FINA Committee Meeting

37th PARLIAMENT, 1st SESSION

Standing Committee on Finance

EVIDENCE

CONTENTS

Wednesday, May 8, 2002

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1535

The Chair (Mrs. Sue Barnes (London West, Lib.))

Dr. Brian Crowley (President, Atlantic Institute of Market Studies)

The Chair

Dr. Brian Crowley

The Chair

Dr. Brian Crowley

The Chair

Dr. Brian Crowley

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The Chair

Mr. Finn Poschmann (Senior Policy Analyst, C.D. Howe Institute)

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The Chair

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1600

Ms. Tracy Snoddon (Individual Presentation)

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The Chair

Mr. Harris

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Dr. Brian Crowley

The Chair

Mr. Finn Poschmann

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Mr. Richard Harris

Dr. Brian Crowley

Mr. Richard Harris

Dr. Brian Crowley

The Chair

Ms. Pauline Picard (Drummond, BQ)

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Dr. Brian Crowley

Ms. Pauline Picard

Dr. Brian Crowley

Mr. Finn Poschmann

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The Chair

Ms. Tracy Snoddon

Ms. Pauline Picard

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Dr. Brian Crowley

The Chair

Mr. Finn Poschmann

The Chair

Mr. Shawn Murphy (Hillsborough, Lib.)

Mr. Finn Poschmann

Ms. Tracy Snoddon

Mr. Shawn Murphy

Ms. Tracy Snoddon

Mr. Shawn Murphy

Ms. Tracy Snoddon

Dr. Brian Crowley

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Mr. Shawn Murphy

Dr. Brian Crowley

The Chair

Mr. Scott Brison (Kings--Hants, PC)

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Dr. Brian Crowley

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Mr. Scott Brison

The Chair

Ms. Tracy Snoddon

Mr. Scott Brison

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Ms. Tracy Snoddon

The Chair

Mr. Bryon Wilfert (Oak Ridges, Lib.)

The Chair

Mr. Finn Poschmann

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Dr. Brian Crowley

The Chair

Ms. Tracy Snoddon

Mr. Bryon Wilfert

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Dr. Brian Crowley

The Chair

Mr. Lorne Nystrom (Regina--Qu'Appelle, NDP)

Dr. Brian Crowley

Mr. Lorne Nystrom

Dr. Brian Crowley

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1705

Mr. Lorne Nystrom

Dr. Brian Crowley

Mr. Lorne Nystrom

Dr. Brian Crowley

Mr. Lorne Nystrom

Dr. Brian Crowley

Mr. Lorne Nystrom

Mr. Finn Poschmann

Mr. Lorne Nystrom

Dr. Brian Crowley

Mr. Finn Poschmann

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1710

The Chair

Mr. Gary Pillitteri (Niagara Falls, Lib.)

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1715

Dr. Brian Crowley

Mr. Finn Poschmann

Ms. Tracy Snoddon

Dr. Brian Crowley

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1720

The Chair

Mr. Richard Harris

Dr. Brian Crowley

Mr. Richard Harris

The Chair

Ms. Sophia Leung (Vancouver Kingsway, Lib.)

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1725

Mr. Shawn Murphy

Ms. Sophia Leung

The Chair

Mr. Finn Poschmann

Dr. Brian Crowley

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1730

The Chair

Ms. Tracy Snoddon

The Chair

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CANADA

Standing Committee on Finance

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NUMBER 099

l

1st SESSION

l

37th PARLIAMENT

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EVIDENCE

Wednesday, May 8, 2002

[Recorded by Electronic Apparatus]

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[English]

    The Chair (Mrs. Sue Barnes (London West, Lib.)): Welcome, everyone.

    Today, pursuant to Standing Order 108(2), we're going to have a discussion on equalization.

    We have three guests and witnesses with us today, Dr. Brian Lee Crowley, who is the president of the Atlantic Institute of Market Studies, from the C.D. Howe Institute Finn Poschmann, senior policy analyst, and Dr. Tracy Snoddon from Wilfrid Laurier University. Welcome.

    Maybe we'll just go in the order you're on the agenda. You'll have approximately ten minutes each, and then we'll take the rest of our time, after all three of you have finished, for questioning by the members.

    Dr. Crowley, go ahead, please.

    Dr. Brian Crowley (President, Atlantic Institute of Market Studies): Madam Chair, perhaps you could just enlighten us as to what the order is on the agenda.

    The Chair: Dr. Crowley, you're first, Mr. Poschmann second, and Dr. Snoddon third.

    Dr. Brian Crowley: I have a copy of my formal remarks, if that would be handy for the translators.

    The Chair: Yes. Our clerk will pick it up, and we'll get it translated and distributed.

    Dr. Brian Crowley: It is only a rough draft, Madam Chair.

    The Chair: That's fine.

    Dr. Brian Crowley: Ladies and gentlemen of the committee, thank you very much for the invitation to be here today to talk to you about a topic I think is of vital importance not only to my region, Atlantic Canada, but to the country as a whole, and that's equalization.

    One of the cardinal rules of economics is that if you subsidize something, you will get more of it, and if you tax something, you will get less of it. If we subsidize the production of milk or petroleum or health care, it's because we think the market, left to itself, will produce less of those things than government thinks is best. We want more, so we pay for it. On the other hand, we all know that by taxing things, like effort, work, consumption, saving, productive economic activity in general, we get less of them than we would otherwise have, and the higher the tax rate the greater the loss of economic activity. The reason I raise that in the context of equalization, ladies and gentlemen, is that this massive federal program subsidizes some very specific things and it taxes some very specific things. The net effect, I'd like to suggest to you, has been significant damage to the ability of the less developed provinces to close the disparity gap with either the national average or the wealthier provinces.

    Apologists for the current regime will say it was never equalization's purpose to close the disparity gap with the rest of the country, but merely to compensate for its existence by subsidizing the taxing power of the less well off provinces. But what we have discovered, after nearly half a century and over $180 billion in equalization payments--and that's not adjusted for inflation--is that incentives matter, and the incentives attached to equalization can penalize the poorer provinces for developing their economies and encourage them to settle for permanent reliance on federal transfers. I would be the first to say that sharing has its virtues, but surely the prime object behind our fiscal arrangements should not be to maintain poorer provinces in a state of splendid dependence, but rather to build their own capacity to pay their way. And the greatest victory of fiscal federalism, in my view, could and should be the elimination of the need for equalization payments, not the elimination of equalization as an objective, but the elimination of the need for equalization payments.

    In trying to make clear the perverse incentives in equalization, let me come back to the question of what equalization subsidizes and what it taxes, and let me take the taxing part first. What does equalization tax, and therefore lead the equalization receiving provinces to produce less of? The answer in my view is two chief things, productive economic activity in the less well off provinces and provincial assets that are being shifted from one form to another without the creation of new wealth. I'll try to explain what I mean by those things.

    To illustrate the first point, I always think a concrete example helps best. I'm sure many of you are familiar with Voisey's Bay; it's a very rich mineral deposit discovered in Labrador a number of years ago. As you know, that mineral deposit has not yet been developed. There are still some very difficult negotiations being carried on between the government of Newfoundland and Inco, which has the rights to that deposit. I would argue that if that deposit were in Ontario or Alberta, equalization paying provinces, rather than equalization receiving provinces, the development would be going ahead today, it would be employing significant numbers of people, and there would have been significant investment in the province. There are several reasons why it hasn't gone ahead. I would argue that one of the principal reasons Voisey's Bay has not gone ahead in Newfoundland is the equalization formula. Let me explain why.

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    In equalization paying provinces there are two streams of benefits that flow from allowing a development like Voisey's Bay to go ahead. There is the tax revenue that flows to the province, because provinces, of course, own natural resources, so you get the royalties, the income taxes, the sales taxes, and all the other things that flow from that development. In addition to that, you get the jobs that are created from the investment and the increase in productive capacity. In Newfoundland and any other equalization receiving province, however, you only get basically one stream of benefits. The tax stream disappears, because it is now deducted by the federal government from equalization. Roughly speaking, 90 percent of that revenue stream is deducted by the federal government for equalization, so the marginal effect on provincial revenues is very small. That means the only stream of benefits an equalization receiving province can point to for its citizens and say, this is what we got for letting Inco develop this mine, the only thing they can point to, is the job stream, because they don't have any extra tax revenue to pay for benefits, programs, and other things people are looking for. The result is, of course, that the negotiations have broken down between Inco and Newfoundland over the scale of the job creation that will happen as a result of this project, whether it will be a smelter, under what conditions they will allow the export of ore, and so on, even though there is a surplus of processing capacity in Canada at the moment.

    There are lots of other things I could say about that, but let me move on to some of the other points I want to make. I could offer other examples perhaps during the question period of this principle at work.

    This view, by the way, that I'm putting forward to you about the economic disincentives implicit in equalization is more and more widespread. Former New Brunswick Premier Frank McKenna, if I can just cite one example, in a recent interview with my colleague Peter Holly of the Frontier Centre in Winnipeg, said equalization and other federal transfers give very little incentive to the receiving provinces to create greater own-source revenues, because those revenue sources are taxed back under equalization.

