Equalization

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.

  1. 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.

  2. 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.

  1. 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]

  1. 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.

  1. 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.

  1. 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.

Background information on Equalization

Per Capita Equalization Payments to Provinces 2018-2019 ($millions)

Equalization Payment $Millions

*The Territories do not receive equalization payments.  They receive Territorial Formula Financing from Finance Canada which is determined through a different process but is included in the federal-provincial transfers total.

In the most recent year, the recipients of transfers are as follows:

Equalization Payments to “Have Not” Provinces Millions of Dollars
2019-2020
2018-2019
2017-2018
2016-2017
2015-2016
Quebec
13,214
11,732
11,081
10,030
9,521
Manitoba
2, 255
2,037
1,820
1,736
1,738
Nova Scotia
2,015
1,933
1,779
1,722
1,690
New Brunswick
2,023
1,874
1,760
1,708
1,669
Ontario
0
963
1,424
2,304
2,363
Prince Edward Island
419
419
390
380
361
Total
19,926
18,958
18,254
17,880
17,342

Source: Department of Finance

⦁ The Federal Government determines the total amount to be allocated to equalization.  Since the 2009-10 fiscal year, this amount has been based on the growth rate of Canada’s GDP.  In 2018-2019 this amount was $18.6 billion. 

⦁ The Federal Government calculates the three-year weighted average of non-resource fiscal capacity. The “fiscal capacity” of each province is determined based on the amount of revenue that province would raise with tax rates equal to the national average. If a province would raise less than the national average then the Federal Government would make an equalization payment to that province to bring it up to the national average. 

⦁ There is a weighted three year moving average calculation made to determine the amount of the payment to any province in any given year, with a two year lag. So the 2018-19 annual payment would be the sum of 50% of its 2016-17 payment +25% of its 2015-16 payment +25% of its 2014-15 payment. This was done to stabilize the year to year payments.

⦁ A determination is made as to whether 50% of resource revenues will or will not be included with tax revenues. The option (50% or 0 ) is used that will result in the highest equalization payment for that province. The “best of” option is used.

⦁ Since all resource revenues are not included, there are situations where a receiving province could benefit too much. In 2009 the Federal Government implemented a “Fiscal Capacity Cap” whereby the combination of own sourced fiscal capacity, including all resource revenues, and the equalization payment to any receiving province cannot exceed the average fiscal capacity of all equalization receiving provinces.

Source: Unpacking Canada’s Equalization Payments for 2018-19. January 17, 2018 BLOG by Trevor Tombe. University of Calgary School of Public Policy.<br>
Source: Canada’s Equalization Formula: Peering Inside the Black Box…And Beyond. September 24 Research Paper by Jim Feehan. University of Calgary School of Public Policy.

As discussed below, Albertans pay a disproportionate amount of Canada’s taxes and receive a disproportionately smaller level of services in return. This is outlined in the section below. Then on top of paying approximately 50% more than we receive, we are faced with the equalization program. This program then penalizes Alberta for our higher earnings and fiscal capacity and then transfers further monies to certain other provinces.

A key structural problem with the formula is that it includes natural resource revenue (50%) in calculating the fiscal capacity of provinces but does not include hydroelectric power revenue (thus primarily providing an advantage to Quebec, but also to some extent providing an advantage to Ontario, BC and Manitoba).  

As well, the program has clearly created structural dependencies in Quebec and certain maritime provinces. Quebec’s fiscal plan counts on the large equalization payments and there is no incentive to wean itself off of its dependency. Equalization programs should be transitional in nature and not structural.

As well, the Federal Government makes no effort to ensure that equalization funds are efficiently spent to ensure minimum national standards are met. There is little or no attention given to what constitutes the required public services within the ambit of section 36 of the Charter.

The Federal Government budget does not match its sources of revenue due to its deficit. The sources of revenue by category are set out below (based on Statistics Canada 2017 data):

Based on Statistics Canada 2017 data.

