Interview with Kenneth J. Boessenkool

JIM BROWN: A new study has found a link between Canada’s equalization program and provincial tax rates. And the study says its findings are more evidence that equalization needs to be changed. Kenneth Boosenkool wrote the study for the Atlantic Institute of Market Studies and he joins me on the line now. Good morning.


JIM BROWN: What link did you find between tax rates and equalization?

KENNETH BOOSENKOOL: Well economists for many years have pointed out that equalization creates incentives for provinces that get equalization payments to levy higher tax rates than they otherwise would without the program being in place. And this has been going around in academic circles for a long time. But for a long time it’s been restricted just to, sort of, the posing of theoretical models. What I did in the study here was to take a look at the tax rates across all provinces and compare them and look at the taxes levied on various different tax bases, such as business taxes, personal income taxes, property taxes and payroll taxes. And what I found was that in provinces that receive equalization tax rates in general are much higher than in provinces that don’t receive equalization.

JIM BROWN: How much higher, on average, how much higher are the taxes in have-not provinces?

KENNETH BOOSENKOOL: Well when you look at personal income tax revenues, in Quebec personal income taxes are about 150% of the average in Ontario and British Columbia. And in all the other equalization receiving provinces, that’s Manitoba, Saskatchewan and the four Atlantic Provinces, they’re about 125%, so about a quarter higher.

JIM BROWN: That’s a substantial difference. How is it that equalization encourages that atmosphere? How does it encourage provinces to raise their taxes?

KENNETH BOOSENKOOL: Well if you’re not in an equalization receiving province and you raise your taxes you get additional revenues, but you also… higher taxes, as everyone knows, higher taxes tend to decrease economic activity. So at a certain point there’s an optimum level of taxation where the amount of damage you’re doing to the economy is offset by the amount of revenue you get. And when you look across different tax bases you try to minimize the amount of damage and economists have a measure for how much damage to the economy a tax is doing. And so what economists say is there’s an optimum level of taxation that minimizes the amount of damage. When you throw equalization in to the mix what happens is that Provinces get compensated for the damage that the tax is doing to their economy. And so, whereas if you didn’t receive equalization, you might have a tax rate of 40%, because if you raised it to 45 you’d be doing more economic damage than it was worth. If you receive equalization, you could raise your taxes to 45% because you’re compensated through the program for those damages.

JIM BROWN: So, just to be clear, when have-not provinces raise their taxes not only do they get the immediate benefit of that, but also by putting their own economy in a sense in worse shape, they get more equalization money?

KENNETH BOOSENKOOL: That’s exactly right. So they get compensated for the ill effects of higher tax rates through the program.

JIM BROWN: But if I was a finance minister in a Province like Newfoundland with a, you know, lower incomes, a smaller tax base, I would think that I would have to raise my taxes even higher if I didn’t have equalization to provide all the services. To me you could make an equal argument that it’s equalization that’s keeping the taxes down in Newfoundland.

KENNETH BOOSENKOOL: Right, but again what I’m saying here is not that we should get rid of the payments themselves. Rather what I’m saying is the way in which the payments are calculated are causing these bad effects. If we distributed payments across the country based on differences in personal income for example, then the Province of Newfoundland wouldn’t get directly compensated for raising capital taxes higher, or wouldn’t get directly compensated for the ill affects of raising personal income tax rates. So you would still get the compensation, or the money for having a weaker economy. But you wouldn’t get directly compensated because of the interaction of raising taxes on the equalization program. So it’s sort of… it’s more of a design issue. Now we can have an argument about are the payments too high, or too low, but that’s a separate argument from the one I make in this paper and that’s that the design of the current program creates bad incentives.

JIM BROWN: The other avenue to this, the sort of the follow up to the initial point you make is if have-not provinces are being rewarded for keeping the tax rates inflated, then they’re essentially being rewarded for stifling economic growth.

KENNETH BOOSENKOOL: Well this is the bigger issue. What policies are the Federal Government… what policies have the Federal Government enacted over the years that have stifled growth in the region? I’ve written previously for the Atlantic Institute for Market Studies about how the treatment of natural resources is probably stifling the development of offshore oil and gas. Now this paper is saying that the design of equalization is resulting in higher tax rates which damages the economy. And if the goal of the Federal Government is to try and ensure that weaker regions of the country grow faster, they ought not to design policies that have the opposite effect. And you know it’s very interesting when you look at the C.D. Howe Institute study a few years ago. If you look at the United States, at the states that border on Canadian provinces and you look at the differences between rich and poor in those states and the differences between rich and poor in the provinces. Over the last 30 or 40 years the difference between the states has narrowed a lot and the differences between Canadian provinces hasn’t narrowed nearly as much. And so you have to ask yourself the question why haven’t the rich and poor… why isn’t the rich and poor gap in Canada closed as much as it has among those border states who have very similar economies? And we could have an hour long discussion about that. But I think equalization is one of the reasons. The way in which the equalization is designed is one of the reasons why our poor regions are not catching up as quickly.

JIM BROWN: An argument is being made here now, with the Voisey’s Bay announcements of the past couple of weeks, is that mega projects like this should have a clawback exemption and that that would be encouragement for the kinds of development you’re talking about in not only exploration with minerals, but in the offshore.

KENNETH BOOSENKOOL: I, in my paper about the offshore industry for the Atlantic Institute for Market Studies, I argued that equalization should not count natural resource revenues, such as oil and gas in their calculation. Because revenue from oil and gas is not like revenue from personal income taxes. What you’re doing when you extract oil and gas from the ground and selling it, you’re converting a liquid resource, if you would, into a cash resource and there’s no real increase in income taking place. And so it shouldn’t be included in equalization. So I’ve gone much further than saying there should be a reduced clawback for those revenues in saying those revenues shouldn’t be in the program at all. It doesn’t make sense from a purely economic perspective to have natural resource revenues in the program. I mean when Alberta developed their oil and gas industry 40, 50 years ago, they were a have-not province. And Ottawa certainly didn’t deduct the revenues that Alberta got from resource revenues, even though there was a type of equalization program in place at the time, they didn’t count those revenues. And the equalization program itself doesn’t include Alberta in the formula, in large part because of the natural resource question. So I raised the question in that other paper, why is it that we include these natural resource revenues? Especially when in doing so hampers the incentives of provincial governments in the Atlantic provinces to develop these resources to their greatest potential.

JIM BROWN: Mr. Boosenkool thank you very much for joining us.

KENNETH BOOSENKOOL: It’s been my pleasure.

JIM BROWN: Goodbye now.


JIM BROWN: Kenneth Boosenkool is the author of a study on equalization and tax rates. The study was published by the Atlantic Institute for Market Studies.