Proceedings of the Standing Senate Committee on
National Finance

Issue 11 - Evidence

OTTAWA, Wednesday, February 23, 2005

The Standing Senate Committee on National Finance, to which was referred Bill C-24, to amend the Federal- Provincial Fiscal Arrangements Act and to make consequential amendments to other acts (fiscal equalization payments to the provinces and funding to the territories), met this day at 6:33 p.m. to give consideration to the bill.

Senator Donald H. Oliver ( Chairman ) in the chair.

[ English ]

The Chairman: Honourable senators, I call the fifteenth meeting of the Standing Senate Committee on National Finance to order. I remind you that this committee's field of interest is government spending, either directly through the Main Estimates or indirectly through bills.

[ Translation ]

Yesterday, Bill C-24, to amend the Federal-Provincial Fiscal Arrangements Act, was referred to our committee by the Senate.

[ English ]

This committee will be very busy in the month of March with business on the Supplementary Estimates (B) 2004- 2005 and the Main Estimates for 2005-2006. It is for this reason that the steering committee has decided to hear from the parliamentary secretary and officials from the Department of Finance tonight.

The steering committee has also instructed the clerk to invite the provinces and territories to make representations on this bill. In order to hear from those provinces and territories that may wish to appear, the steering committee wishes to schedule a meeting outside of our regular time slot, on Monday, March 7, to accommodate our tight schedule. As we receive news from the provinces and territories, the clerk's office will circulate the appropriate notices to all honourable senators.

[ Translation ]

To begin our meeting this evening, I would like to welcome the Honourable John McKay, Parliamentary Secretary to the Minister of Finance. Mr. McKay was elected for the first time to the House of Commons in 1997.

[ English ]

Mr. McKay was named Parliamentary Secretary to the Minister of Finance in July 2004.

Welcome, Mr. McKay. After your opening remarks, honourable senators would like the opportunity to put some questions to you.

The Honourable John McKay, P.C., M.P., Parliamentary Secretary to the Minister of Finance, Office of the Minister of Finance: Thank you, Mr. Chairman. In the interests of time, I will forgo a formal presentation and highlight a couple of points.

As experienced parliamentarians, you are aware that the large majority of transfers to the provinces and territories are through our five major transfer programs: the Canada Health Transfer, the Canada Social Transfer, the Health Reform Transfer, Equalization and Territorial Formula Financing programs. That is what we are dealing with today. Most of you are familiar with the numbers of $33 billion over the next ten years with an escalator of 3.5 per cent over that period of time.

This was in direct response to a number of representations by the provinces. They wanted a floor and the certainty that monies would be coming on a regular basis to facilitate their budget planning.

The Prime Minister convened a meeting of the premiers where this arrangement was negotiated. There has never before been a floor to equalization. The level has previously fluctuated according to fiscal capacities and economic performance in the provinces and territories. Those are the points I wanted to highlight.

With me this evening are Mr. Sean Keenan, Mr. François Delorme and Ms. Clare Scullion from the department who will assist me in answering your questions. I appreciate the opportunity to appear before the committee as well as your recognition that the provinces wish to have this dealt with in a timely fashion as it is a negotiated deal that honours a commitment by the Government of Canada and the Prime Minister.

The Chairman: Thank you, Mr. McKay. We appreciate your leaving lots of time for questions.

In addition to the regular members of this committee, we have with us tonight Senator Massicotte, who is the government sponsor of this bill. Yesterday in the chamber, Senator Massicotte gave an excellent address not only on the bill but also on the meaning of equalization to Canada, in the country and around with world. I would like Senator Massicotte to begin the questioning.

Senator Massicotte: I understand the bill quite well, but I am trying to understand the whole theory of equalization. Obviously, in a theoretical sense, if everyone had the same delivery costs, equalization would bring everyone up to the same level of support for the provision of public services.

In an academic sense, the other major programs are funded, more recently, on a per capita basis. When one program is adjusted for income, everything else should be on a per capita basis. One can make the argument that once you have adjusted for income and done a redistribution of wealth, you should not be giving up money for other programs.

Mr. McKay: This becomes a little complicated. There are 33 indicia —

Senator Massicotte: I understand the equalization theory. The objective of that program is to allow every province to reach that bar.

Senator Murray: Except that they do not reach that bar.

Senator Massicotte: The theory is that each province should reach that bar, and the panel will study that to make it more perfect.

I gather that all other programs should be per capita, but they are not. Explain to me the philosophy of having so many other grants and subsidies for various provinces when, in theory, funding has already been equalized.

Mr. McKay: Health care money is distributed on a per capita basis and equalization payments are not. There is an overall recognition that you try to address those inequities in a variety of ways. Sometimes you simply cannot distribute monies on a one-person-one-dollar basis.

As well, various provinces have unique needs. For example, not all provinces have high unemployment, but they still receive equalization payments, so sometimes measures for employment are targeted in a specific region. It is in the nature of Confederation that we try to address those issues in a more equitable manner through various programs, particularly equalization.

Mr. Francois Delorme, Director, Federal-Provincial Relations Division, Department of Finance Canada: I believe that equalization is the only program in the Constitution. When it was created in 1957, its main purpose was to equalize the differences among the provinces. It is due to the very nature of equalization that the program was devised in this way.

Senator Massicotte: I have no problem with equalization. I think it has a lot of merit. If one were looking for simple government, one would recommend equalization so that every province has the same potential to deliver public services, and then get out of the way.

Senator Murray: That is pure federalism.

