Trevor Tombe is an associate professor of economics at the University of Calgary and research fellow at the School of Public Policy.
Federal-provincial tensions are a Canadian condition as old as Confederation. Claims of unfair treatment are common political cudgels for premiers. But now, the COVID-19 pandemic has brought fiscal challenges unlike anything in recent memory – and in Canada, that means that those already difficult debates over federal transfers will be all the more combative.
In fact, it’s already begun. Newfoundland and Labrador has demanded equalization payments. New Brunswick fears its payments will shrink. Everyone is complaining about the conditions of the federal government’s “Safe Restart” funds. Meanwhile, in Alberta, a referendum on equalization looms. “The fundamental issues with fairness in the federation don’t go away because of this strange, aberrant COVID year,” Alberta Premier Jason Kenney said in July.
Much of the debate will be about equalization, which is easily the most broadly misunderstood transfer program. The basics are simple enough: provinces with below-average revenue-raising capabilities are topped up by the federal government to the national average. Provinces with above-average incomes, after all, have an easier time raising revenues. And this is doubly true for provinces with significant natural resources. Measuring provincial “fiscal capacity” is not easy, to say the least, but economic strength is usually an excellent good proxy. Economic shocks can therefore affect who receives a payment, and how much.
That’s where things get ugly. The latest projections from RBC suggest Canada’s economy may shrink six per cent this year. And oil-producing regions will see the largest declines: Newfoundland and Labrador, for example, may see its economy contract by nearly 10 per cent, while Alberta’s is estimated to shrink by 8.7 per cent. Worse, nominal GDP – which is, roughly, total income – may decline by more than 16 per cent in both provinces.
Plunging resource revenues only compound the problem. Although official projections are not available, Mr. Kenney recently suggested resource revenues will approach $600-million this year – a staggering drop from the $6.7-billion forecast for last year. At less than $140 per person (or roughly 1.5 per cent of total provincial revenue), Alberta hasn’t seen such vanishingly small numbers since the mid-1940s – before the first major oil discoveries in Leduc and Redwater.
No oil-producing province has qualified for equalization in recent years, despite the massive blow from low oil prices; their incomes remained too high. But with COVID-19, that’s about to change.
Using the latest data, forecasts, and some judgment calls, I estimated provincial post-COVID fiscal capacity and calculated what this means for equalization. My findings – which are highly uncertain, to be sure, but are instructive all the same in broad strokes – suggest that both Saskatchewan and Newfoundland and Labrador will potentially qualify for payments. That won’t happen right away, as it takes time for data to be finalized and incorporated into the calculation. But by 2022-23, their payments may be roughly $600 per capita (totalling $1-billion between the two). By 2023-24, these payments may grow by 50 per cent. While that’s positive, the lag will draw ire.
Alberta, meanwhile, will still not qualify – but it has never been so close. Even in the worst of its recessions, Alberta’s fiscal capacity remained strong; in fact, at no point since John Diefenbaker added resource revenues to the formula in 1962 has Alberta failed to have the highest fiscal capacity in Canada. But my analysis suggests that COVID-19 will cause it to fall below both Ontario and British Columbia. If this holds, it would count as a major development.
The shrinking national economy will also affect the provinces that currently benefit from equalization. Currently, the equalization formula increases with a rolling average of economic growth, and the sharp 2020 contraction will drag that down. As a result, the program will grow more slowly – potentially shaving off a total of $2-billion over the next three years – which will mostly cost Quebec.
On the one hand, this creates a political challenge for Ottawa, which might force its hand in the fall. But on the other, slower growth may be warranted. Equalization, after all, helps alleviate inequality across provinces. With the largest shocks hitting higher-income regions, there is less “need” for equalization. Indeed, at no time since equalization started in 1957, have provincial fiscal capacities been so similar. Savings from a smaller program could be redirected to support all provinces more equitably.
However the details shake out, the largest economic shock since the Great Depression will expose the shortcomings of our current arrangements and reveal gaps we’ll need to fill. Reform won’t be easy. Any lag or even absence of payments, as well as the potential slow growth, will only amplify claims of unfair treatment in many provinces – and Ottawa should be ready for it.
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