Tegan Hill is director of Alberta Policy and Joel Emes is a senior economist at the Fraser InstituteAs the Alberta Next Panel continues discussions on how to assert the province’s role in the federation, equalization remains a key issue. Among separatists in the province, a striking 88% support ending equalization despite it being a constitutional requirement. But all Canadians should demand equalization reform. The program conceptually and practically creates real disincentives for economic growth, which is key to improving living standards. First, a bit of background.The goal of equalization is to ensure that each province can deliver reasonably comparable public services at reasonably comparable tax rates. To determine which provinces receive equalization payments, the equalization formula applies a hypothetical national average tax rate to different sources of revenue (e.g. personal income and business income) to calculate how much revenue a province could generate. In theory, provinces that would raise less revenue than the national average (on a per-person basis) receive equalization, while provinces that would raise more than the national average do not. Ottawa collects taxes from Canadians across the country and then redistributes money to these “have not” provinces through equalization..EDITORIAL: Danielle Smith must continue fight against porn in school libraries.This year, Ontario, Quebec, Manitoba, and all of Atlantic Canada will receive a share of the $26.2 billion in equalization spending. Alberta, British Columbia, and Saskatchewan — calculated to have a higher-than-average ability to raise revenue — will not receive payments. Of course, equalization has long been a contentious issue for contributing provinces, including Alberta. But the program also causes problems for recipient or “have not” provinces that may fall into a welfare trap. Again, according to the principle of equalization, as a province’s economic fortunes improve and its ability to raise revenues increases, its equalization payments should decline or even end..Consequently, the program may disincentivize provinces from improving their economies. Take, for example, natural resource development. In addition to applying a hypothetical national average tax rate to different sources of provincial revenue, the equalization formula measures actual real world natural resource revenues. That means that what any provincial government receives in natural resource revenue (e.g. oil and hydro royalties) directly affects whether or not it will receive equalization — and how much it will receive. According to a 2020 study, if a province receiving equalization chose to increase its natural resource revenues by 10%, up to 97% of that new revenue could be offset by reductions in equalization. .EDITORIAL: Scrap the Temporary Foreign Worker Program so Canadian young people can work again.This has real implications. In 2018, for instance, the Quebec government banned shale gas fracking and tightened rules for oil and gas drilling, despite the existence of up to 36 trillion cubic feet of recoverable natural gas in the Saint Lawrence Valley, with an estimated worth of between $68 billion and $186 billion. Then in 2022, the Quebec government banned new oil and gas development. While many factors likely played into this decision, equalization “claw-backs” create a disincentive for resource development in recipient provinces. At the same time, provinces that generally develop their resources — including Alberta — are effectively punished and do not receive equalization..The current formula also encourages recipient provinces to raise tax rates. Recall, the formula calculates how much money each province could hypothetically generate if they all applied a national average tax structure. Raising personal or business tax rates would raise the national average used in the formula, that “have not” provinces are topped up to, which can lead to a higher equalization payment. At the same time, higher tax rates can cause a decline in a province’s tax base (e.g. the amount of income subject to taxes) as some taxpayers work or invest less within that jurisdiction, or engage in more tax planning to reduce their tax bills. A lower tax base reduces the amount of revenue that provincial governments can raise, which can again lead to higher equalization payments. .EDITORIAL: The 'Wild West' had more justice than Liberal Canada.This incentive problem is economically damaging for provinces as high tax rates reduce incentives for work, savings, investment, and entrepreneurship. It’s conceivable that a province may be no better off with equalization because of the program’s negative economic incentives. Put simply, equalization creates problems for provinces across the country — even recipient provinces — and it’s time Canadians demand reform.Tegan Hill is director of Alberta Policy and Joel Emes is a senior economist at the Fraser Institute