Senator Massicotte: Perhaps we could also do a social transfer, but then the issue arises of getting into someone else's jurisdiction. Politics being politics, members of Parliament want to be visible and do things for their constituents, so there is a competition to see who will be the nice guy.

Mr. McKay: I do not think we can add much to that.

Mr. Sean Keenan, Chief, Equalization & Policy Development, Federal-Provincial Relations Division, Department of Finance Canada: The provinces are providing a certain basket of services to the municipalities as well, and the equalization program is there to ensure that those services are provided on a comparable basis at comparable levels of taxation. There are other types of transfers, health and social transfers, in which there is a general sharing, and those are allocated in recognition of a certain equality across all Canadians and, therefore, we allocate those on an equal per capita basis.

There are things that the federal government needs to do that are region specific such as agricultural assistance and military spending. Your naval budget will only be spent on the coast. That is just a fact.

I think that there are things within the federal government's purview that have to be region specific, and certainly the government does that. I do not know if you are speaking of these specifically, but it is certainly within the purview of the federal government, in areas where it has provided equalization support on a long-term basis and people are falling behind, to make a level adjustment, and it has done so at times.

Senator Massicotte: I am very pleased with the bill, and that is why I am sponsoring it. The good news for me is that I am sponsoring this one and not the other ones.

Senator Murray: A pure federation has its advocates, including quite a few in your province. I read the other day that one of the ministers said that they would prefer a vastly more generous equalization program as a substitute for federal-provincial shared cost programs to let the provinces carry out their responsibilities, but that is not the way we have been doing things in this country for a long time. I take your point, however.

Do you know when we might expect the legislation giving effect to the offshore accords with Newfoundland and Labrador and Nova Scotia?

Mr. McKay: I cannot give you a definite answer on that. I expect that ``shortly'' would be a fair comment, but that bill has not been introduced in the House yet.

Senator Murray: Is there a time line?

Mr. Keenan: There is a commitment that legislation would be introduced in a timely manner.

Senator Murray: It is not like this bill, which we have to get through before the end of the fiscal year?

Mr. McKay: There is no time line.

Senator Murray: I cannot resist asking you about the offshore accords. The backgrounder that is put out by the department says that the Nova Scotia accord provides for a further eight-year extension as long as the province receives equalization in 2010-11 or 2011-12 and that its per capita net debt has not become lower than that of at least four other provinces. In the case of Newfoundland and Labrador there is a somewhat similar provision, that is, per capita debt servicing costs will not be lower than that of at least four other provinces.

What is the incentive to fiscal prudence in that provision? Do you know why they put that in?

Mr. McKay: I could not respond to that question.

Senator Murray: There seems to be an incentive to keep your per capita debt up, is there not?

Mr. Delorme: This is one of the two conditions, continuing to benefit from equalization and being in a fiscal situation that is worse, relatively speaking.

Senator Murray: But it is an incentive to keep it worse.

Mr. Delorme: I understand that. These conditions were negotiated, which is why we have two different conditions — the debt servicing charges for Newfoundland and debt level for Nova Scotia. If, despite their efforts, they are still in those situations, they would qualify for the second eight-year period.

Senator Murray: The relevance of the bill before us is that there is some exposure for both of those provinces in the sense that no one knows what the equalization program will look like after the distinguished panel reports. Is there not some exposure there? Could it not happen that one or other or both of those provinces would, under some conceivable new program, no longer be eligible for equalization?

For example, one of the things the panel is supposed to consider is macro variables. Suppose that one of those macro variables was GDP growth. Newfoundland and Labrador had a pretty rapid GDP growth in recent years. Suppose it turned out that they were no longer eligible for equalization because of a big change in the equalization program. Are they not exposed?

Mr. McKay: You point out perverse incentives. You can find quite a number of government programs where there are perverse incentives. People can argue about the allocation of employment insurance — who qualifies and who does not — and get into all kinds of issues about perverse incentives. I am sure, senator, that you know those arguments better than I. I would respectfully suggest, however, that your speculation and hypothesization is fairly far removed from what we have before us tonight.

Senator Murray: The Newfoundland finance minister wrote to Mr. Goodale. I did not see that letter, but I saw Mr. Goodale's reply. He acknowledges the concern and then says that if there is any argument, he will hire a mediator and consider his or her views.

Mr. Keenan: The condition of the accord suggests that we will say how much equalization the province does receive and how much it would receive if we removed the offshore revenues from the program. Today it is very simple because it is a separate base. You can set that base at zero and do the calculation again.

Given the uncertainty surrounding what the panel may say on how the formula will work, they were looking for certainty that if they do not agree with how the calculation is done they can ask someone else.

Senator Murray: I am sure those provinces will be sharpening their pencils and looking at every recommendation the panel brings in to ensure it will not prejudice their position under the offshore accord. However, perhaps Mr. McKay is right and my concerns will turn out to be unjustified.

I am interested in the numbers for Saskatchewan and British Columbia. In the budget of March 2004, Saskatchewan's entitlement was $462 million and British Columbia's was $824 million, including their share of the $150 million top-up that was brought in in the March 23 budget. The total pie for equalization was then $9.6 billion.

By October 2004, the total pie seemed to be down to $8.8 billion, from a reading of some of the documents that you have put out. Then, the government set the floor for 2004-05 at $10 billion and at the same time said that no province would get less in 2004-05 than had been forecast in the budget documents.

