FINA Committee Meeting

STANDING COMMITTEE ON FINANCE

COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Tuesday, April 24, 2001

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[English]

The Chair (Mr. Maurizio Bevilacqua (Vaughan—King—Aurora, Lib.)): I'd like to call the meeting to order and to welcome everyone here this afternoon.

As you know, the order of the day is Bill C-18, an act to amend the Federal-Provincial Fiscal Arrangements Act.

We have the pleasure to welcome here, from the Department of Finance, Susan Peterson, assistant deputy minister; Dominique La Salle, chief, strategic planning, federal-provincial relations; Sean Keenan, senior program analyst; and Frank Vermaeten.

Ms. Peterson, the floor is yours.

Ms. Susan Peterson (Assistant Deputy Minister, Federal-Provincial Relations and Social Policy Branch, Department of Finance): Thank you, Mr. Chairman.

I welcome the opportunity to appear before you today to discuss Bill C-18. I intend to keep my remarks fairly brief so that there will be time for questions from you.

This bill, as you know, amends the Federal-Provincial Fiscal Arrangements Act to lift the ceiling on the equalization program for the 1999-2000 year, thereby fulfilling the commitment made by the Prime Minister when he met with the first ministers on September 11, 2000. At that meeting an agreement was reached among the first ministers on a plan to renew health care and to improve support for early childhood development.

[Translation]

The Government of Canada's financial support for these agreements totals $23.4 billion over the next five years. Of this funding, $21.1 billion is being provided through the Canada Health and Social Transfer, which is one of the three major transfer programs through which the federal government provides support to the provinces and territories for health and other social programs.

A block fund, the CHST provides support for health care, post- secondary education, early childhood development, and other social programs in the form of cash and tax transfers.

The second program, Territorial Formula Financing, recognizes the higher costs of providing public services in the North.

[English]

Equalization is the third major transfer program and the subject of Bill C-18. It provides funds to less prosperous provinces to enable them to offer reasonably comparable programs and services to their residents. The Government of Canada has shown the importance it attaches to this program as part of the essential fabric of the country. The equalization program was set apart. It was one of the very few programs not touched during the period when the government was struggling to bring order to the nation's finances.

Equalization payments are unconditional. Provinces can spend them as they see fit. The seven receiving provinces, which are Newfoundland, Prince Edward Island, Nova Scotia, New Brunswick, Quebec, Manitoba, and Saskatchewan, are expected to receive payments totalling $10.8 billion in the fiscal year 2000-01.

Since 1993, equalization has grown by 33%, or $2.7 billion. According to the estimates, which are updated twice a year, the program is now at its highest level ever. Over the same period, by way of comparison, other non-transfer program spending has grown by 2.6%.

The latest official estimates were released in February, and they indicate that the payments to the receiving provinces will be about $1.8 billion higher than was estimated just last October. These higher figures are not due to the poor economic performance of the receiving provinces, Mr. Chairman. Rather, they are due in large part to the exceptionally strong economic growth in Ontario over the last two years.

Payments are increasing immediately by about $1 billion. Of this amount, about $52 million is in respect of 1999-2000 and $955 million in respect of 2000-2001. The other $800 million is dependent on the passage of this bill that is before you.

[Translation]

The equalization program is reviewed on an ongoing basis by federal and provincial officials to make sure that differences in the abilities of the provinces to raise revenues are measured as accurately as possible.

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The program is also renewed legislatively every five years, most recently in 1999. Work is already under way on the 2004 renewal. Payments are based on a formula that measures the relative performance of provincial economies.

A province's capacity to provide public services obviously depends on how its economy is performing. The formula, Mr. Chairman, is applied in the same way to all provinces and adjusted automatically in response to economic developments in the provinces.

[English]

When a province's economy is doing well relative to other provinces, its equalization payments automatically decline under the formula upon which the program functions. When a province's economy, and therefore its fiscal capacity, declines relative to other provinces, its equalization payments automatically increase. In this way the program acts as an automatic stabilizer of provincial government revenues.

In addition, equalization payments are subject to both ceiling and floor provisions. The ceiling allows equalization to grow from year to year but puts an upper limit on the growth. This ensures that the program remains within the bounds of sustainability for the federal government. The ceiling prevents abnormally fast growth in equalization. For example, when Ontario's economy was going through rapid growth in the late 1980s, equalization entitlements outpaced the growth in the national economy. The ceiling has been triggered in only five of the last twenty years.

The floor provision provides protection to provincial governments against large and sudden decreases in equalization payments that would otherwise be warranted by the straightforward application of the formula. This could be caused, for instance, by a significant decline in the economy of Ontario or by a dramatic increase in a receiving province's fiscal capacity; for instance, an increase in the price of oil for Saskatchewan. The floor has protected New Brunswick on one occasion and Saskatchewan on four occasions from decreases that would otherwise be called for by the proper functioning of the program.

The ceiling for 1999-2000 was set at $10 billion and, except for the provisions in this bill, will grow at a rate equal to the growth of GDP in subsequent years of the legislation. Based on the forecast for GDP growth outlined in the government's October economic statement, the ceiling will rise to $12.5 billion in the year 2003-04, which is the last year of the current legislation.

Bill C-18 lifts the equalization ceiling for the 1999-2000 fiscal year, and only for that year. The final cost of removing the ceiling will not be known until the fall of 2002 when the final estimates for 1999-2000 become available. However, the cost is currently estimated to be $792 million.

In keeping with the way the equalization program functions, this amount will be allocated among the seven eligible provinces on an equal per capita basis. Each receiving province will receive an additional $67 per person. These per capita figures are multiplied by the total population of each receiving province to arrive at the payment for each province. Newfoundland will therefore receive an estimated $36 million; Prince Edward Island, $10 million; Nova Scotia, $62 million; New Brunswick, $50 million; Quebec will qualify for an estimated $489 million; Manitoba, $76 million; and Saskatchewan, $69 million.

I and my colleagues here today would be pleased to take any questions you now have.

The Chair: Thank you very much, Ms. Peterson.

