Equalization, Incrementalism, the Unlikeliness of Rapid Reform

Equalization is a staple of the Canadian Dominion. Policymakers in the 19th century designed and implemented it to ensure that government provided equal services throughout the country and achieve greater balance between the provinces (or, as they were at the time, regions). The rationale is that small provinces, like Prince Edward Island (PEI), should be able to offer the same quality of public services as larger provinces that have greater fiscal capacity. Ottawa collects revenue from each province, based on a complicated formula that takes into consideration income levels, economic growth, and a swath of complex variables, and then redistributes it to those provinces in need.

The structure of Canada’s equalization program results in wealthier provinces contributing to poorer ones. This year, for example, Ontario, Quebec, New Brunswick, Nova Scotia, PEI, and Manitoba–colloquially referred to as the “have-not provinces”–will receive equalization payments, while the remaining four provinces–the “have provinces”–serve as their creditors.

Equalization’s current structure receives a great deal of criticism from both provinces that receive payments and those that provide a net contribution. Although this is a generalization, some believe that the formula no longer works and requires substantial reform. However, there is a disparity between defining the problem and delineating solutions to fix it. In Eastern Canada, for example, critics indicate that the program does not distribute enough wealth throughout the region, whereas those in Western Canada–where three of the four “have provinces” are located–argue that subsidizing the “have-not provinces” is unfair. In fact, some intellectuals question its constitutionality.

The inability to accurately define equalization’s most serious deficiencies precludes the capacity to solve them. For recipient provinces, including natural resource revenues in the equalization formula would increase the scope of its distributional effect. This is problematic, however, as it could also discourage creditor provinces from developing their natural resources (or, much less damaging, it would reduce their total revenue). Furthermore, including natural resources disproportionately penalizes the provinces that rely on developing them.

Conversely, those opposed to equalization argue that eliminating it or reducing its overall scope. Unfortunately, although this would benefit the “have provinces,” it would be severely damaging for those receiving the transfer payment each year–at least in the short-term. Not only would it reduce the size of federal transfer they receive, but also it could encourage residents of recipient provinces to migrate toward the more affluent West, which would only exacerbate the current migratory trend.

Reforming the Canadian equalization programme is difficult: neither those supporting nor opposing it will accept facing negative externalities of whichever reform route the government chooses. Solving this problem requires alternative solutions and, likely, a tremendous compromise between both sides. Alas, it might be better to transfer wealth directly to individuals, rather than provincial coffers, where bureaucratic excess erodes the government’s ability to effectively distribute it to individuals and families.

Ultimately, though, significant reform is unlikely and incrementalism may very well be the only option.

Randy Kaye 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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