-1-

EXECUTIVE SUMMARY

Equalization is a federal program that is an essential element of Canada’s

distributive social justice and is indispensable for the maintaining and the improvement

of Canadian society and economy as a whole. For it is this program that insures that all

Canadian’s have free access to comparable and free health care in every province

within Canada; effectively offering Canadians the right to social equality, while

maintaining competitive rates of taxation. This insures that quality and quantity of

Canada’s human capital, standard of living, and completive taxation rates will never be

compromised.

This program has been a centerpiece of fiscal federalism and has been an

essential tool for maintaining the Canadian Federation over the last half century.

Though Equalization has been an issue of strife in the relations between the provinces

and the federal government, this program is currently a major issue in federal public

policy. This issue has come to a head recently as it presently threatens to remove the

Government of Stephen Harper. How does this pose such a threat to the federation of

Canada and how can this be resolved? Though there is no one solution to such a

diverse problem, after extensive examination of some of the most prevalent proposals

by the most predominate experts in the field, we have committed ourselves to

advocating our own set of solutions.

 -2-

The main problems perplexing the finding of a coherent and agreeable solution

for the policy problem are: transparency, natural resources, provincial-federal

agreements and accords, tax base analysis, constitutionality, legitimacy, equity, and

reasonability. We examined five proposals in light of these inherent problems, by five

separate agencies or individuals, including: The Exert Panel on Equalization and

Territorial Formula Financing, The Advisory Panel on Fiscal Imbalance, Thomas J.

Courchene, Donald Drummond, and Robin Boadway. After analyzing these proposals,

by using four analytical tools – equity, effectiveness, manageability and

implementability, and legitimacy and political feasibility – we were able to arrive at our

own solutions.

We believe that the policy recommendations offered will develop a sound and

effective program that will establish a firm and sustainable foundation for the future of

fiscal federalism in Canada. Seventeen recommendations have been made covering

the main points that any future program must be founded on the historical principles of

equalization, the return to a calculation-based formula, the Representative Tax System,

the inclusion of all ten provinces and all natural resource revenues in determining the

size and the scope of the program, and the establishing of an independent commission

to oversee the continuation of the Equalization program and to uphold its legitimacy.
 -3-

INTRODUCTION TO FISCAL FEDERALISM

Equalization is reflective of the very principles upon which Canadian Federalism

was formed; unity and cohesion despite the obvious uniqueness between the regions of

Canada. That unity is derived from shared values and a collective well-being. The

unique diversification of populations, natural resources, and industry across the

Canadian provinces produces drastic and systemic disparities in the abilities of

provinces to raise revenues to provide for their population. Due to the structure of the

Canadian tax system, revenues can be raised from limited sources; some provinces

have strong industrial sectors and therefore produce more revenues from income and

corporate taxes, whereas others lack the financial strength in taxable areas of their

economy to raise sufficient revenues.

Despite these differences, it is important for the maintenance of federalism in

Canada to ensure that Canadians in all provinces receive and have access to roughly

the same level of social services – such as social assistance and education – without

being taxed at excessive levels. It has been said that “money is the life’s blood of

governments”1; this is certainly true when considering the division of the responsibilities

between the federal and provincial levels of government, the fact that the majority of

taxing powers lay in the hands of the federal government, and the resultant need for

funding for social programs provided by provincial governments. Given this reality, it is

the duty of the federal government to provide for its provinces, and to ensure that this

process is fair and equitable for all Canadians.

Although the principles of equalization can be traced back as far as

Confederation with the division of legislative powers based on the principle of

 -4-

‘coordinate federalism’, Equalization itself was enshrined in the Canadian Constitution

for the first time in 1982. The purpose of equalization is to allow provinces to provide

“comparable levels of service at comparable levels of taxation”, as described by

Subsection 36, paragraphs 1 and 2 of the Constitution Act, 1982:

“(1) Without altering the legislative authority of Parliament or of the provincial

legislatures, or the rights of any of them with respect to the exercise of their
legislative authority, Parliament and the legislatures , together with the
government of Canada and the provincial governments, are committed to (a)
promoting equal opportunities for the well-being of Canadians; (b) furthering
economic development to reduce disparity in opportunities; and (c) providing
essential public services of reasonable quality to all Canadians.”

“(2) Parliament and the government of Canada are committed to the principle of
making Equalization payments to ensure that provincial governments have
sufficient revenues to provide reasonably comparable levels of public services at
reasonably comparable levels of taxation.”

Today, equalization is the federal government’s primary instrument for reducing

fiscal disparities between the ‘have’ and the ‘have not’ provinces. Equalization, as it is

known today, is the product of a philosophical and structural evolution that has taken

place over several decades. There are a number of other vehicles for reducing fiscal

disparities; equalization is just one of four major federal transfer programs. The others

are the Canada Health Transfer, the Canada Social Transfer, and the Territorial

Formula Financing (TFF) - the main source of revenue for territorial governments.

The Canada Health Transfer is the primary federal transfer to provinces and

territories in support of health care; the allotment of funds to provinces is based on per

capita instalments to ensure equal support for all Canadians regardless of their place of
 -5-

residency. The program totalled $31.8 billion in 2006-07, and is set on an escalator of

six per cent annually.

The Canada Social Transfer is a block transfer to provinces and territories in

support of post-secondary education, social assistance and social services, including

early childhood development and early learning and childcare; the allotment of funds is

again on a per capita basis and totalled $15.7 billion in 2006-07.

The Territorial Formula Financing program is an annual unconditional transfer

from the Government of Canada to the three territorial governments to support the

provision of public services. A new financial "framework" for TFF was legislated with

overall TFF payments calculated based on historical data, predetermined at a minimum

of $1.9 billion for 2004-05 and $2.0 billion for 2005-06. These last three federal transfer

programs are specifically targeted by the federal government to deal with burgeoning

disparities in particular areas of social services. There are two main differences

between these three programs and equalization: equalization is enshrined in the

constitution, and it is designed to be unconditional.

PRINCIPLES OF EQUALIZATION

The distribution of federal funds to provide comparable levels of service at

comparable levels of taxation has manifested itself according to the following six core

principles which can be derived from both the constitutional indication and from the

structure of federal tax system; these principles comprise the overall guiding essence of

reducing inter-provincial disparities: (1) Equalization is funded entirely by the federal

government using taxes paid from all across the country. (2) The basis for determining
 -6-

need is to assess the financial capability of provinces, also referred to as the revenue-

raising ability or fiscal capacity to deliver public services; provinces that have a lower

ability to pay for comparable levels of public services receive payments while others do

not. (3) Due to provincial jurisdiction, payments are unconditional and, as such,

provinces have full discretion over these funds to use them as they see fit. (4) The

equalization program is designed to be permanent in its distributing of funds; the

program is meant to stand the test of time and effectively raise the fiscal capacities of

provinces depending on changing economic capacities. (5) This being said, equalization

entitlements are not designed to be permanent; as a province’s aggregate wealth

increases, so do taxable revenues, and therefore entitlements decrease relatively. (6)

Provinces are supposed to move in and out of the program depending on their changing

economic capacities and their position relative to a common standard; if a province

develops more revenues and has a fiscal capacity higher than the common standard,

they do not receive a payment. Conversely, provinces with fiscal capacities above the

common standard do not see any reductions in their fiscal capacities as a result of

Equalization.
 -7-

• Fiscal Capacity Explained

Since 1967, Canada has based the distribution of equalization on a fiscal

capacity measure known as the Representative Tax System (RTS) Index. This type of

index, introduced by U.S. economists in the early 1960s, measures the relative revenue

per capita that each province could raise if it applied a national-average tax rate as its

own. The tax bases include 33 different sources of revenue, including2:

