All askew with resource revenues

Monday, July 7, 2008

Somewhere in Ottawa, probably in Finance Minister Jim Flaherty's office, frazzled bureaucrats are wincing every time the price of oil edges higher. With every increase, resource-rich provinces such as Alberta pocket more royalties. The feds don't get any of that money; royalties go only to provincial governments. But the new federal equalization formula still includes 50 per cent of those escalating revenues when calculating each province's entitlements. Every upward tick in the prices of natural gas and oil adds to Ottawa's tab for that federal transfer program, which helps poorer provinces deliver roughly similar services for roughly similar levels of taxation compared to richer provinces. The problem with this increasingly generous federal largesse is that Ottawa and its taxpayers, especially those in Ontario who supply much of the funds, cannot afford it.

The damage to Ottawa's bottom line could be so severe that the Queen's University economist Tom Courchene calls the impending crisis a "fiscalamity." In an extraordinary analysis for Policy Options magazine, Mr. Courchene outlines how the inclusion of resource royalties in the calculation of how much each province raises from its taxes is driving the so-called average provincial fiscal capacity up into the sky. As this average rises, poorer provinces will be eligible for more equalization to bring their per capita payments close to that amount. The 2008-09 equalization tab is already hefty at $13.6-billion. If provincial resource revenues soar by $1-billion this year - and that is probably a low estimate with oil closing at $144.18 (U.S.) a barrel on Friday and natural gas prices that have more than doubled over the last year - Mr. Courchene figures this could add hundreds of millions of dollars to next year's equalization tab.

That is bad news for Ontario taxpayers, who provide roughly 40 per cent of federal revenues, and for Ottawa's own finances. As Mr. Courchene told The Globe and Mail, "Ottawa simply cannot afford to equalize mushrooming provincial energy royalties from which it receives no revenues." He added that this dilemma could destroy the current formula, plunging the country into another bitter federal-provincial squabble. So far, only Ontario Premier Dalton McGuinty has complained that the formula is out of step with reality: Why are taxpayers in a province on the brink of recession exporting money to the six provinces that now qualify for equalization? It's clear the federal Conservative government will eventually be forced to adjust the revenue- gobbling formula that it adopted last year.

Mr. Courchene's calculations of the inequity are startling, crammed into one small chart that parses the past to predict an unsettling future. First, he examines total provincial revenues from all sources last year, including federal transfers, concluding that the Ontario government had less money per person than any other provincial government. A lot less. Alberta had $11,942 per capita; Newfoundland and Labrador had $11,520; Ontario had only $8,155 per person. Yet Ontario taxpayers are financing generous services for the people of other provinces. Then Mr. Courchene calculates the average weekly wage in each province for public administration and for health and social services. In every province other than Ontario, including British Columbia and Alberta, those employees are paid less. These costs are higher in Ontario, so workers earn more and pay more taxes. But Ontario taxpayers are funding an equalization program that provides a better standard of living for other provinces, where services such as health care cost less to provide.

It gets worse. Suppose Ontario starts receiving equalization. The new formula stipulates that a province's per-capita equalization entitlements are capped if they exceed the fiscal capacity in a non-recipient province. But Ontario is likely to qualify for equalization next year or in 2010. So its fiscal capacity per person will not act as the cap on equalization payments to other provinces. Mr. Courchene says this honour will likely go to British Columbia - with "very significant consequences" - because the fiscal capacity of British Columbia is so much higher. Saskatchewan would almost certainly start receiving equalization again, and Newfoundland's payments could skyrocket. Ontario taxpayers will be sending more money to Ottawa - some of which will find its way back to the Ontario government - to fund an even more generous program.

This is folly. Because the Alberta government is raking in royalties, the federal government has to find a lot more money to bring other provincial governments up to that standard. The equalization program has turned generosity into an unsustainable redistribution scheme. Ottawa should change the formula now, before the oil riches of Alberta bankrupt everyone else.

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Cheers; Scott