F. The Williams administration’s rationale for change
The Williams administration is seeking changes to the Equalization offset provisions of the Accord so that the province will receive both direct and indirect revenues and the maximum possible Equalization payments. The provincial government’s position is based on three contentions.
First, reductions in any Equalization payment attributable to increased non-renewable resource revenues amounts to a “clawback” since these resources are finite. Second, as David Norris has argued for example, declines in Equalization amount to added revenue for the Government of Canada and hence violate the commitment that Newfoundland and Labrador should be the principal beneficiary. Third, the existing offset mechanism will run out before the most significant revenue benefit can be realized. Let us examine these in order.
The non-renewable “clawback”: The Equalization program has consistently operated as a form of top-up for certain province’s revenues. Any increase in a province’s own-source revenues would mean a lowering of the top-up amount. If Newfoundland and Labrador experienced a growth in revenue from information technology, it could reasonably expect to see its Equalization entitlement reduced. Newfoundland and Labrador is treated like all other provinces when it comes to the application of the Equalization program.
Clawback is a simple concept and applies in many areas of individual and business life. A clawback is defined by the Concise Oxford Dictionary as meaning to “regain gradually or laboriously, to take back (allowance by added taxation, etc.)” WordNet and Dictionary.com similarly define clawback as “finding a way to take money back from people that they were given in another way; ‘the Treasury will find some clawback for the extra benefits members received’”.
Since the Government of Canada remits in full offshore revenues to the Government of Newfoundland and Labrador, and applies no special tax or levy on those revenues, there is no clawback of these revenues as the term would be generally understood. Since the Atlantic Accord contains specific provisions to offset losses in Equalization, there is also no clawback of direct offshore revenues in that sense either.
The “clawback” argument is based on the contention that non-renewable resources hold a special status among provincial revenue sources. As the argument goes, these resources are finite and hence the period of time in which a province can derive benefit from the resources is finite. A province cannot achieve maximum benefit from non-renewable resources if it loses Equalization as revenues grow from these non-renewable resources. Hence these revenues should be exempted in some fashion from the Equalization calculation.
Two aspects of the argument on non-renewable resource “clawback” approach are worth considering in greater detail.
First, no source of revenue will exist for all time. Non-resource enterprises that generate sales tax and corporate and personal income taxes succeed and fail based on many factors. Western countries, states and provinces, that a decade ago made substantial income from the information technology sector and call centres, are now watching these revenues migrate to India and other Asian countries.
Even supposedly renewable natural resources such as fish can be destroyed by folly or a fundamental misapprehension of the circumstances affecting the health of the stocks. The reasonable lifespan of a mine or oil field may be 50 to 100 years. It took a mere 50 years for human misadventure to decimate the supposedly renewable fish stocks that had fed most of the Western world for five centuries.
Second, the “clawback” argument is one most often advanced by advocates of increased federal Equalization transfers to provinces. No one should forget that the Equalization program is funded entirely through federal general revenues. In other words, a significant portion of federal revenues derive from the very same sources for which the provincial governments claim a theoretical exemption from Equalization. Logically, what is sauce for the provincial fiscal goose should be sauce for the federal gander. The federal government holds obligations to provide services to residents of Canada just as the provinces do. Therefore, if one accepts that some revenues come from “non-renewable” sources, it would be logical for the federal government to seek the same exemption for its revenues as the one demanded by some provinces.
It is beyond the scope of this paper to calculate the level of federal funding from “non-renewable” sources. Were the amount to reach $10 billion – approximately the total outlay for Equalization – it is conceivable that the federal government would seek to eliminate the Equalization program altogether, possibly transform the system to one of low-interest loans or seek to control how province’s spend the Equalization transfer.
The 85:15 revenue split: In the overhead slide presentation, the provincial government includes several colourful charts that purport to show that the federal government receives 85 per cent of revenues from the offshore with the Government of Newfoundland and Labrador receiving only 15 per cent. A similar argument and similar slides are also found in the report of the Royal Commission on Renewing and Strengthening Our Place in Canada and in two research papers completed for that Royal Commission, one by David Norris and the other by John Crosbie.