We'll now proceed to the question and answer session. We'll begin with Mr. Harris. We'll go with a 10-minute round.

Mr. Richard Harris (Prince George—Bulkley Valley, Canadian Alliance): Thank you, Mr. Chairman.

Thank you for your presentation. I have some prepared questions, which I brought with me.

First, there has been some argument that the lifting of the cap is an ad hoc reaction and that it could fail to address the bigger, long-term problems. The fact that this bill is even before us could indicate that there's a need for a more open discourse in Parliament to review the equalization program in its entirety.

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There are some concerns about what could be the penalizing effect for, say, the three “have” provinces, B.C., Alberta, and Ontario. For example, is it possible that they could end up with less funding for things like health care under this new bill, under the new policies?

Ms. Susan Peterson: There is an opportunity for Parliament to have a thorough look at the program once every five years, because the legislation runs out every five years, so that there is a bill on a regular basis that provides an opportunity to do that broader examination you mention. As with the last time it was renewed, the next time we'll be happy to help in any way we can to provide for that broader discourse.

As for your latter question, it was an agreement among all first ministers last September that the federal government supported in the form of large increases in the Canada health and social transfer to the benefit of all provinces and the lifting of this ceiling for one year. Obviously first ministers thought that was a reasonable balance.

Mr. Richard Harris: The equalization system should, for the most part, serve the longer-term purpose of equalizing economic opportunity within the autonomy of all the regions. There's also a concern that it could create incentives for perverse economic policies on the part of provincial governments. So what type of safeguards do we have that would prevent eligible provinces from, say, bringing in some economic policies that would possibly win them an election, knowing they're going to show up in worse state in the next year and they're going to be eligible for increased equalization funding?

Ms. Susan Peterson: There certainly has been some commentary in the academic literature that suggests one has to be careful with the equalization program, so it doesn't become, on the provincial side of things, the equivalent of the welfare trap for individuals. However, there are certainly pretty strong limitations to that analogy between a welfare trap at the individual level and the provincial level.

One thing, for starters, is that provincial governments are not the sole determinants of what economic activity occurs in their province, and indeed, most are very keen on bolstering economic activity for what it obviously means for their citizens. It's questionable whether equalization has ever been a major determinant or has stood in the way of a wise economic decision within a province.

Mr. Richard Harris: I come from the province of B.C., and given our province's dismal economic performance over the last several years, how on earth can we still be considered a “have” province in respect of the equalization program? Is there a formula that works for everyone else, but not for B.C.?

Ms. Susan Peterson: I assure you that the formula works exactly the same for every province. We measure the capacity of each province to raise revenues: If provinces levied average taxes, how much would they be able to collect on a per capita basis? If a province's capacity to raise revenues falls below the equalization standard, they get equalization, and British Columbia isn't there yet.

Mr. Richard Harris: I'm sure the government is going to want to solve the softwood lumber dispute so that we don't drop below that line.

Thank you very much.

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[Translation]

The Chair: You have 10 minutes, Ms. Picard.

Ms. Pauline Picard (Drummond, BQ): I have no questions, Mr. Chairman.

[English]

The Chair: Mr. McCallum.

Mr. John McCallum (Markham, Lib.): For the benefit of Mr. Harris, I saw somewhere in the clippings, I think today, that British Columbia was getting this far away, almost at the have-not position.

Are you aware of how close British Columbia is to receiving equalization? I think it's pretty close, at least from what the media reports say.

Ms. Susan Peterson: Yes, there were documents released under access to information today.

Do you know exactly how close British Columbia is to...?

Mr. Sean Keenan (Senior Program Analyst, Federal-Provincial Relations Division, Department of Finance): B.C. has started from a point that's very high if we measure on a per capita basis. So they have been about $1,000 away per person, which is substantially higher.

Over the years, through the period of the 1990s, as the economies of other provinces have improved, British Columbia's has not done as well. They're getting close to less than $100 away per person, so it's getting down there.

Mr. Richard Harris: We have two weeks' cash left in our province.

The Chair: We have a little graph that we'll probably distribute to the members.

Go ahead, Mr. McCallum.

Mr. John McCallum: Okay, that was just in response, but I have one question. It doesn't specifically have to do with the bill and I'm not sure if you'll want to answer it, but one of the things that Brian Tobin used to impress on me in my former job, when he had his former job, was—and a number of people have talked about this—the tax-back rate when a province gets additional revenues, let's say from oil in Newfoundland or from gas in Nova Scotia. For every extra dollar of revenue they get, they lose 90-some cents, I believe, in their equalization payments. It's kind of the equivalent of a 90% marginal tax rate for an individual, and one could argue that this would blunt entrepreneurial activity by provincial governments because they get so little return for any additional activity they generate.

Naturally, any province receiving equalization would like this tax-back to be removed, but that's just another way of increasing the cost of equalization, potentially. But might one not change the structure so that the total cost might not change too much, but you would somehow get rid of this 90% tax-back rate, which arguably is a disincentive?

Ireland has received a lot of money in Europe. I don't think they have that same tax-back provision in Europe. Might we have something to learn from the European system? They also give a lot less money than we do, in total, but they don't seem to have that negative 90%-plus tax-back rate.

Ms. Susan Peterson: There are two levels on which I'd like to comment on your question. The first is that as economic activity increases in a province and thereby government revenues increase, there's obviously a smaller gap between what the government can collect itself and what the equalization standard is. But increased economic activity does not just benefit the provincial treasury; it obviously benefits the people in the province in many different ways, through jobs, through family income, and what have you.

So to say it's an incentive or disincentive, you cannot look just at the effect on the provincial treasury; you have to look at the effect on the citizens of the province as well, which is related to my response to your question. That's one level of answer.

Of course, cost is relevant, and the program has been growing at a healthy pace, but quite apart from that, I think the core issue here is fairness. The equalization program is designed in a fishbowl with all provinces watching. But if you yourself can raise revenues up to a certain level per capita and you set a standard indicating that every province in Canada should have a certain wherewithal of a certain amount, then when you get everyone up to that level, what is the justification for saying that if you happen to have resources from royalties in contrast to resources from anything else, we're going to let you keep equalization so that it takes you above that level? There's a real equity question here in that.

