Thursday, January 8, 2015

Will Ontario and Quebec Government Revenues Rise with the Falling Oil Price?

Lots of media talk recently about the changing of the guard in the Canadian economy. The oil-rich provinces of Alberta, Saskatchewan and Newfoundland will lose their economic mojo thanks to the recent halving of the world oil price. Ontario, Quebec and the other non-oil provinces will do relatively well after more than a decade of watching money and people flowing to the Alberta oil boom.
I believe macroeconomists' predictions that income will grow faster in Ontario and Quebec than in the oil provinces during 2015 and subsequent years if the price of oil stays low in the present US$50 range. 
In past years before Ontario qualified for federal equalization payments, we would expect faster economic growth in Ontario to generate faster growth in Ontario government revenue.
But, now that Ontario is an equalization recipient, I am not sure whether this expectation will come true. 
The Ontario government's own revenues from income, sales and other taxes will rise as the Ontario economy strengthens pulled along by rising demand for Ontario exports to the United States. But, as Ontario's economy strengthens relative to the Canadian average, Ontario's entitlement to federal equalization revenue will fall. 
Even worse, the sharp fall in Alberta, Saskatchewan and Newfoundland government oil revenue -- estimated in some reports to be more than $10 billion/year drop for the 3 provinces combined plus BC which has some oil -- will reduce equalization payments to all provinces because total provincial government revenue to be equalized will be that much less.
At one time, total revenues for an equalization-receiving provincial government were tied tightly to the fortunes of all provinces. An increase in Prince Edward Island's revenue capacity per person relative to the national average would be offset more or less dollar-for-dollar by a decline in equalization revenue per person. But, the equalization formula has been amended significantly over the past decade. 
Equalization adjustments to changing economic and fiscal circumstances are now much more gradual. It may be the case that the Ontario and Quebec governments will reap a short-term total revenue gain from the economic growth generated by the oil price fall. However, over time, it is possible that equalization losses will offset Ontario and Quebec government revenue gains. 
I am not certain that the oil price fall and Ontario's sunnier economic outlook improve the chances that the Ontario government can meet its target of balancing the provincial budget by 2017-18. Quebec is more ambitious with a goal of balancing the 2015-16 budget. The difference between Quebec and Ontario is that Quebec is taking concrete steps to reach the balanced budget target. If Quebec's total revenue growth remains weak, Quebec might still get to balance.
I would be very interested in hearing comments from anyone out there who has kept up to date with the complex operation of the federal equalization formula. Am I right to suspect that Ontario's total revenue may not be boosted, and may even be cut slightly, by the effects of the oil price fall on the equalization formula? 
(Update 1 January 2016: I was interested to see in recent media reports that Ontario may be on its way out of equalization.)

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