[HALIFAX] — The Atlantic Institute for Market Studies (AIMS) today released its latest report on the damaging affects of the federal equalization programme. Taxing Incentives: How Equalization Distorts Tax Policy in Recipient Provinces (Requires Adobe Acrobat Reader), by noted policy analyst Kenneth J. Boessenkool, demonstrates how equalization, although noble in intent, essentially rewards poorer provinces for imposing high and damaging tax rates.
The $10.5 billion equalization programme is one of the federal government’s largest. According to the Canadian constitution, it exists to “ensure that provincial governments have sufficient revenues to provide reasonably comparative levels of public services at reasonably comparable levels of taxation.” In practice, however, equalization is so complex and highly technical in nature that there is often little debate about its true effects on those provinces that receive this so-called “helping hand”. But if placed under a magnifying glass, it’s not hard to see that the equalization programme is actually infested with perverse incentives that are frustrating the economic growth of Canada’s poorer provinces.
For at least thirty years, economists studying equalization have built models showing how equalization creates incentives for less-developed provinces to raise their taxes. By manipulating their own tax rates, in theory poorer provinces can affect the size of their equalization payment, and get partially compensated for the debilitating effects of those higher taxes.
But until now, no one has actually checked the evidence to see whether this prediction about equalization’s perverse incentives is actually borne out by the facts. The verdict is now in: there is strong evidence that equalization does, in fact, encourage poorer provinces to overtax their population.
Taxing Incentives thoroughly examines and compares the burden of various taxes on both recipient and non-recipient provinces, and the numbers are striking to say the least. For example, personal income taxes in poorer provinces are, on average, one third higher than in richer provinces (British Columbia, Alberta and Ontario). Capital taxes in poorer provinces are more than two times higher than in the rich provinces; sales taxes are half-again as high; and fuel taxes are one-tenth to three-fifths higher. Even if you take low-tax Alberta out of the calculation, and compare taxes in the equalization-receiving provinces only with those in Ontario and B.C., the conclusion still holds.
The economic models not only predicted that taxes would be higher in recipient provinces; they also foresaw two other effects of equalization on taxes. First, they predicted that the bigger the province, the stronger the incentives would be – i.e. these incentives should be stronger for Quebec (the largest recipient) than for the Atlantic Provinces. Second, they predicted there would be a perverse incentive to levy higher tax rates on weaker tax bases (those tax bases most likely to shrink under the burden of heavy taxation) and lower tax rates on stronger tax bases (those more resistant to the effects of heavy taxes).
The evidence supports both predictions – tax rates in Quebec are generally higher than tax rates in Manitoba and Saskatchewan, which are in turn higher than in the Atlantic Provinces To take but one example, average personal income tax rates, as measured by Ottawa’s equalization calculations, are more than 43 percent higher than the national average in Quebec, 18 percent higher in Manitoba and Saskatchewan and 16 percent higher in the Atlantic provinces. Recipient provinces also show evidence of levying higher tax rates on relatively weak tax bases, and lower tax rates on relatively stronger tax bases.
The findings in this report open up a new challenge: namely, how might equalization be reformed to reduce these perverse incentives? While only tentative suggestions have been made in the report, work to meet this challenge must now proceed if Canadian citizens who live in equalization-receiving provinces are to be relieved from the excess tax burdens that equalization’s incentives appear to be producing.
Kenneth J. Boessenkool is the President of Sidicus Consulting Ltd., an economic and public policy consulting firm. Kenneth has published a number of ground breaking studies for AIMS on issues of fiscal federalism. Kenneth has an extensive portfolio of work on public policy issues, including papers on
federal-provincial transfers, provincial welfare, the tax treatment of the family, and monetary policy. His opinion pieces have appeared in the Calgary Herald, the Edmonton Journal, the Ottawa Citizen, the National Post, and the Globe and Mail. He was formerly a policy advisor to the Provincial Treasurer
of Alberta, a policy analyst at the C.D. Howe Institute, and an economic policy advisor to an opposition party in Ottawa. Kenneth currently resides in Airdrie, Alberta, with his wife and three daughters.
This enlightening report represents the third paper in AIMS’ Equalization Series. The first two papers called Equalization: Milestone or Millstone? (Requires Adobe Acrobat Reader) by Roland T. Martin and Taking off the Shackles: Equalization and the Development of Nonrenewable Resources in Atlantic Canada (Requires Adobe Acrobat Reader) – another report by Kenneth J. Boessenkool are available in full text on AIMS’ website (www.aims.ca). AIMS also collaborated with the Frontier Centre for Public Policy and the Montreal Economic Institute on a series of critical papers by some of the leading experts on equalization, including Nobel Laureate James Buchanan. These papers are also available on the AIMS website.
For further information, contact:
Brian Lee Crowley, President, AIMS, 902-499-1998
Kenneth J. Boessenkool, Author, 403-948-9854 or 403-703-8854