The two provinces that benefited from that latter provision were British Columbia and Saskatchewan, and the amount in question was $774 million. I find the tables very difficult to get through because, at a given point, all they talk about is the increases and I do not have the basic numbers.

In October, before those floors were decided upon, what was the equalization entitlement of Saskatchewan and British Columbia? When it was down to $8.8 billion, what was Saskatchewan and British Columbia's entitlement going to be?

Ms. Delorme: It was $62 million for Saskatchewan and $434 million for British Columbia.

Senator Murray: The numbers in the March 23, 2004 budget were $462 million for Saskatchewan and $824 million for British Columbia, so I assume that those were the floors for those provinces and that that is what they will get in 2004-05.

Ms. Delorme: The Saskatchewan number for the October estimate, as you correctly pointed out, was $62 million. With the protection we are giving them, the total payment to Saskatchewan, with the floor payment and the net protection, would be $590 million.

Senator Murray: How is that made up? It is $62 million plus what?

Ms. Delorme: That is the way the calculation is done. It is complicated.

Senator Murray: Really?

Mr. Keenan: We have a number of open years. As you may know, we do not finalize the calculation of equalization payments until 30 months following the end of the fiscal year, so at any given time four years are open.

When we start a fiscal year, we have essentially paid up all amounts to the end of the last fiscal year, and with the February estimate we have a first estimate for every province, Saskatchewan being at $462 million.

Senator Murray: That was in March of 2004.

Mr. Keenan: That was in March. By the time of the October estimate, we have not only re-estimated payments for 2004-05, we have also re-estimated payments for 2001-02, 2002-03 and 2003-04. In the case of Saskatchewan, those adjustments turned out to be $200 million negative, so they would have essentially owed us money from prior years.

Senator Murray: Can you not stick to 2004-05, though?

Mr. Keenan: The policy was that they would not get less than what they were told in February 2004.

Senator Murray: That was $462 million and they were down to $62 million by October.

Mr. Keenan: Yes, which is a decline of $400 million. As a result of the decline in the other years, we said that those amounts will affect your revenues this year and we will recover them in the 2004-05 fiscal year, so by not recovering them, we had to pay them an extra amount. The mechanics are that we recovered and then we paid them more.

Senator Murray: Therefore, they got $590 million.

Mr. Keenan: Exactly.

Senator Murray: What about British Columbia?

Mr. Keenan: That was a very similar situation. There were a number of years that are open and some of those were positive and some were negative.

Senator Murray: They started at $824 million in March 2004 and by October they were down to $434 million. Where do they end up?

Mr. Keenan: They receive a payment of $248 million.

Senator Murray: How can they receive a payment of $248 million when you protected them? Should they not be getting $824 million?

Mr. Keenan: They have some prior years that are positive and some that are negative.

Senator Murray: I see. So for 2004-05 you are not giving $824 million. The floor says that they would not get less than was provided for in the March budget, $824 million, so what are they getting?

Mr. Keenan: For the 2004-2005 year, they are receiving $682 million plus some positive adjustments from the prior years that will bring them up to the $824 million level.

Senator Murray: I see. So the positive adjustments are negative adjustments that you have turned positive. You have forgiven the negative adjustments.

Mr. McKay: That is right. They really owed us money.

Senator Murray: Now that I have all that information, what am I going to do with it?

If it had not been for these negative adjustments that were made positive, the floor and so on, on the basis of the formula that existed up to now neither Saskatchewan nor British Columbia would be in for 2005-06.

Mr. McKay: In equalization?

Senator Murray: Yes. They would not be recipients of equalization, would they?

Mr. Keenan: It is hard to say because the 2005-06 data is not in yet, but certainly the October numbers turned out to be significantly lower than the February numbers.

The Chairman: When does the 30 months run for 2005-06? When is the end of that 30-month period?

Mr. Keenan: It would normally be in the middle of 2008-09.

Senator Murray: However, it no longer matters.

Mr. Keenan: Bill C-24 provides for set amounts for each province for 2005-06. They are fixed right from the beginning of the year so there is no need to do any calculations.

Senator Murray: As of October 2004, had it not been for your policy of forgiveness, plus the floors that you put in, Saskatchewan and British Columbia would be out of the equalization program. I contend that neither of those provinces would be recipients going into 2005-2006.

Mr. Keenan: We do not have estimates beyond the October estimates. We have the numbers as they are today. The Government of British Columbia was projecting zero equalization. The Government of Saskatchewan suggested that they would be out of equalization but for the provisions of this bill. We do not have official estimates beyond October.

Mr. Delorme: As you know, one equalization year is impacted by several other years. We have revisions to past years plus the current year.

Senator Murray: Are these in budget plan 2004? Does the $1.1 billion for New Brunswick include adjustments for previous years? Table A6.1 in the budget plan of 2004 is entitled ``Equalization Entitlements.'' Does the equalization entitlement number for New Brunswick include previous year's adjustments and all of that?

Mr. Keenan: At the beginning of the fiscal year, when we produced the first estimates, which are those estimates, we paid all outstanding adjustments for all prior years. At the beginning of a fiscal year we start with an amount for the first estimate which is essentially clean with no prior year adjustments built in.

Over the course of the fiscal year, as new data becomes available and we re-estimate in October and again in February under a normal cycle, we potentially discover positive or negative adjustments.

Senator Murray: And they would be added to or subtracted from?

Mr. Keenan: That is right.