1. Personal income taxes,

2. Business income taxes,
3. Capital taxes,
4. General and miscellaneous sales taxes,
5. Tobacco taxes,
6. Gasoline taxes,
7. Diesel fuel taxes,
8. Non commercial vehicle licenses,
9. Commercial vehicle licenses,
10. Revenues from the sale of alcohol
11. Hospital insurance premiums,
12. Race track taxes,
13. Forestry revenues,
14. New oil revenues,
15. Old oil revenues,
16. Heavy oil revenues,
17. Mined oil revenues,
18. Third-tier oil revenues,
19. Heavy third-tier revenues,
20. Natural gas revenues,
21. Sales of crown leases,
22. Other oil and gas revenues,
Generally, the revenue a province is capable of 23. Mineral resources,
24. Water power rentals,
raising from each of these sources is calculated at a 25. Insurance premiums,
26. Payroll taxes,
27. Provincial-local property taxes,
100% value of most taxable sources, and at 50% of 28. Lottery ticket revenue,
29. Other games of chance revenues,
others. The differences between the 50% inclusion 30. Provincial-local taxes and revenue,
31. Offshore activities/Newfoundland,
versus the 100% inclusion of certain revenues has 32. Offshore activities/Nova Scotia,
33. Preferred Share Division

become highly controversialized in recent years and will be discussed later on. The

calculation of fiscal capacity is then converted to a per capita basis, which allows

officials to compare the fiscal capacity of provinces with differing populations.

 -8-

BRIEF HISTORY OF EQUALIZATION

The devastating effects of the depression created the need for increased social

programs and public infrastructure. As the majority of these programs fell under

provincial jurisdiction, and the majority of the taxing powers were possessed by the

federal government, the sudden gap developed between the expenditure needs of

provinces and the revenue-raising abilities of those provinces. Thus glaringly obvious

fiscal disparities between provinces developed, and reinforced the need for the

constitutionally embedded “coordinate federalism”. The 1940 Rowell-Sirois Commission

was established to recommend actions to be taken by the federal government after the

Great depression to deal with the virtually bankrupt Prairie Provinces. The Commission

recommended that a program should be created to provide annual grants to the

provinces based on their fiscal needs. This program however was not fully

implemented until after World War II.3 The Commission concluded:

“Under the federal rationale, the provinces must have revenues sufficient to
exercise the powers assigned to them under the Constitution. Under the
citizenship rationale, Canadians, wherever they live, must have access to
certain key economic and social rights; for those rights that fall under
provincial jurisdiction, provinces should have access to adequate funds to
provide them.”(p1)4

The basic determination made is that it is the responsibility of the federal government to

ensure the equalizing of quality and access to key social programs for all Canadian citizens,

even though these may fall under provincial jurisdiction.

In 1957, Equalization was finally established as a recognizable, formula-driven

program; in which provinces received a grant from the federal government if their per

capita revenue from personal income tax, corporate income tax, and inheritance taxes

was less than the per capita average of what the two richest provinces of the day
 -9-

(Ontario and British Columbia) could raise at the same tax rates. The program was to

be reviewed every five years.5 In the 1962 renegotiations, the PIT share entering the

formula was increased to 16 percent (rising to 24 percent by 1967); one-half of

provincial revenues and taxes from natural resources also entered the formula. At the

same time, the national average became the equalization standard. In fiscal year

1964/65, the equalization standard again reverted to the top two provinces. In addition,

resources were pulled out of the formula and provinces were entitled to equalization

only to the extent that their per capita entitlements exceeded 50 percent of the amount

by which their per capita resource revenues exceeded the national-average level.6

The 1967 fiscal agreements created the representative-tax system approach,

which is still emplace, with the national average as the equalization standard based on

a 16 provincial revenues resources included. In 1977 the RTS was restructured to

include 29 specific revenue resources with 50% of all energy revenues being included

as opposed to 100% do to the energy shock in the early 1970’s. As a result of the 1977,

Ontario qualified to receive equalization payments. This was corrected by: (1)

retroactive legislation striping Ontario of its entitlements. (2) The removal of Alberta from

the averaging equation and also the Atlantic Provinces. The result, was the five

province standard (FPS). This also included all municipal and natural resource

revenues within the five provinces (1982).7 The 1982 creation of the Constitution

prompted changes in the calculation process primarily the introduction of ceilings and

floors. As the Canadian welfare state expanded and the province’s role within this

increased so did the equalization program – based in citizen rationale. The importance

of equalization also increased as it became evident that without compensatory

 - 10 -

payments to the “have-not” provinces, large divides in social program quality would

have been created. This is largely due to the limited tax based maneuverability – feds

fighting the deficit. The provisions that were created in 1982 are designed to limit the

effects of both internal and external shifts in the economy, also to depoliticize the

process.8

Due to the rising costs of oil prices – as continually driving the national average

standard higher and higher- and increasing government expenditure in the time of

global recession, the government began to focus on reducing the size of the

equalization program. “In 1982, a number of significant changes were made. First and

foremost, Equalization became part of Canada’s Constitution. Second, the standard

was changed. Instead of a national average or 10-province standard, five-province

standard was introduced based on the average of Québec, Ontario, Manitoba,

Saskatchewan, and British Columbia. This new standard excluded the highs and the

lows in fiscal capacity of the provinces (taking out oil-rich Alberta and the less-wealthy

Atlantic provinces) and focused instead on the middle range of provinces. This reduced

the costs to the federal government of including 100 percent of resource revenues in the

Equalization formula.”9

• The Five-Province Standard

Equalization payments were calculated according to a formula set out in federal

legislation and regulations. Provinces with revenue raising ability, or "fiscal capacity",

below a threshold or standard amount received would qualify to receive Equalization

payments from the Federal Government to bring their capacity up to that standard: The
 - 11 -

standard was the calculated average fiscal capacity of the five "middle income"

provinces – Quebec, Ontario, Manitoba, Saskatchewan and British Columbia – based

on the RTS 33 revenue sources format. The “middle provinces” are referred to as such

because they represent the centre of a ten province fiscal capacity scale. The 1977

Energy shock caused the fiscal capacities of provinces to shift drastically, the inclusion

of Alberta into calculations resulted in Ontario qualifying to receive equalization

payments; this was corrected by the retroactive legislation retracting Ontario of its

entitlements and the removal of Alberta and the Atlantic Provinces from the averaging

equation. It is also important to note that this was the point at which natural resources

were included at 50% value rather than 100% to deal with the sudden instability caused

by the energy shock. Equalization payments were also subject to a "floor" provision,

which protected individual provinces against any large year-to-year declines in

payments. The results of the five province standard are depicted below10; Ontario and

Alberta do not appear in this illustration because they do not receive payments.

