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On October 18th Albertans will go to the polls to elect new mayors, reeves and municipal councillors. Also on the ballot will be two referendum questions: one on whether or not to remain on Daylight Saving Time year-round; and the other addressing whether the principle of equalization payments should be removed from Canada’s constitution.

This latter issue is far more contentious and complex than the former and with a ballot question presented, has raised many questions within Alberta and across the country. Polling data suggests Albertans are evenly divided on the issue.

In the interests of contributing to an informed debate, the Business Council of Alberta, and the Edmonton and Calgary Chambers of Commerce have partnered to produce a primer on equalization: how it works, what a yes or a no vote could mean, how equalization might be improved, and how it fits into a broader assessment of fiscal fairness in Canada.

 

WHY DOES CANADA HAVE AN EQUALIZATION PROGRAM?

Provincial governments are responsible for providing critical public services such as health care and education. But for a range of reasons, some provinces are richer than others, meaning they have an easier time raising the money they need to deliver those services.

Imagine a simple example: workers in Province A have an average wage of $100,000 and workers in Province B have an average wage of $50,000. If both had the same population and the same tax rates, Province A would be able to raise far more revenue than Province B. But both would have the same obligations in in terms of delivering health care and education to their residents. So Province B is left with a hard decision: does it provide fewer or lower-quality services or does it raise taxes? Either choice comes with negative consequences.

Equalization exists to partially smooth out those differences. As set out in the Constitution Act, the principle of equalization payments is “to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation.”

 

HOW DOES EQUALIZATION WORK?

Equalization is a federal government program that provides unconditional cash payments to poorer (“have not”) provinces to help them pay for the services they deliver. The total amount paid out in 2020-21 was about $20.6 billion.

How much each province receives is determined by a formula. The formula itself can be changed over time but payments in any given year are determined by a mathematical formula and are not an arbitrary decision by the federal government of the day. Simply put, numbers get plugged into the formula and an entitlement amount is generated.

On the surface the formula itself is intuitively simple. In a broad sense, it calculates how much money each province could hypothetically generate (per person) if they all applied an identical set of taxes and tax rates to their actual tax base. It then compares each province’s resulting total to the national average. If they are below that average, provinces get enough equalization (per person) to bring them to the national average. Provinces that are above the average do not receive equalization, but neither are they required to make any payments.

For example, let’s say that the equalization formula determined that if all provinces had identical taxes, the Alberta government would collect $7,000 per person per year. New Brunswick would collect $3,500, and Quebec, $4,500. Nation-wide, the average was $5,000 per person. In this case, the New Brunswick government would receive $1,500 per person in equalization payments and the Quebec government would receive $500. In reality, because of its large population, Quebec receives by far the largest total amount of equalization, but the largest per capita payments go to the maritime provinces. Alberta has not received a dollar of equalization in more than 55 years.

Equalization gets very complicated very quickly if you were to dig any deeper. There are different rules surrounding the treatment of natural resource revenues, some revenue sources are not treated the same as others, and there are mechanisms in place to determine the total size of the pot of money that gets distributed every year, to name just three.

 

DO ALBERTANS PAY EQUALIZATION TO OTHER PROVINCES?

There are two questions here:

- Does the Alberta government pay equalization to other provinces?

- Do individual Albertans pay equalization?

The answer to the first question is no. Equalization is entirely funded out of federal government revenues. The Alberta government pays nothing into equalization and cancelling the program would not provide the Alberta government with any additional revenue, it would only take federal money away from poorer provinces. The only way the Alberta government might benefit from cancelling equalization is if Ottawa took that $20.6 billion and gave each provincial government a share of it.

The answer to the second question is a little more complicated. Albertans are Canadians, and because we are all federal taxpayers we all contribute money to Ottawa that is used to finance all the programs and services provided by the federal government, including making equalization payments.

Albertans undoubtedly send more send more money to Ottawa than other Canadians, but that’s not because the federal government taxes us differently; it’s because we have more people earning higher salaries and higher earners pay higher taxes.

This means that Albertans, on average, do contribute a little more to federal coffers, and that money is used to pay for a range of things, including equalization. This can add up over time and seem unfair on the surface, but Alberta and Albertans are not treated any differently than anyone else.

 

WHAT IS THE REFERENDUM QUESTION ASKING?

The exact question that will be put to Albertans on October 18 is this:

“Should section 36(2) of the Constitution Act, 1982 – Parliament and the Government of Canada’s commitment to the principle of making equalization payments – be removed from the constitution?”

It is worth highlighting that the question does not ask about whether equalization should be discontinued or changed. It only asks whether it should be specifically mentioned in the constitution.

 

WHAT WOULD A “YES” VOTE MEAN?

The federal government is not tied to the results of an Alberta referendum and the province cannot force any unilateral changes to the Constitution. Amendments can only be made if the House of Commons, the Senate AND at least seven provinces (representing at least 50% of the population) all agree. This threshold is effectively impossible to achieve.

Moreover, even if the principle of equalization were removed from the Constitution, it would in no way prevent the federal government from continuing with the program. It would simply remove the constitutional imperative.

However, a “yes” vote would signal Albertans’ broad dissatisfaction with the province’s place in confederation. It could also spur other provinces to put similar pressure on the federal government to highlight fiscal fairness as an issue and spark a national conversation on either reforming equalization as it is presently designed, or finding alternative ways to improve fiscal fairness across Canada.

