The Uneasy Case for Equalization Payments

The Uneasy Case for Equalization Payments The Uneasy Case for Equalization Payments Dan Usher The Fraser Institute Vancouver, British Columbia Copyright © 1995 by The Fraser Institute. All rights reserved. No part of this book may be reproduced in any manner whatsoever without writ- ten permission except in the case of brief quotations embodied in critical articles and reviews. The author of this book has worked independently and opinions ex- pressed by him, therefore, are his own, and do not necessarily reflect the opinions of the members or the trustees of The Fraser Institute. Printed in Canada. Canadian Cataloguing in Publication Data Usher, Dan, 1934- The uneasy case for equalization payments Includes bibliographical references. ISBN 0-88975-153-6 1. Fiscal Equalization Program (Canada)—Evaluation. 2. Federal-provincial fiscal relations—Canada.* 3. Transfer payments—Canada. 4. Grants-in-aid—Canada. I. Fraser Institute (Vancouver, B.C.) II. Title HJ795.A1U73 1995 339.5’22 C95-911122-0 www.fraserinstitute.org Table of Contents About the author ..................vi Foreword by Michael A. Walker ...........vii Introduction .....................1 Part I: From Section 36(2) to the Canadian Equalization Formula ............9 Part II: Equality ...................27 Part III: Efficiency ..................61 Part IV: Equity ...................97 Part V: Reform ...................117 Endnotes .....................131 Appendix Tables ..................151 www.fraserinstitute.org About the author AN USHER IS A PROFESSOR of economics at Queen’s University in DKingston, Ontario. He is the author of The Price Mechanism and the Meaning of National Income Statistics (1969), The Measurement of Economic Growth (1980), The Economic Prerequisite to Democracy (1981), The Welfare Economics of Markets, Voting and Predation (1993) and two volumes of col- lected papers, National Accounting and Economic Theory and Welfare Eco- nomics and Public Finance (1994). On the Canadian scene, Usher has been concerned for some time about the reorganization of English Canada in the event of the separation of Quebec. His papers on this theme include “The English Response to the Separation of Quebec,” Canadian Public Policy, 1978, “How Should the Redistributive Power of the State be Divided between Federal and Provincial Governments?” Canadian Public Policy, 1980, “The Design of a Government for an English Canadian Country,” in D.D. Purvis ed., Economic Dimensions of Constitutional Change, 1991 and “The Interests of English Canada,” Canadian Public Policy, 1995. www.fraserinstitute.org Foreword HIS IS A VERY IMPORTANT STUDY. It is appearing at a crucial time in the Thistory of Canada and at a turning point in the future of our national fiscal arrangements. It is being published as part of an exploration of the economic and political structure of Canadian Confederation. Earlier this year in Thirty Million Musketeers, a book about the future of our federation, Gordon Gibson pointed out that by the end of this cen- tury, the federal government will have lost control over what have been the shared programs of health, education, and welfare. Lacking the budgetary clout to enforce a federal intrusion into an area constitution- ally reserved for the provinces, the national government will have to be content with what the provinces individually determine in these areas. Gibson’s analysis did not deal with the future of equalization payments, except to remark that there was probably need for change, and that these payments should probably be made to people rather than to governments. The exact form equalization should take is not specified in the constitution. Its constitutional enshrinement is a reflection of a general con- sensus that it is something we do in Canada—part of the Canadian fabric as it were. But also, because it “just growed” over a long period of time, and because it is a technical swamp, the equalization payments system has been spared the kind of root and branch dissection that other programs have routinely received. This book remedies that deficiency. Dan Usher has systematically examined the motivations, the methods, and the effects of the current equalization system. He concludes that it www.fraserinstitute.org viii should be scrapped or dramatically altered. While I happen to disagree with Usher’s proposed replacement and to favour Gibson’s approach, The Fraser Institute is pleased to publish this monograph in the hope that it will encourage a detailed and comprehensive reconsideration of this $10 billion dollar program. At the very least, Dan Usher’s book must make us all feel very uncomfortable with the economic ineffi- ciency and inequity of the current system and make us want to find an alternative. Since Usher has worked independently, the views he expresses may not correspond to those of the members or trustees of The Fraser Institute. —Michael Walker, Executive Director The