FINA Committee Meeting

STANDING COMMITTEE ON FINANCE

COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Wednesday, March 3, 1999

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[English]

The Vice-Chair (Mr. Nick Discepola): Good afternoon. In accordance with the order of reference of the House of Commons of Monday, February 15, 1999, the finance committee resumes its study of Bill C-65, an act to amend the Federal-Provincial Fiscal Arrangements Act, more commonly known as the equalization payments.

This afternoon I'd like to welcome, from the Queen's University economics department, Professor Dan Usher; and from the C.D. Howe Institute, a policy analyst, Mr. Finn Poschmann. Welcome to both.

Professor Usher, you've been here before, I believe. You have ten minutes to make a presentation, and we'll leave ample room for discussion afterwards.

Professor Dan Usher (Economics Department, Queen's University): I will begin by saying I'm not quite sure why I was invited. Five years ago I wrote a book on equalization payments that didn't have a whole lot to do with the exact detail of the program but was a general evaluation of the program itself. When I was invited a week ago I had absolutely no idea what subjects were on the table today and I was not informed. By calling up a few people, I was able to get a bit of information, but I suspect I certainly know less about these matters than Finn Poschmann and probably anybody in this room. I'm here because I was asked to be here, and I consider it a civic duty to be here.

I asked that my little book be distributed, thinking this might be a fairly general discussion of equalization payments, which I gather it is not. My understanding now is that some very specific changes are on the table and any general changes have to be put off for another time.

So with your indulgence, sir, I will pass around copies of my book, which I'd hoped would have been passed around before, and which you got from the Fraser Institute, together with one sheet of paper that reviews a variety of proposals for reform. May I do that, please?

The Vice-Chair (Mr. Nick Discepola): Yes, Professor. I would also encourage you to engage in any discussion. You've obviously been called here because of your expertise in this matter. We are parliamentarians, and other witnesses have gone beyond strictly the bill itself, so feel free to comment in any way you see fit that would hopefully enhance the bill, maybe not in this round but in four years or five years' time when we're discussing it again. So I would ask you to be as free-flowing as you wish to get your points across and to give us the benefit of your experience and knowledge. That's why you were asked here.

Prof. Dan Usher: I will do so, sir.

The Vice-Chair (Mr. Nick Discepola): Thank you.

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Prof. Dan Usher: When I wrote the little book on equalization payments, my general concern was with the rationale for the program as a whole. Reasonably comparable public services at reasonably comparable rates of taxation, which is the mandate in the Canadian Constitution, are not self-evidently desirable. It seemed to me, as it seemed to virtually everybody else who had studied the program, that some criteria beyond that would be necessary.

The three criteria I considered were equality, efficiency, and what I called equity, where equity is differentiated from equality. I examined the three criteria and found the program distinctly wanting under each. I concluded that the rationale for the equalization program was so distinctly weak that major modifications would be necessary. Indeed, it wouldn't disturb me one bit if the program were scrapped altogether.

This is not a majority view in Canada, in Parliament, the general public, or the academic community. Nonetheless, this is my view.

Under equality, it seemed essential to make a distinction between equality of income of the provinces and the equalization of income among people. These are two very different things, with the latter being reasonably desirable—the redistribution of income—and the former not necessarily desirable.

Finn Poschmann has done probably more than anybody in examining the detail of the redistribution effect of the equalization program. It's negligible, largely because as far as anybody can tell, the equalization program ultimately is a transfer of income from rich folks in rich provinces and even some poor folks in rich provinces, to rich folks in poor provinces and some poor folks in poor provinces too. But the effect on the poor is not very substantial. It may give about $100 per family in Quebec and cost about $100 per family in Ontario and British Columbia, for families under $20,000. Those are Poschmann's numbers. My general sense of the thing concurs with that. He did a more careful study than I ever did.

On the other hand, if you took $10 billion and redistributed it in something like a negative income tax, you could produce roughly $1,000 for each person in the bottom one-third of the income distribution—it's simple long division. That would be a very substantial increase and a very substantial improvement in the redistribution, and go very far toward the elimination of poverty. We've chosen not to do that.

On efficiency, there's a huge literature on the subject. Let me just say that although it seems a reasonable criterion, efficiency as the maximization of the national income is simply not promoted by the program. There are forces going every which way. There are some models that under certain assumptions say equalization is advantageous. There are other models that under different assumptions say the program is disadvantageous. The whole thing, as far as I can tell, is a wash. That's by and large the academic opinion now, although I might stand corrected.

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Under equity, I think it's very important to distinguish between horizontal equity, where within any single jurisdiction it's terribly important that people with the same incomes are taxed the same, and equity across provinces, where people in different jurisdictions might conceivably be taxed differently. I think that matters very little, just as it doesn't matter if there are different tax rates for folks in the same income distribution between two countries like France and India. It just doesn't have the disintegrative consequences that a violation in horizontal equity within a single jurisdiction would have.

Those were the criteria I considered. I consider the program wanting under each of them.

As far as the policies before you, which I gather are all that can be considered now, by and large I don't have much to say except on casino gambling. There I think the proposed bill is making a serious mistake.

The question is not whether revenue from casino gambling ought to be included within the equalization formula—I think there's a good case for doing so—but how to include it. In my rough judgment of the thing, it's being done wrong. It has to do with the breakdown of total revenue into tax rate and tax base. The federal-provincial relations division wants the breakdown to be 80% based on personal income and 20% based on net gambling revenues.

