INTERGOVERNMENTAL TRANSFERS AND CANADIAN VALUES: RETROSPECT AND PROSPECT

Thomas J. Courchene

In this article Thomas Courchene reviews the historical rationale for and evolution of Canada’s system of intergovernmental financial transfers. One key building block, he says, was the introduction in 1954 of Quebec’s personal income tax, because this led to directly to the decentralization of Canadian income taxation and the system of equalization payments. In turn, this facilitated the role of federal cash and tax transfers in developing provincially run social programs in health, education and welfare. With this in place, the challenges on the transfer front had to do with surging energy revenues and the resulting difficulty of Ontario becoming a have-not province, initially in the 1973-82 era, and again in the current time frame. The author concludes with a set of perspectives that may come to the rescue.

Après avoir retracé les fondements historiques et les éléments constitutifs du système de transferts financiers intergouvernementaux, Tom Courchene explore quelques pistes intéressantes pour l’améliorer. L’introduction en 1954 de l’impôt des particuliers au Québec, dit-il, constitue un des piliers de ce système, car il a directement entraîné la décentralisation du système fiscal canadien et permis l’arrivée des paiements de péréquation. En retour, ceci a favorisé l’utilisation des transferts en espèces et en points d’impôt fédéraux pour soutenir le développement des programmes sociaux en santé, en éducation et en sécurité du revenu gérés par les provinces. Par la suite, c’est l’essor des recettes de l’énergie qui posera problème, notamment en faisant de l’Ontario une province moins nantie, de 1973 à 1982 et de nouveau cette année. L’auteur propose en conclusion quelques pistes qui pourraient aider à solutionner l’impasse.

ll is far from well on the federal-provincial fiscal rate of nominal GDP), irrespective of the likelihood that arrangements front. The equalization-receiving interprovincial fiscal disparities have, for the most part, A provinces are concerned that the combination of a been decreasing. fixed equalization pool (albeit escalating annually), on the And all of this without recognizing that the elephant in one hand, and the reality that populous Ontario has joined the room — carbon pricing and the resulting revenue allo- the have-not provinces, on the other, will significantly cation between Ottawa and the provinces — may be about reduce the value of their equalization payments. Drawing to stir. Peter Lougheed may yet be proved correct when he on analysis from Winnipeg’s Frontier Centre for Public suggested that the federal-provincial and interprovincial Policy, Alberta spokespersons have aired the concern that struggle over the revenues arising from carbon pricing may Canada’s system of federal-provincial transfers is over-equal- well overshadow the National Energy Program donnybrook. izing, with the result that the poorer provinces are able to For these and other reasons it seems appropriate, as part deliver enhanced levels of public services than can some of the federal-provincial relations theme of this issue, to pro- richer provinces (e.g., higher teacher-student ratios, more vide a historical overview of the evolution of and rationale physicians and nurses per capita). In other quarters there is for Canada’s system of federal-provincial financial relations. concern, thanks to Paul Martin’s 2004 10-year accords, that Arguably, the most appropriate starting point is the intro- health transfers are growing by 6 percent annually, while duction of Quebec’s 15 percent personal income tax (PIT) in inflation is only in the 2 percent range, and that the equal- 1954. The trigger for this action was the attempt by Ottawa in ization pool is increasing annually (currently at the growth 1951 to transfer monies directly to the universities, i.e.,

