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In Defence of Equalization

          Recently, the Equalization payments made by the Government of Canada to provinces with a lower than average capacity to raise revenues, have been debated in our newspapers. Political, academic and media commentators have criticized the so-called disincentive effects that Equalization is alleged to have on provincial economic development.

          Equalization is based on the principle set out in section 36 of the Constitution Act, 1982 which commits the Government of Canada to helping provincial governments provide reasonably comparable levels of public services at reasonably comparable levels of taxation. Inherent in this principle is the requirement that Equalization payments should decline when a province’s fiscal capacity increases.

          The economies – and hence the fiscal capacities – of Nova Scotia and Newfoundland will benefit greatly from the development of offshore resources. Consequently, the Equalization they receive will decline – and may even end one day. The Premier of Nova Scotia, the Honourable John Hamm, acknowledged this himself when he said that, under favourable conditions, offshore resources could give Nova Scotia its "economic independence".

          However, Premier Hamm and others seem to be saying that this situation could not come about unless Nova Scotia and Newfoundland receive special treatment. Notably, they do not want their Equalization payments to decline – or they want them to decline very little – in the wake of the projected increase in their offshore revenues in the years ahead. In other words, Canadian taxpayers should pay these two provinces exceptionally generous Equalization payments today so that they no longer have to be paid later.

          The Government of Canada believes it would be ill-advised to grant such special treatment to Nova Scotia, Newfoundland or any other province. First, it is wrong to attribute to Equalization a disincentive or paralysing effect on economic development. And second, it is essential to maintain equitable treatment of all the provinces within the Equalization framework.

          The fact that the Equalization received by a province declines when its fiscal capacity increases does not prevent it from taking action to develop its natural resources or promote any other form of economic development.

          The impact of economic development on their revenues is far from being governments’ main consideration when they make their economic policy decisions. What guides them above all is a concern to meet their residents’ desire for increased prosperity. No government can long escape the critical scrutiny of its electorate if it does not do everything in its power to promote the job creation and greater well-being that flow from taking advantage of whatever economic development opportunities present themselves.

          Equalization has not stopped provinces from developing their natural resources. Saskatchewan’s oil and natural gas industry was developed even though that province’s Equalization payments declined as a result. Similarly, other examples – potash in Saskatchewan, nickel in Manitoba and hydro-electric development in Quebec, Manitoba and Newfoundland and Labrador – show that Equalization has not impeded development of natural resources in the past. There is no reason for it to be otherwise in the future.

          The treatment the Government of Canada has given to Nova Scotia and Newfoundland with regard to offshore resources demonstrates that it is possible, in our federation, to give effective help to less advantaged provinces without compromising equity and the principle of Equalization.

          The Government of Canada signed agreements with these two provinces in the mid-1980s to help start the development of offshore resources. Under these agreements, the Government transferred all royalties derived from the offshore resources to the treasuries of the two provinces, even though the Constitution stipulates that these resources are the property of all Canadians. In comparison, in the United States, all resources found more than three miles from shore and any royalties generated by their development belong to the federal government.

          Under these agreements, the Government of Canada created a $225 million development fund for each of the two provinces (the equivalent of $375 million in today’s dollars). These funds provided them with additional monies to take advantage of opportunities associated with the early development of the offshore resources. Also, the Government agreed to make special payments to increase their revenues over a lengthy transition period.

          The Government of Canada has scrupulously carried out all of the undertakings it made in signing these agreements. It went ever further in 1993 by taking a 8.5 percent equity stake in the Hibernia project, at a cost of $435 million, at a time when no other investors were prepared to do so.

          In this way, the Government has greatly assisted Nova Scotia and Newfoundland without jeopardizing the equitable treatment of all the provinces or the integrity of the Equalization program.

          In fact, changes made to the calculation of Equalization under the Chrétien government have had the indirect effect of further benefiting the treatment of offshore oil and gas revenues going to Nova Scotia and Newfoundland. The effect is indirect, since the goal was not to give these provinces any special treatment. Rather, it was to deal with a technical problem that occurs in exceptional circumstances when a province accounts for all or virtually all of a particular revenue source. After consulting with all the provinces, the government agreed that, in such situations, 30 percent of the revenues in question would be excluded from the Equalization calculation. In the future, this provision will likely apply only to Nova Scotia’s offshore natural gas and to Newfoundland’s offshore oil, although it has applied to other sources in the past. No other source of provincial revenues, including onshore oil and natural gas, will benefit from this treatment.

          It would be unfair to taxpayers in the other provinces to provide an even more generous treatment to offshore revenues in calculating Equalization. This would be difficult to justify to residents of other Equalization-receiving provinces that do not have significant revenues from oil or natural gas. Canadians living in British Columbia or Ontario, whose governments do not receive Equalization, could ask why Nova Scotia and Newfoundland should receive Equalization payments that give them fiscal capacities surpassing those of Victoria or Queen’s Park.

          Some have proposed that the Equalization calculation exclude all provincial revenues from non-renewable natural resources. In this way, they contend, fairness among provinces could be preserved while allowing the Nova Scotia and Newfoundland governments to increase their offshore revenues without having their Equalization payments decline. This proposed change also cannot be justified. Its effect would be to disadvantage those provinces that have few natural resources in comparison with those that have many.

          It would be arbitrary to exclude certain revenue sources from Equalization, be they oil and natural gas royalties, revenues from other natural resources or any other source of provincial revenues. The fundamental reality is that provincial governments use all these revenues to finance their public services. In order to make Equalization payments that allow provincial governments, as stated in the Constitution, "to provide reasonably comparable levels of public services at reasonably comparable levels of taxation", the Government of Canada is obliged to take into account all of their sources of revenue.

          In short, far from being an obstacle to economic development, Equalization is one of the most tangible manifestations of Canadian solidarity. While respecting the principle of Equalization, the Government of Canada has been able to help Nova Scotia and Newfoundland derive full benefit from their offshore resources.