Equalization payments

Equalization payments are cash payments made in some federal systems of government from the federal government to state or provincial governments with the objective of offsetting differences in available revenue or in the cost of providing services.

Canada

In Canada, the federal government makes payments to less wealthy Canadian provinces to equalize the provinces' "fiscal capacity" — their ability to generate tax revenues. Ontario is the only province to have never received equalization payments. Canada's territories are not included in the Equalization program - the federal government addresses territorial fiscal needs through the Territorial Formula Financing (TFF) program.

Equalization payments are based on a formula that calculates the difference between the per capita revenue yield that a particular province would obtain using average tax rates and the national average per capita revenue yield at average tax rates. The current formula considers five major revenue sources (see below). The objective of the program is to ensure that all provinces have access to per capita revenues equal to the potential average of all ten provinces. The formula is based solely on revenues and does not consider the cost of providing services or the expenditure need of the provinces.

Equalization payments do not involve wealthy provinces making payments to poor provinces; rather, the funds for equalization payments come from the federal treasury. As an example, a wealthy citizen in New Brunswick, a so-called "have not" province, pays more into equalization than a poorer citizen in Ontario, a so-called "have" province. However, because of Ontario's greater population and wealth, the citizens of Ontario as a whole do pay more federal taxes and thus their total contribution to equalization is greater than that of New Brunswick.

Equalization payments are one example of what are often collectively referred to in Canada as "transfer payments," a term used in other jurisdictions to refer to cash payments to individuals (see transfer payments). Unlike conditional transfer payments such as the Canada Health Transfer or the Canada Social Transfer, the money the provinces receive through equalization can be spent in any way the provincial government desires. The payments help guarantee "reasonably comparable levels" of health care, education, and welfare in all the provinces. The definition of "reasonably comparable levels", however, has been the subject of considerable debate.

In 2006-07, the total amount of the program was roughly 11.7 billion Canadian dollars.

Traditionally, the payments have been seen as a way of promoting national unity. Quebec, the most populous of the "have not" provinces, is by far the largest single recipient of the payments. When BC and Saskatchewan are removed, approximately 70% of the 10 million Canadians residing in "have not" provinces are in Quebec. However, recent negotiations surrounding the renewal of the program have created considerable tension among provinces. Due to the zero-sum nature of the formula, increases in entitlements for some provinces necessarily lead to decreases for others.

Regional fiscal disparities in Canada

There are significant differences in the provinces in terms of size, geography, population, and economic activity. While there has been considerable convergence in provincial Gross Domestic Product per person and personal incomes among the regions over the last fifty years, the gap between the most and the least well-off provinces continues to be a primary economic concern.

Gross Domestic Product per capita by province - 2005
($ per capita)

"Source: Statistics Canada"

Equalization payments in Canada – 2007-08

($ millions) Notes:

Totals may not add due to rounding.

"Source: [http://www.budget.gc.ca/2007/bp/bpc4e.html Finance Canada, accessed 19 March 2007] "

ources of fiscal capacity

The fiscal capacity of the provinces is determined by measuring their revenue from five general sources. Those revenue categories are:
* Personal income taxes
* Business income taxes
* Consumption taxes
* Natural resources
* Property taxes and miscellaneous

History

The basics of equalization payments have been around since Canadian Confederation when the federal government had most of the taxation powers. The federal government would make transfer payments to the provinces to cover their needs. There was no obligation that these transfer payments had to reflect the amount collected in each province and thus wealth was always redistributed.

A formal system of equalization payments was first introduced in 1957. The idea was based on the proposals of American economist James M. Buchanan and they were introduced mainly to help the struggling Atlantic provinces who were seeing low rates of growth and high rate of emigration to central Canada.

The original program had the goal of giving each province the same per capita revenue as the two wealthiest provinces, Ontario and British Columbia, in three tax bases: personal income taxes, corporate income taxes and succession duties (inheritance taxes). Five years later, 50 per cent of natural resource revenues were included as the fourth tax base. At the same time, however, the standard of the two wealthiest provinces was lowered to the national average. In 1967 the system was redesigned to work with every government revenue scheme with the exception of energy, this gave Canada by far the world's most generous system of equalization payments.

The rise in energy prices and the resulting increase in provincial natural resource royalties in the late 1970s created several problems for the Equalization formula. The need for amendments to the formula became clear when the traditional "have" province of Ontario qualified for equalization payments in 1978. This result went against the spirit of the system and would have led to substantial costs for the federal government; it was agreed that Ontario should be excluded from receiving payments. In 1982, the equalization standard was shifted from the national average to the average of the five "representative" provinces: British Columbia, Saskatchewan, Manitoba, Ontario, and Quebec.