32 OPTIONS POLITIQUES MAI 2010 Intergovernmental transfers and Canadian values: Retrospect and prospect bypassing the provinces. Not surpris- tial program equalized the revenues additional transfers from Ottawa to ingly, Premier Maurice Duplessis from the PIT, CIT and succession duties the provinces in the form of equalized viewed this as an unwanted intrusion to the average of the top two provinces personal income tax points. in an area of Quebec’s exclusive juris- (Ontario and British Columbia, with Thus the shift from federally fund- diction, an intrusion made possible in Ontario emerging as the only non- ed, federally regulated/administered large measure by Ottawa’s superior equalization-receiving province). programs to shared cost programs under access to revenues. In order to counter Hence, Canada’s formal equalization provincial design and administration, this, Quebec realized that it also needed program clearly finds its origins and and finally to autonomous provincial additional revenue sources. Hence its rationale in accommodating the programs funded by effectively uncon- introduction of the PIT and that tax’s Quebec PIT. While equalization is typi- ditional grants and equalized tax-point role as the symbol of provincial auton- cally viewed as benefiting only the transfers is not only a model for decen- tralized federations every- All of this without recognizing that the elephant in the room where, but is witness to the — carbon pricing and the resulting revenue allocation creative ability that between Ottawa and the provinces — may be about to stir. Canadians and their govern- ments can bring to the gov- Peter Lougheed may yet be proved correct when he ernance of our federation. suggested that the federal-provincial and interprovincial At this juncture several struggle over the revenues arising from carbon pricing may further observations are in well overshadow the National Energy Program donnybrook. order. First, suppose that a federal country operates a omy, created as much as a bulwark receiving provinces, a case can be made progressive income tax and uses the pro- against the exercise of the federal that equalization also benefits the rich ceeds to provide expenditures that are spending power as an instrument to provinces. This is so because, without roughly equal per capita. While similarly generate revenues, per se. an equalization program in place, situated citizens (e.g., same income, However, the implications of the Ottawa would not have ended up same family composition) will pay iden- Quebec PIT turned out to be both dra- transferring anywhere near as much in tical amounts of taxes no matter where matic and far reaching. The first of these the way of tax room to the provinces they reside, it will nonetheless be the was the decision by the federal govern- that it eventually did. More to the case that provinces with higher-income ment, as part of the 1957 Tax Sharing point, the traditional have-not residents will find that their residents Agreements, to offer all the provinces provinces would have stood in the way. (but not the provinces themselves) are the option of levying their own taxes (or A third and truly transformative paying more to Ottawa than they are receiving an abatement or reduction in implication arising from the above receiving from the equal per capita federal tax) equal to 10 percent of the analysis draws from the writings of expenditures. This is the inevitable and federal PIT, 9 percent of the federal cor- Claude Forget. He points out that, appropriate consequence of the opera- porate income tax (CIT), and 50 percent prior to the Quebec PIT, if the tions of an income tax system, progres- of succession duties, with the federal provinces wanted a new program in an sive or even proportional. I would government agreeing to collect the area of exclusive provincial jurisdic- hazard a guess that it is this natural oper- provincial taxes free of charge. Because tion, the obvious route was to amend ation of the PIT (and CIT, etc.) that these provincial revenues from piggy- the constitution and transfer this accounts for much to the “excess contri- backing on federal taxes were to be allo- power to Ottawa. This was what bution” that Ontario (earlier) and cated across provinces on the basis of the occurred for unemployment insurance Alberta (now) claim that they are mak- derivation principle (i.e., on the basis of in 1940 and for old age pensions in ing to the financing of the federation. what was actually raised in each 1951. However, the key spending pro- Yet, the reality is that individual province), they generated very different grams that came after the Quebec PIT Albertans and Ontarians are treated per capita revenues across provinces. and the above-noted associated devel- identically to similarly situated Nova opments, namely hospital insurance, Scotians. A related observation is that no his led to a second key implication medicare, post-secondary education province ever transfers any of its own- T of the Quebec PIT: in order to and social assistance, were provincially source revenues to Ottawa or to its sister compensate for these per capita differ- administered programs with federal provinces, although one often hears ences in this federal move toward tax cost sharing. Moreover, while the cost comments from various quarters that sharing, Ottawa inaugurated Canada’s sharing initially took the form of con- seem to imply this. formal equalization program, also as ditional grants, these eventually part of the 1957 quinquennial rework- became unconditional and, to a con- ow that the funding of equaliza- ing of the fiscal arrangements. This ini- siderable degree, were replaced by N tion has been broached, a third

