Equalization: Welfare Trap or Helping Hand?

[HALIFAX] — Fresh from winning a prestigious international prize for their innovative work on Canada’s equalization programme, three of Canada’s leading public policy institutes today released a new series of papers analysing the strengths and weaknesses of this major national transfer programme. The papers, prepared by prominent policy thinkers and analysts, including Nobel Laureate James Buchanan, are based on talks given by the authors at a conference in Montreal on October 25, 2001. The conference, entitled Equalization: Welfare trap or helping hand? was jointly organized by the Atlantic Institute for Market Studies (AIMS), the Frontier Centre for Public Policy (FCPP) and the Montreal Economic Institute (MEI).

The clear conclusion that emerges from these papers is that equalization is seriously flawed and must be reformed.

Nobel Laureate James Buchanan (“Fiscal Equalization Revisited”) argues that, while the theory of equalization is defensible, such programmes are too easily captured by politics and undermined by serious design flaws.

Michel Boucher (l’ENAP) and Jean-Luc Migué (Fraser Institute) show (“Federal Grants Under the Discipline of Market Forces”) that free trade has been associated with smaller governments at both the national and provincial levels, but that equalization-receiving provinces adjust to the new competitive environment more slowly than provinces that do not receive equalization, thus harming their economic prospects.

Herb Grubel (David Somerville Chair in Taxation and Finance, Fraser Institute) in “What’s Wrong with Equalization: Social Insurance and Moral Hazard”, takes the view that the incentives in equalization reward certain kinds of economically harmful behaviour by recipient provinces. He argues
for the gradual phasing out of equalization.

University of Alberta economist Bev Dahlby, in “The Incentive Effect of Fiscal Equalization Grants”, drawing on his own and others’ analysis of the incentives implicit in equalization, predicts that empirical analysis will confirm that recipient governments will set higher tax rates and spend more on consumption-related programs. Conversely, recipient governments are predicted to spend less on income-producing initiatives.

Ken Boessenkool, Principal of Sidicus Consulting, takes the view that non-renewable natural resource revenue should be removed from the formula used to calculate equalization. In his view, the most important result of this change would be significantly to improve the incentive for provinces to develop these resources to the full.

In “Equalization and the Treatment of Nonrenewable Resources”, Acadia University economist Paul Hobson contends that non-renewable natural resource revenue should be included in the calculation of equalization whenever that revenue is used to create net fiscal benefits for provincial residents – either through lower taxes, more government services, or the direct distribution of such to residents. It should not be included, however, when such revenue is saved is a ‘heritage’ fund of the type used in the past in both Alberta and Saskatchewan.

Annette Ryan of the Government of PEI, in “Equalization: neither Welfare Trap nor Helping Hand”, argues that it is unfair to expect equalization to reduce inter-provincial disparities when no one argues that within-province transfers should eliminate all intra-province disparities. Ryan uses within-province data on incomes, showing that there is as much intra-provincial as inter-provincial disparity. She argues for a significant enrichment of equalization.

Paul Boothe, an economist at the University of Alberta and the editor of this series, in “Modest But meaningful Change: Reforming Equalization”, takes the view that equalization needs reform to create a scheme that is 1) limited, 2) federally funded, 3) a net equalization scheme and 4) based on a macroeconomic indicator.

The release of these papers comes soon after the joint AIMS/FCPP/MEI Equalization Initiative won the prestigious Sir Antony Fisher International Memorial Award for innovative think tank projects. Over 100 think tanks operating in more than 40 countries are eligible for this juried award.

To view this series follow this link: www.aims.ca/Main/series.htm

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For further information, please contact:
Brian Lee Crowley, President of AIMS, (902) 499-1998
Michel Kelly-Gagnon, Executive Director of the MEI, (514) 273-0969
Peter Holle, President of the FCPP, (204) 957-1567