British Columbia
Total: $8,388
Manitoba
Total: $7,010
Prince Edward Island
Total: $6,150
New Brunswick
Total: $6,486
Alberta
Total: $11,738
Ontario
Total: $8,817
Newfoundland
Total: 8,844
Saskatchewan
Total: $8,642
Quebec
Total: $6,397
Nova Scotia
Total: $6,862

The total contribution by Alberta to the Federal Government is the per capita amount of $11,738 multiplied by the population of 4,262, 642 which is $50.03 Billion. When compared to Alberta’s entire provincial budget of $48 Billion, this amount is extraordinary.

Further, the below table shows equalization per capita and the sum of the two. Notably, except for Newfoundland, the “have not” provinces have higher per capita revenue than the “have” provinces after Equalization is added to own source revenues. Before equalization PEI and New Brunswick have the lowest per capita revenue, however, after Equalization payments, Alberta and Saskatchewan have the lowest per capita revenues. (Source: Equalization payments in Canada, Wikipedia).

2016-17 Per Capita Impact of Equalization Dollars
Equalization Per Capita
Equalization Plus Own Source Revenues
British Columbia
0
9,118
Alberta
0
8,890
Saskatchewan
0
8,682
Manitoba
1,328
9,570
Ontario
166
9,281
Québec
1,206
11,089
New Brunswick
2,259
9,555
Nova Scotia
1,822
9,798
Prince Edward Island
2,573
9,465
Newfoundland and Labrador
0
10,752

The transfers to Provinces on a per capita basis are outlined below.   It is important to note that the Alberta per capital revenue contribution is approximately 50% higher than the per capita services received.

Federal Revenues and Expenditures by Province, 2017 (in dollars per capita)
National Average
Revenues
Expenditures
British Columbia
8,736
8,408
Alberta
11,738
6,642
Saskatchewan
8,641
8,322
Manitoba
7,011
10,247
Ontario
8,816
7,648
Québec
6,397
8,355
New Brunswick
6,485
12,987
Nova Scotia
6,862
14,000
Prince Edward Island
6,150
14,814
Newfoundland and Labrador
8,844
11,768

Analytical work originally done by Fred McDougall (Fred is a Vice President of Fairness Alberta) and later by others, including Robert Mansell of the University of Calgary, focused on the broader net fiscal contributions of the provinces. This goes well beyond the impact of equalization transfers and measures the total funds flowing from provinces to the Federal Government and the funds flowing back to the provinces. This is based on Statistics Canada data. This data is shown below by province in both gross dollars and per capita.

Federal Government Revenue & Expenditure in Alberta (2012-2018)

Millions of Dollars
Revenue
2012
2013
2014
2015
2016
2017
2018
Personal income Tax
21,295
23,629
25,737
26,992
22,707
24,444
25,737
Corporate income Tax
7,839
9,066
10,041
8,697
7,296
6,376
6,531
Goods and services tax
4,503
4,808
5,169
5,250
5,014
5,330
5,547
EI Contributions
2,769
3,273
3,449
3,415
3,256
2,799
2,934
Other Revenue¹
4,969
5,353
5,593
5,352
5,028
5,480
5,997
Total Revenue
41,375
46,129
49,989
49,706
43,301
44,429
46,728
Expenditure
Health and social transfers
3,855
4,143
4,733
5,273
5,551
5,860
6,077
Final expenditure on goods and services
4,637
4,617
4,641
4,604
4,721
5,132
5,187
Old age security
3,150
3,277
3,434
3,621
3,823
4,106
4,407
EI benefits
1,281
1,334
1,471
2,094
3,079
2,760
2,278
Interest on public debt
2,999
3,036
2,857
2,720
2,553
2,488
2,748
Other expenditure²
6,218
6,204
5,797
6,638
7,615
8,824
8,856
Total Expenditure
22,140
22,611
22,933
24,950
27,342
29,170
29,553
Net Contribution (Revenue less Expenditure)
19,235
23,518
27,056
24,756
15,959
15,259
17,175
Net Contributions
($ per capita)
4,964
5,908
6,625
5,973
3,803
3,596
3,994

¹ Other revenue – withholding taxes, fuel taxes, excise duties, etc.
² Other expenditure – child benefits, interest on the debt, transfers to aboriginal governments, etc.