POLICY OPTIONS 33 MAY 2010 Thomas J. Courchene

observation is in order. Because the rev- combined with those of other have- nd all of these were a prelude to enues subject to equalization in the not provinces with a low or zero oil A the infamous National Energy 1957 version of equalization (PIT, CIT tax, brought the total to the above- Program (NEP) in the fall of 1980, and succession duties) were shared with noted 75 cents. More concretely, the which was a broadside against the ener- Ottawa, there was complete congruence calculations for 1981-82 indicated that gy patch and especially Alberta, and between the provincial source of any continuing with the then-existing which remains permanently etched in increase in equalization and the provin- equalization formula would have the psyche of Albertans. Among its pro- cial source of Ottawa’s revenues needed increased equalization by $3 billion — visions were a federal tax on natural gas sales; an 8 percent tax on The reality is that individual Albertans and Ontarians are corporate resource royalties; treated identically to similarly situated Nova Scotians. A a charge to promote related observation is that no province ever transfers any of its Canadian ownership in the oil sector; the Petroleum own-source revenues to Ottawa or to its sister provinces, Incentive Program (PIP) although one often hears comments from various quarters grants to explore in “Canada that seem to imply this. Lands” rather than in “province lands”; and the to finance this increase. For example, if from $4.6 billion to $7.6 billion. Since “back-in” provision, whereby Ottawa the increase in equalization is occurring Ottawa cannot constitutionally get reserved a 25 percent interest in all because income taxes are rising in the access to any energy royalties accruing existing and future petroleum rights on rich provinces, Ottawa’s income taxes to the provinces, this meant that Canada Lands. While the NEP was from residents in these same provinces Ontario’s residents would contribute appropriately viewed as a political and must, by the definition of shared taxes, roughly 40 percent of this additional constitutional affront to the western also be increasing. It was this conven- $3 billion in equalization, whereas energy provinces, it was not, of and by ient congruence that came to an abrupt Albertans would contribute about 12 itself, the fiscal disaster that it is com- end with, first, the introduction of the percent, these percentages reflecting monly assumed to have been. 1967 comprehensive equalization sys- the provincial shares of Ottawa’s rev- There are two prongs to this claim. tem, which equalized all provincial rev- enues. The projections at the time The first is that the revenues diverted enues (classified into 30-odd tax bases, were that federal income tax revenues or appropriated from Alberta by the including roughly a dozen energy and would have to increase by 25 percent. series of initiatives prior to the NEP resource bases) to the national average Clearly, Ottawa was not about to were arguably much larger than the standard (NAS) and, second, the two let this scenario play out. Rather, actual fiscal damage arising from the energy shocks (the 1973-74 OPEC hike Ottawa embarked on a dizzying array NEP itself. For example, in 1979-80 the and the 1979-80 Iraq-Iran War). of defensive and all-too-often contro- made-in-Canada oil price was $20 per In the face of the resulting dramat- versial initiatives: pegging the domes- barrel below the world price, the result ic upward spikes in energy prices, had tic energy price well below the world of which was that the foregone provin- Ottawa allowed domestic oil prices to price; implementing an export tax on cial energy revenues were, at go to world levels, the reality would oil equal to the difference between the unchanged production levels, $7 bil- have been not only that Ontario global and the domestic price; disal- lion per year. Another perspective is would become a have-not province lowing the deduction of provincial that by 1980 the province of Alberta but, thereafter, every additional dollar royalty payments for the federal CIT; had already “subsidized” Canadian of oil revenue accruing to the energy reducing the amount of energy royal- consumers (via lower domestic oil provinces would have increased feder- ties that could enter the equalization prices) to the extent of some $30 bil- al equalization payments by 75 cents. formula; and retroactively disqualify- lion. The second prong relates to the This is clear from the NAS formula, ing Ontario from receiving equaliza- post-NEP period. Ottawa’s 1981 series where the equalization payments aris- tion, even though it was a have-not of NEP compromises with Alberta ing from oil revenues for each province, for each year between 1977 included a commitment to allow the province can be expressed as follows: and 1982, among many others. This domestic price to rise to $60 per barrel equalization for oil = total oil revenues last initiative was accomplished via the instead of the $40 ceiling under the (% population – % tax base). Given “personal income override”: a NEP. This would have led to very sig- that Ontario has about 37 percent of province could not receive equaliza- nificant revenues for Alberta and, the population and zero percent of the tion if its per capita personal income more generally, the western energy oil base, Ontario equalization alone was above the national average. While provinces, were it not for the reality would be 37 cents on any additional this was cast in general terms, the only that by 1986 the world price had col- dollar of oil royalties which, when province affected was Ontario. lapsed to $20 per barrel, dragging the

34 OPTIONS POLITIQUES MAI 2010 Intergovernmental transfers and Canadian values: Retrospect and prospect

Jason Ransom, PMO Prime Minister Stephen Harper shares a lighter moment with Ontario Premier Dalton McGuinty and Manitoba Premier Gary Doer, now Canada’s ambassador to the US, at a First Minister’s Meeting in November 2008. Intergovernmental affairs are about to get a lot more complicated.

Canadian price down with it. Ever s already noted, former Alberta Part of the rationale for replacing these since then, domestic and world prices A Premier Peter Lougheed has heretofore open-ended 50-50 shared- have moved in lock-step. In other recently warned Canadians that the cost programs was that federal expendi- words, it was the global energy price intergovernmental political and finan- tures on them were beyond Ottawa’s collapse, not the NEP per se, that led to cial stakes are so high in this area of control: they were determined by the the depressed fiscal fortunes of the “environmental federalism” that we collective decisions made in the provin- Alberta economy in the mid-to-late may be marching toward a crisis that cial capitals. Henceforth these transfers 1980s and to its qualifying for federal could even overshadow the NEP. And would be unconditional and would be stabilization payments. in terms of the NEP itself, Premier equal per capita across provinces at a However, the longer-term politi- Lougheed, before leaving office in level that equalled the average amount cal/constitutional ramifications of the 1985, brought Alberta fully onside spent on these programs by the two NEP proved to be most significant. In with the Canada-US Free Trade richest provinces in 1977, escalated order to bring Alberta and the energy Agreement (FTA) negotiations annually by the three-year average of provinces onside in the 1980-82 consti- launched in 1986, because its provi- GDP growth. Half of the overall financ- tutional negotiations, Ottawa intro- sions virtually guaranteed that Ottawa ing came in the form of cash transfers, duced s.92A into the Constitution Act could never repeat the NEP: “the FTA is and the other half was in the form of 1982. In effect, this gave the provinces our auto pact,” was his response to 13.5 personal income tax points and control over the exploration, develop- Ontario and Ontarians who were one corporate income tax point. Since ment, management, conservation and against the FTA. the provinces were already in receipt of any means of taxation, in respect of Meanwhile, much was also afoot 4.357 PIT points and one CIT point, nonrenewable natural resources, on the fiscal arrangements front. The this represented a transfer of an addi- forestry and the generation of electrici- 1977 arrangements led to the block- tional 9.143 tax points (where a tax ty. Among other implications, this new funding of the so-called “established point is 1 percent of the federal PIT). constitutional provision bolsters the programs” (federal-provincial cash This was the last transfer of PIT points various provincial attempts to imple- transfers for hospital, medical and post- from Ottawa to the provinces, so that ment carbon pricing, the revenues from secondary education expenditures), subsequent increases or decreases in which may well rival those associated with the transfers for welfare continu- provincial PIT rates would reflect with energy royalties themselves. ing with their 50-50 tax-sharing format. provincial decisions.

