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Canadian government

Equalization for the 21st century

June 12, 2007

Equalization began in 1957 as a noble gesture to help share the wealth within the Canadian family and ever since, Ottawa and the provinces have been squabbling over it like the putative heirs of Anna Nicole Smith, at almost predictable 10-year intervals.

  • The mid-1970s, the Trudeau years, saw the first of the bitter battles over Alberta's burgeoning oil wealth and culminated in the decision to shield provincial resource revenues from the already complex equalization calculations.
  • The mid-1980s, the Mulroney years, witnessed the protracted court battles over offshore resources and resulted in the creation of the Atlantic accords, first with Nova Scotia and then with Newfoundland and Labrador, and the decision that equalization payments for these two provinces would not be affected or "clawed back" as their oil wealth came on stream.
  • The mid-1990s, the Chrétien period, saw Ottawa retrenching under its own fiscal burden. Equalization, a federal program, became patched together like an improvised quilt, with its almost incomprehensible generic formulas and side deals to withstand the strains.

Now, it's Stephen Harper's turn. In the name of resolving the so-called fiscal imbalance among the provinces and, as the new Conservative PM saw it, cleaning up the dog's breakfast the Liberals had left, the Harper government introduced a new and enriched equalization formula in the March 2007 budget. It was to run concurrent with the old one and, indeed, three other variations, giving the provinces the right to cherry-pick which package worked best for them.

Solution found? The Conservatives thought so. "It's certainly the end of the bickering," Finance Minster Jim Flaherty said on budget night as he shovelled out a massive amount of new money to the provinces, equalization being just one part of it. That, alas, was a full three months ago, a political eternity when equalization dollars are at stake.

Since then, first Newfoundland Premier Danny Williams and, more recently, Nova Scotia's new premier, Rodney MacDonald, both Conservatives, have accused Harper in the strongest terms of bullying their provinces over equalization and breaking the tenets of the Atlantic accords.

Their attacks have certainly hurt the federal Tories politically in Atlantic Canada. (Bill Casey, a long-serving N.S. MP was kicked out of the federal caucus for voting against the budget over this; he had voted for the same budget on at least three previous occasions.)

But Harper has fought back just as vigorously, denying the premiers' accusations, noting it's "ironic" that the attacks are coming from those benefiting the most from equalization, and basically challenging the premiers to meet him in court if they feel there is a real problem here.

All of this raises the question: Who's right? And whose money is this anyway?

What's this fight about?

There are two issues at play here. One is the interpretation of the terms of the two Atlantic accords. The other is how big a slice of pie any one province can take from equalization.

To smooth the way for his reforms, Harper offered two basic choices to the provinces, choices that really only affect those, N.S. and N.L., that are also bound by their respective offshore agreements.

These two provinces have the option of staying with the old equalization formula, the one that's been cobbled together over the years, and thereby shielding virtually the full amount of their offshore revenues from any kind of clawback, at least until the accords end in 2012.

Or, they can opt for the enriched equalization plan that Ottawa is now offering, but the calculation for this plan includes 50 per cent of a receiving province's wealth from natural resources, including those offshore, which the two premiers see as a violation of their respective accords.

By Ottawa's calculation, the enriched plan is worth more for both provinces., at least for the foreseeable term. Under it, for example, equalization payments for the current year, 2007-08, would jump from $477 million to $733 million in the case of Newfoundland and Labrador, and from $1.3 billion to $1.53 billion for Nova Scotia.

But there's a catch. The provinces can jump into the new plan at any time. But once they're in, they only have a year to test drive it if they want to go back to the old one. In its spring budget, Newfoundland elected to stick with the old equalization regime. Nova Scotia opted for the new version, which may explain why it's been beating the drum so loudly of late: It has only a year to get this changed in its favour before it's stuck with a hard choice down the road.

The Nova Scotia argument

Nova Scotia's position is that it shouldn't have to choose between two competing equalization schemes. A 2005 addendum to its offshore accord says revenue offsets are to be based on the equalization formula "as it exists at the time." The province, therefore, should be able to choose from whichever formula suits it best, while still being able to protects its offshore revenue, as per the Atlantic accord.

Premier MacDonald put it this way in an interview with the National Post: "Suppose you are an employee in a company and you achieve a bonus from your boss. Two years later, the company is doing better so the boss gives everyone a raise.

"But he gives you a choice between your old salary with the bonus you got two years ago or the raise. But the catch is that if you take the raise you have to pay back the bonus you got. Is that fair?"

Good question. One thing to consider: The new enriched formula wouldn't claw back the entire bonus, just that portion representing 50 per cent of offshore royalties. And it may still represent a better long-term deal.

But this could still be a huge gamble in Nova Scotia's case in particular. It took $830 million in future payments upfront in 2005 when it signed an extension to its accord, and has already spent the money paying down debt. If some of this money is to be clawed back, the province's ability to manoeuvre in the future will undoubtedly be compromised.

Has Stephen Harper violated the Atlantic accords?

Not in his view, certainly. But it may depend on where you sit. Harper personally has been a strong defender of the accords in the past — they were a Conservative government legacy after all — and it must gall him no end to have his words of support now thrown back in his face.

You can look at this in two ways. Ottawa is either being too cute by half, by offering inducements to the accord provinces to abandon the deal on their own. Or Newfoundland and Labrador and Nova Scotia want to have their cake and eat it too.

Harper would clearly like to see one rational equalization formula apply to everyone equally at some point in the not too distant future. But at this juncture, he is saying that Ottawa is offering the two options precisely because the Atlantic accords are in place and his government is prepared to abide by them. It is up to the two provinces directly affected to decide what is in their best interests.

Is this likely to end up in court? Probably not. The accords are more of a political arrangement than an ironclad contract, in the view of many experts. But Ottawa is certainly getting beat up in the court of public opinion in Atlantic Canada at the moment.

What is equalization?

Simply put, equalization is one of five federal programs through which Ottawa transfers money to the provinces and territories, in this case to try to ensure that every province has roughly the same capacity to pay for basic public services.

In its heyday, it was worth as much as one per cent of GDP, which in 2006-07 would have been something in excess of $14 billion. Instead, it was just over $11 billion last year. The new, enriched program will be worth a total of $12.7 billion in 2007-08. The value of all five federal transfer programs this year is just over $51 billion.

Only three provinces — Alberta, B.C. and Ontario — are considered wealthy enough not to require equalization. But all, except for Ontario, have received it in the past.

To calculate the amounts due, Ottawa analyzes up to 30 different taxes and royalties in each province and territory to try to determine a national standard.

The most recent changes, introduced in the March 2007 budget, flow from the recommendations of a so-called Expert Panel that attempted to strike a balance between competing claims.

The provinces, for example, had wanted something called the 10-province standard (as opposed to that of the five middle-income provinces, which had been the standard since 1982).

Basing the calculations on 10 provinces would bring Alberta, with its huge provincial revenues, into the mix and so ensure a higher fiscal capacity, or a bigger pot for Ottawa to fill. The tradeoff, from the federal perspective, was to include 50 per cent of provincial resource revenues into the calculation. (Before now they had been excluded so Alberta's massive energy royalties would not skew the mix and so provinces like Saskatchewan, with energy royalties but a low tax base, could be included.)

This is the tradeoff, of course, that has caused the problems with the Atlantic accord provinces. The Harper plan also includes something called a fiscal capacity cap to ensure that have-not provinces don't get boosted to a level above Ontario.

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