Equalization payments
From Wikipedia, the free encyclopedia
Equalization payments are cash payments made in some federal systems of government from the federal government to state or provincial governments with the objective of offsetting differences in available revenue or in the cost of providing services.
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[edit] Canada
In Canada, the federal government makes payments to less wealthy Canadian provinces to equalize the provinces' "fiscal capacity" — their ability to deliver government services. Currently Ontario and Alberta are the only provinces that do not receive equalization payments. Some economists have suggested that Saskatchewan and British Columbia will join the ranks of the "have" provinces (i.e., those provinces that do not receive equalization payments) in the near future. British Columbia is sort of on the edge of equalization payments. Some years British Columbia gets them and some they don't. Canada's territories are not included in the Equalization program - the federal government addresses territorial fiscal needs through Territorial Formula Financing (TFF).
Equalization payments are based on a formula that calculates the difference between the per capita revenue yield that a particular province would obtain using average tax rates and the national average per capita revenue yield at average tax rates. The current formula considers 33 revenue sources (see below). The objective of the program is to ensure that all provinces have access to per capita revenues equal to the potential average of all ten provinces. The formula is based solely on revenues and does not consider the cost of providing services or the expenditure need of the provinces.
Equalization payments do not involve wealthy provinces making payments to poor provinces; rather, the funds for equalization payments come from the federal treasury. Thus a wealthy citizen in New Brunswick, a "have not" province, pays more into equalization than a poorer citizen in Ontario, a "have" province. Because of Ontario's greater population and wealth, however, the citizens of Ontario as a whole do pay more federal taxes and thus their total contribution to equalization is greater than that of New Brunswick.
Equalization payments are one example of what are often referred to in Canada as transfer payments, a term used in other jurisdictions to refer to cash payments to individuals (see transfer payments). Unlike conditional transfer payments such as the Canada Health Transfer or the Canada Social Transfer, the money the provinces receive through equalization can be spent in any way the provincial government desires. The payments help guarantee "reasonably comparable levels" of health care, education, and welfare in all the provinces. The definition of "reasonably comparable levels", however, has been the subject of considerable debate.
Today the total amount of the program is around 11.7 billion Canadian dollars per year.
Traditionally, the payments have been seen as a way of promoting national unity. Quebec, the most populous of the "have not" provinces, is by far the largest single recipient of the payments. When BC and Saskatchewan are removed, approximately 70% of the 10 million Canadians residing in "have not" provinces are in Quebec. However, recent negotiations surrounding the renewal of the program have created considerable tension among provinces. Due to the zero-sum nature of the formula, increases in entitlements for some provinces necessarily lead to decreases for others.
[edit] Regional fiscal disparities in Canada
There are significant differences in the provinces in terms of size, geography, population, and economic activity. While there has been considerable convergence in provincial Gross Domestic Product per person and personal incomes among the regions over the last fifty years, the gap between the most and the least well-off provinces continues to be a primary economic concern.
Gross Domestic Product per capita by province - 2005
($ per capita)
| NL | PE | NS | NB | QC | ON | MB | SK | AB | BC | Average | |
|---|---|---|---|---|---|---|---|---|---|---|---|
| GDP per capita | $41,802 | $30,166 | $33,484 | $32,152 | $36,009 | $42,812 | $35,500 | $43,330 | $66,644 | $39,658 | $42,374 |
| Ratio to mean | 98.6 | 71.2 | 79.0 | 75.9 | 85.0 | 101.0 | 83.8 | 102.3 | 157.3 | 93.6 | 100.0 |
Source: Statistics Canada
[edit] Equalization payments in Canada – 2007-08
($ millions)
| NL | PE | NS | NB | QC | MB | SK | BC | Total | |
|---|---|---|---|---|---|---|---|---|---|
| Equalization | 477 | 294 | 1,465 | 1,477 | 7,160 | 1,826 | 226 | - | 12,925 |
| Per capita | $938 | $2,118 | $1,564 | $1,968 | $931 | $1,543 | $230 | $0 | - |
Notes:
Totals may not add due to rounding.
