Five ways to stop everyone hating the federal equalization program

Water rushes through the Carillon Hydro electric dam Thursday, April 25, 2019 in Carillon, Quebec. Ryan Remiorz/The Canadian Press.

Today Albertans will let the rest of Canada know how they feel about the federal equalization program.

Maybe the rest of the country is already well aware of how Alberta feels about equalization, but at least, by the end of October, it will be official.

By Oct. 26, municipalities across Alberta will report the results of a province-wide referendum on whether Canada should remove the reference to equalization from the Canadian Constitution.

Polling conducted last week shows that Albertans are solidly in favour of removing equalization from the Constitution, although there is still significant uncertainty about the vote due to the low turnout cities tend to see for municipal elections.

If Albertans vote against equalization, some experts believe it could bring about negotiations with the federal government, similar to Quebec’s referendum on seceding from Canada. Other experts believe the “Quebec precedent” is valid only for a referendum on secession. Either way, a “yes” victory on Monday will set up an intriguing situation between Alberta and the federal government.

One of the problems with tweaking equalization is that it can be a zero sum issue, with changes supported by one province invariably opposed by another. But if the federal government decides to substantially change the equalization program, there are a few options it could take, either drastic or minimal.

In that event, here are a few choices for Prime Minister Justin Trudeau if he decides to listen to Albertans and revamp the federal equalization program.

Remove non-renewable resource revenues

The equalization formula attempts to calculate a province’s “fiscal capacity,” which is the amount of revenue it would take in with median tax rates.

This calculation stops a province from lowering its tax rates, and therefore its revenues, and turning to the federal government for help through equalization. But it’s still possible for a province to game the system either by artificially lowering electricity rates or not developing some resource deposits.

Some provinces have even called for removing non-renewable resource revenue from the calculation to avoid creating bad incentives. Removing these revenues from the formula may tweak the payments around the margins, likely benefiting Newfoundland and Labrador the most, but it wouldn’t change anything for Alberta or Saskatchewan. Currently, 50 percent of non-renewable resources count towards the formula.

“Removing nonrenewable resource revenues from the equalization formula would not change Alberta’s status as a nonrecipient province because it has the strongest economy in Canada,” wrote a team of policy experts at Policy Options.

Change the formula to a GDP-based system

One innovative way of changing the formula would be to move away from the idea of “fiscal capacity” altogether.

A simple way to calculate equalization payments would be to have a formula based on GDP per capita, said University of Calgary economist Trevor Tombe in today’s Hub Dialogue.

Tombe said basing the formula on GDP would make it difficult for provincial governments to game the system.

“It is something that can be nudged up or nudged down through policy choices, but it wouldn’t be subject to the same direct ability to affect in the same way as resource revenues are,” said Tombe.

A GDP-based formula could have some unexpected outcomes, too. For example, Tombe noted that British Columbia’s fiscal capacity is elevated by high real estate prices, which wouldn’t be reflected in the same way with a GDP calculation, possibly pushing the province into payment-receiving status.

Remove the cap

One of the strange quirks of the federal equalization program is that a cap that was brought in to limit the growth of the program is now functioning as a revenue floor, generating constant growth even as the disparity between provinces shrinks.

This quirk has led to some strange outcomes, such as Ontario continuing to receive payments even as it made the transition from “have-not” province to “have” province.

“Eliminating the requirement of constant growth in program costs should be seen as a prerequisite for additional reforms,” write Ben Eisen and Joel Emes at the Fraser Institute.

This change wouldn’t soothe the grievances of any particular province and, in fact, it may create a whole crop of new grievances. But it would go a long way to satisfying economists who can’t figure out why the program continues to grow even as the problem it aims to solve gets better.

Create a commission to review the formula

With the equalization program becoming something of a political lightning rod lately, it may be helpful to take the politics out of it.

Tombe has suggested that Canada take a lesson from Australia and convene a panel of experts tasked with reviewing and amending the formula every few years.

“I think we could think about having institutional changes to the equalization formula, so that the formula itself wouldn’t be the focus of so much political attention in the way that it is, and regularized adjustments to it became normalized,” said Tombe, in a recent discussion at The Hub.

Equalization rebates

In the recent federal election, the Conservative Party announced a policy innovation that aimed to find a solution for Canadians annoyed at the equalization program.

Because the equalization formula uses a three-year average of a province’s fiscal capacity, it’s not well-placed to provide relief during temporary economic downturns. The federal fiscal stabilization program is better-suited for relief during a recession, but that program has been chronically under-funded.

The Conservatives promised to boost the fiscal stabilization fund, cutting Alberta $4 billion cheque in the process, and advertised it as an “equalization rebate,” winning praise for the policy and the marketing.

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