More to the point, some believe that a 1998 Supreme Court decision on Quebec Secession states that if a province holds a referendum on a proposed constitutional amendment with a clear question and a clear majority voting in favour, the federal government has an obligation to negotiate that amendment in good faith. Not all legal scholars agree, however, with many stating the obligation in question refers only to secession negotiations.

However, a “yes” vote could potentially still trigger negotiations, albeit more indirectly. Some argue that, according to Section 46 of the Constitution Act, a provincial legislature can initiate procedures for constitutional amendment by passing a simple resolution. Alberta’s Constitutional Referendum Act requires the province to hold a successful referendum vote before it can attempt to pass such a resolution in the Legislature. So, in other words, a “yes” vote could allow the provincial government to pass a resolution that would then trigger negotiations.

That said, it is unclear what, exactly, would be negotiated.

 

WHAT WOULD A “NO” VOTE MEAN?

This answer is more straightforward. A “no” vote would mean that the provincial government would not have the legal authority to pass a resolution in the Legislative Assembly on removing the reference to equalization in the Constitution. There would be no imperative requiring the federal government to negotiate.

However, that does not mean the underlying concern – Alberta’s outsized net contribution to Canada – would be resolved. The provincial government would likely still advocate for a more equitable distribution of federal transfers across Canada and for improvements to the existing equalization formula.

 

COULD EQUALIZATION BE AMENDED OR IMPROVED?

The equalization formula in its present form has several weaknesses and critics. Three issues are specifically worth mentioning.

First, the basic idea of equalization is to help narrow fiscal disparities between richer and poorer provinces. In theory, this would mean that if the gap between richer and poorer provinces shrank over time, the total amount of equalization payments would also fall – there would be less to equalize.

However, a rule was introduced in 2009 requiring overall payments to increase each year based on growth in the national economy. At the time, this measure was intended to put a ceiling on ballooning entitlements. Alberta was becoming, thanks to rising oil prices, so wealthy that it was driving up the size of equalization payments distributed to the rest of the country. Ottawa was concerned about the growing expense. Since 2014, however, the Alberta economy has struggled and other provinces are catching up. As a result, the growth ceiling has turned into a floor; it is forcing payments to increase even as the fiscal gap between provinces is narrowing.

Second is the treatment of natural resource revenues. One of the perverse consequences of equalization is that it provides a powerful disincentive for poorer provinces to develop their natural resources. At the extreme, every dollar generated from new royalty revenues could result in a one dollar loss in equalization payments. Provincial governments would be just as well off whether or not they developed their resources.

At various points in the past, natural resource revenues have either been in the equalization formula, excluded from it, or a bit of both. At present, provincial governments can choose one of two options: they can run an equalization formula that fully excludes resource revenues or a formula that excludes 50% of resource revenues. They are able to choose whichever gives them the largest cash payment.

There is no easy answer to how resource revenues should be treated. Some argue they should be fully included, others, fully excluded. However, a hybrid system that gives provinces the best of either world runs counter to the principle of equalization.

Finally, not all provincial revenue sources are treated consistently in the current equalization formula. The best example is provincial hydroelectricity generation. Quebec and Manitoba both produce large amounts of hydroelectricity, but sell it to their residents at below-market rates – effectively providing a subsidy to local consumers and businesses. But by intentionally selling it at below-market prices, those governments lower their own revenues, and end up qualifying for more equalization to make up for it. A more principled approach to equalization would remove this quirk.

 

IS ALBERTA TREATED FAIRLY BY OTTAWA?

At its core, the equalization referendum is not about the program itself, but about whether Alberta is being unfairly treated in confederation.

There is no doubt that Albertans make an outsized contribution to Canada. In 2019, the federal government collected just under $50 billion in revenues from Alberta, but spent only $31.8 billion in the province. On a per capita basis, that gap amounts to about $4,100 and is more than double that of the next largest contributing province (BC, at $1,900 per person).

Why do Albertans contribute so much more than other Canadians? There is no single answer to that question. About half the gap is on the revenue side – Ottawa collects more tax money from Alberta per person than other provinces – and the other half is on the spending side.

The revenue side is easy to explain. In spite of our recent economic challenges, Alberta is still wealthier than other provinces. Our per capita incomes are higher. We spend more. We have proportionately more business activity taking place here. All those things translate into higher tax revenues for Ottawa, even though we pay the exact same federal tax rates as everyone else.

The spending side is a little more complicated. About 90% of federal spending falls into one of three broad categories: transfers to households; transfers to provincial governments; and direct expenditures on goods and services. In every one of these, Ottawa spends far less in Alberta than in any other province.

But in some cases, there are good reasons why. The gap in transfers to households is largely because Alberta is younger and wealthier than other provinces. That means Albertans have less need for means-tests income support programs like Old Age Security and the GST tax credit. This gap could only be closed by making Alberta poorer.

The same goes for the gap in federal transfers to provinces. Ottawa sends about $500 less per person to the Alberta government than it does to provincial and territorial governments generally. That amount is effectively the same as average per capita equalization payments. In other words, without equalization, federal transfers to the Alberta government would be about in line with the national average. And, as noted earlier, removing equalization would not help Alberta, it would just harm recipient provinces.

Where the true gap lies is in federal spending on goods and services, including government offices and agencies, direct spending on infrastructure, defence, and others. In this category, the federal government spent an average of just under $2,200 per person across Canada, but only $1,250 in Alberta. This gap is not simply the mechanical result of Alberta’s relative prosperity and is the obvious target for improving fiscal fairness.