Source: Finance Canada, accessed 19 March 2007
[edit] Sources of fiscal capacity
The fiscal capacity of the provinces is determined by measuring their revenue from 33 different sources. Those sources are:
- Personal income taxes
- Business income taxes
- Capital taxes
- General and miscellaneous sales taxes
- Tobacco taxes
- Gasoline taxes
- Diesel fuel taxes
- Non commercial vehicle licenses
- Commercial vehicle licenses
- Revenues from the sale of alcoholic beverages
- Hospital and medical insurance premiums
- Race track taxes
- Forestry revenues
- New oil revenues
- Old oil revenues
- Heavy oil revenues
- Mined oil revenues
- Third-tier oil revenues
- Heavy third-tier revenues
- Natural gas revenues
- Sales of crown leases
- Other oil and gas revenues
- Mineral resources
- Water power rentals
- Insurance premiums
- Payroll taxes
- Provincial-local property taxes
- Lottery ticket revenue
- Other games of chance revenues
- Miscellaneous provincial-local taxes and Revenue
- Shared revenues: Offshore activities/Newfoundland
- Shared revenues: Offshore activities/Nova Scotia
- Shared revenues: Preferred Share Division
[edit] History
The basics of equalization payments have been around since Canadian Confederation when the federal government had most of the taxation powers. The federal government would make transfer payments to the provinces to cover their needs. There was no obligation that these transfer payments had to reflect the amount collected in each province and thus wealth was always redistributed.
A formal system of equalization payments was first introduced in 1957. The idea was based on the proposals of American economist James M. Buchanan and they were introduced mainly to help the struggling Atlantic provinces who were seeing low rates of growth and high rate of emigration to central Canada.
The original program had the goal of giving each province the same per capita revenue as the two wealthiest provinces, Ontario and British Columbia, in three tax bases: personal income taxes, corporate income taxes and succession duties (inheritance taxes). Five years later, 50 per cent of natural resource revenues were included as the fourth tax base. At the same time, however, the standard of the two wealthiest provinces was lowered to the national average. In 1967 the system was redesigned to work with every government revenue scheme with the exception of energy, this gave Canada by far the world's most generous system of equalization payments.
The rise in energy prices and the resulting increase in provincial natural resource royalties in the late 1970s created several problems for the Equalization formula. The need for amendments to the formula became clear when the traditional "have" province of Ontario qualified for equalization payments in 1978. This result went against the spirit of the system and would have led to substantial costs for the federal government; it was agreed that Ontario should be excluded from receiving payments. In 1982, the equalization standard was shifted from the national average to the average of the five "representative" provinces: British Columbia, Saskatchewan, Manitoba, Ontario, and Quebec.
The Canada Act 1982, which amended the constitution, included the rights of the poorer provinces to equalization payments. Subsection 36(2) of the Constitution Act, 1982 states that "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 services at reasonably comparable levels of taxation." It is unlikely that this provision will be amended.
In 2004, the federal government and the provinces agreed to suspend the traditional formula that determined payment amounts and move to fixed funding levels. Some "have not" provinces accepted the deal reluctantly however, complaining of insufficient money and a new per capita formula to be introduced in 2005-06 that will award cash based on population size.
[edit] Criticisms
Equalization payments have mostly been criticized by leaders of the wealthy provinces. The Premiers of oil-rich Alberta and of Ontario, with its large manufacturing base, have criticized the drain on local finances. However, money is collected for equalization payments by federal taxation and is collected regardless of whether or not the province is a 'have' or 'have not' province. The difference is whether the provincial government receives money from the federal treasury. Thus, citizens in Alberta and Ontario are not necessarily taxed more, though their provincial governments do receive less.
Normally, under the equalization scheme, equalization payments go down a dollar for every dollar increase in a province's treasury. However, if a province loses a dollar for every dollar it makes from the sale of its energy resources, there is less incentive to develop those reserves.
[edit] Australia
Australia is considered to be the first federation to introduce a formal system of equalisation. The system was implemented in 1933 based on the recommendations of the Commonwealth Grants Commission. In Australia a similar system operates whereby horizontal fiscal equalisation operates to compensate States which, due to influences beyond their control (e.g. a small population spread over a large area) have a greater need for government spending or a lower capacity to raise revenue.
[edit] Germany
The German system of equalisation consists of three parts: (i) revenue-sharing of the Value Added Tax (VAT); (ii) Landerfinanzausgleich (LFA) or horizontal fiscal equalisation; and (iii) Bundeserganzungszuweisungen (BEZ).
[edit] United States
Despite considerable differences in the abilities of states to generate revenues, there is no federal program in the United States that aims explicitly at reducing the disparities in state fiscal capacity. Certain federal-state transfers, however, do contain equalizing elements. For instance, some formula grants consider a state's personal income in determining levels of federal support.
Some grant programs are consistently equalizing, such as education programs aimed at the disadvantaged, food and nutrition programs and, for the most part, Medicaid. In aggregate, however, U.S. federal grants do little to reduce horizontal fiscal imbalances. With the responsibility for public goods and services scattered over three levels of government (federal, state, and local), the U.S. system of intergovernmental transfers responds foremost to the needs determined by the various grant programs.
[edit] External links
[edit] Canada
- Maple Leaf Web: Equalization Program in Canada
- Department of Finance: Equalization Program
- A Strong Ontario for a Stronger Canada
- Expert Panel on Equalization and Territorial Formula Financing
