Proceedings of the Standing Senate Committee on
National Finance

Issue 29 - Evidence

OTTAWA, Tuesday, November 20, 2001

The Standing Senate Committee on National Finance met this day at 9:34 a.m. to examine the effectiveness of, and possible improvements to, the present equalization policy in ensuring that provincial governments have sufficient revenues to provide reasonably comparable levels of public service at reasonably comparable levels of taxation.

Senator Lowell Murray (Chairman) in the Chair.

[English]

The Chairman: Honourable senators, this is our eighth public meeting on the question of equalization. Our witness today is Dr. Paul Boothe, Professor of Economics at the University of Alberta. Professor Boothe, before joining the economics department at that university, worked in the international department of the Bank of Canada. He has held visiting positions at Queen's University, the University of Tasmania and the Alberta Treasury. He recently completed a two-year secondment as Deputy Minister of Finance and Secretary of the Treasury Board for the Province of Saskatchewan.

His current research interests include fiscal relations between governments, and government budgeting and performance measurement. Professor Boothe has authored or edited numerous books, articles and monographs including: Tax Collection in Canada: Principles for Design, "Prospects for Reform," "The Growth of Government Spending in Alberta" and "Reforming Fiscal Federalism for Global Competition."

In 1998, he delivered the CD Howe benefactor's lecture, entitled "Finding a Balance, Renewing Canadian Fiscal Federalism." His most recent book is Deficit Reduction in the Far West.

It occurs to me that my relating of his work on these various subjects might serve as an incitement to honourable senators to stray from the matter at hand, which is equalization. I implore you not to do so, but this will be of interest to you as evidence of Professor Boothe's broad education, interests and qualifications.

Professor Boothe has served as an adviser to a number of provincial and federal government departments over many years. He was a founding director of the Institute for Public Economics at the University of Alberta.

You will have received, because he was kind enough to send it in advance, and we circulated it, a copy of the brief statement that he will be making. It has been translated into French, and you have copies.

Without further ado, I welcome Professor Boothe and invite him to make his opening statement.

Dr. Paul Boothe, University of Alberta: Thank you very much, honourable senators, for inviting me to meet with you today to discuss Canada's equalization program. I have been following your deliberations with interest, and I hope that I can contribute to them by bringing to bear a somewhat different perspective, as that of someone who is both an academic and a student of equalization and a former deputy minister of finance. I have been one of the technocrats to which Minister Selinger referred to in his testimony. In my opening statement, I will briefly review some of the arguments that you have heard from witnesses so far and try to tie them into a coherent framework.

Before I do that, I should say something about my own biases. The federal finance minister and all the provincial ministers who have appeared have advocated positions that are beneficial to their respective treasuries. That is completely understandable and consistent with the proper discharge of their duties.

Some of the academic witnesses you have heard are advocates of a more centralized federation with more distribution of income than we currently have. I call this position the "Queen's School of Fiscal Federalism" because that is the home of some of its intellectual leaders.

My view is that we have the balance between federal and provincial governments about right for this moment in our history. Senators, I want to say that I am a strong supporter of Canada's equalization program, but I also believe that we should be open to improving the program, if we can do so in a way that is consistent with the role accorded to equalization in our Constitution.

I would like to organize the arguments you have heard to date under four headings. Of course, other frameworks are possible, but I believe these headings provide a useful way to think about the views that you have heard.

Witnesses have given you their views on the program's adequacy, on its sustainability, on the incentives that are embodied in it, and its transparency and accountability. I would like to deal with each of these in turn.

The first heading is adequacy. You have heard discussions of the ceiling and floor provisions of the program, the five-province standard and the needs-based equalization. All of these issues are raised by recipient provinces because of concerns relating to the adequacy of the program. Now that one ad hoc measure, the ceiling, is constraining the overall growth of the program, some recipient provinces are starting to complain about another ad hoc measure, the floor. I am referring here to the complaints you have heard about Saskatchewan's recent floor payment. When the overall size of the pie is fixed, the size of your neighbour's slice becomes much more important.

The federal minister has argued that the ceiling only restricts the growth of the program in a year when it grows faster than the economy, but this is not the whole story. As it alters the base of equalization, invoking the ceiling may have the effect of permanently reducing the program's overall size.

Recipient provinces would like to see a return to the 10-province standard of the 1970s and early 1980s, since including Alberta in the standard would increase the overall size of the program. Of course, the federal government imposed the five-province standard precisely to slow the growth and reduce the variability of the program when Alberta's energy revenues soared in the 1980s.

Some provinces would like to see so-called needs factors included in the formula. Again, they believe this would increase their transfers. However, whether they would actually benefit from such a change is uncertain. For example, in Australia, population dispersion is associated with increased need, yet population congestion is an indicator of increased need in Germany.

Ultimately, the adequacy of the program must be judged against its ability to fulfil its constitutional mandate to give provinces the capacity to provide reasonably comparable levels of services at reasonably comparable levels of taxation. The federal government can argue that the relative fiscal capacity of the recipient provinces has improved over time, while the provinces can argue that the share of federal revenue devoted to equalization has fallen. Both are correct.

However, in my view, neither side has yet made a convincing argument regarding adequacy. Further work needs to be done to settle this issue.

Senators, the next heading is sustainability. I have already mentioned some of the issues that belong under this heading. Both the ceiling and the five-province standard are ad hoc measures instituted by the federal government to protect its treasury against unbounded growth and unmanageable volatility in the program. However, there is also a provincial counterpart to the sustainability problem. Given its design, one would expect that equalization would reduce the volatility of provincial revenues.

My recent work shows that this is not, in fact, the case, at least not for Saskatchewan. The extra revenue volatility stemming from equalization may well be due to the ad hoc features that have been built into the program over time. In my view, the criteria for judging reforms should include their impact on the sustainability of the program for Ottawa and the impact on the volatility of provincial revenues.

The third heading is incentives. Some policy commentators and academics have identified two kinds of potentially perverse incentives. The first has to do with the incentive for recipient provinces to pursue economic development opportunities less vigorously because of the corresponding loss in equalization revenue. The other perverse incentive is that provinces may set tax rates too high because losses in revenue are offset by equalization. As deputy minister of finance, I learned that policy-makers do not always operate on the same margin as economic theorists.