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In fact, the so-called tax back rate in the normal functioning of the program is not 90%, it's 100%.

Mr. John McCallum: That just reinforces my point then.

Ms. Susan Peterson: No. The point is, if British Columbia, for example, were at a level where by collecting its own revenues it was just at the equalization standard, then what would British Columbia—or any other province who wasn't getting one cent in equalization but was just at that standard—think if the federal government gave money to another province and brought them above that standard, but wouldn't give any money to British Columbia? It's that deep equity issue that's at play here.

The disincentive issue, I would argue, is offset by the fact that it's not just provincial treasuries and the effect on provincial treasuries that determines whether there's an incentive to increased economic activity. It is the much wider equation of what economic activity means for the people in the province.

Mr. John McCallum: Right, but from a government point of view...and I'm not talking about economic activity generated by the private sector. If you're a government and you realize that if you made such and such an investment, for example, in oil, and for every dollar you get in revenue a dollar is taken back by Ottawa, you might just say “Why bother?”

I understand your equity argument, but there's something to be said for stability over, say, a five-year period so that you can plan better and not have this disincentive effect.

I just wonder if you've looked at the European formulas. I think Ireland probably doesn't deserve anything now because it's caught up so much. It's richer than the United Kingdom, but I believe—and you're the experts—they had a certain stability in their funding for some number of years. Even though they did very well, they didn't have it immediately clawed back.

Ms. Susan Peterson: I do not know how the Irish program works vis-à-vis the money they're getting from the European Union.

Does anyone here know?

Frank.

Mr. Frank Vermaeten (Chief, Policy Development and Research, Federal-Provincial Relations Division, Department of Finance): I don't know exactly how that program works, but certainly we have looked at models like that. We look at everything and all different kinds of possibilities.

The provinces have told us repeatedly that they support a system that measures the true fiscal capacity of the province, and then they get topped up to the standard. So certainly, as far as the mechanics, we've looked at that. When our technical group looks at that, there seems to be very little problem with incentives. Provinces are doing everything to try to encourage employment and investment. As technicians and bureaucrats, we don't see it as an impediment to development at all.

Mr. John McCallum: Thank you.

Ms. Susan Peterson: Could I just add one thing? I wouldn't like to leave the wrong impression. I made the point that the normal tax-back is 100%. There are exceptions to deal with very special situations where it's hard to measure what an average tax rate across the country is. Because a particular tax basis is largely located in one province, its tax rate then becomes the average by way of definition.

In order to deal with situations like that, which includes offshore oil and gas, potash in Saskatchewan, and asbestos in Quebec, there are special provisions that have been developed so that the tax-back is not 100%. So now, on offshore oil and gas, both Nova Scotia and Newfoundland have both offshore accords and something that we call the “generic solution” to mitigate the 100% tax-back.

The Chair: Thank you.

Mr. Pillitteri.

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Mr. Gary Pillitteri (Niagara Falls, Lib.): Thank you.

I would like to just follow up on the same line of questioning. Have we taken away the potential of a province in generating taxes rather than just considering how has it evolved, and looking back on how that province has done? How about looking at the potential wealth of a province, whether it be in natural resources or so on, something out being developed. Is there any way that the transfer penalizes those provinces?

Ms. Susan Peterson: Let me come at the answer this way, and then tell we whether I've hit the nail on the head or not. The equalization program is interesting in that it doesn't measure what taxes any particular province actually chooses to levy, because obviously each province can choose to have higher or lower personal income taxes, higher or lower property taxes, higher or lower corporate taxes, and what have you.

What the equalization program measures is the capacity of a province to raise revenues. It does it by asking if a province were to levy average tax rates on all those tax basis, how much could it raise. If a province has what we call low tax effort—in other words, if it has made a choice for whatever reasons to have lower taxes than average—then the equalization program does not come in and compensate by giving it money, and thereby encourage a low tax effort.

On the other side of the equation, if a province that receives equalization decides that it wants higher taxes than average because that's its choice, we do not decrease equalization for that, and thereby penalize it for having chosen to have higher tax rates.

So it's very carefully designed to be neutral with respect to the actual taxation decisions that any individual province takes.

Mr. Gary Pillitteri: Let me put it a different way, then. As we can see in the chart, in the previous agreement the oil and gas revenues were coming on for Nova Scotia and also for Newfoundland. Of course, it was lowering the payments to Newfoundland—for the year 2001, I believe—and as you know there was a change in the last accord.

Now, if, instead of having chosen not to develop Voisey's Bay, the government had chosen to develop that wealth in the ground, it could have made a difference in equalization payments. Had they developed Voisey's Bay, it would have meant much more revenue coming into Newfoundland. Will that make any difference in a transfer payment? That's what I'm getting at. The potential is there for that development, and the potential is there for that government to receive much more money. Does that government get penalized for not developing that potential of wealth?

Mr. Frank Vermaeten: I think the answer is no, in that, in order for the program to remain objective and very concrete, we just measure the actual economic activity—the amount of oil taken out of the ground and sold. While theoretically it would be possible to say, “Look, this is how much you could have made”, and then adjust the equalization for that, really that would be an endless set of arguments: “If you had done this in 1957, this is what would have happened.”

In each and every year, we'd have to do all kinds of speculative estimates, not just with Voisey's Bay but with anything they had tried to encourage employment in this way, whatever province you're talking about.

So in the end, we don't do anything like that. All we're doing is measuring the actual economic activity—total sales for measuring sale tax capacity, actual income for income tax, and the actual resources that are taken out of the ground. That's how we measure their capacity. So whether a province ultimately has made wise or unwise decisions, we don't make any judgment of that.

Mr. Gary Pillitteri: In other words, it's not that we promote mediocrities, but in a sense we condone it, if some governments choose not to fully explore the potential of the province.

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Ms. Susan Peterson: I'm going to give you a non-technical answer to that question. The equalization program is meant, in a sense, to be a reflection of a mature federation. It is designed so the program is neutral as to what choices provinces make with respect to the tax rates they decide to have.