    In addition, I mentioned that equalization also taxes equalization receiving provinces that take a stock of assets and turn them from one form to another, without creating any new economic value. That will sound obscure, but let me give you a concrete example. Nova Scotia has perhaps the highest per capita debt in the country--if it's not the highest, it's the second highest--yet it also has major economic assets on its balance sheet, such as forest lands and offshore natural gas. A sensible economic strategy might see them clean up their balance sheet by selling some of those assets and retiring debt. No new economic value would be created, you're simply taking an existing asset, turning it from one form into another, and using it to pay down debt. But as soon as you do that conversion, as soon as you take an existing asset and you convert it from, say, natural gas to cash, forest land to cash, Ottawa, in effect, seizes those assets, up to 90 percent, under equalization. Therefore, it's not worthwhile for a province like Nova Scotia to clean up its balance sheet by converting those assets to a different form and retiring debt.

    I'm going to now quickly turn to the question of what equalization subsidizes, because while equalization taxes economic activity from the provincial point of view, and does so rather hard, it also subsidizes quite a lot of things, ensuring that we get a lot of them. The most important thing equalization subsidizes, of course, is provincial government. If you accept the principle that if you want more of something, you should subsidize it, the effect of equalization is to produce more provincial government in Atlantic Canada. In fact, I think it is a commonplace that Atlantic Canada is overgoverned. A lot of people shake their heads at the continued existence of so many provinces serving such small populations, but really, there should be little surprise that government in our region looms so large relative to the size of the productive economy, because taxpayers in other parts of the country pay for us to have much larger public sectors than we would choose for ourselves if we had to foot the entire bill. It seems clear that Newfoundland would not have the lowest pupil-teacher ratio in the country, Nova Scotia would not have the highest number of universities per capita in the country, Manitoba would not spend the highest amount per capita on health care of any province in the country if taxpayers in each of those provinces had to foot the bill themselves. It is a virtual certainty that if the Atlantic provinces did not receive a large subsidy from federal taxpayers, there would be a lot more cooperation and collaboration across provincial boundaries.

    As an aside, I would draw your attention to the fact that equalization introduces some very difficult problems for democratic accountability. Under the principle of no taxation without representation, we normally expect that the electorate that is voting for policies is also the electorate that must bear the burden of taxation to pay for the policies it supports. With equalization, of course, this accountability loop is broken. Politicians in equalization receiving provinces may promise programs to their voters knowing they will not have to impose the burden of taxation necessary to pay for those programs, and voters can vote for spending secure in the knowledge that they can pass the bill along to others who do not vote in the province. To that extent, equalization subsidizes democratic irresponsibility.

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    The final point I want to make is that equalization can subsidize poor economic policy. Many of you will be familiar with Tom Courchene's work in this regard, dating already from the 1970s, in which he analysed the way equalization compensated the Province of Quebec for having the highest minimum wage in North America. But I think we can now update Courchene. For instance, my institute is about to publish a paper by Ken Boessenkool, a well-known public policy analyst who works for the C.D. Howe, amongst other things, out in Calgary. In the paper we're about to publish Ken does the empirical analysis to demonstrate what the theory would predict, namely, that equalization incentives encourage equalization receiving provinces to keep their tax rates, particularly income taxes, higher than they would have been otherwise.

    I'm sure that there are lots of other things we could talk about, but let me, in summary, say the arguments I've laid out here suggest that the equalization receiving provinces have little reason to try to maximize their long-term tax revenue and economic development, most of which would be scooped up by Ottawa, which is, relatively speaking, a much wealthier government. Instead, they have every reason to try to extort superficial benefits out of local industry, such as, often, very short-term and relatively low skilled jobs. In the Atlantic offshore, for instance, they build outdated gravity-based structures for oil extraction, or require companies to make vague promises of massive exploration and development spending in exchange for drilling rights. They could sell those resources up front, retire their huge debt, and reduce their crushing interest payments, but after Ottawa's take it would not be worthwhile.

    In short, equalization vigorously taxes productive economic activity in the least developed parts of the country and taxes attempts by the poorest governments in the country to become more reliant on their own-source revenues. It places those governments in a position where a new dollar raised in local taxation produces, generally speaking, maybe 10 cents for them actually to spend, but a dollar raised in new federal transfers or by borrowing is a dollar available for spending today. Is it any wonder that many of these provinces have learned to be dependent and have so much debt?

    I thank you, ladies and gentlemen.

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    The Chair: We'll move on to Mr. Poschmann.

    Mr. Finn Poschmann (Senior Policy Analyst, C.D. Howe Institute): Good afternoon, Madam Chairman and members of the committee, and thank you very much for inviting me today.

    I think it's understandable that few Canadians pay attention to the details of federal fiscal equalization, but the bill for the program is running over $10 billion annually, $10 billion of federal taxes that Canadians pay, and its partner program, the CHST, is running near $19 billion in cash annually. These are big numbers. They're numbers worth talking about when we try to ensure value for money in federal spending, especially because equalization, as it's practised, has impacts on taxpayers and their governments that are certainly not all to the good.

    Canadians do tend to agree with the principle of equalization, if you ask them, the principle being the one imbedded in the Constitution. The aim is to make possible the provincial delivery of basic services without needing to raise very different taxes from the national norm. But the Constitution, like a lot of the debate on the program we've heard in the past couple of years, is pretty short on specifics.

    The program, since 1957, has redistributed federal tax dollars amongst provincial governments to top up revenue for provinces with weak tax bases. The mechanics of the program are simple. Provincial revenues are assessed by detailed category and brought up to a per capita standard amount. The specific entitlement for a province is the difference between that province's tax base multiplied by a national average tax rate and the standard tax base multiplied by representative tax rate, all evaluated on a per capita basis and multiplied by provincial population. So in principle, it's actually quite simple. The program's renewed every five years, last in 1999. We've passed the mid-point of the program, so the time is right for a re-examination.

    Scrutiny is important, because government programs tend to develop an inertia of their own. Institutions, behaviour, and even personalities become tied to particular features of these programs. Passionate defence of the status quo becomes second nature occasionally for policy-makers and their supporters. This is why open debate is important and windows for change ought not be missed.

    My worry over the design of equalization is rooted in the program's possibly pernicious influence on provincial policy-setting. But however designed, the existence of transfer programs that operate along provincial lines ensures that provinces take account of the incoming money when making their tax and spending decisions. They're meant to, otherwise, having the programs would make no sense.

    So my message is simply that we should look at the programs with a skeptical eye. If Canadians want transfers across regions, we are free to have them. We should keep in mind exactly why we want them and watch for unwanted results.

    Before turning to that, I wanted to comment on the scale of the program and the implicit scale of the transfers. How big are the effective transfers Canadians have apparently voted for? This is where my illustration comes in. If you look at the top panel of the table, these are just the cash payments federal taxpayers make to provincial capitals under equalization and the CHST. So in the top left we have just over $1 billion representing Newfoundland's equalization entitlement, for example. The next panel shows the implicit cost of the program, assuming that the total program is funded by provincial taxpayers in proportion to their relative contributions to the provincial purse. The third panel shows the difference. To use Newfoundland as an example again, the province receives more than 10 percent of total benefits paid under the equalization program, as in table 1, but Newfoundland's taxpayers pay less than 1 percent of the total costs. So the net benefit paid in their name to the provincial capital is $1 billion, roughly, or as shown in the fourth panel, roughly $2,000 for every man, woman, and child in the province. Conversely, Ontario taxpayers contributed a net $45 per man, woman, and child, again taking equalization and CHST together.

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    This illustration is meant only to make tangible the scale of the cross-province transfer. If you think about this on a family basis, just multiply it by four. You have receipts in Newfoundland running over $8000 per family, costs running $2000 per family of four in Ontario. These are big numbers, and I think, when we talk about the program, we should bear in mind just how big that transfer is.

    To turn back to the question of unwanted results, one sort Brian just mentioned, and it's been discussed at some length by Nova Scotia Premier John Hamm and former industry minister Brian Tobin, among others. According to them, equalization sharply reduces the benefit to a province from investing in or encouraging development, which they see as a real problem for natural resource development. So do I. The reason is that the new economic activity these projects bring increases the province's tax base, as measured by the formula, cutting the net cash entitlement from equalization. The complaint is not that this is necessarily unfair, because the province does, of course, get to keep the revenue from, say, natural gas exploration, but that by eliminating the net reward residents may receive from developing natural resources, those resources may, inappropriately, stay undeveloped. Brian just ran through this example. I would just point out that according to this logic, virtually every kind of development is inhibited, and again Brian drew on this in saying it tends to decrease or limit the extent to which provinces might otherwise be expected to converge economically.