YEAR NL PE NS NB QC MB SK BC Total
1993-94 900 175 889 835 3,878 901 486 0 8,063
1994-95 958 192 1,065 927 3,965 1,085 413 0 8,607
1995-96 932 192 1,137 876 4,307 1,051 264 0 8,759
1996-97 1,030 208 1,182 1,019 4,169 1,126 224 0 8,959
1997-98 1,093 238 1,302 1,112 4,745 1,053 196 0 9,738
1998-99 1,068 238 1,221 1,112 4,394 1,092 477 0 9,602
1999-00 1,169 255 1,290 1,183 5,280 1,219 379 125 10,900
2000-01 1,112 269 1,404 1,260 5,380 1,314 208 0 10,948
2001-02 1,055 256 1,315 1,202 4,679 1,362 200 240 10,310
2002-03 875 235 1,122 1,143 4,004 1,303 106 71 8,859
2003-04 766 232 1,130 1,142 3,764 1,336 0 320 8,690
2004-05 762 277 1,313 1,326 4,155 1,607 652 682 10,774
 - 12 -

CURRENT STATE OF EQUALIZATION – “The New Framework”

Due to formula-based assessments of fiscal capacities, as would be expected, as

Canada’s real GDP increases, taxable revenues increase, and thus the fiscal capacities

of provinces consequently increase. According to the principles of equalization, the size

of the payment pool should decrease as a result of the increased fiscal capacities, but

not by much; as the fiscal capacities of the ‘have not’ provinces increase, so does the

common standard. Because there are more ‘have not’ provinces with increasing fiscal

capacities (i.e. Nova Scotia, Newfoundland, Saskatchewan) than have provinces with

increasing fiscal capacities (i.e. Alberta), the overall payment pool will decrease in

numbers as the gap between the standard and the fiscal capacities of receiving

provinces is shrinking. In 2004, receiving provinces with increasing fiscal capacities saw

their transfers decrease and, although they were partially protected by the ‘floor’

provision, they accused the federal government of “clawing back” their equalization

payments.11 Concurrently, non-receiving provinces contested the continued issuing of

payments, given the apparent closing of the horizontal fiscal gap, complaining that they

were “net contributors” to the system.12

As a result of the 2004 First Ministers Meeting and the reoccurring federal

surplus, in October 2004, the Government of Canada announced a “new financial

framework" for Equalization following two meetings of First Ministers. As outlined in the

New Framework a number of important changes occurred; normal formula-based

calculations of provincial entitlements were suspended, provincial payments shares for

2004-05 were fixed based on historical data on the 2000-01 pool size of $10.9 billion set

to a growth rate of 3.5 percent over a ten year period, a floor provision was introduced
 - 13 -

at $10 billion, and a provisional formula was used to distribute payments for 2005-0613.

For those provinces that saw a decline from the amount they had been advised of in

November 2005, a one-time adjustment would be made to offset this decline.14 Before

the changes in 2004 the formula was measured on the per capita capacity of provinces

using the RTS. A review of the Equalization program by an independent Expert Panel

was announced. The Panel submitted its report in Spring 2006. The New Framework

would be extended to determining factor of entitlements for 2006-07. Following

consideration of the report of the Expert Panel and consultations with provinces, a new

allocation formula is supposed to be introduced for 2007-08 and beyond.

YEAR NL PE NS NB QC MB SK BC Total

2005-06 861 277 1,344 1,348 4,798 1,601 82 590 10,900

2006-07 687 291 1,386 1,451 5,539 1,709 13 459 11,535

2.
Figures for 2006-07 are as proposed in Budget 2006 and include one-time adjustments.

• Problems with the 2004/2005 New Framework

There are a number of inherent problems with the abandonment of a calculation

based formula for entitlements and a fixed pool entitlement calculation; common

criticisms of the “New Framework” are: that it creates Provincial dependencies on said

transfers and results in decreased efficiency in provincial programming as they are

guaranteed to be receiving continuous and expansive transfers. Also, it defeats the

two principles of equalization in that it allows Provinces to continue to differ in levels of

taxation with retaining the same payment, and does not ensure equal quality of social

programs. It institutes continued unfairness to the 'have' provinces: Ontario and Alberta.
 - 14 -

The most critical error of this new framework is that it provides guaranteed funds, which

does not account for possible future economic instability; the result is that the federal

government may be legislating funds that it may not have in the future, or, more simply

put, counting its chickens before they hatch.

The New Framework’s main implication was that “the interim allocation does not

have a common standard to which all provinces are compared and raised. Instead, the

standard varies for individual provinces depending on their former shares (over the last

three years) of total Equalization funding, regardless of changes in their relative fiscal

capacity. As a result, some receiving provinces receive more and others less than they

would have if the previous Equalization formula had been applied.”15 From the fiscal

year of 2006-07, the Federal government of Canada will provide fiscal transfers to the

provinces and territories in upwards to $61 billion through all major cash and tax

transfer programs; including Equalization.16 Under the present program eight provinces

in 2006-06 qualified to receive equalization payments totaling $10,900,000, which will

increase to around $11.5 billion for the fiscal year of 2006-07.17

• Offshore Accords

As a result of the declining equalization entitlements for Newfoundland and Nova

Scotia due to the newly developed offshore oil resources, the Federal government has

made agreements with the two provinces to effectively exempt them from declining

entitlements through the 2004 Offshore Accords. The purpose of the Accords, as they

were developed, was to protect the two provinces from losing any revenues gained from

petroleum revenues at the expense of equalization payments, until each of the

 - 15 -

provinces is “sufficiently able to establish its respective offshore petroleum industries”.

Furthermore, the Federal government would provide finical support to the provinces for

developing their natural resource industries. The agreements made with the federal

government states that the Government of Canada recognizes the “unique economic

and fiscal challenges” faced by Nova Scotia and by Newfoundland and Labrador and

“the strong commitment of the province to improve its fiscal situation”.18 The basic

tenets of the Accords are that the Government of Canada “intends to provide additional

offset payments to the province[s] in respect of offshore-related Equalization reductions,

effectively allowing [them] to retain the benefit of 100 per cent of [their] offshore

resource revenues”19

ISSUES & ACTORS

The “new framework” and the offshore accords are generally perceived as

reactive policies to counter a heavily politicised issue. Given the highly politicised nature

of this system, there are a number of concerned and affect actors to consider, each with

its own set of goals, needs, demands, and leverage. No one actor is completely right,

and an effective equalization strategy must take all actors into account and create a well

balanced synthesis of their concerns, while still adhering to the over-arching principles

and goals of fiscal federalism.

(1) The Federal Government is bound by its constitutional responsibilities and,

whereas this may be open to interpretation, may have a responsibility, at least in

the public eye, to settle any perceived “vertical fiscal imbalance” that may exist.

There is therefore much pressure from the provinces to act in conflicting ways.
 - 16 -

The fact is that pressure from the provinces is representative of the fact that

Equalization, among the other transfer programs, has become a political tool

used to win over the public.

(2) Provincial Governments are ideological, self-motivated, creating situation based

assessments depending on their constantly changing economic position, altering

their constitutional interpretation of their right to entitlements.

(3) The Canadian citizen is often confused about the process and calculation of

Equalization, the responsibilities of government, and where the money comes

from. Public opinion is value oriented when it comes to fiscal matters, provinces

will often remind the people of Canada of their constitutional rights when it comes

to receiving entitlements.

(4) Extra-governmental and Non-Governmental Actors are contracted to conduct

studies regarding equalization including: CD Howe, the Council of the

Federation, the Expert Panel, independent banks and policy organizations. Each

will produce reports describing the system of Equalization, attempting to simplify

or clarify the program for the layman, and suggests policy solutions based on

different information, depending on the perspective of its design. For example,

the report conducted by the Council of the Federation necessarily conflict with

that of the federal government because this organisation represents the

provinces.

As this is a fiscal matter, and although the issue has been politicized, it can be

concluded that all actors are generally self-interested; dollars mean votes in this case.
 - 17 -

Structurally speaking a Province’s positions will certainly be altered to a large extent by

their characteristics and attributes.

There are essentially two main distinctions that create a four section matrix for

determining a provinces interest: Richness of natural resources and position in the

process as either a receiving or non-receiving province. In this evaluation there are

provinces that are natural resource rich, provinces that are not rich in natural resource,

provinces that are traditionally receiving will, and provinces that are non-receiving will.

Under what classification a specific province falls under is presented in Figure 1.

