Prince Edward Island’s provincial government has historically relied on equalization payments as a significant source of revenue. In recent years, however, equalization payments have fallen markedly relative to the size of the provincial economy. Spending restraint and a willingness to make tough decisions will be necessary for the province to eliminate its large budget deficit and begin to reduce its large debt load in this context of reduced equalization payments.
In fiscal year 2009/10, Ontario became a “have-not” province and began receiving equalization payments. This development has had important implications for the smaller provinces that receive money under the program. The arrival of a new, much larger have-not province consuming equalization grants “squeezes out” each of the smaller recipient provinces to some extent. Exacerbating the situation further, Ontario’s emergence as a have-not province immediately followed a five-year period during which economic weakness in Quebec contributed to a large and sustained increase in that province’s share of equalization payments.
Statistics from Finance Canada succinctly tell the story. In fiscal year 2004/05, when the increase in Quebec’s share of equalization payments began to grow and Ontario was still a “have” province, those two large provinces combined received 37 per cent of all equalization payments; the smaller provinces received 63 per cent. By 2014/15, largely because of growing payments to Quebec and the arrival of Ontario as a have-not, those numbers have been completely reversed. Ontario and Quebec will consume 67 per cent of all equalization payments in this fiscal year, whereas the remaining provinces will receive 33 per cent.
All four of the smaller provinces that continue to receive equalization payments saw their share decline during this period. The decline in P.E.I. has been particularly pronounced since Ontario became a have-not province. In 2009/10, the first year that Ontario began receiving equalization payments, P.E.I. received 2.3 per cent of all equalization payments. In this fiscal year, that share will have dropped to 2.1 per cent. As a share of GDP, equalization payments to P.E.I. have declined by 11 per cent over the five year period since Ontario became a have-not province.
The 11 per cent decline in equalization payments as a share of GDP represents a significant and relatively sudden reduction in a major source of provincial revenue. In total, P.E.I.’s annual equalization payments have decreased by 0.74 per cent of the province’s entire gross domestic product (GDP) since fiscal year 2009/10. To help put this figure in context, the provincial government projects the fiscal year 2014/15 budget deficit to be 0.69 per cent of provincial GDP. In this fiscal year, the reduction in equalization payments as a share of GDP from 2009/10 levels is, therefore, slightly larger than the province’s entire projected budget deficit of $40 million.
Declining equalization payments as a share of P.E.I.’s GDP is clearly a contributing factor to the fiscal challenges facing the province. This decline, however, should not be taken as evidence that the federal government has been overly parsimonious with respect to transfers to the provinces. In fact, federal transfers to the provinces are currently quite generous in historical terms.
Over the course of the 1970s, combined federal transfers to all of the provinces averaged 4.3 per cent of GDP on an annual basis. This number fell during the 1980s and 1990s, but then began to increase again during the first decade of the new millennium. In the past five years, federal transfers to the provinces have averaged 4.2 percent of GDP, almost the exact same level that prevailed during the high-spending 1970s.
Given that overall federal transfers are at historically high levels, and that the federal government has signaled it does not intend to significantly increase overall transfers to the provinces, the prudent course for P.E.I. is to assume that help is not on the way.
It would be unwise to depend on a prolonged economic turnaround in Ontario that may or may not materialize to return that province to long-term “have” status and free up equalization dollars for others. Instead, P.E.I.’s government should assume it will have to address its daunting fiscal challenges for itself. The province faces a significant budget deficit in fiscal year 2014/15 and a per capita net debt load approaching $15,000. Returning the province to fiscal balance in the context of reduced equalization payments will be difficult, and will require committed spending restraint and pro-growth economic policy to boost own-source revenue in the years ahead.
Ben Eisen and Shaun Fantauzzo are researchers with the Atlantic Institute for Market Studies and David Murrell is a professor of economics at the University of New Brunswick. They are co-authors of “Declining Equalization Payments and Fiscal Challenges in the Small ‘Have-not’ Provinces”