Federalism

The Canada-US Softwood Lumber Dispute

Jay Makarenko — Tue, 10 Jun 2008 09:57:34 -0600

The Canada-US softwood lumber dispute has been one of the longest and most significant trade disputes between the two countries in modern history. Central to the dispute is not only competition between Canadian and US softwood lumber companies, but also conflict over basic forestry management styles. This article discusses the North American softwood lumber industry and explains the nature of the dispute, including its basic issues, its history and the signing of the 2006 Softwood Lumber Agreement.

The North American Softwood Lumber Industry

Structure and importance of the softwood lumber industry

Issues in the Canada-US Softwood Lumber Dispute

What exactly is the softwood lumber dispute about?

History of the Canada-US Softwood Lumber Dispute

Overview of the dispute between 1980 and 2001

2001-2006 Canada-US Softwood Lumber Dispute

Issues and litigation in the recent Canada-US softwood dispute

2006 Canada-US Softwood Lumber Agreement

Highlights of the recent Canada-US softwood lumber deal

Sources and Links to More Information

List of article sources and links to more on this topic

*Note: This article was originally written by Rhonda Parkinson. It has since been altered and updated by Jay Makarenko.

The North American Softwood Lumber Industry

Structure and importance of the softwood lumber industry

What is Softwood Lumber?

It is important to remember that the Canada-US softwood lumber dispute does not involve the entire North American lumber industry, but simply one component; namely, the softwood lumber sector.

Softwood is a classification of wood based upon the tree’s method of reproduction. Softwood trees are gymnosperms, developing from seeds that produce no outer covering. A pine cone is an example of the type of seed produced by a gymnosperm. Hardwood trees, on the other hand, are angiosperms, growing from seeds that are fully enclosed. While softwood trees have needles or scale-like leaves, hardwood trees have broad, flat leaves. Softwood includes a number of trees such as cedar, Douglas fir, pine and spruce commonly found in North America.

Softwood forests are found in both Canada and the United States. In Canada, softwood forests make up two-thirds of forested land available for timber production, and can be found in most provinces and territories. The largest Canadian softwood forests are in British Columbia. In the United States, softwood forests are predominant in the Pacific Northwest and in the southern US.

Softwood Lumber Industry

Softwood lumber forms the bulk of wood used commercially in North America. It has a wide range of uses, the most important of which is for structural building components. Softwood is also used for furniture, millwork (mouldings, doors and windows), paper production and for various types of boards, such as MDF.

Canada is one of the largest softwood lumber producers and exporters in the world, with a large portion of the industry in British Columbia. Canadian export of softwood lumber to the US is a multi-billion dollar industry, employing thousands across the country. In 2005 alone, Canada exported 21.5 billion board feet of lumber to the US, totaling $8.5 billion in trade (Foreign Affairs and International Trade Canada, 2006).

Different Forest Management Styles

A key element of the softwood lumber dispute involves differences between Canada and the US concerning forest ownership and management styles. In the United States, the majority of forest land is privately owned; nearly 90 per cent of lumber production takes place within privately owned forests. Under this system, forested land is held in fee-simple ownership, whereby the owner (and his/her heirs) can manage, sell or transfer the property as s/he sees fit.

The situation is very different in Canada, where more than 90 per cent of the nation’s forests lie within lands owned by federal or provincial governments (also known as Crown land). The provinces own the majority of Crown land (78 per cent), while the federal government owns 22 percent. Overall, the provinces own 90 per cent of land classified as productive forest land, that is, land capable of producing more than a certain quantity of wood annually. The territories fall into a separate category, and will be discussed later.

This difference between Canada and the US, in terms of public and private ownership of forestry resources, has led to a significant divergence in the stewardship of their respective forestry industries. In the United States, companies compete for the right to harvest wood through an auction method on the open market.

In Canada, companies wishing to harvest wood from government-owned land do not compete with one another on the open market. Each company enters into a tenure agreement with the provincial government, whereby the company is granted a licence to harvest trees from a specified portion of Crown land. Tenures can be of short- or long-term duration. They may be area-based or volume-based tenures, granting the company either the right to manage the area or simply to obtain a specified volume of wood. The tenure holder then pays the provincial government a fee for the wood they harvest, commonly referred to as a “stumpage fee.”

A similar situation exists in the territories, where significant portions of federal Crown lands are located. In recent years, the federal government has handed responsibility for managing these lands to territorial governments, while retaining ownership. Accordingly, companies wishing to harvest wood enter into an agreement and pay stumpage fees to the territorial government, not the federal government.

Each province or territory is responsible for setting the terms of tenure agreements. All tenure agreements require the tenure holder to follow responsible conservation and forest management practices. This is particularly true of longer-term tenures, where the company is granted a licence to manage the designated forest area.

Each province or territory is also responsible for the method of determining stumpage fees. Often, governments factor in non-market-based criteria when setting stumpage fees, such as provincial revenue goals or the job-creation potential of the contract. Stumpage rates may also reflect the cost, to the forest company holder, of following responsible forest management policies. The goal is to encourage forest companies to be “good stewards” of the forest. Consequently, stumpage fees are often lower than the market price.

Issues in the Canada-US Softwood Lumber Dispute

What exactly is the softwood lumber dispute about?

The softwood lumber dispute comprises many different issues. The following provides a brief overview of a few key elements.

Provincial/Territorial Stumpage Fees

Canada’s system of stumpage fees, whereby forest companies pay a fee to a provincial or territorial government for the right to harvest and/or process wood on a specific piece of land, is a major source of contention. The US contends that Canada’s provincial and territorial governments are subsidizing forestry companies by setting the stumpage fees too low. This gives Canada’s softwood lumber exporters an unfair pricing advantage over American softwood suppliers, who must sell their lumber at a price that reflects the real economic cost of harvesting the wood.

International trade laws stipulate that if Canada is subsidizing the softwood lumber industry, the United States has the right to even out the situation by applying a “countervailing duty” to imports of Canadian softwood lumber. International trade panels have ruled, however, that Canada’s system of stumpage fees does not meet the legal definition of a subsidy.

Allegations of Canadian Dumping

A more recent issue in the softwood lumber dispute involves American claims that Canadian forest companies are “dumping” lumber — pricing softwood lumber in the US market at a price below the cost of production or, at least below the price for which it would sell in Canada. The Americans allege that “dumping” has allowed Canada’s softwood lumber exporters to claim a higher portion of the American softwood lumber market than would otherwise be the case. In this regard, the US has won several decisions under the North American Free Trade Agreement (NAFTA) and the World Trade Organization (WTO) on this issue, although both concluded that the mechanism used by the United States to determine the percentage of duties to be applied was flawed.

Canada’s Multi-Jurisdictional Forestry Management System

Attempts to resolve the ongoing softwood lumber dispute between Canada and the United States are complicated by the number of players involved. Instead of dealing with one government (Canada), US trade negotiators must enter into talks with, and understand the forestry management systems of, several provincial governments.

The process is further complicated by the frequent lack of consensus among the provinces over how softwood lumber negotiations should proceed; a concession that one province is willing to make in order to reach an agreement may be unacceptable to another. Furthermore, the provinces may also disagree with the federal strategy. Prior to reaching the most recent agreement in 2006, for example, the federal government took a very adversarial position towards the United States, at least publicly. By contrast, several provinces, such as British Columbia, made it clear they were more interested in reaching a compromise with the US than in starting a trade war.

History of the Canada-US Softwood Lumber Dispute

Overview of the dispute between 1980 and 2001

The softwood lumber dispute between Canada and the United States has been an ongoing disagreement which began in the early 1980s. In actuality, there have been four different trade disputes, which are commonly referred to as Lumber I, Lumber II, Lumber III and Lumber IV. The following provides an overview of each dispute.

