Equalization

December 2, 2004

Equalization - the BC Ministry of Finance Version

As a result of the recent series of articles on equalization posted to StrategicThoughts.com, I was offered a not-for-attribution briefing by a senior official in the Ministry of Finance. The essence of the almost hour long telephone call is that the province maintains it not only had no reason to believe in February that it would receive a windfall from equalization, but that as late as September it was still in the dark. According to the official from the Ministry of Finance, Ottawa surprised the provinces with its offer regarding a new equalization formula and the bridging arrangements for fiscal years 2004-05 and 2005-06.

It is not known whether BC, or any province, has ever hit it so big in the game of federal-provincial relations. Usually a gift of $1.4 billion ($1 billion in 2004-05, $400 million in 2005-06) has strings attached or is a tradeoff for concessions elsewhere. At the very least, such generosity can raise suspicions of possible claw-backs sometime in the future, if not through equalization then through losses in some other program. The official from the Ministry of Finance simply stated that only the federal government can explain why it did what it did, and that there is no reason to expect a payback time.

Students of federal-provincial relations, and cynics in general, might suspect that a deal was reached at a higher level table, perhaps between first ministers, whose details will never be fully shared with the public. For the time being, the debate in BC has shifted to what to do with the one time windfall rather than on the question of how public policy can make such an abrupt shift with so little transparency.

The BC official contends that the $824 million figure on the federal government website dated April 7, 2004, is based on economic data from 2001 and 2002. Updated information is shown on the federal website that explains the new approach to equalization. According to that site, based on "current" data, in fiscal 2004-05 BC would have received $473 million in equalization using the old formula, but now will receive an extra $248 million in payments for a total of $721 million. BC also gets $259 million due to revisions to the three previous years, for a grand total of $980 million in fiscal year 2004-05. The BC Ministry of Finance official explained that BC would not have received the "updated" $473 million if the data had not been frozen as of October 2004, and might not have received some of the $259 million for earlier years. The way equalization works is that the amount due for any fiscal year is not finalized until 30 months after the end of the fiscal year. BC's Finance Ministry believes that under the old formula improving economic data for BC would have wiped out any entitlement, but under the new formula there will be no further updates to the data used to calculate the payments.

Maybe BC really did win the federal-provincial lotto and is laughing all the way to the bank. Since equalization is a zero sum game, it is hard not to believe that some provinces will view BC's windfall as their loss. The size of the total equalization pie was increased to help overcome problems like that.

In February's budget Finance Minister Gary Collins forecast a surplus of $100 million and confirmed program cuts of $803 million. In November's Second Quarterly Report he revealed the equalization windfall, which added to the windfall from high prices for natural resources, yields a surplus of over $2 billion. Maybe it was all good luck and "prudence" but that won't help the families who suffered from the cuts that are now known to have been unnecessary. When social costs are valued, it is as imprudent to run an enormous surplus while cutting services as it is prudent to protect services and run a small deficit; maybe February's budget wasn't so prudent after all.

December 1, 2004

Credibility Challenged over Billion Dollar Equalization

On Friday November 26th the Vancouver Sun ran a leaked story about BC receiving record level equalization payments leading to a $2 billion surplus. On Monday November 29th Finance Minister Gary Collins released the Second Quarterly Report which confirmed a $2 billion surplus and attributed most of it to a record level federal equalization payment. There was only one little problem; suspicions arose as to when the Campbell government first knew about its windfall from the federal government. Contradictions between the federal government's website on equalization and provincial claims about equalization made it look like Collins should have known about the windfall at least by April 2004, and possibly as early as when he presented his budget in February.

Shortly after Black Thursday, January 17, 2002, Collins said that he was committed to restructuring government. In other words, regardless of the financial details, the Campbell government wanted to shift the tax burden to lower income earners and to cut government services. They went beyond that by not only shifting taxes and cutting services but also by privatizing crown corporations and core government services. Could they have withstood the public pressure if it were known that they were sitting on a $2 billion surplus in 2004-05? What if the public knew that the Campbell government proceeded with its third year of cuts even though it knew that its revenues were vastly understated? What kind of government does it take to cut $70 million more from Children and Family Development while sitting on a $2 billion surplus?

Differences between federal and provincial information call the credibility of the Campbell government into question. That is not new. The government that promised not to sell BC Rail, that promised to adequately fund Children and Family Development, and that promised not to expand gambling would have you believe that between September and November it suddenly learned of almost $1 billion in additional federal grants even though a federal website identified that money in April. No one should believe anything the Campbell government says.

November 30, 2004

Second Quarterly Report Provides more Questions for Collins

The "Second Quarterly Report on the Economy, Fiscal Situation, and Outlook", released on November 29th, devotes 2 of its 49 pages to a topic box titled "A New Framework for Equalization". A table is included in the summary of changes to equalization that should make it clear how BC got a windfall from equalization. Equalization Entitlement Changes Unfortunately, the numbers in the table do not match the numbers in Appendix A.3 of the Report which shows "2004-04 Revenue by Source". The Appendix indicates that on a full year basis, equalization was $402 million in February's budget, and increased to $980 million in the Second Quarterly Report. The $980 figure does not appear in the table that is supposed to shed light on how the government could have such an enormous variance in its forecast.