Similarly, it's neutral with respect to what provinces decide—in your example, to develop or not to develop—because it's not meant to pass judgment on provincial decisions. Obviously those decisions are judged by the provincial electorate, not by the federal government through the equalization program.

Mr. Gary Pillitteri: Thank you.

On this last amount, was it close to $1 billion that was distributed because of this legislation going through? What is the package of the last five years? Was it $10 billion? What is the next package to be put on the table for equalization payments?

Mr. Frank Vermaeten: The official estimates for 2001-02 are at $10.585 billion, as preliminary estimates. In the equalization process, we start out with an estimate in the spring, the beginning of the fiscal year. We go on and continue to refine these estimates until 30 months after the close of a fiscal year.

The amount the provinces will actually receive for 2001-02 isn't going to be finalized until the fall of 2004. The $10.585 billion is a very preliminary number and is going to change quite a few more times before it's finalized in the fall of 2004.

Mr. Gary Pillitteri: Thank you.

Thank you, Mr. Chair.

The Chair: Ms. Bennett.

Ms. Carolyn Bennett (St. Paul's, Lib.): Could you help me with the territorial formula of financing with an overview in terms of whether that is solely per capita?

Then I have a second question.

Mr. Frank Vermaeten: The territorial formula of financing is not per capita. It's a program where, for each of the three territories, we measure their spending needs. Then, similar to equalization, we measure their ability to raise revenues on their own and we fill the gap. The amount the three territories receive differs considerably and is different from what the provinces receive. This reflects the special needs of the north, the higher costs, and the challenges they have up there.

Ms. Carolyn Bennett: When you're up there, they are obviously very concerned that they still need airports and roads, regardless of how many people live at the other end. You're saying the territorial formula of financing is supposed to understand that. Is that correct?

Mr. Frank Vermaeten: Absolutely. It's supposed to. There is, of course, no magical way to know how much you should give them for an airport or something, but there's a way where we measure the overall needs. It reflects the fact that, yes, they lose economies of scale by having a small population base. They have higher transportation costs and higher needs for various programs. There's an overall measure and it does reflect those needs.

Ms. Carolyn Bennett: Therefore, are there any provinces that feel because of parts of their remote communities they also require that kind of understanding? Are all of the provinces pretty happy with the per capita system when it comes to their major expenses, health care, education, and those kinds of things? Is the equalization system totally acceptable to all provinces, or do some have some special needs that may not be met because of their remote nature?

Ms. Susan Peterson: Let me be clear about one thing. The amount each province gets from the equalization program is not equal per capita. It varies a lot and it varies so as to raise all provinces. When you combine equalization with their own revenues, it brings them up to a common standard. All the equalization provinces end up with equal per capita revenues when you combine equalization with all their other revenues.

So it's not equalization itself that's equal per capita. Do you understand what I'm saying?

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Ms. Carolyn Bennett: Yes, okay.

Ms. Susan Peterson: What you're asking is, do provinces accept that this is a fair way of running the equalization program, given that some of them may have remote communities and what have you?

Again, from time to time when we've sat down there with the provinces at the time of renewing the equalization legislation, we've looked at this issue. The odd thing is, one, it's very hard to objectively measure differing needs; and two, each province has its own differing need. One may have remote communities, the other may have more low-income families, and the other may have more elderly people who require more health care.

When Ontario is part of these discussions, it often makes the observation that one shouldn't assume that it's the less well-off provinces that have greater need. The fact of the matter is, in Ontario, for instance, providing a lot of services is much more costly because of the higher wages that have to be paid on a lot of public services. The great bulk of it is the wages you pay to the people who deliver the services. We call all that territory of investigation “expenditure need”.

Suffice it to say that after looking into it on more than one occasion, people kind of collapse at the complexity of it. In the final analysis, there is no objective way of measuring this. As well, if you think the equalization program is complex now, just see what it might look like if you got into that range of territory.

So in that sense, I think everyone realizes that theoretically it sounds attractive, but practically, no one wants to go there. I think that's a fair sum-up.

Ms. Carolyn Bennett: That's the same for how many potential taxpayers you have, whether that's seniors or a province that maybe now is looking at having 50% of its population under 20 years of age and not paying any tax. So all that is sort of rolled into an average.

Ms. Susan Peterson: It is rolled into an average, because when you think about it, equal per capita is a crude way of measuring your needs. It says you have 100 people, so we're going to give you a certain amount per person; you have 200 people, so we're going to give you twice as much. So how many people you have is the proxy for need.

The Chair: As a question in reference to what I believe you said earlier in your opening remarks, that equalization has grown by 33% since 1993, what has brought on this growth? That's quite a bit. I know CHST was kind of being lowered, but to me the figure of 33% is pretty high. I don't know what has grown 33% since 1993.

Ms. Susan Peterson: There is no other program that has grown 33% since 1993. The program depends on the overall growth in the economies of the provinces, plus it really can take off if some provinces grow much faster than others, and in particular if Ontario, just given the sheer size of its population, is growing much faster than others. The recent spurt in the growth in equalization has been due to the exceptionally strong growth in Ontario. But there's normal growth that takes place. It tends to grow with the growth in the economy but then can have spurts.

The Chair: So that means that throughout this process, you always have money being transferred from the have provinces to the have-not provinces, whether their conditions are improving or not. Is that not right, more or less? Would you say that's true since 1993?

Ms. Susan Peterson: Sean, go ahead.

Mr. Sean Keenan: The equalization standard is a moving standard. In one year it might be $5,000 per person, but because it's a representative standard and because it's representative of the economic activity in the five middle rich provinces, when those provinces get richer or their economies improve, the standard increases. So as the economy improves, that will drive up the level to which all provinces are equalized.

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There was also a phenomenon in the 1990s that provincial governments, like the federal government, were getting to a position where they were balancing their budgets. Their revenues were increasing, and so they were taking the revenue increase; they were relying on revenue increases to balance their budgets, whereas in the early 1980s they were running large deficits. You were at a point where revenue growth was significant. That also drives up the cost of the program, because it's representative of the average tax rate across all the provinces.