Lumber I: 1982-1983

The first Canada-US lumber dispute occurred in 1982, when the US Department of Commerce investigated the stumpage programs of British Columbia, Alberta, Ontario and Quebec. Upon completing its investigation in 1983, the Department of Commerce concluded that the provincial stumpage programs were not open to countervailing duties, because stumpage was generally available and not limited to a specific industry. Under US law, a good from another country is only considered subsidized if the program is available only to a specific industry. Provincial stumpage programs, however, were available to the entire timber sector, not just to the softwood lumber industry.

Lumber II: 1986-1987

Following the first softwood lumber dispute, two significant changes occurred. First, the US Department of Commerce began to apply US trade law more aggressively, especially in natural resource countervailing duty cases. Second, the Coalition for Fair Lumber Imports, the US lumber industry coalition and lobby group which favours high duties on Canadian softwood lumber, emerged as a well-funded and politically connected group in the US.

In 1986, the US Department of Commerce initiated another investigation of Canadian stumpage programs, this time concluding that they represented unfair subsidies. As a result, the US government levied a 15 per cent tariff on Canadian softwood lumber imports.

Later that year, the governments of Canada and the United States signed a five-year Memorandum of Understanding (MOU), under which the US would drop its 15 per cent tariff. In its place, the Canadian government agreed to impose a 15 per cent export charge on lumber exports to the US. The MOU also allowed provinces and territories to replace the export charge through other policy changes, such as increased stumpage fees.

The Memorandum meant that Canadian softwood companies would have to submit to a 15 per cent charge when exporting their products to the US. However, it did have several advantages for Canada. By making it an export charge collected by Canada, the money was kept within the country, as opposed to going to US coffers in the form of a countervailing duty. Moreover, it gave Canadian companies some measure of predictability, as Canada itself controlled the level of the charge, as opposed to it being controlled by US authorities.

It is important to note that under the Memorandum the Canadian government did not admit that stumpage fees represented a form of government subsidies. Instead, it simply volunteered to impose the 15 per cent export charge on softwood lumber exports.

Lumber III: 1991-1996

The Memorandum increasingly became viewed by some provinces, in particular British Columbia, as an infringement of provincial sovereignty. Pressure grew within Canada to eliminate the Memorandum, and the federal government unsuccessfully attempted to negotiate its termination with the US government. In 1991, Canada unilaterally withdrew from the agreement and ended the practice of imposing a 15 per cent charge on softwood exports to the US.

This initiated another investigation of provincial/territorial stumpage fees by the US Department of Commerce. In 1992, the Department imposed a 6.51 per cent countervailing duty on Canadian softwood lumber (although, the precise duty varied from province/territory to province/territory, depending on its particular stumpage programs).

This led to a number of legal battles between Canada and the United States under the Canada-US Free Trade Agreement. As a result of these battles, the US Department of Commerce eventually revoked its countervailing duty order in 1994. That same year, Canada and the United States agreed to implement a consultative process on softwood lumber trade in order to eliminate any further trade disputes.

This consultative process resulted in the 1996 Softwood Lumber Agreement. Under the agreement, Canada was permitted to export 14.7 billion board feet annually to the United States free of any export charges or duties. Exports above this threshold would then be open to escalating charges. The US, in turn, agreed not to initiate a trade case for the duration of the agreement. It is important to note that these restrictions applied only to the softwood exports of Alberta, British Columbia, Ontario and Quebec.

For more information on the 1996 Softwood Lumber Agreement:

Government of Canada: Softwood Lumber Agreement 1996

2001-2006 Canada-US Softwood Lumber Dispute

Issues and litigation in the recent Canada-US softwood dispute

The 1996 Softwood Lumber Agreement managed to bring some level peace in Canadian-US trade relations in softwood lumber. In 2001, however, the agreement expired, leaving both countries without a framework for managing softwood lumber trade. This led to another softwood lumber dispute between Canada and the US, commonly referred to as Lumber IV.

US Actions Against Canadian Softwood Lumber

Immediately following the expiration of the 1996 Agreement, the US Coalition for Fair Lumber Imports filed a countervailing duty and anti-dumping petition against the Canadian softwood lumber industry. This represented the first time allegations of dumping had been made against Canadian companies.

See the Issues in the Canada-US Softwood Lumber Dispute section of this article for more information on the dumping issue.

In 2001, the (US) International Trade Commission made a preliminary ruling that subsidies to Canada’s softwood lumber industry posed a threat of injury to the United States softwood lumber market. In August 2001, the US Department of Commerce imposed a countervailing duty of 19.31 per cent on Canadian softwood lumber imports.

In October 2001, the US Department of Commerce determined that Canadian companies were “dumping” softwood lumber (selling it in the US market at a price below market value) and that an additional “anti-dumping” duty of 12.57 per cent should be applied to US imports of Canadian softwood lumber.

In April 2002, the Department of Commerce reached a final determination that the countervailing and anti-dumping duties should be lowered to 18.79 per cent and 8.43 per cent, respectively. The total amount of duties charged on imported Canadian softwood lumber was set at 27.22 per cent.

Litigation of the Softwood Trade Dispute

Canada responded to the duties by launching several trade challenges. At both the World Trade Organization (WTO), and under the North American Free Trade Agreement (NAFTA), Canada requested separate panels to examine all three determinations made by the US Department of Commerce: 1) Canadian softwood lumber exports are unfairly subsidized; 2) the subsidies pose a threat of injury to the US market; and 3) Canadian lumber firms are “dumping” softwood lumber onto the US market.

The history of this litigation has been rather complex, largely due to contradictory rulings by separate panels. Additionally, rulings against the US have often been based on technical issues, or the need for more information, as opposed to a clear victory in Canada’s favour for the right to export softwood lumber to the US duty free. Due to the complexity of the issues, both countries often hail rulings as victories.

Under NAFTA, a July 2003 ruling supported US anti-dumping duties, but also ruled that the method used to calculate the duties was flawed. Similarly, in August 2003, a NAFTA panel ruled that the Canadian softwood lumber industry was indeed being subsidized, but, again, that the method the US used to determine the level of subsidy was flawed (resulting in excessively high duties).

Despite these findings, in August 2003, a subsequent NAFTA panel ruled that the US had not provided sufficient evidence to show that domestic softwood lumber producers were threatened with injury from Canadian softwood lumber imports. In 2004, following similar rulings by subsequent panels, the US requested an Extraordinary Challenge Committee under NAFTA to review the issue. In August 2005, the Committee affirmed the original decision. This was significant, as countervailing and anti-dumping duties can only be imposed if the dumped or subsidized imports are deemed to cause, or have the potential to cause, a threat of injury to the domestic industry.

In March 2006, a NAFTA panel ruled in Canada’s favour, finding that the Canadian stumpage program did not constitute a subsidy of softwood lumber exports. By this time, the total duties collected by the US had reached $5.2 billion (CBC, 2006).

The WTO panels customarily made rulings similar to those of the NAFTA panels. However, in August 2005, the WTO reversed itself on an earlier decision, concluding that Canadian softwood lumber imports did constitute a threat of injury to the US market.

Dispute over Repayment of Duties

The contradictory rulings of the NAFTA and WTO panels led to a further dispute over whether or not the United States was obligated to repay billions of dollars in softwood lumber duties it has collected. Canada took the position that the US must return billions of dollars in duties it has charged on imports of Canadian softwood lumber. The US took that position that Canada must return to the bargaining table before it would discuss any repayment of duties. Canada broke off scheduled talks on softwood lumber after the US announced it would ignore the decision of the 2005 NAFTA Extraordinary Challenge Committee and would continue to pursue its case at the WTO.

2006 Canada-US Softwood Lumber Agreement

Highlights of the recent Canada-US softwood lumber deal

In April 2006, the Canadian and US governments announced that they had reached a framework agreement for settling the softwood lumber dispute. In July 2006, representatives from both countries formally signed the legal text of the agreement, and it was passed into law by the federal Parliament in December 2006.