The Canada Act 1982, which amended the constitution, included the rights of the poorer provinces to equalization payments. Subsection 36(2) of the Constitution Act, 1982 states that "Parliament and the government of Canada are committed to the principle of making Equalization payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation." It is unlikely that this provision will be amended.

In 2004, the federal government and the provinces agreed to suspend the traditional formula that determined payment amounts and move to fixed funding levels, which were scheduled to grow at a fixed rate - regardless of the economic performance of the provinces. In 2007, based on the recommendations of a federal Expert Panel, the program was returned to formula-driven calculations and enhanced by moving to a standard based on the national average.

Criticisms

Equalization payments have mostly been criticized by leaders and residents of the wealthy provinces. The Premiers of oil-rich Alberta and of Ontario, with its large manufacturing and service sectors, have criticized a perceived drain on local finances. However, money is collected for equalization payments by federal taxation and is collected regardless of whether or not the province is a 'have' or 'have not' province. The difference is whether the provincial government receives money from the federal treasury. Residents of Alberta and Ontario are not necessarily taxed more by the federal government. However, since those provincial governments receive less total dollars per capita from the federal government than 'have not' provinces, they are required to collect more taxes from their residents than otherwise would be required if the equalization program did not exist.

Normally, under the equalization scheme, equalization payments go down a dollar for every dollar increase in a province's treasury. Under the current formula, a have-not province loses a dollar in equalization for every dollar it makes from royalties off the sale of its natural resources, therefore creating a disincentive for developing those resources.Aside from the deal struck by Danny Williams, the premier of Newfoundland and Labrador, for their natural resource exploration and revenues. Typically a 'have-not' province, they are exempt for a period of time from the traditional calculations.

A March 2007 paper published by the Fraser Institute questioned the constitutionality of the equalization payment system. [http://www.fraserinstitute.org/commerce.web/article_details.aspx?pubID=4601]

Australia

Australia is considered to be the first federation to introduce a formal system of equalisation. The system was implemented in 1933 based on the recommendations of the Commonwealth Grants Commission. In Australia horizontal fiscal equalisation operates to compensate States which, due to influences beyond their control (e.g. a small population spread over a large area) have a greater need for government spending or a lower capacity to raise revenue.

Belgium

The only mechanism designed to reduce fiscal disparities between the federated entities in Belgium is a program called the National Solidarity Intervention or Intervention de solidarité nationale (ISN). Under the program, those Regions in which the average per capita yield of personal income tax falls below the national average are entitled to an unconditional transfer from the federal government.

The amount paid to each Region reflects the gap in the yield of personal income tax in the Region in relation to the national average, weighted by an indexing factor and a factor pertaining to the amounts received by beneficiaries when the ISN was introduced. Due to their inferior fiscal capacity, the Brussels and Walloon regions are recipients of ISN transfers. The region of Flanders does not receive funding under this program as its fiscal capacity lies above the national average.

Germany

The German system of equalisation consists of three parts: (i) revenue-sharing of the Value Added Tax (VAT); (ii) Länderfinanzausgleich (LFA) or horizontal fiscal equalisation; and (iii) Bundesergänzungszuweisungen (BEZ).

witzerland

The first elements of an equalization system in Switzerland were introduced in 1938 in the form of conditional grants, which varied according to the tax capacity of the cantons. In 1958, a constitutional article gave the federal government the authority to equalize fiscal disparities.

United States

Despite considerable differences in the abilities of states to generate revenues, there is no federal program in the United States that aims explicitly at reducing the disparities in state fiscal capacity. Certain federal-state transfers, however, do contain equalizing elements. For instance, some formula grants consider a state's personal income in determining levels of federal support.

Some grant programs are consistently equalizing, such as education programs aimed at the disadvantaged, food and nutrition programs and, for the most part, Medicaid. In aggregate, however, U.S. federal grants do little to reduce horizontal fiscal imbalances. With the responsibility for public goods and services scattered over three levels of government (federal, state, and local), the U.S. system of intergovernmental transfers responds foremost to the needs determined by the various grant programs.

External links

Canada

* [http://www.mapleleafweb.com/features/equalization-program-canada-overview-and-contemporary-issues Maple Leaf Web: Equalization Program in Canada: Overview and Contemporary Issues]
* [http://www.fin.gc.ca/FEDPROV/eqpe.html Department of Finance: Equalization Program]
* [http://www.strongontario.ca/ A Strong Ontario for a Stronger Canada]
* [http://www.eqtff-pfft.ca/index.asp/ Expert Panel on Equalization and Territorial Formula Financing]

Australia

* [http://www.cgc.gov.au/ Commonwealth Grants Commission]