Sadly for those wishing to assess the argument, none of these documents contains the data used to compile the charts. Neither the provincial government overhead slides nor Mr. Crosbie’s paper contain any figures. Mr. Norris does provide some evidence of his calculations. David Norris was a member of the provincial government team that negotiated the Atlantic Accord. A former provincial deputy minister of finance, Mr. Norris is currently a senior advisor to Premier Danny Williams. In 2002/2003, Mr. Norris served as senior researcher for the Royal Commission on renewing and strengthening our place in Canada. Mr. Norris is also author of one of the research papers the Royal Commission released with its final report. The fiscal position of Newfoundland and Labrador is broad overview of the provincial government’s financial status. It includes prominent sections on offshore revenues that undoubtedly form much of the basis for current government policy. In it, Mr. Norris argues, among other things that “The revenue analysis concludes that the Government of Canada is the “principal beneficiary” of future offshore oil revenues.” Given the obvious connection between Mr. Norris and current government policy and the fact that his paper is reasonably detailed, the remainder of this section will discuss the revenue split argument as he presented it.
Mr. Norris’ conclusion follows a lengthy preamble in which he sets the bases for his remarks and his assumptions on revenues and relative amounts flowing to each of the provincial and federal governments. He also quotes from section 2 (c) of the Atlantic Accord, the now famous “principal beneficiary” clause and deduces that “[a]ccordingly, revenue offset provisions were incorporated in the Accord which were intended to protect the province against sharp downturns in equalization entitlements.” He produces a chart showing the revenue sharing based on his analysis.
[Table 3-1 ]
On the face of it, his argument is persuasive. It does not stand up to closer scrutiny, however.
One of the fundamental problems with any economist’s projections is that they are based on assumption. Adjust the assumptions and the outcomes change, sometimes dramatically. Aside from the traditional economist’s folly of assumption, there are at least five reasons to doubt the validity of Norris’ contention.
First, the “principal beneficiary” provisions of the Atlantic Accord are undefined. It is erroneous to conclude that the phrase is synonymous with provincial government revenues. As a member of the negotiating team for the Atlantic Accord, Mr. Norris may be privy to information that does not exist in the public domain. Until such time as his contention is properly documented, we must remain skeptical of it. The matter of principal beneficiary is dealt with in greater detail below.
Second, as discussed above, the Atlantic Accord is based in part on the premise that the Equalization program would continue to apply. Knowing the premises on which the Accord was based, it is ludicrous for Mr. Norris and others to argue now the opposite of what was said 20 years ago. That single point is sufficient to cause Mr. Norris to remove the Equalization adjustment from his revenue chart above. Eliminate that single contention and the revenue sharing split moves from being a 76:24 split favouring the federal government to a 62:38 split favouring the province.
Third, the Accord’s Equalization offset provisions were never included in any public statement as being part of the revenue sharing arrangement between the Government of Canada and the Government of Newfoundland and Labrador. Mr. Mulroney’s original proposal is absolutely clear on revenue sharing: “Newfoundland will be entitled to establish and collect resources revenues as if these resources were on land.” As such, it is ludicrous to now suggest that the Government of Canada and the Government of Newfoundland and Labrador intended Equalization to be used in the calculation of relative incomes. In fact, the Atlantic Accord makes no mention of how much revenue or what proportions of revenue are to flow to each order of government. The intention of the two parties, as evident from the signed agreement, is merely that the province may have the opportunity to raise such revenues as it can.
Fourth, and flowing in the same vein, the Accord Equalization offset provisions are not structured to ensure that the flow of maximum financial benefits to the province, i.e. revenues plus offsets, are timed to coincide with the maximum level of revenues based on actual development of the offshore fields. Simply put, the offset provisions begin when oil reaches a defined level - irrespective of value. They decline until an arbitrary period has expired, in this case 12 years. As it turned out, and indeed as anyone may have reasonably expected in 1985, production from one discovery was sufficient to trigger the offset provisions. It would be ludicrous to suggest that anyone believed all four commercially-viable discoveries that existed in 1985 could have been fully developed and in production within four years. Hence it is virtually impossible for the existing offset provisions to have coincided with a period of maximum revenue for the province using both the provincial government’s revenues plus Equalization offsets.
Fifth, even if one allows that his contentions about revenue sharing are correct, Mr. Norris presents only a portion of the revenues flowing to the province. As noted in Section D of this paper, the province is entitled to collect revenues of no fewer than six general types. In addition, the provincial government receives indirect revenues from such sources as personal income tax, new business start-ups and revenues that come from the construction and development phase of each project.
In his chart, Mr. Norris includes only royalties, which the federal government does not claim and corporate taxes, which are in fact collected by both the federal and provincial governments. The total economic impact of offshore oil development is not considered in his argument. If these wider sources of revenue are included in the province’s claim or the paper by John Crosbie, sadly, we cannot tell since they have not made this information public.