Highlights of the 2006 Softwood Lumber Agreement

Under the new softwood lumber agreement, the United States agreed to remove its countervailing and anti-dumping duty orders on Canadian softwood lumber. Furthermore, the US agreed to return more than $4.5 billion in duties it had collected since 2002. This represented a large portion of the total duties it had collected. The US also agreed not to initiate any new investigations against Canadian softwood lumber during the period of the agreement.

In exchange, Canada agreed to a cap on its softwood exports to the US at 34 per cent of the US market. Furthermore, Canada agreed to impose an export charge on Canadian softwood lumber exports when the price of lumber is at or below US$355 per thousand board feet. These charges are collected by the federal government, and then transferred back to the provinces.

Both Canada and the United States further agreed to terminate all litigation before the entry into force of the agreement (such as pursuing cases through NAFTA and the WTO). The 2006 Agreement also provided a broad framework for dispute settlement. Disputes relating to the agreement are to be resolved through a final and binding dispute-settlement process. The process is to be neutral, transparent and expeditious.

The new agreement only applies to the provinces of Alberta, British Columbia, Saskatchewan, Manitoba, Ontario and Quebec. The Atlantic Provinces and the territories are excluded from the agreement because their timber industries do not operate on a provincial/territorial stumpage fee system. As such, they may export softwood lumber to the US free of any restrictions or duties.

The length of the agreement is seven years, beginning in 2006, with an option to extend it for an additional two years. Although, under the initial agreement signed in July 2006, either country could unilaterally exit after three years.

Amendments to the Initial Softwood Lumber Agreement

While the initial Softwood Lumber Agreement was signed in July 2006, there remained some opposition in the Canadian softwood lumber industry, as well as from the government of British Columbia. Of particular issue was a provision that allowed either Canada or the United States to unilaterally terminate the agreement after only three years. The concern was that this would undermine the value of the agreement, and allow the US to reintroduce duties unilaterally as early as 2009.

In response, the federal government negotiated with the US to rework the deal, to make it harder for the US to exit the agreement. For example, under the amendments, if the agreement isn’t renewed, or if the US unilaterally decides to terminate the agreement, then it cannot re-impose duties until one year after the end of the deal. The US is also now required to provide Canada with six months’ notice before ending the agreement, up from three months in the initial deal.

Sources and Links to More Information

List of article sources and links to more on this topic

Sources Used for this Article

“Softwood Lumber Dispute.” CBC. 23 August 2006. 04 May 2008. <http://www.cbc.ca/news/background/softwood_lumber/>
“Softwood Lumber.” Foreign Affairs and International Trade Canada. 11 October 2006. 04 May 2008. <http://www.dfait-maeci.gc.ca/eicb/softwood/intro-en.asp>
“Softwood Lumber Agreement 1996.” Foreign Affairs and International Trade Canada. 11 October 2006. 04 May 2008. <http://www.dfait-maeci.gc.ca/eicb/softwood/sla-en.asp>
“The Canada-US Softwood Lumber Agreement.” Foreign Affairs and International Trade Canada. 17 October 2006. 04 May 2008. <http://www.dfait-maeci.gc.ca/eicb//softwood/SLA-backgrounder-en.asp>
“Canada-US Lumber Trade Disputes.” British Columbia Ministry of Forests and Range. 05 July 2002. 04 May 2008. <http://www.for.gov.bc.ca/HET/Softwood/disputes.htm>

Links for More Information

Auto Insurance in Canada: Overview and Issues

Jay Makarenko — Fri, 02 May 2008 11:24:47 -0600

Auto insurance is a central issue in provincial and territorial politics, and a highly complex area of public policy. In Canada, the industry reflects a collection of provincial and territorial systems, each differing significantly in how auto insurance is delivered and regulated. This article offers an introduction into auto insurance policy in Canada, and includes a look at auto insurance in the context of federalism, alternative models of auto insurance, provincial/territorial auto insurance systems, and key issues and debates in this public policy area.

Auto Insurance and Canadian Federalism

Federal and provincial jurisdictions in auto insurance

Alternative Models of Auto Insurance

Overview of different possible auto insurance systems

Auto Insurance Systems Across Canada

Comparison of provincial/territorial auto insurance systems

Issues in Auto Insurance in Canada

Key public policy debates on auto insurance

Sources and Links to More Information

List of article sources and links to more on this topic

Auto Insurance and Canadian Federalism

Federal and provincial jurisdictions in auto insurance

Canada does not have a national auto insurance system, but instead a collection of different provincial and territorial regimes. This is due, in large part, to Canada’s system of federalism, and its division of powers and responsibilities between the different levels of government.

Provincial/Territorial Jurisdiction in Auto Insurance

Under the Canadian Constitution, jurisdiction over auto insurance falls predominantly to the provincial level of government. Only provincial governments have the constitutional power to create auto insurance schemes and regulate auto insurance practices. As such, provincial governments have the power to establish public or private auto insurance schemes, to regulate the conduct of auto insurers (providers of auto insurance policies), and regulate the rights and obligations of the insured (holders of auto insurance policies). In sum, the various auto insurance options that are available to Canadians are the direct result of decisions and policies chosen by their respective provincial governments.

As territories, the Northwest Territories, Yukon, and Nunavut do not have any autonomous powers under the Canadian Constitution, but are instead entities of federal legislation. Nevertheless, the federal government tends to provide the territories with similar powers and jurisdictions as the Canadian provinces. This is also the case in the area of auto insurance; the territories enjoy the same powers as the provinces – both to create their own auto insurance schemes and to regulate general auto insurance practices.

Federal Jurisdiction in Auto Insurance

Under the Canadian Constitution, the federal government does not have jurisdiction over the establishment and regulation of auto insurance regimes. Nevertheless, it does have a significant role to play in the industry as a whole.

The federal government is responsible for the prudential supervision of auto insurance providers that are incorporated under federal legislation. This includes Canadian insurers that operate in more than one province, as well as foreign insurers that have branch operations in Canada. In its role as “prudential” supervisor, the federal government is responsible for ensuring these insurers exercise caution and good judgment in the management of their business matters. Of primary concern is protecting the solvency of insurers and reducing the risk of a general collapse of the insurance industry, which would be highly detrimental to the national economy.

For more information on the federal prudential supervision of auto insurers:

Government of Canada: Office of the Superintendent of Financial Institutions Canada

Federal responsibility in this area does not extend to regulating the general market conduct of insurers (such as the terms and conditions of their insurance policies). This falls strictly under provincial jurisdiction. Moreover, Canadian insurers that operate in only one province may incorporate under provincial legislation, with the respective provincial government being responsible for the prudential supervision of these insurers.

In addition to its role as prudential supervisor, the federal government also has an indirect influence on the basic terms and conditions of auto insurance policies. Many auto insurers, for example, deny insurance coverage in cases where a motor vehicle is operated in a prohibited manner, or is used in the commission of an illegal act (such as a robbery). What counts as an illegal act depends largely on federal legislation, such as the Canadian Criminal Code.

Another important aspect of federal influence is the Canadian Charter of Rights and Freedoms and the judicial branch of government. The Charter is legislation, entrenched in the Canadian Constitution, which sets out the basic citizen rights and freedoms. All government laws and regulations, including those regarding provincial and territorial auto insurance systems, must be consistent with the Charter. In Canada, the judicial system also plays a central role in relation to auto insurance in that it settles auto insurance-related legal disputes, in addition to reviewing provincial and territorial systems from a Charter perspective. At the pinnacle of the Canadian judicial system is the Supreme Court of Canada, a federally appointed and administered court.

Several examples illustrate the significance of these federal institutions on provincial and territorial auto insurance systems. In 2008, a provincial court struck down an Alberta law which capped insurance claims on soft-tissue injuries, concluding that the law violated the Canadian Charter (at the time of this article, the Government of Alberta had stated that it would appeal the decision). Additionally, during the 1970s, the Supreme Court of Canada rendered several decisions that effectively placed an upper limit on what persons could claim in financial compensation for non-pecuniary damages due to a motor vehicle accident. (These include damages such as a loss of future earnings, cost of future care, and awards for pain and suffering.)

