FISCALAMITY! : FROM DERA FE TI E O HEARTLAND TO HAVE-NOT H N

T Thomas J. Courchene L A For the second time in Ontario's history, the province has joined the ranks of the N F O have-not provinces, and the cause both times was soaring energy rents and royalties É TI accruing to the energy-rich provinces. With this as a backdrop, Contributing Writer DÉRA Thomas Courchene focuses on selected details of Ontario’s fiscal position in relation to its sister provinces. He also examines suggestions that the equalization program can be seen as complicating Ontario’s fiscal bottom line. The author concludes by presenting a policy blueprint for the province in an era that will likely be characterized by high energy prices and the continuing volatility of the dollar.

Pour la deuxième fois de son histoire, l’Ontario se retrouve parmi les provinces moins nanties. Et cette fois encore, ce recul s’explique par les rentes et redevances tirées des ressources naturelles qu’ont accumulées les provinces riches en énergie. Dans ce contexte, notre collaborateur Thomas Courchene fait le point sur quelques aspects clés de la situation financière de l’Ontario par rapport à celle de ses provinces sœurs. Il examine aussi les hypothèses selon lesquelles le programme de péréquation vient compliquer cette situation. Il propose enfin pour la province un plan d’action adapté à une époque qui sera vraisemblablement caractérisée par des prix de l’énergie élevés et une instabilité permanente.

he Ontario of Frost and Robarts and Davis was this great province at a Dominion-Provincial Canada’s economic heartland. The province was so Conference, saying something like this. He said, “You T prosperous, so diversified economically and so pow- have all read that we have three thousand new indus- erful politically that Canadian policy had little choice but to tries come to Ontario since the war.” (This was about be cast in a pro-Ontario light. In effect the old saw “What is ten years after the war. They already had three thou- good for General Motors is good for America” was even sand new industries.) He said, “You think this is won- more relevant for the Ontario-Canada relationship because derful, don’t you?”— looking at the nine of us, the the latter was reciprocal. Since heartland Ontario could gen- other premiers. “You think this is wonderful. You don’t erally count on Ottawa to further the province’s interest, it realize the other side of it, all the new schools we have was in favour of a strong central government. And Ottawa to build and all of the housing and all of the hospitals delivered the Seaway, nuclear power for Ontario Hydro, the and all the new roads and paving and everything Auto-pact, the National Energy Program and so on. As a else.” I said, “Stop, you are breaking my heart.” result, more so than their fellow citizens in other provinces, Ontarians are unhyphenated Canadians, although this may et heartland Ontario did recognize its privileged posi- have less to do with fealty than with the crass reality that Y tion and did attempt to play an integrating role in the Ontarians often elect two governments — their own and federation. For example, Premier John Robarts magnani- Canada’s — so why not like them both. mously orchestrated the aforementioned 1967 Not surprisingly, Ontario’s “king of the hill” status did Confederation of Tomorrow conference in order to (in Jean- not elicit much sympathy for its concerns from its sister Luc Pepin’s words) “give Danny [Quebec Premier Daniel provinces. No one expressed this more creatively, yet Johnson] the biggest soap box in Canada to tell the people tellingly, than Newfoundland Premier Joey Smallwood. of the country what he really wanted for his province.” Speaking at the 1967 Confederation of Tomorrow confer- Moreover, Ontario MPs often tended to view them- ence, Smallwood noted: selves as national rather than Ontario parliamentarians, I notice that Premier Frost is here today and I remem- much to the chagrin of Ontario premiers Rae, Harris, Eves ber his saying when he was in office as the Premier of and McGuinty, as noted below. But even here, one might