POLICY OPTIONS 35 MAY 2010 Thomas J. Courchene

he challenge facing the 1982 round transfer development was the set of tors that resulted in the FPS equalization T of the fiscal arrangements agree- bilateral off-shore energy accords with program effectively confiscating the ments was how to rework equalization Newfoundland and Nova Scotia, which province’s energy royalties. Specifically, in the context of (still) sky-high energy allowed these provinces to tax their off- in fiscal year 2000/01 Saskatchewan’s prices. In particular, the new program shore energy resources as if the energy revenues totalled $1.04 billion had not only to be affordable but it also provinces were the sole owners. Given and its equalization clawbacks on these had to exclude Ontario as a recipient. that a separate tax base was created for revenues totalled $1.13 billion! Intrigu- Initially, the notion of an Ontario stan- Newfoundland and Nova Scotia within ingly, all other have-not provinces were dard held sway: all provinces would the equalization formula, the operation better off fiscally (in terms of equaliza- have access to the Ontario level of per of the FPS program would have reduced tion) because of Saskatchewan’s energy capita revenues. Since Ontario had no other equalization flows to these revenues. Arguably, this served as one of fossil energy oil and since, by definition, provinces, dollar for dollar, in terms of the triggers for the abandonment of the it could not be eligible for equalization, the off-shore revenues. Ottawa’s solu- FPS standard in 2004. the two criteria were satisfied. In the tion to this was to enact the peculiarly event, the negotiations coa- eturning to the federal lesced around the five-province R provincial cash transfer standard (FPS) , where the five The calculations for 1981-82 front, the 1990s were truly trans- provinces were Quebec, Ontario, indicated that continuing with the formative. After a series of cuts Manitoba, Saskatchewan and then-existing equalization formula and freezes to federal transfers BC. It was essential that Alberta would have increased equalization (e.g., the cap on the CAP be excluded from the standard (Canada Assistance Program), in order to minimize the impact by $3 billion — from $4.6 billion to which limited to 5 percent the of oil on equalization, and this $7.6 billion. Since Ottawa cannot annual transfer increases over was offset by also excluding the constitutionally get access to any the 1990/91 to 1994/95 period four Atlantic provinces, at that energy royalties accruing to the and whose cost to Ontario ran time the poorest. This was a into double-digit billions; and stroke of political genius in that provinces, this meant that Ontario’s after a set of a freezes and caps on the FPS held sway until 2004, residents would contribute roughly health and PSE transfers over a when Prime Minister Paul 40 percent of this additional $3 similar period) Finance Minister Martin wreaked havoc with the billion in equalization, whereas Paul Martin really lowered the traditional approach to equaliza- boom on the provinces in his tion via a series of arbitrary Albertans would contribute about 12 historic 1995 budget. changes from which the pro- percent, these percentages reflecting Specifically, Martin rolled estab- gram has yet to recover. the provincial shares of Ottawa’s lished programs financing (EPF) Finally, and as befits the 25th revenues. The projections at the time and CAP transfers into the newly anniversary of the inaugural created Canada Health and 1957 formula, the equalization were that federal income tax Social Transfer (CHST), which he principle was enshrined as s.36(2) revenues would have to increase by then cut by nearly $6 billion of the Constitution Act 1982: 25 percent. Clearly, Ottawa was not (from $18.3 billion to $12.5 bil- “Parliament and the government about to let this scenario play out. lion by 1997-98), and obviously of Canada are committed to the much more, cumulatively. principle of making equalization Intriguingly, this download- payments to ensure that provincial gov- termed, but particularly relevant, 1994 ing of a large part of the federal deficit to ernments have sufficient revenues to pro- “generic solution,” i.e., a province with the provinces via the transfer system trig- vide reasonably comparable levels of at least 70 percent of a tax base can shel- gered what turned out to be a most cre- public services at reasonably comparable ter 30 percent of its revenues arising ative bout of nation building by the levels of taxation.” from entering the equalization formula. provinces. Under the aegis of the reinvig- While Saskatchewan also had at least 70 orated Annual Premiers’ Conferences he remainder of the 1980s was percent of several of the various FPS (APCs), the Ministerial Council on Social T punctuated primarily by some key energy tax bases, it did not have 70 per- Policy Reform and Renewal produced “A economic developments — among oth- cent of the overall or national-average Report to Premiers” in December 1995, a ers, the Canada-US Free Trade Agree- tax base (which included Alberta) for document that still ranks as Canada’s ment, the adoption of price stability as a these categories, so that it was not most impressive statement of social policy Bank of Canada policy goal, and the allowed to take advantage of the gener- principles and goals. One immediate and introduction of the GST. The major ic solution. This was one of the key fac- significant result was the introduction of

