Annex 10: Illustrative Financial Impacts of the Panel’s Recommendations

Impact of individual measures

The Panel has recommended a package of changes to put Equalization back on a sustainable formula-based track. While individual recommendations within the package have distinct fiscal implications, the Panel did not consider each change in isolation. Instead, each change was examined in the context of an entire package that balanced a series of important principles. For example, the recommendation to adopt a 10-province standard was considered appropriate in the context of a 50 percent exclusion of resource revenues, and the 50 percent exclusion was considered appropriate only in the context of a fiscal cap to ensure that Equalization did not push a receiving-province’s total capacity above that of a non-receiving province.

In the Panel’s view, the recommendations comprise a carefully balanced package that should not to be picked apart by each government endorsing only the elements that provide it with the biggest fiscal benefit.

Nevertheless, governments and Canadians will undoubtedly want to have some sense of the fiscal impact of individual recommendations, if only to assist in their understanding of the overall impact of the package.

The Panel has therefore decided to provide a table breaking down the impacts of individual recommendations. These tables should be reviewed cautiously and with the following caveats in mind:

First, as explained above, the Panel has recommended a carefully balanced package, where each item was examined and recommended in the context of an entire package that balanced a series of important principles.

Second, and of critical importance, the impact of individual items differs radically depending on the methodology.

Table 9 – Responsiveness of the Panel’s Formula to Oil and Gas Prices

Note: Totals may not add due to rounding.

Observations

Table 9 shows total entitlements for 2007–08 using the Panel’s formula, followed by the High Energy Price and the Low Energy Price scenarios (also using the Panel’s formula).

The table shows that as oil and gas prices increase (High Energy Price Scenario):

• Saskatchewan’s fiscal capacity increases above the 10-province standard, and Saskatchewan no longer receives Equalization.
• Newfoundland and Labrador continues to receive Equalization, but its higher fiscal capacity (including higher payments from the Offshore Accords due to increased oil and gas revenues) results in lower Equalization entitlements.
• Other receiving provinces receive additional Equalization, primarily due to a higher 10-province standard resulting from increases in oil and gas revenues.

Conversely, as oil and gas prices decline (Moderate Energy Price Scenario):

• Saskatchewan and Newfoundland and Labrador’s fiscal capacities decrease and they both receive additional Equalization.
• Other receiving provinces receive less, primarily due a lower standard.

Note also that the cost of the Equalization program does not fluctuate significantly as a result of changes in oil and gas revenues. This is because the 50 percent exclusion of resources and the fiscal capacity cap tend to moderate fluctuations in the cost of the program caused by changes in resource prices.

For example, one could calculate the impact of each recommendation, holding the rest of the formula in the base case (the 2004 Renewal formula) constant. Each calculation would show the impact of modifying the base case by adopting a single Panel recommendation. While this approach has some appeal, it results in a residual of billions of dollars. That is, the sum of each individual impact does not equal the total impact of the entire package. The residual is large because this approach fails to take into account the interaction among various recommendations.

A variant of this approach is to modify the base case by adopting all but one of the Panel’s recommendations. Each calculation would then show the impact of adopting the recommendation in question. While this approach has appeal, it also generates a large residual as it fails to take into account the interaction among the various recommendations.

Alternatively, one could begin with the base case (the 2004 Renewal formula) and calculate the incremental impact of moving one recommendation at a time toward the Panel’s formula. That is, one calculates the impact of the first recommendation on the base case. One then calculates the additional impact of making a further change to the base case. A third recommendation is then incorporated on top of the first two changes, and the impact is calculated. This continues until all of the recommendations have been incorporated. While this approach does not leave a residual, the order in which each recommendation is calculated affects the calculation. For example, the impact of the 10-province standard is different depending on whether it is calculated before or after the recommendation to exclude 50 percent of resource revenues.

With these major caveats in mind, Table 10 provides the breakdown of the impacts of individual recommendations using the last approach described above. The first row shows the impact of adopting the Panel’s recommendations on resources (50 percent exclusion rate, using actual revenues, and changing the treatment of hydro revenues), assuming all other aspects of the base case remain constant.

The second row shows the impact of adopting the 10-province standard, after the aforementioned changes to resources are incorporated into the base case.

The third row shows the impact of excluding user fees that do not generate a profit, against a base case that incorporates changes to resource revenues and a 10-province standard.

The fourth, fifth, and sixth rows show the impacts of making successive modifications to include the Panel’s recommendations on property tax, RTS simplification, and the fiscal capacity cap.

Given that the order of the calculations has an impact on the cost breakdown of the Panel’s recommendations, the text under Table 10 provides a brief explanation of why the Panel chose this specific order.

Table 10 – Decomposition of the Impact of the Panel’s Recommendation
for 2007–08

Observations

Treatment of resources: The Panel views the treatment of resources (the 50 percent exclusion, the use of actual revenues, and the treatment of hydro revenues) as a critical recommendation that underpins the recommendation to return to a formula-based system. It is therefore presented first. Note that this measure, assuming the 2004 Renewal formula with $11.7 billion fixed aggregate entitlements, increases entitlements for resource-rich provinces.

10-province standard: The Panel examined the impact of moving to a 10-province standard, assuming the 50 percent exclusion of resource revenues. In this context, the Panel considered that the $1.8 billion increase in cost would be in line with historical expenditures on Equalization.

The Panel also made a series of recommendations on non-resource tax bases. The order of presentation here was chosen to minimize the interactive effects.

Exclusion of user fees: The recommendation to stop equalizing user fees that do not generate profits reduces entitlements by $472 million. Provinces with lower overall (non-resource) fiscal capacities experience the largest per capita reduction in entitlements, since they were assumed to have the lowest capacity to raise user fees under the previous formula.

Property tax: The Panel recommends that the multiconcept approach be replaced by the stratified market value approach, and sees this as a significant improvement in the way residential property taxing capacity is calculated. In the Panel’s view, the multiconcept approach consistently over estimated the capacity of Québec to collect property taxes, while it under-estimated British Columbia’s capacity.

RTS simplification: The Panel’s recommendation to simplify the RTS results in a significant reduction in the number of tax bases, from 33 to five. The approach suggested is to move the revenues from small bases (a number of which were not based on strong conceptual models) and to equalize these amounts under the larger Equalization bases.

Fiscal capacity cap: Finally, while the Panel endorses the partial exclusion of natural resources in the formula, the additional entitlements provided by this measure should not push a province’s overall fiscal capacity above the lowest non-receiving province. As a result, the cap restrains Saskatchewan and Newfoundland and Labrador’s Equalization so that their overall fiscal capacity (own-source revenues, payments from Offshore Accords, and Equalization) is the same as Ontario’s.

Table of Contents	Next