Reforming equalization to drive economic growth
Alberta wants to work with other provinces to improve the federal Equalization Program to benefit all Canadians.
Alberta’s position paper, Responding to Canada’s Growth Challenge – Options to Reform Equalization, explores potential options to simplify the program, make it more transparent and promote economic growth nationwide.
“We heard loud and clear from Albertans that the federal Equalization Program is unfair and must be changed or abolished. Alberta is committed to working closely with other provinces to ensure Canada remains a prosperous, vibrant and diverse place for Canadians to succeed. The current program creates barriers to regional economic growth and gives excessive transfers to recipient provinces. These are challenges we must tackle together. This paper gives us a starting point to begin a national conversation on how to change the Equalization Program to better reflect the true need of provinces for support and to best position all provinces for economic success.”Danielle Smith, Premier of Alberta
The paper proposes reforms that would encourage provinces to adopt pro-growth policies to reduce their dependence on federal transfer payments. Complicated elements currently used to calculate payments, such as the GDP floor, the fiscal capacity cap, multiple resource revenue inclusion rates and others, would be replaced with a simpler approach that uses publicly available macroeconomic indicators, such as gross domestic product (GDP) and population, to determine if a province falls above or below the national average. This new approach could streamline the program while helping Canadians understand it better.
“The Equalization Program in its current form is not sustainable. The taxes that fund it are a hindrance to the wealth-creating regions of the country, and it disincentivizes investment and economic growth in receiving provinces. Our hope is that the federal government will commit to consulting with provinces and introducing a fair federal transfer program that incentivises economic growth in all provinces.”Travis Toews, President of Treasury Board and Minister of Finance for Alberta
Alberta’s proposed approach would use an agreed upon definition of revenue to calculate the revenue-to-GDP ratio that represents the national average tax rate. Each province’s fiscal capacity per capita would be calculated by applying the national average tax rate to its GDP per capita and comparing it to the national standard. The paper also recommends gradually lowering the standard to 95 per cent from 100 per cent of the national average. Provinces with GDP per capita that is more than five per cent below the national average would still receive equalization. Provinces with GDP per capita within the five per cent band would be considered to have enough fiscal capacity to provide reasonably comparable public services.
The paper highlights that improving the Equalization Program is only one piece of the growth puzzle. Reform must go hand in hand with policies that drive economic growth, including a renewed federal focus on improving private sector investor confidence and taking leadership in addressing global energy security.
The position paper was drafted in response to the results of Alberta’s October 2021 referendum, in which 61.7 per cent of those who voted said “yes” to removing the equalization section from the Constitution. The results indicated a clear need to review the federal Equalization Program, including addressing how it hinders regional economic growth, and to engage with other governments across Canada to explore alternatives.
How the Equalization Program works:
- The Equalization Program is a federal transfer program that addresses disparities in provincial ability to raise revenue (fiscal capacity).
- The program is funded by federal taxes paid by all Canadians (i.e., federal income taxes, Goods and Services Tax, and other taxes and fees).
- Equalization payments are determined by a complex formula measuring each province’s fiscal capacity and then comparing it to the national average. Provinces below the national average generally qualify for equalization. Resource revenues and four major tax bases are used to determine a province’s fiscal capacity: consumption, business income, personal income and property.
Key challenges with the current Equalization Program:
- Complexity: the current program lacks transparency and creates numerous unintended consequences.
- Automatic growth: The automatic growth of the program even when fiscal disparities shrink can result in provinces being “over equalized.” This often results in more money distributed through the Equalization Program than necessary to bring “have-not” provinces up to the average level provincial capacity.
- For example, in 2023-24, the Equalization Program will disperse almost $24 billion, however, only $21.6 billion is needed to bring the fiscal capacity of receiving provinces to the national average.
- Growth disincentives: Equalization can reduce the incentive for provinces to implement policies that promote growth.