The equalizers

Equalization payments skewed by volatile resource revenues

Premier Ralph Klein’s verbal slip when he visited Nova Scotia last week – saying the province needed a constitutional amendment to gain control over its offshore oil and gas resources — was entirely due to Premier John Hamm’s reluctance to talk candidly about what his battle with Ottawa is really about.

According to Brian Crowley, director of the Atlantic Institute for Market Studies, it is not a dispute over ownership. The problem is with the formula used to calculate equalization payments.

Hamm has been touring about the country to garner support to stop Ottawa from appropriating 70 cents of every dollar of resource revenue from Nova Scotia’s offshore oil and gas projects. Klein appears to have interpreted that to mean Nova Scotia does not have the same control over its resources as Alberta. Not so.

In a 1986 agreement, the federal government agreed to let Nova Scotia get 100 per cent of royalty revenues from the development of its offshore reserves.

The problem is, for every dollar of royalty revenue a have-not province gets, the federal government typically reduces the equalization payments dollar for dollar. Nova Scotia was able to negotiate a side deal, where the government agreed to clawback only 70 cents of the equalization dollar. Now, Hamm wants it changed so the clawback is only 30 cents.

We agree with AIMS that the problem requires a more permanent solution: The way equalization is calculated needs a major rethink.

The principle behind the program is sound. Provinces should be able to enjoy roughly equivalent services with roughly equivalent tax rates. However, the transfer calculations should be made on the long-term, stable sources of provincial revenue — such as corporate profits, personal income and sales taxes — not volatile royalty revenues.

Ken Boessenkool, author of a recent AIMS study on the issue, argues that royalties should not be considered part of a regular income stream. Albertans know this intuitively — “windfall” oil revenues should be used to retire debt, shore up savings or spent on one-time projects, not for regular program spending.

Royalties are merely a resource asset that has been converted into a cash asset. Expecting a province to turn around and use it to replace equalization dollars the federal government withdraws is, as Crowley says, like selling the house to pay for groceries. It just doesn’t make sense.

Far better to exclude natural resources from the calculation altogether. This is not unprecedented. Alberta was already dropped because its massive oil revenues skewed the formula so much it would have made even powerhouse Ontario a have-not province on paper.

Boessenkool says if equalization was calculated using the revenue sources of all 10 provinces, excluding royalty revenues, it would reduce the amount of transfers to most have-not provinces by only one per cent. In Saskatchewan, transfers would actually rise nine per cent.

The upside is that such a formula would eliminate the clawback and encourage have-not provinces to develop their natural resource wealth without penalty. Royalty revenue would have the chance to work through the economy, increasing investment, corporate profits and wages. Only when revenues from these latter sources increased would transfer entitlements be reduced.

We sympathize with Hamm’s crusade, but he needs to think more along the lines of fundamental reform, instead of minor tinkering. Changing the equalization formula is worth a closer look.