Senator Ringuette: We did not hear about the forgiveness program last year when we were looking at the other equalization bill. I recall that at that time there was an overpayment from the Government of Canada to the Government of Quebec that had to be repaid by the Government of Quebec, and there was an underpayment from the Government of Canada to the Government of Saskatchewan that had to be paid to Saskatchewan under the formula and the two-year revision.

What has happened? Are you telling us that you have forgiven overpayments and underpayments?

Mr. McKay: Yes, the forgiveness is unique to this bill. The reason you did not hear about it in another bill is that it only applies to this one.

Senator Ringuette: Is this a one-time situation?

Mr. McKay: That is right.

Senator Ringuette: Could you tell us what has been forgiven and for whom? Send us a list. This is very important. If some provinces were forgiven overpayments and others were not paid underpayments, it completely distorts the previous year's equalization process with the ceilings.

Mr. McKay: That list is readily available. However, you are probably interested in an explanation of the ups and downs of the forgiveness.

Senator Ringuette: I know how the ups and downs work with the evaluation of the previous years and so on. My concern that is that a one-time forgiveness not only deals with this one year but also with three previous years in a program that had a ceiling, which affects every other province receiving equalization payments. It changes the distribution of the pie.

Mr. Keenan: To be clear, in the past we had situations where new data was discovered through a census and income tax information.

Senator Ringuette: We understand that process.

Mr. Keenan: There were significant declines in equalization last year and, as a matter of policy, the government decided that the recoveries we were required to make by law we would extend interest free over a period of five years. That was in the past.

The payment that was made to Saskatchewan in the last budget of $120 million was to correct the error in measurement of their fiscal capacity with respect to their Crown lease basis.

Senator Ringuette: We understand all that.

Mr. Keenan: This bill has two individual floors. It says that the program will not pay out less than $10 billion in the current fiscal year and that no province will receive less than it was told it would receive in February.

Because there are adjustments to past years that would have a negative impact on the payments to Saskatchewan this year, we will recover those amounts from the previous years but we will pay them an additional amount this year such that the total amount they receive is not less than their February level.

It is the same situation for the Government of British Columbia.

Senator Ringuette: Talk to me about the situation for Quebec, which was not an underpayment but an overpayment.

Mr. Keenan: As a result of the increase in the total envelope from $8.9 billion to $10 billion, Quebec will receive a payment of $477 million under this bill.

The government had suggested that the repayment of those monies be extended over five years. Under this bill, and also under the government's policy at the FMM, that recovery would be extended to 10 years interest free, and those recoveries will not start on April 1 this year but rather on April 1 next year.

Senator Ringuette: In essence, you are telling me that this is not a forgiveness policy. You are just redistributing the payments, be they overpayments or underpayments. It is just a new redistribution mechanism for those situations.

Mr. Keenan: Yes. We are increasing the amount of equalization to all provinces and no province will receive less than it was told it would in February. That means that we pay British Columbia and Saskatchewan a little more to ensure that, from a budgetary perspective, they are no worse off than we told them they would be under equalization in the March budget.

Senator Murray: Equalization payments have effectively been de-linked from the measurement of relative fiscal capacity for the future, have they not?

Mr. Delorme: They will be with this bill.

Senator Murray: Therefore, for 2005-06 there is no formula in operation. You simply put down the number $10.9 billion, which is the size of the pie —

Mr. McKay: For the first two years of this plan it will be the same formula measurement. It is just that the size of the pot of money is set.

Senator Murray: It is not quite.

Mr. McKay: Once the committee reports, there will presumably be a change in the measurement of fiscal capacity.

Senator Murray: If that is what the standard will be.

For 2005-06, you took $10.9 billion and then looked at the distribution. It says in the document that it was decided that payments for 2005-06 should be based on a compromise between an average of fiscal capacities from the past three years and an average of shares for the past three years, so it is not quite the same formula, Mr. McKay.

Mr. McKay: That is a fair comment. We are not changing the bases and we are not introducing a new measurement or anything like that.

Senator Murray: The payments should be based on a compromise between an average of fiscal capacities from the past three years and an average of shares — by which I take it you mean your share of the pie — for the past three years.

Mr. Delorme: Again, this decision was made in consultation with the provinces. Some provinces wanted the new pie divided on a share basis and others on a per capita basis, so we decided to use a compromise.

Senator Murray: The bill says:

The fiscal equalization payments referred to in paragraphs 1( b ) and ( c )...

which is what we are talking about —

...shall be allocated to each province in the same proportion as the fiscal equalization payment referred to in paragraph 1( a ) is allocated under subsection (2).

That means that for years following 2005-06 you will distribute the $10.9 billion plus 3.5 per cent in the same proportion among these provinces. That seems to mean that Saskatchewan and British Columbia will continue receiving equalization no matter what.

Ms. Clare Scullion, Senior General Counsel, Law Branch, Department of Finance Canada: That provision only comes into force on a date to be fixed by the Governor-in-Council. We put that in because, if the panel is a bit late, we do not want to delay payments to the provinces, but we did not want to pre-empt what the panel would say.

The Chairman: Can you tell us who is on the panel?

Senator Murray: The budget announced someone by the name of Al O'Brien.

Mr. Delorme: He is the chairman.

The Chairman: Who will be on the panel?

Mr. Delorme: That has not yet been announced. The only public information available is the name of the chairman, who is Mr. O'Brien.

Senator Murray: Was he a federal or provincial public servant?

Mr. Delorme: He was the former deputy minister of finance of the Alberta government.

