Q&A: The wonky world of equalization payments

Many people complain about equalization payments, but it takes a true policy wonk to fully explain how they work.

The equalization moniker might imply fairness, but some, particularly in Alberta, argue it's anything but fair. That perception might in part be a product of its complex nature and the politics associated with it.

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Canada's equalization program was first introduced as a formal way to transfer funds from the federal government to the provinces in 1957 so that each could provide "reasonably" comparable services at "reasonably" comparable rates of taxation. The program was enshrined in the Constitution in 1982.

Here's a more recent history of federal transfers to the provinces, including equalization payments.

We asked University of Calgary economist Trevor Tombe to disentangle the facts from the politics and explain equalization, as policy.

Here's how he answered our questions.

Q: What is the purpose of the equalization program?

A: Provinces differ in their ability to raise revenues. That is, if all provinces had exactly the same tax rates, the Maritime provinces would raise less revenue per person than richer provinces like Alberta and British Columbia.

The equalization program partially compensates for this so all Canadians, regardless of where they live, have provincial governments capable of delivering needed services. To do this, a formula measures each province's "fiscal capacity," and equalization payments then bring poor provinces up to some average level.

Importantly, equalization payments do not raise recipient provinces above the fiscal capacity of non-recipient provinces.

Q: What are the biggest myths about it?

A: Many see equalization as a transfer between provincial governments. It isn't. In Alberta, for example, some blame the equalization program for our $10-billion deficit. This misses two critical aspects of the program.

First, equalization payments are funded by the federal government from its own general revenue. There is no "equalization pot" into which rich provinces contribute.

Second, the equalization formula is based on a province's ability to raise revenue, not how much revenue it actually does raise. Alberta — even today — has the largest capacity to raise revenue in the country. Our deficit is a choice, not something caused by equalization. 

Q: Is the stated purpose — to provide "reasonably" comparable services at "reasonably" comparable rates of taxation — being achieved?

A: Equalization payments are unconditional. And different provinces will make different choices about how to allocate their spending. The program is not meant to require equivalent services be offered in all parts of the country, but to ensure provincial governments have the ability to offer such services if they so choose.

The transfers can often be substantial, worth over $2,500 per person in Prince Edward Island, for example. The program therefore does succeed in making more comparable the various provinces' ability to fund programs.

Q: There are complaints from politicians in provinces who are net contributors and net recipients. How many times has the formula changed to respond to criticisms?

A: It's somewhat misleading to see some provinces as net contributors. No provincial government pays equalization to any other province. The program is funded through federal revenue, paid for through federal taxes on all Canadians.

To be sure, there are valid concerns and governments should have productive discussions on possible changes to the equalization formula. And pressure by provinces can sometime lead to big changes, such as with the 2005 Atlantic Accord, which itself also sparked further review and changes, most recently in 2009.

But to know how best to change the system, we must be focused on the equalization program itself. Too often discussion is hijacked by broader concerns over federal taxation and spending decisions.

Q: Does any other country with a similar political system have anything similar?

A: Federal transfers across regions are extremely common. Explicit programs exist in Australia, Belgium, China, France, India, German, Switzerland, the United Kingdom and many, many others. Even where explicit transfers are absent, many other programs implicitly transfer resources from rich to poor regions.

Regions with high incomes, such as Alberta, pay relatively more in federal personal and corporate income taxes, for example. We face the same rates as everywhere else, but more people here earn high incomes. We also receive relatively less in benefit payments, such as OAS or EI, since we have a younger population and [typically] have fewer unemployed people.

Measuring all such implicit transfers, the United States actually transfers more across regions than Canada — at roughly 2.5 per cent of its GDP, compared to Canada's 1.8 per cent. For Canada, equalization is only about one-quarter of these total transfers.