So if their tax rate is increasing, then the size of the program will increase.

The Chair: I find that figure quite high. You said the top five provinces, right?

Mr. Sean Keenan: The middle five.

The Chair: Was that just to get a median? Why won't you use the 10 provinces?

Ms. Susan Peterson: To explain, the best analogy is when they're judging skaters in a skating competition. The judges are scoring them, and they ignore the top and the bottom and take the middle. It's the same kind of thing.

Alberta is excluded from the standard because Alberta is an outlier from time to time in that its revenues per capita are considerably higher than any other province and very volatile. The history of the capacity of Alberta has been that it has zoomed way up and then crashed, and what have you.

So Alberta is excluded from the standard both because of the volatility of its revenues and the fact that sometimes they are so much higher than those of anyone else. You exclude Alberta for those reasons. One, you want some stability in the equalization payments, and don't want them jumping all over the place. Two, it has to be affordable to all the taxpayers of Canada.

Having excluded Alberta from the standard for that reason, then the quid pro quo, in a sense, was to exclude the four Atlantic provinces at the other end of the scale to balance that, and you're left with the five provinces in the middle.

The Chair: Thank you.

Ms. Guarnieri.

Ms. Albina Guarnieri (Mississauga East, Lib.): We've just heard that the federal government contributes close to $11 billion in equalization payments to the provinces. Presumably these funds are spent on health care, education, and other programs, which are also funded by the Canada health and social transfer. However, it has become part of the course that the receiving governments always exclude these equalization funds from their calculation of the federal contribution, let's say to health care.

So I ask you, how would you view a change in policy such that equalization payments would be required to be reinvested, let's say in health care, which is the national priority?

Ms. Susan Peterson: I'll answer that question from the point of view of the goals and objectives and the philosophy behind the program.

The objective is to ensure that each province has reasonably comparable revenues at its disposal to provide public services. It's not intended as a means for the federal government to direct a province as to where it should spend those revenues. So whether the three provinces who can collect those revenues on their own or the others who are less well off need equalization to get them to that level, the federal government doesn't tell the other provinces what to do with that amount of money, and it doesn't tell those who need it to get to that level what to do with that amount of money either.

Ms. Albina Guarnieri: I understand that certainly provincial governments wouldn't find it appealing to necessarily properly reflect the federal government contribution to provincial health care budgets, for instance, but wouldn't you agree that Canadians would like to know where their tax dollars are going? Wouldn't it create more harmony amongst provinces?

For instance, you have situations where companies are lured from richer provinces to poorer provinces. A taxpayer may certainly undergo a little bit of resentment to see his or her tax dollars going towards contributing to his or her unemployment. Wouldn't this be a more equitable way if the taxpayers could actually see where their money is going rather than just simply allowing for provincial pet projects?

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Ms. Susan Peterson: Once again, it is true Canada has the most mature federation in the world. Provinces have at their disposal virtually the same tax base as the federal government and can decide how much tax to raise from the tax base. That's not true of most federations. The money the federal government transfers directly to the provinces is not earmarked. Canada is pretty mature among federations in that respect as well.

On whether Canadian taxpayers would be better off if there was more accountability for what happens with the transferred money, I would say the same thing I said before. The money is transferred to provinces and provinces are accountable to their citizens, as opposed to the federal government, for how they use it.

Ms. Albina Guarnieri: I guess my point is simply either the money is spent on health care or it's not. If it is, it should be earmarked as such. That's the point I would make. I think Canadians would find comfort if the money was being spent on what I think is the national priority right now.

Ms. Susan Peterson: I think one of the interesting new developments in the agreement reached last September among first ministers was provinces agreed they were going to have more public reporting and accountability to their own public for what they spend on health care, early childhood development; indeed not just what they spend, but what good it does.

Certainly both the Department of Human Resources Development, with respect to the early childhood side of things, and the Department of Health, with respect to the health side, are working with the province to come up with a common set of indicators or measurements. In making this information available to the public, it would be done in a way where the public cannot say that's what's happening in their province, but compare it to what's happening in other provinces.

First ministers agreed to that form of accountability. I think there's great potential for the public to know a heck of a lot more about what happens to their tax dollars and how they're being spent.

Ms. Albina Guarnieri: Thank you very much.

The Chair: Thank you, Ms. Guarnieri.

I have a question in reference to your opening remarks again. You said the program is also renewed legislatively every five years, most recently in 1999. Work is already under way on the 2004 renewal. Can you expand on that? What type of work and what issues are you looking at?

Ms. Susan Peterson: Mr. Vermaeten is deeply involved in that.

Mr. Frank Vermaeten: We have a technical group called the transfer subcommittee. It looks at all transfers, but most of the technical work is done on equalization. Really we look at everything to do with equalization.

At the most technical level, we look at how to measure a province's fiscal capacity. That's a very difficult process. We have provincial members as well as a federal team to look at that. When we're trying to measure capacity, we're trying to reflect what provinces are doing. As tax systems evolve, so does the equalization program.

For example, when some provinces moved to a value added tax, we had to take the equalization system and ask how we were going to measure fiscal capacity to reflect the fact that taxing practices have changed towards a value added tax, provinces are developing gaming revenues, or there are user fees.

In all those cases, it creates technical challenges where we have to say this is the best way to measure fiscal capacity.

We meet every few months and we write papers. Provinces write papers and federal officials write papers. We say “This is the way we do it”. We discuss it and try to come up with the best technical approach. We also look at things like tax-back. We discuss those openly, the equalization ceiling and all those aspects including the standards.

It's really an ongoing forum where we meet every three to six months. It's going to go on until 2003-04, and we'll introduce the legislation probably in the fall of 2003 for the next five-year period.

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The Chair: Ultimately, I guess the resources that governments have must be invested in the best possible way that generates economic growth, for those who believe in a pro-growth agenda. When you look at the $10.8 billion—and I'm just quoting from the remarks you made—is equalization the best way to generate the type of economic growth we're talking about? Are other options being considered?

