Overview –

The CTE develops studies, papers and outreach activities that:

• Develop and expand the dialogue about the problems created by Canada’s current equalization system.
• Discuss why a highly political and apparently ineffective system of regional subsidies unnecessarily hobbles recipient regions and the entire nation in today’s competitive world markets.
• Explore methods of creating politically saleable alternatives to the present system.  

The goal is to shift away from today’s transfer regime, which creates dependency while discouraging economic growth and opportunity. The model we seek is transformational in nature – one that empowers economically vibrant, self-sustaining provinces to pay for their own public services.

The Need

The topic of equalization is one of the most poorly understood areas of Canadian public policy. Most people believe the system helps recipient provinces, but a substantial body of evidence indicates that unconditional transfers lock the “have nots” in a powerful welfare trap, where they fall prey to perverse incentives to maximize subsidies by keeping taxes and spending high. Specifically, the present formula and program:

• Rewards provinces for keeping taxes high. Research by the Atlantic Institute shows that high tax rates on weak tax bases will maximize the yield of equalization payments. High taxes discourage economic growth and investment, but today’s competitive, wide-open economy requires precisely the opposite approach.
• Retards beneficial structural reform of the public sector. These subsidies tend to be capitalized into bigger government budgets. Manitoba, for example, has among Canada’s most expensive education and healthcare systems, thanks to generous equalization transfers that account for 20% of its provincial budget. Without subsidies, the province’s politicians would have to consider well-known, feasible structural reforms to public services, such as competitive service delivery and the divestiture of low-performing public assets.
• Supports less than optimal environmental policy by subsidizing low prices for greener, renewable forms of energy in hydro rich provinces like Manitoba and Quebec.  (Increases in oil prices result in equalization claw backs for provinces like Saskatchewan. Meanwhile the formula fails to penalize lower than market prices for hydro electricity. (For discussion click here.)

In a 2001 Frontier Centre interview, the intellectual father of equalization, economist and Nobel laurate James Buchanan recanted his original theory, which laid out a limited case for governments to “bribe” people not to move to more economically vibrant areas. Canada had made a mistake, he argued, by transferring equalization subsidies to governments instead of individuals and accurately predicted that transfers would simply bloat up recipient governments. His original proposal, that taxes be reduced in “have not” areas, would have avoided the capture of transfers by higher state spending.

Equalization is a classic “concentrated benefits versus dispersed costs” challenge, where the unorganized public simply has little individual incentive to confront an entrenched subsidy system. It is no coincidence that the “have not” provinces have overly politicized economies, as different elements chase subsidies that arrive with no strings attached.

The challenge is developing options that allow politicians in recipient provinces safe and reasonable ways to move to smarter alternatives. These paths to reform would enable politicians to say their provinces are not losing benefits, that alternatives clearly have more benefits than downsides, and enjoy an adjustment period to facilitate a move to a normal growth economy for their regions.

Other Resources

• Time for a Vision of Ontario's Economy - TD Bank
   
• Federal Fiscal Transfers - The Mowat Centre for Policy Innovation
   
• Atlantic Institute for Market Studies (AIMS) - much of the groundbreaking research on this subject has been done by this institute.
   
• Vertical and Horizontal Fiscal Imbalances: an Ontario perspective by Thomas Courchene
   

A Policy for the Future, Not the Past

The Centre for Transformational Equalization will develop a theme of transformational equalization that considers several alternatives:

Tinkering with the formula

• Making transfers sensitive to the effectiveness of spending in recipient regions, with a simple rule, phased in over five years that recipient provinces cannot spend more than national averages on public services.
• Instituting clawbacks of below market hydro-electricity subsidies to discourage distortion of energy markets and promote conservation of a valuable resource.

Regional federal tax reductions

• This would redirect equalization towards the original idea proposed by Buchanan, dramatic income-tax reductions in “have not” provinces.
• Converting ineffective regional development and job-creation programs into a 10-year federal tax holiday for “have nots.”

Debt-for-equalization swap

• Most equalization goes right back out the door in the form of provincial debt service charges. With a debt-for-equalization swap, provinces could clean up their balance sheets. This reform would have to be accompanied by strict rules that prevented provinces from simply running up their debt again.

The tax swap

• Subject to harmonizing the GST with provincial sales taxes, the federal government would simply hand provinces the GST as a substitute for equalization and CHST programs, values that, prior to the recent run up in transfers, were approximately equivalent.

As a final task, the CTE would deal with the very public misconception that equalization as we know it is here to stay since it was entrenched in the Canadian constitution in 1982. It is, in fact, quietly acknowledged that the constitutional basis for equalization is tenuous and legally unenforceable. Read more.

The debate about our federal government’s dysfunctional transfer programs needs an injection of fresh new ideas, and the timing could not be better.  The Frontier Centre’s Transformational Equalization Project examines how “have not” provinces have been harmed by these well-intended subsidies, and explores comparatively big picture ideas aimed at converting equalization from a welfare trap into a helping hand.  These include a one-time buy-out, where the federal government would retire debt and provide a “heritage fund” to replace annual transfers, or the swap of the GST to the provinces in exchange for an end to both equalization payments and federal social and health transfers, or another trade-off, the reduction of federal taxes in “have not” regions.