The Trudeau government’s recent announcement that Quebec will receive billions in equalization payments next year while Alberta, Saskatchewan and Newfoundland—Canada’s major oil producers who are facing hard times—will not, caused outcry in some circles.

While the much of the controversy stems from a misunderstanding of Canada’s equalization program, it’s a good time to take a closer look at Quebec’s recent role in the program.

While campaigning last fall, now-Premier Francois Legault (pictured above) said if elected he would aim to end Quebec’s reliance on equalization from Ottawa. More specifically, he said his government would gradually eliminate the income gap between Quebec and the rest of Canada. 

Per person income and economic production are primary drivers of a provincial government’s ability to raise revenue at a given level of taxation, which is what the equalization formula measures to determine which provinces get equalization and how much. So, if Quebec were to start catching up to the rest of Canada in economic production per person, equalization payments would gradually shrink and could eventually disappear. 

Ending or at least reducing reliance on equalization is a great goal for Quebec’s provincial government. But closing a per person GDP gap of approximately 20 per cent is a huge lift and would take a very long time to achieve under any realistic scenario. But the goal helps focus policymakers to attract investment, develop natural resources and drive growth. 

Unfortunately, the equalization program itself creates obstacles and disincentives that may discourage policy choices that can help Quebec generate its own fiscal resources. 

Specifically, it’s almost impossible to imagine Quebec getting off equalization in the foreseeable future without a substantial increase in natural resource revenues. For reasons too baroque to explain here, the math just doesn’t add up. Even with a big increase in natural resource revenues, it would still be a massive lift to get off the list of “have-not” provinces over the next 20 years. 

Still, a big boost to resource revenues would at the very least help Quebec shrink its reliance on equalization over such a time frame and potentially get within shouting distance of being a “have” province. Again, it’s therefore ironic that a complicating factor for Quebec’s objective of ending its reliance on the program is that equalization itself creates strong disincentives for natural resource development in have-not provinces.

Here’s the problem.

If a have-not province sees an increase in natural resource revenues, the extra money is largely offset by a reduction in equalization payments.

In other words, if the government of Quebec encourages natural resource development it bears the full burden of any resulting costs—including, in some instances, environmental or political risks—but receives less than one-third of the fiscal benefits. This skews the cost-benefit analysis against policies friendly to natural resource development.

This is a longstanding problem. It was recognized decades ago when the federal government completed the Atlantic Accord, which offset lost equalization payments to Atlantic provinces resulting from offshore oil and gas royalties through a separate transfer program. 

In the years following the signing of the accord, both Newfoundland and Nova Scotia saw extensive offshore resource development. Meanwhile, for resources found on dry land where the disincentives of equalization remain in effect, policy choices that restrict resource development have often prevailed in the same provinces. A clear example is the proliferation of moratoria on hydraulic fracturing in the region. 

There’s no easy solution to this problem. Simply replacing equalization revenue lost due to natural resource development can raise important fairness questions as per capita fiscal capacity rises close to the level found in provinces such as Ontario and British Columbia that are close to the national average. These provinces receive either no equalization payments or, in the case of Ontario, very small per capita equalization payments. 

Solving this problem isn’t easy, and facing it brings some of the challenges associated with the broader equalization program into focus. The program requires a juggling act of competing priorities related to fairness to taxpayers in provinces that are net contributors to the program, affordability for taxpayers, and the incentives facing provincial policymakers. 

The challenges, however, shouldn’t prevent us from addressing the problems. Quebec’s goal of ending its reliance on equalization is a good one, and the fact that features of the program create incentive problems that may make it much harder to achieve is deeply problematic. Hopefully the emergence of this issue in the public sphere can prompt a rethink of the equalization program more broadly as the current formula includes a number of problems and expensive quirks that are difficult to justify. 

Closing the income gap with the rest of Canada will likely require Quebec’s government to work to attract investment to the province by reducing burdensome tax rates, strengthening provincial finances and creating a regulatory climate conducive to natural resource development. 

Getting off equalization will require a lot of pro-growth policy change and won’t be easy under any circumstances. The ask is only made harder by disincentives for natural resource development, ironically found within the equalization program itself.