Saturday, October 27, 2001
The National Post

Where is the gold in equalization pot?

By William Watson

A study released by Statistics Canada this week shows that people who move between Canada’s provinces get a big economic payoff from doing so. Young, entry-level workers, in particular, made impressive gains. When between 1982 and 1995 male entry-level workers left the Maritime provinces or Quebec they averaged an increase in wages of at least 40% — and fully 88% when they left Newfoundland. The increases were less for older workers and for women, who still often follow their husbands around, but they were still increases, and in many cases large ones.

These results are both unsurprising and heartening. Unsurprising because one of the reasons people move is to better themselves economically. Moving is usually costly. It doesn’t pay unless there’s a bigger pot of gold at the end of the rainbow. Economists are often accused of spending their time proving the obvious. But the real-world data so often mumble, it’s nice to see them speak loud and clear in support of a simple economic idea.

That people do gain economically by moving is also heartening. The way to get the most out of the economy is to have people work where their productivity is highest. They may not like leaving their home provinces in order to earn higher incomes. It might be better if every part of Canada were as prosperous as every other. But after 40 years of regional development programs, that still isn’t the case. And as different regions’ fortunes rise and fall — Newfoundland and Nova Scotia are now on an upswing, with offshore oil and gas — it probably never will be. One reason to have a country in which people can live wherever they want is to let people take advantage of economic opportunity wherever it arises.

But what about equalization? Doesn’t our constitutionally enshrined system of paying money to the poorer provinces block efficient interprovincial migration?

Actually, maybe not. James Buchanan, winner of the 1986 Nobel Prize in economics, was in Montreal this week to talk about equalization. In 1950, in an article based on his Ph.D. dissertation, he pointed out that in a federal state, that is, one in which provinces or states exercise independent tax and spending powers, you could get inefficient migration.

Suppose a person’s earning power were the same in both a rich province and a poor province. He or she wouldn’t move, right? Maybe, maybe not. People also consider public services and tax rates when they move. In the richer province, tax rates are likely to be lower and public services better than in the poor province. Why? Because higher incomes can be taxed at a lower rate to provide the same standard of service. Thus, in recent years, Alberta usually has had both the country’s lowest tax rates and its best public services. In fact, people might be tempted to move there even if their private income fell as a result, so long as the difference was made up by the lower taxes and better schools and hospitals.

Prof. Buchanan’s 1950 article argued that unless you had a system of equalization that offset this difference in “net fiscal benefits” across provinces by giving money to the poorer provinces, you’d get too much mobility. A properly designed equalization system would, in effect, take the public sector out of people’s mobility decision and make sure they moved only if their private, pre-tax income rose as a result.

This assumes, of course, that the equalization system in question is designed solely with that purpose in mind. After 1950, Prof. Buchanan was instrumental in the development of the “public choice” school of economics, which focused on the perverse incentives policy-makers face that often cause them to take actions and design programs that don’t further “the public good.” This possibility of “government failure” is hardly shocking news to laymen but until Prof. Buchanan and the public-choice school came along, economists spent much of their time designing optimal policies that could only ever be implemented in a world of economist-kings.

Since then, Canadian scholars have pointed out that the equalization system itself produces perverse incentives. Former Quebec premier Jacques Parizeau always argued that Quebec could do almost as well if Ontario’s economy grew, since that increased equalization to Quebec, than if Quebec’s did. The Maritime provinces, in particular, are concerned that equalization imposes a heavy tax on offshore oil and gas development. For every dollar of revenue they make from the offshore, they get as little as 19¢. Implicit tax rates that high are like the welfare trap poor people face when they lose most of their benefits if they get a job.

Prof. Buchanan himself admitted in his Montreal speech that, because of these and other complications that have been pointed out since 1950, his view of equalization was now more nuanced. There were several costs to go along with the potential benefits and whether the benefit was worth the cost would vary from case to case. Unfortunately, he declined to comment on how the benefit-cost calculation came out in Canada, a case he said he wasn’t familiar enough with to judge.

But he also conceded that the benefit-cost calculations were very hard to do in any rigorous way. If the father of equalization wouldn’t condemn equalization — as his sponsors may have wished — he hardly gave it a ringing endorsement: It may be a good thing. It all depends on the exact size of costs and benefits that are in their nature hard to calculate.

If equalization weren’t already in place, perhaps we wouldn’t feel the need to invent it. But now that it’s in the Constitution, we’re likely never to be rid of it.