Senator Murray: I want to draw your attention to a meeting on equalization that Mr. Delorme and Mr. Keenan attended here on November 27, 2001. It was an in camera meeting, but one of the things that came up, which we reported it in our report, was the fact that your department was then studying the possible consequence of adopting a macro formula. As the department's work was incomplete, it was not prepared to comment on the merits and shortcomings of this concept.

Three years and some months later, I presume your study is complete and that you have something you can show us on this study as to its merits and shortcomings.

Mr. Delorme: Unfortunately, during the previous renewal that we concluded last year, there was so much to do in terms of fixing or improving a number of key tax bases that we decided, due to the limited resources we have, to postpone the work on the macro approach. That is effectively what we did, because we had too much work to do on the other tax bases.

Senator Murray: So the panel will be starting from scratch, will it?

Mr. Delorme: Yes.

The Chairman: Mr. McKay, I was a little disappointed when, in response to a question from one of the senators, you said that there is no date yet for when the offshore legislation will be introduced. Could you tell me whether the cheques can be cut before legislation and whether Newfoundland and Nova Scotia can anticipate receiving their cheques in response to the accord that has been agreed to and signed?

Mr. McKay: I think the cheques can be cut, but I do not think they can be sent.

There is a fairly complicated answer to a fairly simple question, because it depends upon whether the money is coming from the 2004-05 surplus monies or whether it is spread out over the term of the agreement.

As I understand it, the monies are set aside at one level, but only booked as they become due over the term of the agreement. It is a complicated formula but Mr. Devries could probably explain how this works, keeping the Auditor General on side.

Mr. Delorme: The bill must be passed before we have the authority to make the payment.

The Chairman: Even an upfront cash payment?

Mr. Delorme: The upfront cash payment is part of the agreement and the agreement will be legislated by the bill.

Senator Day: It is just $1.3 billion.

Ms. Scullion: The Constitution Act says that you cannot pay money out of the Consolidated Revenue Fund without the authority of Parliament.

Senator Harb: Thank you, Mr. McKay, for the excellent work you are doing on this legislation and other bills.

I understand that there is a three-pronged approach to what the government is trying to do: first, to establish a new framework that will set the rules of the game; second, to have an independent review panel; and third, to have a minimum amount of payment in terms of equalization payments to eligible provinces on an annual basis.

Am I correct on that?

Mr. McKay: That is correct.

Senator Harb: With regard to the review panel, I understand that terms of reference have been put in place and that the provinces, the Government of Canada and the private sector will appoint experts to the panel. Since the provinces will be intimately involved on that panel, why will their recommendations be considered only as an advisory recommendation and not as recommendations with legitimate weight? If they were given legitimate weight, in the event of a dispute issues that were debated and approved by the panel would have to be accepted. That would make sense, given the complexity of the issue.

Mr. McKay: First, there will be no private representation on the panel. Second, this is still a constitutional responsibility of the Government of Canada and the panel will advise the Government of Canada, but the Government of Canada is not necessarily bound by its recommendations.

Senator Harb: My second question is with regard to the agreement that the federal government entered into with Newfoundland and Labrador and what impact this agreement might have on equalization payments to other provinces. We are hearing the Province of Ontario publicly expressing its displeasure with what has taken place and also asking for their share of the pie. The same is true of Saskatchewan. One of my colleagues raised the fact that Saskatchewan also has natural resources.

Is this a slippery slope? Will we see a lot of this in the future in the event that other provinces have positions similar to that of Newfoundland and Labrador, or is this an isolated case?

Mr. McKay: That is essentially a political question. First, the Newfoundland and Labrador and Nova Scotia accords are outside of equalization. Those are separate deals. You do not have to stretch too far to think of the times that the Government of Canada has entered into separate deals with provinces to recognize certain unique things. As to whether this is launching a round a me-too-ism, I suppose that is ultimately a decision of the premiers.

I want to bring to the attention of senators that these deals — the health accord and the equalization deal — were negotiated by the Prime Minister and the premiers in September and October. At the end of those negotiations, the Prime Minister said to the premiers, ``I am going to strike a deal with Newfoundland and Labrador and Nova Scotia, because that was my election promise. Are there any objections?'' No hands went up. In fact, a number of the complaining premiers pronounced themselves quite satisfied with the equalization deal that was struck among the premiers at that time.

I cannot predict whether this will precipitate another round of unhappiness, but this is $75 billion spread over 10 years. We have addressed a number of the most egregious concerns of the premiers and they all pronounced themselves satisfied with the deals, then shortly thereafter we are back to the same old, same old.

Senator Harb: My final question deals with the base that the government seems to be proposing, that is, that the amount of the equalization payments will not go below a certain level, and that is in, I think, 2004-05. If that is the case, is there any provision in the event that we hit an economic downturn, a recession or some unforeseen economic difficulties? What would happen in the event the government was not in a position to make those transfer payments? We have gone through that before. There were a number of years where we did not see much action.

Mr. McKay: The government did a bump up to $10 billion and a final bump up to $10.9 billion. If things go south on us, the Government of Canada is on the hook. It is a risk transfer. The Government of Canada has absorbed that risk for those provinces.

Senator Downe: Mr. McKay, my question is a follow-up to Senator Harb's question. I appreciate that the Prime Minister met with the premiers and they all agreed and thought it was a wonderful thing, then when they heard the details of the Atlantic accord a certain amount of jealousy or me-too-ism set in.

