From the Fraser Institute

By Tegan Hill and Nathaniel Li

Due to the “fixed-growth rule” introduced by the Harper government in 2009, the amount spent on equalization increases whether or not the gap between ”have not” and “have” provinces increases or decreases. For example, from 2007/08 to 2020/21, equalization payments increased by nearly 60 per cent despite the gap in fiscal capacities between richer and poorer provinces actually shrinking over that period.

As the Alberta Next Panel, which is tasked with assessing Alberta’s role in Confederation, reconvened last week, Canada’s equalization program remains near the top of the agenda. At the same time, the Alberta government is backing a legal challenge led by Newfoundland and Labrador arguing that the program does not achieve its intended purpose. While individuals may hold differing opinions on the program’s core principle—to ensure reasonably comparable public services delivered at reasonably comparable tax rates across the country—it’s clear that any reasonable assessment would find the current equalization system is broken.

Ottawa collects taxes from Canadians across the country then redistributes money to so-called “have not” provinces through equalization. To determine who gets money, the federal government calculates the “fiscal capacity” of each province—that is, a province’s ability to raise revenue. Basically, the formula applies a tax rate to different sources of income (including personal income, business income, resources, etc.) to determine how much revenue a province could generate. In theory, money from provinces with higher fiscal capacity (i.e. greater ability to raise revenue through taxes) is transferred to provinces with lower fiscal capacity.

This year, equalization payments will total a projected $26.2 billion. Seven provinces including Ontario, Quebec, Manitoba and all of Atlantic Canada will receive equalization payments. Alberta, British Columbia and Saskatchewan will not receive payments. Again, in theory, these three provinces have a greater ability to generate government revenue so they will not receive equalization.

But here’s the problem. Due to the “fixed-growth rule” introduced by the Harper government in 2009, the amount spent on equalization increases whether or not the gap between ”have not” and “have” provinces increases or decreases. For example, from 2007/08 to 2020/21, equalization payments increased by nearly 60 per cent despite the gap in fiscal capacities between richer and poorer provinces actually shrinking over that period.

If equalization is meant to close the gap between provinces, then the amount spent should reflect the gap. But the formula—and thus, the program—is broken.

More broadly, the principle of equalization—again, to ensure that all provinces can deliver reasonably comparable services at reasonably comparable tax rates—assumes that provinces with higher incomes (and a greater ability to generate tax revenues) will not receive equalization while provinces with lower incomes will receive equalization. Yet in 2020, for example, Newfoundland and Labrador, which received equalization, had higher income (measured by GDP per person) than B.C., which did not receive equalization. In 2018, Ontario had higher income than B.C., but Ontario was a recipient while B.C. was not. Clearly, there’s a problem with how the formula determines a recipient versus a contributing province.

Another problem is the treatment of subsidized electricity in Quebec and Manitoba. The Quebec government, for example, provides below-market electricity prices to Quebecers—even though charging the market rate would provide more revenues to Hydro Quebec, which manages the generation, transmission and distribution of electricity in the province. But the equalization formula only accounts for actual resource revenues and doesn’t account for this lower-than-market electricity rate in determining Quebec’s ability to raise revenues. In fact, an increase in Hydro Quebec’s profits of $100 million would result in a decrease in equalization payments of an estimated $70 million. Simply put, the equalization formula underestimates Quebec’s ability to raise revenue from its electricity provision while effectively penalizing provinces that don’t provide subsidies.

Ironically, the formula does not follow that same approach for Alberta, which has no provincial sales tax. Again, the formula accounts for Quebec’s actual resource revenue, not hypothetical resource revenue if Quebec charged market rates for its electricity. Yet the formula includes a hypothetical Alberta provincial sales tax when determining Alberta’s fiscal capacity. So, the formula does not penalize Quebec for foregone hydro revenues, but does penalize Alberta for foregone sales tax revenues. Quebec also bans fracking (as did Nova Scotia until lifting its ban), but the equalization formula does not apply any forgone hypothetical fracking-related resource revenue to Quebec. This inconsistency in the treatment of different types of revenue in different provinces is yet another sign of a fundamentally broken equalization system.