Figure 1:

Tax base Natural resource Non-resource

resources heavy heavy

Position in
process

Receiving Newfoundland, Quebec*

Provinces Saskatchewan** Manitoba
Nova Scotia New Brunswick
P.E.I.
Non-receiving Alberta Ontario
Provinces British Columbia**
*
*Large amount of Natural resources, but open for interpretation.
**Sometimes receiving, some times not.
 - 18 -

ALTERNATIVE POLICY PROPOSALS:

(1) "Achieving a National Purpose: Putting Equalization Back on Track"20 Expert Panel
on Equalization and Territorial Formula Financing, Consultations and
Communications Branch of the Department of Finance, Canada (May 2006)

(2) "Reconciling the Irreconcilable: Addressing Canada’s Fiscal Imbalance"21 Advisory

Panel on Fiscal Imbalance, The Council of the Federation

(3) “Variations on the Federalism Theme”, Thomas J. Courchene, Senior Scholar at

the Institute for Research on Public Policy.

(4) "What a Tangled Web We Weave" Don Drummond, Senior Economist TD Canada
Trust

(5) "Two Panels On Two Balances." Robin Boadway, professor in the Department of
Economics at Queens University.

1. Achieving a National Purpose: Putting Equalization Back on Track

The Expert Panel on Equalization and Territorial Formula Financing was created

by the Martin government in 2005 to independently review and asses the current state

of federal fiscal transfers to provinces. The Expert Panel completed there report on the

state of Equalization and provided recommendations for the improvement of the current

system in a report which was provided to the federal government in 2006. The Expert

Panel after an extensive review process constructed a list of 18 recommendations on

how the Equalization program could be improved; touching on such issues as the

principles of equalization, the calculations process, and improving transparency.

The Expert Panel stresses the need to return to a calculation based equalization

program in order to insure that the founding principles of the equalization program are

being achieved. This focus on a return to a rules-based, formula driven approach is

 - 19 -

embodied in the Panels recommendations two through five. First the Equalization

formula should be used as a tool to diminish the overall size of the current equalization

pool and determine the payments transferred to each individual province. Provinces

argue that a fixed pool creates stability and predictability for the federal government but

not for the receiving provinces, what they receive in transfers can be subject to drastic

fluctuation. A fixed pool juxtaposes the true intentions of the equalization program –

equalization is supposed to respond to the changing needs of the provinces. Secondly,

the formula must be based on a ten-province standard (TPS). Currently, this

recommendation holds support with almost all actors involved within equalization. The

TPS is a more natural standard which is reflective of the actual financial circumstances

of all ten provinces.

The previous FPS is seen as inadequate and was adopted for the soul purpose

of reducing the overall cost of the equalization program due to the high prices of oil in

the early 1980’s. The Panel recognizes that the inclusion of Alberta in the formula

through the TPS will raise the overall cost of the program in comparison to a FPS,

however, if these cost exceed what the government is willing to spend there are specific

actions that can be taken to reduce the cost of the program; such as scaling back on a

per capita basis. Thirdly, the equalization formula should only focus on the fiscal

capacity of provinces as opposed to their individual expenditure needs. A needs-based

approach would require the federal government having detailed access to information of

programs which are autonomous to the provinces; this would lead to increased

complexity and conflict among jurisdictions. Fifthly, The Panel also suggests that

Equalization should be the primary vehicle for federal transfers to the provinces.
 - 20 -

Through the TPS, the Expert Panel recommends that the actual formula for

equalization be changes. These changes are to be attained through the use of the

Representative Tax System (RTS). This formula determines how much revenue a

province could raise on its own national average tax rates, and compares this to a given

national standard. If a province’s per capita revenue-raising capacity falls short of this

standard, Equalization fills the gap. The RTS provides an accurate measure of the fiscal

capacity of provinces, reflects the actual tax practices of the provinces, and is more in

keeping with the constitutional mandate of equalization of insuring “reasonably

comparable” levels of taxation, as opposed to a Marco-formula approach. However, do

to the complexity of a standard RTS formula; The Panel suggests that it should be

simplified in order to improve the transparency of the calculation process. As it stands,

a calculation based formula would include 33 different tax bases. The fear of the Panel,

is the over complexity of the tax bases system would lead to potential side deals and ad

hoc practices. In light of this increased transparency is needed and could be achieved

by creating an approach based on a four tax base system for all non-resource revenues

- personal income tax, property tax, business income tax, and sales tax - while including

natural resource revenues.

The issue of natural resource inclusion in the Equalization process is the most

hot button item within the program, in light of this the Panel recommends that that

balance be achieved between all conflicting views. The Panel does stress, however, the

importance of inclusion of natural resource revenues, as this does provide a net benefit

for the provinces that own them. Moreover, the panel also recognizes that the workings

of equalization should not compromise provincial ownership of resources. Equalization

 - 21 -

should not represent a barrier preventing provinces from developing their resources,

due to an immediate reduction in equalization payments as provincial resource

revenues increase. Resources present themselves as a tool to develop ones own

economy, and this needs to be acknowledged; this is why inclusion of these revenues

must not offset the provinces desire to develop said resources.

Based on this, the Panel supposes that fifty percent of provincial resource

revenues should be included in the determining of the overall size of the equalization

pool. This presupposes that total inclusion or total exclusion is unattainable within the

Canadian context. The main argument for only fifty percent inclusion is do to the

uncertainty of natural resource prices on a global market; as lows lead to fiscal

decreases for provinces and highs lead to a ballooning of the equalization pool making

it difficult for the federal government to afford the program. Furthermore, the federal

government does not want incentives or disincentives for provinces to develop their

natural resources and for them to adjust their royalty programs. The Panel also

recommends that the natural resource revenues involved in the formula be measure at

actual revenue rates as opposed potential market rates. The Panels final

recommendation with regard to natural resource revenues is the introduction of a

capping mechanism to ensure that no receiving province ends up with a fiscal capacity

higher then that of the lowest non-receiving province.

An additional issue of importance for the Panel is improving the stability and

predictability of the equalization program. The Panel first recommends that a one

estimate, one entitlement, one payment approach be used. This would solve the

problems of complexity and lack of efficiency embodied in the current entitlement

 - 22 -

system. Secondly, provinces stress that the equalization program needs to be reflective

of current economical circumstances while still maintaining relative stability in year-to-

year entitlements. To solve this issue, the panel recommends the establishing of three-

year moving averages combined with a two year lags in data. Using a three-year

moving average will ensure that changes in data are accommodated for on a continuing

basis. The Panel recommends that data used in the three-year moving average be

weighted on a 50–25–25 basis. This gives the highest weight to the most recent year

and makes the formula more responsive to changes in provinces’ financial

circumstances. The use of two-year lagged data will help improve the accuracy of the

data used to determine Equalization entitlements.

The issue of transparency as long been held has an inherent falsie of the

Equalization process as the calculation of and the distribution of transfers occurs behind

close doors. To remove this problem, the Panel suggests the establishing of a

permanent independent commission to oversee the program. The Panel believes that

an independent commission would be better equipped to provide the public, through

research and independent assessments, with information in manner that it can

understand.

2. Reconciling the Irreconcilable: Addressing Canada’s Fiscal Imbalance

The Council of the Federation was created in Charlottetown in 2003 by the

Premiers of Canada. The council was created as a new tool “for a new era in

collaborative intergovernmental relations”22 in Canada. One of the main portfolios

handed to Council was that of the Advisory Panel on Fiscal Imbalance. The report that

was created by the Advisory Panel covered the two main issues pertaining to the fiscal
 - 23 -

imbalance of Canada; the horizontal and vertical imbalances. For the purposes on this

policy paper, only the proposals dealing with the horizontal fiscal imbalance will be

covered.

The Horizontal Fiscal imbalance, as defined by the Advisory Panel, identifies that

there exists substantial differences in the revenues raising capabilities of the provinces

which results in imbalances between province with regards to social programs and

human capital. The main mechanism which is used by the federal government reduces

fiscal disparities among provinces is Equalization. The panel recognizes, along with

most provinces, that the current New Framework falls considerable short of fulfilling the

guiding principles for Equalization. The main problems with the current framework

pertain to the matters of the fixed pool, the annual exposition of the pool, and the

distribution of equalization.