    Past changes to equalization's design have sought to shrink this problem, but it remains an irritant. Some people in the past couple of years have looked for new changes that, for example, would take natural resource revenues out of the equalization formula altogether. I would rather look for a solution in a simpler program that doesn't directly depend on provincial tax choices and doesn't favour any one kind of development over another, to ensure that the distortions the program necessarily creates are as small and spread out as possible.

    There is no doubt that federal transfers distort provincial decision-making. For example, federal transfers in the past decade averaged 40 percent of P.E.I.'s total government revenue, 44 percent of its program spending, quite sufficient to be a driving force in local tax and spending decisions. So for each dollar of provincial spending, P.E.I.'s government bears the political cost of levying only 60 cents in taxes on their residents. The implication, one noted very well by Mike Smart at the University of Toronto, is that an equalization receiving province is substantially insured against the cost of making bad economic policy choices, financially shielding governments from the economic good or harm that may or may not be caused by their decisions. In contrast--and again Brian brought this out--the have provinces, which do not receive equalization payments, face directly the consequences of good or bad choices, and the good or bad choices may be tax rates that attract or repel investment. These choices are quite directly transmitted to the pocketbooks of governments and their voters .

    Another key problem with equalization's design is its reliance on national average tax rates to scale a province's money-raising capacity. The result is that a provincial tax rate choice in Ontario affects the size of the federal equalization payment to P.E.I., for example, something presumably not wanted by Ontario voters, and arguably not wanted by their eastern friends either. This bizarre economic spillover can be muted, and should be, through significant changes to the equalization formula, all the while maintaining interprovincial transfers of roughly the direction and scale Canadians have apparently voted for.

    In any event, the program has been with us for nearly forty years, and that's a long time in program world, and it's often been changed, which suggests that the program is indeed politically sustainable in practice, but also open to modification. So while it's not yet perfect, Canadian policy-makers certainly do have an open window to make it better.

    The Chair: Thank you very much.

    Dr. Snoddon, go ahead, please.

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    Ms. Tracy Snoddon (Individual Presentation): I too would like to thank you for the invitation to come and present my thoughts on equalization.

    I would argue that equalization is an important component of our system of fiscal federalism. As Mr. Poschmann has noted, it's been around for quite some time, and it's worthy of the attention you're giving it. From an academic or a theoretical point of view, I would say there are strong economic arguments to be made in favour of the principle of equalization. There's an efficiency argument and an equity argument. Also, we have a constitutional commitment to equalization, not to mention the historical commitment that we've demonstrated.

    What I'd like to talk about is the current formula, which is based on a five province standard. We've had it since 1982. The questions I'd like to ask--and perhaps everybody is asking the same questions--are, does our current system serve the purpose for which it was designed, will it in the future, and are there better alternatives?

    To the question of whether the current system serves the purpose for which it was designed I'm going to give a qualified yes. It equalizes differences in fiscal capacity or revenue raising abilities, perhaps imperfectly. So let me talk a little bit about the qualification, the imperfectness, if you will, of the current system.

    The first point I'd like to make is that it doesn't equalize across all provinces. In other words, it's not a national average standard, it doesn't include all ten provinces. So in that sense it's imperfect. Second, it's not, as many economists or as the theory would suggest we require, a net scheme. It's not a transfer directly from have provinces to have-not provinces, but rather a gross scheme run by the federal government. This tends to make it bigger in scale.

    Aside from those two economic rationales for why our current system might be imperfect in its goal, there are some other issues on equalization, and we've heard some of these already. There are those who argue that it's destabilizing, that rather than dampening the fluctuations in own-source revenues for provinces, it enhances them or amplifies them, and this is contrary to the purpose of equalization.

    A second issue would be unpredictable entitlements. Equalization is difficult to forecast, because it's forward-looking. Consequently, we have lots of adjustments for past years, and this is an issue currently with Quebec and some of the other recipient provinces as well.

    We've heard a little bit about the perverse taxing incentives, and in theory there are some arguments to suggest that those indeed are there. We've also seen some debate about the perverse redistributive properties of the current equalization system.

    Finally, but maybe not least, this system is really hard to understand, even for people like myself who've been looking at it for a number of years.

    So these are some of the imperfections, and I'd like to ask how imperfect the current system is. In order to answer the questions whether the current system meets our needs or serves the purpose for which it was designed, whether it will do so in the future, and whether the alternatives are better, we need answers on how important these imperfections are. So to make my point, I will focus on one issue we've already heard a little bit about, which is the perverse taxing incentives.

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    In theory and through the mechanics of the equalization formula, we see that recipient provinces have disincentives to develop new resources, the clawback effect or the tax back effect, as it's known. Second, we've seen that in theory, the equalization formula can encourage provinces that are recipients of equalization to raise their tax rates above what they otherwise would be. Taxes generally are distortionary, so this would have costs for the economies of those provinces. Third, we see that equalization, through the workings of the formula, gives provinces an incentive to overutilize their weak tax bases. These are some fairly strong predictions that come out of the theory and the mechanics of the equalization formula.

    The question I have, and perhaps you might have too, is, what is the empirical relevance of these effects? In other words, what is the evidence or the data we have to support the fact that these are serious disincentives that have real costs for the economy? Or do we have evidence to say that we can ignore most of these disincentive effects, because they're fairly small? So I would ask the question, to what extent have recipient provinces' decisions to slow down their natural resource developments been affected, and how big are those effects? I would also ask, how much have they raised their distortionary tax rates in response to these perverse taxing incentives? I would ask, what are the real economic costs? We need to know the answers to these questions before we can really think about how best to reform our flawed system, if indeed it is flawed.

    For the current system we don't really have the hard, economic, empirical data to support or refute these claims yet. I know of some research going on in the area that's going to help us answer these questions, but it's not yet available and it's incomplete. If we don't have the answers to these questions on how big or empirically relevant these disincentives are for the current formula, we're not going to be able to evaluate whether we do better on an alternative formula.

    This is just with one set of issues, the perverse taxing incentives. If you want to think about another set of issues, equalization entitlements are difficult to forecast, and as a result, don't get determined or finalized till roughly 30 months or three or four years after the fiscal year for which they're intended is over; that's a long delay. These entitlement shocks generate uncertainty for the province. What we might like to know is what the real impact is. How has it influenced provincial fiscal decisions, spending decisions, revenue decisions? I myself am working on that issue right now, but the work isn't complete.

    I think there are lots of unanswered questions. Academic economists have spent a lot of time talking about the principles of equalization, which is important, and developing theory, but the theory has been far removed from the practice. Theory doesn't take into account the fiscal realities that different government levels face, it doesn't take into account the risks of revenue instability at all. So it's difficult to make predictions about how the current formula influences provincial decision-making.

    So what are my conclusions? As an academic, I'd say we need more research, but that's kind of lame, so I won't say that. Well, I will say that, but I'll also say I am encouraged by the fact that we have lots of interesting and new research going on right now, and that's just really started to happen in the past five years. If change proves inevitable, and I think it will, we need to make an informed decision and we need more empirical data to make it.

    Thank you.

    The Chair: Thank you very much.

    I'll start 10-minute rounds with Mr. Harris.

    Mr. Richard Harris (Prince George—Bulkley Valley, Canadian Alliance): Thank you very much, and thank you, presenters, for your insights.

    A few years ago I attended a little seminar put on Dr. Herb Grubel, who some of you may know, and he showed us a direct link; the lower the responsibility, the lower the benefit, and people would tend to improve. He used insurance deductibles as an example. Through scientific statistics, he clearly showed that the lower the deductible, the higher the benefit, the more careless and less responsible people became. Of course, the higher the deductible, the more careful and responsible people became. So there was a benefit on the one side of the equation and a disincentive on the other side.

    I see that here. It appears to me that with provinces that are below the standard, the have-not provinces, there appears to be a huge disincentive to try to do better, get their act together, and make responsible investment decisions, to try to be more responsible in how they run the governments of their provinces. As they improve, of course, their equalization payment would drop as they get closer to the line, and then they lose it altogether. While people may think, it'd be a good thing if we could become a have province, once you're below that line for a length of time, I fear you tend to get used to it and get comfortable with those guaranteed dollars coming in every year. On the other hand, provinces that do well under this formula appear to be penalized for doing good business and making good decisions.

    So what you're saying makes a lot of sense to me. If it can be pretty clearly shown that it acts as a disincentive to the have-nots and could act as a disincentive to doing better in the have provinces, why are we still doing it? It's almost 50 years ago we've had that experience. Why are we still there. Is there any hope of ever getting a formula or a program that will get us out of this equalization environment we're in? Is there any hope that we're going to get out of it some day and get a good free enterprise system going among our provinces?

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    Dr. Brian Crowley: Each of us will have comments on that. Let me echo something Tracy has said. While we all have our thoughts about what the likely outcomes are of the incentive structure, we don't have good hard empirical information on a lot of aspects of this. I can regale you with all kinds of anecdotes, which I happen to think are very powerful anecdotes, giving you chapter and verse about how specific governments in specific circumstances have acted in a way that's clearly not going to promote economic development, but we don't have a good aggregate picture.

