What were they thinking? How the equalization debate ended before it even began

Economist Trevor Tombe looks at the equalization program, and what a formula freeze means to Alberta.

Whatever the reason, the current formula is here to stay

The federal government has renewed the existing equalization formula until 2024, to much surprise in Western Canada (CBC)

What were they thinking?!

Debates over equalization payments are never easy — many, especially in the west, were pushing for changes — but this debate has ended before it even began.

As was first reported by the Globe and Mail buried within the 584-page Budget Implementation Act is a provision to extend the current formula until 2024. Neither opposition MPs nor, apparently, some provincial governments noticed. And neither did I.

But it's now a done deal.

It's "disadvantaging Alberta," says Premier Rachel Notley of the current system.

It has "not worked for Alberta, even during the depths of our recession," says provincial Finance Minister Joe Ceci.

Opposition leader Jason Kenney is even proposing a referendum on the matter. No surprise, since roughly 71 per cent feel the system is unfair.

In neighbouring Saskatchewan, Premier Scott Moe calls equalization an "obviously flawed program" and has an idea to fix it.

On Wednesday, he released a specific proposal called the "50/50 Plan."

It's simple: cut the equalization program in half and distribute the savings to all provinces based on population. He'll have an ally in Joe Ceci, who plans to demand changes from Ottawa "as loud as he can" in a meeting of finance ministers next week.

They're angling for a fight. They won't get it.

While the formula was set to expire on March 31, 2019, there will now be no real consultation, discussion, or renegotiation on a new formula. None.

Missed opportunity

To be sure, Ceci and Moe were unlikely to see their recommended changes accepted.

Ceci's concerns, like Kenney's, betray a fundamental misunderstanding of how the program works.

And Moe's proposal, though coherent, is dead on arrival politically. I suspect they know it, and realize they're stretching the truth to play to their respective voters, but the opportunity to debate and discuss the pros and cons of various possible changes has value.

That the federal government shut down open consultation and reform is a big missed opportunity.

Not only are there sensible changes available, the lack of transparency on an issue of such importance is deeply puzzling. Perhaps their hands are full. From pipeline politics to climate policy to NAFTA renegotiations to everything Donald, that's understandable.

Whatever the reason, the current formula is here to stay.

Is equalization unfair to Alberta?

This year, Ottawa will transfer nearly $72 billion to the provinces.

Roughly three in four of those dollars are allocated based on population. Larger provinces get more than small, but all receive the same per person.

Equalization is different.

It allocates dollars based on economic strength, not just population. Provinces with stronger economies get less (or none) while provinces with weak economies get more. That's it. That's how equalization works.

There are complexities within the tangled web of a formula, of course.

It tries to measure a province's "ability" to raise revenue, its so-called "fiscal capacity," with many adjustments along the way. But at the end of the day, economic strength is all you really need. If you're below average, you get equalization; if not, you don't.

Alberta has the capacity to bring in more revenue, but chooses not to. (Trevor Tombe)

So why didn't Alberta receive any equalization during its recession?

Is Ceci correct that this means the program hasn't worked? No. Not even close.

Despite its recession, Alberta's economy remained the strongest in Canada.

At bottom in 2016, Alberta's GDP was nearly $73,000 per person — higher than any other province and much higher than the national average of $56,000.

Saskatchewan is in a similarly advantageous position, with Canada's second strongest economy. No reasonable formula meant to equalize would transfer scarce dollars to the highest income province.

Yes, both provinces have deficits. But this does not reflect economic weakness. It reflects their reliance on resource revenues.

Low commodity prices mean lower government revenue. If the two provinces had tax structures that mimicked other provinces (or, yes, spent less than they do) neither would be in the situation they're in.

It's worth repeating: our deficits are a choice.

Of course, a fight with the federal government is politically convenient — having someone else help pay the bills, even more so.

Simple, fair, and equitable proposal?

Premier Moe's proposed changes are simple: cut the equalization program in half and distribute the savings equally across all provinces based on population. It means more money for five provinces and less for the rest.

Comparing current equalization to Saskatchewan's 50/50 plan (Trevor Tombe)

For Saskatchewan, it would receive $300 million more per year in federal transfers — from the current $2.5 billion to $2.8 billion.

For Alberta, it would mean an additional $1.1 billion per year — from $8.2 billion to $9.3 billion. The biggest beneficiary would be Ontario with $3.2 billion more and the biggest loser is Quebec with $3.7 billion less.

The political challenge is clear.

Shifting the mix of major federal transfers from 74 per cent based on population to 87 per cent, as Moe's plan entails, is an entirely defensible proposal to put forward.

But it doesn't address any shortcomings with the equalization formula, as it merely shrinks its size.

Such proposals, however, don't matter. The federal government is having none of it. At all.

Surprise! Nothing changes

Whatever one thinks about the pros or cons of various proposals on the table, the current formula can be improved.

Economies, tax policies, and spending pressures all change over time. The formula needs to keep up. By keeping equalization frozen as it is, the federal government missed an opportunity to make many sensible changes. 

First, there's a costly quirk that doles out more dollars than necessary.

Ontario, for example, will continue to receive $1 billion in equalization despite not really qualifying.

It's a possibility first raised by the Fraser Institute's Ben Eisen, Joel Emes, and Steve Lafleur. This year, it actually happened. And this quirk is being kept.

Under the formula, there's a certain amount of equalization dollars available. If the formula calls for more, then the entitlements are clawed back. If the formula calls for less — as happened for the first time this year — the government can, if it wants, distribute the leftovers.

These "adjustment payments" add up to nearly $1.8 billion this year and are the entire reason why Ontario receives any dollars at all.

Second, the formula doesn't treat carbon tax revenue appropriately.

And, as Wilfrid Laurier University economist Tracy Snoddon notes, it treats a province's own carbon tax differently than it will the federal backstop.

As carbon prices ramp up to $50/t, this will become a major issue.

If Alberta scraps its own carbon tax, for example, and the federal backstop kicks in, that's roughly $2.5 billion early in the next decade that Alberta will potentially receive as a transfer from the feds.

Does that count as provincial revenue or not? This matters, and it's not at all clear.

For the government to reject any changes without any public discussion is troubling. But worse than the lack of consultation and negotiation is the lack of any information at all. Until the story broke, many (including the Saskatchewan government) had no idea.

Want to keep equalization as is? Fair enough. Say so, and say why.

While equalization is widely misunderstood and a political minefield — remember Danny Williams? — federal leadership is necessary.

When the most coherent proposal on offer is to simply cut the program in half, we have a problem.

This column is an opinion. For more information about our commentary section, please read this editor's blog and our FAQ.

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Trevor Tombe is a professor of economics at the University of Calgary and a research fellow at the School of Public Policy.