The roots of Canada’s Equalization program date back to the 1940s. The first formula-driven approach was established in 1957.
Several books and articles have been written tracing the history of Equalization and changes in fiscal arrangements throughout Canada’s history. For the purposes of this report, we’ll only highlight the origins of the program and some of the major changes that have taken place leading up to the present day.
Equalization’s roots can be traced back to the Rowell-Sirois Royal Commission Report in 1940. Following Canada’s Great Depression, when three prairie provinces were virtually bankrupt, the Commission recommended that the federal government set up a program to provide grants to provinces based on their fiscal needs. The Second World War pre-empted action on the Royal Commission recommendations but, in the 1950s, the federal government turned its attention to the issue once again.
The first formula-driven Equalization program was established in 1957. Under that program, provinces received a grant from the federal government if their per capita revenue from personal income tax, corporate income tax, and inheritance taxes was less than what the two richest provinces of the day (Ontario and British Columbia) could raise at the same tax rates. The program was to be reviewed every five years.
Between 1962 and 1967, the program was changed to include half of natural resource revenues as the fourth tax base in the formula. The standard of the two richest provinces was also changed to a 10-province or national average standard.
Several key changes took place over the next twenty years. The number of
different types of revenues included in the formula grew from the original three to 29. This resulted in a more comprehensive approach with more detailed measures but also added to the complexity of the program. Also,
during that time, substantial increases in oil prices drove up the revenues of oil-producing provinces, especially Alberta. With a 10-province standard in place, the impact on Equalization was to drive up the national average and the costs to the federal government of providing Equalization grants to receiving provinces. Consequently, many of the adjustments made to the program were focused primarily on reducing the overall impact of provincial natural resource revenues and containing costs for the federal government.
Successive changes to Equalization have added layers of complexity to the program.
In 1982, a number of significant changes were made. First and foremost, Equalization became part of Canada’s Constitution. Second, the standard
was changed. Instead of a national average or 10-province standard, a
five-province standard was introduced based on the average of Québec, Ontario, Manitoba, Saskatchewan, and British Columbia. This new standard excluded the highs and the lows in fiscal capacity of the provinces (taking out oil-rich Alberta and the less-wealthy Atlantic provinces) and focused instead on the middle range of provinces. This reduced the costs to the federal government of including 100 percent of resource revenues in the Equalization formula.
From 1982 to 2004, the program remained largely the same in its basic approach. But the formula became increasingly complex through a series of technical adjustments discussed by federal and provincial officials or added at the discretion of the federal government. New tax bases were added
(particularly in relation to resource revenues), ceilings and floors on the total amount of Equalization were added, and adjustments were made in how provinces’ revenues were estimated and payments were made.
In the mid 1980s, the federal government entered into specific agreements with both Newfoundland and Labrador and Nova Scotia in relation to their offshore resources. These agreements (Canada-Nova Scotia Agreement on Offshore Oil and Gas Resource Management and Revenue Sharing  and Canada-Newfoundland and Labrador Agreement on Offshore Oil and Gas Resource Management and Revenue Sharing ) provided for time-limited, partial compensation for any reductions in Equalization payments to these two provinces as a result of increasing revenues from offshore developments. In effect, the Accords meant that the two provinces would receive separate offsetting payments from the federal government if increasing revenues from offshore developments led to decreases in their Equalization payments.
In February 2005, new Offshore Accords (Arrangement between the Government of Canada and the Government of Newfoundland and Labrador on Offshore Revenues, 2005 and Arrangement between the Government of Canada and the Government of Nova Scotia on Offshore Revenues, 2005) were signed with the two provinces. Those Accords extend protection to 2012 and provide full compensation for any reductions in Equalization payments as a result of increased revenues from offshore developments. Generally speaking, in order to qualify for the full offset payments (made outside of the Equalization program) and a potential extension to 2020, the two provinces would have to continue to qualify for Equalization and continue to have a higher-than-average per capita net debt burden. Both provinces received
guaranteed advance payments of a part of the benefits they were expected to receive over the first eight-year term of the 2005 Accords.
The impact of these Accords on the Equalization program is controversial. Both Newfoundland and Labrador and Nova Scotia contend that the Accords have nothing to do with Equalization and are intended to support economic development and debt reduction in the two provinces. On the other hand, others have argued that these so-called “side deals” have broken the fundamental, underlying nature of the Equalization program and opened the door to calls for similar deals with other provinces.