Pay provinces’ debt, seize the credit cards

by Neil Reynolds

OTTAWA — Canada has pressed rich countries to forgive the debts of poor countries. Or, at the least, to make the monthly payments for them. (Former finance minister Ralph Goodale proposed last year “a permanent debt relief solution” for poor countries — a program that requires rich countries to pay the poor countries’ debt service charges for the next 15 years.) Assuming that Canadians are in general agreement with this strategy, why don’t we extend the same principle to our own poor provinces? If it’s debt that keeps poor countries down, isn’t it reasonable to think that it’s debt that keeps poor provinces down? Why not require the federal government to assume this debt? Or, at the least, to make the monthly payments?

The short answer is that, after a fashion, we already do. Now pumping money to the provinces at a guaranteed rate of more than $10-billion a year, the federal equalization program pays the interest payments on all of the debt of all eight of the officially designated poorer provinces. Except for Quebec, which needs to top up its $4-billion equalization entitlement. Has the equalization program itself induced poorer provinces to go further into debt than they otherwise would have gone? Were the federal government to increase funding to these provinces, would they use it to finance more debt? What’s the purpose of equalization anyhow? To guarantee a decent level of essential public services? Or to make interest payments on past consumption?

In a think tank paper prepared last year for the federal government’s “expert panel” on equalization reform, the Halifax-based Atlantic Institute for Market Studies (AIMS) observed that equalization payments now encourage provinces to go deeper into debt. It noted “a troubling tendency” for poorer provinces to spend more than their own tax revenues can support. Who can doubt the temptation? In the short run, high debt and high taxes can enable a province to make itself poorer — and thereby collect full compensation for its fiscal excesses. It can pay, in other words, to get poorer, proving again that you get more of the behaviour you subsidize.

“Debt financing is a deadweight cost to provincial finances,” AIMS asserted. “Equalization dollars used simply to cover debt financing costs buy little or no public services. Over the past five years, equalization payments have offset provincial borrowing costs but with fewer services delivered.” This was obviously not what the fathers of Confederation intended when they entrenched the principle of equalization into the BNA Act in 1867. Or what their successors intended when they re-entrenched it in the Constitution Act in 1982.

Of all the poorer provinces, Quebec relies most heavily on equalization funds to make its interest payments. It uses 100 per cent of them — and, indeed, must use 5 per cent of its own revenue as well. (Quebec’s debt service costs equal 17 per cent of its own revenue.) Newfoundland covers all of its interest payments and has a few dollars left over. (Its debt service costs equal 35 per cent of its own revenue.) New Brunswick and Nova Scotia are a little better off. Although they have as much debt as Quebec — relative to their own revenues — they are able to direct some equalization funds to actual programs. For New Brunswick, it’s one-half. For Nova Scotia, it’s one-third.

The federal government has recognized the drag imposed by public debt on the provinces, calling it — in one 2004 Finance Department document — “critical.” Oddly enough, though, it still requires poorer provinces to remain deeply in debt in order to prove that they remain officially poor. On one level, this makes sense. How can you designate a province without debt as poor? Former prime minister Paul Martin’s side deal with Newfoundland and Nova Scotia on offshore oil revenues made this point explicitly.

Normally, a dollar in new tax revenue causes the loss of a dollar in equalization payments. In these deals, the government agreed to pay the provinces for any losses in equalization payments that offshore revenues might otherwise cause. The government further stipulated, though, that these “offset payments” would be made outside of the equalization program, ensuring that any extraneous flows of federal money into Atlantic Canada would not be officially confused with actual prosperity. And it stipulated — an otherwise odd condition, don’t you think? — that these offset payments might end in eight years unless the recipient provinces maintained “higher-than-average debt.”

This didn’t stop former Nova Scotia premier John Hamm’s from using the first offset payment that came his way to pay down $830-million in provincial debt — and from buying his province a higher credit rating. An excellent decision. And herein lurks a critical reform. As AIMS said in its equalization critique, the poorer provinces have mortgaged their capacity to provide public services. One way for the federal government to help? Forgive the provinces’ direct debt — all $250-billion of it. Swap equalization payments for the provincial mortgages. In exchange, take away the provincial credit cards. Debt-free Alberta, of course, would get nothing. Whether you regard this as good or bad will depend completely on your personal perspective.

A journalist for more than 40 years, Neil Reynolds has held top editorial positions at newspapers from coast-to-coast. Most recently, he was editor-in-chief of The Vancouver Sun. He held editor-in-chief positions at a number of newspapers, among them the Kingston Whig-Standard, New Brunswick Telegraph-Journal, Saint John Times Globe and  the Ottawa Citizen. He is national affairs columnist for the Report on Business section of The Globe and Mail. In his column, Reynolds writes on public policy issues from an economic perspective and is a strong advocate of policies that promote economic growth, supply-side tax reform, and small government.