I am not advocating this position, but I want your opinion on it. The Premier of Prince Edward Island has said publicly that, since Prince Edward Island does not have natural resources such as oil or potash, it should be compensated for agriculture and tourism, that that should be factored into the equalization program. That, of course, would open up similar demands from all the provinces across the country.

Have you heard that? If so, do you have a comment on it? What views do you have on expanding resources to non- traditional areas?

Mr. McKay: I had not heard that, so I cannot comment specifically, but on the general proposition, every province seems to have its grievance. Quebec is advocating that renewable resources should be taken out of the equation. They do not seem to be quite so enthusiastic about renegotiating the Newfoundland and Labrador deal for hydroelectric power. Saskatchewan has its grievances as well.

Prince Edward Island does fairly well out of Confederation. I recollect that $2,400 per capita is transferred to the province. That is a significant sum of money. Although it is less than the territories receive, it is more than any of the other provinces.

The best and final answer is that if the premier has an argument to make to take tourism and agriculture out of equalization, or re-weight it in some way or another, he should make that argument to the panel.

Senator Downe: Mr. McKay is right. On a per capita basis, Prince Edward Island does very well, I think the best in Canada, through a host of measures. You would not know that from local commentary, but it is a message that a number of us try to get out on a regular basis.

My more immediate concern is with regard to the delivery of programs. Prince Edward Island may have the highest proportion of seniors in Canada. I recall reading a speech delivered in the last year or year and a half by the current Canadian ambassador to the United States, Frank McKenna, wherein he said that over half of the medical costs incurred by a person are incurred in the last six months of their life. That makes sense as most people are ill before they pass away. However, in the delivery of programs, Prince Edward Island's costs would be higher because of its senior population. Is any thought given to taking demographics into consideration when calculating equalization entitlements, as they do in some countries?

Mr. McKay: That is news to me. After the budget the minister just delivered, the people in Prince Edward Island should be dancing in the streets. If ever there was a seniors' budget, this was the seniors' budget to end all budgets, because the GIS increase is being phased in over the next two years, and it is a very significant amount of money. At the end of the phase-in after two years, there will be in the order of $400 for a single person receiving the GIS and $700 for a couple receiving the GIS.

They should also be dancing in the streets with respect to the health care accord because that, again, is a significant benefit to seniors. Frankly, health care is more beneficial to seniors than it is to all the youthful senators around this table.

You are right to say that a great deal of the health care money is spent in the latter years of life. As to whether a demographic analysis is applied to equalization, I encourage you to raise that with the panel, but I do not see that as an immediate take-up. I do not see how that measures fiscal capacity.

Senator Massicotte: Only in the territories. In the territories you do consider the costs of providing services.

Mr. McKay: Yes, that is based on geography.

Senator Murray: The panel will consider expenditure needs.

Mr. McKay: That was not an interpretation I put on the terms of reference, but that is a fair comment.

Senator Ringuette: You will provide a list with the overpayments and underpayments and how this bill is resolving that?

Mr. Delorme: Yes, we will.

Senator Ringuette: Thank you.

To follow up on what Senator Harb and Senator Downe raised, equalization is based on taxation capacity whereas the health care accord and numerous other federal-provincial agreements, including the new funding for cities, are all calculated per capita.

You do not need a Ph.D. in administration to know that the cost of delivery for services in rural Newfoundland, P.E.I., New Brunswick and Saskatchewan is much higher than in areas of concentrated population such as Toronto and Montreal. The cost per capita and demographics are major factors. There is a greater senior population in rural areas than in urban centres.

There is a balance, and I wonder whether per capita distribution of funds under federal-provincial agreements is not biased in favour of Ontario and against more rural provinces. The cost to deliver programs is lower per capita in areas of concentrated population than in rural settings, and the balance is legislated through those federal-provincial agreements.

Mr. McKay: This is a little outside of Bill C-24. For cities and communities, it seems that the government will accept the formula of the FCM, which is that 75 per cent will be distributed on a per capita basis and 25 per cent will be distributed on a more weighted basis in favour of remote communities, so there is some recognition there of the difference.

With respect to per capita distribution of health care, I come from Toronto, and I can tell you that to build a hospital or a clinic in Toronto costs a lot more than it costs in Prince Edward Island.

Senator Ringuette: However, it is a one-time capital expenditure.

Mr. McKay: The costs continue in that vein. Wages in Toronto are far higher than in Prince Edward Island. I am not in any position to extend this debate, but I would like to throw down a couple of markers. It is not as simple as saying that programs are more costly to deliver in rural areas. You have to look carefully at the costs of delivery of services in places like Toronto, which are quite stressed these days.

Senator Stollery: The whole country comes to Toronto for the services, and we have to pay for them.

Senator Ringuette: I am looking forward to a full discussion on the health care agreement. I reiterate that I definitely differ from your opinion. Perhaps that is because I was an MLA in New Brunswick and I know the cost of delivering services in a province with a small population base and a large territory. Instead of having one hospital to serve 20,000 people, we need three because of the distance and the geography.

Mr. McKay: Senator Ringuette has made her point and we will have to agree to disagree.

[ Translation ]

Senator Ferretti Barth: My questions are addressed to Mr. McKay. To me, equalization is, as it were, a gamble. It is a complicated mechanism I do not quite understand. Yet, when I hear Senator Ringuette, the principle seems so simple. Politics sometimes create simple things as well as complicated ones.

Bill C-24 includes provisions for setting up an advisory committee of independent experts to make recommendations on the allocation of equalization payments. This recommendation is nothing new. We also find it in another committee report which was submitted in the past. I am happy to see this recommendation is made once again.