Implications for Auto Insurance in Canada

The structure of federalism in Canada has an important impact on the auto insurance industry. As jurisdiction over the creation and general regulation of auto insurance falls exclusively under provincial and territorial authority, there is an absence of national institutions and legislation to create uniformity across the country. Instead, auto insurance in Canada is made up of a set of separate provincial/territorial auto insurance schemes based on rules and practices that differ greatly from one province/territory to another.

See the Auto Insurance Systems Across Canada section of this article for a comparison of auto insurance regimes by province and territory.

This, however, is not to suggest that national standards are impossible. Provinces and territories can voluntarily agree to uniform rules and practices. Moreover, the federal government also does enjoy some leverage in creating national standards through the use of other constitutional powers, such the federal spending power. In employing such as strategy, the federal government can offer financial enticements to persuade provincial and territorial governments to implement federal policies in auto insurance, much in the same way the federal government influences provincial/territorial health care insurance regimes. At the time of writing, however, no such cooperation has ever been pursued in any robust manner by either level of government.

Alternative Models of Auto Insurance

Overview of different possible auto insurance systems

Concept of Auto Insurance

Auto insurance is simply a system by which the owners/operators of motor vehicles may obtain financial protection against losses associated with that vehicle. This may include financial protection against the loss or damage of the vehicle, as well as personal injury or property damage caused in the vehicle’s operation.

Under most auto insurance schemes there is an insurer, which is the party (usually a private insurance company or government agency) that issues the insurance policy and provides the financial protection. Additionally, there is the insured, which is the party (either the operator or owner of the motor vehicle) that purchases the insurance policy and receives the financial protection.

In most cases, the insured purchases the insurance policy by paying an annual or monthly fee (or premium) to the insurer. In return, the insurer provides some guarantee of payment for any losses associated with the insured’s motor vehicle. If, for example, John (the insured) has his car stolen, then his auto insurance company (the insurer) will financially compensate John for the loss, usually by paying him the monetary value of the vehicle at the time it was stolen. The same is true in cases of personal injury. If John gets into an accident where the driver of the other vehicle is injured, then John’s insurance company will cover any financial liability incurred by John as a result of the accident (or up to the maximum compensation as set out in the insurance policy)..

Auto insurance, therefore, operates as a sort of financial safety net for persons in relation to the operation of their vehicles. On the one hand, it protects the insured from large financial losses stemming from the operation of his/her motor vehicle. Instead of having to pay for a new car, or pay for injuries incurred by others as the result of an accident, the insured only has to pay a regular and smaller insurance fee.

On the other hand, auto insurance provides financial protection to other persons besides the insured by guaranteeing financial compensation in cases of property damage or personal injury. If John didn’t have auto insurance, then the other driver may not have been able to receive compensation for his/her injuries, as John simply may not have had enough money on his own to pay. By having insurance, however, the other driver is guaranteed compensation – regardless of whether John personally has enough money, as the insurer should always have the capability to pay.

Within this basic framework, however, auto insurance schemes can operate in a number of very different ways. The following provides an overview of some key characteristics of different auto insurance systems.

Public versus Private Insurance Systems

One key distinction, especially in Canada, is private versus public systems of auto insurance. Public insurance systems are characterized by a single auto insurer which is publicly administered in some manner. The insurer may be a crown corporation or some other agency which is controlled by the government. Under pure public systems, then, persons seeking auto insurance only have the option of purchasing policies from the public insurer. Moreover, the public insurer is solely responsible for covering all financial liabilities incurred by insured owners and/or operators of motor vehicles in their jurisdiction.

Private insurance schemes, by contrast, are characterized by a plurality of private auto insurers. In a purely private system, auto insurers are non-governmental financial companies or institutions (such as banks or insurance corporations) which provide insurance policies to customers for profit. As such, persons seeking auto insurance may choose from a variety of different auto insurance products offered by a number of competing insurance providers.

It addition to purely public or private schemes, there can also be hybrid insurance systems, which incorporate both public and private characteristics. It may be the case that basic insurance products are provided through a single public insurer, while additional insurance products can be obtained through private auto insurance providers. Under such a system, all insured persons would have the same basic public coverage, but have the option of purchasing additional or secondary coverage from a variety of private, for-profit insurers.

Mandatory versus Voluntary Insurance Systems

Another key distinction is mandatory versus voluntary insurance system. Mandatory systems are characterized by government laws which require all persons whom own and/or operate a motor vehicle to purchase some level of auto insurance. As such, it is illegal, punishable under the law, to own and/or operate a motor vehicle without proper insurance. The purpose of this type of system is to ensure financial protection in the case of all losses associated with the operation of motor vehicles. As all persons or vehicles have (or should have) insurance attached to them, cases should not arise in which an injured party is unable to receive financial compensation because the driver does not have enough money to pay damages.

Voluntary insurance schemes, by contrast, are characterized by an absence of laws that require all persons whom own and/or operate a motor vehicle to obtain auto insurance. Persons are, instead, free to decide themselves whether or not to purchase insurance, and may own or operate a vehicle without coverage if they so choose. Under such a system, those without insurance are directly responsible themselves to cover any financial liabilities associated with operation of a motor vehicle.

Again, there can be hybrid systems, which blend characteristics of both a mandatory and voluntary system. It may be the case, for example, that persons are required to purchase insurance for certain kinds of financial liabilities (such as those arising from the injury of another party), but are free to purchase or decline insurance for other losses (such as theft, damage to one’s vehicle, or injury to one’s self).

Theoretically, public and private systems can involve either mandatory or voluntary insurance stipulations. In practice, however, it is generally the case that public systems involve some level of mandatory insurance. This can be due to a number of different factors. For example, public insurance systems are often viewed as “public goods,” in which the benefits and costs are to be shared by all in the community. It may also be the case that the government wishes to ensure the financial stability of its public insurance scheme by requiring all owner and/or operators to pay into the system.

Fixed versus Flexible Compensation Systems

Another key difference centres on the level of financial compensation that persons can receive when incurring property damage or personal injuries from automobile accidents.

Under a fixed system (also commonly referred to as a “cap system”), the level of compensation for specific damages or injuries is established by government legislation. In other words, the government explicitly sets out how much money persons can receive for particular sorts of property damage and/or personal injury. Persons are thus prohibited from negotiating or litigating for monetary settlements above the thresholds set out in the government legislation.

In a flexible system, by contrast, there is no fixed level of financial compensation – at least, not through government legislation. Under this sort of system, persons are free to negotiate or litigate whatever monetary settlement they desire. As such, compensation can range widely from case to case, as well as over time. What a person receives depends on what s/he can negotiate with the other party (be it an individual or insurance institution), or what is deemed proper by a court of law if the parties proceed to court.

Again, public and private schemes can have either a fixed or flexible system of compensation. Generally speaking, fixed systems are implemented as a means of reducing costs for the insurer, not only in terms of what they must pay for damages or injuries, but also in terms of the cost of litigating cases in the courts. Under a fixed system there is no opportunity to litigate the level of compensation; this is dictated by government legislation. Such savings can be beneficial in both a public or private context as a means of reducing or stabilizing insurance premiums.

At-Fault vs. No-fault Insurance

Another important distinction is between at-fault and no-fault insurance schemes. The key distinction here is which insurer is responsible for paying compensation for the damages or injury resulting from a motor vehicle accident.

Under an at-fault system, responsibility for paying compensation falls to the insurance institution that insured the person responsible for causing the accident and associated damages or injuries. Consider the example that follows: John and Jane are involved in an accident in which John ran a red light and side swipes Jane, causing damage to her car and minor injuries. As such, John is completely at fault for the accident. Under a fault-based system, John’s insurer is responsible for paying for the damages and injuries incurred by Jane. Moreover, in order to receive her compensation, Jane must either negotiate with John’s insurer or take her case to court.