36 OPTIONS POLITIQUES MAI 2010 Intergovernmental transfers and Canadian values: Retrospect and prospect the Canada Child Tax Benefit in Martin’s percent indexing). On the equalization Recognizing that the equalization 1997 budget, a recommendation con- front, Martin introduced the “New file was becoming increasingly arbitrary tained in “A Report to Premiers.” Framework,” which followed the COF and problematic, in March 2005 federal Similarly, the popularity of the premiers’ recommendation by increasing the Finance Minister Ralph Goodale estab- focus on social policy eventually led level of equalization to its earlier his- lished the Expert Panel on Equalization Ottawa to get on the social policy band- toric high ($10.9 billion). But then and Territorial Formula Finance, whose wagon, the result of which was the Social Prime Minister Martin went beyond report is henceforth referred to the Union Framework Agreement (SUFA). this to fundamentally alter the equal- O’Brien Report, after its chair Al O’Brien, And, led by the newly elected Premier of ization formula. Henceforth, this former deputy minister of finance for Quebec, Jean Charest, the APC evolved $10.9 billion of equalization would Alberta. The recommendations of the into the Council of the Federation (COF) grow by 3.5 percent, irrespective of the O’Brien Report were fully incorporated in December of 2003. Thus far the COF degree of interprovincial fiscal dispari- into the Conservatives’ 2007 budget. has played a key role in improving the ties. Hence, the role of the formula Among its provisions were: the formula internal economic union, and one would be to only determine the alloca- would revert to determining both the expects that it will continue to play an tion of this fixed pool across provinces amount of equalization and its distribu- important role in internalizing the vari- and not the size of the pool. Overall, tion across provinces; the new formula ous provincial social, economic and envi- the 10-year agreement would add $33 would maintain the national average ronmental externalities. My view of this billion to equalization. standard, but include only 50 percent of post-1995-budget evolution toward the Complicating all of this was the resource revenues (i.e., NAS-50); the 30+ COF is that the provinces realized that in stand-off between Prime Minister revenues sources would be equalized order to preserve, let alone increase, the Martin and Newfoundland and FIGURE 1: PER CAPITA EQUALIZATION degree of decentralization in the federa- Labrador Premier Danny Williams (and PAYMENTS TO PROVINCES, 2010/11 tion, they would have to embrace a cor- to a lesser degree Nova Scotia Premier responding degree of coordination/ John Hamm) deriving from a private BC 0 responsibility for their collective policy telephone conversation between Martin AB 0 actions. The COF is a significant step in and Williams in the final weeks of the this direction. 2004 federal election, in which Martin is SK 0 purported to have promised Williams MB 1,494 owever, the COF is also a lobby that the revenues from the offshore ON 74 H group for the provinces, and its would be protected from equalization QC 1,092 initial cause celèbre was to press for clawbacks. In the event, by lowering the NB 2,109 restoring fiscal balance in the federa- flag, Premier Williams succeeded in rais- tion. And in its first meeting in July ing the (equalization) standard: the new NS 1,183 2004, the COF responded to Prime 2005 Offshore Accords provide full com- PEI 2,340 Minister Paul Martin’s commitment in pensation until 2012 to Newfoundland NL 0 the 2004 election to convene a First and Labrador, and to Nova Scotia, for 0 2,000 4,000 6,000 8,000 10,000 Ministers’ Conference (FMC) on health any reductions in equalization pay- Dollars care wait times in the fall of 2004 with ments as a result of increased revenues Sources: Department of Finance Canada and two recommendations: one, that the from offshore developments. Statistics Canada. Canada Health Transfer be increased to 25 percent of health spending (i.e., fill- TABLE 1: EQUALIZATION PAYMENTS TO PROVINCES, 2005/06 TO 2010/11 ing the so-called “Romanow gap”) and (MILLIONS OF DOLLARS) then be indexed, and, two, that equal- ization be increased immediately to its 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 historic high (2001) and that the for- Newfoundland and Labrador 861 687 477 – – – mula be shifted from the FPS back to a Prince Edward Island 277 291 294 322 340 330 National Average Standard (NAS). By Nova Scotia 1,344 1,386 1,465 1,465 1,391 1,110 160 New Brunswick 1,348 1,451 1,477 1,584 1,689 1,581 way of an intriguing aside, the COF Quebec 4,798 5,539 7,160 8,028 8,355 8,552 also recommended that Ottawa take Ontario – – – – 347 972 over Pharmacare, a proposition that Manitoba 1,601 1,709 1,826 2,063 2,063 1,826 Saskatchewan 89 13 226 – – – Ottawa did not react to but one that Alberta – – – – – – may not be permanently off the table. British Columbia 590 459 – – – – In the event, Ottawa’s health Total 10,908 11,535 12,925 13,462 14,185 14,371 accord gave the provinces $41 billion over 10 years (the Romanow gap plus 6 Source: Department of Finance Canada.

