Provincial-Local Equalization in Canada: Time for a Change?

This paper makes the case for provincial-municipal equalization transfers, to ensure that all local governments can provide reasonably comparable levels of service at reasonably comparable tax rates. A municipality’s inability to provide a comparable level of service may arise because the costs of services in the municipality are higher, the need for services is greater, the tax base is smaller, or some combination of these factors. Although six provinces in Canada provide some form of equalization to municipalities, arguably none provides sufficient funding to achieve the underlying objective of equalization.

To design a proper equalization system, this paper sets out a number of issues that need to be resolved. These include the overall amount of equalization and how it is determined from year to year, which municipalities are entitled to equalization, whether the variables determining the grant allocation can be influenced by municipalities, how fiscal capacity is measured, how needs are measured, and whether transitional funding is required to ensure that no municipality is worse off even if fiscal capacity and needs change. The paper concludes that every province in Canada would do well to establish a sound equalization transfer approach, which is an essential element of a fair and efficient system of local public finance.