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The unintended consequences of Canada's equalization program

By Ben Eisen
web posted May 23, 2011 

The stated objective of Canada's equalization program is to ensure provincial governments in less-prosperous regions of the country are able to deliver high-quality public services to residents. This is a worthwhile, even noble objective. That the program is motivated by good intentions, however, does not necessarily mean it is producing positive results. In fact, equalization is producing disastrous unintended consequences for all the provinces, including those receiving the biggest cheques.

In February, the Ontario Chamber of Commerce released a study (PDF format) entitled "Dollars and Sense: A Case for Modernizing Canada's Transfer Agreements." It described a number of different ways that Canada's system of fiscal transfers, of which equalization is a major component, hurts our country.  The study's author, David MacKinnon, a Prince Edward Island native who served as a senior civil servant in both Ontario and Nova Scotia, is uniquely well-positioned to describe how equalization's negative impacts are felt even in provinces  the program is meant to help. 

The most obvious negative consequence of Canada's fiscal transfer system is the financial burden it places on residents of the provinces that pay most of the bill – historically Alberta and Ontario. MacKinnon notes that regional subsidies absorb about five percent of the combined economic output of Alberta and Ontario each year – comparable to the burden of national defence on taxpayers in the United States. This outflow of money from Ontario was an important reason that its provincial government was ill-equipped to absorb recent financial shocks. Consequently, the province is emerging from the recession facing staggering public debt. The fact that Ontario has received small equalization payments the last two years doesn't alter the reality that transfers remain a huge net drain that have contributed to its fiscal crunch.

What makes bearing the burden associated with transfers particularly frustrating for Ontarians and Albertans is that equalization payments are so large they often result in more generous, more accessible public services in the recipient provinces than they themselves have access to. For example, the average undergraduate university tuition in "have-not" Quebec stands at approximately $2, 200. In Manitoba, average tuition is about $3,300. Compare that to Alberta's average tuition of $5, 400 or Ontario's $5,700. Of course taxpayers in Ontario are frustrated by being forced to subsidize rock-bottom tuition in neighbouring Quebec while their own kids are paying more than twice as much. I could give many examples, but here's just one more – "have-not" New Brunswick, Nova Scotia and Prince Edward Island all have more than 800 registered nurses per 100, 000 provincial residents. Meanwhile, Alberta, Ontario, and British Columbia have between 619 and 715, the lowest ratios in Canada.

The problems created by our transfer system are not confined to Alberta and Ontario.  Equalization actually hurts the provinces it is meant to help. While low tuitions and larger numbers of nurses are nice, the broader reality of the transfer system is that it pumps so much money into recipient governments that the public sectors there have grown overly large. In all of the perennial have-not provinces, total government spending as a share of gross domestic product is far above the national average. This politicizes local economies and dampens private sector-led economic growth. While the transfer system provides short-term security for recipient provinces, it traps them in a cycle of dependency and economic underperformance that is difficult to break.

The entrenchment of inefficient public sectors in the have-nots is a serious national economic problem. For years, Canada's comparatively weak productivity growth has vexed economists and policymakers, who have devised a number of programs in response. These efforts have been undermined by a transfer system that punishes productivity, shifting tens of billions of dollars from high-productivity provinces to regions dominated by inefficient public sectors. This transfer of money from high- to low-productivity regions has a cumulative effect that reduces productivity growth and living standards in Canada.

In addition to these economic impacts, our transfer system also has toxic political effects. It has undermined national unity and bred regional resentments - largely because the federal government has failed to address the system's inequities. Sadly, policies borne out of a laudable desire to ensure high-quality public services in all regions are now sources of regional tension and disharmony.

Equalization is just one part of a larger system of regional transfers that is quite simply broken. Until its defects are addressed, the system will continue to place a drag on economic performance and will continue to pose long-term threats to the prosperity and unity of our country. ESR

Ben Eisen is a policy analyst with the Frontier Centre for Public Policy.

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