Section

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Section 7 (b)
Understanding the Equalization Formula
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What is Equalization?

• A program of unconditional grants by the
  federal government to make more equal the ability
  of Canadas provinces to provide a basic level of
  public services.
• Is is essentially one of the principal means by
  which the federal government contributes to
  public services for Canadians in less affluent
  provinces.

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Purpose of the Program

• The purpose of this program is to ensure that
  provincial government have sufficient resources
  to be able to provide their residents with
  reasonably comparable levels of public services,
  without having to resort to tax rates that are
  higher than average.

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Purpose of the Program

• The primary objectives are thus
• To correct the imbalance between revenue-raising
  capacity and expenditure responsibility.
• To mitigate against tax competition among
  provinces.

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Objectives of the Program

• The Royal Commission on the Economic Union and
  Development Prospects for Canada (1985) once
  commented that
• An essential element of citizenship in the
  Canadian federation must be relatively equal
  access to basic government services, irrespective
  of place of residence.

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Objectives of Equalization

• The Canadian Constitution now entrenches the
  equalization payments
• 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 service at reasonable
  comparable levels of taxation.
• (Subsection 36(2) of The Constitution Act,
  1982)

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Primary Objective Revenue-Raising Capacity

• After Equalization payments are made, no province
  should have a revenue-raising capacity below a
  specified standard.
• This does not mean, however, that the revenue
  raising capacities of all provinces should be the
  same.

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Secondary Objectives

• The Department of Finance has established a
  number of other secondary objectives for the
  program
• Sustainability implies that if the program is
  to remain financially viable, its payout growth
  needs to be prudent.
• Stability implies that payouts to provinces
  needs to be free of large and destabilizing
  fluctuations.
• Accountability Finance is accountable to
  Parliament for this program and the federal
  government has some responsibility to consult
  meaningfully with provinces.

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A Bit of History

• Over the last 25 years, the program has expanded
  as more provincial revenue sources were added,
  such as various sales taxes, resources royalties
  and property taxes.
• The Equalization program is set out in the
  Federal-Provincial Fiscal Arrangements Act, which
  is traditionally reviewed and renewed by
  parliament every five years.
• Current legislation expires March 31, 2004.

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What is Equalization?

• The Equalization program measures how well
  provinces can raise revenues relative to one
  another.
• Provinces with an above-average revenue raising
  capacity are designated have provinces
  currently Alberta and Ontario.
• Those provinces with lower capacity are
  designated have not provinces.

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What is Equalization?

• Equalization payments are unconditional grants
  -- receiving provinces are free to spend the
  funds on public services according to their own
  priorities.
• The current program, first formally initiated in
  1957, is designed to equalize fiscal capacity
  across 34 different tax bases (called the
  representative tax system, RTS).

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The Equalization Process

• The detailed process of determining Equalization
  entitlements for have-not provinces follows
  essentially four fundamental steps
• Determining Fiscal Capacity
• Establishing the Equalization Standard.
• Measuring Equalization Entitlements.
• Allowing for Special Provisions in the Formula.

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Fiscal Capacity (step 1)

• Fiscal capacity is a measure of the ability of a
  jurisdiction to finance its own government
  services.
• Measuring fiscal capacity is measured by using a
  standardized tax system known as the
  representative tax system (RTS).

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Fiscal Capacity (step 1)

• The RTS estimates each provinces ability to
  raise revenues from over 30 different revenue
  sources that are called tax bases.
• Fiscal Capacity is a hypothetical number that
  measures how much a province could raise if it
  applied national average tax rates on commonly
  defined tax bases.

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Fiscal Capacity (step 1)

• The measurements are made on a per capita basis
  to allow comparisons among provinces with
  different populations.
• The most important tax bases, on a percentage
  basis, are personal income taxes, consumption
  taxes, and property taxes.

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Fiscal Capacity (step 1)

• (Equalization Revenue Sources 2000-01)

Gaming Revenue 3
Other 6
Resource Revenue 8
Income Taxes 26
Business Taxes 15
Property Taxes 18
Consumption Taxes 23
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Equalization Standard (step 2)

• Once provincial per capita fiscal capacity has
  been calculated, the next step is to establish a
  benchmark against which each provinces fiscal
  capacity can be compared.
• The Standard measures the average per capita
  fiscal capacity of the five middle income
  provinces Quebec, Ontario, Manitoba,
  Saskatchewan and B.C.