The main focus of the Panel was that a comprehensive and inclusive formula be

developed in order to re-establish the legitimacy and equinity to the equalization

program. This all inclusive formula for equalization is to include the TPS and all

provincial resource revenues (TPS+100). This is to be achieved by measuring the fiscal

capacity of a province as defined by its resource raising revenue capabilities of a

province based on the 33 revenues tax base or the RTS. Furthermore, the Panel

recommends that the TPS be used, instead of the FPS, as it is more comprehensive

and takes a more equitable and accurate “snap shot” of the discrepancies between all

provinces.

As with the Expert Panel, the Advisory notes that natural resource revenues are

the most controversial component of the Equalization debate, and thus gives this item
 - 24 -

particular attention. The Council of the Federation presents five options with regards to

the calculation process of Equalization and the extent to which natural resources are

included in that process, these are 100, 70, 50, 25, and 0 percent. The Panel proclaims

that the use of a FTS with 100 percent inclusion rate would result in equalization

payments in total of $9.3 billion, which is slightly less then payments under the New

Framework. If a TPS was to be used with the inclusion of 100 percent natural resources

it would result in a program expansion around 15.1 billion per annually. “The ten-

province or national average standard with comprehensive revenue coverage provides

the most accurate and the fairest measurement of fiscal disparities. It is the only way to

equalize fully fiscal capacity across provinces. In terms of transparency and fairness,

the ten-province standard works best.”23

The Panel acknowledges that the adoption of the TPS at a 100 inclusion rate

would raise issues of affordability for the federal government, as this would increase the

program by $5.7 billion. The TPS +100 would also be very volatile as it would be very

reactive to energy prices. In order to reduce the unpredictability of a formula-driven

approach, hard-information needs to be continuously interjected into calculations. The

Panel addresses the issue of volatility by suggesting the use of a three-year moving

average on all revenues bases, lagged by two years to allow government’s to anticipate

and plan more effectively.

Furthermore, the issue of increased costs is also created by the TPS +100, as

the overall size of equalization increases the federal government’s expenditures.

However, The Panel believes that any exclusion of natural resources from the equation

reduces the equity and the legitimacy of the program. Reducing the inclusion rate
 - 25 -

reduces the overall size of the program and increases the fiscal capacity of some

province, Newfoundland and SK, above the calculated national standard. To reduce the

overall costs of the program the Panel “believes that the best course in these

circumstances would be to scale back the standard. Reducing the overall cost in this

way would not change the distribution of fiscal resources among the provinces; it would

simply lower on an equal per capita basis the amount all received.”24 The scaling rate

upholds equitability by holding all provinces in the same relative position in comparison

to others.

The final important recommendation that the Panel provides is the creation of two

independent commissions in order to better manage its intergovernmental fiscal

relations effectively. The first commission to be created is the First Ministers’ Fiscal

Council (FMFC). The principle purpose of the FMFC is to be the primary vehicle for

which Canada deals with intergovernmental fiscal issues holding continuous and regular

meetings between the Prime Minister and the Premiers. Second is the creation of the

Canadian Institute of Fiscal Information (CIFI). The role of the CIFI would be to

undertake analysis and the gathering of quantitative information on fiscal federalism at

the discretion of the FMFC.

3. Variations on the Federalism Theme

Thomas J. Courchene is one of the most notable academics in the field of public

policy and has written extensively on the topic of equalization. Courchene is currently a

member of the faculty at the Queen’s University Policy Studies department and is the

Senior Scholar at the Institute for Research on Public Policy. His works have been
 - 26 -

reviewed extensively by both government and the independent advisory commissions

on Equalization. But in comparison to the previous policy proposals outlined above,

Courchene holds numerous differences. The first major difference is that Courchene

supposes that equalization should focus on the development and standardizing of

human capital among provinces at a national standard.

Courchene believes that Equalization should be the only federal transfer program

to the province, this as an inherent problem as some provinces will be viewed in a

different light then others with regards to per capita amount of fund being distributed.

For Example, the CHST is a per capita transfer system which views all Canadians as

equal; this transfer should not be used as a mechanism for regional

improvement/equalization.25 Furthermore, each individual program should be calculation

to up hold Fiscal Neutrality. Presently, according to Courchne, if provinces do not

receive what they desire out of the equalization program they can use back door

negotiation to receive increased transfers through other programs such as the

CHT/CST. In the current state of equalization, provinces through the negotiation

provision of the New Framework are able to persuade the federal government to give

their specific province an increased share of the pool.26

The lack of fiscal neutrality within the New Framework raises serious questions

about its legitimacy, equalization is supposed to be held as completely neutral through a

formula based system. There are two was that the federal government can accomplish

fiscal neutrality. (1) To amalgamate all provincial transfers into the equalization

program. (2) The establishment an over-reaching equalization program to allow non-

neutral transfer programs to persist while effecting transfers under the Equalization
 - 27 -

program. For example, if one province needs specifically an increase in EI due to

increase unemployment rates, thus the amount need would decrease that provinces

overall equalization by an equal amount.27

Courchene also holds that the fiscal needs of the provinces have not been met

by any previous Equalization program and that equalization should not only bring the

“have-nots” up, but also bring the “haves” down. The inclusion in equalization of the

greater expenditure needs of provinces as never been fully assessed, thus meriting

additional revenues to some provinces above the equalization them receives. Moreover,

many provinces are involved in extensive and costly program initiative to improve

human capital that need to be taken into account. Each individual province has different

expenditure needs and societal demands. Courchene suggests that Equalization, in a

similar fashion to the CHT/CST, could also distribute funds on the per capita basis of

expenditure levels of provinces. There Main problem with this is the conditionality of

increased transfers base on conditionality. If this was to occur there could be a

reduction in fiscal transfers to “have-not” as based on their expenditure needs.

Courchene also outlines a two tiered approach in light of the horizontal balance

to deal with issues of the New Framework and the increasing importance of natural

resources in Canada. The first tier would incorporate only the equalization of non-

resource revenues, base on the RTS. This would be established on the NAS formula

and would be finance by the federal government. The second tier would be a voluntarily

negotiated inter-provincial resource-revenue sharing pool operated and would be run by

the provinces. This would only incorporate 20% of all provincial resource revenues.

Drawing form this pool would be based on per capita shares. This second tier would be
 - 28 -

beneficial for most non-natural resource reliant provinces; for example do to the over

whelming size of Ontario’s population it would mostly receive more expenditure from the

pool then it committed. 28

4. What a Tangled Web We Weave

Donald Drummond is the Senior Vice-President and chief economist of the TD

Bank Financial Group and expert on Equalization and Fiscal federalism. Drummond

focuses on the notion of a fiscal imbalance within the federation and how it is now all

provinces that perceive that there is a fiscal imbalance and it is no longer the “have-not”

provinces advocating such an issue. He focuses on the over reliance of some provinces

on federal transfers to finance programs as these provinces, as a trend, have less

incentive to curtail cost increases or increase cost efficiency with regards to programs

when they can turn to outside financial sources.

Do to this dependency, Drummond believe that Provinces should become more

accountable for there spending. To achieve efficiency and accountability of provincial

spending on social and health programs the federal government should allow for more

provincial tax room. However, Drummond is also cautious as tax point transfers at the

federal level will deprive the federal government from highly important tax revenue and

could have the potential of send the federal government into another deficit. Also

provinces may not perceive tax transfers as a contribution to the fiscal imbalance.

