Canada’s Equalization Paradox: When Does Support Become Dependence?

Does Equalization actually make poorer provinces stronger?

After nearly seven decades of modern Equalization, Canadians should ask a simple question: Does Equalization actually make poorer provinces stronger?

International experience reveals an important distinction. Equalization is effective at helping provincial governments spend at comparable levels. It is much less clear that it helps weaker provincial economies catch up.

Section 36(2) of the Constitution Act, 1982 commits Ottawa to making equalization payments so provinces can provide "reasonably comparable levels of public services at reasonably comparable levels of taxation." The purpose is to help provinces with weaker tax bases provide public services. The payments are unconditional.

There is a strong argument for that principle. Canadians should not be denied reasonable public services simply because they live in a poorer province. But are recipient provinces becoming stronger and less dependent on Equalization?

The evidence is not particularly encouraging. OECD research comparing equalization systems has found no significant relationship between the degree of fiscal equalization and whether poorer regions catch up economically. A country can narrow the gap between provincial government budgets year after year without narrowing the economic gap between the provinces themselves.

Worse, a poorly designed system may preserve the problem it was intended to address. If federal transfers cushion provincial governments from the consequences of weak economic growth, they may also reduce pressure to attract investment, increase productivity and expand the tax base. Economist David Albouy's research on Canada raises a related question: are our transfer programs sometimes subsidizing economic patterns that public policy should instead be trying to change?

Ottawa could invest more in things that make weaker regions stronger: ports, railways, electricity transmission, highways, broadband and trade corridors

James Buchanan, the Nobel Prize-winning economist often described as a father of fiscal equalization, offers a useful perspective. His original concern was fairness between individuals: Canadians in similar circumstances should not face radically different taxes and public services simply because they live on opposite sides of a provincial boundary.

He later emphasized another reality: when billions arrive through unconditional transfers, does it encourage provinces to become stronger or to remain dependent?

Canada should strive to provide a reasonable national level for essential public services, while recognizing that geography, cost and individual choice affect how those services are delivered. The Constitution does not guarantee an equal outcome. It promises reasonably comparable services at reasonably comparable taxation.

That leaves room for a different approach. Ottawa could invest more in things that make weaker regions stronger: ports, railways, electricity transmission, highways, broadband and trade corridors.

Such investments attack the causes of economic weakness rather than continually paying for its consequences. We could also direct more assistance to people rather than governments. Tax credits, employment insurance, child benefits and other federal programs can help Canadians in need regardless of where they live.

Perhaps we have been asking the wrong questions. Should Canada equalize? Our Constitution has already answered that: Canada has made a national commitment to Equalization. But the Constitution does not prescribe today's formula, determine how Equalization must be applied, tell us how much is enough, or dictate how recipient governments should be held accountable.

Those questions remain ours to answer: How much should Canada equalize, and what should we equalize?