Shifting responsibility: Equalization and government spending

Canada’s equalization program, through which the federal government mandates the richer provinces to subsidize their poorer equals, is central to Canadian federalism. Whether the provinces receive or contribute to the scheme determines their “have” or  “have not” status, and political battles over transfers seldom end peacefully.

Although it is understandable that the beneficiary provinces defend the equalization program, taking a closer look reveals the current scheme reduces fiscal accountability in recipient provinces, which compared to the contributing provinces, have a generally bloated public sector (in addition to other perks, such as lower tuition averages and higher teacher-student ratios).

Equalization ensures that poorer provinces are able to provide quality public services to their residents by assessing each province’s ability to pay for a basket of services and using this information to determine whether they will receive from, or contribute to, the program.

An oddity of the scheme is that overlap exists between equalization recipients and net contributors. In 2012, for example, Ontario received roughly $3 billion in transfer payments, while its taxpayers paid over $6 billion toward the program. Even recipients “contribute” to their own transfers: last year, Quebec paid nearly $3 billion toward equalization and took in over $7 billion. In fact, because Ontario receives equalization payments, most of the funds transferred by the program come from its recipients.

The incentive structure of Canada’s equalization program discourages accountability, since the provinces can treat the money they receive from equalization as though it came from thin air, despite the fact that their residents contributed to the scheme via taxation. Furthermore, the provinces are not limited in spending this money and, in some cases such as Nova Scotia’s, use the funds to pay the interest on provincial debt.

The effect is that public sector spending increases in recipient provinces, who justify their spending habits on the premise that “someone else is covering the cost.” Consequently, recipient provinces spend more per capita than the “creditor” provinces. For instance, the net beneficiaries of equalization–Atlantic Canada, Quebec, and Manitoba–there are, on average, more registered nurses, regulated childcare spaces, and residential care beds per resident, as well as lower tuition rates at post-secondary institutions.

Studies published by both the Fraser Institute and the Frontier Centre for Public Policy demonstrate the relationship between equalization and public sector outcomes. In Super-sized Fiscal Federalism, for instance, Mark Milke shows how the recipient provinces outperform the creditor provinces on thirteen of nineteen indicators of public goods provision, whereas the net contributors provided more services in only three categories.  One of these areas, for example, is the number of physicians per capita: in 2011, four of the six provinces receiving payments had more doctors proportional to their populations than Alberta, the biggest giver.

Therefore, although equalization is intended to ensure comparable public services across provincial borders, it actually results in significantly better-funded services in poorer provinces with lower costs.

This inverse relationship between public expenditures and provincial wealth seem to be the result of equalization and its effect on provincial spending incentives. Although the idea of providing comparable levels of public services is noble, Canada’s experience illustrates how equalization transfers preclude accountability. In essence, the recipient provinces have weaker incentives to take responsibility for their spending and, instead, encourage public sector growth that may very well be unsustainable should payments cease.

Michael Sullivan is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute

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