    I think Tracy is again right that in the last few years people have started to focus on this problem in a way they never have before. Certainly, my institute has taken this as a major policy issue for us. We've done quite a lot of work on it, we've got more work yet to do. I think what we're in the process of doing is establishing on a firmer scientific basis the picture of how this program works. It's true it's been here for 40 years, and maybe we should have done this earlier, but the program keeps changing too. I think we're going to be at a point where we'll be able to bring along a lot more people, because we're going to be able to point to some more solid evidence, over and above the anecdotes, and I think we're going to move to a period of significant change to equalization. But that would only be my thought on it.

    The Chair: Mr. Poschmann.

    Mr. Finn Poschmann: Hope springs eternal, doesn't it?

    There is, as the other speakers have said, at least some theoretical work that supports the insurance problem. In fact, I used the analogy myself in pointing at the fact that equalization insures provinces against some of the bad economic outcomes associated with inappropriate tax policy choices. I'll humbly submit that this is not going to win over a lot of hearts and minds. The program, in something like its current form, has been around for more than forty years. We've had intergovernmental transfers for a hundred more years than that.

    The reason is politics more than anything else. This is Canada, and we have multiple levels of government. The reason for talking about it and working away at it is that the smaller you can keep the program, the smaller the ancillary problems. That has to do with accountability for spending and revenue. The real problem here is the fractured accountability for raising taxes and delivering the programs that go along with having raised those taxes, and it's that very accountability problem that I think is the key point to raise when arguing for not making it bigger.

º  (1615)  

    Mr. Richard Harris: Would you say, given that some provinces have lived on the have-not side of the bar for so long, any political party that suggested ending equalization payments would virtually be committing political suicide in those provinces, and any federal party or federal government that continued to encourage the equalization program would be well-received in those have-not provinces as long as they kept doing that? Does it come down to politics? Is that why we haven't tried to tackle this thing?

    Dr. Brian Crowley: You are the political expert. We are merely technical experts. We bow to your superior knowledge.

    Mr. Richard Harris: I'm asking for your opinion on that. I'm trying to put you on the spot, I guess.

    Dr. Brian Crowley: Everything depends on people being able to see alternatives. The fact of the matter is that equalization has existed for forty years, significant amounts of money are transferred, a lot of people in the equalization receiving provinces have grown dependent on those. I don't suggest that in any morally judgmental way. If you're a provincial government employee, you're a teacher, you're a health care worker, you understand that in an equalization receiving province your job probably depends in some way on equalization continuing.

    So there's political inertia in that, plus the fact that every provincial finance minister who gets equalization is going to hang on to that thing for dear life, because it's real money. If you're saying, we want to get you off equalization because we want you to grow your economy and become reliant on your own-source revenue, he says, what own-source revenue are we talking about? The reason I'm getting equalization is that I don't have enough own-source revenue. You're not going to get very far. If you want to move to an alternative, you have to give people a reason to think the alternative is better. I don't think Canadians, and I include people in the Atlantic provinces and other less-developed provinces, enjoy being recipients of transfers from other parts of the country, but people have not been shown what the alternatives are. Frank McKenna has talked about, for instance, moving to a system that, instead of being based solely on transfers, would be based on reductions of federal taxes in less well off provinces, so that we'd encourage the growth of the private sector and have a larger tax base. I think ideas like this really deserve a proper hearing and some very serious study.

    The Chair: Thank you.

    Madame Picard, avez-vous quelques questions? Commencez.

[Translation]

    Ms. Pauline Picard (Drummond, BQ): Thank you very much.

    When we speak of equalization, it is important that we don’t confuse numbers and value because, in my opinion, the goal of equalization is to redistribute wealth.

    I therefore find it difficult to hear you say that most of the provinces which benefit from equalization have become dependent upon it. These thoughts are echoed by my colleague from the Alliance party. You seem to be saying that these provinces, although not proud to have become dependent upon equalization, are not doing much to get out of it. This is like saying to persons benefiting from welfare that we are tired of paying for them because they enjoy living off the system and do nothing to better their situations.

    I am from Quebec and I do not believe that my province is particularly proud to be dependent on the equalization system. I believe that Quebec has proven over the past few years that it is doing everything in its power to lower unemployment and create jobs. Indeed, according to the latest figures from Statistics Canada, Quebec is even on the forefront of job creation.

    I personally find it disappointing when I am told that equalization has perversed effects on a province’s motivation to move forward. It’s like saying that these provinces tell themselves that this is their bread and butter and that this is the way it’s supposed to be. I personally find this very difficult to believe.

    I am simply commenting on what I believe I heard earlier. If I’ve misunderstood you, please correct me.

    I do have a question however. Recently, the federal government discovered it had over-contributed its transfer payments to Quebec by more than $800 million from 1999 to 2000 and again from 2001 to 2002. It is being said that:

This excess can be attributed in part to a quicker than expected economic growth in Quebec and in part to a modification in the way Statistics Canada calculates the household value.

    Of course, this news came as a complete choc to Quebec. As you were saying earlier, the province is counting on this money since it has been budgeted for. First the province was told it would receive $800 million, and now it is being told that after recalculating this sum is to be withdrawn. Everyone is worried because the programs that were anticipated and included in our budgets are now looking very shaky.

    Therefore, my question is: what can we do to predict these significant fluctuations in equalization payments which have the potential to destabilize a province? And more generally, what is the extent of such annual adjustments?

º  (1620)  

    Dr. Brian Crowley: If you’ll allow me, I will first respond to your earlier comment and then let Finn and Tracy answer your question.

    I believe it is very important to clarify what I said earlier.

    Ms. Pauline Picard: Okay.

    Dr. Brian Crowley: I would like to highlight that there is a difference between the intentions and the effects of a social program such as equalization.

    Indeed, often there is a significant gap between our intentions which are to help people and the results of a given program. One must thus look further than simple intentions to understand whether the goals of the equalization program are truly reflected in the actions and in the policies of the governments receiving payments through this program.

    I maintain, and I believe Finn would agree with me, that certain provincial governments receiving equalization payments are demonstrating behaviours that may not be working towards the development of their economies. The goal of equalization, as I understand it, is not to simply give out equalization payments, but rather to eventually eliminate the divide between rich and poor provinces in Canada.

    If as a result, however, equalization maintains or worsens the gap between these two classes of provinces, then we have a problem. That is what I meant earlier.

[English]

    Mr. Finn Poschmann: I have one point.

º  (1625)  

[Translation]

    The government of Quebec took a good decision in 1966 or 1967. The federal government offered the province a choice.

[English]

    You could take some cash to support provincial program spending for post-secondary education and some for health, or you could take tax points, the federal government would back off its tax collection to give a little more room for provincial taxes to be collected. Quebec was the only province that took up the federal government on that offer, and I think it was a very good choice, because it preserved more freedom of action for the Quebec government in decisions about spending and revenue, and they were free of a portion of interference that otherwise would have been necessarily engendered by the federal spending purse. I think the other provinces were wrong not to make that choice and retain the room to shift taxes amongst levels of government and avoid the uncomfortable politics that arise when you start collecting taxes in the name of one government and provide them for spending by another.

    The Chair: Dr. Snoddon.

     Ms. Tracy Snoddon: I'd like to respond on the equalization shocks, the errors in determining entitlements, and the fact that three years down the road you can get big mistakes that provinces then have to adjust to. This is not new. This is a big instance, but it's happened before, and in the past, as part of political bargaining, other recipient provinces had those adjustments they would have to pay back forgiven. But it's not always the case. There certainly is lots of evidence. I'm working on this issue myself, to look at the size of these shocks and the implications for fiscal decision-making of the provinces.

    One of the potential solutions to this is to have a backward-looking equalization formula--and this has been suggested elsewhere--where, rather than trying to forecast the upcoming year, you look at fiscal deficiencies from the past three years and average them out; then you have more information when you're making your decision on how to calculate entitlements. You have more full information, so those errors are likely to be smaller. This option hasn't really been fully discussed, but people are now starting to think about whether that would reduce the fluctuations in entitlements and make entitlements more certain. There's work under way to look at the costs of having that uncertainty.

[Translation]

    Ms. Pauline Picard: This whole equalization issue seems very complicated. Although you are well versed in the subject it is difficult for us to follow you. Thankfully, the explanations are clear.

    Maybe what we need to do is to get rid of the current formula and replace it with a simpler one that could be more equitable for all 10 or 11 Canadian provinces?

º  (1630)  

    Dr. Brian Crowley: Once again, I am certain that each and every one of us will have a thing or two to say about this.

    Personally, based on the research, the readings and the conversations that have taken place at my institute I am of the opinion that we should move towards something new.

    I believe that it is possible to conceive a program that will further encourage the local development of provincial economies without afflicting these provinces’ finances with too heavy a burden that would result in an economic crisis. Indeed, the challenge is maintaining stability during the period of transition from one system to another.