POLICY OPTIONS 37 MAY 2010 Thomas J. Courchene

through five tax bases — the PIT, the result that the equalization cap will be income override,” which would once CIT, property tax, sales tax and natural $800 per capita higher (than with again exclude Ontario from equaliza- resources; the tax base for resource rev- Ontario as the cap), so that the equaliza- tion. In other words, equalization has enues would be the actual amounts of tion payments to the resource-rich resumed its unenviable state as an acci- resource revenues collected; a cap will be receiving provinces will likely rise. To dent waiting to happen. imposed so that, as a result of equaliza- eliminate this possibility, the cap has Some elaboration of the details in tion, no receiving province ends up been redefined to equal the per capita table 1 may help clarify aspects of the with an all-in fiscal capacity (i.e., NAS average over the receiving provinces of above analysis. Most striking is the huge with 100 percent inclusion of resource the sum of national average fiscal capac- increase in Quebec’s equalization, from $4.798 to $8.552 billion. Because Ontario is so large and energy prices are so volatile, Indeed, this increase was the result will likely be considerable variability in the larger than the overall payments flowing to the traditional recipients. Indeed, one increase in equalization over this period. The reason for can anticipate that these provinces would argue for a return this is that with an escalating of the “personal income override,” which would once again fixed pool, and with exclude Ontario from equalization. In other words, Saskatchewan, Newfound- equalization has resumed its unenviable state as an accident land and BC becoming have provinces, Quebec garners a waiting to happen. much larger share of the revenues) larger than that of the nonre- ity (including 100 percent of resource equalization pool. At the margin, and ceiving province with the lowest fiscal revenues) and equalization. with Ontario excluded, Quebec gets 69 capacity (assumed at the time to always But with Ontario as a have-not cents of every additional equalization be Ontario); and finally, the data enter- province, the equalization program is dollar arising from energy revenues. ing the formula would be in the form of likely to become unaffordable. In the However, with Ontario now in the have- a three-year moving average, lagged two 1977-82 era, Ontario being a recipient not group, Quebec’s 68 cent share of the years. province meant that an extra dollar of marginal equalization dollar falls to 32 oil revenues would lead to a 75 cent cents, with decreases as well for the other owever, thanks to the upward increase in equalization. In the current receiving provinces. Small wonder that H spiral in the price of oil (which time frame, because the resources base they would like to keep Ontario out of approached $150 per barrel in mid- includes more than oil, and because the recipient pool. 2008), this comprehensive rethinking Newfoundland and Saskatchewan are While one presumes that the sys- and reworking of equalization was now have provinces for resources, the tem will find ways of hobbling along, overwhelmed by events and had to increase in equalization is in the range prodded by self-interested provinces undergo yet another transformation in of 57 cents. This would still break the and aided by very able plumbers, it the 2009 federal budget. By now, read- equalization bank, especially given the may be useful to conclude this ers might guess that again the trigger likelihood of rising energy prices. overview of federal-provincial finan- was that Ontario had joined the ranks Obviously, this was the real reason cial relations by briefly highlighting a of the equalization-receiving pro- why the equalization program was series of alternative perspectives or vinces. Data for equalization payments returned to a fixed-pool framework. practices elsewhere that might be from 2005/06 to 2010/11 appear in A further problem, however, is brought to bear on rethinking aspects table 1, and the per capita values for that an increase in Ontario’s equaliza- of the theory and/or mechanics of the current year are shown in figure 1. tion (either from escalating energy rev- equalization, and the transfer system In elaborating on the several inter- enues or because Ontario’s fiscal more generally. Many, perhaps all, of related facets relating to this latest revi- capacity is falling, in absolute terms) these alternative perspectives may be sion, it is a pleasure to acknowledge the means that under a fixed pool there viewed as unacceptable. Nonetheless, excellent paper by Michael Smart, “The are fewer equalization dollars for the each sheds light on selected features of Evolution of Federal Transfers since the traditional equalization receiving the current arrangements, features O’Brien Report.” First, under pressure provinces. And because Ontario is so that often go unnoticed. from surging resource revenues, the large and energy prices are so volatile, total amount of equalization have again the result will likely be considerable he first relates to the manner in be fixed (and indexed). Second, and a variability in the payments flowing to T which hydro rents are treated contributing factor to the first, BC has the traditional recipients. Indeed, one within the existing formula. Currently now become the nonreceiving province can anticipate that these provinces will revenues from this sector are in the with the lowest fiscal capacity, with the argue for a return of the “personal form of either (1) charges for use of the

