Equalization 101

Rightly or wrongly, Equalization has a reputation of being largely incomprehensible to the vast majority of people. In fact, the Panel heard that university professors shy away from explaining it in economics classes because it’s just too complex.

“Canada’s Equalization has a reputation as too arcane and complex to be understood by mere mortals. This reputation is largely undeserved. At the level of principle, the program is entirely straightforward. ... Of course, the devil remains in the details.” - Michael Smart4

At the risk of baffling the majority of people reading this report, it’s essential to begin with the basics of Equalization – what it’s intended to achieve, how it has changed over time, and how the program operates, without unnecessarily exposing the “devils” lurking in the details. It’s also important, given the questions and misconceptions surrounding recent discussions about Equalization, to get the facts straight so that Canadians can judge for themselves.

The essence of Equalization

“A society which strongly favours universal medical coverage must surely also be committed to universal quality education. Investment in essential public services is an investment in economic well-being and Canada cannot afford to stint in developing a productive society and workforce. Equalization is the underpinning of this objective.” - Donald G. Dennison5

The purpose of Canada’s Equalization program stems from a basic commitment to fairness and equity. In a diverse federation like Canada, Equalization has a specific purpose: to ensure that across the country, people have access to reasonably comparable public services at reasonably comparable levels of taxation.

Unlike most other federal funding programs, Equalization is unique in that its purpose is specifically included in Canada’s Constitution. While the details of how the program operates can and do change over time, the fundamental commitment remains. Without a change in Canada’s Constitution, Equalization will remain an essential component of Canada’s federation.

Canada certainly is not alone in providing a mechanism for redistributing federal revenues and addressing disparities among provinces or states. In fact, many countries that are federations involving a central government and several regional governments have equalization systems similar to ours. That includes countries like Germany, Switzerland, Australia, India, Pakistan, and South Africa. The United Kingdom also has an equalization approach that takes into account the special fiscal needs of Scotland, Wales, and Northern Ireland. While they vary in approach, all have a similar objective—to allow regional governments to provide more comparable public services than otherwise would be the case.

“Equalization is too important a component of Canadian federal democracy to leave in the hands of a select group of fiscal high priests. And now, probably more than at any time in our history, we need to understand this critical institution.” - Gregory P. Marchildon6

To understand the basics of Equalization in Canada, it’s important to keep some key points in mind:

• Equalization is funded entirely by the federal government using taxes paid by Canadians all across the country.
• The basic approach is to assess the financial capability of provinces (defined for Equalization purposes as fiscal capacity) to deliver public services. Those provinces that have less ability to pay for reasonably comparable levels of public services receive Equalization payments while others do not.
• The Equalization payments a province receives from the federal government are unconditional; they have no strings attached. Provinces have complete discretion as to how they use the funds to provide public services to their residents.
• Equalization does not take the different expenditure needs of provinces into account. The formula that was developed over the years measures a province’s fiscal capacity to deliver public services, but does not take into account a range of factors (except for the size of a province’s population) that would affect the volume or costs of public services in different provinces.
• Equalization is only designed to raise provinces up to a common standard. Provinces with fiscal capacities above the common standard do not see any reductions as a result of Equalization.
• Equalization is designed to fill the gap between a province’s own fiscal capacity and a common standard across the country. It was not designed as a permanent entitlement. As a province’s wealth increases, the principle is that it should receive less money in Equalization payments and none whatsoever if its fiscal capacity is above the common standard. As a result, the amount provinces have received has moved up and down. Since the program was initiated, three provinces (British Columbia, Alberta, and Saskatchewan) have actually moved in and out of the Equalization program.

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