Changing equalization won’t be easy—partly for good reason

You hear a lot these days about reforming equalization. If Jason Kenney’s United Conservative Party wins the next Alberta election, you’ll likely hear more. As it is, Saskatchewan has already put a reform proposal on the table: keep essentially the current formula for half of equalization but hand out the rest as a per capita grant.

Of course, the current formula has just been renewed for five years so we’ve got a lot of time to think about changes. Some provinces accuse Ottawa of doing the renewal on the sly, burying its intentions in footnotes in the federal budget. But come on! When hundreds of millions of dollars of provincial revenue are at stake, somebody in your treasury should be reading the federal budget’s footnotes.

I’m not a lawyer (to my mother’s everlasting regret) so I’m not sure exactly how binding the Constitution’s commitment to equalization is. But it reads as if it’s pretty binding. Section 36, paragraph 2 of the 1982 document reads:

Parliament and the government of Canada are committed to the principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation.

A first thing to note is that the commitment is on behalf of the (federal) Parliament and the (federal) Government of Canada. Equalization is a federal program. The money is raised by federal taxes and the rules governing it are an act of the federal Parliament. No province “pays into” equalization. Provinces only receive—though of course not all provinces do receive. Alberta and Ontario contribute more to equalization than other provinces do only in the sense that they have more higher-income federal taxpayers, and since the federal tax system tends to be progressive, more of the federal revenue that goes into equalization is generated by their citizens.

Note also that there’s no “shall” in the equalization provision. It doesn’t say Parliament and the government of Canada must do this or that. It merely says they’re committed to a principle. How effectively that would stand up in court should Ottawa decide to give the current system a transformative overhaul, I have no way of even guessing.

A final thing to note is the principle itself: the idea is to supplement provincial revenues so that all provinces can provide reasonably comparable levels of public services at reasonably comparable levels of taxation. The adverb “reasonably” provides obvious and probably ample wiggle room but courts are accustomed to applying “reasonableness” tests so the slack is likely not infinite.

Why would equalization be needed to allow provinces to provide comparable levels of public services at comparable levels of taxation? Because some provinces’ tax capacity is greater than others. If you do have lots of high-income people or investment or marketable natural resources, you can finance a given level of public expenditure with a lower tax rate than other provinces. Or, if you maintain the same tax rate as other provinces, you can have a lot more public services. What equalization does is raise the tax capacity of provinces where it’s less than it is in other provinces, up to some kind of standard level. (The exact target has varied over the six decades of equalization’s existence.)

Why would you want to do that?

There’s a fairness argument for equalization. Some Canadians (probably not all) would regard it as unfair if people in different provinces paid more for what are widely regarded as basic public services than people in other provinces. You could get rid of the unfairness by having Ottawa deliver the services, but we’re a country that has opted for federalism. If federalism means anything, provinces must have real responsibilities.

There’s also an economic efficiency argument for equalization. You want people to move about the country in response to their economic productivity. They should go where they personally are most productive. That’s how Canadian output gets maximized. Without equalization, however, they may all move to Alberta, where taxes are lower and public services better. But that kind of mobility has nothing to do with productivity. If the tax-spending difference is big enough, they may even leave places where their own personal productivity is higher than it is in Alberta, which you don’t want them doing. It’s a respectable argument though I’m not sure how important it is empirically.

Finally, the big debate in equalization is whether the program itself actually widens the differences in fiscal capacity that it’s meant to reduce. Does a province that receives equalization do things with the money that lower its tax capacity? It’s not a question of whether equalization reduces its tax revenues. Equalization is about tax capacity—the ability to raise taxes, not the actual tax revenue raised.

If a province gets federal cash and responds by reducing its taxes, which would probably be good for economic growth and therefore its tax capacity, that’s its choice. Again, it’s a federal country. In a federal country we want provinces to make real choices. (Saskatchewan Premier Scott Moe recently tweeted about how monthly daycare rates are much higher—$875—in his province than in Quebec—$173), presumably partly because Quebec gets $12 billion a year in equalization.

The implication was that that’s unfair.

Well, premier, that’s Quebec’s choice. Saskatchewan has the fiscal capacity to make the same choice if it wishes. Quebec could have used its equalization funds to lower tax rates—as a Quebec taxpayer, I wish it would!—but it has instead poured a lot of money into child care. That’s federalism for you.

There’s also the possibility that provinces will try to game the system and deliberately reduce their tax capacity in revenue areas where their capacity is relatively low and therefore already generating equalization for them. I suspect some of that goes on, but I have trouble believing it’s a big problem. Higher tax capacity comes from economic growth and you’ve got to think that for a provincial premier economic growth is just about all upside. But if provincial treasury bureaucrats want to fill us in on how they rejigged their policies and tax rates to maximize their equalization, lots of us will be all ears.