If you think of it as personal income, consider a province's tax base from the point of view of gambling revenue as its total personal income. Forget about the other. I think that misses a tremendous opportunity because there is a real problem with casino gambling, and that has to do with what's technically called a prisoner's dilemma, which most of you have probably encountered before.

The idea is this. If one city establishes a casino and another city does not, people from both cities will gamble at that casino, and the city where the casino is located will take the gambling revenue, and the cost of the gambling—the destruction of lives, compulsive gambling and that sort of thing—will be borne everywhere. Since both cities know they're going to bear the costs, regardless of where the casino is located, and the revenue occurs where the casino is located, cities have an incentive to establish casinos even though all cities together, if they could co-ordinate their activities, might have a good case for not having gambling casinos at all.

What you want to do under those circumstances is redistribute gambling revenue from jurisdictions that have casinos to jurisdictions without casinos. It turns out that the equalization program can do just that. What you have to do is establish a base that is 100% net gambling revenue. So the base in the equalization program is net gambling revenue, namely total bets minus total winnings. If you put that as the base of the equalization payment instead of personal, disposal income, the implied rate is 100%.

The effect of that will be to transfer revenues from a province that chooses to have casinos to all provinces. All provinces pay the cost of casinos. If, for example, Nova Scotia has no casinos and New Brunswick does, people will travel from Nova Scotia to New Brunswick to play, and the costs will be borne in Nova Scotia as well as in New Brunswick. I picked these provinces wholly out of a hat. I've no idea what the different provinces actually do.

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The way to correct that at least to some extent through the equalization payments is to change the formula from what's actually intended. Instead of using an 80-20 formula, 80% personal disposable income, 20% gambling revenues, go to 100% gambling revenues as the base, and you will automatically redistribute the gambling revenues through the intermediary of the equalization payments across provinces and reduce substantially the perverse incentives for each province to establish a casino. I think this would be worth doing.

If you're uncertain about this business of how you allocate revenue between base and rate, I would be very happy to elaborate on that. Indeed, for that purpose it would be rather helpful to have a blackboard.

I think you have a real opportunity here to improve the efficiency of the Canadian economy very substantially through the detail of the equalization program, and it would be an enormous shame not to do it. I do not know whether this matter has been considered at all by this committee. Indeed, I have been given remarkably little documentation about what the considerations of this committee actually are.

I think I've probably used up my ten minutes. That's my suggestion, and I make the suggestion with some vigour. You have a real opportunity here, and it would be a shame to throw it away.

The Vice-Chair (Mr. Nick Discepola): Thank you, Professor Usher.

We'll now continue with the presentation from Mr. Poschmann.

Mr. Finn Poschmann (Policy Analyst, C.D. Howe Institute): Thank you, Mr. Chairman, and thank you to the committee for inviting me.

I'll just begin by noting that Bill C-65 more or less does as advertised in terms of reauthorizing spending under the Federal-Provincial Fiscal Arrangements Act. It does so in a quite reasonable way in that it phases in the overall impact of the changes in a sensible way, as far as I can see. It does change a floor provision and a ceiling provision within the bill. You've already heard from other witnesses on that.

Most important from my point of view, it makes possible the adoption of changes to the revenue bases that are equalized, as described in the government's proposals. But note that it doesn't actually implement many of these proposals. For the most part this is left for regulation. For example, we are led to understand from the government's indications that forestry revenues will be equalized according to the value of the harvest within a province, as opposed to the volume of wood harvested on crown land. Now, this is probably a perfectly sensible idea, but it's not actually in the bill. The bill refers to forestry revenues, just as the existing act refers to forestry revenues. It is just a matter of allocating the harvest according to volume harvested as opposed to revenues. This shift in the measurement of the base is to be accomplished by regulation, but of course we are not going to see those regulations until some time after the act is passed. So it's very hard to come up with a final opinion on whether or not this is being done in a right and reasonable way.

Another example would be lottery revenues, which are now to be separated from other gaming revenues. This is perfectly reasonable, but in either category how the base is going to be determined in the end, which is an important question for all parties—meaning all the provinces as well as the federal government—will be done by regulation. Under what circumstances should net as opposed to gross gaming revenue be equalized? I'm thinking of the distinction you might make between revenues of a direct agency of government as opposed to the net profit of a crown corporation. This question was raised in the Auditor General's very thoughtful review of the program a couple of years ago. But the bill doesn't deal with this question. It simply makes it possible to determine how the base will be established, and that is to be determined, of course, in the regulations.

The next example is user fees. This was also raised by the Auditor General. Simply put, if provincial government or municipal government user fees are an appropriate price for the service delivered, which means they are approximately equal to the cost of delivering the service, then there is no net revenue to be equalized. The provincial resident has simply purchased a product at cost. They've not paid a tax supporting a provincial government provision of a free or subsidized service, and that's normally the kind of revenue-raising capacity we associate with equalization.

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If user fees are far in excess of the cost of providing that service so that they really are a tax, then there might be and probably is a reasonable case for equalization. Apparently, the government believes this is at least sometimes true, because we are told we're going to equalize half of user fees. But as far as I can see, there's no such thing in the bill, and what and how this is to be done is left for regulation.

What the bill does do in subclause 2(3) is authorize regulation to do that. What subclause 2(3) does is allow a revenue source to be equalized to be defined in a way that excludes all or part of it, and this is one of the new powers of the bill. Apparently, this is the tool we're going to use to decide how much of user fees to equalize and under what circumstances. It is the same kind of decision we have to make about net versus gross revenues of casinos or other gaming ventures.