Reasonable people can debate the core principle of Canada’s equalization program, but as the Alberta Next Panel continues discussions, policymakers should recognize that the current system is badly broken and requires a major overhaul.

Tegan Hill

Director, Alberta Policy, Fraser Institute

Nathaniel Li

Senior Economist, Fraser Institute

From the Fraser Institute

By Alex Whalen and Jake Fuss

Post-deregulation Australia’s dairy industry increased exports by $3 billion. Exports now account for more than 30 per cent of Australia’s total dairy production (and 20 per cent in New Zealand, which also ended its supply management system) compared to less than one per cent in Canada.

In one of the latest salvos in his trade war, President Trump recently took aim at supply management in Canada—a set of regulations that restricts  supply and controls imports to allow Canadian dairy producers of milk, eggs and poultry to maintain higher prices for their products than would otherwise exist in a competitive market.

In his attacks on Canada, Trump gets a lot wrong. But in fact, if Ottawa and the provinces dismantled our supply management system in a fair and productive way, it would be a rare win-win in trade negotiations with the Trump administration. And a win-win for both Canadian consumers and Canadian farmers.

For lessons in reform, Canada can look to other countries. For example, Australia’s dairy industry was heavily regulated for most of the 20th century, but by the 1990s, the weight of higher prices for supply-managed goods created public pressure for reform. The country also faced pressure from its trading partners to stop shielding its domestic dairy industry on grounds of fairness, much like the U.S. pressure Canada faces today.

So, around the turn of the century, the Australian government gradually dismantled its supply management system. Immediately following deregulation, milk prices fell by 12 cents per litre in Australia. Since then, prices have remained relatively flat, with price increases below the rate of inflation.

In other words, when the Australian dairy industry transitioned from a tightly-regulated protected industry to a more open industry with competition from both domestic and international firms, consumers reaped the rewards.

Of course, opponents of reform in Canada (including the dairy lobby) claim that supply management is necessary to help Canadian farmers survive and thrive. But in fact, after the Australian government eliminated supply management, the farming industry was arguably stronger. Some farmers exited the industry (and were compensated for doing so), and those that remained were more productive and more competitive in export markets.

In fact, post-deregulation Australia’s dairy industry increased exports by $3 billion. Exports now account for more than 30 per cent of Australia’s total dairy production (and 20 per cent in New Zealand, which also ended its supply management system) compared to less than one per cent in Canada. Despite Canada’s larger economy and population, both Australia and New Zealand export more dairy products than Canada.

At the same time, the Australian government introduced programs to financially support farmers to either help them adjust their operations or exit the industry. Farmers who remained in the industry experienced a 56 per cent increase in revenues and a substantial increase in the value of exports.

Moreover, according to a study from 2011, government subsidies for farmers equalled six per cent of total farm receipts in Australia and one per cent in New Zealand compared to 18 per cent in Canada. Which means that, due largely to Canada’s supply management system, the burden on taxpayers in Canada is far heavier than in those two countries.

Here in Canada, reform requires cooperation between the federal and provincial governments. Currently, Ottawa controls the trade component of supply management through restrictive import tariffs, while the provinces work alongside the federal government to regulate milk marketing boards, which set minimum prices for consumers.

In the face of President Trump’s aggressive trade actions, the premiers should agree to work with the Carney government to finally eliminate Canada’s arcane supply management system. It won’t be easy—politicians are slow to challenge entrenched interests and constituencies. But as the experience of our other allies clearly shows, governments can reform the dairy industry to the benefit of both consumers and farmers. There could be a silver lining to Trump’s attack on supply management in Canada.

Alex Whalen

Director, Atlantic Canada Prosperity, Fraser Institute

Jake Fuss

Director, Fiscal Studies, Fraser Institute