Ironically the table, titled "2004-05 Equalization Entitlement Changes", further suggests that Finance Minister Gary Collins had reason to know about the enormous payments to BC at the same time he was launching his third year of cuts, including cutting the Ministry of Children and Family Development by a further $70 million. Although the numbers in the table do not match the $980 million the Campbell government says it will receive in equalization this year, some of the numbers match the table on the federal government's equalization website. According to the table in Collins' report, as of the First Quarter Report $195 million was owed for fiscal year 2001-02 (see the number in the upper left corner). That is exactly the same as the figure for 2002-02 on the federal government website. Collins' table also shows nothing owed (as of the First Quarter Report) for fiscal year 2002-03; again, that is exactly the same as the federal government site. Where the federal government and provincial tables differ are for fiscal 2003-04 and fiscal 2004-05; again using the numbers as of the First Quarterly Report, the BC table has $176 million for 2002-03, the federal table has $332 million. For 2004-05, the BC table has $39 million, the federal table has $824 million. It looks like BC certainly should have known in September that the province was receiving much more money, and since the federal site is dated April 7, 2004, it is not too hard to believe that Collins may have known as early as February when he introduced his service slashing budget.

November 29, 2004

Update: A representative of the federal Department of Finance promptly responded by telephone to the question I emailed regarding equalization. He verified that the $824 million figure on their website was their estimate as of April 7, 2004 of what BC would receive in equalization. He said the table will be revised as a result of recent negotiations, but that no province would receive less money. He said that provinces make their own estimates but the federal website reports the estimate of the Department of Finance. In February BC estimated that it would received $402 million in equalization; in September it reduced its estimate to $39 million; on November 29th, the Second Quarter Financial Report was released with an estimate for equalization of $980 million - an increase of $941 million in just two months!

The reply from the federal Department of Finance adds credibility to the suggestion that Finance Minister Gary Collins failed to reveal the full extent of BC's surplus while he proceeded (or perhaps so he could proceed) with $803 million in program cuts.

Material Errors in the Budget

Think back to February 2004 when Gary Collins introduced this year's budget. It called for a further $70 million in cuts to the Ministry of Children and Family Development. In total, 14 Ministries were slated for $803 million in budget cuts. Would the Campbell government have gotten away with its third year of cuts if it were known that they were sitting on a $2 billion budget surplus? Were they keeping it secret, or was BC just extremely lucky in the past few months. Keep in mind that the surplus arises because of federal transfers and high resource prices, not because of anything that resulted from provincial government policies.

Accountants use the word "material" when they describe something that really matters. If changes are discovered after a set of books close, they frequently say the changes aren't material, meaning not big enough to make a difference. $100 million seems like a lot of money, but for the BC budget, it is less than one half of one percent. On the other hand, $800 million is material, which is why anyone who is serious about understanding public finance needs to know how equalization payments can suddenly change by $800 million in this fiscal year and $400 million next year.

The explanation given by Finance Minister Gary Collins for BC's equalization windfall is that as a result of the change in how the federal government calculates equalization, BC benefits from closing the books on the old system. He points out that the amount of money due in any year isn't finalized until three years later, and it is re-calculated eight times over the three years. With the change, all the recalculations stop and BC receives everything it is owed.

Late equalization payments pose a problem for BC's style of full compliance with generally accepted accounting principles. With perfect foresight BC should accrue monies owing this year even though they aren't going to be paid for another three years. Of course that can't be done when the amount owning is constantly recalculated. That forces a certain amount of cash accounting into what is otherwise an accrual system. For the purposes of equalization payments, it also makes BC's accounting more like other provinces.

It is hard to believe that BC is the only province with a material change in its equalization payments, yet a search of news stories reveals nothing regarding big changes in equalization for any other province. That is enough to cause some cynics to believe that Collins really wasn't very surprised over the $800 million windfall. When combined with the difference between what is shown on the federal government website, $824 million for BC, and what was previously claimed as expected by BC, $39 million, it might make even reasonable people think that Collins had good reason to believe BC would receive much more than previously revealed in the provincial budget and First Quarter Report.

In order to give Collins the maximum benefit of the doubt, the following note was sent to the communications department for the federal Department of Finance:

The website at http://www.fin.gc.ca/fedprov/eqpe.html says it was last updated 2004-04-07. The table towards the bottom of the page lists BC as receiving $824 million in equalization payments in 2004-05. The BC government in its September First Quarter Financial Report claimed that it would only receive $39 million in 2004-05, but in the last week it reversed its position and said it would receive an unexpected $800 million.

Does the $824 million figure in your table require revision, and was it accurate as of April 7, 2004?

November 26, 2004

When did Collins know?