Nevertheless, in the case of Ontario, it is better to receive tax credit transfers then

receive fiscal transfers from an increase transfer program, as Ontario represents 43

percent of federal revenues. It is in the best interest of Ontario to receive tax point
 - 29 -

transfers from the federal government to make Equalization more equitable.29 Tax

transfers allow province more autonomy through there spending and allow them to

achieve more competitive tax rates.

Though Drummond does focus on tax transfers more so then others, he also

believes that equalization does hold a strong place in fiscal federalism. That

Equalization is still the main mechanism alleviate the fiscal discrepancies between

provinces. Drummond’s main focuses on the equity of the programs by specifically

looking at the position of Ontario. The equity of Equalization is not one which is meant

to harm non-receiving provinces in order to aid the “have-nots”, though presently

Ontario as the lowest spending per capita then any other province.30 To uphold the

evenhandedness of the program for all provinces, Drummond suggests that the Expert

Panel’s inclusion of 50% of natural resource revenues at a TPS should be sufficient with

the use of a capping mechanism to insure that the program doesn’t balloon and that no

receiving province has a fiscal capacity larger then any non-receiving province.

Furthermore, Drummond suggests that the overall size of the equalization pool be

established by upfront payments by the provinces. If the provinces receive large tax

transfers from the federal government, it would be up to the provinces to pay on a per

capita basis for Equalization. As this involves large changes to the traditional structure

of Equalization, Drummond proposes that the government use incrementalist change to

implement such a program.

 - 30 -

5. Two Panels on Two Balances

By far, out of all the policy proposals that were reviewed, that of Rodin Boadway

held the most fundamental prescriptions. As a professor in the Department of

Economics at Queen’s University, Boadway’s recommendations are highly economical

based; as is seen in his article for Policy Options. Within his article “Two Panels on Two

Balances” Boadway begins by examining the role of natural resources in the

Equalization formula

For Boadway natural resources are the key aspect of conflict amongst province

and the Federal government and hence should be excluded from equalization, but not

just for this reason alone. The inclusion of natural resources holds very little legitimacy

in light of the constitution as provinces hold authority over natural resources. For

Boadway this establishes a grey area for the formulation process as it is the pricing and

the development of the resource which are under the authority of the provinces.

Furthermore, Boadway explains that the inclusion of natural resources in the

Equalization program will result in diminished incentives of provinces to develop there

natural resources. Though a province maybe reluctant to develop a resource as this will

equate into lowered Equalization payments, in a cost-benefit analysis and opportunity

cost analysis the initial loss of equalization is much less then the revenues to be

received in the long run. Secondly the real disincentive for provinces is whether to

explore for resources rather than to develop them once found, as once they are found

there possible revenue potential could be incorporated in to the calculation process of

Equalization.
 - 31 -

The issue of measurability, effectiveness, and cost are also reasons for the

exclusion of natural resources. First, a dilemma of measurability arises as the over

complexity of the price setting and tax revenue capacity of natural resources is called

into question. Royalties are difficult to translate as the extraction costs and the market

prices fluctuate between different types of resources. Secondly, the inclusion of natural

resource reduces the overall cost of equalization for the federal government. However,

this can only go so far as the federal government receives more tax revenue from the

cyclical motion of capital in the economy through investment and purchasing for the

initial increase revenues for natural resources. Furthermore, the government also has

the ability to increase tax revenues through increasing income tax rate. Lastly, the 10-

province standard is reduced to a mire formality due to the Expert Panel’s inclusion of

claw back mechanisms and cap, hence becoming ineffective.

Boadway also states that is of narrow focus to look at the horizontal fiscal

imbalance only in terms of equalization, to amend this issue the CHT/CST system of

(roughly) equal per capita transfers must be analyzed as well. An equal per capita

transfer scheme financed by federal government’s general revenues meets many of the

criteria for a good equalization system, and in some key ways outperforms the

Equalization Program itself. It is essentially a system of net equalization, and is as

simple a system as one can imagine.31 Boadway, in order to finace such a system, call

for the federal GST and provincial sales taxes to be consolidated into a national GST

(NGST). This would be accompanied by an explicit revenue sharing arrangement

whereby a share of NGST proceeds would go to the provinces (as in the Australian

case). The share either could be turned over on an origin basis, in which case it would
 - 32 -

be equalized as own-source revenue, or it could be given in equal per capita amounts to

the provinces, which would be a superior form of equalization. 32

POLICY GOALS

“to provide comparable levels of service at comparable levels of taxation”

1. Equity & Accuracy

Is the program a true reflection of the over-arching goals of equalization?

Does the program distribute equal benefits and costs among all participating actors?

2. Effectiveness

Is the program easily implemented?

Does the program meet all primary goals of Equalization?

3. Manageability

Is the program easily implementable and easily maintained?

4. Legitimate & Politically Feasibility

Given the constitutional embeddedness of equalization, the provincial reliance on such

payments, the politicized nature of equalization policy, and the number of actors

involved, is the program politically feasible?

Is the program legitimate and accountable to taxpayers and provinces?

 - 33 -

COMPARING THE ALTERNATIVES

The Expert Panel:

Equity: The use of the TPS as a provision for a return to a calculation based

formula or the RTS is a very positive note, as this would create an Equalization program

that is reflective of the true position of provinces and the Canadian economy as a whole.

Another positive note is the use of a cap provision to prevent receiving provinces from

having a fiscal capacity larger then that of any non-receiving province. The use of only a

fifty-percent inclusion rate of natural resource receives merits mixed results. First, the

fifty percent inclusion rate does not provide an accurate depiction of the revenue raising

capabilities of the provinces. Secondly the inclusion of only fifty percent of natural

resources at actual tax rates can lead to provinces tax bellow market standards. Lastly,

the Exert Panel seems to neglect the 2005 Offshore Accords and how to implement

their policies in light of that fact, thus leaving it open for interpretation that the member

provinces of said agreements could have fiscal capacities larger then Ontario until 2012.

Effectiveness& Accuracy: The Expert Panel’s proposals also receive mixed

results in whether they truly reflect the goals of the equalization program. The use of a

TPS or NAS achieves an accurate picture of the revenue raising capabilities of the

provinces and their ability to provide comparable public services. Nevertheless, the fifty

percent inclusion rate does not provide an accurate picture and enables some province

to surpass the standard while still receiving transfers. In comparison to the New

Framework, this proposal is much more effective at achieving the goals of equalization

within a reasonable budget.

 - 34 -

Manageability/ Implementability: The fifty-percent inclusion rate increases the

implementability of this proposal, as it is likely to receive varying levels of support from

all provinces. However, the absence of policy to address the Offshore Accords lessens

the likeliness of Ontario signing on. The program is seen to be manageable in the long

run as it holds the three year averages and two year lag, but the simplification of the

RTS adds increased difficulties in setting standards and averages for tax revenue prices

especially for natural resources.

Legitimate & Politically Feasibility: A strength and a weakness of this policy is

the establishing of an independent council; its transparency leads to legitimacy while it

suffers from a lack of political feasibility as governments do not like to weaken their

positions policy programs. Another strength of the program is the transparency that is

created by the simplification of the RTS which leads to a better general understanding

of the inner workings of the program.

The Advisory Panel:

Equity: By far the policies proposed by the Advisory Panel can be seen as the

most equitable. The panel calls for a calculation based formula on a TPS + 100 and the

RTS in its true form; creating an Equalization formula that is a direct representation of

the fiscal capacity of all provinces. Though this presents an expanded fiscal mandate for

the federal government, the scaling back average allows the federal government to

manipulate the overall costs of the program to a small extent. This program,
 - 35 -

nevertheless, can be seen as unfair for Ontario as the federal revenues from their tax

payers would largely be used to finance such an expansion. The Panel also suggests

that Offshore Accords hold no legitimacy in the debate for natural resource inclusion in

Equalization and hence Newfoundland and Nova Scotia should never hold a fiscal

capacity higher then that of Ontario.