38 OPTIONS POLITIQUES MAI 2010 Intergovernmental transfers and Canadian values: Retrospect and prospect hydro potential, which enter the for- share. While the energy provinces are wages, rents, etc., it takes more rev- mula as resource revenues or (2) as almost certain to reject this revenue- enues in higher-wage and higher-rent remittances from provincial Crown sharing option, it might be noted that provinces to deliver a comparable corporation, which are classified as a version of a revenue-sharing pool bundle of public services (e.g., one business revenues. As the O’Brien exists in the German federation. police officer, one social worker, one Report noted, provinces can influence The third and fourth perspectives welfare recipient, one appendectomy, the form in which these revenues enter are related in that they address many one nurse, and so on). Hence, Ontario the formula so the negative impact on Canadians’ concern that we are needs more revenues per capita than their equalization entitlements is mini- overequalizing. I want to come at this New Brunswick does to deliver com- mized. This has become more impor- from the vantage point of what is usu- parable services. But we make no cor- tant recently, because of the prospects ally referred to as “capitalization.” The rection for this. Therefore, because of for exporting hydro to the US, likely at third perspective focuses on the rev- the impact of capitalization on the prices that exceed those in the export- enue, where the property tax base is a revenue side, our equalization pro- ing province. An option suggested by good example. It has recently been gram brings New Brunswick’s overall the O’Brien Report was to work toward redefined to take account of the high per capita revenues to a higher level a framework to calculate hydro rents, land values in BC and other places, so than those of Ontario. The combined whether they are left in hands of hydro that BC’s share of the formula-defined effect is one of the reasons why the consumers via low prices or accrue to property tax base is larger than its earlier-noted Frontier Centre for provincial governments. Beyond this, share of actual property tax collec- Public Policy study shows that the energy prices and therefore hydro rents tions. Similarly, the PIT base for equalization-receiving provinces pro- will probably rise as progress is made in Ontario has been adjusted upwards vide more “bundles” of public servic- moving toward a green economy and because it has a higher share of high es than do the rich provinces. To be society. To be sure, the O’Brien Report income earners, so that Ontario’s share sure, if New Brunswick needed more ended up not recommending this of the equalization formula’s PIT base bundles per capita (i.e., had greater course of action, because it would be is larger than its actual share of PIT tax needs than Ontario), then this out- too difficult and controversial. collections. Given that the revenues to come would be appropriate. But this However, not following along this be equalized for property taxes and for is far from obvious, and in any event, path, if hydro rents do rise, may well the PIT are huge ($55 and $79 billion, Canada’s equalization program has make continuing with current respectively), a couple of percentage- always assumed that per capita needs approach to resource equalization too point increases in favour of the receiv- are everywhere identical. difficult and controversial. ing provinces’ deficiencies makes a A second perspective might focus very significant difference. long similar lines, one might note on the funding inequity (the provin- Enter the companion (fourth) A that the oft-cited rationale for the cial source of the increase in equaliza- perspective. If one is going to invoke lack of an equalization program in the tion differs from the provincial source capitalization, there is a much US federation is that any fiscal differ- of Ottawa’s revenues to fund it), and stronger case to be made for doing ences are capitalized (i.e., it takes more take the view that Ottawa should not equalize tax In fiscal year 2000/01 Saskatchewan’s energy revenues bases (1) that are large and totalled $1.04 billion and its equalization clawbacks on these variable across provinces, revenues totalled $1.13 billion! Intriguingly, all other have-not and (2) from which Ottawa receives no direct revenues. provinces were better off fiscally (in terms of equalization) This would amount to because of Saskatchewan’s energy revenues. Arguably, this excluding energy revenues served as one of the triggers for the abandonment of the FPS from the formula, an standard in 2004. option that the nonre- source provinces would clearly reject. this on the spending side, rather than revenues to deliver a bundle of servic- But Ottawa could invite the provinces on the revenue side. Note that s.36(2) es in New York than it does in to embark on a self-financing inter- of the Constitution Act, 1982, states Mississippi), so that in the final analy- provincial revenue-sharing pool for that revenues be reasonably compara- sis there is nothing to equalize, as it resource revenues that could be run ble across provinces so that reason- were. In the Canadian context, this US through the COF. For example, all ably comparable public goods can be assumption of 100 percent capitaliza- provinces could put 20 percent of delivered. However, because well over tion would be wholly unacceptable, their resource revenues into the pool half of public goods and services are but the tandem of the third and fourth and then draw out their population somehow related to the level of perspectives brings to light the

