Gassing up the welfare trap machine
Dated: 6 Jan 1997

6 January 1997
Gassing up the welfare trap machine

Ottawa-bashing, long a favourite local sport, is about to be given a new lease on life by offshore natural gas. At least that is where we seem to be headed in the controversy about how the tax revenues from this natural resource should be shared between Ottawa and Nova Scotia. To hear most of the local chattering classes tell the story, Ottawa and former premier John Buchanan made a deal in the 1980s that is going to rip us off when the gas royalties start flowing. What exactly is the rip-off? Roughly speaking, Ottawa will take one dollar out of equalization payments to Nova Scotia for every dollar in royalty revenue the province receives. A heinous attack on poor Nova Scotians, right?
Not really. We get equalization payments because our economy performs less well than the national average. Our local tax revenues get topped up by Ottawa so that we can provide reasonable levels of public services at reasonable levels of taxation. If we suddenly get wealthier, as when gas royalties start to flow, we have that much less of a claim, morally and economically, to the equalization dollars. All the bluster in the world isn’t going to change that.

If you think about it in terms of individuals and not governments, it all becomes much clearer. Suppose that you’re on social assistance, and you suddenly get a part-time job. Your income is still well below the average, and it costs a lot to look after your kids and pay the rent. You still need a bit of public assistance to make ends meet. If you hold the traditional values of our society, if you believe in the moral value of self-reliance and independence, you will regard this new job as an important step in the right direction. You will not be upset that you are getting less public money because you have replaced it with money you earned yourself.

Indeed, most of us would be scandalized if such a person then turned around and said that they had a right to all that they had been receiving before from the public purse, plus what they were now earning on their own. Any social assistance program that allowed such a result would be rightly condemned as unfair to taxpayers. What not many people are willing to say anymore, unfortunately, is that such a result is also a perverse incentive rewarding people for abandoning desirable personal qualities such as independence, thrift and self-reliance.

Nova Scotia is in the same position. We will be less poor as a result of natural gas royalties, and taxpayers in the rest of the country—who have been subsidizing us because of our relatively poor economic performance—have every reason to expect us to pay more of our own way. We may be poor, but we are in better fiscal shape than Ottawa; our budget is just about balanced this year, while Ottawa will still borrow tens of billions of dollars.

That doesn’t mean that Ottawa should claim a dollar-for-dollar reduction in equalization, just as we shouldn’t claim a dollar-for-dollar reduction for social assistance recipients who make themselves better off through their own efforts. That would be just as destructive of self-reliance and independence. In fact there’s a name for this kind of inflexible tit for tat: it’s called the welfare trap. If there is a 100 percent clawback, no one, individual or province, has any reason to work harder and to become self-sufficient. Incentives matter, so we need a system that rewards the province for becoming more productive and efficient, while also recognizing that the national taxpayer deserves a break when we do better. The lack of such an incentive is the real flaw in the gas royalty regime.

Here’s a simple way to fix that flaw. Let’s scrap the old Buchanan-era agreement. Instead of the dollar for dollar clawback on gas royalties, set the clawback rate at the top marginal income tax rate payable by Nova Scotians, which is 50.3%. Say offshore gas earns Nova Scotia $100 million in royalties each year. That royalty income would be "taxed" by the federal government at that same rate of 50.3%.

We might have to repay some of the $200 million "signing bonus" that John Buchanan took from Ottawa and then largely squandered on our behalf. But that’s a small price to pay for the benefits. Each year Nova Scotia would get a $49.7 million net increase in revenues, Ottawa a $50.3 million reduction in equalization payments. The province would see that when it builds the province’s economy, it gets to keep some of the benefits. Intriguingly, when the province lowered income tax rates, its share of royalty income would rise. Now that’s an incentive that points us in the right direction.