Saturday, July 29, 2006

Equalization: Is a non-renewable resource an asset?

Talks over Canada's provincial equalization program collapsed this week when premiers failed to agree on the best way to distribute federal funding across the nation.
By far the best point I've seen raised on this issue is regarding the formula used to calculate equalization. How should we calculate profits from non-renewable resources? Here are some excerpts from the Atlantic Institute for Market Studies (AIMS) website:

The equalization program is a major bone of contention at the Council of the Federation meetings, which wrap up in St. John's, N.L., today. The 13 provincial and territorial premiers agree the program, which is designed to allow provinces to provide similar services across the country through payments from the federal government, needs to change to fix the so-called "fiscal imbalance" between Ottawa and the provinces. They just can't seem to agree how.
Resource revenue is included in the current formula and some provinces, such as New Brunswick, Quebec, Manitoba and P.E.I., want it to stay that way, arguing that a dollar is a dollar, no matter where it comes from.
But the AIMS report argues that a non-renewable resource is an asset, not a revenue from income or sales taxes or from renewable resources such as forestry or hydroelectric power.

"Non-renewable natural resource revenues come from the sale of finite resources," argues the report. "When the oil and gas, or copper, or coal, or nickel are gone, they are gone. So, when we sell these resources, it is a one-time deal. God is not going to put new oil and gas and coal and copper under the ground when we deplete current resources.""We therefore have both a financial responsibility and a moral obligation not to treat this money like a lottery windfall, or to sell the house to finance a splurge on fancy cars and new clothes."

Any changes to the equalization program should consider what provinces are doing with the money they receive from non-renewable resources, argues the report. If they spend the money on ordinary programs, it should be taken away from their equalization entitlement, but if they invest it or apply it to provincial debt, it should not count against them.

I couldn't agree more. A wealth of information can be found on the AIMS website, including, “Ten Reasons to Remove Nonrenewable Resources from Equalization.”


Candace said...

That's an interesting argument. Does that mean that, since Klein has put $500 million toward cancer research, Alberta shouldn't receive any (or reduced) health care funding? I'm not sure I agree with that.

It's difficult to argue that Alberta "needs" the money, but the reality is that Albertans pay federal taxes, too, so why WOULDN'T we get contributions toward healthcare etc from the federal government?

Methinks it is easier to be a "havenot" province in these discussions.

true dough said...

Ew. Healthcare. Nice topic.

I'm going to assume that you view Canada as a free market system where provinces behave like firms. Eg – The resource-rich province of Alberta must attract workers, so it increases its wages and provincial benefit offerings (ie healthcare). As supply meets demand, the most productive province will out-compete the inefficient, lesser-endowed provinces. Weak provinces will face a downward spiral in productivity (and healthcare) causing rational individuals (especially young families, etc) to migrate to Alberta. This certainly solves the supply and demand equation if we view Canada as a market; however, instead of a firm going bust, a province will be depressed.
(I take this to mean that you don't favour equalization in the first place?)

Despite my criticism, I don't believe it's such a simple issue. Part of me is tempted to favour competitive behaviour between provinces. To be sure, if provincial healthcare spending meant a cut in a province's equalization payments (perhaps some kind of distinction needs to be made in the case of research and development), worker mobility across Canada would be less bias than the competitive scenario above. On the other hand, this shouldn't be a debate between aggregate efficiency of productivity and aggregate welfare.

Still, with our Conservative government I can't help but think we're going to see a trend in favour of aggregate efficiency of national productivity.

On a side note, Paul A. Hobson shares an interesting perspective in his paper "Equalization and the Treatment of Non-renewable Resources” (2002). It helped shape my (fragile) view. Link to pdf:

phew. That rant was longer than I expected.

Marc said...

But is not the real problem in federalism right now the imbalance among provinces themselves with regard to resource revenues? In recent years, Alberta has been able to finance about two-fifths of its budget expenditures through resource royalties. This means Alberta is able to have the lowest income taxes in Canada, no sales tax, no provincial debt, and can pay top dollar to attract public service professionals like doctors, nurses, teachers, etc.

Thus, there is already a lot of tax competition because of Alberta's unique situation. My preference would be for a resource-royalty sharing pool among the provinces, so that all Canadians can benefit from resources. Why should Alberta, out of pure dumb luck, be able to drive decisions in other provinces, particularly when what is boosting Alberta's revenues -- high oil prices -- actually hurts other provinces (like Ontario and its manufacturing base)?

And don't forget that the government of Canada, decades ago, financed much of the research for how to get oil from the tar sands. And don't forget that one of the reasons why we have an Equalization program is because Alberta and Saskatchewan flirted with bankruptcy during the Great Depression.

Equalization can only do so much because it is a federal program funded out of federal revenues. Provinces have exclusive access to resource royalties as a tax base. Since this is the cause of the distortions above, it is hard to reconcile as long as the feds do not have access to the resources base (outside the territories, that is).

As for non-renewable resources being an asset, isn't all income the return to some investment -- the return to investments in machinery and equipment, to human capital, to infrastructure? Why should non-renewable resources be treated differently?

That's my quick rant. Congrats on your blog. I've linked to it from, where you can find some other links related to equalization and the "fiscal imbalance"?

true dough said...

Hi Marc,

First, let me admit that the reading I've done on this subject is cursory. Anyway, you raise some interesting points. I think the resource-royalty sharing pool among the provinces has strengths; however, there are a few things in particular that attract me to the model I wrote about in my post.
I'll bring up one here.
I happen to be a fan of Klein's Heritage Fund. I've heard this view expressed somewhere else and I'll echo it: a province should not be punished for investing wisely. Alberta is not the next Dubai, and we can be thankful for that. Instead, Klein has directed money towards investment and research: two things that are key to long-term productivity. Would every premier have invested like Klein did if they were running the show? Would Stephen Harper?

Although, you're absolutely right: this isn't the model to use if the primary objective is inter-provincial equality. But the fact that this model does not allow the endowed province to do much else than invest is not a terribly bad use of provincial power. Anyway, I look forward to reading more on this subject. I don't believe we'll find the golden ticket, but at best we can minimize our losses – if only we could agree on what they are!

Thanks for adding me to the progecon links! It's a site I enjoy reading. I look forward to reading more of your insight.