POLICY OPTIONS 39 MAY 2010 Thomas J. Courchene

likelihood that the formula is equalization, Alberta has a per capita aving thus managed to impugn overequalizing. At the very least, it is fiscal capacity that is in the range of H every province, implicitly or explic- passing strange that the US uses capi- $5,000 above those of the traditional itly, I will close on a hopefully more com- talization to argue that there is no equalization-receiving provinces, along forting note. Australia is the most need for equalization, whereas we with $2,000 for Saskatchewan and just centralized and egalitarian federation, employ it to increase equalization! over $1,000 for Newfoundland and and it has the most comprehensive and My final two observations bring Labrador. While s.36(2) of the egalitarian set of fiscal arrangements — the federal-provincial cash transfers Constitution Act 1982 may not be justi- on the equalization front, the states rev- back into the analysis. The first obser- ciable, these data would nonetheless enues are equalized both up and down to vation is that the current system of appear to fall way short of the spirit the national average. Germany is the cash transfers is very generous — intended by the equalization principle next most centralized federation, with “uniformity of living condi- The current system of cash transfers is very generous – health tions” enshrined in its Basic care transfers are rising at 6 percent in a 2-percent-inflation Law and a revenue-sharing environment. One expects that after 2014 these will be scaled pool among Länder. At the other end of the spectrum is back closer to the rate of inflation. If the real costs of health the rugged individualism of increase, the provinces will probably have to resort to tax the US federation, where the financing. absence of concern about point-in-time income distri- health care transfers are rising at 6 and may eventually lead to citizens in bution has its counterpart in the absence percent in a 2-percent-inflation envi- some provinces not having access to of a formal equalization program. And ronment. One expects that after 2014 reasonably comparable public services. Canada’s intergovernmental tax and these will be scaled back closer to the Assuming that interprovincial fiscal transfer system reflects the decentralized rate of inflation. If the real costs of disparities, after equalization, become nature of our federation and the “Peace, health care increase, the provinces an issue, then one approach would be Order and Good Government” of our will probably have to resort to tax to “revenue-test” the federal-provincial constitutional rhetoric. The fascinating financing. Now that almost all transfers (CHT, CST etc.). Currently, story in all this is that despite all the provinces have converted their sales these transfers are running about assumptions, short cuts, bargaining and taxes to the GST/HST format, one $1,000 per capita. One variant of rev- special interests that are inevitably option would be to follow Nova enue testing could work as follows. brought to bear on the design of the Scotia and Quebec in taking up the 2 Calculate the per capita national aver- intergovernmental fiscal arrangements in percent GST tax room vacated by the age of the sum of own-source and all federations, in the final analysis the Conservatives early in their mandate. equalization. If a province has, say, financial arrangements are anything but Another would be to impose a over 110 percent of this all-province arbitrary. Indeed, they complement the deferred user fee for certain medical average, then its federal cash transfer existing tax and expenditure assignments services, which would be reconciled would decrease by 20 cents for every in ways that integrate fiscal federalism in via the provincial PITs and could be dollar of its revenues in excess of the directions consistent with the implicit or made quite progressive because they 110 percent threshold. The resulting explicit values and norms that underpin would be linked to one’s income. federal savings would be used to per- their respective federations. Quebec has recently moved in this form further rounds, until the cash From this perspective, the myriad direction. Intriguingly, since both of transfers are fully distributed. Hence, if of intergovernmental problems high- these are tax measures, if they become a province has $5,000 per capita above lighted above are part of the ongoing widespread, they would likely be eli- the threshold, then its $1,000 per capi- challenge of restructuring our fiscal gible for equalization, in which case ta federal cash transfer would fall to arrangements, not only in light of the the combined result would be an zero. However, the province would still dictates of the new global order, but increase in provincial taxes and a have the $5,000. While this may seem also in ways that will ring true with the reduction in the growth of cash trans- radical, revenue-testing, or its close rel- values we hold with respect to our fed- fers partially compensated for the ative, income-testing, is employed in eration and our fellow citizens. poorer provinces via an increase in many policy areas (the Canada Child equalization. The key message here is Tax Benefit, Employment Insurance, Contributing Writer Thomas J. that the transfer system is sure to play the Guaranteed Income Supplement, Courchene is Jarislowsky-Deutsch a role (proactive or reactive) in any Old Age Security, and so on) and some Professor at the School of Policy Studies, shift in how health care is funded. version of it characterizes most federal Queen’s University, and senior scholar at My last observation is that, after systems. IRPP.

40 OPTIONS POLITIQUES MAI 2010