Under a no-fault system, responsibility for paying compensation falls, at least initially, to the insurance institution of the person who experienced the damages or injury. In John and Jane’s accident, then, Jane would receive compensation for her loss from her own insurance company, even though it was John that caused the accident. Jane’s insurer would then be entitled to sue John’s insurer in order to recover the monies they paid out to Jane.

The commonly cited benefit of no-fault insurance is that it allows persons quicker access to financial compensation in addition to other insurance benefits (such as health care benefits). Under an at-fault system, responsibility for the accident often has to be established first before persons can access the benefits of their insurance. This can take some time, especially if the parties decide to litigate the case in court. Under a no-fault system, the issue of fault has no bearing on access to compensation or benefits. It is simply an issue for the insurers to figure out later on.

Regulation of Insurance Premiums

Auto insurance systems can also differ in their regulation of auto insurance premiums. Under a completely unregulated scheme, insurance institutions are free to charge any level of premiums to their clients they wish. Under a regulated scheme, the government establishes rules which restrict what insurers can charge their clients for insurance.

The level of regulation can differ substantially. It may be the case, for example, that a government simply wishes to protect consumers from large annual increases in insurance premiums. As such, it will enact legislation that limits the amount by which insurers can raise their premiums from one year to another. In may also be the case that a government wishes to deter profiling by insurance institutions when determining insurance. In this way, the government will pass legislation that prohibits insurers from charging higher premiums to particular individuals or groups because of their age, gender, or ethnicity. In the most extreme case, a government may wish to control insurance premiums completely, and will institute a government board or agency which has the power to set insurance premiums.

Auto Insurance Systems Across Canada

Comparison of provincial/territorial auto insurance systems

As already discussed, Canada’s auto insurance system is made up of a set of separate and different provincial and territorial regimes. The following section provides an overview of these provincial and territorial systems.

Mandatory Auto Insurance Regimes

All provinces and territories in Canada have mandatory auto insurance regimes which require motorists to purchase basic auto insurance. While this mandatory basic insurance always includes some level of coverage for property damage, personal injury, and third person liability, the precise level of this coverage can differ significantly from one jurisdiction to another. Above this mandatory basic insurance, motorists in all provinces and territories have the choice of whether to purchase additional coverage.

Public and Private Auto Insurance

All provinces and territories in Canada allow private institutions to offer insurance products to motorists. The level of this private participation, however, ranges greatly from one jurisdiction to another.

Nine provinces and territories have purely private auto insurance systems: Ontario, Alberta, Newfoundland and Labrador, Nova Scotia, New Brunswick, Prince Edward Island, Northwest Territories, Yukon, and Nunavut. In these jurisdictions, residents purchase their auto insurance strictly from private insurance institutions.

The four remaining provinces have hybrid auto insurance systems, which combine both public and private insurers. The hybrid systems of British Columbia, Saskatchewan and Manitoba are divided along “basic” and “additional” coverage. The mandatory basic insurance must be purchased through the provincial government insurer. If, however, residents desire additional insurance coverage, they have a choice of purchasing it either through the government insurer or through private insurance institutions.

Quebec’s hybrid system is divided along different lines. There, the government insures against injuries to people resulting from the operation of motor vehicles, while private institutions insure against damage to property. As such, residents have two auto insurance policies – one from the government and another from a private insurer.

Fixed versus Flexible Compensation Systems

All provinces and territories in Canada operate a fixed system in at least one respect. In a series of decisions during the 1970s, the Supreme Court of Canada established an “upper limit” or “cap” for non-pecuniary general damages resulting from motor vehicle accidents, which is applicable to all provincial and territorial auto insurance systems. As noted earlier, “non-pecuniary damages” include, for example, a loss of future earnings, the costs associated with future care, and awards for pain and suffering. “Pecuniary damages,” by contrast, include damages incurred during the accident. In 1978, the upper limit was set by the Court at $100,000, to be adjusted annually for inflation.

Generally speaking, most provinces and territories operate under a flexible compensation system within this general upper limit on non-pecuniary damages. Persons are entitled to claim any amount of financial compensation for pecuniary damages, and any amount up to the judicially established limit for non-pecuniary damages. The level of compensation persons receive depends on what they can negotiate with the insurer or successfully litigate in court.

Between 2000 and 2005, however, several provinces instituted elements of a fixed compensation system in order to curb rising auto insurance costs. New Brunswick, Nova Scotia, Prince Edward Island, and Alberta all introduced caps on compensation for minor injuries, ranging from $2,500 to $4,000.

These provincial caps for minor injuries have been recently challenged in the courts. In February 2008, an Alberta court ruled that Alberta’s $4,000 cap unconstitutionally violated the Canadian Charter of Rights and Freedoms. The decision potentially affects not only that province’s cap system, but also those of New Brunswick, Nova Scotia, and Prince Edward Island. At the time of this article, the Government of Alberta had announced its intention to appeal the decision.

No-fault Insurance Regimes

All provinces and territories in Canada have instituted some form of no-fault insurance, which provides motorists with some access to compensation and/or benefits through their own insurers, rather than having to deal strictly with the insurer of the at-fault party. The precise operation of no-fault insurance, however, ranges across jurisdictions.

On the one hand, Alberta motorists are only entitled to access very modest accident benefits through their own insurer, and must deal with the at-fault party’s insurer to recover additional damages. On the other hand, Quebec motorist have access to very substantial accident benefits through their own insurers, and are disallowed from suing the at-fault party’s insurer for additional damages. The other provinces and territories fall somewhere in between the Alberta and Quebec examples.

Regulation of Insurance Premiums

Each province and territory in Canada has its own system of regulating insurance premiums. Most jurisdictions have some government body which oversees the market conduct of insurers (private or public), including the amount of money they charge for their insurance policies. The power of these regulatory bodies, however, can range from jurisdiction to jurisdiction.

In Alberta, for example, the Automobile Insurance Rate Board (AIRB) has very robust powers to control premium levels for basic insurance coverage, including the authority to set the maximum chargeable premium for basic coverage. Private insurers (Alberta has a private insurance system) are prohibited from charging premiums above this government-set threshold; although, they are free to charge any amount less than the maximum allowable level. In Ontario (also a private system), the provincial government’s Financial Services Commission is responsible for overseeing auto insurance premiums. Unlike its Albertan counterpart, the Commission does not have the authority to set maximum chargeable premiums. That said, all insurers are required to submit applications to the Commission before changing their premiums. The Commission has the power to deny an application if it deems an increase to be unreasonable.

Additionally, all provinces and territories prohibit insurers from using certain profiling techniques when determining premiums for particular motorists. Again, this differs from jurisdiction to jurisdiction. Some provinces/territories place fairly severe restrictions on insurers, denying them from considering such things as age, ethnicity, marital status, and not-at-fault accident history. Other jurisdictions are more lenient in what insurers may and may not consider.

It’s also important to note that some jurisdictions have acted directly to regulate auto insurance premiums. During the early years of the new millennium, for example, several governments introduced legislation to temporarily freeze or reduce auto insurance premiums. This included the governments of Ontario, Alberta, Nova Scotia, New Brunswick, and Newfoundland and Labrador.

Issues in Auto Insurance in Canada

Key public policy debates on auto insurance

Auto insurance in Canada is often a highly political issue. The following section offers an overview of some of the key issues and debates that dominate this policy area.

Private versus Public Auto Insurance

One of the more contentious debates has been over basic framework of auto insurance; in particular, whether it should be a public or private system. The precise nature of this debate differs from jurisdiction to jurisdiction. In the Atlantic Provinces, for example, the debate is centred on whether or not to scrap current private auto insurance systems in favour of public systems. In British Columbia, by contrast, the debate revolves around whether to introduce more private participation in a predominately public industry.

