Monday, June 18, 2007

Tom Courchene weighs in on equalization

From today's Globe and Mail. . . . . "Should a program intended to redistribute wealth be able to significantly erode the ability of provinces to exercise their constitutional powers over natural resources?"

He makes the case for Saskatchewan and raises the idea that maybe it's time to rejig equalization completely.


For nearly a quarter century, the old adage Why drill for oil in the provinces when you can drill for cash in Ottawa? has arguably held sway, but never has it been so prominent as in the on-going energy/equalization tug of war. To be sure, the stakes are much higher when oil is $60-plus per barrel and when the underlying issues are masked by a series of complex bilateral deals and a set of multiple and none-too-transparent equalization options. In any event, the equalization program, long viewed as an integral component of our East-West glue, seems to be coming unstuck.

Put simply, the current dispute puts three provinces - Nova Scotia, Newfoundland and Saskatchewan - at odds with the federal government over how the provinces' revenues from oil and gas should be treated in the equalization formula.

Nova Scotia and Newfoundland cut separate accords with Ottawa in the 1980s and again in 2005 to compensate them for equalization payments that were reduced because of the rising revenues from their energy sectors. The 2007 federal budget offers a variety of different approaches to the treatment of energy.

At one extreme, the two Atlantic provinces can continue with the status quo option - that is, they can apply the accords within the pre-existing model (3.5-per-cent annual growth in overall equalization).

The new model embodies a 10-province standard for calculating average fiscal capacity, a calculation that counts only 50 per cent of resources and a "cap," or ceiling, to ensure that an equalization-receiving province does not end up with total per capita revenues in excess of those of the lowest "have" province (in this case, Ontario). Provinces can also choose to calculate their equalization under a formula that excludes all non-renewable resource revenues, subject also to the above cap. This option was presumably included to respect Prime Minister Stephen Harper's election promise that non-renewable resources would be excluded from the equalization formula, although the provinces were quick to point out that the cap was not part of that electoral commitment.

The basic concern of all three provinces is obviously with the confiscatory cap. And the Atlantic provinces also argue that the manner in which the offsets interact with the cap under the accords serves to violate their spirit, even their letter.

Beyond this, Nova Scotia's concern is that while the new formula would, currently, be better for the province, the status quo option may be preferred in future as its energy revenues grow. Therefore, it wants flexibility to move between the two approaches, rather than the no-return feature of the new formula.

Newfoundland's additional problem is that, at existing energy revenues, it is likely to join the ranks of the have provinces, which would then mean that the province would not only be ineligible for the offsets under provisions of the 2005 accord, but that the accord itself would not be renewed in 2012. This cannot blamed on Mr. Harper.

Saskatchewan's cause for concern is that the current cap is only the latest version of a series of measures that have left it with precious little of the revenues it collects from its energy patch. It was denied access to the generous Atlantic accords and even to the 70-per-cent maximum clawback that applied to Nova Scotia and Newfoundland. Indeed, in the early years of this decade, the equalization clawbacks on Saskatchewan's energy revenues were at or near 100 per cent. To be sure, at current energy prices, Saskatchewan is a have province, but the cap will become confiscatory if and when prices fall back to the $50-a-barrel range.

The impact of the cap would be that for several hundred millions of dollars of energy revenues, the equalization offset would be dollar for dollar. So where is the incentive for a province like Saskatchewan to collect royalties in the first place? It would be rather strange if the equalization program, intended to help provinces provide comparable public services, led to the situation where it made sense for a province to abandon royalties altogether, perhaps in return for a guarantee from the energy companies to maintain the province's expensive energy infrastructure and maybe build a few hospitals and schools.

Intriguingly, the Atlantic provinces are seeking redress through the court of public opinion (which has finally brought Ontario into the fray as counterweight), whereas Saskatchewan has accepted Mr. Harper's invitation to pursue a court challenge.

The prevailing wisdom is that the equalization program is not justiciable. However, the issue at stake here is not related to equity. Rather, it would appear to be a division-of-powers issue: Should a purposively redistributive program be able to significantly erode the ability of provinces to exercise their constitutional powers over natural resources?

But matters need not go this far. In the short term, why not set the clawback under the cap at, say, 70 per cent, rather than 100 per cent, so that there is always some fiscal reward for collecting energy rents. This might not be far off an estimate of the costs borne by the provinces to run their energy sectors.

Moreover, this may not be very costly since, at current prices, Saskatchewan, for example, might still qualify as a have province.

While this would completely satisfy none of the provinces, it would make significant improvements on both the equity and allocation fronts.

Over the longer term, it might be better to follow Australian practice and bring both horizontal transfers (such as equalization payments) and vertical transfers (such as health and social transfers) within the ambit of equalization. That would provide more instruments that can be drawn upon to achieve cross-province fiscal equity. Within this larger framework, the equalization formula would require less fine tuning, since the vertical transfers could accommodate any remaining provincial variations.

But first, we have to get to the longer term.

Economics professor, School of Policy Studies, Queen's University and Senior Scholar, IRPP

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