I would note about this provision that it might be a bit much or a bit heavy-handed, because if I understand what the government is trying to do with this provision of the bill, it is to redefine the definition of these particular revenue sources. If this is the case, this redefinition allowed in proposed subsection 4(3) of the bill need only apply to revenue sources z.3 and z.4, and that's where user fees and gambling revenues are. But as written, it applies to every revenue source in the bill. This allows the Privy Council to decide, presumably on the advice of the department, how much, if any, of any particular revenue source is to be equalized. I don't understand why such an important distinction should be left to regulation.

The Auditor General also dealt with my next topic, wherein his report read: “The Department of Finance should ensure that Parliament is consulted in a meaningful way on the periodical renewal of equalization”. Now, the department's response was and is: “The department is prepared to respond to any request of Parliament in this regard”. Leave aside that the department has apparently misunderstood the Auditor General's recommendation, because the recommendation would require action from the department rather than simply being available to give a response. Be that as it may, of course the Auditor General's recommendations have no teeth, which is to say that in the end he can't force action on his recommendations. We'll leave the Auditor General's views aside on the point.

Parliament must still hold the government accountable for the taxing and spending decisions it makes, because it is Parliament alone that ultimately represents Canadians' interests in these questions. So the first point to draw is that in effective consultation and review, timeliness is essential. I would assert that the imperative of timely review is not being met when Parliament begins its review of the act only a matter of days before it intends to begin spending under the act. This is a problem whether or not closure has been voted, which of course would render much of this discussion moot in the end.

The second point, which is distinct from but not unrelated to timeliness, is the extent to which deep and broad program review is being executed. Whatever happened to program review? It wasn't very long ago that we took this sort of thing very seriously and used the results of program review to frugally reallocate resources within the budget.

By way of proper review, Parliament and Canadians should be able to answer a few basic questions. First, is the program continuing to serve the function for which it was designed? Second, is it the right design and the right size to serve that function, which is to say is it doing so in the most efficient manner possible? I note that efficiency does not mean here the number of staff running the program or the associated administrative costs but instead the matching of costs and benefits associated with having a program at all. The third question is whether Canadians continue to support the existence of the program, and specifically, whether they support the program given full knowledge of its design and apparent net benefits.

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I have no idea if the finance department knows the answer to these questions, and I have no idea if Parliament knows, or can know. I do know we probably won't find out, given the time available for program review. And this is a little disappointing, because we have had five years to work with.

Finding the answer to at least one of these questions, which is one that's important to me, the question of informed Canadian support.... It's what my principal exhibit is about. Let me just walk you through that, if I may, Mr. Chairman.

In table A we have equalization entitlements by province. These are from historical reports as well as the February budget. We have millions of dollars by province, so we'll be looking at about an $11 billion program by 2003 or 2004.

The next panel is something a little different, where I simply allocate the tax cost of supporting these benefits according to the distribution of tax revenue across provinces. For example, Ontario—which is where I like to start—supplies something like 40% of federal tax revenue, or a little more. It's not surprising that it contributes something near $5 billion of the cost of an $11 billion transfer program.

If we flip over to table B, I net those against each other, so we have benefits less cost. For Ontario, Alberta, B.C., and of course the territories, who don't receive equalization, the net cost is their allocation of tax revenue times the cost of the program.

It's a little interesting in the case of Saskatchewan. In 1996-97 and 1997-98, when they were, in fact, equalization recipients, they came out as net losers, given the cost to Saskatchewan taxpayers of raising federal revenue in support of the program.

Let's bring this home by allocating these by person in each province. To make this a little more tractable, I do it by family of four within a province, so we can switch to dollars per family. That's at the bottom of my table B here. And that's a really neat one. Let's start with Ontario. My question about public knowledge and acceptance of the program seems to me to be predicated on your public being informed of what some of these amounts are.

If you go to 2003-04, what we're talking about is a tax cost for every single family of four within Ontario of $1,600, and that's the way to read this. Again, I'm doing it on the basis of four people per family. That's $1,600 from each family in support of, for example in P.E.I., a payment to the government in respect of each family within that province of four times that amount to about $6,500.

Now these are really quite surprising. I knew there were going to be some significant numbers, but even when you start down a road like this you're sometimes surprised by the magnitude of the cross-province transfers that pop out.

My question about whether or not Canadians support this program, given knowledge of its design, scale, and scope, seems to be predicated on some general knowledge of what that scale and scope is. And I don't know of any evidence that Canadians are very well informed about this.

Now, on this reading it's a zero-sum game. We've just reallocated the cost of equalization across taxpayers. But note that zero sum does not imply zero efficiency-cost. There is, of course, a tremendous effect on output and income associated with collecting say $1 billion of federal tax revenue in Alberta and using it to finance $1 billion worth of New Brunswick government expenditure. All you have to do is say it to recognize there are some significant resource allocation costs associated with this kind of transfer, or resource allocation distortions.

These are mostly issues of private resource allocation decisions, but equalization profoundly affects provincial government decision-making as well. What equalization typically does is remove the net financial reward to governments that take action to expand their tax base. That's the way equalization works. Equalization also insulates governments from the consequences or the costs of bad actions that happen to shrink their tax bases. This is because by design, equalization cannot respond positively to supply-side incentives when any such changes in incentives are undertaken by provinces.