46 OPTIONS POLITIQUES JUIN 2008 Fiscalamity! Ontario: from heartland to have-not note that supporting the interests of lation were still in play today, it would ing and tax cuts) and the resulting other parts of the country was not nec- again exclude Ontario from receiving depreciation of the Canadian dollar essarily inconsistent with advancing equalization, because Ontario’s per- (relative to the US dollar), Ontario Ontario’s own interests: a comprehen- sonal income is still above the nation- embarked upon an impressive export- sive system of equalization payments al average since energy royalties accrue led boom and soon forgot about any would eventually benefit Ontario as directly to provincial governments energy/equalization concerns. This the principal east-west supplier/distrib- and, therefore, do not enter personal was obviously influenced by the col- utor of manufactured goods, both income.) lapse in global energy prices and the domestic and imported In return for agreeing to forgo advent of the FTA (which Ontario’s In any event, heartland is no equalization payments, Ontario Peterson government opposed in spite more. Even before the end of the Davis requested a reworking of the equaliza- of the fact that Ontario business was government, Ontario’s fiscal star tion formula and proffered several onside because it wanted, inter alia, to began to shine much less brightly. options, including a proposal that “lock in” the earlier and dramatic export penetration of US Heartland is no more. Even before the end of the Davis markets). The FTA and later government, Ontario’s fiscal star began to shine much less NAFTA provided the back- brightly. Indeed, for each and every year over the 1977-82 drop for Premier ’s launching of period, Ontario qualified as a have-not province. The reason Ontario as a “North for this is the very same as the reason why Ontario is again American region state,” becoming a have-not province — massive fossil energy which, I would argue, for- royalties accruing to the energy provinces. mally spelled the end of heartland. Indeed, for each and every year over would have Ottawa equalize only In the interim, and foreshadowing the 1977-82 period, Ontario qualified non-resource revenues and would Dalton McGuinty’s ongoing list of as a have-not province. The reason for have the provinces embark on an grievances against Ottawa, Ontario’s this is the very same as the reason why interprovincial revenue-sharing pool next reality check came first with the Ontario is again becoming a have-not for resource revenues. Bank of Canada’s 1988 policy of price province — massive fossil energy roy- stability as its operating strategy alties accruing to the energy provinces. s I can attest after advancing this (replete with a damaging transition But the Ontario of Davis remained A proposal on several recent occa- period of high interest rates, a soaring too proud (heartland was still alive, sions, this is a tough sell at the best of currency and sharply deteriorating eco- even if not well) to receive equaliza- times, but it was impossible in the nomic and fiscal fortunes) and then tion payments. So Premier Davis, not time frame of the National Energy with the early 1990s global recession. unlike Premier Dalton McGuinty Program, which came into being with This was the context for the call by today, took the position that if Ontario the blessing of the Davis government. Premier (1990-95) for “fair- qualified for equalization this must Ottawa’s initial proposal for reworking shares federalism,” based on a series of mean that there was something seri- equalization was an “Ontario stan- position papers prepared by ously awry with the equalization for- dard” — this would bring all have-not Informetrica. What is rather surprising mula. Accordingly Davis supported the provinces up to Ontario’s level but is that these fairness issues, which passage in the House of Commons in would not break the federal bank became the rallying cry of successive 1981 of what was referred to as the because Ontario had no energy rev- Ontario premiers through to McGuinty, “personal income override.” The enues to equalize. The compromise were met with stonewalling by succes- express purpose of this legislation was was the “five-province” standard, sive prime ministers (Mulroney, to strip Ontario, retroactively, of its which essentially accomplished the Chrétien, Martin and even Harper). In equalization entitlements. The essence same thing, namely that Alberta and terms of the impact on Ontario’s fiscal of the personal income override was the Atlantic provinces were excluded position, the most serious of Rae’s con- that no province would be eligible for so that Ottawa’s twin goals were still cerns was the 5 percent growth cap on equalization payments if its per capita satisfied — the fossil energy influence the Canada Assistance Plan for Ontario, personal income exceeded the nation- on equalization would be substantially Alberta and BC. This “cap on CAP” cost al average per capita personal income muted and Ontario would again Ontario nearly $10 billion before CAP in the current year and the previous become a have province. was folded into the CHST in the 1995 two years. While this is written in gen- budget and then promptly reduced by eral terms, its specific and only target ith President Reagan’s “military one-third. Paul Martin’s generous was Ontario. (Intriguingly, if this legis- W Keynesianism” (military spend- health care and equalization decade-