I'm talking as a nation here. You have $10.8 billion. Some money is going to Quebec, a little to New Brunswick, and what have you. From a public policy forum and debate point of view, what other options are people talking about? What's the latest thinking on equalization? Or is this ingrained in our system and always going to be there?

Mr. Frank Vermaeten: In the Constitution it says that the federal government has a requirement to provide equalization to ensure that all provinces can provide comparable services at comparable tax rates. So in that respect I think it will be there for quite some time.

I'd like to make one more point, and then I'll pass it over to Susan. As Susan mentioned, the program is primarily about equity, to ensure that Canadians everywhere have access to services. It's not an economic development tool. It's not a targeted tool to try to encourage employment or whatever. It's there to—

The Chair: Let me ask you a question. I want to piggyback on what Ms. Guarnieri said. She was advocating for greater accountability. You said that equalization is basically to provide comparable services across the provinces and territories. But if we don't have clear accountability for the money, how do you know that it is being used to provide those services? Formerly, it was established programs financing, and I remember people telling me stories about roads in Ontario being paved with education money, that kind of thing. How do we make sure that doesn't happen?

Ms. Susan Peterson: If we say that equalization payments are to ensure that provinces can provide services of reasonably comparable quality, that doesn't exclude services that are designed to promote economic development or anything else. That is meant to be a pretty global term. There are transportation services, and so there are roads. That's a service. It's really meant, I would say, to build up the base to a certain level so that all provinces can do reasonably equal things. Whether that money goes to promote economic development or to provide basic social services is really at the call of the province.

In the end, of course, money is fungible. That money flows into the provincial coffers, and equalization makes up varying degrees of total provincial revenues. The highest is Newfoundland. About how much of provincial revenues does it provide?

My point is that it flows into the coffers, and then the province is accountable to its citizens for how it spends all of its revenues. You can't say that dollar is an equalization dollar and that dollar is what they raised themselves through personal income taxes. They're judged for their overall priorities, including what they do to encourage economic development. But this is just making sure that their wherewithal in total reaches a certain level.

Federal transfers to Newfoundland in total, which includes CHST, make up about 42% of Newfoundland's revenues. Federal transfers to other provinces vary downward from that. It's much higher for the territories, of course. It's 90-odd percent for Nunavut.

The Chair: Mr. McCallum.

Mr. John McCallum: I just wanted to follow up because I didn't understand your answer to my colleague's question about Voisey's Bay. I don't think there's anything hypothetical in it in terms of guessing what a province might have done. The question is, does the existence of equalization affect the incentive for a province to undertake a project such as Voisey's Bay?

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My answer is that definitely it is a disincentive, compared with if there were no equalization. When a province is considering whether or not to do a project such as Voisey's Bay, it looks at the jobs created, the revenues coming in, the environmental impact, all sorts of things.

The only difference between having the equalization and not having it is that if you have it, any additional revenues you get are taken away by Ottawa with this 100% tax-back rate. You may still do it because of the jobs and other things. But if you're on the margin, there's absolutely no doubt, it seems to me, that the existence of equalization is a disincentive to undertake such projects, other things being equal.

That's not to say it's bad. I'm in favour of equalization. One can debate how important that disincentive effect is, but I don't see how one can deny that it exists.

Ms. Susan Peterson: I think you can look to other provinces and ask “Has New Brunswick discouraged the setting up of call centres in New Brunswick because their equalization goes down not 70¢ on the dollar but 100¢ on the dollar?” The answer to that is no. New Brunswick is delighted with the economic opportunity that offers. It is pursuing those sorts of things and would be, I take it, happy if they had more of them.

Similarly, when Saskatchewan had potash coming on stream, it was very keen to have everything that implied for incomes in the provinces, and it didn't say, “Gee, that's going to reduce our equalization”.

Mr. John McCallum: What you said is correct, and what I said is correct. There's no doubt that if a project is on the margin, the fact that you will get zero revenue because of the clawback is a negative when you're deciding whether or not to do it. It may be an important negative or an unimportant negative. We can debate that. Clearly in the case of call centres, that negative is outweighed by other things, such as the desire for employment. But there's no doubt that it is a negative.

Ms. Susan Peterson: If you mean that, all things taken into consideration, if the equalization program worked in a way that you increased your own government revenues and gap to keep your federal government revenues, of course that would be the best of all possible worlds, but it would be grossly unfair. So the program within limits allows, as I said, in particular situations for the province to keep some of its equalization revenues even though they end up at a higher standard than other provinces. But provincial fairness is such an important consideration to the sustainability and acceptability of the program, that kind of trumps in the end.

Mr. John McCallum: I'm not denying that. I just want to establish the point that, other things being equal, it is a disincentive. And you haven't denied that point. It might be that the equity thing is far more important so we will live with that disincentive. I'd accept that. But you seemed to be denying earlier that there was any disincentive. That is false, I would contend. That's my only point. I'm not saying that therefore it should be changed. I just want to register the point that disincentive is clearly there.

Ms. Susan Peterson: Certainly, the reduction that occurs in equalization as a province's revenues increase is taken into consideration by provinces.

Mr. John McCallum: Okay. I think—

The Chair: I would think the ultimate goal of any provincial leader would be to have the province become a have province rather than a have-not province.

Mr. John McCallum: One last thing, and then I'll be quiet. I do agree with your point that the federal government should not demand of the provinces receiving equalization payments any accountability for how they spend the money. I think this program is designed to equalize capacity to deliver programs, and it doesn't give the federal government a licence to boss around the poorer provinces more than the richer ones. I think the accountability lies with the provincial electorate.

Ms. Susan Peterson: Yes.

The Chair: I want to make this clear here. Let's say we were to raise equalization payments to the Province of Newfoundland. Are you saying that they would probably go ahead with more exploration?

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Mr. John McCallum: I'm saying that at the margin—and I don't know how important this effect will be, and there would be equity concerns—if you refrained from taxing back at 100% Newfoundland's additional revenue from exploration or if you taxed it back at a rate of 50% instead of 100%, then that would encourage Newfoundland to do more exploration than it's doing under the current system.