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I do have some illustrations of that, but I won't walk through them right now because I'd like things to proceed apace. We can take it up in question period, Mr. Chairman, if anyone is interested.

The Vice-Chair (Mr. Nick Discepola): Anybody having a heart attack?

Mr. Finn Poschmann: I'll wind up.

To summarize, the bill does what it has to do, but in doing so it probably leaves more power than it has to in the hands of the Privy Council. Likewise, several important claims that the government has made for this bill are mostly manifested in regulation, and the result of this is to take executive federalism to a new height.

Thank you, Mr. Chairman.

The Vice-Chair (Mr. Nick Discepola): Thank you, Mr. Poschmann.

I would like to now turn to questions from members. Is it Mr. Epp or Mr. Ritz?

Mr. Ken Epp (Elk Island, Ref.): It's me first. We may split our time; we'll see how things go here.

The Vice-Chair (Mr. Nick Discepola): All right, go ahead, Mr. Epp.

Mr. Ken Epp: I'd like to thank you for coming. I wish I could have been here for the whole thing, but we're also at the same time debating the budget in the House of Commons, and I was down there. So until we get this cloning perfected, I can only be in one place at a time.

I am very interested in a couple of your ideas. First, I want to ask the question about conversion to a macro-base and not having the 31 categories. I think the implication here—and it was probably you, Dr. Usher, who said this—is that it has to do with using only provincial income as the base. In other words, you're basically going to use only a provincial gross domestic product to compute the potential of raising revenue. Have you actually done some numbers, if that were to be applied, to do a comparison or a correlation between the distribution that would come from that compared to what we have now?

Prof. Dan Usher: Yes. I wish somebody had telegraphed me that question so I could provide a decent answer. Yes, it's in my little book. I did it five years ago, and I haven't looked at it since.

It depends very much on.... Let's see, this is for 1994.... Yes, if you look at page 125 in the book, you have a copy of it.

Mr. Scott Brison (Kings—Hants, PC): It has “Reform” on the top.

Prof. Dan Usher: Yes, I hadn't thought of that.

Mr. Ken Epp: That's a big “R”.

Prof. Dan Usher: It doesn't say “United Alternative”.

Mr. Paul Szabo (Mississauga South, Lib.): It doesn't like to admit it.

Prof. Dan Usher: There are some differences, and at this point I can't figure out why the total is different for Canada as a whole. There are some differences by province, because some provinces are rich in tax bases that tend to have high taxes attached to them. In my opinion, there's absolutely no reason that provinces ought to receive high equalization payments on that account.

The total amount of equalization payments is pretty close.... Well, it's about a billion less, as I calculated it. I'd have to look rather carefully to figure out why.

Mr. Ken Epp: Well, at least I could see just by looking at the numbers that it correlates very closely.

Prof. Dan Usher: Yes, it does.

Mr. Ken Epp: Of course all you're doing is trying to find a more efficient way—one that's probably, I would hope, less subject to political manipulation—of finding a way of equalizing the payments to the provinces.

Prof. Dan Usher: That's certainly correct. Some of the problems that Finn Poschmann identifies about perverse incentives on the provinces would go away to a very large extent with the introduction of a macro-formula.

Mr. Ken Epp: Yes, good.

Prof. Dan Usher: And if you'll just look at the next column, a macro-formula based on 85%—

Mr. Ken Epp: Yes, I saw that.

Prof. Dan Usher: —of provincial GDP would of course cut equalization down considerably, concentrating it on the really poor provinces. I'd love to see that, but I don't think you guys would go for it.

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Mr. Ken Epp: We should be going in that direction.

Prof. Dan Usher: Well, there's certainly an easy way to do it. You can go gradually.

You see, column 3 is equalization based on 85% of provincial GDP. There's nothing magic about 85%. You could go down a couple of percent each year and gradually concentrate the equalization payments on the poorest provinces in that way, cutting out provinces where provincial revenue is very close to the national average.

The closer revenues are to the national average, the less chance there is for the equalization program to be really equalizing among people and the greater the general mixed-up-edness to which Mr. Poschmann refers, the more important that is, relative to any real effects on the distribution of income in Canada or indeed the efficiency of the Canadian economy.

Mr. Ken Epp: I have another question, quite unrelated to this. It's one of the things that I started investigating yesterday in our hearings, and I was informed that you had mentioned this. I can't get the same answer from different people. I ask one person, and they say yes, you're right, and other people say no, you're wrong.

This is my contention: Manitoba, according to Bill C-65, is going to be losing a substantial amount of equalization payment, and at least a portion of that is due to the fact that there are too many people in Manitoba too wise to spend a lot of money on lottery tickets. So the fact is that the provincial government, by having a relatively low rate of participation in lotteries in Manitoba, does not get a lot of revenue from that, but the equalization payment goes on the basis that if they did, then they would have so much revenue, which of course cuts down their room. Therefore, they're actually taking a hit because they don't buy lottery tickets.

That's what I'm saying, and I can't get an answer. I'd like to know what your answer is on this.

Mr. Finn Poschmann: I haven't looked at the lottery revenues in Manitoba, potentially subject to equalization or not, but I would note that under simulations I've done where you do look at a macro-base, as we've been discussing, Manitoba's entitlement would go up quite a bit. To me, this suggests that there may be something to that. Whether it is lottery revenue specifically, I don't know.

Prof. Dan Usher: Could I jump in here, please? Unfortunately I believe you came in just after I discussed this very point.