I have never seen an economic development proposal, no matter how ill-conceived, defeated in Treasury Board or cabinet because of a potential loss in equalization revenue. Likewise, even if governments are compensated by equalization for losses associated with too high tax rates, voters are not. As political leaders know, voters call the shots. Thus, in my experience, the potentially perverse incentives do not pose a problem at the practical policy level.

The next issue under the heading of incentives deals with removing natural resource revenue from the equalization formula. I have always been uncomfortable with the treatment of natural resources in the program because, in reality, such revenue represents the proceeds from the sale of a capital asset rather than ordinary income. However, I am strongly opposed to yet another ad hoc change to the program. I also wonder if policy commentators have considered the practical impact of such a change. If this change were enacted, it would provide a massive windfall to Saskatchewan. With the ceiling in place, this windfall would mean a correspondingly massive reduction in transfers to the other recipient provinces. I wonder if this is the effect for which commentators are really hoping.

The final heading is transparency and accountability. The committee has heard a good deal of discussion regarding whether the program is simple or complex. While it is true that the program is based on a simple idea, the reality is very complex.

In his testimony, Minister Martin joked that when he began as minister, only one person in federal finance understood the program, and that person had retired. Although said in jest, the statement is not far from the truth.

In reality, with all its ad hoc features, the program is so complex that it is almost impossible for provincial finance departments to predict transfers from budget to budget, or to explain the changes to decision-makers or to the public. How can we possibly expect voters to hold elected leaders accountable for what, in some cases, is a substantial portion of their budget if almost no one understands how the final transfer is determined, or can predict it with any accuracy?

In closing, I would like to say a few words about the way forward. One of the strengths of our equalization program is that it is renewed every five years. Currently, federal and provincial officials are in the process of analyzing options for reform. Some of the reforms being considered are significant, including substantially simplifying the program by basing it on a single macro indicator, something I have written about elsewhere.

In my view, the government should resist making any more ad hoc changes until the review is complete. In addition, I believe that the review should be as open as possible and should include interested parties from outside governments. The recommendations that flow from that review should be subject to a thorough debate at the political level to ensure that Canadians get the best possible design for this important program.

Senator Bolduc: I must say that is a clear, concise, and pretty good presentation. Unfortunately, we do not have the solution.

You say that we should resist making any more ad hoc changes until the review is complete. The review, as I understand it, is done through a group of finance ministers and their senior advisers.

You ask for a more open review. How would you see that occuring? Would you add some academics, and maybe some pressure groups, to the process?

Dr. Boothe: Senator, I see this meeting today, and the meetings that you have held, as an important part of that review. This committee and its meetings is an important contribution to having a public discussion about this matter. It is important that the federal and provincial officials continue their work. I am gratified that they are consulting with academics.

As a deputy minister of finance, I instituted a public conference on fiscal federalism. It is my understanding that the Province of Manitoba is organizing a similar conference for the spring of 2002.

This public discussion is well under way, both at the political level and at the official or technical level. The last review that we had was really confined to more narrow, technical issues. Since we are considering big changes to equalization, for example, using a macro indicator, I suggest that we could look at changes that are more fundamental than the narrow, technical changes we made the last time.

We are well underway. The final ingredient, of course, will be a public discussion by finance ministers and governments more broadly about where we want to go with equalization and what should be done before we complete any major changes to the program.

Senator Bolduc: Resisting any ad hoc changes means that you are for leaving Alberta's resources outside of this system, and that you are also not accepting the views of the Maritime provinces of having the natural resources outside. However, you seem to be a bit sympathetic, but you resist any change for the time being.

Would you be kind enough to give us your view of the basic criteria for a review process, ideally speaking? What is your idea for having a framework of equalization? For example, are you favourable to the academic view that we heard here from one professor, I do not recall his name, about the single macro indicator? What do you think about that?

Dr. Boothe: I am favourable to a macro indicator, and I have worked on that in the past. I am resisting changes at this stage because it is most appropriate that we put the alternatives side by side and have a real comparison of them before we make a decision about which way we should go.

I would say that I am not in favour of the proposal by some of the Atlantic provinces to take natural resources out of the formula.

As I said in my remarks, I am not sure that people really understand that the immediate consequence of such a change would be a tremendous redistribution of equalization revenue to Saskatchewan.

The program is complex. You might think that we are about to get natural resources revenue, so maybe it would be beneficial to us to take them out of the formula. The practical implication is that equalization revenues would be reduced to all the recipient provinces, except Saskatchewan, in the short run. I am not in favour of that.

If we were to use a single macro indicator, it would not be necessary to make these decisions about choosing among the various tax bases. That constitutes much of the discussion at the officials level on an ongoing basis. What should be included? How should they be measured? Should it be 100 per cent or 50 per cent? It is going on all the time, senator.

Senator Bolduc: In your third paragraph, you say that:

The federal finance minister and all the provincial ministers who have appeared before you have advocated positions that are beneficial to their respective treasuries.

I can understand that coming from politicians, but then you add:

That is completely understandable and consistent with the proper discharge of their responsibilities.

I have difficulty with that because it seems to me that they must have been advised by their senior officials, who are not politicians. Those officials would not only give the good case for their minister but also the bad case. They would represent both sides of the picture. You would know that, since you have been a deputy minister.

I am a bit puzzled at that because those senior officials at the federal government level, at least, should give a more balanced perspective for the whole country. Normally, their perspective should be a perspective of common good for the whole country. You seem to imply that they have advised the minister of the best case for the federal government.

Dr. Boothe: I certainly did not want to imply that deputy ministers did not give balanced advice to their ministers. I am noting that it is the ministers' responsibility to advocate or to protect their respective treasuries. In reading the evidence I have read, those are the arguments as I understood them.

Senator Banks: I would like to hear your comments focused on the question to which Senator Bolduc referred, and to which you also referred obliquely. That is, would you comment further on the position we have heard from the Atlantic provinces with respect to a reduction of their natural resource revenues, in their view. We hear from them that, in effect, the federal government is getting by far the lion's share of those natural resource revenues, and the provincial governments are getting very little of them.