POLICY OPTIONS 47 JUNE 2008 Thomas J. Courchene

long agreements in fall 2004 will large- addressed some of Ontario’s fiscal con- laid at the feet of the McGuinty ly restore these cuts in cash transfers. In cerns, its response has arguably been Liberals in an “I told you so” manner. a related move, however, Ontario more than offset by its opening up Politics aside, these two develop- argued for equal-per-capita values for some disconcerting issues on the polit- ments are interrelated in that it will be the non-equalization federal-provincial ical front, including a proposal to argued that one of the key reasons why cash transfers, a request that was finally redress the House of Commons repre- Ontario cannot reduce its income taxes granted in the 2007 federal budget for sentation shortfall for British relates to $100 oil and the operations of the social transfers and will take effect Columbia and Alberta, but not for the east-west transfer system, including in fiscal year 2014-15 for the Canada Ontario. equalization. My thesis is that Ontario’s Health Transfer. This is the historical backdrop to economic and fiscal relationship with the In several other areas, however, the the remainder of this article, which federation is such that, first, the province perceived inequities as of the early addresses Ontario’s descent into “fis- is arguably not able, fiscally, to match the 1990s still exist: Ontario’s share of calamity.” The analysis will be income tax rates in most other provinces, labour market and training funds was, informed by two developments. The and that, second, reducing income taxes and still is, well below its population or first is the advent of $100-plus oil (with is, in any event, not its primary econom- unemployment share (in 2006, unem- “oil” as a catch-all for all fossil fuels) ic challenge. ployed Ontarians accounted for 39 per- and the second is the rather unprece- A convenient starting point for cent of Canada’s unemployed, addressing this assertion is to but received only 27 percent of Ontario’s share of labour market and focus on Ontario’s revenues rela- the national funding under the training funds was, and still is, well tive to those of its sister training component of EI); the below its population or provinces. Toward this end, the EI provisions discriminate consolidated provincial and against Ontario in terms of both unemployment share (in 2006, local revenues per capita appear eligibility requirements and unemployed Ontarians accounted for as row 1 of table 1. These are length of benefits, an issue that 39 percent of Canada’s unemployed, actual revenues and they include returned to the headlines recent- but received only 27 percent of the own-source revenues, federal ly when it was revealed that only cash transfers (equalization and 22 percent of ’s unem- national funding under the training CHT/CST), investment income, ployed qualified for EI benefits, component of EI); the EI provisions sales of goods and services, etc. compared to nearly 50 percent discriminate against Ontario in terms What is surprising is that in selected other major cities; of both eligibility requirements and Ontario’s per capita revenues are and Ontario finally signed an so far below those of the other agreement with the Martin gov- length of benefits, an issue that provinces. At the most general ernment that only partially returned to the headlines recently of levels, this has to be because addressed the long standing when it was revealed that only 22 of one or more of the following: underfunding of immigration- percent of Toronto’s unemployed cash transfers to the poorer settlement for Ontario. provinces; energy revenues for What is surprising is that qualified for EI benefits, compared to Newfoundland and the three the Chrétien/Martin govern- nearly 50 percent in selected other westernmost provinces; low tax ments, at times with two-thirds major cities. rates for the high-personal- of their caucus composed of income provinces (e.g., Ontario Ontario MPs, held out so long against dented public berating of Ontario’s and British Columbia). The role that McGuinty’s fiscal imbalance claims. It policies by the former Ontario treasur- federal cash transfers play in all of this was only when McGuinty’s arguments er and now federal finance minister Jim can be seen by comparing row 1 with began to find traction among Flaherty — in particular, Flaherty’s row 2, which presents provincial own- Ontarians that Liberal Ottawa made claim that Ontario is causing its own source revenues (excluding cash trans- some concessions. If Ontario MPs are economic troubles by not reducing its fers). Here, Ontario is in the middle of impervious to documented concerns income tax rates. By way of an intrigu- the pack, well behind the energy from their own province, even when ing aside, while the polls suggest that provinces and Quebec (which is the their government is of the same polit- this berating of Ontario may not be province with the highest tax rates), but ical stripe, then one can only con- playing well in Ontario for the federal above the Maritimes and Manitoba. clude that some aspects of heartland Conservatives, presumably the longer- And when the comparison is only on still survive. term political rationale is that, during terms of personal income taxes (row 3), By way of a final comment here, the eventual federal election, Ontario’s then Ontario is second only to Alberta while the Harper government has poor economic performance can be but, perhaps, about to decline.