It is interesting to note that even in times of economic downturn in Alberta, Alberta’s per capita net contribution to the federal government of approximately $3,994 per year exceeds the total annual per capita contribution of all other provinces of $3,567. 

Net Fiscal Contribution, $ per capita
Revenue
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
AB
6,318
2,258
4,807
4.451
4,721
4,964
5,908
6,625
5,973
3,803
3,596
3,994
BC
1,547
1,013
212
-408
301
707
686
1.006
1,227
1,482
1,718
2,046
ON
1,423
703
-194
-823
-75
95
188
652
985
1,178
1,474
1,519
SK
-1,219
-807
-502
-825
-250
42
709
1,141
960
111
-321
-271
QC
-906
-1,678
-2,075
-2,331
-1,970
-1,833
-1,818
-1,830
-1,718
-1,742
-1,825
-1,533
NL
-4,552
-3,313
-5,004
-4,981
-3,583
-3,211
-2,313
-2,052
-2,346
-2,627
-2,939
-2,032
MB
-3,391
-3,807
-4,097
-4,374
-3,952
-3,574
-3,180
-2,857
-2,803
-3,061
-3,309
-3,429
NB
-4,941
-5,278
-5,871
-6,381
-6,169
-5,990
-5,849
-5,726
-5,876
-5,999
-6,269
-6,411
NS
-5,450
-6,376
-6,621
-6,911
-6,931
-7,177
-7,058
-6,746
-6,901
-6,824
-7,037
-7,361
PEI
-6,673
-7,755
-8,871
-9,142
-8,183
-7,666
-8,023
-7,492
-7,451
-7,770
-8,420
-8,842
Net Fiscal Contribution (millions of dollars)
AB
22,201
22,504
17,686
16,610
17,888
19,235
23,518
27,056
24,756
15,959
15,259
17,175
BC
6,640
4,408
935
-1,823
1,355
3,227
3,178
4,737
6,100
7,202
8,459
10,231
ON
18,164
9,053
-2,525
-10,811
-991
1,271
2,536
8,881
13,498
16,343
20,745
21,750
SK
-1,222
-821
-519
-867
-266
46
780
1,270
1,076
126
-369
-315
QC
-6,972
-13,026
-16,276
-18,484
-15,769
-14,779
-14,743
-14,911
-14,043
-14,326
-15,147
-12,856
NL
-2,317
-1,695
-2,586
-2,600
-1,881
-1,690
-1,219
-1,084
-1,239
-1,391
-1,553
-1,068
MB
-4,034
-4,560
-4,952
-5,340
-4,875
-4,467
-4,021
-3,654
-3,622
-4,022
-4,417
-4,641
NB
-3,683
-3,942
-4,403
-4,805
-4,662
-4,543
-4,437
-4,346
-4,459
-4,579
-4,807
-4,942
NS
-5,096
-5,967
-6,212
-6,511
-6,545
-6,772
-6,638
-6,331
-6,463
-6,434
-6,688
-7,063
PEI
-919
-1,076
-1,241
-1,295
-1,178
-1,108
-1,156
-1,081
-1,077
-1,142
-1,267
-1,358
Source: Statistics Canada Table 36-10-0450-01 November 7, 2019

It is important to note that in the context of Alberta receiving no equalization payments and making a very large contribution to the Federal Government revenues,  Alberta scores near the bottom among provinces in term of the numbers of doctors and nurses,  student-teacher ratios and social services employment per 100,000 of population where Alberta is the lowest in Canada (source:  University of Calgary—Haskayne School of Business)

Normally, organizations re-invest in those divisions or activity centres that generate the greatest net contributions to fund the rest of the organization.   This is not the case with Canada.   Rather than Canadians re-investing in Alberta, or allowing Albertans to re-invest in Alberta, the opposite has consistently happened.   Canada has “milked” Alberta for decades, not allowing for necessary re-investment.   

Often, Alberta is compared to Norway, with statements made to the effect the resource revenue was squandered.   This is not the case. Rather, it was taken by the Federal Government to meet federal spending needs in the rest of Canada.

The failure to allow for oil exporting pipelines further accentuates this failure to re-invest in the source of the Federal Government’s key revenue source.