In fact, I think that the provinces get all of the resource revenues, but then it is clawed back because it has an impact on their equalization payments. Their argument, of course, is that if the federal government would refrain from clawing that money back, it would allow the provinces to more quickly become debt free, more developed and better able to be a contributor, rather than a recipient of equalization payments.

Have you addressed that question? That is to say, if, in the end, by whatever means, ad hoc or otherwise, the effect of resource revenues upon the equalization payments of the Atlantic provinces, in particular, would allow them to become self-sufficient more quickly and efficiently?

Dr. Boothe: First, I would say that I believe - and I have only read the testimony of Minister Mella from PEI - that two Atlantic provinces would be advocating in that direction, Nova Scotia and Newfoundland, and two would not. Certainly, PEI would not. Minister Mella was clear on that. I would expect that to be the position of New Brunswick as well, although I am not sure.

Senator Banks: I am asking the question under the assumption that they might sign an accord one day, too.

Dr. Boothe: Perhaps. Just as a caveat, there are really two issues here: One is the treatment of off-shore resources, and the other is the so-called tax-back of this revenue. I will just deal with the tax-back issue, because that is the real equalization issue.

It comes down to determining the goal of the program. We teach our economics students that you must have the same number of targets and instruments. The way in which I teach that is that you must have one arrow for every bull's eye at which you are aiming. It is always a mistake to try to use a program to accomplish a number of diverse objectives because you end up not accomplishing any of them very well.

What is the goal of equalization? It is not regional development. It is so that the provinces can provide comparable levels of service at comparable levels of taxation. If you want to have separate economic development measures in Atlantic Canada, then there is nothing stopping the federal government from doing that separately. However, why would we distort the equalization program in order to do that?

If you take out resources for Nova Scotia and Newfoundland, should you take it out for Saskatchewan? Saskatchewan is a recipient province, and it gets a lot of natural resource revenue. Saskatchewan could make the argument that it could use some economic development help from the federal government equally well.

If we are talking about oil and gas, are there other non-renewable resources - mining, for example - to which we should extend that policy? The mining industry is pretty important in Manitoba and Quebec, as well as in other provinces.

My view is that if the federal government wants to target financial resources to economic development in Nova Scotia and Newfoundland, they should do so. However, they should not distort the equalization program and move it away from its original aim as laid out in the Constitution.

Senator Banks: We already have the general economic development programs, however effective they might be. That distinction is clear in your mind, and we should not mix the two?

Dr. Boothe: That is true. If people are worried about the incentives that come from the tax-back - that is, as provincial revenues grow, equalization transfers are reduced - I would say two things: First, that is the way the program is supposed to work. Second, other formulations, for example a macro formula, might mitigate that, but it will never be eliminated completely because you cannot have your cake and eat it, too.

The Chairman: Professor Boothe, you say you have always been uncomfortable with the treatment of natural resources in the program because, in reality, such revenue represents the proceeds from the sale of a capital asset.

You seem to be saying that, in principle, you agree that they should be removed from the equalization formula, but that you are concerned about the windfall impact of doing so. You are concerned that we could not find a formula that would be equitable?

Dr. Boothe: I would put it somewhat differently. I am concerned about the way those revenues are measured, rather than that there should be nothing related to natural resources in the formula. I would add that if we are doing a fundamental review, a macro formula moves you away from having to deal with those kinds of measurement issues.

It is not so much that I think that any particular revenue base should be excluded; I have a concern about how natural resources are measured. In any case, I am against making an ad hoc change at this stage when we should be considering this in a broader context.

The Chairman: You are stating a principle here, I think, with regard to revenues that represent the proceeds from the sale of a capital asset. You are making a distinction between those revenues and others. You remain uncomfortable with the treatment of non-renewable natural resources.

Dr. Boothe: That is right. I remain uncomfortable with the way in which they are measured, yes.

The Chairman: I may come back to that. Certainly, someone will want to discuss the question of the macro formula.

Senator Banks: You have a capacity, Mr. Boothe, for putting things in terms that we can understand. We have had a presentation or two on the macro formula. I will speak only for myself. I found it extremely difficult to understand. As difficult as the present formula is, at this moment I understand it better than I do the macro formula.

In the space of the next 30 seconds, would you be able to put into English, so plain that even I could understand, the fundamental difference between a putative macro formula on the one hand and the present 33 measurement on the other hand? Please put the explanation of the differences in the lovely, direct sentences with which are you able to speak.

Dr. Boothe: Senator Banks, very simply, the macro formula would base equalization on a single indicator rather than on the 33 tax bases. Let us pick one I have used in some of my previous work for the C.D. Howe Institute: personal income. Provinces with per capita personal incomes that were, on average, below some standard, say the national average - a ten-province standard - would receive equalization in direct proportion to the difference between their per capita personal income and the national per capita personal income. That is essentially it.

Instead of looking at all of these 33 tax bases, you make equalization payments available to provinces that have below average personal income per capita. The size of their payment would be proportional to how far away they are from the national average.

Senator Banks: If you were able, tomorrow afternoon, to institute that change and that program, would you be comfortable that personal income should be the measurement, and that that does not, in some way, penalize certain provinces?

Dr. Boothe: I am absolutely not comfortable in picking one measure over the other. I have only looked at three measurement factors. Personal income was the best of the three at which I looked.

However, that is exactly the work that federal and provincial officials are undertaking at this time. I expect that if we have a set of criteria that we want to satisfy, officials could put those alternatives in front of us and note that one is better for criteria one and two, another one is better for two or three, and that, overall, a particular alternative is recommended.

It is important to allow the technical work to be done by officials in order to get a fair comparison among these alternatives. You would not compare only different macro formulae; you would also compare the existing program, and perhaps modifications to the existing program.

Senator Bolduc: Would you take personal income statistics for that? If we look at personal income tax, we must remember that some aspects of taxation are calculated twice for some people. An example is dividends.

