Transfers and equalization often flare up in Canadian policy discussions with the cry that there is a need for reform. A recent Cohn column in the Toronto Star on Ontario’s economic stall concluded “Outdated equalization and transfer payments cry out for reform, but will likely continue to bleed Ontario’s taxpayers of about $12 billion a year (a burden that would wipe out our deficit and balance the budget instantly.” This is a continuing mantra in Ontario that began with the 23 billion dollar fiscal gap put forth by Dalton McGuinty in 2006 and estimated at $11 billion by the Mowat Centre in a report in the spring of 2013. I suspect the target of the Mowat Centre or Martin Regg Cohn here is not so much the Canada Health Transfer or the Canada Social Transfer – which is paid put on a per capita basis to all the provinces – but equalization. So, how much equalization has the federal government out, and what are we to make of an equalization system that currently has Ontario as a recipient?
Some background: Equalization has operated since 1957 and according to the Federal Department of Finance “is the Government of Canada's transfer program for addressing fiscal disparities among provinces. Equalization payments enable less prosperous provincial governments to provide their residents with public services that are reasonably comparable to those in other provinces, at reasonably comparable levels of taxation.” The justification for a system of transfers to equalize fiscal capacity can be traced back to the Rowell-Sirois Report in 1940, which recommended a system of National Adjustment Grants in lieu of the ad hoc federal grant system of the day. One might even argue that the Dominion Subsidies put in place at the dawn of Confederation were the first federal transfer payment in recognition of diminished provincial fiscal capacity as a result of giving up customs duties as a revenue source to the federal government.
Then there is the rationale provided by James Buchanan in “Federalism and Fiscal Equity” that fiscal residua – the per person difference between benefits received and taxes paid across regions - needed to be equalized as differences would result in migration for fiscal benefits rather than marginal productivity reasons. And of course, there is the Boadway-Flatters argument that in the presence of resource rents, equalization is justified on efficiency reasons in the presence of interregional mobility – you want migration for marginal productivity reasons rather than to capture resource rents - and equity reasons if there is no interregional mobility.
Counter arguments to equalization often focus on the potential for such payments to interfere with the adjustment process whereby economic resources flow from regions of low to high productivity. As well, while the program is financed out of general federal revenues, the equalization formula calculates entitlements based on whether a province’s revenues are below or above a national average – if below, you get a grant entitlement. As a result the equalization program has developed a popular but misplaced reputation as a direct transfer from have provinces to have not. Hence, the argument that have provinces like Ontario have been bled to finance transfers to poorer regions.
However, Ontario is currently a recipient of equalization having obtained its have not status in 2009. Prior to 2009, Ontario, Alberta and British Columbia were the provinces that generally did not get equalization and hence viewed themselves as paying into it while the other provinces received transfers. At present, there are six provinces receiving equalization – Prince Edward Island, Nova Scotia, New Brunswick, Quebec, Ontario and Manitoba.
Tracking down how much equalization has been paid out since 1957 is an interesting exercise and the figures not easily obtained. I managed to track down equalization entitlements by province for the period 1982/83 to the present from a 2006 Budget on the Federal Department of Finance website. The earlier period was a little more difficult but I came across a manuscript document in my old fiscal federalism files titled “The Fiscal Equalization Program, Federal Provincial Relations Division, Department of Finance, October 1991” that provided the entitlements from 1957 to 1991 and the numbers overlap period from 1982 to 1991 matched the 2006 Budget numbers.
So, Figure 1 plots total annual equalization both nominal and in 2002 dollars for the entire period 1957 to 2013. The total payout in 1957/58 was 139.1 million dollars (940 million in 2002 dollars) and by 2013/14 is projected to reach 16.1 billion dollars (13 billion in 2002 dollars). If one sums up all the annual total values of equalization, over the entire period 1957 to 2013, a total of 340.2 billion dollars was disbursed (437.6 billion in 2002 dollars). Figure 2 presents the total nominal value of equalization received by each province since 1957 and first is Quebec at 169.5 billion dollars, followed by Manitoba at 40.8 billion and then Nova Scotia and New Brunswick at 38.6 and 37.9 billion dollars respectively.