48 OPTIONS POLITIQUES JUIN 2008 MATIÈRE À RÉFLEXION : « ON ESTIME QUE LES ÉMISSIONS DE GAZ À EFFET DE SERRE RÉSULTANT DE LA DÉFORESTATION CORRESPONDENT À PLUS DE 18 % DES ÉMISSIONS TOTALES DE GES. »

Rapport Stern sur les changements climatiques, octobre 2006

Compte tenu d’un taux de déforestation virtuellement nul et de plus de forêts vierges, de forêts certifiées et de forêts protégées que tout autre pays, le Canada est un chef de file de l’aménagement forestier durable depuis un certain temps déjà. L’industrie canadienne des produits forestiers s’engage à l’amélioration continue et elle souscrit à cette déclaration du Groupe d’experts intergouvernemental sur l’évolution du climat : « À long terme, la stratégie d’aménagement forestier durable qui vise le maintien ou l’augmentation des stocks de carbone en forêt, tout en assurant un rendement annuel soutenu en bois, sera la plus avantageuse en termes d’atténuation continue. »

Il est temps que le reste du monde suive l’exemple du Canada dans l’aménagement durable des forêts — le climat de la planète en dépend. Thomas J. Courchene

hile Ontario’s overall per capi- tion and for health/social services. ber of bundles per capita? Perhaps W tal revenues may be surprising- The row 1 values are then divided by Ontario requires the fewest bundles, in ly low, they are lower still in terms of this index, with the results labelled which case having the lowest effective the underlying rationale for equaliza- “effective revenues,” presented in row per capita revenues is, for present pur- tion. Section 36(2) of the Constitution 5. Row 6 then expresses these effective poses, just fine. My hunch is that this is Act, 1982 states that equalization pay- revenues as an index (again with not true, for at least two reasons. First, ments should ensure that “the Ontario = 1.00). Ontario is now by far many of the traditional have-not provinces have sufficient revenues to the “poorest” province. Second-place provinces are, compared to Ontario, sig- nificant positive net recipi- While the Harper government has addressed some of its ents of regionally privileged Ontario’s fiscal concerns, its response has arguably been more EI benefits, which in turn than offset by its opening up some disconcerting issues on the limits the draw on their political front, including a proposal to redress the House of respective provincial welfare budgets. Second, it very Commons representation shortfall for British Columbia and much seems to be the case Alberta, but not for Ontario. that Ontario’s immigrant settlement expenditures as provide reasonably comparable levels British Columbia can provide 14 per- well as the various costs of urban con- of public services at reasonably com- cent more standardized “bundles” of gestion will offset any presumed advan- parable levels of taxation.” Assuming public services than can Ontario (with tages of economies of scale that may for the moment that provinces have a conceptual bundle being a weighted attach to Ontario. identical needs for public services, average of the cost various types of Hence an initial assessment of what level of revenues across services: civil servants, teachers, police one of the themes of this essay is provinces would be sufficient? Given officers, rents, welfare payments, med- that Ontario’s income taxes are rela- that much of government spending is ical procedures and so on). Next-in- tively high because the province is related in one way or another to wages line Nova Scotia can produce 21 revenue- challenged relative to its in each province, row 4 of table 1 pres- percent more bundles, and so on sister provinces. (That the province ents an index of wage costs across through to Newfoundland/Labrador could reduce income taxes and provinces (with Ontario = 1.00), and Alberta, with a 68 percent and 61 increase consumption taxes is obvi- where the underlying data are a sim- percent advantage respectively. ously possible and even desirable ple average of average weekly wages in This begs the obvious question: do and will be dealt with later, but this each province for public administra- all provinces require an identical num- is a different issue.)