Mr. Ken Epp: I think that is when I got the phone call to get down here.

Prof. Dan Usher: Oh, I see.

What I suggested, sir, was that the method by which the lottery revenues are to be incorporated in the equalization formula is a mistake.

What the federal-provincial relations department is planning is to base lottery revenues on disposable income, use that as the base of lottery revenues, which means if Manitoba has a high disposable income, the assumption is that it could have a lot of high lottery revenue if it wanted. What I suggested as an alternative for the base of lottery revenues is actual lottery net revenue—that is, the difference between total total bets and total winnings.

If you took that as the base—which you could do, and I presume this committee or Parliament could mandate it—then Manitoba would have no lottery winnings, and Manitoba would be paid equalization payments to compensate it for the lottery earnings of other provinces. Under that base, Manitoba would do relatively well, even though it chooses not to have a lottery industry at all, if that is indeed the case—I don't know whether it does or not.

They would receive some of the lottery revenues from other provinces through the intermediary of the equalization payments, but to do that, you have to have actual lottery revenues as the base, not disposable income as the base. If you do it that way, then I think Manitoba will be okay.

Do you agree?

Mr. Finn Poschmann: I don't have the data.

Prof. Dan Usher: You don't need data; it's logic.

Mr. Ken Epp: That was my logic. I'm glad to have found someone who agrees with me.

Prof. Dan Usher: Well, maybe we're both wrong, and considering my record, there's a good chance of that.

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I was simply told that disposable income is to be the base of lottery revenue. I was told that when I started to make inquiries, because I'm interested in lottery revenues. And that, as I say, is not what we ought to be doing. We ought to be having actual revenues as the base, with an implied 100% tax rate. Then Manitoba, refusing to have a lottery, to have a casino, would do relatively well out of all this.

Mr. Ken Epp: Is it your reasoned judgment that the basis for finding the potential to raise revenue that is used in this formula by the federal authorities is rather arbitrary? They pick and choose. They use one method here. When it comes to oil and gas, they use quite a different method. Is it arbitrary, or do you think there is some basis? I'm running the risk here of calling all these other people irrational, but I think it's irrational from the little I understand it, and I don't pretend to understand one-tenth of it.

Mr. Finn Poschmann: The methods chosen seem to be more complex than necessary, given what we presume and think we agree are the goals of the program. If, on the face of it, we conclude that similar results can be established through much simpler methods, then I suggest that this choice ought to dominate in the end, for many reasons, but in particular to avoid either the reality or the suspicion that the decision we make about these things is being gamed to produce a certain result. And you wouldn't be the first person to suspect that this is something that happens when federal and provincial finance representatives get together to horse-trade in order to come up with an acceptable result.

Mr. Ken Epp: My colleague and I were just having a little side conversation here while we were listening on the main channel to you, and it seems to me that this may be part of the motivation to bring this thing in at the last moment, since we've known it's been coming for five years. And I'm speaking to the parliamentary secretary here, who is listening. We've known for five years this is coming, and yet they bring it in at the very last moment and then invoke closure so that there can be no meaningful debate on it. I already talked about that yesterday in my intervention. So we need to fix that.

Mr. Paul Szabo: There's no motivation for a meaningful debate.

Mr. Ken Epp: I didn't hear that.

Did you have some questions, Gerry, to use the rest of our time?

Mr. Gerry Ritz (Battlefords—Lloydminster, Ref.): Just one.

You briefly talked about how there's no appetite to scrap or change substantively this program, that it just seems to evolve on its own. Another thing that came out was a program review. It is a five-year program. There's $43 billion worth of projected spending in it. It is a huge chunk of change. What could we do to implement a program review? Do we have to have some changes, and so on, like that? What do you foresee?

Mr. Finn Poschmann: As a matter of process, I don't think there's anything stopping Parliament or this committee from launching into pretty much any investigation of parliamentary expenditure that it chooses.

Something that wouldn't be a bad idea in this area would be, as I've suggested, an examination of the first principles: Why are we doing what we're doing; are we doing it in the best way; what changes, minor or major, are sufficient to do that? We've suggested some of them. I'm certain that we can suggest more and farther-reaching ones.

I think what you have to do as parliamentarians, Mr. Chairman, is seize the opportunity when it confronts you. Apparently that opportunity has not confronted us this round. Perhaps next round.

Mr. Gerry Ritz: Thank you.

Prof. Dan Usher: I've put in front of you a list of changes that have been proposed by various academics, and that list is by no means comprehensive. There's a considerable literature developing now among academics on how the equalization program could reasonably be reformed. So there's plenty of material to get your teeth into, and God knows how many good proposals are out there to be identified.

Mr. Gerry Ritz: Thank you.

The Vice-Chair (Mr. Nick Discepola): Thank you, gentlemen.

Mr. Brison, please.

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Mr. Scott Brison: Thank you, Mr. Chairman.

I apologize to Mr. Usher for having missed his intervention, but I'm familiar with the Fraser Institute's positions on many of these issues through the Fraser Forum, as well as those of the Atlantic Institute for Market Studies, in Halifax, which has done some interesting work on, particularly, the disincentives side of it. I understand the C.D. Howe Institute, as well, has addressed some of those issues.

In terms of the disincentives for recipient provinces to bootstrap themselves from that status, I have some concerns relative to resource development and natural resource development.

