FRASER/AIMS FRASER RESEARCHBULLETIN I N S T I T U T E A JOINT INITIATIVE OF THE FRASER INSTITUTE AND THE ATLANTIC INSTITUTE FOR MARKET STUDIES
December 2014
Nova Scotia, New Brunswick, Fracking and the Equalization Policy Crutch NB by Ben Eisen and Mark Milke NS
Ottawa
Summary
Generally speaking, the equalization pro- In contrast, Newfoundland & Labrador is gram creates disincentives in have-not prov- reaping benefits from conventional oil produc- inces for economic development that would act tion. Pennsylvania, too, has benefitted from to increase own-source revenues. tapping into the Marcellus gas discovery.
The 2007 equalization reform sought to The potential benefits of overcoming the weaken these disincentives for natural resource equalization disincentive and allowing resource development by excluding 50 percent of re- development for Nova Scotia and New Bruns- source revenue from equalization calculations. wick include increased private sector invest- It appears that the incentives are still not ment, stronger job creation, higher incomes, strong enough for Nova Scotia and New Bruns- and additional royalty and tax revenues, which wick. Nova Scotia recently extended a morato- would then allow both governments to reduce rium on hydraulic fracturing and New Bruns- their noticeably high tax levels. wick introduced a similar moratorium.
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Figure 1: Average Household Income in 2013 ($)
$60,000 $54,088
$50,000 $44,288 $42,652 $41,687 $41,678 $37,687 $37,657 $37,456 $36,373 $40,000 $35,208
$30,000
$20,000
$10,000
$0 AB SK BC NL ON QC MB NS NB PE
Source: Statistics Canada (2014a), Cansim Table 384-0042.
Introduction: A prosperity problem in A key part of the explanation for the poor per- Nova Scotia and New Brunswick formance of both provinces is their inability to attract private sector investment. Such invest- Across almost every major economic indica- ment is the foundation for prosperity. (For the tor, Nova Scotia and New Brunswick underper- purposes of this paper, prosperity is defined by form the rest of Canada and rank amongst the higher incomes, higher levels of job creation, poorest regions in the country. Figure 1 illus- and greater economic opportunities.) Figure 2 trates the average household income by prov- illustrates the average annual level of private ince in 2013. Nova Scotia and New Brunswick sector business investment in each province rank eighth and ninth, respectively, amongst per private sector worker over the last decade the provinces for average household income. (2004-2013) in inflation-adjusted dollars. As Only Prince Edward Island has a lower average with the average household income measure, household income level. Nova Scotia and New Brunswick rank third last An even more dramatic indicator of the pros- and second last, respectively, of the ten prov- perity gap is the fact that the average house- inces. Only Prince Edward Island attracts less hold income in Nova Scotia and New Brunswick investment. Tellingly, the average level of pri- is less than four-fifths that of the top three vate sector investment per private sector work- provinces: Alberta, Saskatchewan, and British er over the period was just 51.0 percent (Nova Columbia. It is clear that Nova Scotia and New Scotia) and 52.2 percent (New Brunswick) of Brunswick are two of the poorest provinces in that in neighbouring Newfoundland & Labra- the country. dor, which ranked third in Canada.
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Figure 2: Average Annual Private Sector Investment* per Private Sector Worker, 2004-2013 (2013$)
$70,000 64,893
$60,000 51,102 $50,000 44,189
$40,000 30,936 $30,000 24,626 23,622 22,487 21,451 20,784 17,890 $20,000
$10,000
$0 AB SK NL BC MB ON QC NB NS PE
Note: private sector investment here refers to a Statistics Canada category known as “business investment” and consists of: residential structures; non-residential structures, machinery and equipment; and, intellectual property products. Sources: Statistics Canada (2014b), CANSIM Table 384-0038; and Statistics Canada (2014c), CANSIM Table 282-0012.