The consideration of the personal income of people who are owners of a family company is very troublesome. Many people are using their company to reflect a small salary with big expenses. Everyone knows that. Somehow, I have always thought that that is unjust. Many people do not pay taxes at all. You see that in all the small cities in Canada. I feel a bit uncomfortable with that.

I tend to agree with the personal income formula. Calculating a just personal income is a very tough problem. We do accept paying our income tax, but it is not the real world, completely.

I would like your comment on that. Have you been in charge of provincial revenues?

Dr. Boothe: Yes, I was in charge of that. However, we rely on the federal government to collect our income tax. We collect the sales tax in Saskatchewan. However, the personal income to which I referred was before tax, not after tax.

Senator Bolduc, you make an important point. There is no perfect measure. I am sure that you would feel equally uncomfortable if you saw how the gambling tax base or property tax is measured in the current formula. These are issues with which officials struggle and debate back and forth.

There is no perfect solution. You must balance them against one another and determine which would do the best job. It is essentially, in my view, a practical question.

Senator Bolduc: You would start from national income statistics?

Dr. Boothe: Yes.

Senator Bolduc: That is probably the best measurement that we could have.

[Translation]

Senator Ferretti Barth: You are right in your statement: "I believe that the review should be as open as possible and should involve interested parties from outside of government." What are those interested parties from outside of government that you are referring to?

[English]

Dr. Boothe: Senator Ferretti Barth, first and foremost I am referring to the reasonably large group of academics that are interested in this issue. Canada, of course, is recognized around the world for its equalization program, and the debate and effort that we put into keeping it current.

You have already heard my comments from my study of the transcripts from public sector unions. When I say that this discussion should be as open as possible, it is not so much that I expect you will have a flood of groups coming to give their views on this or any other aspect of equalization.

However, it is very important that Canadians become better educated about equalization. It is one of our most important federal-provincial programs. It has been referred to as the glue that binds the federation. I think that is, at least in part, true. As part of this process, I would hope that Canadians in general would become more aware and more knowledgeable about the program. It is tough to interest people in financial matters, in general. It is particularly tough to interest them in equalization, because it is a very complex program right now.

[Translation]

Senator Ferretti Barth: When I started studying equalization, it was really a matter of mathematical calculation: two and two is four. I can no longer find this in the concept of equalization. I asked the question and they told me: Senator Ferretti Barth, when the equalization program was developed, only one person could understand it in the Department of Finance. After that person left, no one could understand it anymore.

Could someone explain for me how the program works and why we want to change it? When we talk about changes, we often refer to the macro-indicator formula and the floor and ceiling provisions. How can we design a simple and clear formula that everyone will be able to understand?

You talked about getting citizens interested. Before they can have an interest in the matter, they have to be prepared, informed, and made aware of what is going to be discussed, otherwise there will be chaos again. This is how I react to your answer.

If the Chairman allows me, I would have another question. I read in one of your articles that you suggested creating an interprovincial reserve fund. Could you explain how this would work?

[English]

Dr. Boothe: Senator, first I want to assure you that there are still people in the Department of Finance who understand the program. The program will continue. The level of detail makes the program complex. There is so much detail. The number of ad hoc changes that have been made over time also makes it complex.

I could give you an example. We typically release our budgets in March in Saskatchewan. As many of you know, I am sure, the preparation of a budget is a four-month to six-month process. One year when I was deputy minister of finance, the federal budget came out in February, as it often does. We were notified at that time of a substantial change in the Saskatchewan transfer payments. In fact, that was an increase in our transfer payments equal to 4 per cent of Saskatchewan's program spending. This was within three weeks of when our budget was to be released.

We had to go back completely to the drawing board. In fact, it was a very difficult period to be the deputy minister of finance because the understandable question from cabinet ministers -

The Chairman: It was not as difficult as it would have been if you had been told that you were to have a significant reduction.

Dr. Boothe: You are absolutely right. I am sure my provincial colleagues have lived through that as well.

My point is that this particular change came about because one of the ad hoc features of the program became operative, the floor payment. It was not possible for us to predict this.

It is possible to boil this formula down so that ordinary Canadians can understand what the issues are. Certainly, we will never be able to conduct a public debate about all the details because - you are right - it is just too complex.

As far as the second question goes, I wrote a paper about two and a half years ago with a colleague of mine that proposed a very substantial change to equalization. The proposal would change it to an inter-provincial equalization scheme. I should tell you, senator, that that was not warmly received in any quarter in Canada. I could spend more time explaining it, but there really is not an appetite for a change quite as fundamental as that. We should be focusing on changes that may be fundamental but still preserve the federal character of the program.

Senator Mahovlich: Alberta was once an equalization-receiving province, but since 1965, that has changed. Were there any special provisions or accords offered to Alberta to help them develop their industries prior to 1965?

Dr. Boothe: Senator Mahovlich, I would say not that I am aware of, but I am not an expert in that period of equalization. Others may know the answer to that, but I do not.

Senator Furey: Maybe we could call upon Senator Banks. In that period when equalization first came into play in 1957 up to 1965, I think that they continued to receive their equalization payments. Is that correct, Senator Banks?

Senator Banks: I would have to check. I believe that it was 1961 when Alberta ceased being on the receiving end of equalization, but I am not sure. It was certainly in the 1960s.

Senator Furey: In the period from the institution of equalization to that time when Alberta stopped receiving, they continued to receive payments during that period even though they were developing their oil fields?

Senator Banks: Absolutely. Senator Furey is exactly right. As far as I am aware, Alberta received the province's entire share of royalties all the time. It took that long for Alberta to cease to be a receiving province. Oil was struck in Alberta in 1905. However, it was the Leduc strike that made a big difference. However, that strike did not result in 2 BMWs being in every garage. It took many years for Alberta to climb out of her financial hole.

The Chairman: I am reminded that, in the early days of equalization, natural resource revenues were not part of the calculation. There were only a couple of revenue sources that were considered. Alberta, therefore, continued to receive equalization. The list was expanded only later in the 1960s to include natural resource revenues.