Effectiveness& Accuracy: A Weakness of the policies proposed is the ability of

the Federal government to manipulate the amount of transfers through the average

“scaling back” to an amount that is lower then the actual needs of the provinces in a

time of fiscal strain. A positive, however is the use of the TPS + 100 and RTS as it

provides a snap shot of the needs and abilities of provinces.

Manageability/ Implementability: The implementability of this program is held in

question has it calls for drastic and invasive changes to Equalization. On the other

hand, the use of the three year averages and two year lag and the “Claw back”

averages allows the federal government greater levels of manageability. A negative

attribute is the proposed addition of the FMFC and the CIFI as this creates an increase

need for information flows and communications.

Legitimate & Politically Feasibility: The Advisory Panel receives negative

marks for Political feasibility as to proclaim that their program will be significantly more

expensive then the current New Framework, thus limiting the desire for the federal

government to implement such a policy. Also, the Panel’s implication with regards to the

Offshore Accords will not garnish support from Newfoundland and Nova Scotia.
 - 36 -

However, the establishing of the FMFC and the CIFI would lead to increase

transparency and increase the legitimacy of the program.

Thomas J. Courchene:

Equity: Courchene’s recommendation of the use of tax transfers would increase

efficiency in the program, but calls into question the equity of such a proposal. For it

would be seen as unwarranted to provide different levels of tax transfers to different

provinces based on their fiscal capacities, as this has a negative impact on the “have”

provinces. The equity of Courchene’s proposals is further tapered by his suggestion that

equalization should be based on a per capita formula comparable if not similar to that of

the CST/CHT. Nevertheless, his proposition of combining all forms of fiscal transfers in

to one under the heading of Equalization could achieve greater levels of fairness.

Effectiveness& Accuracy: Courchene’s use of expenditure needs in to the

equation of Equalization does not fit within the founding principles of the program.

Equalization is supposed to evaluate and compensate for the revenue abilities of

provinces and not be a financer for individual provincial projects. Using equalization as

an expenditure tool is also presented with the problem of how the federal government is

to insure that transfers for specific spending needs are being used for that program in

question and that program only. Furthermore, the goal of equalization is not to bring

provinces above the standard down to the standard.

 - 37 -

Manageability/ Implementability: The two-tier system of equalization also has

issues of manageability as provinces are suppose to voluntarily provide funds for a

national transfers pool based on their natural resource revenues.

Legitimate & Politically Feasibility: What is proposed by Courchene receives

mixed reviews under this criterion. First, this program provides both the federal and

provincial governments with more autonomy over the workings of the program, possibly

increasing their willingness to sign on. On the other hand, it also creates larger division

among provinces fiscally and decentralizes the Canadian federation even further,

weakening the federal government’s overall position within Equalization.

Don Drummond

Equity: The first negative aspect of Drummond’s proposal is the use of tax

transfers. Once tax room has been given to provinces it is exceedingly difficult to make

up the lost tax revenues of the federal government. This is exacerbated by the reality

that a tax transfer will not be received by most provinces as a form of equalization, thus

upholding the demand for a relatively large program. Drummond suggests a “clawed

back” provision to prevent receiving provinces for having a fiscal capacity higher then

the NAS. The use of the TPS is a positive note, but is dulled by the use of only a 50

percent inclusion rate.

Effectiveness& Accuracy: Though highly equitable, Drummond’s suggestions

fall short of the primer principles of equalization. First, the use of tax transfers as a
 - 38 -

major aid in reducing the fiscal imbalance will put increased strain on federal

government to provide federal transfers. Secondly, the upfront payments by provinces

completely ignore the principle that equalization is supposed to be a federally funded

program.

Manageability/ Implementability: The use focus on the use of tax transfer for

Drummond is unique as he prescribes this policy tool assist all provinces, particularly

Ontario. This tool would increase the amount of self raised fiscal capacity of all

provinces and lessens the burden of the have provinces. The use of “up-front”

payments increases the provinces influence in the overall workings of the programs

which could lead to a lack of efficiency or transfers.

Legitimate & Politically Feasibility: Though the use of tax transfers increases

provincial fiscal autonomy and will make so provinces happy, others - most notable the

“have-nots” – could take issue with this as transfers are a more reliable source of fiscal

resources. In addition, the use of tax transfers and the up-front payment system inhibits

the federal government’s role within the whole presses. However, Drummond’s

recommendation that this should occur incrementally increases its political feasibility.

Robin Boadway:

Equity: A major disadvantage as presented by Boadway is the exclusion of

natural resources and the removal of a formula for equalization based on a NAS. This is

largely a result of his proposal for fully merging the CHT/CST with equalization, which
 - 39 -

has been suggested above. However, Boadway calls for distribution of transfers to be

based largely on a per capita basis; this presents major problems as the fiscal capacity

of a provinces can fluxgate through inter-provincial migration.

Effectiveness& Accuracy: The idea of “net” equalization through the inclusion of

the CST/CHT does not meet the criteria of the overall goals of equalization. If

equalization is only transferred based on per capita formula it becomes exceedingly

difficult to define a national standard and for the federal government to us Equalization

as a programs to coax provinces into achieving a comparable level of services.

Manageability/ Implementability: A positive of the “net” transfer system is its

relative simplicity and control. As population rates are less flexible then economic

trends, net equalization would be relatively manageable. However, its implementability

is severely lacking as both “have-not” provinces and the federal government would not

sign on.

Legitimate & Politically Feasibility: Though the idea of per capita transfer rates

would seem legitimate to some on the basis of high levels of transparency, it is not

feasible as it does not meet the outlined needs of the provinces under the NAS.

Secondly, the combining of provincial and federal GST into one tax to finance the “net”

equalization program would receive very little support from any province.
 - 40 -

• Comparison Matrix:

Alternatives 1. “Achieving a 2. “Reconciling 3. "Variations on 4. “What a 5. "Two Panels

National the the Federalism Tangled web We On Two
:
Purpose: Putting Irreconcilable: Theme." Weave.” Balances."
Equalization Addressing
Back on Track” Canada’s Fiscal
Goals: Imbalance”
- 50 percent -100% increase + Flexible cap -Tax transfers to -exclusion of
inclusion rate overall size of the +Inclusion of provinces. natural resources.
1. Equity and does not reflect program = CHT/CST. - 50% inclusion - Removal of TPS.
Accuracy actually fiscal Increase costs for -claw back of high rate. +33 based RTS.
capabilities of Ontario. fiscal capacity +TPS.
Provinces + standard 33 tax province +Cap provision.
- Simplification of base for the RTS
the RTS. +TPS
+TPS and return +Removal of
to calculation Offshore Accords.
formula.
+ cap provision.
+less expensive - More expensive - Claw back - Tax transfers. -Net equalization
then 100% then 50% provision. - Up front
2. Effectiveness inclusion. inclusion payments
-more expensive + Actual snap
then New shot of provincial
Framework. landscape.