TABLE 1. FISCAL ONTARIO IN COMPARATIVE CONTEXT

NL PEI NS NB QUE ONT MAN SASK ALTA BC Total

1. Total revenues1 (2007) ($/capita) 11,520 10,022 9,079 9,755 10,602 8,155 9,424 10,416 11,942 9,138 9,614 2. Own-source revenues ($/capita) 7,110 6,270 6,478 6,494 8,3043 6,922 6,876 8,710 10,995 7,728 7,8013 3. Personal income taxes ($/Capita) 2,273 1,797 2,281 1,883 2,8173 2,783 2,085 2,369 3,214 2,020 2,6503 4. Average weekly earnings2 index (Ontario = 1.00) 0.84 0.93 0.92 0.95 0.93 1.00 0.81 0.89 0.91 0.98 5. Effective revenues (row 1) ÷ (row 4) 13,714 10,776 9,868 10,268 11,400 8,155 11,635 11,703 13,123 9,324 6. Effective revenues index (Ontario = 1.00) 1.68 1.32 1.21 1.26 1.40 1.00 1.43 1.44 1.61 1.14 7. National average fiscal capacities (2006-07) ($/capita) 6,020 4,506 5,461 4,885 5,962 7,053 5,228 7,340 13,042 7,669 7,317 8. O’Brien fiscal capacities (2006-07) ($/capita) 5,402 4,503 5,301 4,759 5,803 7,002 5,127 6,476 11,617 7,176 6,953

Notes: 1 Includes own-source revenues plus federal cash transfers (Statistics Canada, CANSIM table 385-0001). 2 This is an average of weekly earnings in public administration and health/social services (Statistics Canada, cat. No. 72-002 XIB). 3 An adjustment of $3.7 billion has been made to account for the Quebec abatement.

50 OPTIONS POLITIQUES JUIN 2008 Fiscalamity! Ontario: from heartland to have-not

s prelude to the implications of their base share, multiplied by the be realized: Ontario residents will be A Ontario becoming a have-not $500 million: therefore by $265 mil- footing a major part of this $1.15 bil- province. I now turn to some of the lion, with Ontario receiving roughly lion increase in equalization going to details of the equalization formula. Row $170 million of this total. Given that provinces that already have revenues 7 of table 1 presents estimates of per Ontario residents account for, say, 40 well in excess of Ontario’s. capita fiscal capacity for fiscal year 2006- percent of Ottawa’s revenues, 07 (the latest year for which data are Ontarians will be saddled with $106 hile the reality that Ontario available), with these fiscal capacities million of the $265-million increase in W would become an equalization- based on the full national average stan- equalization. This is the essence of receiving province has garnered dard (NAS): 100 percent of all provincial McGuinty’s “churning” issue: namely, national attention and, as the title of revenues enter the formula. Ontario that the bulk of any equalization pay- this essay suggests, merits the label would easily quality for equalization ments that the province receives will “fiscalamity,” a much more meritori- were the NAS in play, since its per capi- come out of the pockets of its own cit- ous recipient of the label is Finance ta fiscal capacity of $7,053 is below the izens. This cannot be efficient. Canada. The cost of the equalization NAS value of $7,317. However, the But McGuinty has a lot more to program in 2004 was in the $9-billion equalization program in place is the so- worry about than this. There is a cap on range. With skyrocketing energy rev- called O’Brien formula, where only 50 equalization in the O’Brien formula: no enues and with Ontario in the ranks percent of resource revenues enter the province can receive equalization if its of the have-nots, the equalization bill formula. Per capita fiscal capacities for all-in per capita revenues exceed those could easily be in the $15-billion 2006-07 under the O’Brien formula of the lowest of the have provinces. It range. Thus, to the extent that equal- appear as row 8 in table 1. With a fiscal was assumed that Ontario would pro- ization is now a fiscal problem, it is capacity of $7,002 per capita and with vide the cap, and it was Ontario that largely Flaherty’s problem and it may the equalization standard equal to insisted that there be a cap. To this very well spell the end of the O’Brien $6,953, Ontario remains a “have” point it was assumed that the Ontario formula adopted only 15 months ago. province by $49 per capita. However, cap was binding on Saskatchewan and Attention is now directed to the since current energy prices have risen Newfoundland. However, now that manner in which the equalization pro- significantly since 2006 (the base for the Ontario is a have-not province, the gram interacts with the pattern of rev- 2006-07 energy revenues) and since “capping province” becomes British enues across provinces (row 1 of table Ontario’s relative growth has fallen, Columbia. This has very significant 1). The message will be that the inter- there can be little doubt that Ontario consequences. As seen in row 7 of table nal mechanics of the equalization pro- has now donned the mantle of our newest have-not With skyrocketing energy revenues and with Ontario in the province. ranks of the have-nots, the equalization bill could easily be in hat happens then? the $15-billion range. Thus, to the extent that equalization is W Suppose that, from a now a fiscal problem, it is largely Flaherty’s problem and it position where Ontario is a may very well spell the end of the O’Brien formula adopted have-not province, energy revenues increase by a fur- only 15 months ago. ther $1 billion (i.e., almost 5 percent of overall resource revenues). 1, the equalization cap increases by gram provide a further reason why This will mean that $500 million will over $600 per capita — from Ontario’s provinces with a lower fiscal capacity enter the O’Brien formula. Focusing $7,053 to British Columbia’s $7,669. than Ontario can leapfrog the province only on the six provinces that will This allows Saskatchewan an additional and end up with higher revenues. For clearly qualify for equalization (Prince $329 per capita in equalization and example, the methodology for calculat- Edward Island, Nova Scotia, New Newfoundland a whopping $1,649 per ing Ontario’s per capita fiscal capacity Brunswick, Quebec, Ontario and capita. In dollar terms, this amounts to for the income tax base leads to Manitoba) and temporarily excluding a potential $1.15 billion increase in Ontario having 112 percent of the all- Saskatchewan and Newfoundland and equalization, most of which would be province average, whereas its actual per Labrador (see below), the population immediately realized, with Ontario tax- capita collections are only 107 percent share of these equalization receiving payers on the hook for something like of the national average (calculated provinces is 71 percent while their an additional $450 million. To be sure, from row 3 of table 1). This serves to share of the resource revenue base is 18 this is a one-shot (although permanent) increase equalization for the traditional percent. Equalization will rise by the increase in equalization. The result of have-not provinces and, therefore, excess of their population share over this is that McGuinty’s worst fears will allows them to acquire more overall per

