Penalizing success

With resource wealth, Ottawa’s equalization program needs a rethink

By Mary Janigan

For decades, Ottawa’s Douglas Clark was probably the only person in the nation who grasped the intricacies of equalization. In the early 1970s, desperate to master the formula, Prime Minister Pierre Trudeau asked the finance department guru for a cabinet briefing on how Ottawa calculated its transfer to the have-not provinces. With now-legendary aplomb, the indispensable Clark gravely allowed that he had a tennis game — but could probably cancel it. His sacrifice was largely wasted. “The prime minister understood things,” Clark, now retired, recalls. “It’s hard to say about the cabinet.”

Today, although there are small pods of specialists in Ottawa and provincial capitals, equalization remains an arcane art. But the formula’s complexity is working against the very provinces it was designed to help. For months, Nova Scotia Premier John Hamm has argued that the program does not provide sufficient incentive for disadvantaged provinces to develop their non-renewable resources. Instead, transfers to Newfoundland and Nova Scotia are reduced by 70 to 90 cents for every dollar of provincial resource revenue. In desperation, Hamm has reached out to other energy-producing provinces such as Alberta, forging a common front to advocate change. It’s hard to rally support in such a Byzantine wrangle. And that’s a pity — because changes may be the only way to help Atlantic Canada help itself. “Equalization was designed for economies in decline,” says Brian Lee Crowley, president of the Atlantic Institute for Market Studies. “It can’t accommodate economies that are experiencing growth. That is the dark side of equalization.”

The program, which will cost an estimated $10.6 billion in 2001-2002, allows the seven poorer provincial governments to provide similar levels of services while keeping roughly similar levels of taxation. To calculate the payment, officials work out the average national rate for 33 taxes, such as personal income levies. Then they figure out the average amount that each of those tax rates could raise, and Ottawa covers any overall deficiency in a given province. (Ontario, Alberta and British Columbia do not receive it.) It’s an accountant’s heaven: experts meet twice a year to debate 60-page papers on tiny changes. Ottawa has transferred $180 billion since 1957 — but the dependency rate has scarcely budged. Newfoundland raised only 64.5 per cent of its own revenues in 2000-2001, barely up from 62 per cent in 1972-1973.

Now, at least two of the provinces have a chance to escape the cycle. Both Newfoundland and Nova Scotia have huge offshore oil and gas reserves. But Ottawa includes 70 per cent of their oil and gas royalties when it does its equalization arithmetic. That means that 70 per cent of those royalties are deducted from the transfer. The formula’s deductions are even higher for royalties from non-renewable mineral resources: about 90 per cent of those revenues are deducted from transfers. Provincial governments respond to such perverse signals, concentrating on short-term job-creation schemes instead of maximizing the amount that companies pay for non-renewable resources. After all, when royalties reduce transfers, there is more political and perhaps more economic advantage in job schemes. Newfoundland’s negotiations with Inco Ltd. over the building of a multimillion-dollar nickel mine in Voisey’s Bay foundered mostly because the firm would not build a sufficiently large job-creating smelter near the site.

There are solutions. Alberta public policy economist Ken Boessenkool has suggested that Ottawa remove the 11 taxes on oil and gas and mineral resources from the 33-tax base. That way, tax revenues from those resources would not be deducted from the transfer. Yet the transfers would gradually decrease as revenues from other sources, like personal income taxes, rose as the province became richer. It would not strain Ottawa’s coffers: payments to Atlantic Canada would drop slightly.

Ottawa’s response is cool. Finance Minister Paul Martin says other provinces would never agree: New Brunswick, for one, would want to exempt revenue from its renewable pulp and paper industry. He prefers to target grants to specific problems. That may be political realism — the formula is not up for renewal until 2004 — but it keeps encouraging dysfunctional behaviour such as Voisey’s Bay. Meanwhile, as Nova Scotia strategic adviser Roland Martin notes, Atlantic Canada’s growth rates are high — but tax rates are also high. As provinces such as Alberta cut taxes, the allure of moving may become irresistible — unless there’s a homegrown resource boom. “The formula should be changed so provinces keep more revenue which they could spend on sustainable growth,” he says. It’s time to stop penalizing success.