Equalization is an increasingly controversial federal program, but there are many misconceptions about it. This federal program is supposed to be aimed at ensuring each province can “provide reasonably comparable levels of public services at reasonably comparable levels of taxation” as per sec. 36(2) of the Constitution.  Our analysis will first provide a basic overview and then propose eight solutions to ways the program either falls short of or overshoots its Constitutional basis.

Funding for Equalization comes from federal taxes and goes directly to provincial governments calculated to be below average in “fiscal capacity.” Albertans’ higher per capita tax payments mean they have been making a net contribution of  $15-27 billion annually – over $3 billion of that goes towards the $20 billion Equalization program.  This is entirely a “net” contribution since Alberta receives no payments.

What is less obvious is that Albertans have been making a similarly large net contribution to federal-provincial transfers through the Canada Health Transfer (CHT) and Canada Social Transfer (CST). They pay in about $9 billion (based on their 16-17% share of tax revenues) but only get roughly $6 billion back (based on their 11.5% share of population).  When this $3 billion net contribution is combined with the Equalization contribution, that is more than $6 billion from Albertans’ federal taxes going directly to other provincial governments to fund their provincial services.

Put another way, Albertans in recent years have had about $6000 per family of four sent from Ottawa – annually – to other provincial governments to fund health and social services through CHT, CST, and Equalization alone.

This $6 billion figure is only one part of the larger $15-27 billion per annum total net transfer from Albertans to the rest of the country.  This larger figure is explained in detail in the “Fiscal Fairness” section at www.fairnessalberta.ca.

This degree of redistribution goes beyond anything required by the Constitution, and it is hard in principle to justify taking such a large sum from taxpayers in one province and sending it to other provincial governments to meet their provincial responsibilities.  This dilemma becomes particularly acute as Alberta’s government struggles to tackle one of the largest provincial deficits in Canada.

Additionally, Equalization dampens the incentive for provinces to seek to expand their own fiscal capacity, even creating a perverse incentive not to approve economic development that has political controversy surrounding it since the gains to provincial coffers will be to some extent offset by lower equalization payments.

It is also notable that the formula solely looks at equalizing revenues, without taking into account what funds would actually be required in different provinces to deliver equal services once relative inflation and cost-of-living levels are taken into account.

Rather than just highlight problems, however, Fairness Alberta has eight concrete proposals for reform that we believe would bring more fairness to the Equalization program by making the fiscal arrangements around it more transparent, affordable, flexible, and inclusive.  We believe this will also strengthen Canada as a whole. 

8 Ways to Bring More Fairness to Equalization

1. Replace the Canada Health Transfer (CHT) and Canada Social Transfer (CST) with tax points to eliminate their “equalization” duplication.  As noted in the introduction, the federal government has been sending almost as many Albertan federal tax dollars to other provincial governments through the CHT and CST as through the actual Equalization Program (roughly $3 billion each, as detailed in the Fiscal Fairness section of our website).[1]

   Funding the health and social transfers by transferring tax points to the provinces would address this duplication in a principled way that has historical precedent.[2]  “Tax points” come in different forms, but those we have in mind would feature the federal government dropping tax points to the equivalent value of these transfers and inviting the provinces to raise their tax rates by a corresponding amount to fund their health and social services.

   Based on recent years, this would equate to a $9 billion reduction in federal taxes for Albertans that would presumably be replaced with a $6 billion increase in provincial taxes which is all that would be needed to replace these transfers.

   Health and social services are exclusively a provincial responsibility under the constitution and are administered independently.  The federal government making this tax point transfer would better ensure that – apart from “Equalization” – the tax dollars Canadians pay for programs covering provincial responsibilities like health and social services are spent in their province, by the provincial government that is accountable to them.

   The next three proposals relate to a concern that the overall Equalization Program should be controlled or reduced rather than being tied to GDP.  The current program structure with Equalization tied to GDP means the same recipient Provinces get more and more annually regardless of need (in addition to the growing CHT/CST transfers). While not mutually exclusive, given the compounding effect the proposals would have on the Equalization program we offer them for consideration in combination or alone.
   
   

2. Reduce the size of the Equalization program 50% over 5 years.  Gradually reducing the program would give recipient provinces time to adjust, while the $10 billion in savings could be used for broader purposes like tax cuts, infrastructure, or, as seems increasingly necessary, debt reduction. Roughly $1.6 billion in Albertan taxpayers’ dollars would then be redirected to shared purposes such as these rather than straight to certain Provinces. This is justified given the problems with the program, size of the federal deficit, and the duplication mentioned above with CHT/CST.
   
   

3. Carve out a substantial revenue stabilization program within the current Equalization program to ensure the program offers something to everyone.  We speak at more length on revenue stabilization in the Issues section of our website, but the notion here is that funding for a reformed and expanded Revenue Stabilization Fund could – on the rare occasions a province’s revenues drop enough to qualify – come from within the existing Equalization envelope. Dr. Trevor Tombe suggests integrating Equalization and Fiscal Stabilization in his recent work on the Fiscal Stabilization Program for the Institute for Research on Public Policy.This is not only a fiscally prudent approach, but as Dr. Tombe notes there is a logic to it in that it is precisely when the resource-based provinces are struggling that there is less inequality and thus less need for Equalization.  It would also, for better or worse, help to address the criticism that the program seems to always send funds to the same provinces decade after decade regardless of economic storms elsewhere.  If provinces like Alberta could draw from the Equalization Program budget to help stabilize the delivery of provincial services in the face of occasional and unexpected revenue shortfalls, this inclusivity would lessen the growing animosity surrounding the program.
   
