Equalization payments in Canada

In Canada, the federal government makes equalization payments to less wealthy Canadian provinces to equalize the provinces' "fiscal capacity" — their ability to generate tax revenues. A province that does not receive equalization payments is often referred to as "have province", while those that do are called a "have not province". In 2010-2011, six provinces will receive $14.4 billion in equalization payments from the federal government. Until the 2009-2010 fiscal year, Ontario was the only province to have never received equalization payments; in 2009-2010 Ontario received $347 million, while Newfoundland and Labrador, which has received payments since the program's creation, is now a so-called "have" province, and is now a net contributor and does not receive them.

Canada's territories are not included in the equalization program - the federal government addresses territorial fiscal needs through the Territorial Formula Financing (TFF) program.

Calculating payments

Equalization payments are based on a formula that calculates the difference between the per capita revenue yield that a particular province would obtain using average tax rates and the national average per capita revenue yield at average tax rates. The current formula considers five major revenue sources (see below). The objective of the program is to ensure that all provinces have access to per capita revenues equal to the potential average of all ten provinces. The formula is based solely on revenues and does not consider the cost of providing services or the expenditure need of the provinces.

Equalization payments do not, technically, involve wealthy provinces making payments to poor provinces, although in practice this is what happens, via the federal treasury. As an example, a wealthy citizen in New Brunswick, a so-called "have not" province, pays more into equalization than a poorer citizen in Alberta, a so-called "have" province. However, because of Alberta's greater population and wealth, the citizens of Alberta as a whole are net contributors to Equalization, while the citizens of New Brunswick are net receivers of Equalization payments.

Equalization payments are one example of what are often collectively referred to in Canada as "transfer payments", a term used in other jurisdictions to refer to cash payments to individuals (see Canadian Transfer Payments). The money the provinces receive through equalization can be spent in any way the provincial government desires. The payments help guarantee "reasonably comparable levels" of health care, education, and welfare in all the provinces. The definition of "reasonably comparable levels", however, has been the subject of considerable debate.

In 2009-2010, the total amount of the program was roughly 14.2 billion Canadian dollars.

Recent negotiations surrounding the renewal of the program have created considerable tension among provinces. Due to the zero-sum nature of the formula, increases in entitlements for some provinces necessarily lead to decreases for others.

Regional fiscal disparities in Canada

There are significant differences in the provinces in terms of size, geography, population, and economic activity. While there has been considerable convergence in provincial gross domestic product per person and personal incomes among the regions over the last fifty years, the gap between the most and the least well-off provinces continues to be a primary economic concern.

Gross domestic product per capita by province - 2005
($ per capita)

	NL	PE	NS	NB	QC	ON	MB	SK	AB	BC	Average
GDP per capita	$41,802	$30,166	$33,484	$32,152	$36,009	$42,812	$35,500	$43,330	$66,644	$39,658	$42,374
Ratio to mean	98.6	71.2	79.0	75.9	85.0	101.0	83.8	102.3	157.3	93.6	100.0
Per capita benefit	-	$2,324	$1,235	$1,973	$978	$166	$1,351	-	-	-

Source: Statistics Canada
Per capita benefit is derived from provincial population data in other Wiki articles and the total payments cited below.

Quebec and Ontario will receive the most from equalization payments in the 2011-2012 year.
However, per capita, PEI benefits the most. In the 2011-2012 year, the following provinces will receive equalization payments:

• Quebec ($7.815 billion)
• Ontario ($2,200 billion)
• Manitoba ($1.666 billion)
• New Brunswick ($1.483 billion)
• Nova Scotia ($1.167 billion)
• Prince Edward Island ($329 million)

The following provinces will not qualify for equalization payments in 2011-2012:

• Alberta
• Saskatchewan
• Newfoundland and Labrador
• British Columbia

Source: Dept. of Finance Canada, accessed 3 June 2011

Sources of fiscal capacity

The fiscal capacity of the provinces is determined by measuring their revenue from five general sources. Those revenue categories are:

• Personal income taxes
• Business income taxes
• Consumption taxes
• Up to 50 percent of natural resource revenue (see below)
• Property taxes and miscellaneous

Note: According to the Department of Finance, "provinces get the greater of the amount they would receive by fully excluding natural resource revenues, or by excluding 50% of natural resource revenues."