The Chair: Yes. And we have the same challenge when we're reforming employment insurance, where you had benefits higher than the average industrial wage, so some people who were receiving benefits had to calculate whether it was better not to work or to actually go out and work. It's the same kind of thing.

Mr. Frank Vermaeten: Perhaps the one thing that might be a little different in this case is that in the vast majority of cases it's the private sector that's undertaking the exploration. Their decision to explore or not to explore is determined by private-sector prices, not by whether the province might end up with more or less in equalization payments. So when we look at whether equalization is a disincentive for development, we'd say in the vast majority of cases that economic activity and those decisions to explore, to open up a call centre, or to do whatever are made by the private sector. Certainly there are cases where government does have some influence, but those tend to be the exception rather than the rule.

Mr. John McCallum: But they tend to be the important exceptions. The megaprojects like Voisey's Bay and Sable Island Gas clearly require government approval and involvement to go ahead.

The Chair: You could make that argument.

Thank you, Mr. McCallum.

Mr. Pillitteri.

Mr. Gary Pillitteri: Thank you very much.

I'd like to go at this again in a little different way, maybe having sat too long at this finance committee table. This is perhaps the third round with this new agreement, the others being in 1994 and 1999, and here we are again at the next stage.

You're saying that in negotiations you have representation from the federal government, provincial governments, and so on. I feel that sometimes it's what part of the country you come from that gives you a tendency to ask “Is this fair or is it not fair?” I do believe in equalization payments, and I do support the concept. But we had a situation—actually until the last time—where equalization was handed over under transfer payments using the equalization formula, which we have changed now. That also gave an incentive to those provinces not to develop as they should have because they actually received a lot more per capita than they do now in the transfer payments.

Let me go at it this way. Has there been any time in the negotiations where anyone has brought forward...? Because what you do now is accounting, strictly accounting. It takes away the initiative. Imagine an entrepreneur like me in the marketplace saying, “Wait a minute, if I'm not going to make money at this, I might as well not develop it”. I'm going to scuttle it.

What I'm getting at is this: Is there any way within these negotiations, on either the federal or the provincial side, to take into account the potential of a province and its natural wealth to be fully developed? What I'm getting at by this is that whatever might be the case.... Sable Island, yes, the natural gas was sitting there for 20 years, but I don't think that was the reason it was not developed. So Voisey's Bay has been there for so many years, but now it's....

Is there any willingness amongst the provinces and federal government to say, “Okay, let's change the standard a bit, change it so we can see how we could all benefit from this, so we don't pit one against the other, and everybody does his part in exploring the full potential of a province”? Or is it just an accounting exercise that takes place after the fait accompli in two years so you finally come up with the amount of money they're going to get?

Ms. Susan Peterson: It's a huge program—$11 billion is a lot of money—and the way it functions has to stand up to the scrutiny of both the have provinces and the have-not provinces. That's why we spend so much time working on both technical details and theoretical-conceptual details about how the equalization program should function.

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You can't ask one program to do everything. This program is meant to do certain things, to bring provinces up to a certain standard and make sure they have a certain wherewithal to do it. Then they're accountable to their citizens as to how they use that money.

I'm getting the sense that you think there are other criteria against which the program should be judged, and I'm just wondering whether this program, which has to be so—

Mr. Gary Pillitteri: There are many programs and transfers into the provinces. In fact, this is one of three. But being as this is the most fundamental, the criteria of the equalization payments.... They're more fundamental than the other two because, actually, they should be the sources of a nation, the sources of a province, if they're fully developed. That's what I'm getting at.

We understand that somebody has to work and generate the taxes all Canadians benefit from, but this is a primary imperative, to give the provinces the ability to provide the services. That's where most of it is directed, to the first line. I consider equalization to be the first line of support of the Canadian standard of living.

Mr. Frank Vermaeten: I'm not completely sure I understand exactly the kind of program you have in mind. I take it that what you want to do is negotiate with the provinces and everybody to say, “Look, here is how much equalization you will get, even assuming you have developed these resources”. That would provide them an incentive to actually develop those resources. Is that what you're...?

Mr. Gary Pillitteri: That's exactly what I'm saying. Instead of that 100% clawback, have a clawback of 60% or whatever. You'd give an incentive to that province to really produce in order to generate higher revenues. There again, we don't want to promote mediocrity, but if it's a natural resource that is not developed—let's go back to Voisey's Bay again—instead of clawing back that 100%, claw back 60% or 40%. Set a figure such that it would benefit them to develop the resource. That's all I'm saying.

Mr. Frank Vermaeten: I think that in theory it makes a certain amount of sense, but there are difficulties when you get to the practical nuts and bolts of it. For example, you'd have to go to Saskatchewan—I don't know how many wells there are in Saskatchewan, perhaps thousands—and say that if they had a thousand more wells, they might be able to produce this much, so we'll give them this much equalization. Saskatchewan might say that it's not realistic for them to do this.

It's not just about natural resources. Then you would come along and say to New Brunswick that if they had some more call centres, then they would do better. Then we'd have to negotiate for the call centre. Then we'd go to the next province and say that they could do something else. It goes well beyond natural resources.

I think that in the end, on a practical level, it would be very difficult to administer because there are so many sources of economic growth that each province has available to it.

Ms. Carolyn Bennett: We'd be punishing the people. This is about giving people what they need, isn't it?

I think your instinct is right. What I've been trying to say is that in a sense it's a basic no-questions-asked payment to ensure a certain amount of equity across the country. If equalization were a serious disincentive for provinces to do what you obviously consider would be the wise thing to do in terms of economic development, then it would be a serious concern, but—

Mr. Gary Pillitteri: I think you're missing my point. What I'm saying is that some provinces have an unrealized potential to generate tax revenues and that until their potential is fully explored, there should not be a 100% clawback. I'm also saying that if they have fully explored their potential, they could still receive transfer payments so as to give more leeway to the province to fully exploit whatever they are doing, be it call centres or whatever. They should not be penalized with clawbacks on equalization payments. That's what I'm saying. You're missing the point of what I'm saying.

