mark Milke is a Senior Fellow, and Fred McMahon is a vice-president, at the Vancouver-based Fraser Institute.

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