Some representations to me have indicated that there is a disincentive for value-added resource development in a province. For a province to pursue value-added resource management, that could actually reduce equalization quite dramatically, because, effectively, if we're paying provinces based on the final value of the product produced, that does not take into account the increased cost factors in increasing the value of those products. That's my first question. I would appreciate your feedback on that, on whether or not you disagree with that basic assertion.

Mr. Finn Poschmann: I certainly don't disagree. In fact it's a problem pretty much common across revenue types.

Because of the presumption that it is taxed at a national average tax rate, any action a province takes to expand its base will increase the assumed revenue from that base, and that will decrease its entitlement. Whether it's personal income that happens to be increased by say lowering provincial tax rates within a province, or mineral resource revenue that is increased by say approving or increasing access to mineral sites, by searching out mineral sites, which does entail specific costs for provincial governments, absolutely, much of the incremental revenue—in some cases, all of it—will be lost to equalization.

It is true that where a province dominates a shared resource type across Canada, there are limits to the effect it is allowed to have on its overall provincial and equalization entitlement. There is a 70% cap, under certain circumstances. But in general, it's true across tax bases, and for every equalization-receiving province, pretty much dollar for dollar each action it takes to increase its revenue will be offset by lower equalization benefits.

Mr. Scott Brison: If a province had a dramatic increase in one given year in one of the 31 categories—if, for instance, in a province like Newfoundland with offshore oil, or Nova Scotia with natural gas, there would be a significant jump in one of those categories—would it make sense, if we're ingenuous about giving those provinces an opportunity to actually bootstrap themselves, to phase it in over a period of time as those increase, let's say a 10-year period, with some commitment that at the end of that period there will be a cessation of that treatment, but some sort of phase-in period that would allow the province to invest in say some of the knowledge-based infrastructure to actually move into other areas?

Accepting that we're dealing with a huge system that is fraught with difficulties and that the best we can do at this juncture is try to make some constructive amendments, I would appreciate your feedback on that.

Mr. Finn Poschmann: The first problem I see is that it rather undermines what I think the Department of Finance would tell you we're trying to accomplish, the equalization. In other words, if there is a huge jump in revenue resources available within a province, then we can safely presume that the taxing capacity of that province has in fact increased. If we are to implement the principles that we again are assuming, in fact, around equalization, then phasing in or limiting the impact of this revenue increase wouldn't make any sense.

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Certainly this is a problem, because everybody recognizes that there is very limited incentive for provinces to undertake expenses associated with expanding tax bases. There may be temporary measures that would limit or mitigate the worst effects of those, but any such measures, say excluding resource revenues in the case of a particular province for a particular period, really go against what it is we think we're trying to accomplish.

Mr. Scott Brison: Unless of course if one of the goals of equalization is the equality of opportunity and the same basic levels of taxation and services. The goal should be that those opportunities would be developed without equalization. As a goal, equalization is a tool to achieve that end, and by not phasing these new sources of revenue in over a period of time it may be actually a measure that prevents provinces from independently developing that same equality of taxation and services.

So it may actually be undoing itself in a sense if we don't phase some of those things in. Do you see what I'm saying?

Mr. Finn Poschmann: Yes, your analysis as far as I can see is quite correct. It's one of these unfortunate by-products of the program.

Mr. Scott Brison: It's a rational response to an irrational system may be one way of describing it.

What about new categories? I suppose new categories would be treated the same way. I understand your concern, but do you agree with me that this might be one way and a small way to address some of the disincentives for provinces to pursue economic activities that would make them more viable?

Mr. Finn Poschmann: There's a further problem, and that is the presumption of the fact that you can identify a particular province or a particular resource area with a problem whose amelioration would be most effectively or most efficiently addressed rather than the implicit tax-back associated with some other tax base in some other province. On what ground really would one choose one particular source in one particular place for one particular period? We don't have any reason to guess that as policy-makers we're going to get it right when we say that it's that particular one that just happens to be the hot button this year.

Mr. Scott Brison: I see. Is that Professor Hobson from Acadia University? Could you give me a thumbnail sketch of what he is suggesting?

Prof. Dan Usher: Could I jump in?

Mr. Scott Brison: Certainly.

Prof. Dan Usher: I have two remarks on the previous question.

Firstly, part of the problem is the distinction between taxation and earnings. In a normal private business the government collects a certain portion of the tax and the bulk of the earnings remains in the hands of the business itself, in which case equalization isn't too much of a disincentive. It's when the earnings of an entire industry are considered part of the provincial revenue that you get into the problem you're talking about.

The second point I would like to make about this is that this is a general problem that you really won't get around as long as you base equalization on the actual revenues of the provinces as though these were different sources of income of an individual, which they clearly are not.

It seems to me that a far better way out of this is to go directly to a macro-formula, to go directly to provincial national income as the basis for equalization, and then you eliminate the problem you are talking about in a stroke. If you try to do what you suggested—and this is the reason I shook my head—the whole process gets more and more and more complicated and you never know where you are. So the implication of what you're saying is that you want to simplify and the macro-formula is a way to do it.

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Now Paul Hobson's proposal is at the moment we equalize up but not down; that is, we provide poor provinces with enough revenue so that basically their revenue per head is what the average revenue across Canada would be in the absence of equalization payments. Still, that doesn't equalize revenue per head across the provinces, because the other provinces that don't get equalization payments have greater-than-average revenue to begin with and continue to have greater-than-average revenue.