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Equalization Standard (step 2)

• This Standard amount represents the revenues that
  would be available, on average, to the
  provinces if they had a common tax system which
  they applied in a common manner.
• For 2002-03, Equalization ensured that all
  provinces had access to revenues of at least
  5,863 per resident to fund public services.

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Equalization Standard (step 2)
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Equalization Entitlements (step 3)

• The federal government pays Equalization to
  provinces whose fiscal capacity is below the
  five-province standard.
• Entitlement paid to each province is equal to the
  difference between the per capita revenue a
  provinces could raise on its own and the per
  capita fiscal capacity of the standard.

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Equalization Entitlements (step 3)

• The total amount paid to a province is then
  determined by taking its per capita entitlement
  and multiplying that by its population.
• Equalization is not a fixed entitlement, however,
  and responds to all changes in population and
  fiscal capacity.

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Equalization Entitlements (step 3)

• Calculation adjustments are made twice a year in
  October and February, with all open fiscal years
  (those not yet finalized) re-calculated at the
  same time.
• The final equalization adjustment is made 30
  months after the end of the fiscal year, once the
  data used is finalized.

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Equalization Entitlements (step 3)
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Equalization Entitlements (step 3)
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Equalization Entitlements (step 3)

• Historically, Saskatchewan receives the lowest
  per capita Equalization of the receiving
  provinces.
• The graph on the next slide provides an
  illustration of the volatility over a 10-year
  period.

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Equalization Entitlements (step 3)
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Equalization Entitlements (step 3)

• These entitlements differ from annual Entitlement
  receipts due to prior-year adjustments and the
  impact of the floor and ceiling provisions
  (discussed later).

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Newfoundland Tobacco Tax Example
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Tobacco Tax Example (contd)
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Special Provisions (step 4)

• Examples of some basic special provisions
• A Floor provision.
• A Ceiling provision.
• The Offshore Accords.

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Special Provisions (step 4)

• Equalization payments are also subject to floor
  and ceiling provisions.
• The Floor protects individual provinces against
  any large year-to-year declines in its payments.
• The Ceiling sets out a maximum amount each year
  for total payments, to protect the federal
  government from growth beyond GDP.

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Special Provisions (step 4)

• The Floor limits the amount by which a
  provinces entitlement can decline from one year
  to the next.
• The calculation is as follows
• The floor limits year-over-year declines in
  each provinces per capita entitlement to no more
  than 1.6 of the standard.

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Special Provisions (step 4)

• For example, entitlements for this coming
  2003-04 fiscal year can not decline by more than
  94.78 per capita since the standard was 5,924.
  
• Note Saskatchewan has qualified most often for
  floor payments since its entitlements often vary
  considerably due to volatility in the prices of
  natural resources.

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Special Provisions (step 4)

• The Ceiling sets an upper limit on the growth
  of total Equalization payments to the provinces.
  
• This maximum payment or limit increases each year
  in line with the growth in the economy.

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Special Provisions (step 4)

• In subsequent years, the ceiling continues to
  grow with the economy that is, by the rate of
  growth of nominal GDP.
• When the program produces entitlements that
  exceed the ceiling limit, the program is reduced
  to the ceiling limit by reducing each provinces
  entitlement by the same per capita amount.

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Special Provisions (step 4)

• The Offshore Accords were established because
  ownership of offshore resources is not as clear
  as natural resources.
• The accords only deal with Newfoundland and Nova
  Scotia and contain provisions that offset the
  impact on Equalization payments on offshore
  resource development, much like the generic
  solution.
• These provisions provide time-limited measures to
  mitigate Equalization reductions.

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Special Provisions (step 4)

• These Offshore Accords operate outside of the
  Equalization program.
• Equalization is calculated as if the Accord
  provision did not exist and payments are made on
  that basis.
• Equalization is then recalculated using the
  special Accord provision and the difference
  between the two calculations is transferred to
  Nova Scotia and Newfoundland.

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Questions on Equalization?