13 January 2005

Equalization for beginners or why Loyola Sullivan gets $400 million from oil this year

Offsets. Clawbacks. Have. Have not.

Equalization is at the heart of the current Atlantic Accord dispute. Yet if you put a gun to the head of the average person at the nearest Tim Horton's, I doubt they could explain it.

Well, here is a simple explanation.

Every province in the country collects revenue (or income, if you prefer) from taxes and fees. We know them all too well - HST, personal income tax, corporate income tax, car licensing fees, park fees.

That money goes to pay for the services the provincial government provides, like health care, education, and provincial parks.

For just about as long as Canada has been a country, different provinces have raised different amounts of taxes on their own. It's pretty obvious that some provinces would be richer than others. In order to even that situation out, the federal government transferred some of its revenue to the provinces. The federal government established the current Equalization program in 1957 after years of debate and discussion with the provinces. The concept of Equalization was enshrined in the constitution in 1982.

Basically, Equalization is like a wage top-up scheme for provinces. The federal government figures out a national average amount of revenue each province should get per person. Fall below the average and the province gets a cheque from Ottawa. Meet or exceed the average and you get nothing. No province pays into the program; the money comes from federal government revenues. As it stands right now, Alberta and Ontario make more than the national average and get no Equalization. Saskatchewan will join them in the "have" category, as some call it, within the next year. All the other provinces get some amount of Equalization. Quebec gets as much as all the others combined because the money is paid out based on population.

In 1957, when the program started provinces were topped-up to the average of the top three provinces. Alberta received Equalization until 1964, but once its income went above the average it didn't get a penny in Equalization. In 1967, the average was based on all 10 provinces and since 1982 it has been based on five selected.

Over the years, some provinces like British Columbia and Saskatchewan have moved back and forth between the so-called "have" (no Equalization) and "have not" (get Equalization) categories.

Like any top-up scheme, as a province's own revenue goes up, the Equalization goes down. That's a pretty simple idea. A province doesn't really lose money; as its own income grows, the top-up is replaced by the growth in revenue.

Under the Atlantic Accord, Newfoundland and Labrador gets an extra payment so that as its oil income grows, Equalization doesn't drop as fast as it otherwise would. It was intended to last for 12 years to give the provincial government a chance to make some headway on its debt and infrastructure after years of hard times. There are current seven years left in the offset under the Accord.

In 1993, the Chretien government also gave Newfoundland and Labrador the chance to hide 30% of its oil income from Equalization each year until oil production ceases once the Accord offsets run out. It's called the generic solution because some other provinces can access it as well for other types of revenue.

The provincial government's proposal since June 10 would work this way. Instead of the offset or the generic solution, the federal government would give the province an amount equal to all of the province's direct oil income in a year, even if the province didn't qualify for Equalization. That's it in a nutshell.

The latest federal offer was to give the province an amount equal to the drop in Equalization from year to year caused by growth in oil revenues, until the province doesn't qualify for Equalization. After that, the province would only get 100% of its oil and gas revenues.

This gets confusing because the provincial government has been explaining the whole arrangement as those something was being taken away when actually it isn't.

Take an example from today with the Atlantic Accord, the generic solution and no new offshore deal. If the provincial government earns $100 million in oil revenues, Equalization would only use $70 million as the provinces oil income when it calculates the province's income.

If the province would have gotten $100 million in Equalization without that new oil revenue, Equalization doesn't drop by $ 100 million. Only $70 million of the oil money is used in the formula, so as far as Equalization is concerned the provincial government is entitled to $30 million.

The result? The province gets $100 in oil revenue PLUS $30 million in Equalization for a total of $130 million.

That's why Brian Peckford can say the Atlantic Accord delivers more money than oil revenues would alone. He's absolutely right.

In 2003, Newfoundland and Labrador earned a little over $123 million in oil royalties (taxes), but that does not include all direct income like corporate income tax. Under the Atlantic Accord the provincial government also received $178 million as an Equalization offset.

Newfoundland and Labrador 2003
Oil Royalties and Offsets
$123 million + $178 million = $301 million

Loyola Sullivan won't explain it to you that way, but those numbers are taken from the provincial government's own budget and the federal Department of Finance website.

This year, the provincial government will receive more than that in direct oil revenues alone. Including the existing offset or generic solution approaches, Newfoundland and Labrador's direct oil revenues in 2004 will likely be close to $400 million.

That's without any new deal.