What Paul Hobson wants to do—and there are other proposals from the C. D. Howe Institute that are in the same line—is to have all provincial revenues go into one pot and be divided up among all provinces on a per capita basis. You take all the provincial revenues and put them here, and you give them back on a per capita basis, so that revenue per capita genuinely is the same across all provinces.

Now, the way you do that in practice is for the federal government to tax provinces with greater-than-average revenue and to give it to provinces with less-than-average revenue. So you take as well as give, whereas the present equalization formula is only giving. It's not taking directly from the provinces. It's taking from individuals through federal tax revenue. So instead of all Canadians being taxed to pay the recipient provinces, the rich provinces would be taxed in order to pay the poor provinces. That's what Paul Hobson would like to do.

I must say that's very much in the spirit of subsection 36(2), although I'm not sure it's a good idea. But that's the program. I also doubt whether it would get by the Canadian Constitution. I think it's unconstitutional. But it may not be. It may be okay. What's constitutional is up to the courts.

Am I making myself clear?

Mr. Scott Brison: Yes.

Prof. Dan Usher: Distribute the money on a per capita basis. That's what it really amounts to.

Mr. Scott Brison: Thank you very much. You recognize that the challenge we face is to try to effectively cobble up something on a subject we agree with in principle but that has some significant systemic problems associated with it. So as legislators, it's a challenge to try to achieve that without making it more cobbled up. Thank you.

The Vice-Chair (Mr. Nick Discepola): I'd like to now turn to Professor Valeri.

Mr. Tony Valeri (Stoney Creek, Lib.): You just made me a professor.

I just want to start off by saying that there's no question, I think, in anyone's mind, certainly the minds of the members of Parliament, that this program of equalization is really a work in progress. We're not here today to discuss a piece of legislation we will never again have an opportunity to discuss in Parliament or outside of Parliament. The Auditor General issued a report back in 1997, and that report played a role in the federal-provincial negotiations that took place. As we move beyond this particular renewal, I personally see no reason Parliament should not be more involved in this particular discussion within that five-year period we have before the following renewal.

I have a question for Mr. Poschmann. When we talk about regulation versus legislation, I think the federal government made its intention clear in the bill as to what it would like to accomplish with regard to equalization and the changes that are being put forward.

You make reference that all of this is going to take place in regulation. How much should be in legislation? Are you suggesting that we should incorporate all changes within the actual legislation and have nothing in regulation? Regulations are still subject to scrutiny, they are public, so members of Parliament and individuals can make interventions with regard to these regulations. They're not concocted behind closed doors so that no one will be able to see them or see the effect they're going to have.

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You made the comment, and I'm wondering, do you have something in mind where you're saying that this should all be in legislation and there should be no regulation? That's the one question I have.

The other point you made earlier was that you're not quite sure whether Canadians support equalization. And you're not sure whether, after seeing the table you provided to this committee and understaqnding what the cost of equalization might be, Canadians, and specifically Ontarians, would support equalization. I'm not sure I can possibly agree with that. I certainly hope you can comment on it.

If you say to a Canadian that the intent of the equalization program is to provide a comparable level of service in provinces of varying levels of affluence without having provinces engage in excessive taxation to provide those services, so that when an Ontarian moves to a have-not province they wouldn't be exposed to all of this level of taxation.... Polls show that Canadians are supportive of equalization. I wonder whether you think that by posting your table Canadians would now feel, and Ontarians specifically, that equalization is not something they're interested in supporting as members of the federation, even if it is a program that forms part of and is in fact enshrined in the Constitution.

Mr. Finn Poschmann: It seems to me, Mr. Chairman, that both of the questions reflect exercises in line drawing, and I'll talk about them in order.

The regulation question is a good one. It's about what should be there in the bill and what should be left to the slightly more arcane processes of regulation development and promulgation. I think the rule I would follow is that what can reasonably be put in the legislation ought to be there. And I didn't choose my examples on this score lightly. The program review and the result are entwined in this issue.

My point is that given a five-year program review cycle, it seems to me that we ought to be able to decide whether and how much of user fees are going to be included in equalization. It wouldn't be terribly difficult or unreasonable to have that in the legislation rather than left for an Order in Council. So that's a matter of line drawing.

I would point out that if we were to adopt rather simpler mechanisms, such as the macro-formula of which some of us are such great friends, the legislation for accomplishing it could be about one page long and the regulations probably half a page long. That's something of a sidelight. But I think it's worth noting that the legislation and regulations, and their transparency and the extent to which Canadians and parliamentarians understand their intent and their effect, depend on how clearly and how simply these things are written. So I think we probably could do a lot better on that score.

As to the question of public support for the equalization program, given a certain minimal level of understanding of that program, I point out that what the Constitution says, in section 36(2) I believe, is that Parliament and the provinces are committed to providing reasonably comparable levels of services at reasonably comparable levels of taxation. This of course is a lot of weasel talk, if I may. I don't think we should kid ourselves that this is ultimately justiciable, because we would have to establish at a fairly onerous degree of certainty what we mean by “reasonably comparable”, a reasonably comparable rate of taxation, and reasonably comparable level of services.

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So I think I agree that if you ask Ontarians whether, as a matter of fact, they support equalization, they would say they probably support a good deal of it. The question is whether they support this extent of equalization and this extent of equalization delivered in the way it happens to have evolved. I'm doubtful of that. I'm not a pollster, and I don't have evidence to point to, but it seems rather unlikely on the face of it.