POLICY OPTIONS 51 JUNE 2008 Thomas J. Courchene

CP Photo Ontario Premier Dalton McGuinty leads a province that was once Canada’s proud economic heartland, but now risks being a have-not province in terms of Canada’s equalization formula. He wants a new deal, one that’s fairer to Ontario, and Tom Courchene writes that he’s got a very strong case.

capita revenues associated with the enues in excess of those of Ontario. access these rents. Rather, Ottawa must income tax than Ontario itself has. This This may have been viewed as equi- finance the resulting equalization is even more the case for the property table under heartland Ontario when increase out of its general revenues, of taxes, where the methodology selected trade flowed east-west behind tariff which roughly 40 percent (perhaps for calculating fiscal capacities again walls, but now it compromises somewhat less recently) will come from allows equalization-receiving provinces Ontario’s north-south competitveness Ontario taxpayers. To be sure, the overall to have larger property tax revenues in tariff-free NATFA economic space. operations of the energy sector do deliv- than does Ontario. This is the fiscal er substantial tax revenues to all version of double jeopardy. To ignore he above equalization concerns provinces and to Ottawa, but so do the differences in the wage costs across T notwithstanding, Ontario’s longest- operations of the banking and auto provinces (i.e., to ignore capitalization) standing issue with equalization, one industries located in central Canada. in terms of the equalization formula (as that was central for Premier Davis, is that Energy rents/royalties are entirely dif- highlighted earlier), but then to allow there is a serious funding inequity asso- ferent, accruing as they do, free from prices or capitalization to augment the ciated with equalizing energy rents. The tax by Ottawa, into provincial coffers. tax bases in richer provinces, serves to issue is actually rather straightforward in At current energy prices McGuinty is increase equalization on both counts principle but an absolute minefield justified in focusing on the funding and, other things being equal, allows politically. Energy rents/royalties are inequity, especially since Ontario will the traditional have-not provinces to escalating and in the process they are likely be somehow denied (again) the acquire actual overall per capita rev- driving up equalization. Ottawa cannot receipt of equalization payments.