   
4. Make overall Equalization payments shrink when the inequality in fiscal capacities shrinks. Fiscal capacities between provinces are becoming more equal, particularly as Alberta’s economy struggles (See Fig. 3 of this analysis by Dr. Tombe). The current program design is flawed as the total dollars allocated to be paid to “have not” provinces is not adjusted downwards when the fiscal capacities of the provinces becomes more equal.  For example, if 7 provinces were 1% above the average fiscal capacity, and 3 provinces were 1% below, those 3 provinces – despite being essentially equal – would still collect the entire $20b (or whatever the program had grown to).[3] To paraphrase a helpful recent bulletin from the Fraser Institute, the Equalization ceiling should not be a floor: instead, within a capped maximum, the global amount paid out should be proportionally reduced each year in accordance with some kind of parity measure.  It only makes sense that as provinces become more equal, Equalization payments should shrink.[4]
   
   The remaining proposals pertain solely to changes in the formula; none of them would benefit Alberta directly in the short term because it will still be considered above-average in fiscal capacity, but they would improve fairness and they reinforce why the current program is in need of reform.
   
   

5. Costs of delivering services should weigh into the equation as much as the fiscal capacity to fund them. S. 36 affirms the principle of provinces being able to afford similar services at similar levels of taxation – as noted by the Mowat Centre, it makes no sense to only look at relative fiscal capacity and ignore the relative costs. If building and staffing a hospital in a given province only costs 85% of the cost of a hospital in BC, Ontario, and Alberta, then 85% of the fiscal capacity would achieve “reasonably comparable levels of public services at reasonably comparable levels of taxation.”In general, the ‘have not’ provinces have significantly cheaper housing, lower labour costs, etc. and this should be factored into their needs just as much as their fiscal capacity – otherwise we are only looking at half of the picture.[5]
   
   

6. Remove non-renewable resource revenues.  These are one-time sales of an asset, and as such do not seem to fit the definition of fiscal capacity. While provinces can use a 50% of resource revenues  or 0% depending on which earns them a bigger payment, excluding non-renewable revenues entirely is not only defensible insofar as it is converting an asset rather than income, but this also mitigates the concern that the inclusion of non-renewable resource revenues in the payment formula creates a perverse incentive for have-not provinces not to develop their resources fully.For example, one province’s decision on prohibiting hydraulic fracturing to extract oil and gas should not be impacted by considerations of the compensation they get from Equalization for leaving resources in the ground.
   
   

7. Include the full fiscal capacity of Crown Corporations, particularly Hydro-power related entities. Hydroelectric power is, of course, a renewable resource, and it should be fully factored into a province’s fiscal capacity as if it were owned privately (including offsetting subsidies to rates, particularly water rental subsidies, etc.). Provinces can of course decide to administer utilities or other Crown corporations like liquor control boards as they wish; for the sake of equalization purposes, however, they should be treated as though they were maximizing their fiscal capacity.
   
   

8. Claw back equalization payments for provinces that choose to have relatively high spending. Ensuring no province struggles to provide basic services makes sense to many, but what are we to do when those receiving Equalization offer considerably higher levels of services? Quebec, in particular, is noted for its heavy subsidization of daycare and universities; does it make sense that lower and middle-class Alberta families are, through Equalization, subsidizing much more generous programs in other provinces that they cannot access?While provincial autonomy is important to preserve, self-reliance is an essential element of autonomy.  It can be fairly argued that Provinces should need to get their spending on programs close to the national average before expecting a subsidy from taxpayers in other provinces.  There should be some control mechanism that reduces a recipient Province’s equalization payment if they are spending at levels higher than the nation-wide per capita average.[6]  This would reassure Canadians that this program is not just taking their tax dollars to subsidize benefits in other provinces that their own elected provincial government considers unaffordable or inefficient.
   
   

Footnotes

[1] Another way to end this duplication is to roll the Equalization program fully into the health and social transfers and distribute the combined funds on a per capita basis. Albertans would still be paying in at a higher rate based on incomes, but would get an equal per person share back, reducing the net transfer in recent years from $3.2 billion to about $1 billion.

[2] As laid out in a Policy Options piece by renowned scholar Dr. Thomas Courchene, the forerunner to the present CST/CHT and Equalization was a version of this: a tax-point transfer based on a “derivation basis” – i.e. funds to support health and social services were allocated to each province based on the share of personal and corporate taxes that came from their residents and businesses. We would welcome the federal government using this method as well, but it would seem to make more sense both politically and practically for them to seek to drop federal tax rates if the money is simply flowing directly back to the province anyway.

This initial program soon had an ‘equalization’ element added, but with the formal Equalization Program now sending $20 billion annually to the have-not provinces, we should return to a version of the original formulation to add transparency and ensure there is no additional net transfer through the federal government for provincial services.

[3] Currently a version of this is happening: when the individual recipient provinces’ calculations from the formula do not use the entire budget, the government simply divides and distributes the remainder between them anyway.

[4] This is distinct from the previous recommendation in that fiscal capacity differentials can narrow considerably over time without any province triggering a Fiscal Stabilization Fund payment (5% drop in revenues).

[5] While there are many variables that could enter into this equation, including age, population density, etc. that would offset some of the relatively lower costs for some of the recipient provinces, there is no excuse for leaving this side of the equation out.

[6] This could also be adjusted for factors like population density and age as well as cost of living. While provinces should have autonomy in decision-making, once they become net Equalization recipients their decisions clash with the principle of not being subsidized by other taxpayers. To balance these, the reduction should stop at the percentage of Equalization that a given province’s taxpayers had funded. That is to say, for example, if 20% of federal revenues came from Quebecers, they could not be reduced below 20% of the Equalization payments due solely to this proposal.