Senator Banks: We must also remember the distinct difference with respect to the Atlantic province resources. Alberta's resources are clearly Alberta's resources, as granted provinces constitutionally. Offshore resources are not quite so clearly the resources of a province.

The Chairman: That was Senator Mahovlich's original question.

Senator Mahovlich: Do you think the offshore accords between the federal government and the provinces of Nova Scotia and Newfoundland are enough to encourage the substantial development of the offshore industries and reduce equalization payments?

Dr. Boothe: I would say, first, that we have seen substantial development of the offshore resources for Newfoundland and the accord has been in place.I am very hesitant to say that economic development would not proceed without government assistance in this respect.

Perhaps I could just go back to my earlier point that, in my experience as a finance deputy, when it comes right down to it, provinces do not look closely at the equalization consequences of economic development because, for them, having revenue that is generated at home, along with the jobs that go with it, is much preferred to getting equalization dollars from Ottawa. If I ever put in front of a provincial cabinet the choice between getting a dollar of their own revenue generated by jobs in their own province or a dollar in federal equalization, there really is no question about which one they would pick.

The other reason I am hesitating, Senator Mahovlich, is that I am of very mixed mind of the efficacy of regional development programs in general. They must be very carefully designed in order to work well. I do not want to say that those ones have worked well because I am not sure, but would the offshore activity have gone ahead without those accords? I think that that economic development will proceed.

Perhaps I could just go to another example that people use frequently, and that is Voisey's Bay. People sometimes point to Voisey's Bay and say that Newfoundland has not proceeded with it because they are compensated by equalization. My answer to that is that Newfoundland will not proceed with Voisey's Bay, in my estimation, until it has the economic development consequences at home that it wants to see.

I have seen Premier Klein in Alberta talk about issues, for example, such as not exporting natural gas unless the upstream is done at home, without the benefit of any equalization payments, for exactly the same reason. People want the benefits to be at home. I do not think that equalization is changing their behaviour in that respect.

Senator Mahovlich: As we go along, this theory of ours is getting more and more complex. As more changes take place, it will be more complex ten years from now. My wife always tells me, "Frank, less is more."

How will we go back? We will have to make some tough decisions in order for the public to understand all this. We are not heading in the right direction, from what I can see and understand in this theory that we are following. Do you agree with that?

Mr. Boothe: Senator Mahovlich, I do agree with you. I think that one of the most valuable features of a macro formula is that it is substantially simpler and increases the transparency of the program and therefore - and this is the other thing I am very concerned about - the accountability that goes with the program. It is very difficult to hold a provincial finance minister accountable for revenues when, for some provinces, a big portion of those revenues come essentially out of a black box and nobody knows what they will be. I hope that simplicity and transparency are among the criteria that we use to judge the alternatives between which we must choose.

The Chairman: Professor Boothe, I think you are the first witness with any senior governmental experience who has been at all sympathetic to the idea of scrapping the present program in favour of something new, such as a macro program. We have had representatives from five or six provinces here. I think I am correct in saying that not one of them has shown any sympathy for scrapping the present program and taking what, to them, would be a leap in the dark with a new program. However, they all want considerable improvement and changes to the present program.

How do you explain the reluctance of your former counterparts and colleagues to contemplate an entirely new equalization program?

Mr. Boothe: I would say several things: First, you should remember, Senator Murray, that I was a professor before I was a deputy minister; perhaps that affected me. Second, finance officials are cautious by nature. They prefer the devil they know to the devil they do not. The other thing is that provinces are quite capable of taking these simple macro formulas - because they are simple - and working out the consequences for their individual treasuries. The only ones you will hear from are the ones that are worse off, so there is a bit of a bias in the selection of who will speak out on this issue.

The Chairman: We have heard from five or six of the recipient provinces, professor. If they will be worse off under a macro formula, it is not clear to me that a macro formula is what is needed. I suppose it depends what the formula is.

Mr. Boothe: That is right.

The Chairman: Senator Bolduc believes less is more.

Senator Bolduc: The lot of each one of them would improve. They would get more.

Mr. Boothe: Certainly in my work in the past on macro formulas, I have tried to design a formula where, among the provinces, there are no losers. I believe if one tries to institute a formula where there will be large redistributions among provinces, it will not work. We have seen that the contribution of the federal revenues to equalization has been declining over time. With a reasonably modest restoration of federal funding to equalization, we could design a macro formula that did not create losers, and we could get a much more simple and accountable program at the same time.

The Chairman: You have written on this issue?

Mr. Boothe: Yes, I have.

The Chairman: This is our last public meeting on this subject. Very shortly, this committee will start meeting to consider what recommendations it will put into its report. In trying to get my mind around how we should approach this as a committee, it occurs to me that the first question we will have to settle among ourselves is whether we want to scrap the present system and go to something new, such as a macro program, which is the only one that has been seriously on the table here. We will then have to ask ourselves whether the present program is so deficient and problematic that we really should scrap it after 40-odd years. Are the advantages of the alternative macro programs so clear that we are willing to take a position in favour of that? That is the first question.

The second question is, if so, what is the macro program that we will recommend? If we decide not to recommend a complete change, then what improvements do we want to recommend to the existing program?

There is much experience, political and otherwise, around this table. I think it is fair to say that we do not have the kind of expertise in designing such programs that you represent, Professor Boothe, but perhaps you could help us, either today or with some of the material you have already prepared on that subject.

Dr. Boothe: Senator Murray, I would make a couple of comments. First, I think that it is too soon to make a determination on whether the current formula should be replaced by a macro formula or a modification of the current formula.

The Chairman: We have a mandate to report to the Senate by December 21, 2001.

Dr. Boothe: I understand that, but I think that, based on the current state of our knowledge, we must decide if we are satisfied with the current program, or are there deficiencies with the current program that are sufficient enough to make us consider other alternatives seriously. That is the issue with which we are faced now.

Given the current state of our knowledge, I would be unwilling to recommend that you get rid of the current formula and adopt an alternative. I would first want to see a comparison that showed the various alternatives with a clear set of criteria on which to judge those alternatives. With that, I would be willing to make a determination.