My next comment is about Quebec. An article published today in La Presse indicated that, according to the new Quebec Minister of Finance, Ottawa has developed an equalization system that makes no sense. They have just established agreements with Newfoundland and Labrador which tend to distort equalization programs. The minister says that if Newfoundland has the right to keep 100 per cent of its oil royalties for a period of eight years without a reduction in equalization payments, why would Hydro-Québec's revenues not be excluded from equalization? Could you comment on the declaration of the Quebec Minister of Finance?

[ English ]

Mr. McKay: Such is the grist of Confederation. For as long as we have been a nation, the provincial premiers and finance ministers have been complaining about the inequities of how Ottawa treats them. Quebec seems to want to have things both ways at times, and I will give you with an example in the area of immigration settlement money. Quebec receives $3,200 per immigrant, whereas Ontario receives in the order of $800 per immigrant. I do not hear the finance minister of Quebec complaining about that settlement rate. As I mentioned earlier, Quebec transfers hydro from Newfoundland and Labrador and makes an enormous amount of money on the way through, and I do not hear the finance minister complaining about that.

I do not know how to deal with those things. Quebec does not want us to say anything about the fiscal measurement of the value of property. However, it certainly wants to complain about British Columbia in that respect. I respectfully suggest that the finance minister of Quebec is being a bit disingenuous.

[ Translation ]

Senator Ferretti Barth: What protects bilateral agreements? Is it the Constitution, a federal law, or is it simply an administrative agreement that a new government could cancel? Agreements exist as long as the government is in power. They are not constitutional laws, nor federal laws, but simply agreements. When the government changes, who will protect this agreement with the provinces?

[ English ]

Mr. McKay: I stand to be corrected, but I would have thought that most bilateral agreements are contractual arrangements between governments unless they are followed up by specific legislation. If it is merely an administrative agreement, it can be changed with a change in government.

I agree with your comment that it is a bit of a crap shoot. Particularly in the last couple of years, equalization has been a bit of a crap shoot. One of the reasons the equalization receiving provinces were quite upset was that Ontario's fiscal capacity declined. With Ontario's fiscal capacity declining, everyone came up closer to Ontario's standard and suddenly the $2 billion that they were counting on was not there. Bill C-24 addresses that. The Government of Canada has essentially assumed the risk of Ontario having a lousy year.

Senator Massicotte: I want to make sure I understand what you said. Is Bill C-24 a bilateral agreement?

Mr. McKay: It is legislation.

Senator Massicotte: If the government wishes to change it in three years, it can change it. There is no contractual obligation to the provinces, other than the constitutional statement of 1982.

Mr. McKay: If Bill C-24 is passed, when the government changes I suppose it could amend the act.

The Chairman: Not only that, but this anticipates that the panel will look at the formula and make recommendations as a result of which the government will make changes that will substantially affect the way equalization works in Canada.

Mr. McKay: Certainly in terms of the distribution of the pie, if you will, but the pie is fixed.

Senator Day: I cannot find the panel of experts in the bill.

Senator Murray: I do not think it is not in the bill.

Senator Day: Is it in the bill?

Mr. Keenan: No.

Senator Day: There must have been some agreement with the provinces on who this panel would consist of.

The Chairman: The briefing book we have contains several sections that deal with the terms of reference and so on.

Senator Day: If the oil and gas in Newfoundland and Labrador had been in the land rather than in federal waters offshore, would the revenues derived from that oil and gas been included in the formula as part of their fiscal capacity?

Mr. McKay: If the resources were onshore, they would have to be treated in the same way as the non-renewable resources in Saskatchewan and Alberta.

Senator Day: Because it was offshore, Newfoundland kept asking for part of the revenue. Mr. Mulroney said they could have 30 per cent of that revenue and this year Mr. Martin renegotiated that and gave Newfoundland up to 100 per cent of the federal revenue from the offshore, and under this arrangement we will not count that as a revenue source.

Is it in fact being counted with a lump sum being given to Newfoundland, or is it not being counted at all?

Mr. Keenan: The arrangements that were reached in the 1980s gave all of the royalties to Newfoundland and Nova Scotia in respect of their offshore. They collect all the money.

Senator Day: All the money that would have been federal?

Mr. Keenan: The federal government collects corporate income taxes from the corporations. The federal government collects the royalties and sends 100 per cent to the provinces. The question was how much of that is to be included in the equalization program.

Senator Day: They were receiving a revenue source and the question was how much was to be included in the formula.

Mr. Keenan: Like everyone else's revenues, those were fully equalized. By virtue of the accords, they were partially equalized, and then under the generic solution only 70 per cent was equalized. Under this new accord, we will determine how much more they would have received under equalization and we will send them a separate cheque.

Senator Day: Is that looking backward or forward?

Mr. Keenan: That is looking forward.

Mr. McKay: It has nothing to do with this bill.

Senator Day: In the latter paragraphs of the bill are consequential amendments to the Appropriation Act and the Budget Implementation Act, dealing with Nova Scotia only.

Could you explain the consequences of this? Why is this here for Nova Scotia and not Newfoundland? Does it have anything to do with the offshore issue, or does it deal with something else?

Mr. Keenan: In the 2004 Budget Implementation Act, we introduced a measure to reset the clock on Nova Scotia's offshore accord, the equalization offset payment. The Budget Implementation Act allowed us to make two payments, one of $21 million plus 20 per cent of their offshore revenues and another payment equal to 10 per cent of their offshore revenues. The definition of those offshore revenues comes from the Federal-Provincial Fiscal Arrangements Act.

