Equalization: Then and Now
For the purposes of this report, it’s important to look at how the Equalization program worked before and after major changes were made
Before 2004, Equalization payments were driven by a complex but consistent formula. The formula determined both the overall amount the Equalization program would pay out to receiving provinces and the amount each province would receive.
Figure 1 – How Equalization has Worked
Per Capita Fiscal Capacity and Equalization Entitlements for 2003–04
Source: Finance Canada
The formula measured the per capita fiscal capacity of provinces using the Representative Tax System (RTS). The RTS measures the amount of money provinces could raise from 33 different tax bases if they taxed those bases at national average tax rates. A province’s fiscal capacity on each of the 33 bases was then summed up and compared to a five-province average standard. If the formula determined that a province’s overall fiscal capacity across all of the tax bases combined was below the standard, that province received an Equalization grant to bring it up to the common standard.
With the formula still in place, Equalization payments had started to decline from their highest peak of $10.9 billion in 2000–01 to an expected level of $8.9 billion in 2004–05. This was due to the combined impact of a
slow-down in Ontario’s economy and tax reductions in several provinces.
At the same time, the financial position of the federal government had improved dramatically and resulted not only in balanced budgets but also unanticipated surpluses. A number of federal transfer programs had been reduced by a substantial amount in the mid 1990s and provincial pressures were mounting to increase Equalization as well as other transfers, particularly in the case of health care.
In response, a New Framework for both Equalization and TFF was announced at a First Ministers’ Meeting in October 2004. Under the New Framework:
There are some important implications of this New Framework.
The interim allocation does not have a common standard to which all provinces are compared and raised. Instead, the standard varies for
individual provinces depending on their former shares (over the last three years) of total Equalization funding, regardless of changes in their relative fiscal capacity. As a result, some receiving provinces receive more and others less than they would have if the previous Equalization formula had been applied.
Figure 2 – Fiscal Capacity and Equalization under the New Framework (2005–06)
Source: Finance Canada