I have advocated a macro formula in the past; a very broad fundamental change. As I said, there is not much appetite for that. I am currently working on a more modest modification. However, until we have those comparisons and a set of criteria with which to judge them, it is too soon for us to say whether we should make wholesale changes to equalization. I recommend that this work, which is part of this broader review, continue so that we will have the information and the public debate that we need to make this decision.

Senator Furey: I would first like, Professor Boothe, to underscore your comments with respect to natural resource development in my home province, Newfoundland and Labrador. Indeed, it has little or nothing to do with equalization. It has to do with obtaining a good and fair deal for the people of Newfoundland and Labrador, and I thank you for that comment.

Your comments with respect to the shortcomings of the program are generally around the concept of the inequalities built into the system, as it exists now. I take from your comments this morning that the purpose of change in the formula would be to create a more equitable distribution, with perhaps the ideal being that we have equality between provinces sometime down the road.

You state very strongly that you are opposed to another ad hoc change, particularly with respect to removing natural resources from the equalization formula. One of your reasons for being strongly opposed is the effect that the ceiling would have on a windfall to a province, in this case Saskatchewan. It would also cause a subsequent reduction in transfers to other recipient-provinces.

If the purpose is to move towards a more equitable distribution, and taking natural resource revenue outside the formula is seen as a good thing, why not tweak the rest of it in terms of items like the ceiling? Why not take that out as well? Would that not achieve more quickly the goal of more equitable distribution amongst the provinces?

Dr. Boothe: Yes, Senator Furey, it might. The distributional consequences of taking out natural resources would require further study. Provinces are expecting natural resource revenue. If that revenue were taken out of the program, it would not be taxed back. That could be good for some provinces. However, we must think about this complex program in its entirety.

Certainly, the ceiling adds an additional distortion to the program. It makes it hard to explain and hard to predict. However, at the same time, the ceiling is there for a reason. The ceiling deals with another of the criteria, and that is sustainability for the federal government. The ceiling provision that was put on equalization is ad hoc, but it is not arbitrary. It was put there for a particular reason: The federal government was worried about unbounded growth in the program.

Yes, you could move further on the equity side by doing that, but only by stepping back on the sustainability side. I recommend against making these changes piecemeal. If you change piecemeal, you do not think about the consequence on the sustainability side of the equation. What about the federal government's point of view?

I have been considering that perhaps equalization should be set as a fixed share of federal revenues. That would protect the federal government against unbounded growth. However, you then give up something in the responsiveness of the program. It then becomes simply a pie-cutting exercise.

There is no free lunch. Economists would say that there is no improving mechanism here. There is nothing that makes everyone better off and nobody worse off with piecemeal changes. Anything we do would ultimately be trading off between these various criteria.

Senator Furey: You had made a comment with respect to putting a needs component into the formula. You used the example of Australia and Germany, where one was dispersion of population and the other was congestion. That is merely a question of geography. We could nonetheless formulate some appropriate needs formula.

For example, the CHST program, which is distributed totally on a per capita basis, is totally unfair. That is an unfair distribution of the monies in that particular program. The gap between the provision of services in health care in Newfoundland and Labrador and the provision of those same services in Ontario gets wider as long as CHST is distributed on a per capita basis.

Do you not think that a needs component should be brought into play when you talk about distribution of CHST, as an example?

Dr. Boothe: I do not believe that we should have a needs formula in equalization because I view it as impractical. Some of your other witnesses have talked about that.

I have worried about the distribution formula for CHST because one of the important features of the CHST is that it supports inter-provincial mobility of Canadians. I recently moved back to Alberta from Saskatchewan. Health care coverage for my family and me was completely uninterrupted. It is a huge benefit to Canadians to be able to move anywhere without a disruption to coverage.

In Alberta we see a number of people moving to British Columbia to retire in warmer weather. We know that as people get older they consume more health care services. Should the CHST be assisting British Columbia in that respect as their population gets older? Should the CHST be adjusted for age and gender factors in the population? That is certainly something I am wondering about now. The general basis of needs and equalization is a morass that would never end. It would shift the debate to needs.

One of my former students was in charge of equalization in the state of Tasmania, in Australia. They have needs-base funding. Every five years the Commonwealth Grants Commission comes to visit them. The members of the commission are put on buses and are driven over bumpy roads to show them how great the need is in Tasmania. I am not sure we want to go in that direction.

Senator Bolduc: Most of our time in this inquiry has been spent on the revenue side. The other side is also a problem. How do we calculate equal and comparable services in terms of education, welfare and health? The answer to that question is not obvious.

Do we have objective criteria? If we only have subjective criteria, such as people are happy where they are, otherwise, if they were so unhappy with the health situation in Quebec, they could move elsewhere. Is it that kind of criteria that we talk about? Is it objective criteria, where you measure the quality of services from one province to another? I have some difficulty with that. I am not sure it is measurable as objectively as one may think.

Dr. Boothe: Senator Bolduc, I agree with you completely. One of the things one wonders about is what if the cost of providing public services is different? That is generally where you start. Dispersion or congestion is one way people have gone about it.

Most of the cost of providing public services is the wage and salaries of the providers of those services. Do you need to take into account their cost of living? It is much more expensive to support a public servant at a living wage in Toronto or Montreal than it is in Regina. Would you put more weight on Toronto, Montreal or Vancouver? That is certainly one way this could be interpreted.

The fact that it is so difficult to measure comparable level of services is why we do not yet have a clear answer on the adequacy question. We can measure whether taxes are comparable but it is difficult to measure whether services are comparable. Should we measure outcomes? Perhaps in education we should compare province-wide tests for educational attainment. Should we measure the amount of spending? If that is the case, perhaps we should take into account different costs in the different locations. If that were the case, if Alberta gave its doctors and nurses a big raise, should that mean that the cost of providing services in Alberta is much greater than in Saskatchewan? Alberta just gave their doctors and nurses a big raise, and it is a big enough problem for Saskatchewan without reducing its equalization. This is a difficult direction in which to go.

While I am sympathetic to the needs-based approach to CHST, because of the mobility issue, I certainly would not go in that direction for equalization.

Senator Bolduc: The result of that is that comparable services is subjective, is that correct?

