From the Fraser Institute

By Tegan Hill and Grady Munro 

The government is opening the door to cronyism, favouritism and potentially outright corruption

In the midst of budget consultations, the Carney government hopes its upcoming fall budget will provide “certainty” to investors. While Canada desperately needs to attract more investment, the government’s plan thus far may actually make Canada less attractive to investors.

Canada faces serious economic challenges. In recent years, the economy (measured on an inflation-adjusted per-person basis) has grown at its slowest rate since the Great Depression. And living standards have hardly improved over the last decade.

At the heart of this economic stagnation is a collapse in business investment, which is necessary to equip Canadian workers with the tools and technology to produce more and provide higher quality goods and services. Indeed, from 2014 to 2022, inflation-adjusted business investment (excluding residential construction) per worker in Canada declined (on average) by 2.3 per cent annually. For perspective, business investment per worker increased (on average) by 2.8 per cent annually from 2000 to 2014.

While there are many factors that contribute to this decline, uncertainty around government policy and regulation is certainly one. For example, investors surveyed in both the mining and energy sectors consistently highlight policy and regulatory uncertainty as a key factor that deters investment. And investors indicate that uncertainty on regulations is higher in Canadian provinces than in U.S. states, which can lead to future declines in economic growth and employment. Given this, the Carney government is right to try and provide greater certainty for investors.

But the upcoming federal budget will likely do the exact opposite.

According to Liberal MPs involved in the budget consultation process, the budget will expand on themes laid out in the recently-passed Building Canada Act (a.k.a. Bill C-5), while also putting new rules into place that signal where the government wants investment to be focused.

This is the wrong approach. Bill C-5 is intended to help improve regulatory certainty by speeding up the approval process for projects that cabinet deems to be in the “national interest” while also allowing cabinet to override existing laws, regulations and guidelines to facilitate such projects. In other words, the legislation gives cabinet the power to pick winners and losers based on vague criteria and priorities rather than reducing the regulatory burden for all businesses.

Put simply, the government is opening the door to cronyism, favouritism and potentially outright corruption. This won’t improve certainty; it will instead introduce further ambiguity into the system and make Canada even less attractive to investment.

In addition to the regulatory side, the budget will likely deter investment by projecting massive deficits in the coming years and adding considerably to federal debt. In fact, based on the government’s election platform, the government planned to run deficits totalling $224.8 billion over the next four years—and that’s before the government pledged tens of billions more in additional defence spending.

A growing debt burden can deter investment in two ways. First, when governments run deficits they increase demand for borrowing by competing with the private sector for resources. This can raise interest rates for the government and private sector alike, which lowers the amount of private investment into the economy. Second, a rising debt burden raises the risk that governments will need to increase taxes in the future to pay off debt or finance their growing interest payments. The threat of higher taxes, which would reduce returns on investment, can deter businesses from investing in Canada today.

Much is riding on the Carney government’s upcoming budget, which will set the tone for federal policy over the coming years. To attract greater investment and help address Canada’s economic challenges, the government should provide greater certainty for businesses. That means reining in spending, massive deficits and reducing the regulatory burden for all businesses—not more of the same.

Tegan Hill

Director, Alberta Policy, Fraser Institute

Grady Munro

Policy Analyst, Fraser Institute

From the Fraser Institute

By Tegan Hill and Joel Emes

As the Alberta Next Panel continues discussions on how to assert the province’s role in the federation, equalization remains a key issue. Among separatists in the province, a striking 88 per cent support ending equalization despite it being a constitutional requirement. But all Canadians should demand equalization reform. The program conceptually and practically creates real disincentives for economic growth, which is key to improving living standards.

First, a bit of background.

The goal of equalization is to ensure that each province can deliver reasonably comparable public services at reasonably comparable tax rates. To determine which provinces receive equalization payments, the equalization formula applies a hypothetical national average tax rate to different sources of revenue (e.g. personal income and business income) to calculate how much revenue a province could generate. In theory, provinces that would raise less revenue than the national average (on a per-person basis) receive equalization, while province’s that would raise more than the national average do not. Ottawa collects taxes from Canadians across the country then redistributes money to these “have not” provinces through equalization.

This year, Ontario, Quebec, Manitoba and all of Atlantic Canada will receive a share of the $26.2 billion in equalization spending. Alberta, British Columbia and Saskatchewan—calculated to have a higher-than-average ability to raise revenue—will not receive payments.

Of course, equalization has long been a contentious issue for contributing provinces including Alberta. But the program also causes problems for recipient or “have not” provinces that may fall into a welfare trap. Again, according to the principle of equalization, as a province’s economic fortunes improve and its ability to raise revenues increases, its equalization payments should decline or even end.

Consequently, the program may disincentivize provinces from improving their economies. Take, for example, natural resource development. In addition to applying a hypothetical national average tax rate to different sources of provincial revenue, the equalization formula measures actual real-world natural resource revenues. That means that what any provincial government receives in natural resource revenue (e.g. oil and hydro royalties) directly affects whether or not it will receive equalization—and how much it will receive.

According to a 2020 study, if a province receiving equalization chose to increase its natural resource revenues by 10 per cent, up to 97 per cent of that new revenue could be offset by reductions in equalization.

This has real implications. In 2018, for instance, the Quebec government banned shale gas fracking and tightened rules for oil and gas drilling, despite the existence of up to 36 trillion cubic feet of recoverable natural gas in the Saint Lawrence Valley, with an estimated worth of between $68 billion and $186 billion. Then in 2022, the Quebec government banned new oil and gas development. While many factors likely played into this decision, equalization “claw-backs” create a disincentive for resource development in recipient provinces. At the same time, provinces that generally develop their resources—including Alberta—are effectively punished and do not receive equalization.

The current formula also encourages recipient provinces to raise tax rates. Recall, the formula calculates how much money each province could hypothetically generate if they all applied a national average tax structure. Raising personal or business tax rates would raise the national average used in the formula, that “have not” provinces are topped up to, which can lead to a higher equalization payment. At the same time, higher tax rates can cause a decline in a province’s tax base (i.e. the amount of income subject to taxes) as some taxpayers work or invest less within that jurisdiction, or engage in more tax planning to reduce their tax bills. A lower tax base reduces the amount of revenue that provincial governments can raise, which can again lead to higher equalization payments. This incentive problem is economically damaging for provinces as high tax rates reduce incentives for work, savings, investment and entrepreneurship.

It’s conceivable that a province may be no better off with equalization because of the program’s negative economic incentives. Put simply, equalization creates problems for provinces across the country—even recipient provinces—and it’s time Canadians demand reform.

Tegan Hill

Director, Alberta Policy, Fraser Institute

Joel Emes

Senior Economist, Fraser Institute