Key Issues for the Review of Equalization and Territorial Formula Financing

2. What are Equalization and Territorial Formula Financing (TFF)?

Equalization and TFF are federal cash transfers to provincial and territorial governments. Their purpose is to give provinces and territories the financial means to offer their residents reasonably comparable public services, at reasonably comparable levels of taxation. In the absence of these programs, the residents of less wealthy provinces and territories would face higher tax burdens and/or lower levels of public services than those of wealthier regions.

The two programs resemble a federal "revenue- supplementation scheme" for provincial and territorial governments. They are formula-based and fill the shortfall between the revenues provinces and territories could raise on their own (at typical levels of taxation) and the revenues required to provide reasonably comparable public services to their residents.

The Equalization program has, since 1982, set that standard of required revenues per person as that of the five ‘'middle-rich" provinces in Canada (B.C., Saskatchewan, Manitoba, Ontario and Quebec), using average tax rates and defining their tax bases in a typical fashion. For instance, as shown in figure 1, the Equalization formula calculated that in 2004-05 every province required about $6,200 per person to provide reasonably comparable public services. This is called the "five-province standard" of Equalization. The program calculates what each province would be able to raise through typical levels of taxation (commonly called ‘'own-source revenue capacity"), and any shortfall relative to the standard is paid out in Equalization. Note that, after Equalization, all receiving provinces have been raised to the same per capita standard of $6,200. Provinces above the standard are not entitled to any Equalization (Alberta and Ontario). Nor are they called upon to contribute any of their revenues to help pay for Equalization, or to reduce further the disparities that remain even after Equalization.

Figure 1: Equalization of own-source revenue capacities under the existing Equalization formula, 2004-05

Figure 2: Equalization of disparities in overall fiscal need under Territorial Formula Financing

Gross expenditure base ("expenditure need") Own-Source revenue capacity Federal transfers (other than TFF)

Equalization Entitlements 1993-94 to 2005-06 ($ millions)

Territorial Formula Financing Transfers ($ millions)

Similarly, TFF seeks to provide territorial governments with sufficient revenue to offer their residents basic services that are reasonably comparable to those available to other Canadians, taking into account their particular spending requirements and the higher costs of delivering public services in the North. TFF works like Equalization, although it defines a different standard of required revenues for each Territory, to reflect the disparities in their relative expenditure needs (due to differences in population densities and other factors).

Equalization will pay out in total close to $11 billion in 2005-06 and the TFF $2 billion. Per resident, Equalization payments will range from about $80 in Saskatchewan to over $600 in Quebec and nearly $2,000 in Prince Edward Island. The size of these payments reflects how far each province is from the standard. TFF payments are much higher, in recognition of greater Northern needs and smaller more dispersed populations, ranging from $15,000 per capita in the Yukon to $25,000 in Nunavut.

The overall importance of Equalization payments as a proportion of gross provincial revenues differs greatly across the country, ranging in 2004-05 from under 10% in Quebec to over 20% in the Atlantic provinces. The importance of TFF in the Territories is an order of magnitude higher, ranging from 70%-75% for the Yukon and NWT to over 85% for Nunavut.

Both Equalization and TFF are federal programs, financed by the federal taxes collected from all Canadians. They are not funded by provincial or territorial governments themselves.

The principles underlying Equalization have a long history going back to the recommendations of the Rowell-Sirois Commission on the eve of the Second World War and to the subsequent legislation creating Equalization in 1957. More recently, in 1982, the "principle of making Equalization payments" was set out in Canada's Constitution. The program is given effect through federal legislation that has traditionally been renewed every five years, after extensive federal-provincial consultations.

TFF has taken the form of five-year intergovernmental agreements, but has recently come under federal legislation, when Parliament passed the legislation giving effect to the October 2004 New Framework for Equalization and TFF (see section 5).

Equalization and TFF seek to provide provinces and territories with sufficient revenue to offer Canadians health care, education, social, roads and transportation services that are reasonably comparable, at reasonably comparable rates of taxation, wherever they live. That is why the two programs have come to symbolize the commitment to equality of opportunity and sharing, which binds Canadians together.

Last Updated: 2010-09-06		Important Notices