The dearth of private sector investment in both highest during this period while New Brunswick’s provinces is a central explanation for the re- unemployment rate was the third highest.1 cord of weak job creation in Nova Scotia and New Brunswick. Figure 3 illustrates the average 1 Some may object that Newfoundland & Labra- annual growth rate in employment in Canada dor had the highest average unemployment rate in between 2004 and 2013, by province, for both Canada over the ten-year period, so perhaps there is the private and public sectors. By this measure, little proof that allowing resource development has Nova Scotia ranks ninth and New Brunswick helped that economy. However, the starting points and the trend are what counts: In 2004, Newfound- ranks dead last. In fact, Nova Scotia’s job cre- land & Labrador’s unemployment rate was 22.7 per- ation record over this period was just half that cent; it declined steadily after that year, rose again of Newfoundland & Labrador. Meanwhile, New to 22.6 percent because of, and in, the recession in Brunswick’s record was less than one-third that 2009, declined again, and as of 2013 was 16.7 percent of Newfoundland & Labrador. (Statistics Canada 2014d). In addition, as per figure 3 and the ten-year average, employment growth in The combination of low investment levels and Newfoundland & Labrador was double that observed the associated poor job creation rates means that in Nova Scotia, and triple that in New Brunswick. both provinces are dealing with relatively high Simply put, Newfoundland & Labrador started “further back” on employment measurements and rates of unemployment. Figure 4 illustrates the accelerated in the 2004-2013 period relative to Nova average annual unemployment rate for all the Scotia and New Brunswick. Thus, Newfoundland & provinces from 2004 to 2013. Nova Scotia’s aver- Labrador’s decision to allow resource development age annual unemployment rate was the fourth has indeed mattered to its economy.
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Figure 3: Annual Average Employment Growth, 2004-2013 (%)
3.0%
2.5% 2.5%
2.0%
1.5% 1.5% 1.5% 1.2% 1.1% 1.0% 1.0% 1.0% 1.0%
0.5% 0.5% 0.3%
0.0% AB SK BC PE QC MB ON NL NS NB
Source: Statistics Canada (2014d), CANSIM Table 282-0002.
An opportunity foregone province itself notes that “Nova Scotia has am- ple onshore exploration and development op- The burden of low economic performance and portunities” (Nova Scotia, undated 1). the dearth of prosperity related to that poor performance have been recognized for de- In 2013, New Brunswick estimated its known cades (McMahon 1996, 2000a, 2000b). Recently shale gas reserves at 15 trillion cubic feet, a though, Nova Scotia and New Brunswick have 350-year in-province supply based on current had the opportunity to change some negative residential, industrial, and commercial use in the economic indicators for the better by allowing province. The New Brunswick Oil and Natural Gas exploratory drilling for natural gas. Depending Blueprint noted that oil and gas in that province on the results of such exploration, and if addi- “holds the potential to be a significant factor in tional commercial activity results, that drilling, the province’s economy” and that the province’s in turn, would result in additional private sector “offshore may contain significant oil and gas re- investment, increased job creation, higher in- serves” with precise estimates to await more comes, and additional tax revenues for the two seismic and exploratory drilling data (New provincial governments. Brunswick, 2013: 1, 11, 30).
For example, in Nova Scotia, the province’s en- The moratorium on hydraulic fracturing means ergy department has noted that offshore, the that both provinces are proactively foregoing province has 120 trillion cubic feet of natural the high paying direct and indirect jobs that gas and eight billion barrels of oil. Presumably could be created from developing this resource. more exists onshore to be discovered given the This is in noticeable contrast to Pennsylvania,
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Figure 4: Average Unemployment Rate, 2004-2013 (%)
15% 13.9%
11.2% 12%
9.2% 8.6% 9% 7.9% 7.3% 6.3% 6% 4.7% 4.7% 5.0%
3%
0% AB SK MB BC ON QC NS NB PE NL
Source: Statistics Canada (2014d), CANSIM Table 282-0002.