The “private versus public” debate comes in many different shapes and sizes. Supporters of private auto insurance tend to emphasize the potential benefits of a free market system, such as greater choice for consumers and reduced premium cost due to competition by insurers. On the other side, supporters of public auto insurance tend to focus on the potential benefits of a universal, not-for-profit, and publicly administered insurance regime. This includes lower premiums overall (stemming from a larger economy of scale), reduced discrimination against certain groups of motorists (private insurers often charge higher premiums for certain demographic groups), and the ability to funnel any profits into other public goods, such as transportation infrastructure.

For an argument in favour of public insurance:

Canadian Centre for Policy Alternatives: Down the Road: The Implications of “Full Competition” for Public Auto Insurance in British Columbia (PDF)

For an argument in favour of private auto insurance:

Fraser Institute: The False Promise of Government Auto Insurance (PDF)

In assessing arguments in the private versus public debate, it’s important to remember the reality of auto insurance in Canada. There are no purely public or private systems. Instead, there are predominately public systems that have some level of private participation or predominately private systems that have high levels of government regulation. As such, the question is not necessarily which is better, a government system or a free market system? Instead, the issue is to what extent, and in what form, public and private actors should participate in the auto insurance industry?

Escalating Costs of Auto Insurance

Another key issue in auto insurance has been escalating premium costs. This issue was particularly resonant during the 2000-2005 period when many jurisdictions in Canada experienced substantial increases in insurance premiums from year to year.

One Year Change in Auto Insurance Premiums (2002-2003)

Jurisdiction	Type of System	Percent Increase

National Average		26.3
Alberta	Private	50.1
New Brunswick	Private	41.2
Newfoundland and Labrador	Private	40.0
Nova Scotia	Private	39.8
Quebec	Public/Private	30.9
Ontario	Private	27.7
Prince Edward Island	Private	24.8
Yukon	Private	18.1
Northwest Territories	Private	12.3
Saskatchewan	Public	9.5
British Columbia	Public	7.3
Manitoba	Public	0.1

(Source: CBC, February 18, 2005)

As the above table shows, jurisdictions with private insurance systems experienced the highest increases during this period. This resulted in public demands for governments to intervene in order to address the issue. As a result, several provincial governments took measures to curb auto insurance costs, ranging from instituting caps on damages for certain injuries, to enacting legislation which temporarily froze or reduced auto insurance premiums. New Brunswick even explored replacing its private insurance system with a fully public one, although the reform was never instituted.

One the more robust sets of reforms were implemented in 2004 by the Government of Alberta. Under new legislation, the government put into a place a Premium Grid which set out maximum thresholds private insurers could charge customers for basic coverage, in addition to placing a temporary freeze on auto insurance rates. Also, in an effort to control costs for insurers, the government instituted a $4,000 cap for minor injuries, such as minor sprains, strains, and minor whiplash. The limit did not extend to other damages, such as loss of income or medical expenses, or to serious injuries. (This limit was successfully challenged in court in 2008. See remaining paragraphs.)

Government Limits on Compensation

In 2003 and 2004, three provincial governments implemented caps on damages for minor injuries: New Brunswick, Nova Scotia, and Alberta. The purpose of these caps was to reduce auto insurance premiums for motorists by controlling costs for their insurers. With lower payouts for minor injuries, insurers could offer insurance policies at cheaper prices.

The government-instituted caps, however, were contested in court, and the first major ruling delivered in February 2008. An Alberta court found that province’s cap on minor injury damages to be in violation of the Canadian Charter of Rights and Freedoms on the grounds that it was discriminatory. At the time of this article, the Government of Alberta had stated its intent to appeal the court’s decision. If upheld, the decision could have important consequences for Nova Scotia and New Brunswick, whom have also instituted caps for damages in cases of minor injuries.

The issue highlights a difficult problem in auto insurance for both private and public systems: how precisely does one balance the rights of injured persons to receive fair compensation, while ensuring that persons have to access affordable auto insurance?

In this context, it’s worthwhile to note that other jurisdictions in Canada have attempted to address escalating auto insurance costs through other non-cap means. Newfoundland and Labrador has implemented a $2,500 deductible for all minor injury claims. While this is not a cap, it does reduce the sum that persons may receive for minor injuries. Other provinces, such as Ontario, have instituted special thresholds for minor injury claims. This threshold reduced the number of people eligible to make claims for minor injuries.

Sources and Links to More Information

List of article sources and links to more on this topic

Sources used for this Article

“Property and Casualty Insurance in Canada.” Department of Finance Canada. 11 December 2007. 17 March 2008. <http://www.fin.gc.ca/toce/2003/property_e.html>
Todd, R. “Alberta Cap Decision May Impact Ontario.” Law Times. 25 February 2008. 17 March 2008. <http://www.lawtimesnews.com/index.php?option=com_content&task=view&id=3900>
Parker, N. “Damages in Personal Injury Cases.” The Accident Report. Spring 2002, Vol. 2, No. 1. <http://www.rmrf.com/files/resourcesmodule/@random4293f2f916ea0/1117053062_accid.pdf>
Miller, S. “Recent Automobile Insurance Reforms in Canada (Special Report on Insurance).” From LawNow in Ecyclopedia.com. 04 January 2005. 17 March 2008. <http://www.encyclopedia.com/doc/1G1-130568768.html>
“What is No-Fault Auto Insurance?” Kanetix.ca. 17 March 2008. <http://www.kanetix.ca/what-is-no-fault-auto-insurance>
“Auto Insurance Grid Rate Calculator: background and Consumer Disclaimers.” Automobile Insurance Rate Board. 17 March 2008. <http://www.airb.gov.ab.ca/gridrate/>
“The Insurance Company You Choose.” Financial Services Commission of Ontario. 17 March 2008. <http://www.fsco.gov.on.ca/english/insurance/auto/undautoins.asp#InsCoYouChoose>
“Insurance…at a Premium.” CBC News. 18 February 2005. 17 March 2008. <http://www.cbc.ca/news/background/insurance/>

Links to More Information

Equalization Program in Canada: Overview and Contemporary Issues

Jay Makarenko — Thu, 24 Apr 2008 11:28:13 -0600

The Equalization Program is an important component of Canadian federalism and the notion of equality between provinces regarding the social services they provide. Moreover, the principle of equalization has been a major source of debate in Canadian politics, between the federal and provincial levels of government, as well as between provinces. This article provides an overview of the purpose, operation and history of the Equalization Program, including a summary of key contemporary issues and debates.

Introduction to the Equalization Program

Definition, purpose and history of equalization in Canada

Operation of the Equalization Program

The equalization formula and how the numbers are crunched

Issues and Debates on the Equalization Program

Contemporary issues on the operation and nature of equalization

Sources and Links to More Information

List of article sources and links to more on this topic

Introduction to the Equalization Program

Definition, purpose and history of equalization in Canada

Definition of the Equalization Program

Equalization is the Government of Canada’s program for addressing fiscal disparities between provinces. The territories do not participate in the Equalization Program (finances for the territories are governed under a separate program – the Territorial Formula Financing program). Under the Equalization program, the federal government makes financial transfers to the provinces in support of their spending initiatives. These federal transfers are unconditional block grants, meaning there are no federal conditions on the transfers, allowing the recipient province to spend the money however it chooses.

In this context, Equalization is one of three major federal transfer programs. The others are the Canada Health Transfer and the Canada Social Transfer.

Purpose of the Equalization Program

The purpose of the Equalization Program is to allow provinces to provide comparable levels of social services at comparable levels of taxation. The program’s goal is to ensure citizens in all provinces have access to roughly the same level of social services – such as education and social assistance – without having to pay exorbitant levels of taxation. In understanding this purpose more fully, it is important to note two sorts of fiscal imbalances that can arise in federations such as Canada – vertical and horizontal.