Fraser Institute www.fraserinstitute.org Introduction* Parliament and the government of Canada are committed to the principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation. —Section 36(2) of the Constitution Act of 1982. HIS IS AN ODD AND UNUSUAL CLAUSE for a constitution: more specific Tthan is customary about the instruments of public finance, yet re- markably vague about its ultimate purpose and its intended impact on the lives of Canadians. There is something peculiar about a constitution that does not require redistribution of income among people, that says nothing about welfare, that does not mandate unemployment insur- ance, though it does allocate jurisdiction, that contains no barrier, other than the very general language about “fundamental justice” in the char- ter of rights, against people starving to death on our streets, but does nevertheless, in the name of equality, require very specific transfers among provinces through the intermediary of the federal government. One wonders what principle of equality, efficiency, or equity might be at stake? * I am grateful to Scott Daniels and Neil Hepburn for excellent research assistance, to Sam Wilson for comments on the manuscript, to Torben Drews for some shrewd advice, and to Patricia Murphy for cheerfully correcting and recorrecting the manuscript as I changed my mind about the text. www.fraserinstitute.org 2 The Uneasy Case for Equalization Payments The political rhetoric of equalization is nothing if not dramatic. The place of equalization payments in Canadian society was discussed in the House of Commons on February 8 and 9, 1994 during a debate over Bill C3, a small amendment to the Canadian equalization program. The bill was introduced by Peter Milliken, Parliamentary Secretary to the Leader of the Government in the House of Commons, who referred to “the singular role of equalization in underpinning the unique sense of Canadian sharing” (House of Commons Debates, vol. 133, No. 017, 1 Ses- sion, 35 Parliament, Feb. 8, 1994, p. 1,036). George Proud, Member of Parliament from Hillsborough, asserted that The equalization program marks our compassion as a nation. Be- cause of equalization, no citizen of Canada is a second class citizen, regardless of where he lives. The citizens of Cape Race, Newfoundland, of Montmagny, Quebec, of York, P.E.I., of Watrous, Saskatchewan, and of Vancouver, B.C. are all entitled to roughly the same level of services in government. That is the essence of Canada. That is why this country remains united. (p. 1045) Not to be outdone in superlatives, John Harvard, Member of Parlia- ment for Winnipeg St. James, said the equalization program as we know it embodies some of the great ideals and the great values of Canadians. I cannot think of a much greater ideal under our democracy than sharing one’s wealth, sharing one’s resources. It is an ideal and a value that all of us cherish. It recognizes that there are those provinces and those people who have it a little better than others. (p. 1116) Sharing through the intermediary of the government is usually thought to be costly in the sense that you cannot get a dollar’s worth of benefit to the poor without causing something more than a dollar’s worth of harm to the rich. A transfer of money through the public sector involves administrative cost to the government and an additional cost to the public from the distortion in production as people rearrange their affairs to maximize their entitlements to transfers and minimize their tax bill. That is commonly understood, and is accepted, within limits, as a fair price to pay to assist the poor. Equalization payments are claimed to be different. A few days after the debate in Parliament, Mr. Guillaume Bissonnette, Director of the Federal Provincial Relations Di- www.fraserinstitute.org Introduction 3 vision of the Department of Finance, informed the House of Commons Committee on Finance that One of the most intriguing things about equalization is that from an economist’s point of view, there is not just an equity case for equalization, but in fact an economic efficiency argument for equalization. The economic efficiency argument for equalization is that if it’s properly calibrated, it prevents people from moving for the wrong reasons. That’s the key thing. In other words, in a world without equalization, where standards of services in schools and hospitals were enormously different from province to province, you would see people moving simply to avail them- selves of better publicly-provided services, not necessarily because they could get better-paying and more meaningful jobs. Economic theory tells us that that’s what you want. You want people to move for the right reasons, the right reasons being moving from a low-paying job to a high-paying job. They shouldn’t move simply because they get better services. (House of Commons Committee on Finance February 17, 1994, p.

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