home to a shale gas boom in the Marcellus region. and extreme case scenarios), royalties could be According to the Pennsylvania Department of three to five times that amount (Cape Breton Labor and Industry, direct jobs attributable to University and Verscheun Centre, 2014: 116- the shale gas sector in the state (as of October 188). These revenues could help eliminate both 2014) were estimated at more than 28,000 (up provinces’ current deficits and, over time, help from 13,000 in 2010). Of note, the average wage lower tax rates so they become more competi- for those directly employed in the industry was tive and attractive to investors. US$92,914 (Pennsylvania, 2014: 6, 8). Despite such an opportunity however, in Sep- As for estimates of potential new royalties, the tember 2014, Nova Scotia extended a 2012 mor- 2014 Report of the Nova Scotia Independent atorium on hydraulic fracturing for natural gas Panel on Hydraulic Fracturing provided a “low- and New Brunswick announced a moratorium er medium case” scenario that estimated the on the same (Younger, 2014; New Brunswick royalties that could accrue to the province from Liberal Party, 2014: 28). These actions lead to the development of shale gas. The report deter- the natural question: why did two provinces in mined that, depending on the year in question, dire need of private sector investment, employ- between $122 million and $209 million annually ment opportunities, and higher incomes and could flow into the provincial treasury for over tax revenues, decide to place a moratorium on six decades from these royalties—a total of $5.9 beneficial, at-home, energy development? billion over that time. The panel noted that un- der more optimistic scenarios (upper medium
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One obvious answer is that politicians will re- from a federal-provincial agreement in 1956 spond to voters and to selected voter concerns (Holden, 2007: 1); the program was later en- on a particular issue—in this instance, the con- trenched in the Constitution in 1982. cern over the safety of hydraulic fracturing. This Section 36(2) of the Constitution Act, 1982, essay will not delve into the degree of public states that equalization is meant to “provide support or opposition to hydraulic fracturing, or reasonably comparable levels of public servic- the debates over the safety of the practice, both es at reasonably comparable levels of taxation.” of which have been covered elsewhere.2 As the federal Department of Finance notes, Instead, this essay will explore one other issue: equalization is meant to address “fiscal dispari- that the federal equalization program provides ties among provinces.” Echoing the constitution- incentives for political actors to allow anti- al imperative, the department notes equaliza- prosperity development policies to flourish. tion exists to “enable less prosperous provincial governments to provide their residents with The origin, description, and formula public services that are reasonably comparable for equalization to those in other provinces, at reasonably com- parable levels of taxation” (Canada, 2013).4 Let’s begin by explaining the equalization pro- gram. In general (and beyond equalization), fed- To determine eligibility, equalization payments eral transfer payments3 date back to Confed- are calculated based on a formula that measures eration, though the start of equalization dates a province’s ability to raise revenues, its “fiscal capacity.” To calculate the differing fiscal capaci- ties, a federal formula including 31 different 2 As one of our colleagues, Dr. Kenneth Green, has provincial revenue sources is used. Revenues observed, a literature review in the peer-reviewed are grouped into five categories (personal in- journal Science concluded that in North America, come taxes, business income taxes, consump- “more than one million hydraulic fracturing treat- ments have been conducted, with perhaps only tion taxes, property taxes, and natural resource one documented case of direct groundwater pollu- revenues) for the purposes of the formula. tion resulting from injection of hydraulic fracturing chemicals used for shale gas extraction” (Green and For all of the categories except natural re- Milke, 2014, quoting Science). The Nova Scotia Panel source revenues, the formula defines the fiscal on Hydraulic Fracturing has also concluded that “a capacity for each province by estimating how number of the potential long-term and cumulative public health impacts of hydraulic fracturing and its associated activities and technologies are sim- germane to this essay and definitions and param- ply unknown at the present time. However, there eters can be found at (Canada, 2014).
is currently no evidence of catastrophic threats to 4 public health in the short-to-medium term that Equalization’s constitutional status leads some to would necessitate the banning of hydraulic fractur- assert the prospect for substantial reform to the ing outright” (Cape Breton University and Verscheun program is difficult, if not constitutionally out of Centre, 2014: 308). reach. However, according to a 2006 paper published by the Fraser Institute and which surveyed the views 3 Current federal transfers beyond equalization of constitutional scholars on this topic, the notion of include the Canada Health Transfer and the Canada an equalization program unable to be substantially Social Transfer, Offshore Accord payments, and the reformed is severely overstated. See Kellock and Total Transfer Protection program. They are not LeRoy, 2006, for a full discussion of this topic.
