Trevor Tombe is Associate Professor of Economics at the University of Calgary and Associate Researcher at the School of Public Policy.
Federal-provincial tensions are a Canadian condition as old as Confederation. Allegations of unfair treatment are common political batons for prime ministers. But now the COVID-19 pandemic has brought unprecedented financial challenges – and in Canada, that means these already difficult debates over federal transfers will be all the more combative.
In fact, it’s already started. Newfoundland and Labrador demanded equalization payments. New Brunswick is concerned that its payments will decrease. Everyone complains about the conditions of the federal government’s Safe Restart funds. Meanwhile, in Alberta, a referendum on equalization is looming. “The fundamental issues of fairness within the federation are not going away because of this weird and aberrant year of COVID,” Alberta Premier Jason Kenney said in July.
Much of the debate will revolve around equalization, which is by far the most misunderstood transfer program. The basic principles are quite simple: provinces with below average revenue generating capacity are supplemented by the federal government at the national average. After all, provinces with above-average incomes have an easier time increasing their incomes. And this is doubly true for provinces endowed with significant natural resources. Measuring provincial “fiscal capacity” is not easy, to say the least, but economic strength is generally a great indicator. Economic shocks can therefore affect who receives a payment and how much.
This is where things get ugly. RBC’s latest projections suggest the Canadian economy could shrink 6% this year. And oil-producing regions will see the biggest declines: Newfoundland and Labrador, for example, could see its economy contract nearly 10%, while Alberta’s is expected to shrink 8.7%. . Worse yet, nominal GDP – which roughly equates to total income – could fall by more than 16% in both provinces.
Falling resource incomes only compound the problem. Although official projections are not available, Mr Kenney recently suggested that resource revenues would approach $ 600 million this year – a staggering drop from the $ 6.7 billion forecast last year. At less than $ 140 per person (or about 1.5% of total provincial revenue), Alberta hasn’t seen such small numbers since the mid-1940s – before the first major oil discoveries at Leduc and Redwater .
No oil-producing province has qualified for equalization in recent years, despite the severe blow caused by low oil prices; their income has remained too high. But with COVID-19, that’s about to change.
Using the latest data, forecasts and some judgments, I estimated the post-COVID provincial fiscal capacity and calculated what that means for Equalization. My findings – which are admittedly very uncertain, but are still broadly instructive – suggest that Saskatchewan and Newfoundland and Labrador will potentially be eligible for payments. This won’t happen right away, as it takes time for the data to be finalized and incorporated into the calculation. But by 2022-2023, their payments could climb to around $ 600 per capita (totaling $ 1 billion in between). By 2023-2024, these payments could increase by 50%. While this is positive, the lag will attract anger.
Alberta, meanwhile, will still not qualify – but it has never been so close. Even in the worst of its recessions, Alberta’s fiscal capacity remained strong; in fact, at no time since John Diefenbaker added resource revenues to the formula in 1962 has Alberta managed to have the highest fiscal capacity in Canada. But my analysis suggests COVID-19 will bring it down under Ontario and British Columbia. If it holds, it will count as a major development.
The contraction of the national economy will also affect the provinces which currently benefit from equalization. Currently, the equalization formula increases with a moving average of economic growth, and the sharp contraction in 2020 will slow it down. As a result, the program will grow more slowly – which will save perhaps $ 2 billion over the next three years – which will mainly cost Quebec.
On the one hand, this creates a political challenge for Ottawa, which could force its hand in the fall. But on the other hand, slower growth may be justified. Equalization, after all, helps reduce inequalities between provinces. As the larger shocks hit high-income regions, there is less “need” for equalization. In fact, at no time since the start of equalization in 1957 have provincial fiscal capacities been so similar. Savings from a smaller program could be redirected to support all provinces more equitably.
However the details change, the biggest economic shock since the Great Depression will expose the gaps in our current arrangements and reveal the gaps we need to fill. Reform will not be easy. Any delay or even lack of payments, along with low potential growth, will only amplify allegations of unfair treatment in many provinces – and Ottawa should be prepared.
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