    Obviously, equalization has its advocates, some of which are very adamant, but I believe that research has been demonstrating more and more that the current program is flawed. We can look to Ireland’s system of economic development to compare with our equalization system. They have a very good system which does not feature equalization as a priority. If we were to follow in those footsteps equalization would be one of the first things to go.

[English]

    The Chair: Mr. Poschmann.

    Mr. Finn Poschmann: Equalization will be with us for quite some time yet, whether I think it's a good idea or not. But I just want to point out that the Séguin commission came up with some very sensible proposals for shifting tax room, and this route offers an opportunity for the federal government to reduce their expenditure on transfers, but only in a world where there's more room for the provinces to step in with their taxing rule and thereby shift the responsibility from the federal to the provincial level, commensurate with the provincial constitutional responsibilities we're talking about.

    The Chair: Thank you.

    Mr. Murphy, Mr. Brison, Mr. Wilfert, and then I have three more on the Liberal side here and the NDP, so we'll keep going.

    Mr. Shawn Murphy (Hillsborough, Lib.): Thank you very much, Madam Chairman.

    First, I want to disclose that I come from Atlantic Canada, Prince Edward Island in particular. I read your comments, and I agree with most of what was said here today. However, we've spent a lot of time identifying the problem and not a lot of time identifying the solution. I agree that equalization does create a lot of problems. It keeps activities outside productive economic activity. I think it distorts public policy, especially in the area of health and education. It introduces a lot of patronage into the system, and that, in turn, creates a lot of human capital problems in the system. Also, as has been identified, there is accountability, where funds are raised at one level of government and spent in another level of government, which is perverse. But as Mr. Poschmann has indicated, equalization's been here for 45 years. Ralph Klein seems to be the biggest defender of equalization, so it's hard to think that there are going to be any wholesale changes in the immediate future.

    If there were one or two or three items, rather than a fundamental change, a sea change, what would you recommend to tweak the system to make it more efficient for everyone?

    Mr. Finn Poschmann: First, shift from a five province to a ten province standard. Second, make sure the coverage of the tax bases is as expansive as possible, so that the distortions induced by the system are as small as possible. There are broader, sweeping things we could do over the course of a couple of decades with the transmission mechanism, but in the short term baby steps like these are easier routes to follow.

     Ms. Tracy Snoddon: I concur with those sentiments, and I would also say there is a perverse benefit to having the current ceiling on equalization. Lots of people are opposed to it, and in principle, I might be opposed to it as well, but one of the things the ceiling does is prevent runaway equalization payments. So if equalization is conflicting with economic development, cap it. It's a potential way of limiting.

    Mr. Shawn Murphy: That's limited now, there's a ceiling now.

     Ms. Tracy Snoddon: Yes.

    Mr. Shawn Murphy: Are you saying take the ceiling off?

     Ms. Tracy Snoddon: No, I said keep the ceiling on.

    Dr. Brian Crowley: I must say, now we've started to get the attention of people like you--because you're the important people, you will make a difference on this--on what has for years appeared to be a totally arcane program that nobody can understand--you say equalization, everybody's eyes glaze over, my eyes glaze over--here's one suggestion, if you wanted to go a little further, but not scrap the whole thing. Both finance minister Paul Martin and former New Brunswick Premier Frank McKenna have talked about this, and I think it's something really worth thinking about. Technically, you're taking money from rich taxpayers throughout the country and transferring it to the less developed provinces, but in practice, since wealthy taxpayers are concentrated in a few places, it ends up being a transfer from Ontario and Alberta principally. Instead of just taking the money and giving it to provincial governments, you should at least introduce an element of what Nobel laureate Jim Buchanan talked about. He's one of the fathers of equalization, and we had him speak at an event in Montreal just a couple of months ago. He said, when he first proposed equalization in 1947, he was very clear: don't give the money to governments, give it to individuals; use the tax system to deliver that money to people, and let them make their decisions about what to do with it. If you were to introduce an element of that, if, instead of just a cash transfer, which is what we do under equalization now, you had a smaller cash transfer and an element of tax transfer, which is partly what Finn was talking about a moment ago, you reduce the federal tax load in equalization receiving provinces, and then you let that work through the system.

    Everybody knows the most successful economic development programs in the world and the most successful jurisdictions are the ones that struggle to keep their tax burden low. Equalization receiving provinces in Canada are not in a position to compete with Ontario and Alberta and the United States and Ireland and so on in reducing their tax burden. What we can do is take some of that money from the equalization system, use it to reduce federal tax burden in the have-not provinces, and build up the economy. So you build the tax base. At the moment, we're all in the equalization receiving provinces. We're falling behind as the tax rates fall in places like Alberta and Ontario, and now British Columbia, and the marginal effect of that on us in the long run is very significant.

º  (1635)  

    Mr. Shawn Murphy: In theory, I think you're right, but we deal in the world of reality here. If we went to the four finance ministers of Atlantic Canada tomorrow and said, as in Prince Edward Island's case, we're going to take away your equalization--which I have it right here, $251 million next year--and we're going to lower the, I assume, corporate tax rates, that would meet with a very hostile reaction, and right across Canada, not only in Atlantic Canada.

    Dr. Brian Crowley: All I can say is that when Paul Martin was in Halifax in January, he raised this subject himself. He said he talked to a number of premiers who were very favorable. Frank McKenna just gave a interview last week in which he said this was the way to go. And we don't have to talk only about equalization. Think about regional development spending and a whole bunch of other money that's very politicized and has not helped us to close the disparity gap. Instead of a spending basis, what if we move to a tax-based system for helping to close that disparity gap? I think, after forty years of very poor performance in closing that disparity gap, when you look at what other places around the world, Ireland, Holland, Georgia, have been able to do in closing disparity gaps with their leading-edge economies, we're way behind. We've spent a lot of money and don't have much to show for it. So I think the time has come for us to ask how we could do this better. We're spending a lot of money. The problem is not money, the problem is we're not getting the results we're looking for.

    The Chair: Thank you.

    Mr. Brison, then Mr. Wilfert, then Mr. Nystrom.

    Mr. Scott Brison (Kings--Hants, PC): Thank you, Madam Chair, and I thank each of you for your interventions here today.

    Frankly, we need a month or more, and we need an exhaustive amount of work, and not just on equalization. We also have to consider the fiscal imbalance issue and the economic development strategies in lock-step with each other, and then try to come up with a policy that works. A lot of what we have now is based on the politics, as opposed to the economic public policy, of it. If we take the goals of equalization to be as originally stated, approximately equal levels of taxation and approximately equal levels of services across Canada, the system is clearly broken now, because we have, and it's been referred to, a growing gap between provinces in tax and fiscal capacity. We didn't realize 20 years ago, or it wasn't as widely accepted 20 years ago, the degree to which tax policy will make or break any jurisdictional economy.

    The notion of disparate taxes across the country is an interesting one. Would it be possible to get over Mr. Murphy's concerns about the initial shock of that? Wouldn't it make sense, for instance, for the federal government to say, for a ten-year period we are going to keep equalization at current levels and we're going to use tax levers to try to create levels of economic growth that will enable the have-not province, at the end of ten years, to get off equalization? Premier Hamm and other premiers have talked about the clawback issue, and it could be said to a province like Nova Scotia, for ten years we're not going to reduce equalization by roughly the same amount as the resource revenue you enjoy or the new revenue you enjoy. This would protect the province in the short term, but there would have to be a quid quo pro; the provincial government would have to say at the end of that, we're prepared to take that leap of faith and be off that system.

    One area where we could do it would be economic development. ACOA's budget in Atlantic Canada is $360 million per year. Federal corporate taxes in Atlantic Canada, elegantly, are about the same, $380 million per year. Some people compare Ireland to Canada. That's not a really good comparison, because of the EU transfers, but with Atlantic Canada there's a pretty neat comparison. Wouldn't that be one area of transfers and economic strategy that would be fairly easy to justify, the elimination of ACOA and the elimination of federal corporate taxes in Atlantic Canada?

    As one other option, Nova Scotia receives $160 million from ACOA. If you took the net present value of that revenue stream over the next 15 years, depending on how you calculate it, you'd have probably a $3 billion to $4 billion figure. That would reduce a third of the provincial debt and dramatically improve the fiscal situation for Nova Scotians.

º  (1640)  

    I'd like some thoughts on practical ways to use the economic development side or adjust our economic development strategies to try to create greater levels of growth. There's no end-game currently. Economic development strategies become fiefdoms, these economic development agencies, whether it's ACOA or Western Economic Diversification, and both with equalization and with our regional economic development strategies, if we can develop an end-game approach, I think it would be far healthier, and I think taxes can play a role. So how practical do you think these suggestions are?

    Dr. Brian Crowley: Maybe, as the Atlantic Canadian here, I can take a run at it, because you've specifically cited Atlantic Canada. Let me first mention to the committee that my institute published two books which are directly relevant here. One's called Road to Growth, which we published two years ago, looking at a number of models of economies around the world that have closed their disparity gaps with richer economies very quickly. Then we wrote Retreat from Growth, in which we compared what these places, Ireland, Holland, Georgia, and so on, had done with what we'd done in Atlantic Canada over the last 30 years with federal transfers and so on. We've basically done exactly the opposite of what was done in places like Ireland.