If you asked Ontarians or Newfoundlanders, if they could start from scratch, whether they would invent a program that looked like this one and had the sort of scale and scope this one does, again, I'd be doubtful in the end.

Mr. Tony Valeri: Okay.

The Vice-Chair (Mr. Nick Discepola): Thank you, Tony.

Professor Usher, you mentioned your preference is to move to a simpler system. In an ideal world we'd like to do that, but one of the benefits I see of the current system is it also measures the ability of a province to be able to generate its own revenues and finance an awful lot of the programs themselves. If we move to a GDP-based system, no matter what percentage you choose to attribute to that, would that goal still be achieved in your mind, and if so, how?

Prof. Dan Usher: I don't see why not. The taxes provinces levy now, on whatever their bases happen to be, are perfectly arbitrary. They can be raised or lowered. A particular tax is not like my income, where I work as hard as I can and this is what I earn. So all you have to do is change your tax base a little bit.

The Vice-Chair (Mr. Nick Discepola): So you're saying that in a province where economic activity is stifled, for example, the province would have to be compelled to increase their taxation.

Prof. Dan Usher: Not necessarily, because remember, if the base is provincial gross domestic product or something like that, the poorer provinces would still receive payments. I don't see that this problem would get significantly worse than it is now. Newfoundland, with a smaller GDP, would still have a smaller notional tax base on a per capita basis than British Columbia. It would still receive equalization payments, and it would still make up the difference on whatever tax base it had, exactly as it does now. So I really don't see that this is a serious problem.

I think the provinces could handle this perfectly well. It would be no worse under a macro-formula than under the present formula.

Mr. Finn Poschmann: Could I just comment, sir?

The Vice-Chair (Mr. Nick Discepola): Yes, please do.

Mr. Finn Poschmann: As an experiment I've looked at some of these numbers and set constraints, such as under a macro-formula we should deliver as closely as possible the same amount of support to each province, so the variation across provinces with respect to what they get now would be minimized.

It's a purely mathematical exercise, where you set a GDP per head target and pick a value for how closely you want to equalize to that target. If you use GDP per head as an indicator, then you choose a number like 19% or 20%. In other words, you make up 19% of the gap between a province's GDP per head and the national standard GDP per head. If you use personal income as a measure instead, you would use a number more like 32%. You would say the province's allocation under this mechanism would be equal to 32% of the gap between their per capita personal income and the national standard personal income, multiplied by the population in the province. That's how you would come up with their entitlement. These numbers can be tuned to something, to my mind, quite impressively close to the actual distribution we have now.

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To me, all that shows is that there are ways to do it, as Mr. Usher said. There's really not very much to it; you just have to decide that you want to do it and come up with the parameters to do so.

The Vice-Chair (Mr. Nick Discepola): All right, thank you.

Are there any other questions?

Mr. Gerry Ritz: I have one short question.

Can labour mobility be affected by equalization, a tax incentive to develop heavy oil in Saskatchewan, a have-not province, as opposed to Alberta, which is a have province?

Mr. Finn Poschmann: That's a good question. I suspect it affects individual decision-making rather less than provincial governments' choices about tax rates.

In other words, let's suppose that a provincial government chooses to lower its income tax rate in the hopes of attracting migrant workers, or perhaps they have a tight labour market and simply need more labour there. One of the things you might look at would be a lowering of the provincial tax rate. If enough labour moves in, you might come out even as far as your own income tax revenue goes, but if the people you draw in have higher incomes than the ones who are already resident in your province, then your equalization will go down, because your per capita income has gone up. So what the equalization does, as we've gone over, in a couple of ways, is inhibit the provinces in their decision-making about policies that would tend to encourage labour mobility—if you can follow what I've made a somewhat tortured chain.

Prof. Dan Usher: Your question is the subject of a hell of a lot of literature. The first pieces to come out on this suggested that in the absence of equalization payments, there would be too many people in the rich provinces and too few people in the poor provinces. But the closer one looked at that, the more wrong that solution became, because what equalization payments do is tend to keep folks in the poor provinces.

There are two reasons why there are at present probably too many folks in the poor provinces and too few folks in the rich provinces: one, because other federal policies tend to favour the poor provinces and probably inhibit mobility out of those provinces into the richer provinces where the economic opportunities are; and two, because of sheer inertia. If the appropriate thing is to gradually move people to the provinces where the jobs are and people don't want to move, then you probably get too many people in the poor provinces.

Equalization payments tend to exacerbate that. They tend to keep people in provinces where their contribution to the national economy is low, and keep them away from provinces where their contribution to the national economy is high. So that's a separate point from the one that Poschmann was making, although by no means in contradiction to it. The two points fit together.

By and large, the effect of equalization payments on mobility is perverse. It keeps people in the poor provinces where they shouldn't be.

Mr. Gerry Ritz: Thank you.

The Vice-Chair (Mr. Nick Discepola): Thank you, gentlemen, for your input. I realize now that no matter what the solution, there's always ongoing discussion, and as the parliamentary secretary said, I think we can probably go on and on with the different analyses. I encourage you to go on and on with those different analyses, because as we go on, I believe we can also make different changes.

I would like to thank you for your suggestions, especially those you've put forth on paper. They may not make it into this session because of the time constraints we have—the legislation expires at the end of the month, so we have to adopt it—but hopefully they will nurture debate for the next time around.

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On behalf of my colleagues, I would like to thank you and wish you a safe trip back home.

The meeting is adjourned.