Canada - West vs East equalization.....?

Equalizaiton Hypocrisy: Part 2

By: Frank Atkins – Research Chair of Finance & Capital Markets at the Frontier Centre for Public Policy

March 2016 – Business in Calgary

In the October 2014 issue of this magazine. I wrote an article concerning the hypocrisy of the Nova Scotia government banning hydraulic fracturing while continuing to receive equalization payments. Apparently, the eastern Canadian hypocrisy club has now expanded to include a group of Montreal mayors. A group that calls itself the Communaute metropolitaine de Montreal (MMC), which is headed by Montreal Mayor Denis Coderre, recently announced strong opposition to the Energy East pipeline.

It is very clear that transfer payments flow from west to east in Canada. Largely funded by the Alberta oil and gas sector, Quebec received the largest amount of transfer payments in Canada. Apparently the MMC chooses to ignore this set of facts. Therefore, they do not want Alberta oil flowing through their political jurisdictions, but they do not mind transfer payments, largely funded by Alberta oil, flowing through their jurisdictions. This can only be labelled as extremely hypocritical.

This problem is compounded by the arcane equalization formula. Normally, if a province develops new sources of revenue, this would reduce the amount that they receive in equalization payments. One example here would be Newfoundland and Labrador, a province which developed their resource sector and relinquished their “have-not” status. However, under the current funding arrangements, the equalization formula does not count the market value of hydroelectric power produced in Quebec, but rather the highly subsidized price at which hydroelectric power is sold in local markets. My colleague Peter Holle has estimated that, over the period 2005-2010, if the funding formula were corrected for this anomaly, Quebec’s equalization payments would have decreased from $42.4 billion to $28.1 billion.

The conclusion here is that Albert’s transfer payments to Quebec are actually subsidizing cheap hydroelectric power in Quebec (this is also true of Manitoba’s hydroelectric power).

The current equalization system creates the wrong incentives for economic development. However, beyond the fact that the current equalization system produces poor economic incentives, it also creates a politically divisive atmosphere in Canada. In the case of Nova Scotia banning fracking, it is somewhat difficult for provinces such as Alberta to understand why Nova Scotia can ban fracking, yet receive transfer payments from a province that uses fracking to generate wealth.

The MMC opposition to Energy East also creates political divisiveness. Alberta is currently in an economic downturn caused by the downturn in the world price of oil. Getting Alberta oil to world markets through the Energy East pipeline would not change the world price of oil, but it would increase the amount that Alberta receives for its oil, which would help alleviate some of Alberta’s current economic woes. Alberta then looks at Quebec, and sees transfer payments subsidizing cheap hydroelectric power, while at the same time Quebec is trying to block a pipeline that would alleviate some of Alberta’s current economic troubles.

There is a growing recognition on the part of provincial and federal politicians that Canada’s equalization system needs to be reviewed and reformed, yet given the East – West dynamics and electoral math involved, there has been no serious effort made to date to determine how we can develop a more fair and responsible system. Until that happens Canadians are stuck with a broke system.