The offset runs out too soon: Under the existing Atlantic Accord Equalization offset formula, the period of maximum potential benefit expired last year. The maximum offset existed only for the first four years after the oil production trigger was reached. Within that time, the provincial government received the largest type of Equalization offset. After four years, the level of offset declines, such that while provincial direct revenues may well grow as White Rose and later, Hebron/Ben Nevis, come on stream, the level of additional money received from the Equalization offset will diminish by 10% per year. On this point, proponents of an amendment to the Atlantic Accord are correct. That is what the Accord provides.
In assessing this argument, it is important to compare the intentions of the Trudeau and Mulroney governments on the revenue issue. The intention of the Mulroney government is clear: the Government of Newfoundland and Labrador would receive the right to set its own direct revenues for offshore resources, as if the resources were on land. Additionally, for a period of 12 years, the province would receive additional money in the form of an Equalization offset. The province would also receive local job and industrial spin-off benefits. That is what the Atlantic Accord provides; that is what has occurred.
The Trudeau government approach was different in one key respect. “The province will receive all provincial-type taxes and the largest remaining federal tax, the Petroleum and Gas Revenue Tax, the PGRT. No one can question the generosity of this proposal. When would the provincial government be expected to share some of these revenues with other Canadians? Not until the Newfoundland Government’s fiscal capacity reached 110 per cent of the national average, with an adjustment for regional unemployment that would now raise this to about 125%.”
More significantly, the Trudeau revenue sharing arrangements reflect the strategic policy commitment the Government of Canada was prepared to make prior to 1984. The federal proposal, made in September 1982, ‘ “recognizes the Government of Newfoundland and Labrador’s fundamental goal of attaining economic development and self-sufficiency by creating a strong and diversified provincial economy able to contribute fully to prosperity throughout Canada.” This goal is shared, the document states, by the Government of Canada.’
Therein lays the major flaw in the Atlantic Accord as it was originally proposed and signed: the duration of the province’s maximum potential revenues (direct revenues plus Equalization offsets) is determined by oil production levels, irrespective of the actual market value of the oil or the impact of oil development on overall fiscal capacity. Under the Trudeau proposal, it would have been linked to overall economic development.
Given the nature of industrial megaprojects of the type offshore Newfoundland and Labrador, it is not at all surprising that each project takes a considerable period of time to bring on stream. The Hibernia development agreement was signed in September 1990; first oil was achieved fully seven years later. It was fully two years after that date that Hibernia reached a sufficient level of production to trigger the Accord’s Equalization offset provisions.
Admittedly, the provincial government did not have the benefit of experience in making its calculations about the Atlantic Accord’s various benefits. However, as the overhead slide presentation indicates, the provincial government apparently anticipated rapid development of the existing fields, continued offshore discoveries at the pace experienced between 1979 and 1984/85, higher royalty regimes and oil prices remaining at then-prevalent levels.
It is beyond the scope of this paper to assess the validity of these assumptions in detail. Such an effort has not been undertaken to date and, in fact, much of the information required would be exempt from public disclosure since they were contained in documents submitted to cabinet. On the face of it, however, it would appear that the provincial government used optimistic projections when assessing the Mulroney offer. Any downward revision of their assumptions – for example, lower per barrel prices for oil – and the revenue impacts alter significantly.
Interestingly, according to slide 7, the provincial government expected that “have status” for Newfoundland and Labrador, i.e. that the province would no longer receive Equalization was “a foregone conclusion”. The one data table from 1985 that has been released (overhead slide 9) does not appear to support that contention, at least in so far as the chart might represent an anticipated worst case scenario. “Revenue and Equalization – 1985 Expectation” examines only royalties, instead of all revenue sources, and only from the Hibernia project. The graph clearly shows that royalties alone from Hibernia would not be sufficient to replace Equalization. In fact, anticipating the Accord offset provisions would begin in 1991, the graph shows the province expected Equalization transfer to climb beginning in 2004/05 and exceed pre-Hibernia levels by 2013.
That said, there can be no doubt that the Atlantic Accord Equalization offsets are working as intended by the Government of Canada and the Government of Newfoundland and Labrador. The provincial government expectations provided in the overhead slide presentation are not reflected in any aspect of the Atlantic Accord or the subsequent implementation legislation.
Given several years of experience and based on the intention of the federal government prior to 1984, it is possible to make a case for amending the Accord’s Equalization offsets. This will be addressed below.
Continued in Part 4