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much revenue each province would raise if all nomic growth and development. It found that of the provinces had an identical tax rate. Natu- a focus on maximizing equalization rather than ral resources are treated differently; because of economic development led to economic poli- differences in royalty structures and other fac- cies that are sub-optimal (Ferede, 2014). Specif- tors, actual resource revenues are used to de- ically, the study found that equalization grants termine the fiscal capacity in this area instead encourage higher tax rates and increased levels of an estimate based on what would be raised of government spending in recipient provinces, using a constant tax rate across provinces. which hinders economic growth.
In total, the formula resulted in $16.7 billion in The equalization formula treats resource reve- equalization grants being paid out to six recipi- nue6 differently than other types of own-source ent provinces in 2014/15 (Canada, 2014). revenue, and in doing so reduces—but does not eliminate—the disincentive effects discussed Once calculations of fiscal capacities are de- previously. Whereas new revenue from most termined, provinces that receive equalization other revenues are “clawed back” at a rate of payments are often referred to informally (not nearly 100 percent, in 2007, the federal govern- in the Constitution) as “have not” provinces, ment changed the equalization formula to ex- while those that do not are referred to as “have” clude 50 percent of resource revenues from provinces. As of 2013/14, the “have-not” prov- equalization calculations.7 This means that for inces were Manitoba, New Brunswick, Nova each new dollar in resource revenue generated Scotia, Ontario, Prince Edward Island, and Que- by a have-not province, approximately 50 cents bec. The remainder (British Columbia, Alberta, are clawed back by the federal government in Saskatchewan, and Newfoundland and Labra- the form of reduced equalization payments. dor), were “have” provinces (Canada, 2014).5 The equalization policy crutch The disincentives The justification for the federal subsidy pro- Economists have identified a number of ways gram is that it ostensibly helps poorer prov- that the equalization program creates disincen- tives for governments in have-not provinces to take sensible economic actions that could im- 6 Under Section 92 of Canada’s Constitution, natural prove their economic performance, and in so resources belong to the provinces in which they are doing, increase their own-source revenues. located. That means provinces receive 100 percent of the royalties from such development, i.e., 100 One clear example is provided in a recent pa- percent of the stumpage fees from forestry opera- per published by the University of Calgary’s tions and 100 percent of the royalties from (onshore) School of Public Policy. It showed that prov- oil and gas development. inces sometimes design their fiscal policies to 7 Previously, resource revenues were treated maximize equalization grants rather than cre- like any other type of income for provinces, and ate economic environments conducive to eco- were therefore clawed back at nearly 100 percent (Courchene, 2004). The 50-percent exclusion rate was introduced in an effort to reduce equalization’s 5 Note that the specific provinces which receive disincentive effects for natural resource develop- equalization, and the total number in receipt, can ment, and encourage provinces to allow sensible change from one year to the next. resource development (Chassin, 2012).
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Figure 5: Equalization payments Figure 6: Equalization as a percentage of 2005/06 to 2013/14 (in 2013 $billions) own-source revenues, 2005/06 to 2013/14
$16 40% $14.532 36.8% $14 34.0% $12.889 $12 30%
$10 22.2%
$8 20%
2013 $ billions $6
$4 10% $3.046 $2.287 4.4% $2
$0 0% NS NB PE NL NS NB PE NL Sources: Canada (2014); and provincial public accounts. Sources: Statistics Canada (2014e), Table 326-0021.
