By Bobby O’Keefe

To understand the current debate over equalization formulas and the Atlantic Accords, the best starting point is not an economics or political-science class, but a quick history lesson.

Canada’s equalization program was formally introduced in 1957, and enshrined in Canada’s Constitution in 1982. The program’s intent was to ensure that all provinces had equal access to the same programs and opportunities, and to provide “reasonably comparable services at reasonably comparable levels of taxation.”

Equalization essentially acts as a revenue “top-up” for provinces with revenues lower than the national average.

The less access a province has to revenues through such sources as income, sales or property taxes, the more it gets topped up. On the flip side, a province with more revenues gets less equalization or none at all.

How that “top-up” is determined has changed several times and been a topic of much debate. Arguably, the greatest source of debate is the treatment of natural-resource revenues within the formula.

While tax revenues on property, income, or goods and services are relatively consistent and reliable sources of revenue in the long run, natural resources are not.

Oil, natural gas and minerals are finite. When they run out, so do the dollars they generate.

As a result, provinces that have a lot of oil, gas or minerals tend to want the revenues they generate excluded from the formula.

When Newfoundland and Labrador discovered the potential revenues available from offshore oil and gas, it recognized the potential for losing out on equalization money.

In 1985, Newfoundland and Labrador signed an agreement with the federal government allowing the province to tax offshore oil and gas revenues as if it were the owner, as well as providing some transitional protection for the province from reductions or “clawbacks” in its equalization payments thanks to increasing oil royalty payments. Nova Scotia followed suit with a similar agreement in 1986.

In 2005, those agreements were extended to protect 100 per cent of offshore resource revenues from clawbacks. These agreements meant that both provinces could use the full amount of resource revenues to help bring the provinces out of “have not” status and potentially eliminate the need for equalization payments entirely. Any amount either province would lose thanks to increases in oil and gas revenue would be returned in the form of an “offset” payment.

Fast forward to 2007. As part of the new government’s commitment to “fix” equalization, a new formula was announced. The new formula, among other things, gave provinces options. A province could include 50 per cent of resource revenues in calculating its equalization entitlement, or it could exclude all resource revenues. So provinces with resource revenues could exclude them, if that meant a greater equalization payment.

Provinces without resource revenues could include them to inflate the national average on which the payment was based. The budget also protected the Atlantic Accords signed in 2005, with Nova Scotia and Newfoundland and Labrador both entitled to the full amount of offset payments.

Or did it? On top of the other changes, the formula included a cap on payments. No province would receive an equalization payment that increased its fiscal capacity to more than that of the province with the lowest fiscal capacity not receiving equalization – or the poorest “have” province, in this case Ontario. In calculating this cap, all revenues are included in the formula, including 100 per cent of resource revenues and 100 per cent of the Atlantic Accord offset payments.

And it is this cap that has caused all the fuss. Capping equalization payments means that no equalization-receiving province has more money to spend than a non-receiving province. But it also means that Newfoundland and Labrador gets $300 million less this year than it would with no cap in place.

Nova Scotia would get $95 million more, but could lose out in the future as its oil-and-gas revenues grow. Saskatchewan is hardest hit, losing out on more than $878 million it would have received if no cap existed.

Of course, this debate would not be happening at all if the government had simply taken non-renewable natural-resource revenues out of the equalization formula entirely.

But that is another column.

Bobby O’Keefe is a senior policy analyst with the Atlantic Institute for Market Studies, an independent, non-partisan think tank based in Halifax.