Comments by Brian Lee Crowley, President, AIMS
to a special Commons Finance Committee roundtable
on the topic of Equalization
Ottawa, Ontario, Canada
8 May 2002
Ladies and gentlemen of the House of Commons Finance Committee, thank you for the kind invitation to be here today to speak to you about a topic of vital importance to my region, as well as the country as a whole: equalization
One of the cardinal rules of economics is that if you subsidise something, you will get more of it, and if you tax something, you will get less of it. If we subsidise the production of milk or petroleum or health care, it is because we think that the market, if left to itself, will produce less of these things than governments think is best. We want more, so we pay for it.
On the other hand, we all know that taxing things like effort or work, or consumption or saving or productive economic activity in general, results in less of these things than we would otherwise have, and the higher the tax rate, the greater the loss of economic activity.
The reason that I raise this in the context of equalization is that this massive federal programme subsidizes some very specific things and taxes some others. And the net effect has been significant damage to the ability of the less-developed provinces to close the disparity gap with either the national average, or the wealthier provinces.
Apologists for the current regime say that it was never equalization’s purpose to “close the disparity gap” with the rest of the country, but simply to compensate for its existence. But what we have discovered after nearly half a century and over $180-billion in equalization payments (NOT adjusted for inflation) is that incentives matter, and the incentives attached to equalization can penalize the poorer provinces for developing their economy, and encourage them to settle for permanent reliance on federal transfers. “Sharing” has its virtues, but surely the prime object behind our fiscal arrangements should not be to maintain poorer provinces in a state of splendid dependence, but rather to build their capacity to pay their own way. The greatest victory of fiscal federalism could and should be the elimination of the need for equalization payments.
In trying to make clear the perverse incentives in equalization, let me come back to the question of what equalization subsidises and what it taxes. Let me take the taxing part first. What does equalization tax, and therefore lead us to produce less of?
The answer, in my view, is two chief things:
1) productive economic activity in the less well-off provinces;
2) provincial assets being shifted from one form to another without the creation of new wealth
To illustrate the first point, I always think a concrete example helps best. Let’s look at Voisey’s Bay. If that mineral deposit were in Ontario, the wealthiest province in Canada, that mine would be developed today. Yet the deposit is in the poorest province, Newfoundland, and after numerous years of hard negotiating, it has still not gone ahead, depriving the province of much needed investment and job creation. Why? While it is not the only explanation, I would argue that equalization plays a major role here, because it deprives the province of one of the two major streams of benefits that development normally allows. For further development of this argument please go to my article in The Globe and Mail (www.aims.ca/Media/2000/prjan18002.htm)
A similar example is to be found in the way Nova Scotia gets oil and gas companies to pay for exploration rights in the offshore. There are two ways to get companies to pay. One is to get cash up front. The other is to get so-called “work commitments”, or promises to carry out a certain minimum amount of exploration work. If NS takes the money up front, Ottawa would take 70% under the equalization clawback. If, on the other hand, NS takes no cash, but requires the companies to offer work commitments, the bulk of the economic value stays in NS. But this requires the province with the lowest amount of money per capita to spend on programmes to forgo a major revenue source. And then there’s Hibernia and the gravity based structure, or GBS, a huge and hugely outdated approach to developing offshore oil and gas in which the Government of Newfoundland gave up a stream of royalties from Hibernia in exchange for a large amount of relatively low-skill short-term employment.
And this view of the economic disincentives implicit in equalization is more and more widespread. Former New Brunswick Premier Frank McKenna, in a recent interview, said that equalization and other federal transfers “give very little incentive to create greater own-source revenue, because those revenue sources are taxed back.” To read this entire interview, follow this link: www.fcpp.org/publications/conversations/frankmckenna.html
I mentioned in addition that equalization also taxes equalization-receiving provinces that take a stock of assets and turns them from one form to another, but without creating any new economic value. Again, a concrete example may help to illustrate. Nova Scotia has one of, if not the highest per capita debts in the country. Yet it also has major economic assets on its balance sheet, such as forestlands, and future cash flow from offshore gas royalties. A sensible economic strategy would see them clean up their balance sheet by selling some of the assets and retiring debt. No new economic value would be created (other than, perhaps, a more efficient use of the assets). Existing assets would merely be transformed from capital stock to cash. But as soon as this conversion is completed, Ottawa, one of the wealthiest governments in Canada, then seizes the assets by clawing back the vast majority under equalization. In most cases the clawback is on the order of about 90%, a very high marginal tax rate indeed on a transaction which, if undertaken by a company or an individual, would not be treated as taxable income at all.
With your permission, I will turn now to the question of what equalization subsidizes, because while equalisation taxes economic activity, and does so very hard, guaranteeing the we get less of it in equalization-receiving provinces, it also subsidizes certain things quite a lot, ensuring we get a lot of it. The most important thing equalization subsidizes, of course, is provincial government, and we get quite a lot of that!
In fact it is a commonplace that Atlantic Canada, for example is overgoverned, and a lot of people shake their heads at the continued existence of so many provinces serving such small populations. But really there should be little surprise that government in our region looms so large relative to the size of the productive economy: taxpayers in other parts of the country pay for us to have a much larger public sector than we would choose to have for ourselves if we had to foot the entire bill.
It seems clear that Newfoundland would not have the lowest pupil teacher ratio in the country, Nova Scotia would not have the highest number of universities per capita, Manitoba would not spend the most per capita on health care of any province in the country if the taxpayers in each of those provinces had to foot the bill themselves. And it is a virtual certainty that if the Atlantic provinces did not receive such a large subsidy from federal taxpayers that there would be a lot more co-operation and collaboration across provincial boundaries.
As an aside, I would draw your attention to the problem that equalization introduces for traditional notions of democratic accountability. Note that under the principle of no taxation without representation, we normally