+three year +Three year - Provincial- - Up front + Net

averages & two averages & two federal payments and tax equalization.
3. Manageability year lag. year lag. cooperation transfers. +RTS
-simplification of +”Claw back”
the RTS. averages

+ 50% inclusion is -Increased cost of +Provincial- +50% inclusion -0% inclusion

easier sell. programs for federal rate. -/+ Creation of
4. Legitimacy + simplification federal cooperation + “Claw back” NGST
and Political leads to increased government. +/-Independent mechanism.
Feasibility transparency +/- Creation of the council. + Incrementalist
+/-Independent FMFC and the - Inclusion of change.
council CIFI. CHT/CST.
 - 41 -

EVALUATION

• Central Debate: The inclusion of natural resources

As mentioned, the inclusion of natural resource revenues into the calculation of
equalization entitlements has offers a contentious debate for policy-makers for years.
This issue is what will often make or break a policy proposal as attaining consensus on
this issue is improbable given the differing interests at stake, making the issue of natural
resource inclusion a nightmare of political feasibility. Unexpected economic phenomena
caused the shift away from 100% resource inclusion and the precedent for contention;
changes to the equalization program often reflect a short-sighted and reactive solution
to immediate problems. This is not to say that these changes were not necessary at the
time, but a more permanent, economically flexible approach is desirable and necessary.
The main argument against the 100% inclusion of natural resources is that it
would raise the bar too high, and therefore make the annual expense of the program too
great. To analyze this suggestion, the numbers were calculated as they have been
provided33, to determine the exact level of the National Average Standard in both cases
for comparison. Whereas the NAS does rise slightly, the overall cost of the program
decreases due to the incorporation of each provinces ability to raise revenues from their
natural resources.

Comparison: Percent Inclusion of Natural Resources in Equalization

Formulating; 2003 Five-Province Standard vs. Proposed Ten-Province NAS

12000
11000
0% 100%
10000
9000
8000
10 Province NAS
7000 6250 $ per capita

6000
Old 5 Province Standard
5000 5900 $ per capita

4000
3000
2000
1000
0
NL PE NS NB QC ON MB SK AB BC
 - 42 -

POLICY RECOMMENDATIONS

1. No one equalization program will ever be perfect; the complex nature of the
calculation of fiscal capacity and fiscal disparities, along with the number of
actors involved determine the fact that equalization will remain a controversial
issue for years to come.

2. Equalization should be permanent in principle; this involves the necessity of

continuous review and adjustments to the program to deal with changing
economic and social issues, and evolving disparities among provinces.

3. This review and evaluation process should be de-politicized and move toward an
arms length, principles-based agency to evaluate the changing factors
concerning equalization to improve transparency, communications, and
governance.

4. The overall amount of the Equalization pool should increase annually, but should
stay flexible with current economic trends; the risks and rewards of economic
changes should be shared between the Federal Government and the Provinces.

5. The responsibility of the Federal Government to transfer funds resulting from a

fiscal surplus should be enshrined in legislature.

6. The calculation of entitlements should be based on a 10-province standard –

National Average Standard (NAS) to properly reflect the economic dynamic of
provinces.

7. Provinces should have their fiscal capacities increase by equalization to create

equity at the national average. Any excess funds once the provinces have been
equalized should be redistributed through other transfer mechanisms.

8. The off-shore agreements should be honored until they expire, but are, in principle
contradictory to the principles of equality among treatment of provinces.
 - 43 -

9. In light of the offshore agreements, a temporary cap should be placed on the

distribution of funds to ensure that, as a result of equalization payments, no total
fiscal capacity of a receiving province should exceed the fiscal capacity of a non-
receiving province.

10. Entitlements should be calculated on an equal percentage scaling off of the NAS
depending on the funds allotted by the Federal Government.

11. The calculation of provincial fiscal capacity should be based on all revenue from all
sources taxable by provincial governments.

12. RST needs to be based on a 33 based tax system, as an overly simplified system
creates difficulties for pegging market prices on natural resources.

13. 100% of resource revenue should be included in the calculation of fiscal capacity
as resources are highly inductive to the economic structures of certain provinces
and will provide a more effective reflection of provinces revenue-raising abilities.

14. Three-year moving averages combined with the use of two-year lagged data
should be used to smooth out the impact of year-over-year

15. Fiscal capacity should be based on market value of the previous year of all sectors
of the economy that provide taxable revenues at the comparable rate of taxation
of the provinces.

16. An independent agency should be created to calculate the appropriate fiscal

capacities of provinces and the market-value of resource revenues.

17. Equalization should be the primary vehicle for impartially equalizing fiscal
capacities among provinces; the CHT and CST transfers should increase their
role as the primary vehicle for the distribution of funds according to need.
 - 44 -

• Results of Proposed Framework:

Benefits:
• More accurate representation of fiscal capacity (avoid "over equalizing"),
• Lower overall program cost,
• High level of transparency,
• Simple calculation of fiscal capacities,
• More apolitical in distribution of entitlements,
• Higher level of provincial efficiency regarding taxation, representation of revenue
calculation and expenditure distribution,
• Effectively achieves principles of equalization
• Equitable.

Proposed Equalization Plan (total cost - $10.8 B)

12000
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
NL PE NS NB QC ON MB SK AB BC

Fiscal Capacity Equalization Accords

 - 45 -

1
www.councilofthefederation.ca
2
Canada, Department of Finance, Federal-Provincial Relations Division, October 2001.
3
Expert Panel on Equalization and Territorial Formula Financing. “Achieving a National Purpose:
Putting Equalization Back on Track” (p.20)
4
Thomas J. Courchene. C.D, Howe Institute – Communiqué: Equalization. (p.1) Rowell-Sirois Report,
p.80
5
Expert Panel on Equalization and Territorial Formula Financing“Achieving a National Purpose: Putting
Equalization Back on Track” (p.20)
6
Thomas J. Courchene. C.D, Howe Institute – Communiqué: Equalization (p.16)
7
Ibid (p.17)
8
Ibid (p.18)
9
Expert Panel on Equalization and Territorial Formula Financing“Achieving a National Purpose: Putting
Equalization Back on Track” (p. 21)
10
Equalization Program, Department of Finance Canada. (accessed 2 Nov 2006)
(http://www.fin.gc.ca/FEDPROV/eqpe.html)
11
Finn Poschmann. “Recalibrating the Federal Balance” (Toronto, Ontario: C.D. Howe Institute, 2006)
p.4
12
Todd Hisch, "Reforming Equalization: a simple solution.”
13
Courchene, Thomas J. “Energy Prices, Equalization and Canadian Federalism: Comparing Canada’s
Energy prrice Shocks.” (p.38)
14
http://www.fin.gc.ca/FEDPROV/eqpe.html
15
Expert Panel on Equalization and Territorial Formula Financing“Achieving a National Purpose: Putting
Equalization Back on Track” (p.24)
16
The Government of Canada “Restoring Fiscal Balance in Canada – Focusing on priorities” (p. 126)
17
Ibid (p. 141)
18
Offshore Resource Accords. Department of Finance Canada.
(http://www.fin.gc.ca/activty/offshoree.html)
19
Ibid
20
Expert Panel on Equalization and Territorial Formula Financing, Consultations and Communications
Branch of the Department of Finance Canada (May 2006)
21
Advisory Panel on Fiscal Imbalance, The Council of the Federation
22
http://www.councilofthefederation.ca/aboutcouncil/aboutcouncil.html
23
The Council of the Federation - Advisory Panel on Fiscal Imbalance “Reconciling the Irreconcilable:
Addressing Canada’s Fiscal Imbalance”. (p. 81)
24
Ibid. (p. 86)
25
Thomas J. Courchene. C.D, Howe Institute – Communiqué: Equalization. (p. 30)
26
Ibid (p. 30)
27
Ibid (p. 31)
28
Courchene, Thomas J. “Energy Prices, Equalization and Canadian Federalism: Comparing Canada’s
Energy prrice Shocks.” (p.47)
29
Don Drummond “What a Tangled web We Weave.” (p.6)
30
Ibid (p.4)
31
Robin Boadway TWO PANELS ON TWOBALANCES (p.4)
32
Ibid (p.6)
33
The Council of the Federation - Advisory Panel on Fiscal Imbalance “Reconciling the Irreconcilable:
Addressing Canada’s Fiscal Imbalance”. (p. 87)