Tuesday, May 30, 2006

The equalization mess

Jack Mintz, in today's Financial Post, sheds some light on the equalization formula and makes some suggestions. People should listen to what he is saying.

The first point is that regional disparity has been on the decline over thae last quarter-century.

For example, back in the high oil price recessionary year of 1981, Alberta's per capita GDP was about 60% above the national average -- other provinces with above-average GDP per capital included British Columbia (10%), Saskatchewan (3%) and Ontario (2%). The Atlantic provincial per capita GDP was about 60% of the national average along with poorer provinces Quebec (85%) and Manitoba (90%).

By 2004, differences among provinces have generally become smaller, with only one really rich province, Alberta, whose per capita GDP is 145% of the national average (a smaller difference compared with 1981). Ontario's position has changed little, Saskatchewan is now at the national average and British Columbia has a GDP per capita that has fallen below the national average since 1983. The Atlantic provincial GDP per capita is now three-quarters of the national average with Newfoundland reaching a level close to Manitoba's at 85% of the national average.
And Mintz identifies the problem:
So why are equalization payments out of sync with actual per capita incomes? The problem lies with the formula to determine equalization -- a dog's breakfast that involves 33 revenue sources -- which purportedly ensures that provinces can provide comparable public services at reasonable tax rates. If provinces use their resource revenues to reduce debt -- as New Brunswick has done in recent years -- they still lose equalization payments, even though public services have not increased. Measurements using tax definitions distort tax bases to reflect political choices rather than true economic resources, such as retail sales taxes, that exempt many services or personal taxes that exclude some forms of income.

And then the solution. Mintz says the equalization formula should not look at provincial revenues, but instead focus on per capita GDP. That would mean my own province of Saskatchewan, with a GDP above the Canadian average, would not receive equalization payments under current conditions.

The current formula has perverse incentives to keep taxes high, and keep the government growing.
As soon as a recipient province tries to grow, say by cutting taxes, it will be penalized by losing almost a full dollar in equalization payments for each dollar in increased tax revenues. A far better approach would use a formula that minimizes distortions and is less subject to manipulation, such as tying payments to per capita GDP.

What do you guys think?

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