52 OPTIONS POLITIQUES JUIN 2008 Fiscalamity! Ontario: from heartland to have-not

Solutions that are politically accept- The first is that Alberta, for example, rity concern has thickened the physi- able, as noted, are hard to come by. The has utilized its energy rents to cal border and jeopardized just-in- interprovincial revenue-sharing pool become the lowest-tax-rate jurisdic- time cross-border production and, on referred to above would pass the equity tion in North America, not just the other, the appreciation has thick- test but would likely founder politically Canada. In turn, this creates a signif- ened the economic border. This latter because the energy provinces would icant tax wedge between Alberta and effect relates as much to the utter actually be transferring, say, 20 percent the non-energy provinces, which not volatility of the exchange rate as it of their energy revenues to the sharing only reduces Ontario’s relative com- does to the actual level, with the result pool (with all provinces drawing out petitive advantage but also adds fuel that foreign investment in the Canadian economy with The overall operations of the energy sector do deliver the intention of producing substantial tax revenues to all provinces and to Ottawa, but for the North American so do the operations of the banking and auto industries market may well be scared away by exchange-rate located in central Canada. Energy rents/royalties are entirely uncertainty. different, accruing as they do, free from tax by Ottawa, into provincial coffers. At current energy prices McGuinty is he reaction of the justified in focusing on the funding inequity, especially since T mainstream economics profession is, almost unani- Ontario will likely be somehow denied (again) the receipt of mously, to fall four-square equalization payments. behind the Bank of Canada’s inflation-targeting their population share). A variant that to the claim that Ontario’s income policy and to ignore the exchange rate gets around this feature would be to tax rates are too high. volatility. To be sure, there is some “revenue-test” all of Ottawa’s non-equal- The second is far more significant, sympathy for the demise of manufac- ization cash transfers. In more detail, at least in the current time frame, turing, but not much, because it was Ottawa would equalize all non-resource because it is serving to frustrate, if not destined to gradually erode in any revenues to the national average stan- severely impair, Ontario’s chosen role event. I believe this to be a major ana- dard. Then the federal CHT and CST as a North American cross-border lytical error on the part of my profes- cash transfers would decrease by, say, 20 region state. Whereas Norway re- sion. Energy prices are driving an cents for every dollar that a province’s deposits its revenues from energy economic wedge between the energy revenues exceed some designated exports back into international capital sector and the rest of Canada. This can- threshold, say, 105 percent of the markets, thereby ameliorating the not be avoided. But to allow the cur- national average of all-in revenues. upward pressure on the Norwegian rency to shoot skyward is to add an Ottawa could then return its savings via krone, the international inflows of additional absolute and relative blow an equivalent tax transfer to the funds from energy exports and invest- to the centre. This is a north-south provinces. We income-test almost every ments in the energy patch are typical- solution to an east-west problem. other program (OAS, GIS, EI benefits, the ly taken directly into provincial While we may hope that Alberta will child tax benefit), so why not equaliza- budgets (or in any event not re- shelter its increasing rents in heritage- tion? While I made a similar recommen- deposited internationally) and have type funds invested in international dation in a previous Policy Options article, resulted in a rapid and dramatic markets, Alberta should not be expect- ideas along these lines may have more appreciation of the Canadian dollar — ed to follow the Norway solution. This traction now that Ottawa will be taking from the low-60-cent range early in being the case, the way forward for much more interest in the funding of the new century to nearly 110 cents, Canada should be some version of a the program, given its looming liability. before settling near parity at the time fixed Canada-US exchange rate with a of writing. The amplitude (60 percent common currency as the longer-term omplicating all of the above dis- from trough to peak) has effectively goal (Policy Options, February 2008). C cussion for Ontario is the fact priced many goods out of US markets that energy prices are having a major and, arguably, unwound a significant hat vision emerges for the economic impact well beyond the amount of the Ontario manufacturing W Ontario of tomorrow from this equalization formula. This arises infrastructure that was accumulated tour d’horizon of the province’s politi- because the energy provinces tend to over the decades in Ontario. cal, fiscal and economic relationship bring their energy revenues directly This is part of the double wham- within Canada and North America? into their annual budgets. This has at my to Ontario’s cross-border trade. On On the political front, once whatever least two significant implications. the one hand, the US homeland secu- psychological impact from joining

