Home › Policy Articles: Fiscal & Budgetary: Fiscal Federalism: 2002

This Communiqué includes a look at the Table of Contents, Foreword, and Introduction to the book Canadian Conundrums, edited by Robert Brown. In his introduction, Brown explains that the purpose of the book is to bring the insights of past Clifford Clark Visiting Economists to a broader audience. Topics included in the volume range from fiscal balance to taxation.

In Equalization and the Treatment of Non-renewable Resources, Paul Hobson analyzes proposals for the inclusion and exclusion of natural resources from Canada’s equalization payment system. According to Hobson, equalization is usually justified on two fronts: 1) it allows for an efficient allocation of mobile factors of production within federations, and 2) it establishes equity between provinces. To evaluate equalization, he posits, is a complex question of costs and benefits. Hobson therefore devotes a portion of his analysis to the theoretical case for equalization and a review of equalization in the Canadian context. He follows by assessing proposals for the treatment of natural resources in equalization, concluding his examination with a discussion of the Atlantic Institute of Market Studies’ proposal to remove natural resources from the equalization formula.

This paper summarizes and analyzes a 1999 report by the Swiss government and the cantons that presents the planned reform of the equalization system in Switzerland.

Annette Ryan’s paper Equalization: Neither Welfare Trap or Helping Hand was prepared in response to a 2001 conference entitled Equalization: Welfare Trap or Helping Hand? Ryan rejects the assumptions in the conference title, arguing equalization is instead a reasonable approach for delivering public services in a widely dispersed country. Equalization is not, she asserts, an economic development program meant to eliminate differences in production or opportunity across provinces. It is simply meant to deliver reasonably comparable services at comparable levels of taxation.

Federal Grants Under the Discipline of Global Forces, by Michel Boucher and Jean-Luc Migué, examines the hypothesis that a more open economy leads to the destabilization of what the authors call the ‘political cartel’ of federalism. According to Boucher and Migué, federalism requires political collusion to remain stable. In their view, the federal government induces this collusion, providing provinces with equalization payments and other forms of grant money. The authors argue, however, that as economies become more open (that is, free from government regulation), increased competition will act as a powerful force against this form of political collusion because capital and labour will enjoy the freedom of moving to new markets. After providing empirical evidence for their hypothesis, Boucher and Migué conclude the result will be decreased levels of equalization funding in Canada.

Fiscal Equalization Revisited is a recap of Nobel Laureate James Buchanan’s keynote address to a conference entitled Equalization: Welfare Trap or Helping Hand? Buchanan stresses he is not an expert on the Canadian fiscal situation; rather, his presentation is an abstract discussion of equalization. In it, Buchanan argues that the benefits of equalization are based on his belief that, without such a program, the over-concentration of resources in different regions would lead to unfair fiscal advantages for some provinces. Buchanan does, however, cite political difficulties with instituting and continuing an equalization program. These political difficulties, he concludes, may negate any overall gains of equalization for governments.

This article by Thomas J. Courchene analyzes Canada’s fiscal turnaround from its dire situation in the early 1990s (with the Wall Street Journal suggesting the Canadian dollar might “go the way” of the Mexican Peso, for example) to budgetary surplus.

In Modest But Meaningful Change: Reforming Equalization, Paul Boothe suggests what he calls “a modest reform” to Canada’s system of equalization payments. Boothe’s analysis discusses the current equalization program and what he believes are its shortcomings.

Kenneth Boessenkool’s paper Taxing Incentives: How equalization distorts tax policy in recipient provinces argues there is strong evidence that Canada’s equalization payments system encourages poorer provinces to overtax their populations. Boessenkool claims economic theorists have long discussed the idea that poorer provinces can increase the size of their equalization payment by manipulating their tax rates. With this paper, he argues, evidence now exists to prove this true.

Kenneth Boessenkool’s short paper Ten Reasons to Remove Nonrenewable Resources from Equalization argues that the treatment of natural resources under Canada’s equalization system hinders provincial economic growth. The ten reasons underpinning Boessenkool’s argument are: 1) resource revenues have been nothing but trouble for equalization; 2) removing them from the equalization equation would vastly simplify things; 3) including resources produces perverse incentives; 4) including resources causes fiscal problems for Ottawa; 5) including resources is arguably unconstitutional; 6) including resources does not make economic sense; 7) the equalization formula double counts the fiscal capacity from resources; 8) removing resources better reflects the fiscal capacities of all provinces; 9) removing resources means only very small adjustments for recipients; and, 10) the politics of the proposal look good. Given emerging oil and gas interests in traditionally poorer regions like Atlantic Canada, Boessenkool concludes by suggesting there is no better time to remove resources from the equalization system.

Bev Dahlby’s paper The Incentive Effects of Fiscal Equalization Grants contends that the inclusion of taxation and expenditures in Canada’s equalization funding formula can distort the fiscal policies of provincial governments that receive equalization funds. Dahlby uses a generic equalization grant funding formula to determine whether the tax and expenditure choices of governments are affected by equalization funds. He finds recipient governments change their fiscal policies to receive higher equalization grants. Most notably, Dahlby asserts that grants (based on his formula) result in higher taxes, excessive spending on consumptive public services, and an under-provision of tax base-enhancing expenditures such as education and infrastructure. Drawing upon his results, Dahlby concludes that equalization builds an inherent bias into provincial fiscal decisions.

In What’s Wrong with Equalization: Social Insurance and Moral Hazard, Herb Grubel argues Canadian social insurance programs have led to overspending and unexpected harm to recipients. Developed to provide protection that private industry would not offer, economists believed the federal government’s social insurance system would be self-funding thanks to compulsory universal membership. Grubel, however, asserts that, to the contrary, the programs have led to dependence and stunted economic growth. Focusing his analysis on equalization payments (Canada’s ‘transfer system’), Grubel claims the reason for this is the ‘moral hazard behaviour’ encouraged by the incentive of transfer payments. Grubel concludes the Government of Canada, for the betterment of citizens and provinces receiving social insurance, should vastly decrease transfer payments, ultimately phasing them out entirely.