Equalization 101

You’ve probably heard about equalization. Equalization is central to the functioning of Canada’s economy, but it continues to be a source of tension. It’s flaming some angry fires in Alberta and Premier Jason Kenney has stated that his government will hold a referendum to remove equalization from the constitution. After the federal election, much of the frustration galvanized into a separation movement named #wexit, a key part of which focuses on getting Alberta a “better deal” in equalization.

But, hold up. What exactly is equalization? If you’re anything like me and are terrified of concepts that remotely look like math, equalization can seem like a complicated matter.

Last week, I had the chance to interview Dr. Trevor Tombe for Btchcoin’s 101 series. Dr. Trevor Tombe is an economist at the University of Calgary who has written extensively on the subject of equalization and is a highly sought after expert. And fortunately, he’s here to explain to us the ins and outs of equalization (without numbers, thank the lord).

  • So, what exactly is equalization?

Equalization is a federal program that provides additional transfers to lower income provinces. The goal — mandated by the Constitution — is to ensure that all provinces can provide comparable public services at no more than comparable tax rates. So, the federal government estimates what provinces could raise if they had “average” tax rates, and any province with below-average revenues from average tax rates gets a top-up. Currently, five provinces receive equalization payments (Manitoba, New Brunswick, Nova Scotia, PEI, and Quebec).

  • What’s the history behind equalization?

Equalization started in 1957, but looked very different than what we have today. At the time, it was a way to allow provinces to introduce their own income tax systems (which were suspended during the Second World War) without penalizing lower income provinces for doing so. The concern was originally that provinces without their own income tax systems received fairly generous transfers from the federal government in exchange. A province that introduced its own system would be topped-up to the same per-capita transfer that everyone else was receiving. The program evolved gradually from there, and the system that we would recognize today as “equalization” of all provincial revenues started in 1967.

  • Okay…so how do we calculate equalization?

Despite it being accused of being an overly complicated formula, it’s actually quite simple.

There are two steps.

First, figure out what the “average” tax rates are across all provinces.

Second, estimate what each province would raise if they had those average rates. This is “fiscal capacity” of a province, and essentially reflects the “ability” of a province to raise revenue. If that capacity is below average then the federal government tops up the province to the average level. This ensures all provinces have the ability to deliver comparable public services without resorting to above-average tax rates.

  • So, why is Alberta so frustrated about equalization?

Much of the frustration in Alberta is less about equalization than it is about perceived unfairness in the federation. Pipeline challenges in the past few years have been particularly frustrating for many. Given that some provinces that oppose pipelines are recipients of equalization, some political leaders have taken to connecting the two issues to remind other regions that equalization is paid for through federal taxes, which are (at least in part) funded through income generated in the energy sector.

  • Are the rest of the provinces or territories upset about equalization?

Saskatchewan and Newfoundland and Labrador are currently upset about equalization, as is Quebec. The two oil provinces would like to see natural resource revenues removed from the formula. If it were removed, they would start receiving payments. This change was made in 2007, and they’ve been mad about it ever since.

In fact, the whole “ABC campaign” (anything but conservative) of former NL Premier Danny Williams was essentially all about this particular feature of equalization.

Quebec is also frustrated with the “fiscal capacity cap”, which can clawback some of its payments in most years to ensure they aren’t made better off than non-receiving provinces.

  • Can you hold a referendum on equalization?

You bet! A provincial government could hold a referendum on anything. But the effect of a referendum on equalization is meaningless. It would be a purely political event, and not one with any legal significance. The federal government has full jurisdiction over the equalization program design.

  • Is there something that we should do about equalization moving forward?

We should talk openly and honestly about changes to the formula. Political, economic and social circumstances change regularly in Canada. Federal transfers can and do change with it. But this requires thoughtful engagement, not political bluster. We’re getting too much of that lately.

 

This interview was conducted and written by Ai-Men Lau (@aimenlau). It has been edited for clarity and length.