    I agree that there is no end-game, to use your langiage, we're not trying to get anywhere. This is maintaining things, but I think we actually want to get somewhere. I think we want to get to not having the need to pay equalization. Equalization is not a virtue in itself. What we want to do is create a country in which prosperity is better distributed, not because government has forced it in one place or another, but because we've been able to pull out the economic dynamism of people all across the country. A lot of the equalization experts will say, well, of course, equalization doesn't have anything to do with economic development, don't mix things up. I think this is a mistake.

    After four years and so much money and all these things we've talked about on the ways it affects the behaviour of provinces, subject to some further empirical work, we need to think about all these things as a package. My recommendation would be that we look at all the strategies you've talked about. There are some others we could talk about. I'll just put on the table the fact that Nova Scotia pays just under $1 billion in debt service every year and gets $1.4 billion in equalization, with a net benefit to program spending, if you take that billion off the top for debt service, of $400 million. Should we be looking at some way to do a debt for equalization swap? I know there are moral hazard issues there that we have to think about, but there are all kinds of ways we could think more creatively than we have done. And I think it would be a terrible lost opportunity here if we didn't ask ourselves not just how we can fix equalization, but how we can create a system that moves all of Canada to a higher level of prosperity, so that we don't need equalization any more. That's the end-game, in my view.

º  (1645)  

    Mr. Scott Brison: On that exact point, if you take the present value of equalization payments to Nova Scotia over a 15-year period, you're looking at two and a half or three times the level of the provincial debt. If you consider it in those terms, you start to see that the reason we have equalization has little to do with economics today, has a lot to do with politics, and particularly federal control over regional electorates. I think we have to be a little more forthright when we're talking about those issues, because it clearly doesn't have anything to do with economics any more, except bad economics.

    The Chair: Dr.Snoddon, you wanted to add something?

     Ms. Tracy Snoddon: I think it's very important that we view these things as a package, because there are so many interactive effects that it's impossible to separate them. I have a worry about customized federalism, where you reduce federal corporate income tax. I think there are dangers there.

    Mr. Scott Brison: Some people have made that argument. I know Finance officials have said we can't have lower corporate taxes in Atlantic Canada. Their argument, effectively, was that it's all right to put $360 million into Atlantic Canada every year as long as it doesn't accomplish anything. I know you're not making that argument.

º  (1650)  

     Ms. Tracy Snoddon: Suppose you say, ten years down the road you're on your own. Is that a credible commitment? I don't think so. Ten years down the road, if it hasn't happened, are we going to see equalization disappear? I don't think so, unless you have some sort of credible policy in place that will allow that to happen, and we don't. We don't have a way of doing that yet. If you're going to think about going down that road, you need to think about the mechanisms to ensure that it actually happens. There are lots of examples in our history where we've turned around at the end date and said, okay, we carry on.

    The Chair: Thank you very much.

    Mr. Wilfert, ten minutes.

    Mr. Bryon Wilfert (Oak Ridges, Lib.): Thank you, Madam Chairman.

    I want to talk about the process leading up to the new legislation for April 2004 on equalization. Before I do that though, I would like to make the comment that obviously, the benefits of Confederation can't be measured by a balance sheet approach. Equalization may not be a virtue, but I think it's a laudable goal, in that we want to make sure Canadians, wherever they live in the country, have reasonably the same public services. I think that's a laudable goal. It may not be a virtue, but this is the nature of the country. I haven't really heard what the alternative is to equalization that would work, which will lead me into my questions to you with regard to the process for 2004.

    As you all know--and I don't think it's any great shock--all governments are governed by self-interest. Those provinces that benefit from equalization clearly aren't going to be the first to stand up and say, let's change the deck. My friends across the way like to talk about taxation, and I'd like to say that both the federal government and the provinces have equal access, founded on the same major tax base, but the provinces, of course, are less reluctant to use it. The provinces' revenues, in fact, have increased substantially over the last two decades in comparison to our own. Our debt we're servicing at 24 cents on the dollar, theirs is 12 cents. There are a lot of factors that we could look at.

    But to come to this whole issue of the new legislation for April 2004, traditionally, federal officials and provincial officials meet. Various ministers make comments. You probably are aware that the Senate released a report within the last day or two with eight recommendations. With all deference to the Senate, I don't think there's anything new in it; I've heard it all before from the provinces. I'd be interested in hearing from you, in regard to achieving this accountability and transparency we all think is important, myself included, what you think we should be doing to foster national debate, if one is warranted, leading up to this legislation. Obviously, we have an opportunity. You've mentioned the comments of various provincial and federal ministers, past and present. What would you suggest we do to get this kick-started, if for nothing else, then to be able, at the end of the day, to say, we've had this discussion, this is what we see as achievable, this is not, in order to eliminate what I agree with you is often a dependency, where provincial governments in particular don't have the incentive to do some of the things they would otherwise have to do if they had to pay for them?

    The Chair: Mr. Poschmann.

    Mr. Finn Poschmann: It's hard to know where to start. I agree, for the most part, with the member's comments, in the sense that one of the aims, I think, with which we can reasonably agree is the idea of having roughly comparable services across provinces. That kind of economic convergence is something few economists would challenge as a reasonable goal for federal policy. The question is whether or not equalization, as designed, is an effective tool for reaching that goal, and the evidence doesn't look good. If you draw a picture of the economic performance of equalization receiving provinces compared with the other provinces over the past roughly four decades, while, for example, in the last year or two Newfoundland is doing relatively well, mostly, it's a tale of two very different countries, a tale of rich and poor. The convergence we'd like to see happening is not happening, and we haven't seen any comprehensive evidence that equalization has helped, rather than harmed, the process.

    This automatically brings us to the next thing. What do you want to do instead? That's a very good question. If the sky is the limit and we've got years to work with, let's just back up a little bit and make sure the program doesn't grow, make sure we give provinces room to adopt good and sensible tax and spending policies, and let's not harm them on the income side when they do make the right choices. That's part of the problem with equalization. When a province does make the right choice, it does lose income. That's reason to be suspicious of the program.

    Here's a real option. The federal government starts reducing payments, and at the same time it starts backing off tax collection. Concurrently, provinces can move into the tax room if they so wish. Some provinces would raise rates, other provinces would stay just where they are. That isn't going to get you equal services today or tomorrow, but in the long run this sort of equal treatment across provinces is exactly the kind of end-game we should have. This is where we can echo some of the statements that have come from eastern premiers, and other premiers, for that matter. They say, an end-game is where we're not equalization recipients. I think that's a great end-game.

º  (1655)  

    Dr. Brian Crowley: I agree with what Finn has said. I think you could go further, because, as I said earlier, no finance minister in an equalization receiving province in his right mind is going to give up a dollar revenue today for the possibility of a dollar revenue tomorrow. What we have to do is build confidence in a different strategy. I think one of the ways we can do that is to start with some of the traditional economic development money, ACOA as an example, but there are lots of others. Let's start to use that money as tax measures instead of program spending measures. Let's see what effect that has. If the effect is positive and we can document that, then we've begun to establish the confidence that we're going to have to build with partners in the federal-provincial system to begin to shift equalization away from transfers to a more tax-based system.

    To come back to your specific question, I think you already have the venue, you have the process for what you've asked for. It's right here. You are the right people to do it. The Commons finance committee is one of the most prestigious committees, perhaps the most prestigious committee, dare I say, in the House of Commons. You have the power to start a national debate, invite the right people to come and talk about this, and write a report that will light a fire under the federal government. Why look any further than this room?

    The Chair: Dr. Snoddon.

     Ms. Tracy Snoddon: I would like to add one comment. Probably, by 2004 these new alternatives won't be operational, but I do think one thing we can do to prepare for the future is to have, say, four alternatives to the current system, just to tweak it, using past entitlements on average. Track that at the same time, track the macro formulas that have been proposed at the same time, and make that open, not just to the inner circle in the Department of Finance, but to academics like myself who would like to have that information.

    Mr. Bryon Wilfert: So establishing the appropriate measurements would be very critical in being able to do that. What you're suggesting is that on the one hand, we have this process, which traditionally has been officials back and forth, etc. We talk about engaging, which is part of the process here in these discussions, and I would agree with you that this is certainly a good place to begin. But obviously, because there is such self-interest at work with various groups and organizations, we should widen consideration on how you would develop that process. Say you had four or five scenarios at the end, you'd really have to have some very clear measurements, and who would be doing the measuring? Could you make a very quick comment?

»  (1700)  

    Dr. Brian Crowley: This is, of course, one of the problems with the current system: in spite of the fact that we've run it for so many years and spent so much money on it, we don't know very much about what it does. We know how the money is spent, but we don't know much about the aggregate, if you add up the good effects and the bad effects. We're beginning to get our heads around it. This comes back to Finn's point about accountability and responsibility. If we're to try out some alternatives, let's do it properly. Let's not do it the way we've run the equalization system for the last 40 years, where we cannot say with confidence what has been the result.