POLICY OPTIONS 53 JUNE 2008 Thomas J. Courchene

the ranks of the equalization-receiv- tion as part of an effort to create world- But the way to do this is to convert ing provinces is absorbed by Ontario class universities. Health care is emerg- the PST into a GST. This will enhance and Ontarians, my hunch is that this ing not only as a major employer of export competitiveness because the will turn out to be a liberating experi- high-level talent but, as well, as a sector GST on exports will be rebated. As ence. Ontario will become much freer with many and varied commercial important, this will pave the way for a to pursue its own interests and to applications. Nothing prevents Ontario tax shift away from income and toward wield its significant electoral power in from introducing internal markets into consumption, namely by reducing the federation. And in doing so it will medicare along the Canada Health Act- income taxes and especially corporate find more support than hitherto from compatible models proposed by taxes and raising the provincial GST. its federal MPs. But toward what end? Senators Kirby and Keon. Finally, but hardly exhaustively, An assessment of the province’s vari- On the institutional front, the the province must be forward-look- ous assets and opportunities would province needs to privilege the Greater ing. By way of an example that links seem to point in the direction of Toronto Area (GTA) and other major up with the earlier analysis, if we are deepening its capital — physical, cities. These cities are the repositories of going to put a price on carbon, then financial, institutional and especially dense concentrations of knowledge and the province should favour a con- human. In terms of the latter, Ontario talent that are essential to sustain the sumer-based carbon tax rather than needs to reorient its entire social expertise in financial, business and an origin-based emissions tax. The infrastructure (education, training, research services that lead our export revenues from the former will accrue post-secondary education, research penetration of NAFTA economic space across the country, which Ottawa can institutes, welfare, medicare, etc.) and beyond. Specifically, the province then share with provinces (perhaps toward being more flexible and effi- needs to remedy the Canadian reality along the lines of the harmonized cient and more geared toward skills that the GTA, for example, is fiscally and sales tax). However, an origin-based and human capital formation, all institutionally/constitutionally weak in emissions tax would presumably with the view of ensuring that the an international comparative context, accrue largely to the energy social infrastructure becomes a plat- and even with respect to US major cities. provinces, so that these provinces will form for skills develop- ment, innovation and Ontario needs to reorient its entire social infrastructure entrepreneurship. Toward (education, training, post-secondary education, research this end the province will institutes, welfare, medicare, etc.) toward being more flexible need to recast some of the existing federal programs and efficient and more geared toward skills and human so that they become consis- capital formation, all with the view of ensuring that the social tent with this underlying infrastructure becomes a platform for skills development, vision of a (trite admitted- innovation and entrepreneurship. Toward this end the ly) “North America headland.” province will need to recast some of the existing federal For example, much of programs so that they become consistent with this underlying the EI program, with its vision of a (trite admittedly) “North America headland.” rewards for short term- labour force attachment, is antithetical This is problematic given that cities are be reaping not only energy royalties to a human-capital-based economy. If deemed to be the new and dynamic but as well the returns from carbon this cannot be altered, Ontario should motors in this information age. abatement. How long will it be before seriously consider pulling its broader On the economic front, Ontario pressures will develop to equalize public sector out of the federal EI (as I needs to deepen its physical capital these emissions tax revenues, with understand it has the right to do) and infrastructure. Actually, the high dol- Ontario again paying nearly 40 per- creating an Ontario version that will lar will help here because it provides cent of the cost of the equalization? embrace skills enhancement. an incentive to increase the capital- Haven’t we been there before? Moreover, meaningful pursuit of a labour ratio. This will allow Ontario knowledge economy requires a com- to compete with the upper levels of Contributing Writer and IRPP Senior plementary immigration program. its labour force and in higher-value- Scholar Thomas J. Courchene is also Again, failing changes by Ottawa in added products that will be less sensi- Jarislowsky-Deutsch Professor of this direction, Ontario has the consti- tive to a volatile dollar, if that Economic and Financial Policy, as well tutional right to mount its own policy remains our fate. Here, Finance as director of the Institute of that could, following Australia, privi- Minister Flaherty is correct — Ontario Intergovernmental Relations at Queen’s lege visa students in terms of immigra- does need lower income taxes. University. [email protected]

54 OPTIONS POLITIQUES JUIN 2008