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Equalization Payments Quebec History Essay

Andy Blatchford, The Canadian Press
Published Monday, December 21, 2015 8:56PM EST
Last Updated Tuesday, December 22, 2015 9:01AM EST


Federal Finance Minister Bill Morneau released fresh figures Sunday outlining how much the neediest provinces can expect to receive from Ottawa in the next fiscal year – and Quebec will receive a large chunk of the money.

Under the formula, the same six so-called "have-not" provinces that received cash in 2015-16 -- Quebec, Ontario, Manitoba, Nova Scotia, New Brunswick and Prince Edward Island -- will get the payments again next year.

The constitutionally guaranteed equalization program will redistribute nearly $18 billion in 2016-17 to poorer provinces, where the cash will help fund public services.

In 2016-17, Quebec will once again be -- by far -- the biggest recipient of equalization payments. It will get about $10 billion from the nearly $18-billion program.

Quebec Finance Minister Carlos Leitao was asked Sunday night about the formula's fairness. He replied by saying the federal coffers take in cash from all provinces -- including about 23 per cent that comes from Quebec.

"So, a portion of it gets transferred back (to Quebec) and more," he said.

That means economies hit hard by the sudden drop in oil prices -- such as Alberta and Saskatchewan -- will continue to pay into the program as "have" provinces.

"Well, the formula is the formula and we're a have province," Saskatchewan Finance Minister Kevin Doherty told the news conference following the talks.

"Based on that formula, there is a lag effect."

It's been a difficult year for the province's bottom line. The oil-price shock has erased about $500 million in revenues from Saskatchewan's $14-billion budget, he said.

"That's a big hole to fill."

Alberta has received a bigger wallop.

Joe Ceci, Alberta's finance minister, says low oil prices may force him to shelve millions of dollars in plans promised by the NDP government, including child-care benefits, school fee reductions, student hiring and environmental retrofits. Last week, Standard and Poor's bumped the province's credit rating down to AA-plus from AAA.

Doherty said Monday he's more focused on how quickly the federal government will start spending the billions of dollars in infrastructure investments it pledged during the election campaign.

The federal Liberals see infrastructure funding as a key to boosting the country's economy, something echoed by several provincial finance ministers.

Morneau was asked Monday when he expected to start seeing the shovels drive into the ground.

"We acknowledged that at this early stage that we don't have all of the details ironed out about how exactly we can deliver on our spending promises," said Morneau, who added the ministers spent a lot of time discussing infrastructure at the meetings.

Morneau said he hoped to sort out the specifics in the coming months. He noted it's important to do it rapidly but responsibly to get the economic impact they're aiming for.

On Sunday night, Morneau appeared to want to steer clear of the sometimes thorny issue of equalization.

"I expect that at every meeting of the finance ministers that is a subject that people will discuss," Morneau said when asked if he thought its formula was fair.

Historically, provinces have had their differences about equalization.

Saskatchewan Premier Brad Wall has expressed frustration with the formula, arguing it doesn't easily take into account the changes in resource prices, such as oil and hydro, making it years behind the times.

Wall has also said provinces like Manitoba and Quebec receive bigger payments because the formula doesn't account for the revenues they rake in from hydro power. The calculation does, however, factor in non-renewable resource revenue from oil and gas.

He has called for the payments to be halved to allow Ottawa to instead invest the money in things like infrastructure projects across the country.

Michael Binnion, CEO of Questerre Energy and head of the Quebec Oil and Gas Association, has a great blog post up in which he discusses the impact that equalization payments have on Quebec's energy and natural resource policy.

Looking at Quebec's budget, Binnion observes:

It seems to me the Quebec budget actually exposes a huge problem and many Quebec commentators have pointed it out. Quebec is being paid by the Federal Government for reduced resource royalties and related taxes. Worse if Quebec increased the price of Hydro, increased its mining royalties or developed its oil and gas discoveries, the Federal Government would penalize them.

What Mr. Binnion is pointing out is the moral hazard inherent in the equalization system, or, for that matter, in most any insurance or social welfare system. According to the OECD, Moral hazard describes behaviour when agents do not bear the full cost of their actions and are thus more likely to take such actions.

There are many examples of moral hazard one could cite, but consider what happens when governments become the disaster insurer of last resort, or otherwise transfer the costs of risk-taking from those who take the risk to those who bear the cost.

As researchers at the Wharton Risk Center observe,

Highly subsidized premiums or premiums artificially compressed by regulations, without clear communication on the actual risk facing individuals and businesses, encourage development of hazard-prone areas in ways that are costly to both the individuals who locate there (when the disaster strikes) as well as others who are likely to incur some of the costs of bailing out victims following the next disaster, either at a state level through ex post residual market assessments or through federal taxes in the case of federal relief or tax breaks.

In the case of Quebec, the people of the province do not have to bear the full cost of their decisions to suppress the economic activities of mining or fossil fuel production, because the rest of Canada will make up foregone revenues through equalization payments. Some people might think that sounds like a good deal: after all, Quebec gets to have a high quality of life without having to dirty its hands with things like energy and natural resource production.

Alas, as the economists say, there's no such thing as a free lunch: with the free ride comes dependency, and eventually decay. As Binnion observes:

The Government of Quebec is like a person on Government assistance. If they get a job their assistance goes down. If they lose a job their assistance goes up. In Provinces like Alberta we need to realize that equalization is not something we do for Quebec - it's something we do to them! A model of producing more than you consume is sustainable for a society, but a model of consuming more than you produce is not.

As Fred McMahon of the Fraser Institute proved in an award-winning essay, the situation is not unique to Quebec -- transfers to Atlantic Canada for economic development can also create economic distortions perversely retarding development in Atlantic Canada:

Government influence in the marketplace also operates through a number of other channels: economic development programs, tax policy and rulings, direct and indirect subsidies, etc. When government does step into the marketplace to influence the distribution of resources, the link between price and the most productive use of a resource is broken, and resources can be misallocated to less efficient uses to the detriment of the economy.

Binnion closes out his blog post on an optimistic note, pointing out that it need not be this way for Quebec, any more than it had to persist in Atlantic Canada:

Newfoundland fought the Federal Government and insisted on a deal that did not penalize them for developing Hibernia or Voisey's Bay. Today Newfoundland is a have province. If it worked for Newfoundland it will work for other Provinces too.

Let us hope that Quebec's public -- and her decision makers -- come to understand the moral hazard of equalization payments and reconsider their antipathy to the valuable economic activities that are energy and natural resource development.

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