Ms. Susan Peterson: It is the disincentive issue that Mr. McCallum was discussing.

Mr. Gary Pillitteri: And that was my first point.

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Ms. Susan Peterson: Yes. I guess there are two questions. One is, could the program ever be designed to do those other tasks that you think would be desirable? But then, to me, there's just the factual question: Has equalization proven to be a serious disincentive to economic development in the provinces that receive equalization?

We've seen no evidence of that, and when we talk to the officials in those provinces most of them will say their governments do not make decisions that way because their electorates would skin them alive if they effectively stood in the way of economic development in the province, which would give them jobs and what have you, because of the equalization program. So it's partly a factual question.

Mr. Gary Pillitteri: Thank you.

The Chair: Thank you, Mr. Pillitteri.

Mr. Gallaway.

Mr. Roger Gallaway (Sarnia—Lambton, Lib.): We are here to study Bill C-18. It's a very brief bill. At the end of the day it affects both us here and those in the provinces.

You've circulated this, Ms. Peterson, I'm sure, to your counterparts in the provinces?

Ms. Susan Peterson: Yes.

Mr. Roger Gallaway: Were there any objections? Is anyone in any way in disagreement with this bill as printed?

Ms. Susan Peterson: I understand you will hear from the finance ministers of Manitoba and the four Atlantic provinces.

Is that right, Mr. Chairman?

They will not be here as supporters of this bill.

Mr. Sean Keenan: They will support the idea of lifting the ceiling. They do not agree with the ceiling. So they would fundamentally have the view that the equalization program should have an unlimited cost. If it costs $12 billion—

Mr. Roger Gallaway: At this committee, I think two or three years ago, we had a review of it. But is their point that they're in some way in disagreement with the basic operations, philosophy, calculations, or whatever of the legislation, or are they in disagreement with CAP?

Ms. Susan Peterson: They have made it quite clear that they believe that Bill C-18 does not go far enough. Their attitude is “Thanks for as far as it goes, but it does not go far enough”. They believe the Prime Minister's commitment was a more generous one than is reflected in the bill.

Mr. Roger Gallaway: I have one last question. The Prime Minister's commitment was about the infusion of certain moneys for certain programs. Was that not clearly understood, then? I'm talking about quantum now as opposed to—

Ms. Susan Peterson: What the Prime Minister said is that the ceiling on equalization for the year 1999-2000 would be lifted, and that's what this bill does.

Mr. Roger Gallaway: All right.

Ms. Susan Peterson: But they will say there's another way of interpreting the Prime Minister's commitment that would provide them with more than this bill provides them.

Mr. Roger Gallaway: Thank you.

The Chair: I want to go back to the point raised by Mr. Pillitteri and Mr. McCallum in reference to disincentives. This $10.8 billion that you transferred to those provinces, isn't it basically, as you said, to provide the provinces with funding so that they can provide services and what have you, whatever their needs are? I'm not so sure about this disincentive argument that provinces would not grow their own economic potential because of a tax-back provision. Does it make sense that you would say “No, I'm not going to develop this because otherwise I'm not going to be receiving money from the federal government”?

Ideally, people who live in those provinces probably wouldn't want to receive equalization payments, they would probably want to generate their own wealth. In your conversations with your counterparts what's the spirit that exists, for example, in Newfoundland and in other provinces?

Ms. Susan Peterson: It's interesting because provincial finance ministers will usually make the point that of course they would prefer to not be reliant on the equalization program. They'd prefer that they had the economic activity that would bring them up to this standard without the equalization program.

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That being said, part of the argument is “In attracting economic investment and developing economic opportunity and what have you, we would get there quicker if you allowed us to keep our equalization payments to a certain extent as if that increased economic activity hadn't occurred”. Most provinces, when they make that argument, regard it as a transition period—that is, “Between now and when we get to complete self-sufficiency without the equalization program, don't be so hard on us by taxing back 100% on the dollar as we move towards that goal”.

That tends to be the way they put the argument.

The Chair: But how can you be saying that somebody is hard on you when you're receiving $10.8 billion in transfers?

Ms. Susan Peterson: You wanted me to play the other side.

The Chair: No, go ahead with the other side.

Ms. Susan Peterson: I can tell you what the provincial arguments are. The provincial arguments are, at least among those provinces that receive equalization, that the constitutional commitment is fundamental to the nation and therefore the equalization program in fulfilling that commitment should not adopt a five-province standard, but have Alberta in the standard so that the equalization program would be even richer.

They will argue that to their minds there is no justification for not having a ten-province standard, which would be the overall average, and have everyone brought up to the average. And they will argue, quite apart from this, that the ceiling in the existing program is an artificial break on the normal functioning of the program and shouldn't be there.

So they'll argue that for both those reasons the program should be richer than it is in order to meet that constitutional goal. And then there are considerations, of course, on the other side, that underlie the program as it currently operates.

The Chair: I'm thinking about the average taxpayer who gets up in the morning, does his best or her best to earn a living, and would find out that transfers were increased 33% during a period of time where perhaps the person's income hasn't risen that much. In looking at this 33%, the $10.8 billion, which I think is quite a substantial amount of money, I'm wondering when do we as legislators begin to actually review these things.

I find that Canada's political class is very focused on inputs, meaning the amount of money you transfer and the amount of money you give to programs, but I think we ought to shift a little bit and give greater focus on what the outputs of these expenditures are. And maybe equalization is not the place to start. There are many other places to do that.

But it's important that people know equalization payments to these provinces have gone up 33% since 1993—it's extremely important. And it's also important that the provinces that do receive these equalization payments understand that Canadians in other provinces—and I think I go back to Ms. Guarnieri's point—want greater accountability for their tax dollar. I sense that throughout the country people want more accountability.

I guess I'm just making a comment.

Ms. Susan Peterson: There's no doubt that, in a sense, despite the fact that equalization is such a large program, it's one of the most invisible programs, partly because of its nature.

The Chair: Any further questions?

Thank you very much, Ms. Peterson, and everyone on the panel. As always, you give great insight to the finance committee and we're very appreciative of that.

Thank you.