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

A further explanation of the fiscal capacity cap

While the Panel recommends the partial exclusion of natural resources in the formula, it also believes that it is essential to ensure that the additional Equalization entitlements provided by this measure should not increase a province’s overall fiscal capacity above that of the non-receiving province with the lowest fiscal capacity. The principle is clear: provinces that receive Equalization should not have a higher fiscal capacity than provinces that do not receive Equalization.

Implementing this principle means that when a receiving province has a higher post-Equalization fiscal capacity than the non-receiving province with the lowest fiscal capacity (currently Ontario), Equalization payments should be reduced accordingly. Calculating post-Equalization fiscal capacity for the purposes of the cap is complicated by two considerations: the existence of the Offshore Accords for Newfoundland and Labrador and Nova Scotia, and the question of what is the proper inclusion rate for natural resource revenues.

The Offshore Accords

The Panel views the Offshore Accords as inextricably related to the Equalization program. Although they are delivered under the authority of their own specific legislation, they are calculated on the basis of Equalization entitlements with and without offshore oil and gas resources. Their magnitude and timing (with the exception of the prepayment provisions of the 2005 Offshore Accords) depend on the structure of the Equalization program. As well, and most importantly from the perspective of the fiscal capacity calculation, they are unconditional grants to the governments of the provinces concerned. They are, therefore, available to provide public services, and consistent with the principles and practice of the Equalization program, they increase the fiscal capacity of the receiving provinces.

For these reasons the Panel considers it appropriate to include entitlements under the Offshore Accords to measure post-Equalization fiscal capacity for the purposes of applying the fiscal capacity cap.

Post-Equalization inclusion rate for fiscal capacity calculations

The Panel considered whether all resource revenues should be included in the calculation of post-Equalization fiscal capacity for the purposes of determining the impact of the cap.

The case can be made that, to the extent that resource revenues do not adequately take into account public expenditures associated with resource development and management (see Annex 7), including 100 percent of resource revenues to calculate post-Equalization fiscal capacity overstates actual fiscal capacity. While appealing in principle, there are practical difficulties with measuring the public expenditure component associated with resource revenues. In principle, this would vary by province, by the nature of the resource from which the revenue is being derived, and by the stage in the life-cycle of the development of that resource. In the absence of any data, and given the methodological difficulties of obtaining such data, the Panel concluded that it is appropriate to include 100 percent of resource revenues in the calculation of post-Equalization fiscal capacities for the purposes of determining the impact of the fiscal capacity cap.

The Panel considered whether a 100 percent resource revenue inclusion rate for calculating the cap would effectively eliminate the net benefit from a 50 percent resource revenue inclusion rate in calculating Equalization entitlements. It concluded that it would not. The cap limits (it does not eliminate) the benefit receiving provinces derive from the partial inclusion of natural resources. As illustrated in Figure 2, Saskatchewan and Newfoundland and Labrador’s post-Equalization fiscal capacity still exceeds that of other receiving provinces due to the partial inclusion of resources. The benefit is limited, however, so that their
fiscal capacity does not exceed Ontario’s.

Figure 2 – How the Fiscal Capacity Cap Works: Provincial Fiscal Capacity Before and After Equalization (using the Panel’s formula) for 2007–08

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