Incentives matter and all the rest is commentary:
Nova Scotia and Equalisation

A talk by AIMS President Brian Lee Crowley
to the Annual General Meeting of the Liberal Party of Nova Scotia
Halifax, Nova Scotia, 21 April 2001

Ladies and Gentlemen,

Thank you for the invitation to be here to speak to you about Canada’s equalisation programme, whether that programme is fair to Nova Scotians, what changes, if any, one might make to improve it.

What is equalisation? Equalisation is a social programme – it is an income support programme for provinces.

But like any social programme, in order to understand its effects on society, you must look both at the intentions behind it, and the actual results that it produces, because as we all know, good intentions are no guarantee of good outcomes.

In analysing social programmes, we must look at two key things. These are what I call the first order effects and the second order effects. Rather than starting with equalisation, let’s start with a programme whose first and second order effects are more easily observable.

The analogy I wish to draw is with individual welfare recipients. The good intentions of welfare are that, in a wealthy society, no individual should be left destitute because of the vicissitudes of life. We can all suffer the slings and arrows of outrageous fortune, and it is both generous and sensible for us as a society that we ensure that no one be left unable to fend for themselves. And there are certain persons who, for a variety of reasons, are permanently unable to fend for themselves, and it is appropriate that we as a society offer them a reasonable basic income.

For the rest, the first order effect of welfare matches our intentions: we intend to prevent destitution and tide people over. Welfare achieves this.

But there are undeniably second order effects of welfare. In particular, there are the problems associated with what has come to be known as the welfare trap. As we, in our good intentions, make welfare benefits more generous, we blunt the economic and social enticements to return to the workforce and to become self-supporting. This takes the form, not merely of higher benefits, but also of taxes that are too high on low-income people, plus the added penalty of the withdrawal of benefits as income rises.

The combined result of these factors is that the highest marginal tax rates in our society are paid, not by people at the top end of the income scale, but by people trying to escape poverty and dependence. They actually make themselves worse off by working. Anyone who doubts this proposition to check out for themselves the numbers for Nova Scotian recipients of social assistance here.

So the second order effects of a social welfare policy intended to be kind and generous, can in fact be cruel and destructive if you believe that pride and self-worth come from each person putting forth their best efforts to be a productive and contributing member of society, and if you believe that the long term result of dependence on state benefits is a whole host of social dysfunctions.

When trapped on social assistance, the most one can aspire to in terms of improved standard of living is whatever the government is willing to give in terms of increased benefits, which will never be much more than subsistence. Yet people who return to the labour market vastly improve their chances of moving up the career ladder, and consistently improving their standard of living as they acquire job skills that make them continuously more valuable to employers.


Let’s return now to equalisation. What are the first order effects of equalisation? Well, the idea is quite a simple one. Canadians, wherever they may live, are entitled to a certain minimum standard of public services. Yet certain services are the responsibility of provincial governments, things like education, health care, highways, etc. Since some provinces are richer than others, that means that residents of poorer provinces might not be able to afford decent public services in those areas if they had to depend only on their local tax base. Either that or they would have to bankrupt themselves with taxes that were ruinously high.

The function of equalisation is to even out those differences in tax bases. And the first order effects, like those of welfare, are quite successful. Less wealthy provinces’ revenues are topped up by equalisation to very close to the national average. Nova Scotia gets about 25% of its total revenues from equalisation (and nearly 40% of its total budget from federal transfers overall). As a result, government spending is far higher provincially than it would otherwise be.

Now equalisation would be fine if the story ended there. But as in the case of welfare, we must examine the second order effects of this policy, and add up all of the pluses and minuses to arrive at an understanding of its overall effects.

I would like to suggest that there are at least 3 second order effects of equalisation that we should be concerned with. Remember that, as was the case with individuals, my argument would be that while it is praiseworthy to support people temporarily deprived of the means to support themselves, there is no virtue in supporting people in such a way that they lose the ability to support themselves.

The first second-order effect I want to mention has to do with the impact equalisation has on the behaviour of less-developed provinces, particularly with respect to promoting economic growth. After all, the alternative to dependence on equalisation is to grow your own tax base so that provincial taxpayers can pay the cost of the public services they choose to have their government provide. Equalisation actually works against this goal. The clearest example I can use comes, not from Nova Scotia, but from Newfoundland: Voisey’s Bay. It is my contention that equalisation is a key part of understanding why Voisey’s Bay has not proceeded. (Read the full argument here.)If you wish to learn more about the impact of equalisation on economic development in Quebec in particular and Eastern Canada more generally, you might care to read an article co-authored by Michel Kelly-Gagnon, the Executive Director of the Institut économique de Montréal and I, published recently in The Globe and Mail: The economic jig is up Mr. Landry

The next second order effect I want to look at is equalisation’s effect on fiscal discipline in the equalisation –receiving provinces. As we all know, in the 1990s, this country went through some wrenching changes in order to redress its fiscal imbalances. We were one of the most heavily indebted countries in the OECD, and only a concerted effort, courageously led by Finance Minister Paul Martin, enabled us to turn a corner and put our finances on a more sustainable footing.

But the effort was far from being shared equally across the country. In fact, if you look at John Richard’s paper last year for the CD Howe Institute, you will rapidly see what a nonsense it is for the provincial government here to claim that its fiscal difficulties are chiefly, or even largely, the result of federal downloading, or cuts in transfers.

Over most of the 1990s, according to Richards analysis, Nova Scotia’s progress towards fixing its fiscal problems was made up of three elements: increases in its own revenue sources, decreases