History

The basics of equalization payments have been around since Canadian confederation when the federal government had most of the taxation powers. The federal government would make transfer payments to the provinces to cover their needs. There was no obligation that these transfer payments had to reflect the amount collected in each province and thus wealth was always redistributed.

A formal system of equalization payments was first introduced in 1957. The idea was based on the proposals of American economist James M. Buchanan and they were introduced mainly to help the struggling Atlantic provinces who were seeing low rates of growth and high rate of emigration to central Canada.

The original program had the goal of giving each province the same per capita revenue as the two wealthiest provinces, Ontario and British Columbia, in three tax bases: personal income taxes, corporate income taxes and succession duties (inheritance taxes). Five years later, 50 per cent of natural resource revenues were included as the fourth tax base. At the same time, however, the standard of the two wealthiest provinces was lowered to the national average. In 1967 the system was redesigned to work with every government revenue scheme with the exception of energy; this gave Canada by far the world's most generous system of equalization payments.

The rise in energy prices and the resulting increase in provincial natural resource royalties in the late 1970s created several problems for the equalization formula. The need for amendments to the formula became clear when the traditional "have" province of Ontario qualified for equalization payments in 1978. This result went against the spirit of the system and would have led to substantial costs for the federal government; it was agreed that Ontario should be excluded from receiving payments. In 1982, the equalization standard was shifted from the national average to the average of the five "representative" provinces: British Columbia, Saskatchewan, Manitoba, Ontario, and Quebec.

The Canada Act 1982, which amended the constitution, included the rights of the poorer provinces to equalization payments. Subsection 36(2) of the Constitution Act, 1982 states that "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." It is unlikely that this provision will be amended.

In 2004, the federal government and the provinces agreed to suspend the traditional formula that determined payment amounts and move to fixed funding levels, which were scheduled to grow at a fixed rate - regardless of the economic performance of the provinces. In 2007, based on the recommendations of a federal expert panel, the program was returned to formula-driven calculations and enhanced by moving to a standard based on the national average. A fiscal capacity cap was added to ensure that Equalization-receiving provinces couldn't be raised to a fiscal capacity above that of a non-receiving province (this could potentially arise due to the partial or non-inclusion of resource revenues).

In 2009, the fiscal capacity cap was modified and a ceiling and floor on aggregate payments were added.

Criticisms

Equalization payments have mostly been criticized by leaders and residents of the wealthy provinces. The premiers of oil-rich Saskatchewan and Alberta and of Ontario, with its large manufacturing and service sectors, have criticized a perceived drain on their finances. However, money is collected for equalization payments by federal taxation and is collected regardless of whether or not the province is a 'have' or 'have not' province. The difference is whether the provincial government receives money from the federal treasury. Residents of Alberta and Ontario pay the same federal tax rate as residents of other provinces. Critics of equalization would argue that, since those provincial governments receive fewer total dollars per capita from the federal government than 'have not' provinces, they are required to collect more taxes from their residents compared to their neighbours than otherwise would be required if the equalization program did not exist.

Normally, under the equalization scheme, equalization payments go down for every dollar increase in a province's ability to raise taxes. So, for example, if a province's economy booms and the provincial government's potential income tax revenues increase, equalization payments decrease. Economist Michael Smart has argued that this gives have-not provinces an incentive to raise taxes, because any harm higher taxes do to the economy is off-set by higher equalization payments.

A have-not province also loses Equalization for every additional dollar it makes from royalties off the sale of its natural resources, thereby creating a disincentive for developing those resources. To protect Newfoundland and Labrador's equalization payments, premier Danny Williams negotiated the Atlantic Accord which provides that province with a special arrangement until 2012. Nova Scotia reached a similar arrangement with the federal government.

A March 2007 paper published by the Fraser Institute questioned the constitutionality of the equalization payment system.