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Jul 25, 2018

How unfair is Ottawa to the provinces? Equalization isn’t the half of it

July 25, 2018

One unfair fiscal transfer has resulted in Ontarians over-contributing to EI by nearly $12 billion over the last 10 years

The Council of the Federation, an annual gathering of provincial and territorial premiers, met in New Brunswick last week. Equalization was surely a topic of heated discussion behind closed doors.

Ottawa’s renewal of the program a few weeks ago has already prompted a Saskatchewan reform proposal that many quickly dismissed. This pushed the question of whether equalization payments are fairly distributed back into the limelight.

Equalization certainly has its shortcomings. But in the public debate, the term “equalization” is often used as a proxy for Canada’s entire system of inter-regional redistribution. This only muddies the waters — after all, equalization only accounts for 5.6 per cent of federal program spending. And there are other transfers within this system that are no less unfair.

When the federal government converts taxes into program spending, it is inevitable that the residents of some provinces will get back more than what they pay, and some less. New analysis from the Mowat Centre shows that Ontarians, Albertans, British Columbians, and more recently the residents of Saskatchewan, have consistently fallen in the camp of “net contributors.” In 2016–17, the difference between the federal taxes that Ontarians paid and the federal spending they received was $12.9 billion. Over the past 10 years, Ontarians’ cumulative net contribution was $96.3 billion — second only to Albertans’ net contribution of $228.6 billion.

How justified is this difference between “money out” and “money in”? The litmus test for fairness is whether money is allocated based on clear principles appropriate to the program’s policy objective. These principles can be per capita, per client, needs-based, or merit-based.

Some of Canada’s fiscal transfers pass this test. The needs-based Old Age Security program, and per-capita allocation of the Canada Health Transfer and the Canada Social Transfer are good examples.

But other important programs are based on unprincipled allocations, with residents of certain provinces ending up receiving less than what is fair. One such case is employment insurance (EI), which continues to massively underserve the unemployed in certain parts of the country. For example, in 2016, 36.0 per cent of Canada’s unemployed resided in Ontario, but unemployed Ontarians received only 29.6 per cent of total EI benefits. As a result, Ontarians have over-contributed to EI by nearly $12 billion over the last 10 years.

Another example is Canada’s Labour Market Development Agreements (LMDAs). These agreements are meant to assist the unemployed in skills training and the job search. Rationally, they should allocate funds based on the number of clients — unemployed Canadians — in each province. Instead, they use a complex and mostly outdated formula which, in Ontario for example, has resulted in 29.5 per cent of federal funding being allocated to serve 37.8 per cent of the nation’s unemployed.

What of equalization, then? Equalization, in its current form, is also unprincipled and unfair, but not in the ways often raised by its most vocal critics.

There are two main problems with the program. First, the federal government recently decided to continue detaching the total amount it spends on equalization from the formula used to calculate which provinces qualify for funding. In other words, the total is not based on a calculation of what is needed to achieve the program’s goal.

Initially introduced to put a ceiling on payments in order to save costs, this practice now serves to establish a payments floor. This means that payments can flow to provinces with above-average revenue-raising capacity, as happened this year with Ontario.

Secondly, the equalization formula only takes into account one side of the service delivery coin, namely a province’s capacity to raise revenues. But provinces also differ in how much it costs to deliver the same services. Since factors such as number of clients, wage levels, and geography vary from province to province, so do the costs of public-service delivery.

None of this is accounted for in calculating equalization payments, but should be. The fundamental principle of equalization is to enable provinces to provide comparable levels of service at comparable levels of taxation, and the cost of providing that service is part of the equation. A more principled approach would factor in these cost variables, along with the differences in provinces’ ability to raise revenues.

To be clear, a fitting dose of redistribution is both needed and welcome in a federation. And wealthy provinces should share their wealth. But this should be done in a fair manner, based on clear principles appropriate to a program’s policy objectives. As it stands, while some of Canada’s fiscal transfers meet the fairness test, others do not, resulting in significant fiscal gaps for a handful of provinces, including Ontario.

It’s good to talk about equalization. But if we’re going to talk about fairness, let’s talk about the entire range of federal spending.

Published in The Financial Post

Release Date

July 25, 2018


Andrew Parkin
Erich Hartmann

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