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How do the entitlements under the Panel’s formula compare with entitlements under the current formula? This depends on what is considered to be the base case formula.
Provincial governments and Canadians will naturally wish to know how much the Panel’s recommendations would give each province in 2007–08 compared with announced entitlements for 2006–07. This suggests that impacts might be measured against what provinces are scheduled to receive under the interim formula of the New Framework, as extended and updated in November 2005.
However, such comparisons do not tell the full story. They measure impacts against a temporary allocation which, for both Canada’s first ministers and its legislators, was never intended to be more than a transitional stopgap, pending a more permanent solution. The allocation under the New Framework has no conceptual underpinning as an ongoing formula.
The Panel believes that the more relevant and rigorous comparison in assessing a return to a principle-based and formula-driven program is against the previous formula-driven Equalization framework. This leaves the 1999 formula or the 2004 formula (which was legislated but never implemented) as candidates for the
base case.
Table 3 – Possible Base Cases
| Possible Base Cases |
Observations |
| 1999 Equalization Renewal (for 1999–2004) |
Legislated by the Parliament of Canada in March 1999. Total payments and their allocation among provinces are formula-determined, using a five-province standard and the Representative Tax System (RTS). |
| 2004 Equalization Renewal (for 2004–2009) |
Legislated by the Parliament of Canada in March 2004, but never implemented because it was superseded by the New Framework described below. Total payments as well as their allocation among provinces continue to be formula-determined based on a five-province standard and vary according to provinces’ fiscal capacity relative to the standard.
Significant formula changes relative to 1999: major reform of property tax base, incorporation of tax-on-income in personal income tax base, introduction of three-year moving average with a one-year data lag and a 10 percent adjustment factor to account for the time value of money. The three-year moving average was to be phased-in over four years. |
| October 2004 New Framework for Equalization (applies to 2004–05 and 2005–06 entitlements) |
Announced by the Prime Minister of Canada after the October 26, 2004 First Ministers’ Meeting and subsequently legislated. Total payments became fixed outside the formula (a fixed pay-out) and their allocation among provinces
is based on an interim quasi-formula, the result of an interim agreement concluded by first ministers.
2004–05 entitlements were determined by the 1999 formula based on October 2004 data, with a top-up allocated according to each province’s share of entitlements for that year. Floor protection was also provided to prevent provincial entitlements from being lower than estimates announced in the February 2004 federal budget.
2005–06 entitlements were based on an average (50/50) of:
(a) A three-year average of Equalization shares (lagged one year) under the five-province standard applied to a fixed payout amount.
(b) Equalization amounts based on a fixed payout approach using a three-year average of fiscal capacities (lagged one year). |
| Extension of the New Framework to 2006–07 |
Announced by the federal Minister of Finance on November 8, 2005, but not legislated. It extends to 2006–07 the allocation methodology adopted for the previous fiscal year and updates it to incorporate more recent fiscal and economic data. No changes were proposed to the fixed funding levels set out in the
October 2004 New Framework. |
The 1999 Renewal formula omits significant reforms (e.g., residential property tax and improvements to the personal income tax base) which resulted from years of collaborative work between federal and provincial officials, and which were legislated in March 2004.
For this reason, the Panel believes that the 2004 Renewal formula is the most appropriate base case. The Panel made two changes in order to make the base case as relevant as possible:
- First, the 2004 Renewal formula used the five-province standard, but the federal government adopted a higher implicit standard when it announced aggregate entitlements as part of the New Framework. The Panel believes that this higher implicit standard is a more appropriate benchmark for comparing the additional costs and impacts of its formula. Accordingly, the Panel increased the size of the pool for the base case under the 2004 Renewal formula to the actual legislated aggregate levels under the New Framework.
- Second, the 2004 Renewal formula uses a three-year moving average, with a one-year data lag. For
example, 2007–08 entitlements would be based on a one-third weighting of 2006–07, 2005–06, and 2004–05 data. The Panel adjusted the 2004 Renewal formula to incorporate the same two-year data lag and weighted three-year moving average that it recommends. This provides a more meaningful comparison. The differences in entitlements are due to formula differences, rather than the year and weights of the data.
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