Canada’s equalization program suffers from structural problems

According to multiple provincial governments including Alberta and Saskatchewan, Canada’s equalization program is inequitable, dysfunctional and flawed. In other words, it’s broken. Proponents of the status quo may dismiss these grievances as inevitable for any government program that redistributes money across provinces. So, is equalization actually broken?

Canada’s equalization program—which will cost $27.2 billion this fiscal year—aims to ensure all provincial governments can provide reasonably comparable services at comparable levels of taxation. To determine which provinces receive equalization payments, and how much they receive, the federal government (specifically, the Department of Finance) uses a complex formula to estimate each province’s ability to raise its own revenue, then redistributes money from provinces with a deemed greater capacity to raise revenue to provinces with a deemed lower capacity. But here’s the problem—peculiarities among provinces can unnecessarily influence the formula and skew the results.

For instance, the formula includes resource revenue when determining a province’s ability to raise its own revenue, yet some provincial governments effectively subsidize hydroelectricity. The Quebec government, for example, requires Hydro-Québec to offer low below-market electricity rates to customers. Consequently, the Quebec government collects less revenue from electricity customers than it would if Hydro-Québec charged market rates. As a result, the equalization formula assumes the Quebec government has a lower capacity to raise revenue, even though it could technically raise more if it charged market prices. This choice impacts equalization—and who gets what—by billions of dollars annually. And this is just one example; there are numerous quirks with equalization that simply don’t add up.

Economists have suggested that indicators such as per-person GDP (a broad measure of prosperity and living standards) could be a simpler and more comprehensive alternative to determine equalization payments. At the very least, it’s a useful indicator. Put simply, if equalization worked as intended, there should be a fairly consistent relationship between per-person GDP in each province and equalization payments per person.

Yet according to our recent study, from 1981 to 2024, there were discrepancies between per-person equalization payments and per-person GDP in all but three of the 44 years.

For instance, from 2009 to 2018, Ontario received equalization payments every year while British Columbia received zero payments even though B.C. had a lower per-person GDP than Ontario in each of the 10 years. Specifically, equalization payments to Ontario totalled $19.0 billion during the period while Ontario’s per-person GDP was 3.3 per cent higher (on average) than B.C.’s. Put differently, Ontario’s per-person GDP was $1,710 higher than B.C.’s (annually, on average) yet Ontarians received $140 per person (annually, on average) in equalization payments while B.C. received no payments.

Additionally, there are numerous cases where, among provinces that receive equalization, a province receives higher payments (on a per-person basis) than one or more other provinces with lower per-person GDP. For instance, from 2000 to 2007, Newfoundland and Labrador had a higher per-person GDP than one or more provinces in every year—and as four provinces in 2005—but received higher equalization payments (again, on a per-person basis).

Some provincial governments have expressed frustration with Canada’s equalization program. It’s easy to see why—there are clear discrepancies between a province’s relative prosperity and the redistribution of taxpayer money collected by Ottawa. This suggests there are ongoing structural issues with the equalization formula.