Equalization—separating fact from fiction

Recently, the Trudeau government announced its forecasted equalization payments for 2019/20—the money sent by Ottawa to “have-not” provinces via Canada’s equalization program. Quebec’s take will increase by approximately 10 per cent next year to just over $13 billion. This increase sparked an avalanche of commentary—some reasonable, some not. Given the importance of equalization and its status as a touchstone for regional friction, it’s important to separate fact from fiction.

The objective of equalization is to ensure that lower-income provinces can provide public services that are reasonably comparable to higher-income provinces at similar levels of taxation. In other words, the program is meant to help bridge the gap between provinces in their ability to raise money for public services. So it stands to reason that if that gap shrinks, the amount needed to bridge the gap should shrink, too.

Therefore, it’s understandable why an increase in equalization payments to other provinces would raise eyebrows in Alberta and Saskatchewan. Both provinces have suffered through difficult economic times and the economic gap between richer and poorer provinces in Canada has generally shrunk.

So why aren’t equalization payments shrinking as well? Here’s why. In 2009, the Harper government introduced a new rule, which required aggregate equalization payments to grow every year in line with the rate of recent national economic growth. In other words, now, it doesn’t matter whether the gap between richer and poorer provinces grows or shrinks—payments continue to grow at the same rate as the Canadian economy.

This “fixed growth rate” rule once served a useful purpose by protecting the federal government from runaway program costs. Had it not been implemented, high energy prices and economic weakness in Ontario would have driven program costs up markedly faster than the rate of national economic growth during the early years of this decade.

Since the downturn in commodity prices in 2014, however, things have changed and the gap between richer and poorer provinces has shrunk considerably. As a result, the fixed growth rate rule now has does the exact opposite of its intended effect, pushing program costs up even as non-recipient (or “have”) provinces such as Saskatchewan and Alberta struggle. In light of these unintended consequences, reform—which reduces equalization payments if the gap between richer and poorer provinces shrinks—would improve the program.

Unfortunately, much of the recent bluster about the new upcoming equalization payments linked equalization with the health of provincial government finances. Several commentators noted angrily that Quebec is forecasting a budget surplus next year, while Alberta is in the red. If Quebec has a surplus, they say, it must not need the money.

In reality, it’s hard to imagine a more harmful way to think about equalization because linking equalization payments to budget deficits would create absurd incentive problems. Take Quebec, which has restrained government spending and eliminated its deficit in recent years. If balancing your budget, for example, disqualified you from equalization, governments may think twice about making hard budget decisions. That’s why equalization payments are based on the productive capacity of each province’s overall economy—not the bottom lines of provincial governments.

Worse still are the misguided efforts to link the recent equalization announcement with Alberta’s fiscal state—using Alberta’s deficit as proof that equalization payments to other provinces should fall or, perhaps, Alberta should itself receive payments. This line of argument completely misunderstands Alberta’s fiscal challenges.

Alberta’s large deficits are the result of policy choices in Edmonton, not Ottawa. Specifically, an undisciplined approach to spending has prevailed across successive governments of multiple political stripes, with program spending substantially outpacing inflation plus population growth. Alberta ran a $3.1 billion deficit in 2012/13—when oil prices were over US$80 per barrel, by the way—because of spending growth. And the Notley government’s refusal to change course and rein in spending is the reason for today’s $7.5 billion deficit.

Clearly, taxpayers in non-recipient “have” provinces such as Alberta have every right to complain about equalization payments increasing despite the shrinking fiscal gap among provinces including Quebec. However, Albertans should also recognize that Alberta’s deficit problem is a completely separate issue and of their provincial government’s own making. Equalization has its problems, but blaming the program for Alberta’s fiscal woes will do nothing to solve them.