    I suspect Finn and his organization would be in a similar position, but certainly, my organization, a public policy think tank based in Atlantic Canada that has done a lot of work on these issues, is at your disposal. We would like to participate and contribute to this national debate. There are some smart people out there who have the ability to do that kind of analysis and to enlarge the discussion beyond the financial officials. This is a terribly important national program that people do not understand and has powerful effects. If we can work together to make people understand that and begin to talk about alternatives, I think we will have done a powerful public service.

    The Chair: Thank you very much.

    Now we go to Mr. Nystrom, followed by Mr. Pillitteri.

    Mr. Lorne Nystrom (Regina--Qu'Appelle, NDP): I want to welcome everybody here this afternoon. I've known Dr. Crowley for a very long time, going back to previous incarnations.

    I want to go back in history a little. When I was first elected as a member of Parliament, the Department of Regional Economic Expansion was brought in by Pierre Trudeau in 1968 and was seen as one of the revolutionary things he did. Then in the constitutional debates in the 1980-81 period we enshrined equalization, of course, in the Constitution as section 36. I can remember the debates over that, the word chiselling, trying to get at the proper language acceptable to the Parliament of Canada and all the provinces. It was a very interesting debate we went through.

    I speak as someone who comes from a province that gets equalization most of the time, although not that much in the net case, and sometimes it does not get equalization. In fact, if you look at the figures we have here today of the receipts less the cost in Saskatchewan, in 1998-99 the net is $257 million. It went down to $147 million, in 2001 to $13 million, in 2001-02 to $10 million. So it's far and away the least, on a per capita basis, of any province in the country. There were times Saskatchewan did not receive equalization as well.

    I wanted to ask Dr. Crowley about one statement he made in his remarks here, that there might be some significant damage to the ability of a less developed province to close the disparity gap. I was going to ask about the policy question here where you are saying the program possibly has a pernicious influence on provincial policy setting. I follow Saskatchewan government stuff very closely, and I'm not sure what impact it might have on a place like Saskatchewan. Do you have examples of what you're talking about, or are you just generalizing? I come from a province where we have sometimes a volatile economy too. The market doesn't decide the weather. It's very dry out there. Last year was the driest year in the history of weather detailing in Saskatchewan.

    Dr. Brian Crowley: This is a very important question. I would like to suggest that one of the effects of being always right on the edge of being an equalization recipient, and sometimes, indeed, not being an equalization recipient, is that it nullifies, more or less, the perverse incentives. When you're down $1.4 billion, as you are in Nova Scotia, for instance, you can never see getting out. It's not something that's going to happen next year. If I take the right decision--

    Mr. Lorne Nystrom: That's all these Conservative governments in Nova Scotia, Social Democrats in Saskatchewan.

    Dr. Brian Crowley: I could talk even about Manitoba, which gets a hugely greater amount, relatively speaking, under equalization than Saskatchewan.

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    Mr. Lorne Nystrom: Absolutely.

    Dr. Brian Crowley: It's about 20 percent of provincial revenue with them, if I'm not mistaken.

    I think this has a big impact. I think the influence on provincial policy-making grows the deeper you fall into the equalization hole. So I suspect you are quite right, that it would be harder to identify perverse policies in Saskatchewan than in Nova Scotia or Newfoundland. The list is as long as both my arms.

    Mr. Lorne Nystrom: I'm glad you say that about Saskatchewan, because a lot of whether we qualify or not depends on the weather, depends on the international farm economy, depends on all kinds of factors not relevant at all to our economy.

    To go back to these general statements, I notice you are saying here that if you subsidize something, you'll get more of it. In general, that's the law of economics, but sometimes you have things like trade wars, the huge American farm bill, $180 billion over ten years. You get more of it in the United States, but less of it here. So again, I think it's hard to generalize.

    Dr. Brian Crowley: When Americans subsidize farming, they get more farming, but there are knock-on effects on other people.

    Mr. Lorne Nystrom: Yes, we get less, or the Argentinians get less.

    Dr. Brian Crowley: Agreed, but the whole discussion we're having here is, what are the unintended consequences of the policies we're discussing?

    Mr. Lorne Nystrom: In the American farm bill case that is an intended consequence.

    Mr. Finn Poschmann: I feel a sense of responsibility for the numbers, and I just want to highlight a quite clear, if implicit, assumption in coming up with a net figure. The net figure is imagining that it makes sense to actually net the implicit tax take against the grant given. Suppose everybody came to zero here, we would have said, okay, we can get rid of the program; there's no net shift, because the taxes are just going to drop by the same amount. That's quite a gamble, isn't it? Why does Ontario continue, at the political level, to support equalization? It costs a lot of money, doesn't it? Wouldn't someone argue that Ontario would be fiscally better off by not supporting it? Well, not necessarily, only if you think the money saved would actually come back your way through other spending or lower taxes, and that's quite a political leap. So there's a note of caution that there is a political economy going on in how provinces think about these questions.

    To get back to the member's question, the past Premier of Saskatchewan talked quite often about being free of equalization's influence and wanting to make sure the province returned to that position and stayed there, and I think that's a very sensible comment.

    Mr. Lorne Nystrom: Absolutely. It means our economy is working better. That's obviously a goal the province has been pursuing for quite a while.

    I want to ask you one more question about using the tax system to create more equalization. The goal is to have equality in all the provinces, and it depends on how you get to that goal. How can you use the federal taxation system to create that? You can't have two tiers of federal taxes, a lower income tax rate for Prince Edward Island than for Alberta.

    Dr. Brian Crowley: We have that now with federal taxes, even in Quebec.

    Mr. Finn Poschmann: Yes, that is an example, the product of the arrangement I mentioned earlier. I don't even want to talk about the pluses and minuses there at a detail level, but let me say that it's extremely dangerous ground, whether we're talking about the personal tax or the corporate income tax, and it's not just the political problems, it's the resource allocation problems, distortions caused by different tax rates in different provinces--huge administrative problems. At the time you're still talking about draft amendments for the tax act, I would be out there creating finance vehicles to incur costs in one province and deliver revenues in another. There's tremendous scope for distortion. I'm extremely doubtful about the wisdom of varying tax rates across provinces, even if I agree entirely with respect to the ultimate aim.

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    The Chair: Okay.

    Mr. Pillitteri.

    Mr. Gary Pillitteri (Niagara Falls, Lib.): Thank you very much, Madam Chair.

    I'm listening with some enthusiasm here, and it's quite a while I've been sitting here in this chair in the finance committee. I want to continue with remarks made by my colleague Mr. Wilfert on what equalization payments were supposed to have meant, to keep Canadians within their districts and their homes and to supply the services other Canadians have across the country, in order that people wouldn't have to move within Canada. Being from Ontario, I do understand this and I do support it wholeheartedly, but Mr. Poschmann also made a remark in response to a question that Miss Picard asked about tax points. The government of the day was very knowledgeable about what it meant vacating room within the federal tax system for the provincial tax system. But this was not only given to Quebec from the federal level, this was given to every other province. If some provinces chose to use the tax room there, that's fine. If they didn't choose to, that's their prerogative.

    I want to go back and ask a simpler question. In the last 20 years no changes have been made for the have provinces and have-not provinces. Prior to that even Ontario at one time collected equalization payments. It was a have-not province. So the need has, over time, changed from province to province. We understand, with the discoveries of oil off Newfoundland and Voisey Bay, if they would utilize all the resources they have and develop them, the Province of Newfoundland would be a have province and probably would not have to collect equalization payments, because it would be developing its own resources.

    So with this notion that equalization payment isn't so good for the country, I beg to differ with you, because it has not been the same provinces collecting at the same time, the provinces have varied. What has to happen in the growth of a province is the growth of the private sector. You're trying to tell me, as an entrepreneur from Ontario, from Quebec, and so on, that the government, through a tax system, should be going into those provinces and stimulating the economy, so you would be doing the total reverse and moving people across the country.

    Today we are in a world economy, like it or not. When someone visited my business, I said, you see this product? This product is grown in Portugal, is manufactured in Germany, is stamped in California, and used here in Canada--a cork, that big.

    If you're trying to tell me we should use the tax system in Canada to have a better understanding and a better living for all Canadians, not to support those who for a time have not been able to support themselves in giving those services, if you want to have the government interfere, I would take offence, because all of a sudden you would be distorting the natural economies of those provinces.

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    If we talk about Ireland, let's put it in proper perspective. Ireland is four million in a sea of 400 million in Europe, an economy of 400 million, and you always use how well that economy's done, with the total subsidy of the European community. It's a benefit not only of the incentive of money they had, but of the economic protection of 400 million people.

    Would you like to respond to that, Mr. Crowley?

