Key Issues for the Review of Equalization and Territorial Formula Financing

5. Context for the Review: the New Framework

In 2000, Equalization payments started a sustained decline from their highest ever peak of $10.9 billion in 2000-2001 to an expected level of some $8.9 billion in 2004-05 (a drop of close to $2 billion, had it been left unchecked). This decline reflected the normal functioning of the Equalization formula at the time, which measured relative fiscal disparities among provinces. The slow-down of the Ontario economy relative to other provinces, and the cumulative effect of provincial tax reductions reduced measured fiscal disparities and corresponding payments.

At the same time, the federal government, having reached a balanced budget in 1997-98, was making successive re-investments in the CHT (and its predecessor the CHST), through the various Health Accords. Equalization-receiving provinces argued that Equalization was ‘'losing ground" relative to the CHT-CST flowing to all provinces.

Provincial pressures for more Equalization were also fuelled by successive health care negotiations and continuing large federal fiscal surpluses. During the negotiations on the 2004 Ten-year Plan to Strengthen Health Care, the Council of the Federation, representing all provinces and territories, argued that Equalization/TFF must be enriched as well as the CHT, if all provinces and territories, including the fiscally less endowed ones, were to be able to honour their health care commitments.

In response, the Prime Minister announced at the October 24, 2004 First Ministers Meeting a New Framework for both Equalization and TFF.

Equalization and TFF were enriched by $33 billion over ten years, relative to their 2004-05 Budget levels. (There were also CHT enrichments of $41 billion). The decline in Equalization was stopped through setting a floor of $10 billion in 2004-05 and increasing funding to $10.9 billion in 2005-06. For TFF the floor was set at $1.9 billion in 2004-05 and funding increased to $2 billion for 2005-06. In addition, the shares to be received by provinces and territories were set out in advance for those two years, thus suspending the normal operations of the Equalization and TFF formulas. Both programs were given a legislative ten-year funding track starting in 2005-06, with 3.5% annual growth rates from 2006-07 onward, and a 5- year review point, when the federal government will reassess funding levels.

Equalization 1988-89 to 2011-12

Territorial Formula Financing 1988-89 to 2011-12

The "New Framework"

The New Framework represents three significant changes to the Equalization-TFF programs.

a) Fixed Funding Tracks for Equalization and TFF

It sets, for the first time ever in these programs' history, their long-term funding levels in advance, and outside the workings of the formulas for measuring revenue disparities, with a mid-term review of funding levels in 2009-10. The federal intent, as set out in press releases, was:

• To guarantee rising funding levels for Equalization and TFF;
• To provide greater stability and predictability to payments made to provinces and territories.

From 2006-07 onward, funding for each program will grow at 3.5% per annum, a growth rate which is roughly in line with long-term historical growth trends in Equalization.

b) Formula changes now only alter shares of a growing pie

Prior to the New Framework, the formula for allocating Equalization among receiving provinces also determined total Equalization payments. Likewise, the TFF formula determined both the overall size of TFF and its allocation among Territories. Consequently, decisions about what revenues to include in Equalization/TFF and how to measure them could impact on both total payments (the "size of the pie") and their allocation among receiving governments (the "sharing of the pie"). The same held for changes in the economy and in underlying revenue disparities. It was thus possible for the formula to change the "shares of the pie", at the same time that the size of the overall pie was diminishing, thus compounding adjustment difficulties for some governments.

With the New Framework, year-over-year growth in overall payments has been legislated, so that changes in the allocation formula may only alter provincial shares of a growing Equalization pie. The fixed funding track for TFF has a similar effect on Territories. Future changes in the TFF formula for each territory can only change territorial shares of an ever-growing transfer.

One of the implications of this new dynamic is that provinces newly eligible for Equalization would necessarily reduce the share of other receiving provinces. Likewise, a province no longer eligible for Equalization increases the ‘'room" available to others.

c) Temporary Fixed Shares

The New Framework defined an interim allocation regime for Equalization and TFF in 2004-05 and 2005-06, to give receiving governments certainty while the Panel is reviewing allocation formulas for 2006-07 onward. This interim regime suspended the traditional formulas for allocating Equalization and TFF among governments and replaced these with fixed shares, as agreed to by First Ministers in October 2004. It also introduced some individual floor provisions, which apply to Saskatchewan and B.C. As a result, after Equalization payments, every receiving province is now being raised to a different standard of fiscal capacity. During this interim regime, there is no uniform Equalization standard to which all receiving provinces are raised.

Fiscal Capacity, Equalization and Benefits from the New Equalization Framework 2004-05

Fiscal capacity Equalization $10 billion floor and other measures

The per capita fiscal capacities of provinces, after the benefits of the October 2004 "New Framework," are all higher than the five province standard of $6,217. In receiving provinces, they range from a low of about $6,280 in Quebec and British Columbia to a high of $6,810 in Saskatchewan. This is the result of agreement among provinces on the temporary allocation of incremental funding for the first two years of the New Equalization Framework. The graph does not depict the offset payments under the recent Offshore Agreements.

d) Background: Newfoundland and Labrador and Nova Scotia Offshore Resource Revenues Agreements

The Offshore Accords and Recent Offshore Agreements

The Supreme Court of Canada ruled in 1984 that the right to explore and exploit the sub-sea resources of the continental shelf off Newfoundland belonged to the federal government. Following this ruling, accords between the federal government and Newfoundland and Labrador and Nova Scotia were signed to allow these provinces to manage and tax offshore resources as if they were onshore. As a result, Newfoundland and Nova Scotia collect royalties and other resource revenues on the same basis as other oil and gas producing provinces.

The Canada-Newfoundland Atlantic Accord (1985) and the Canada-Nova Scotia Offshore Petroleum Resources Accord (1986) provided for time-limited, partial compensation for Equalization reductions associated with offshore revenues. The compensation is made through annual offset payments, outside of the Equalization program

The new agreements signed on February 14, 2005 extend the period of protection to 2020 for both provinces (under some conditions), and provide for full compensation for offshore-related reductions in Equalization. In order to qualify for the full offsets and the full period of protection, the province must qualify for Equalization (based on the formula at the time), and continue to have a higher-than-average per capita debt burden. Should either province no longer qualify for Equalization, transitional payments will be triggered.

The two provinces are to receive up-front payments of $2 billion for Newfoundland and Labrador and $830 million for Nova Scotia - these amounts represent about three quarters of the estimated benefits to be provided over the next eight years. These payments are guaranteed, and need not be repaid, even if the actual value of compensation owing during these eight years turns out to be less than the up-front payments. Each year, the value of offset payments will be calculated. Up to year eight, the accumulated offset total will be compared to the upfront payment and actual annual offset payments would begin once the level of the upfront payment is reached.

If the second eight-year period is triggered, annual payments would be based on the calculated offset payments for each year.

Interaction with the Equalization formula under review by the Panel

The main interaction has to do with potential changes to the treatment of offshore revenues in Equalization. Should a new allocation formula exclude more than the current 30 per cent of offshore revenues (the current "generic solution" under Equalization), both provinces would experience smaller Equalization claw-backs, and smaller offset payments would be owed. The two provinces would obtain a larger share of the fixed Equalization envelope, the other receiving provinces would get less, and the federal government would owe smaller offset payments. Conversely, should a new formula exclude less than the current 30 per cent of offshore revenues, the two provinces would obtain a lower share of Equalization, other provinces would get more, and the federal government would owe larger offsets.

Last Updated: 2012-02-04		Important Notices