inces. However, the practical, real-world reality tia, and Prince Edward Island are highly depen- is that the program also mitigates the conse- dent on equalization payments relative to own- quences of provincial choices that opt to forego source revenues (e.g., total provincial revenues additional own-source revenues that could re- after subtracting federal transfers) (Canada, place some or all equalization transfers. Simply 2014; provincial public accounts—various years). put, as currently designed, equalization creates perverse fiscal incentives. For example, it is ap- Over the nine-year period, Nova Scotia re- parent that even the 50 percent exclusion rate ceived $12.9 billion in equalization payments, for natural resources has not been enough to equivalent to 22 percent of all own-source rev- tempt some provinces—such as Nova Scotia and enues. Federal equalization payments to New New Brunswick profiled here—to allow further Brunswick amounted to $14.5 billion, equiva- onshore resource development. lent to 34 percent of all own-source revenues. Prince Edward Island received $3 billion in This is a problem, given that as of 2013/14, equalization, equivalent to 36.8 percent of PEI’s three of the four Atlantic provinces are high- own-source revenue. ly dependent on equalization (see figures 5 and 6). A look at the period from 2005/06 to The exception in Atlantic Canada is Newfound- 2013/14 (from the earliest year data was avail- land & Labrador, which last received an equal- able through to the most recent provincial an- ization “cheque” in 2007/08. Over the nine nual reports), clearly shows the dependency. years surveyed, equalization was a compara- The data show that New Brunswick, Nova Sco- tively small amount of revenues for the prov-
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ince relative to its own-source revenues. Be- Chassin, Youri (2012). Equalization: Towards a tween 2005/06 and 2013/14, Newfoundland Formula that Promotes Further Resource De- & Labrador received just under $2.3 billion in velopment. Economic Note. Montreal Eco- equalization payments, akin to 4.4 percent of nomic Institute.
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McMahon, Fred (2000a). Road to Growth: How Pennsylvania, Department of Labor and Indus- Lagging Economies Become Prosperous. Atlan- try (2014). Marcellus Shale Fast Facts. Govern- tic Institute for Market Studies. ment of Pennsylvania.
Nova Scotia, Finance and Treasury Board (vari- Younger, Andrew (2014, September 3). Andrew ous years). Public Accounts. Government of Younger Statement on Nova Scotia Hydrau- Nova Scotia.
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Ben Eisen is the Director of Re- Copyright © 2014 by the Fraser Institute. All rights search and Programmes at the At- reserved. Without written permission, only brief lantic Institute for Market Studies. passages may be quoted in critical articles and reviews. Prior to joining AIMS, Mr. Eisen worked as a research analyst for ISSN 2291-8620 the Citizens Budget Commission in Media queries: call 604.714.4582 or New York City. He also worked as e-mail: [email protected] the Assistant Research Director for the Frontier Centre for Public Poli- Support the Institute: call 1.800.665.3558, ext. 586 cy (FCPP), a Winnipeg-based think or e-mail: [email protected] tank. Mr. Eisen has published in- Visit our websites: fluential studies on several policy www.fraserinstitute.org and www.aims.ca topics, including intergovernmen- tal relations, public finance, and higher education policy. He holds a BA from the University of Toronto and an MPP from the University of Toronto’s School of Public Policy and Governance. Acknowledgments The authors would like to thank Snow Ren, Mark Milke (mark.milke@fraser Milagros Palacios, and Jason Clemens for institute.org) is a Senior Fellow assistance with the data, and two anony- at the Fraser Institute. He has ex- mous reviewers for their comments on tensive experience analyzing and early drafts of this paper. As the research- writing about public policy, partic- ers have worked independently, the views ularly in the areas of government and conclusions expressed in this paper do spending, land claims negotiations not necessarily reflect those of the Board of and property rights, and taxation. Dr. Milke has a PhD in political Trustees of the Fraser Institute or the At- science and has been published by lantic Institute for Market Studies, or the public policy institutes in Canada, staff or supporters of either organization. the United States, and Europe.
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