Equalization

Feb 26, 2002

Equalization as Tax Recovery

Equalization payments are an important part of nation building. They attempt to make an adjustment for "fiscal capacity" between very diverse provincial economies. In fiscal year 2000-01, Canada received almost $25 billion in revenue from the Goods and Services Tax and redistributed just over $10 billion in equalization payments. While there is no connection between the GST and equalization, the comparison helps to keep things in perspective. Equalization redistributes to the provinces less than half the monies Canada takes in from GST, and the GST raises only 14% of Canada's revenue.

The actual equalization formula considers more than 30 provincial revenue sources and calculates a payment to those provinces that fall short of a standardized tax base. Ontario is the only province that has never received equalization, although if revenue from oil and gas had not been diminished in the formula, Ontario might have become a "have not province" with Alberta being the only "have" province.

Some provincial politicians view being a "have not" province, i.e. receiving equalization, in the same negative light as being on the dole. In fact, receiving equalization merely means that some of the federal tax revenue received from a province is returned to that province. In the most extreme cases, revenue received from one province could be redistributed to another.

British Columbia received $132 million in equalization payments in 2001-02. In that same fiscal year, Canada collected over $3 billion in GST from BC and many times more than that in corporate and personal income tax. The last time BC received an equalization payment was in fiscal year 1961-62. In the forty years that separated those payments the BC economy has been subjected to substantial changes. Forestry is in trouble in BC and, while important, is becoming less important.

Hopefully the BC economy will become sufficiently diversified that fluctuations in commodity prices will not determine whether it is in the "have" or "have not" category for equalization. In the meantime, those who equate equalization with being on the dole ought to pay more attention to nation building and fiscal equalization. At the last Premier's conference, Canada's premiers called on Ottawa to pay attention to "fiscal imbalance" with respect to rising health care costs. There is no difference between that call and a call to adjust for differences in fiscal capacity between provinces with very different provincial economies. When eight of ten provinces are in the "have not" category, and Ontario teeters, there is no shame for BC to recover some federal tax revenues.

Feb 26, 2002

Have and Have-Not = Equalization

Premier Campbell and Finance Minister Collins should apologize not only to British Columbians but to Canadians everywhere for derogatory statements about have and have-not provinces. Those terms are defined by which provinces receive federal equalization payments. By that criterion, Alberta, with its enormous energy revenues (until recent price drops), could be called the only province at a safe distance from the have-have-not dividing line. BC did receive federal equalization payments from 1957 until 1962 as did every other province except Ontario. In order to look seriously at this important program that holds Canada together, it is necessary to examine the history of equalization rather than engaging in cheap politics.

During his 2002 Budget Speech, Collins said:

"We believe that British Columbia, by all indications, became a have-not province in 1999-2000."

"Some people might take comfort in the fact that being a have-not means we'll get an equalization payment."

"But that hardly compensates for the utter indignity - the downright shame - of seeing this great province . . . with all our talented, hardworking people, and all of our resources, and all of our advantages . . . having to take a hand-out from our neighbours in other provinces."

Canada has always struggled with unequal abilities of provinces to raise the funds necessary to provide similar levels of basic public services. Since Confederation federal grants were used to assist some provinces. In 1957 Canada put in place federal legislation to regularize equalization payments.

The basic idea behind equalization payments is to pretend there is a standard tax system and then to apply that tax system to each province. Those provinces which fall below a comparison standard of revenue per person from the standard tax system become eligible for federal payments to make up the difference. Over the years the standard tax system and the average used for comparison have changed.

Until 1962 the standard tax system used personal income tax, corporate income tax and succession duties. Half of natural resource revenues were added to the formula in 1962. At the same time the standard for comparison was changed from the average yield of the standard tax system from the two wealthiest provinces to the national average.

Since 1982 the standard for comparison is the average of the five middle income provinces - Quebec, Ontario, Manitoba, Saskatchewan and British Columbia. The hypothetical common tax system is applied to the fiscal capacity of each province, and then compared to the five province average. The common tax system, fiscal capacity, is based on 33 separate provincial revenues sources. Personal income tax remains the most important. The Campbell government's cuts to personal income tax do not affect the equalization formula because they are based on a representative tax system for the entire country rather than on the actual tax system of any one province.

Payments are made by the federal government to the provinces on a monthly basis. The formula for calculating the payments is updated with new statistical information twice a year and then final adjustments are made with revised data 30 months after the fact. Consequently, when Finance Minister Collins refers to fiscal year 1999-2000, the final numbers won't be in until the fall of 2002.

Lest Collins gets his hopes up that he might score a political point, the equalization formula also has various provisions to prevent sudden changes. In order to protect the federal government from open ended payouts, a ceiling is applied to total federal payments. The ceiling for total federal payments was $10 billion for 1999-2000. That ceiling is moved up at the rate of growth of nominal GDP.

The full calculation of equalization payments involves thousands of pieces of data from over 300 data series provided by Statistics Canada and Canada Customs and Revenue Agency. In simple terms, however, one can think of a province qualifying for equalization payments when it falls below 97% of the average fiscal capacity of all provinces.

Preliminary numbers put BC at 99.0% of the average fiscal capacity of all provinces for the fiscal year mentioned by Collins, 1999-2000. For comparison, there were only two provinces with higher fiscal capacity - Alberta at 141.3% and Ontario at 107.5%. The two provinces immediately below BC's fiscal capacity for 1999-2000 were Saskatchewan at 91.8% and Quebec at 85.7%.

Preliminary numbers also showed a decline for BC in the next two fiscal years. The early figures put BC at 97.4% for 2000-01 and at 97.3% for 2001-02. The latter year was on Collins' watch and the former year will no doubt be revised due to the high energy revenues received by BC in 2000-01. Saskatchewan did not receive equalization payments from 1981-86 when energy prices were high enough to disqualify it from payments.

If BC's Energy Minister is correct, growth in energy revenue for BC may soon put it above Ontario in terms of fiscal capacity.

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References used for this article:

"Fiscal Federalism in Canada", Report of the Parliamentary Task Force on Federal-Provincial Fiscal Arrangements, August 1981.

"The Equalization Program", Federal-Provincial Relations Division, Department of Finance Canada, October 2001. (Available from me by email as a 1 meg Word document for those with high speed connections.)