Archived - Backgrounder on Equalization and Territorial Formula Financing Renewal

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Since 2006, the Government has made significant investments in major transfers.

Long-term, predictable transfer arrangements have ensured that major transfer support to provinces and territories in 2013-14 will reach a record level of $62 billion, including $16.1 billion in Equalization and $3.3 billion in Territorial Formula Financing (TFF).

Equalization enables less prosperous provincial governments to provide their residents a range and level of public services comparable to those offered by the other provinces, at comparable levels of taxation. Likewise, TFF enables territories to offer services comparable to those offered by provinces at a comparable level of taxation.

From 2005-06 to 2013-14, the Equalization program has grown by almost 50 per cent and TFF by 60 per cent. Equalization will continue to grow in line with the rate of growth of the economy, while TFF will grow according to its legislated gap-filling formula.

Equalization since 2005-06

For details, refer to the preceding paragraph.

Calculating Equalization and TFF payments

Equalization entitlements are determined by measuring provinces' ability to raise revenues – known as "fiscal capacity". Before any adjustments, a province's per capita Equalization entitlement is equal to the amount by which its fiscal capacity is below the average fiscal capacity of all provinces. Provincial Equalization amounts are then subject to a fiscal capacity cap and a ceiling to ensure fairness among provinces and sustainable program growth. More information on the calculation of Equalization payments is available on Finance Canada’s website.

The TFF program uses a gap-filling formula to recognize the unique circumstances of the territories.  Each territory’s grant is based on the difference between a proxy of its expenditure needs and its capacity to generate revenues (eligible revenues). Eligible revenues are made of two elements: seven of the largest own-source revenues for the territories are measured using a Representative Tax System (similar to that used by the Equalization program) and the remaining eleven sources are estimated in a revenue block. More information on the calculation of TFF grants is available on Finance Canada’s website.

2014-15 Transfer Renewal

The legislation governing Equalization and TFF has typically been renewed every 5 years. Prior to the introduction of renewal legislation, the programs are subject to a technical review to consider newly available sources of data and suggest adjustments to the calculation to better reflect provincial and territorial taxing practices.

While Equalization and TFF are federal programs funded entirely from federal government revenues, the technical review of these programs is conducted in collaboration with the provinces and territories, in recognition of the important role these programs play in the Canadian federation.  

The current Equalization and TFF legislation is set to expire at the end of the 2013-14 fiscal year. At the June 2010 Finance Ministers Meeting, the Honourable Jim Flaherty, Minister of Finance, and his provincial-territorial counterparts jointly mandated their officials to undertake a review of the two programs to identify technical changes that would ensure these programs are continuing to meet their goals. This technical work is now complete and has helped to inform renewal discussions among federal, provincial and territorial Finance Ministers.

Improving Equalization and TFF

On December 17th, Minister Flaherty proposed to his provincial and territorial counterparts a small set of technical changes to the Equalization and TFF programs for the 2014 legislative renewal. These changes, which build on the improvements made in 2007, will increase the accuracy of the programs by simplifying elements of their formulas; incorporating the most up-to-date data; better aligning sources of provincial and territorial revenues with measures of fiscal capacity; and ensuring a more consistent treatment of certain revenue sources.

Equalization

The Government is proposing to better classify certain sources of revenue in the formula. In particular, all hospital and medical insurance premiums would be part of the personal income tax base; miscellaneous motive fuel taxes that are currently grouped with property taxes would be re-classified as consumption taxes; and fines and penalties paid by businesses would be treated with other sources of business income.  Certain insurance premiums currently in the program constitute user fees and would be removed to ensure consistent treatment with other user fees.      

The calculation of fiscal capacity for personal income tax would be simplified by using a measure gross of refundable tax credits, while the calculation of fiscal capacity for general sales taxes would be streamlined by reducing the number of expenditure categories. These changes would improve program accuracy.

The Government is also proposing to further simplify the consumption tax base by using expenditures net of taxes in the measure of fiscal capacity from these revenues to ensure that this measure remains neutral to provincial taxation choices.

Finally, the Government is proposing to update the weights applied to general sales taxes and in the property tax base to better reflect current data.

Territorial Formula Financing

The Government is proposing to increase the responsiveness and accuracy of TFF by converting the revenue block into Representative Tax System (RTS) measures, as is currently the case for the other TFF revenues.  This change would improve the measures of fiscal capacity in the program and better align these measures with their equivalents in Equalization. These changes would be matched by an adjustment to the proxy of expenditure needs for each territory to ensure grant neutrality in 2014-15. In addition, the weights and parameters used in the gasoline, diesel and payroll tax bases would be updated to better reflect current taxing practices and the technical changes being proposed for Equalization would be implemented, where appropriate, in TFF.