June 1, 2017
The complex problems confronting equalization and simple solutions to address them
The Equalization program plays an important role in the fiscal arrangements that underpin Canada’s federal system. However, the program is and will continue to be beset by problems. In this report, the Mowat Centre examines the most critical of these problems: the issues of unpredictability and unequalized fiscal capacity.
Broadly, the challenges of unpredictability and unequalized fiscal capacity have three root causes: Ontario, oil and unreliable data. While addressing these complex issues would involve some trade-offs, the fixes are relatively simple. Programmatic changes focused on the Equalization program’s role as a vehicle for long-term redistribution in Canada’s federal fiscal system would address the problems of unpredictability and unequalized fiscal capacity while continuing to meet the goals of the program.
A fundamental principle of Canada’s national identity is that all Canadians should have access to similar levels of public services, regardless of which province they live in. The federal Equalization program is Canada’s most important tool for ensuring this equity among provinces, given that provinces differ in their ability to generate revenues to pay for the services they are each responsible to provide.
Over the past decade, several factors have challenged the program’s ability to achieve this goal. The three most important factors have been federal fiscal restraint, Ontario’s qualification for payments, and the role of natural resources, particularly oil. Successive federal governments have introduced and upheld measures to address these challenges. But these measures have themselves created additional problems, particularly for Equalization-receiving provinces. Furthermore, the data used for calculating entitlements may be mis-measuring the differences between provinces that the program is supposed to equalize.
Looking forward, these challenges will persist if unaddressed. Ontario may drop in and out of Equalization-receiving status creating unpredictability for the province and potentially for other provinces and the federal government as well. Natural resources will be a continued source of volatility and unequalized fiscal capacity, contributing to a divergence in levels of service between provinces – precisely the outcome the Equalization program was designed to prevent.
The upcoming five-year legislative renewal of the program is the best time to address these issues in a more systematic manner. A set of interconnected reforms, targeting the three challenges noted above and thinking through the potential side effects of their complex interactions is the order of the day.
Such reforms should be designed such that they will increase predictability for provinces and the federal government while enhancing the accuracy of the data upon which equalization decisions are made. These changes would benefit the fiscal planning efforts of provinces and the federal government alike. The problematic issue of resource revenue inclusion should also be addressed by including in Equalization calculations only the proportion of provincial resource revenue that gives rise to differences in spending levels among provinces. Lastly, Canada lacks a program to effectively protect provincial revenues from idiosyncratic economic shocks. Improvements to the federal Fiscal Stabilization program should be undertaken to better share fiscal risks across the federation. We propose a set of simple solutions to achieve these goals.