Dr. Boothe: No, as I understand the Constitution, it is not that provinces must provide comparable services but rather that they have the capacity to do so. Provinces choose to provide different bundles of services to their citizens based on the preferences of those citizens, expressed through general elections.

Senator Bolduc: The levels of satisfaction may be different.

Senator Tunney: Professor, I was very interested when you were talking about the tendency of provinces not to lobby or even consider changes. Provinces reflect Canadians; Canadians will tinker, but not too much.

Have you studied programs such as we have here in Canada through other countries which have something like parallel programs? We are probably recognized as innovators here, but perhaps other countries may have caught up or even exceeded our program or the mechanics of our program.

I was somewhat surprised when you said that in putting together your provincial budget in Saskatchewan, you had to hurriedly redo it because of the terms of the federal budget. I did not think that one would impact on the other to that extent. That is a situation that bothers me.

You mentioned that you were working on a formula whereby, with hope, there would be no losers. If there are no losers and everyone is actually stagnant or equal, and others are gainers, then the total would have to be substantially increased, would it not?

Dr. Boothe: There are a number of other countries with different equalization schemes. The one I know best is Australia. Australia is a much more centralized federation than Canada. The central government or Commonwealth in Australia collects much more revenue than does the federal government in Canada. In the past, there has been much more redistribution.

In Australia, for example, the total amount of redistribution is decided arbitrarily each year by the federal government, not on a formula basis. The division of the transfer is decided by a formula that includes needs. In Australia, they call those needs disabilities. That is why they had their Commonwealth Grants Commission travelling around the bumpy roads of Tasmania; in order to convince them of that disability.

Recently, Australia has made a change in their revenue structure and introduced a GST. However, in Australia when they introduced the GST, all the revenue from the GST went to the states rather than to the Commonwealth. That was done so that the states could get rid of some of their most distorting tax bases. For example, there was a tax that was applied every time you made a deposit or withdrawal from your bank account. Some of those taxes were eliminated.

Australia has quite a different system, although they have moved a bit in our direction in terms of the degree of decentralization. Canada is quite decentralized, by international standards. That is why I said at the beginning that we have the balance about right. I am not advocating a large additional amount of decentralization, perhaps because of my time in Saskatchewan.

As far as the budget in Saskatchewan is concerned, if you get a change in your revenue, positive or negative, that is equal to 4 per cent of program spending, it causes an enormous change, because you have gone through a process where many hard trade-offs have been made. You have been working toward an overall budget constraint. It is hoped that there is a rational process to arrive at that. Here I mean "rational" not only in the policy sense but also in the political sense, making the political compromises that are necessary to form a budget.

If you take that budget constraint off at the last minute, you do not get to go through the same rational process to make those spending decisions. In my experience, spending decisions made in a hurry will often be regretted down the road.

Finally, regarding the situation of there being no losers, I guess I had better be clearer. I meant to say that there would be no losers among the provinces. In order for this to work, there would have to be some restoration of federal monies to equalization. You know that now it is about 6 per cent of federal revenues. Previously, it was about 8 per cent. If we had at least a partial restoration of that share of federal revenues, then it would be possible to do this, if we do not use up all that revenue room in ad hoc or piecemeal changes beforehand.

Senator Doody: Professor, I wonder if we could revisit the natural resources question that we touched on briefly before. You say you are not uncomfortable with the inclusion of natural resource revenues in the formula but you do feel uncomfortable with the way they are treated. Could you elaborate on that? That natural resources question is central to many of the problems the provinces have with the formula now.

Dr. Boothe: Maybe I could elaborate by way of an example. In Alberta, instead of the provincial government taking the natural resources as revenue, if these natural resource revenues were distributed to individuals and included in their income, that would have a different effect than if they were treated as provincial revenues.

The key thing is that when we sell natural resource revenues we are taking a physical asset and changing it into a financial asset. I can understand why the income from that financial asset should be treated as revenue, but I am not sure whether the proceeds from the sale of the capital asset should be treated all as revenue in the beginning.

This is a complicated issue. It is something that would require a lot of analysis. It is one of the reasons that, in order to avoid that kind of problem, I have advocated a macro formula, because a macro formula does not hinge on those kinds of questions.

Senator Doody: The major concern, as with the non-renewable resources, which obviously is a sale of a capital asset, the property of the people of the province, is whether it would be possible to somehow depreciate or write them down over a period of time and deduct the depreciation from the value of the asset? One day there will be no more nickel in Voisey's Bay. So far, it seems to be a pretty permanent fixture, but eventually it might very well turn out to be a disappearing resource. Is there some way that the equalization formula or the provincial revenues could be adjusted to compensate for the loss of the resource?

Dr. Boothe: The first thing required is a change in the way those revenues are treated by the provincial governments rather than the federal government. Yes, it probably is possible to do that. My caution is that the variation in the value that comes from changes in the price of the commodity will probably far outweigh the variations in the value due to the fact that it is becoming depleted.

That is certainly true of oil and gas. If you looked at the capital gains and losses to Alberta's stock of oil and gas over the past several years, when oil has been as low as 14 and as high as 35, and natural gas has been as low as 2 and as high as 11, they certainly by far swamp any depletion of the physical quantity of oil and gas in Alberta. Therefore, it is not a trivial matter.

Senator Banks: You were careful to say that there are no provincial losers and therefore, although "loser" is not perhaps the right word, a redone formula that you have in mind would imply that, as you have said, the Government of Canada would be spending more money. Would you comment on that in light of the fact that in the past few years - and I cannot remember exactly when this happened - in the aggregate, provincial revenues in Canada considerably exceeded the revenues of the Government of Canada? That was not formerly the case. I would suggest it was an easier case to make, when it was the other way around, that the Government of Canada ought to top up this and that. However, since provincial revenues now exceed federal revenues, does that have any impact or importance in what you are talking about?

Dr. Boothe: Senator Banks, I read that comment in the testimony that I have reviewed. To be honest, I think it is a red herring. The point is, how do provincial revenues compare with provincial spending responsibilities, and how do federal revenues compare with federal spending responsibilities?