Vertical imbalance is an imbalance between the different levels of government; in the case of Canada, between the federal and provincial levels of government. This sort of imbalance occurs when the responsibilities of one level of government are disproportionately large compared with its share of revenues. Such imbalances can be addressed by a transfer of responsibilities and/or revenues from one level of government to another. In the context of Canada, the Canada Health Transfer and the Canada Social Transfer are meant to address vertical imbalances by transferring funds from the federal government to the provinces.

Horizontal imbalance, by contrast, is a fiscal imbalance within one level of government; in the case of Canada, between the various provincial governments. This sort of imbalance occurs when some provincial governments have much weaker fiscal capacities than others. Traditionally, this has included provinces such as Quebec, Manitoba and those in Atlantic Canada. Because of their smaller populations and/or economies, these provinces tend to have less capacity to support social services than their larger provincial cousins, such as Alberta, British Columbia and Ontario. Equalization is meant to address this horizontal imbalance by providing federal monies to those provinces with lesser financial capacities. The result is greater equality between provinces in terms of their levels of taxation and ability to provide comparable social programs.

Equalization and Tax Rental Agreements

The history of equalization dates back to the 1940s, with the introduction of tax rental agreements between the federal government and the provinces. These agreements meant that each province ‘rented out’ its right to collect taxes to the federal government. Under this arrangement, the federal government took over the collection of personal income taxes, corporate income taxes and succession duties from participating provinces. In exchange, the federal government paid annual compensation to the provinces to make up for the income each province lost by not collecting these taxes. The terms of the tax rental agreements were renegotiated every five years, and federal compensation was unconditional, meaning that provinces could spend the money as they saw fit.

First implemented during World War II, the tax rental agreement arrangement between the two levels of government ran until 1962. Thereafter, the federal government entered into a new system of tax collection with the provinces. Throughout this period, several provinces remained uncomfortable with the idea of ceding taxation powers to the federal government, even as part of a temporary rental agreement. Ontario did not participate until 1952, when the federal government changed the way payments were calculated, and Quebec never participated in the tax rental agreements.

Initially, the principle of equalization was not found in the tax rental agreements. Indeed, the arrangements were designed solely to compensate a province for lost tax revenues, not to increase the revenue of the provinces to a higher level based on a national norm. In 1957, however, poorer provinces whose per capita tax revenues fell below a national standard found themselves eligible for additional federal compensation. This marked the beginnings of the Equalization Program in Canada.

Evolution of the Equalization Program

Since 1957, the Equalization Program has undergone a number of significant changes, mainly having to do with the manner in which equalization has been calculated. Originally, Ontario and British Columbia were used as the comparative benchmarks. If a province’s per capita revenue from three sources of revenue (personal income tax, corporate tax and inheritance taxes) were less than these two provinces, then it was entitled to receive equalization from the federal government.

Over time, however, the equalization formula was adjusted. Today, the comparative benchmark is based upon a multi-provincial average, as opposed to simply British Columbia and Ontario. Moreover, the number of different revenue sources included in the calculation has been significantly broadened beyond simply personal income tax, corporate tax and inheritance taxes. For example, provincial revenues from natural resource extraction is now included. However, offshore oil revenue for Nova Scotia and Newfoundland has been excluded at times through individual deals between the federal government and those provinces.

See the Operation of the Equalization Program section of this article for more information on precisely how the equalization payments are calculated.

One of the most important changes to the Equalization Program came in 1982, with its inclusion in the Canadian Constitution. Section 36(2) of the Constitution Act, 1982 states that the federal government and the provinces are “committed to the principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation” (Department of Justice Canada, Constitution Acts 1867 to 1982). It is important to note, however, that Section 36(2) only provides a commitment to the principle of equalization payments, but does precisely outline how such payments are to be calculated or made.

Operation of the Equalization Program

The equalization formula and how the numbers are crunched

Legislative Framework of the Equalization Program

As the Equalization Program involves federal transfers to the provinces, its framework is set in federally enacted legislation. This legislation is renewed every five years, at which time the federal government and the provinces work together to negotiate any changes to the program. The legislation is then debated upon and passed by the federal Parliament. Within the five-year period, the federal government can modify the program.

Calculation of Equalization Payments

The federal legislation sets out precisely how equalization payments are calculated. The following provides an overview of the equalization formula as of December 2007. It is important to note that this current Equalization Program is the result of significant reforms introduced by the federal Conservative government in its 2007 budget.

The equalization formula involves two key calculations. First, the fiscal capacity of each province must be determined. Provincial fiscal capacity is measured using five tax bases: personal income tax, business income tax, consumption tax, property tax and natural resources. However, 50 per cent of natural resource revenues are excluded in determining each province’s fiscal capacity, as well as the national standard (see below for more on the national standard). The result is a determination of how much revenue per capita (or per person) each province is able to raise. These figures will not be uniform across all provinces, as some have higher fiscal capacities than others.

Second, these per capita revenue figures are then compared with a national standard. Prior to 2007 this national standard was based on the average incomes of the five middle-income provinces: Quebec, Ontario, Manitoba, Saskatchewan and British Columbia. Following the 2007 changes, however, the national standard is now based on the average incomes of all 10 provinces. Whether a province is eligible for equalization, and how much it may receive, is based on its comparison to this national standard. Those provinces that are below the national standard will receive funds to top them up to the average of all 10 provinces. Those provinces that are above the national standard are not eligible for equalization payments.

Certain qualifications have been built into this basic system of calculation. For example, Nova Scotia and Newfoundland and Labrador have been allowed to maintain the benefits the Atlantic Accords, which had been agreed to in 2005. Under these Accords, the federal government had committed to completely protecting the two provinces from any reduction in equalization payments due to increased revenues stemming from the offshore oil industry. Originally, the Conservatives’ new system of equalization had backtracked from this commitment, which had been negotiated by the previous Liberal government. However, after these two Atlantic provinces strongly denounced the plan, the Conservative government agreed to a compromise. Under the agreement, Nova Scotia and Newfoundland and Labrador have the option of continuing under the old equalization system with the full protection of the Atlantic Accords, or adopting the new system, which includes higher levels of federal transfers for those provinces that fall below the national standard.

Comparison of Provincial Equalization Entitlements

In 2007-2008, the federal government transferred $12.9 billion to the provinces through the Equalization Program (Department of Finance, Federal Transfers to Provinces and Territories). The following provides a breakdown of equalization payments by province.

2007-2008 Equalization Payments by Province ($ millions)
British Columbia	0	Quebec	7,160
Alberta	0	Newfoundland/Labrador	477
Saskatchewan	226	Nova Scotia	1,465
Manitoba	1,826	New Brunswick	1,477
Ontario	0	Prince Edward Island	294

(Source: Department of Finance, Federal Transfers to Provinces and Territories)

Traditionally, the key recipients of equalization payments are the Atlantic provinces and Quebec, especially when examining the amounts they receive on a per capita basis. By contrast, Alberta, British Columbia and Ontario generally do not receive equalization payments (although, British Columbia did receive small levels of payment between 1999 and 2006).

Issues and Debates on the Equalization Program

Contemporary issues on the operation and nature of equalization

Determining the Equalization Formula

Since its inception in 1957, there has been a debate on precisely how equalization payments should be calculated. Two issues are central to this debate: calculation of the national standard and calculation of individual provincial fiscal capacities.

A province’s fiscal capacity is measured against a national standard comprising the average taxing capacity of a number of given provinces. Since the first equalization agreement in 1957, the number of provinces making up the national standard has changed several times. In 1957, a province’s fiscal capacity was measured against the average taxing capacity of Ontario and British Columbia, which, at the time, were Canada’s two richest provinces. In the 1960s, the federal government changed the calculation to include all 10 provinces. Including oil-rich Alberta in the calculation created problems in the 1970s when international oil prices skyrocketed. Alberta’s tax revenues raised the average to the point where even Ontario would have received equalization.