What is interesting is that all of the provinces have at one point or another collected equalization – even Alberta from 1957 to 1963 – though its share of the total paid out is miniscule. What is also interesting is that while Ontario has only been collecting equalization since 2009, it has already collected more than either Saskatchewan or Prince Edward Island ever did. Of course, the dollars per capita picture is quite different as Figure 3 shows with Ontario and Quebec being the lowest per capita recipients as a result of their much larger populations. (Note: I calculated these myself using the estimated entitlement out of the budget and dividing by population estimates from Statistics Canada).
So what is my point? Well, the people in Ontario who argue that equalization should be reformed or Ontario needs more transfers because Ontario either was or is being milked are missing an important point. Ontario may have been milked in the past but reparation payments now are no way to manage a federal transfer system. Moreover, even if Ontario was paying more into the tax-transfer system, it was because it was a very wealthy province and it derived much of that wealth from its membership in the Canadian federation. Ontario businesses particularly in manufacturing intensive southern Ontario benefitted immensely from the tariff. In addition, Ontario has always managed to obtain a large share of federal employment and service contracts because the capital was located in Ontario.
Equalization should be reformed because Ontario is now a have not province and not because it is or was being milked. Equalization is a relatively modest expense for the federal government when the have not provinces are mainly the smaller provinces – with Quebec being the obvious exception. However, what will happen over the next ten to fifteen years if two of the have not provinces are the country’s largest provinces in population terms? Can Canada really afford two “Quebecs” when it comes to equalization payments? How can the country’s equalization system be taken seriously if 71 percent of the population effectively lives in the have not provinces?
Moreover, while Ontario total equalization entitlement growth rate has slowed considerably over the last two years, the average annual growth rate for the period 2010 to 2013 was 70 percent. If the average growth rate over the next decade is even one-tenth that amount – say seven percent - total equalization paid out to Ontario could double during that time from the current 3.2 to 7.4 billion dollars. True, Ontario’s economy has stalled and per capita GDP has fallen below the Canadian average but Ontario still has the fourth highest per capita provincial GDP – after resource fueled Alberta, Saskatchewan and Newfoundland. Does it make any sense to be providing equalization to a province with forty percent of the country’s population and the fourth highest per capita GDP?
If memory serves me, the last time the equalization formula was on the verge of providing payments to Ontario it was also during the resource boom of the late 1970s. The current equalization formula – like that in the 1970s – includes natural resource revenues as one of the revenues used to calculate the equalization entitlement. In 1981, Ontario also had the fourth highest per capita provincial GDP but was above the national average in GDP and the result was the passing of the “Ontario Override” that provinces with a per capita GDP above the national average would not get equalization. Shortly thereafter, the equalization formula was changed to the Representative Five Province Standard that dropped resource rich Alberta from the national average used to calculate entitlements to mitigate the effect of resource revenues.
It is an excellent example of how short human memories are that the new equalization formula created after the 2006 Federal Export Report put natural resource revenues directly back into the equalization calculation at a time of rising resource prices. This time, as resource prices rose, the resource boom fueled per capita GDP in Alberta, Saskatchewan and Newfoundland so high that Ontario fell below the national average even while still having the fourth highest GDP.
Some might argue that equalization might be doing exactly what it should be doing in the presence of high natural resource rents in a handful of provinces. Also, the federal government is moving into a surplus position and its main spending role as simply a check-writing agency to provinces, businesses and individuals is not at odds with more health or education transfers for Ontario – or any other province for that matter. However, I think it is a stretch to consider provinces with a per capita GDP in the top half of provincial per capita GDP rankings as being have not provinces and in need of equalization payments.
The equalization program does need reform but it is not going to disappear anytime soon given that Section 36(2) of the Constitution commits the Government of Canada to the principle of making equalization payments. I also don’t think either the federal or provincial governments want to risk a Supreme Court case to define what comparable levels of public services at comparable levels of taxation means. As for Ontario, receiving over three billion dollars in equalization while moaning about being milked by the federal tax and transfer system is rather hypocritical. And judging from the economic performance of the other main equalization receiving provinces over the last fifty years, more equalization will certainly not reverse its economic stall. Ontario should stop whining and work on raising its productivity.