Going forward, the provinces have expanded because the programs that they have to fund have expanded, especially education and, on the top of the list, health care. Of course, that is a subject for another day.

I believe that that is really a red herring. The reason I do not think the adequacy question has been settled is that, certainly, the share of federal revenues that goes to equalization has declined from about 8 per cent to about 6 per cent, but at the same time, the relative disparity of the provinces has also declined. If the program's design is to compensate for these disparities, and if the disparities have declined, and the differences in fiscal capacity have declined, then you would expect the amount of federal money devoted to the program to likewise decline. What is not settled is whether it has declined by too much, the right amount or not enough. I do not think we have the answer to that question.

Senator Furey: Professor Boothe, when you were talking about going to a macro system and using income as a yardstick, you stated that distribution was on a proportionate basis of income, depending on how it varied from the national average. Is there not built into that a kind of needs function or component, when you determine how salaries are determined, for example, in a province such as Newfoundland and Labrador?

Dr. Boothe: It may indirectly, senator, but I view needs as trying to measure the costs of providing public services in different jurisdictions.

Senator Furey: If a hospital in Corner Brook, for example, has a budget to provide hospital care and it determines that, in order to provide a certain level of care, salaries have to be at a certain level, that builds into that whole macro formula, if you are using income, a type of needs element?

Dr. Boothe: I guess indirectly it would have that effect, but depending on how large the public service is, and how different the wages and salaries are, my view is simply that, instead of these 33 tax bases, if we just take a single indicator of our variations from the national standard - and here I say national; a 10-province standard - we get big benefits in accountability and transparency. We also reduce some of the tax-back problems that people have talked about, because it is spread over the entire economy. I would not want to go too far down the road that incorporated needs.

The Chairman: For the record, the new, very simple standard would be per capita personal income pre-tax in each province. Those provinces that were below the national average would be compensated by the federal treasury to bring them up to the national average; is that correct?

Dr. Boothe: That would be a good example of a macro formula.

The Chairman: That is it; nothing else. It would not be difficult if someone had the tables in front of them to make a quick calculation as to what the program would be worth nationally, in terms of what it would cost the federal treasury today, and also what it would mean to each province. Have you done that?

Dr. Boothe: Mr. Chairman, when I did this before, it was for an interprovincial equalization scheme that rolled together the CHST and regionally specific portions of employment insurance. Certainly, I would not argue that my previous work is directly relevant to what you are talking about now.

The Chairman: You are not suggesting that the government ought to consider rolling the CHST or regionally specific parts of the EI program into this; is that correct?

Dr. Boothe: There was absolutely no appetite for that idea when I proposed it earlier. However, the scheme that you mentioned a moment ago is exactly the kind of thing that federal and provincial officials are examining at present. They are working out all of the consequences. What you want to avoid, when you make a big change like this, as far as it is possible, are the unintended consequences that often accompany big changes.

The Chairman: That is why your counterparts are so reluctant to commit to anything except improvements in the present system?

Dr. Boothe: That is correct.

Senator Bolduc: We are facing a problem of economic analysis on the one side and the economics of politics on the other side. This is a way for the federal government to individually satisfy most people so that, at the end of the day, nobody will be not very happy but everyone will be fairly happy. That stands against transparency, in my opinion, but that is the way it works.

You will probably have a tendency to agree with what I say. On the one side it is clean, and it will work this way. As a slight variation, I would not necessarily take the average; I would take a kind of median instead in the income. Otherwise, when we hit Alberta, it would be viewed in such a way that is not reasonable. I suspect that is what would happen.

You must have an equity, but not necessarily equality. After all, if they are richer, they are richer. That is the way it is for the time being. I do not see it as an equity problem in the sense that everyone must be on the same level. I do not think it is fair to say that. What do you think?

Dr. Boothe: I said at the beginning that I am a strong supporter of equalization. If you travel outside Canada, as I do from time to time, and talk about intergovernmental relations, you will realize that people around the world look to Canada as one of the best examples of a well-functioning federation.

One of the reasons Canada functions so well is that we take this time to constantly work on these programs to try to get them to fit the circumstances. We debate and discuss, and sometimes we make changes and sometimes they are big changes.

The changes to the CHST that came in the first mandate of the current government were big. They were huge. Sometimes they are small, changing this tax base or the other. However, it is because we devote all this energy to the system that it works so well. That is why I am pleased to participate in this process that you have going because this is part of the ongoing work that makes Canada one of the world's best federations.

Senator Banks: Out of curiosity, the program which you were designing which you said did not find any favour anywhere, that you described as interprovincial, would that involve provinces literally writing cheques to each other?

Dr. Boothe: That is correct, contributing to an interprovincial equalization scheme.

Senator Banks: We heard a strong and convincing argument that we must take care to bear in mind the constitutional description as it now consists of equalization: that is, as you have described, to provide roughly comparable services as opposed to straying into the area of making it into a program of income redistribution. Would not a macro formula based upon personal income constitute, in effect, a redistribution of personal income in Canada and not be a proper part of the equalization formula, plan and intent as it is now set out constitutionally?

Dr. Boothe: I read those comments to which you refer. That is a matter on which we would disagree.

Richard Bird, a professor at the University of Toronto, said that equalization is a political bargain between the provinces and the federal government. Ultimately, that is what it is. If the goal of the program is to provide the capacity for provinces to provide comparable services at comparable levels of taxation, then that is how it should be judged. It is not the how of the program; it is whether it accomplishes its constitutional mandate. Using one tax base or another, or a macro indicator or another, is not really relevant. When we judge these programs and alternatives, we should address what does the best job at giving provinces that capacity to provide comparable services at comparable levels of taxation. Whichever formula does the best job, that is the one we should pick.

The Chairman: Thank you. I think you know, Professor Boothe, that this has been extremely enjoyable and interesting for all of us. You will have seen that from the participation of all the members of the committee. We thank you very much.

Honourable senators, that is a good note on which to end our public hearings on this subject. I do not know whether we will take your advice to lob the ball back to the Department of Finance. We may be braver than that; we will see.

The committee adjourned.