    Dr. Brian Crowley: I' m sure everyone will have their thoughts on this. You've raised a number of things. Let's go through them.

    First, on the number of provinces that have depended on equalization, I think Ontario and British Columbia were the only two paying when the system came in. British Columbia was pretty marginal. I don't think Ontario has ever been an equalization recipient.

    Mr. Finn Poschmann: That's right. I'll just jump in right there. Ontario did briefly qualify for equalization, but that was too embarrassing, and the rules were changed so they wouldn't be paid.

     Ms. Tracy Snoddon: Ontario itself agreed that they should not get equalization.

    Dr. Brian Crowley: Let's be clear about this. Since the program began, only one province has reliably escaped equalization, Alberta. Alberta was a recipient when the program was invented in 1957 and moved off in the early sixties, if I'm not mistaken. British Columbia, for the first time, is a province that has fallen from paying status to recipient status. So to suggest that there have been all kinds of movement in and out is not accurate. One province has reliably left, one province hovers on the border, and one province has fallen from have status to have-not status. So I don't think that's going to get us very far.

    As far as the objectives of the program go, I hope it's clear that no one is disputing the desirability of the intentions of equalization. What we're talking about is the unintended consequences of trying to realize those good intentions. And there are a series of unintended consequences, nothing to do with what people wanted to do with equalization. I have tried to say we have to set these in the balance besides the good intentions and ask whether the balance that is struck is the right one.

    Let's talk about Ireland for a moment. It's true it's a small country in a large continent. Atlantic Canada is a small region in a large continent. Ireland is wealthier now than Canada, and it was way behind just 15 years ago. Transfers from Brussels to Ireland over the last 15 years have varied between, if my memory serves, 5 percent and 9 percent of Ireland's GDP. Transfers from Ottawa to Atlantic Canada have varied between 20 percent and 40 percent of GDP. In other words, Atlantic Canada has had, at the lowest level, transfers more than twice as large as the highest level of transfer Ireland has ever had, and Ireland has closed the disparity gap hugely faster than Atlantic Canada. So simply writing cheques has not solved the problem.

    I will be glad to distribute to members of the committee the books I mentioned, Road to Growth and Retreat From Growth, in which we describe in some detail exactly what's happened in these other jurisdictions vis-à-vis Atlantic Canada. I venture to say Ireland and a number of these other examples are relevant, except that there is never any direct analogy. There are always different circumstances, I agree with that.

    But surely, we're in a position now, as we've said several times today, to step back from what we have done in, say, Atlantic Canada and ask ourselves if that is the best we can do, look at what other people have done and say, that looks better; how can we do more of what they've done and less of what we've done? Surely that's what we want.

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    The Chair: Five minutes each, Mr. Harris, and then Ms. Leung.

    Mr. Richard Harris: I take it that these seven provinces that are currently in it, with the exception of B.C., which has just jumped in, have been equalization recipients for 45 years.

    Dr. Brian Crowley: Yes. Saskatchewan is right on the border.

    Mr. Richard Harris: After 45 years under this program perhaps these provinces may be destined to stay there for another 45 years, because we haven't, apparently, figured out an alternative. Mr. Wilfert asked what the alternative to equalization is. I would suggest--and call me stupid or something--a more buoyant economy in the provinces is the alternative to equalization, and that comes about through increased consumer spending, increased business investment in the province, which translates into more jobs. The trickle-down effect is more tax dollars in the provincial coffers to build more infrastructure and provide more services.

    Mr. Poschmann, I think you said it's inconceivable to think about differing federal tax rates in the provinces, it could create a nightmare. But don't we have that now, in another form, through the equalization payments? It is tax dollars that are going back to the province, but they're going to the government and not the people. That's the difference, but it still is a form of differing tax rate in the provinces. Alberta and Ontario get no equalization, while the others will.

    People a lot smarter than me have said, let's try a 20-year program to get out of this equalization. Each year we will offset a reduction in equalization payments with a reduction in federal tax. We won't try to do it overnight, but over 20 years we might be able to get to a point where the provinces have seen the trickle-down benefit of reduced federal income tax, they have seen the consumer spending and business investment go up, and the trickle-down effect has actually shown some fruit.

    It's apparent to me that after 45 years, if the seven provinces are still recipients of equalization, there's a pattern that's going to be pretty hard to get out of unless we're prepared to take the first step to getting out of it. I guess it's people like you who come up with the plans, and it's people like us who try to put pressure on the government to implement the plans to take that first step. It's a step of faith, but we do need to have something to start on, and another 45 years of this simply isn't the answer. These provinces have to be able to build their economies to get out this equalization thing. B.C. is going into it for the first time in its history, I believe. We're not happy, we're embarrassed about it, believe me, and I think we all hope we get out of it next year--we're going to do everything we can to get out of it.

    The Chair: I think there is no time for a response.

    Ms. Leung, go ahead.

    Ms. Sophia Leung (Vancouver Kingsway, Lib.): Thank you, Madam Chair.

    The three of you have made very fine presentations, very interesting.

    I still vividly remember--it was probably last year--that all the finance ministers of the have-not provinces came here and urged us to have the increase. That wasn't a very good impression, but today I really look at it in a different way. We are like a national Robin Hood system here, and we do give to the have-nots. But I can also see we need reform, definitely. The 33 areas where you derive the tax revenue are really absurd. It doesn't make sense. I'm sure there's a lot of misinterpretations, and that's why overpayments are there.

    I'm from B.C. We're from different parties, but we agree that this have-not position is not very good. We do not intend to stay here. I recently had a discussion with the B.C. Premier, and he doesn't want to even mention the term have-not.

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    Mr. Shawn Murphy: Those are the Liberals, though.

    Ms. Sophia Leung: Kind of Liberals.

    But anyhow, I just want to say we are really very motivated, we do not want to stay in this position.

    In B.C. we have so many new immigrants. They say, no wonder Canadians are not motivated. Look, everything is from the womb to the tomb, it's handed to you. That sometimes offends me, because we are really compassionate, we want to give, we're not a kind of welfare state. On the other hand, I really think incentive and motivation are very important, but I can see that in the meantime you have to help the have-nots.

    I'm really interested to see how we reform, trying to restore motivation. I know the Premier already said we're going to start new industry to increase the investment etc., and also the construction infrastructure. But I would like to know from you three experts what you would suggest as the best way to start reform?

    The Chair: Mr. Poschmann.

    Mr. Finn Poschmann: That's a big question, and again, it really depends on the horizon. If you're looking for recommendations that are seriously going to respond to some investigation for this round, it's going to have to be small, there's just no way around it. We can talk, but there's a huge economic and political case that has to be better developed before there's a realistic chance of reaching a more fundamental reform approach.

    But I'm very encouraged. I'm absolutely intrigued that everyone I've talked to from B.C. and everyone I've heard at the political level is absolutely horrified by the prospect of becoming a recipient. There's a very powerful message there that all is not right in the world of equalization.

    Dr. Brian Crowley: I've already talked too much about some of the things we might do about equalization, but let me just come back to what I think is the really key point. If we could shift one thing, I would like us to talk about shifting our thinking about equalization from a steady state program. Steady as she goes. It's just an ongoing thing. There just happen to be some people who are poor and some people who are rich, so we take money from the rich and give it to the poor, and that's the end of it. We have to start thinking about how to change the situation that requires us to pay equalization. If we can get people to buy into a vision of where we're trying to get, they will follow when you lay out a plan to get there. Our problem is that the only thing the finance ministers, when they come in the door, are interested in is the dollar signs for this year--not even next year, it's this year.

    The only way we're going to get improvement in equalization and deal with some of these perverse incentives is to start getting people to focus on the fact that these programs have unintended consequences, they have long-term build-up in the system, and the only way we're going to fix it is by having an alternative long-term vision we can all agree on down the road, and then we can work out a program of how to get there.

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    The Chair: Dr. Snoddon..

     Ms. Tracy Snoddon: Equalization increases over time. One of the reasons is that as the wealthy provinces get wealthier and their tax bases grow, equalization rises. One of the problems is equalizing to that standard, with the standard rising over time. So an alternative to consider is what we mean to be the standard. Is it the standard that moves over time in some nominal or real growth, or do we want to define some national minimum standards that would prevent that escalation? So once you've equalized up to some minimum standard that doesn't have to be a national average standard or a five province standard, make the standard lower. Then you prevent that escalation, and it acts as a cap on those disincentive effects.

    The Chair: Thank you very much.

    On behalf of all my colleagues who have been here today and all the members of the finance committee, I would like to thank you for giving us your expertise and sharing this time with us. As a committee that has some new members and some old members with varying levels of understanding, this is what we wanted to have, a basic discussion. At some point in the future maybe there'll be more, but thank you very much for helping us out today.

    For colleagues, we had a future business meeting. Because we don't have voting numbers here right now, I will just reschedule that. Mr. Cullen said he didn't want to pursue his motion at this time. He may do it some time after the break. So I'll just postpone all the rest of that business till that time.

    Thank you. The meeting is adjourned.