In 1982, the federal government removed both Alberta and the poorer provinces from the calculation. The national standard was based on the average taxing capacity of five middle-income provinces – British Columbia, Ontario, Saskatchewan, Manitoba and Quebec. Several provinces argued that the five-province standard unfairly lowers their entitlements, and sought a return to the ten-province standard.

In 2007, the Conservative federal government introduced significant reforms to the Equalization Program to address some of these issues. The new system reverts back to a national standard based on the average fiscal capacities of all 10 provinces (instead of just the five middle-income provinces). In order to deal with problems stemming from including oil-rich Alberta, the new system includes only 50 percent of provincial resource revenues in calculations of the national standard. This qualification is meant to mitigate a rise of the national standard to an inflated level. Nevertheless, the result has been a substantial increase in equalization payments to eligible provinces.

In regard to the calculation of individual provincial fiscal capacities, some experts had argued that the equalization formula was too complicated. Since its inception, the number of items used to determine each province’s fiscal capacity had risen from the three items contained in the original tax rental agreements (corporate income tax, personal income tax and succession duties) to 33. Critics argued this made the program more difficult to understand, and increased the possibility of error.

The new equalization system introduced in 2007 significantly reduced the number of items used to determine a province’s fiscal capacity. Instead of taking into account 33 different types of provincial revenues, the new system is now based on only five types: personal income tax, business income tax, consumption tax, property tax and natural resources.

Equalization Encourages Dependency

Some economists have argued that the Equalization Program contributes to financial and economic dependency, particularly in the case of Atlantic Canada. The basic argument is that no incentive exists for a province to strengthen its economy, since generating more revenue would equal losing out on financial transfers from the federal government. Similarly, if a province has discovered potential sources of revenue, such as natural resources, there is no incentive to develop them, as the new revenue would lower the provinces equalization payments.

In the past, the federal government has attempted to address this issue with special agreements, such as the Atlantic Accords. These agreements provided Nova Scotia and Newfoundland and Labrador with temporary protection from reductions in equalization payments due to increased government revenues from their offshore oil industries (until these industries are fully developed). As such, the motivation to develop new revenue streams is maintained.

It is important to note that such dependency arguments assume that provincial governments are only motivated to develop their economies if it will result in greater government revenues. One may argue, however, that other factors motivate provincial governments in this respect, such as improving the economic conditions and quality of life of their residents. In this context, a government may be motivated to improve its economy even though it may result in decreased equalization payments.

Equalization Unfair to the Richer Provinces

Another important debate regarding the Equalization Program concerns its fairness to richer provinces — in particular, those provinces ineligible to receive payments from the federal government. The basic concern here is that the federal government takes tax dollars it has collected from the richer provinces, and redistributes those monies elsewhere in the country. As such, the equalization system is unfair in the sense that it represents a financial drain on the economies of non-eligible provinces.

Supporters of the Equalization Program, in contrast, draw attention to the fact that all provinces, even the rich ones, receive substantial transfers from the federal government every year (for example, through the Canada Social Transfer and the Canada Health Transfer). Moreover, supporters argue that the Equalization Program is fair in the sense that it is meant to ensure a comparable level of social services at a comparable level of taxation across the country.

At the core of this debate are very different senses of ‘fairness.’ The anti-equalization argument conceives of fairness in terms of proportionality. Those provinces with stronger economies are entitled to the full rewards of their economic success, while those with weaker economies should be satisfied with what they have. The pro-equalization argument, by contrast, views fairness in terms of sameness; all citizens are entitled to the same social services at the same tax rate, regardless of where they live. How one personally views fairness in this context will bear heavily on whether or not they support the very notion of the Equalization Program.

Equalization and the Atlantic Accords

Another important issue regarding equalization has been the 1985 and 2005 Atlantic Accords, which were agreed to by the federal government and the provinces of Newfoundland and Labrador and Nova Scotia. Under these Accords, the federal government agreed to protect these provinces from any loss in equalization payments due to increased provincial revenues stemming from the development of offshore oil industries.

For more information on the Atlantic Accords:

Mapleleafweb: Federalism and the Atlantic Provinces: Contemporary Issues and Debates

Some critics of the Atlantic Accords have questioned whether such protection should be afforded Newfoundland and Labrador and Nova Scotia. If these provinces are gaining new revenues from the extraction of offshore oil, why should they be entitled to the same levels of equalization payments as before? This criticism can seem particularly strong considering that no other provinces received similar protection regarding their natural resources revenues.

In response, supporters of the Accords have argued that Newfoundland and Labrador and Nova Scotia still require equalization protection in order to continue their financial turnarounds. These provinces have endured an extended period of economic decline, which have contributed to a cycle of government deficits and ballooning debt. Moreover, unlike other oil-rich provinces, such as Alberta, the Atlantic offshore oil industry is still in its infancy, and will not fully reward the provinces for several years to come. As such, supporters of the Accords argue that some temporary equalization protection must be offered to Newfoundland and Labrador and Nova Scotia to ensure their long-term financial stability.

This debate came to a head in 2007, when the new Conservative federal government, helmed by Prime Minister Stephen Harper, unilaterally altered the Equalization Program and the Atlantic Accords. Under the reforms, federal transfers under the Equalization Program were enriched; Newfoundland and Labrador and Nova Scotia, however, would no longer be completely protected from declines in these payments due to increasing provincial oil and gas tax revenues. This change led to a very public conflict between the two provinces and the federal government, and created strong dissent within the federal Conservative Party and its Atlantic caucus.

In an effort to overcome the issue, the Harper government offered two options to Newfoundland and Labrador and Nova Scotia. The provinces could either continue with the old equalization formula and the Atlantic Accords, or they could enter into a new enriched equalization formula that included a cap on the amount of equalization payments if offshore oil and gas revenues reached a certain level. In 2007, both provinces agreed to the new formula – although Newfoundland and Labrador did so only for one year, leaving the door open to change its position in the future.

Sources and Links to More Information

List of article sources and links to more on this topic

Sources Used for this Article

Bélanger, C. “Canadian Federalism, the Tax Rental Agreements of the Period of 1941-1962 and Fiscal Federalism from 1962 to 1977.” MarianopolisCollege. 19 February 2001. 11 February 2007. <http://faculty.marianopolis.edu/c.belanger/QuebecHistory/federal/taxrent.htm>
Courchene, T.J. “Equalization Payments.” The Canadian Encyclopedia. 11 February 2008. <http://www.thecanadianencyclopedia.com/index.cfm?PgNm=TCE&Params=A1ARTA0002632>
Makarenko, J. “Federalism and the Atlantic Provinces: Contemporary Issues and Debates.” Mapleleafweb.com. 06 February 2009. 11 February 2008. <http://www.mapleleafweb.com/features/federalism-and-atlantic-provinces-contemporary-issues-and-debates>
“The Constitution Acts 1867 to 1982.” Department of Justice Canada. 11 February 2008. <http://laws.justice.gc.ca/en/const/index.html>
“Achieving a National Purpose: Putting Equalization Back on Track.” Expert Panel on Equalization and Territorial Formula Financing. May 2006. 11 February 2008. <http://www.eqtff-pfft.ca/english/EQTreasury/index.asp>
“Renewing Equalization.” Department of Finance Canada. 11 December 2007. 11 February 2008. <http://www.fin.gc.ca/transfers/transfers_renew_e.html>
“Equalization Program.” Department of Finance Canada. 11 December 2007. 11 February 2008. <http://www.fin.gc.ca/FEDPROV/eqpe.html>
“Federal Transfers to Provinces and Territories.” Department of Finance Canada. 11 December 2007. 11 February 2008. <http://www.fin.gc.ca/FEDPROV/mtpe.html>

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Flaherty's Comments on Ontario Create a Problem for PM Harper

Greg Farries — Wed, 02 Apr 2008 11:54:31 -0600