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Drilling pipe is unloaded for a drilling rig near near Golden Prairie, Sask. (Larry MacDougal)
Drilling pipe is unloaded for a drilling rig near near Golden Prairie, Sask. (Larry MacDougal)

Ottawa needs to fix a broken provincial transfer payment system Add to ...

As the country’s finance ministers prepare to meet next week, one big item that was expected to be on the agenda, but will not be, is the future of federal-provincial transfer payments.

Although existing arrangements technically expire in March, 2014, this perennial topic of federal-provincial discord is evidently off the policy radar screen. Indeed, the federal government’s previous unilateral decisions, taken well in advance of the renewal deadline, have successfully pre-empted the debate.

This is unfortunate, as it means that governments are missing a crucial opportunity to strengthen key adjustment mechanisms in our federation – mechanisms that are sorely needed to cope with a boom-bust resource economy and the regionally skewed growth it produces, and that are required to support a well-functioning economic and social union.

The global resource boom of the past decade has clearly been beneficial to Canada, boosting our economic activity and purchasing power. But it has also significantly widened economic disparities between the resource-rich provinces and the rest of the country, and redefined who are the “haves” and the “have-nots.” During the peak of the resource boom in 2002-08, the economies of Alberta, Saskatchewan, and Newfoundland and Labrador all grew at a remarkable nominal rate of 11 per cent a year, on average. Growth in the other regions of the country was much weaker, at only 4 per cent annually.

These large differences in the provinces’ economic growth are largely a function of unalterable geography – the allocation of resource endowments across our vast country. This, however, quickly translates into wide disparities not only in wages, incomes and job prospects among provinces, but also in provincial governments’ abilities to raise revenues and to provide public services.

Our Constitution’s unique allocation of federal-provincial powers further exacerbates such disparities. Because provinces own, manage and tax their natural resources, and raise most of their own revenues, the resulting large differences in fiscal capacities are of great consequence for the federal government, which is constitutionally bound to address fiscal disparities among the provinces.

The equalization program is the primary tool to address these gaps. It transfers federal revenues to provincial governments with below-average fiscal capacities, so they can provide reasonably comparable public services to elsewhere in the country, with similar tax burdens.

However, as we argue in a recent paper published by the Institute for Research on Public Policy, the equalization program is failing to meet its objectives. There are now larger “shocks” to equalize.

Fiscal disparities before equalization increased by about 20 per cent in the past decade. (See graph.) This is due mainly to the resource boom, and there’s little that can be done on this score. More importantly, however, the effectiveness of the equalization program has diminished, and as a result, disparities after equalization have increased much more (by 40 per cent). This reflects the fact that, while have-not provinces are equalized up, provinces with above-average revenue-raising capacities are not equalized down.

Luckily, the path to a stronger equalization program is clear. It doesn’t require a Royal Commission or a major re-working of the program’s arcane formula. A simple, effective way to improve the system is to remove the cap on total program payouts recently imposed by the federal government.

This temporary stop-gap measure was applied in 2009, during the global financial crisis, when Ontario became a “have-not” province. In effect, the perfect storm hit, as equalization payouts were expected to grow at a time when the federal cupboards were bare.

But with federal-provincial transfers technically up for renewal in 2014, the economic and fiscal situation for the federal government is much improved. The worst of the economic crisis has passed and with subsequent policy changes – including reduced growth in federal health care transfers to the provinces – Ottawa now has significant fiscal room to manoeuvre. Conversely, the long-term outlook for the provinces is far worse and features rising, not falling, public debt.

The Parliamentary Budget Office estimates that Ottawa could raise spending or lower taxes by about $25-billion annually without increasing federal debt as a share of the economy over the long run. The cap on equalization payments should be removed. This would allow the program to operate as intended, while likely using up less than one-tenth of Ottawa’s long-term fiscal room.

A complementary approach to address these fiscal inequalities would be for the federal government to tie some of its other transfers to overall provincial revenue-raising capacity. This would mean, for example, that because resource-rich have far higher revenues than other provinces due to their resource wealth, Ottawa would lower their per-capita transfers for health and social spending.

Unfortunately, the federal government is moving in the opposite direction – in favour of equal per-capita cash transfers, under the guise of fairness. In fact, a truly fairer approach would be to use these other transfer programs (such as CHT and CST) to offset some of the interprovincial imbalances created by natural resource endowments.

Discussions of transfer programs have faded from view. Nonetheless, they remain an essential and underused tool for the federal government to play its appropriate adjustment and insurance role in the federation. In fact, they may just be the complementary tools needed to muster national support for Ottawa’s push to increase resource development.

Robin Boadway is a professor at Queen’s University. Serge Coulombe and Jean-François Tremblay are professors at the University of Ottawa. They are the authors of the Institute for Research on Public Policy (IRPP) Insight publication “Canadian Prescriptions for Dutch Disease”.

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