Bill C-24 eliminates the definitions that existed in the act before, because we are moving to a new equalization system. We needed to make a consequential amendment to the Budget Implementation Act to say that, although we no longer have the old definitions, we still refer to them to implement the policy of the last budget.

Senator Day: That arrangement that was made with Nova Scotia was exclusive to Nova Scotia before this most recent round of discussions but after the deal that was made ten years ago with Mr. Mulroney?

Mr. Keenan: Yes.

Senator Day: That would presumably have been taken into consideration during the most recent negotiations on the 100 per cent offshore agreement made with Mr. Martin.

Mr. Keenan: Yes.

Senator Day: My final question is a point of clarification. We were talking about the fact that for the next three years the proportion of distribution has already been fixed according to proposed subsections 4.1(1), (2) and (3) to the act. Then we were referred to page 9 of the bill, clause 1(2) and proposed subsection 4.1(3), which talks about the next two years. For next year the proportions are set out, and then there is a percentage increase and there is to be a proportional distribution with a percentage increase for two years after the next fiscal year, which starts next month.

At the bottom of page 9 of the bill, in clause 1(2), we see that these particular sections of proportional distribution in the coming years ``come into force on a day or days to be fixed by order of the Governor in Council'' as you pointed out to us.

I am not sure what is behind this. Are you suggesting that the act may be implemented but this section will come into force at a time other than when the act comes into force? If so, what are the triggering mechanisms for bringing these other sections into force?

The Chairman: They said earlier that it was because the panel might report late.

Ms. Scullion: The act will come into force when it receives Royal Assent, except for two provisions. Proposed subsection 4.1(3) deals with the payments for the fiscal year beginning on April 1, 2006 and all following fiscal years, not only two years. It will be the same proportion, but only if the Governor-in-Council brings that provision into force.

We wanted to be able to make those payments to the provinces even if the panel reports late. If the panel makes a recommendation that allocates the equalization payments differently, the act will be amended.

Senator Murray: Assuming the government accepts the recommendation.

Ms. Scullion: I cannot predict that, and I am not touching that with a 10-foot pole.

Senator Murray: Neither can I.

Senator Day: That brings us back full circle to the panel. We would like to have some confidence in the panel. I understood from the answer to a question earlier that the panel will not be an arm's length panel but rather an internal panel. Did I misunderstand?

Mr. McKay: It is arm's length in the sense that the provinces will appoint people and the federal government will appoint people. The chair has already been appointed.

The Chairman: You said there would be no private interest.

Mr. McKay: There will be no private representation.

Senator Murray: Is it three federal and two provincial?

Ms. Delorme: Four and two.

Senator Murray: The chair was appointed by the federal government?

Ms. Delorme: That is correct.

Senator Murray: He is one of the four nominees from the federal government?

The Chairman: But with a provincial background.

Senator Murray: An Alberta provincial background.

Senator Day: What oversight will Parliament have of this panel? These are civil servants we are talking about.

Mr. McKay: Not necessarily.

Senator Day: Not necessarily but most likely.

Mr. McKay: I suppose Parliament retains a supervisory jurisdiction with respect to anything that might happen but, in theory, if they made recommendations that were translated into legislation, we are back here.

Senator Day: No, we are not. There will not have to be legislation. The government is proceeding with an advisory group over which it has no oversight. It is like buying a pig in a poke. We would pass this section now, but it would be up to the Governor-in-Council to implement it when they hear from a panel they have appointed over which we have no oversight, which could totally skew this distribution formula.

Mr. McKay: I would have thought that the distribution formula carries on absent any changes the government is prepared to recommend. It just keeps on keeping on.

Senator Day: No. It looks to me like proposed section 4.1 might have used a formula to determine the proportional distribution of the $10.9 billion for the next fiscal year, and then after that the increase and the distribution is in the same proportions if this is implemented.

Senator Murray: Until there is a change.

Senator Day: The change would have to come back to us.

Mr. McKay: The change would have to come back. However, if it is status quo, we carry on carrying on.

The Chairman: The government could also bring in its own recommendations for variation and change in the absence of the panel. As the witness said earlier, the government is not duty bound to accept any or all of the recommendations of the panel.

Senator Murray: They could just implement our report.

Mr. Delorme: The reasoning behind that is that, given the challenges the expert panel faces, they may not meet the deadline of December 31. The provinces will be in budget planning mode and we do not want to stall that process. It would not be fair to the provinces to do that. That is why we provided an insurance policy, a fall-back position under which we can make payments to provinces without jeopardizing their budget planning.

Senator Massicotte: I thought that paragraph referred to the three-year average ability to pay and not the existing program of 33 economic measures. I gather from Mr. McKay it was the existing 33, but I read that paragraph to mean that the interim approach we took in 2005-06 will apply and that formula will be frozen.

Mr. Keenan: That is right. Those shares have been determined by the existing formula, but those shares would not be updated.

Senator Massicotte: They are frozen, in other words?

Mr. Delorme: The shares are frozen in 2005-06. If needed, it will be applied in 2006-07.

Senator Day: There are some other sections that provide for small adjustments, notwithstanding that distribution. I think that was because of overpayments or underpayments.

Mr. McKay: We may have some more accords; who knows.

The Chairman: Mr. McKay, it seems that everything now is really in the hands of this panel, and it has the opportunity to look at whether it should be a permanent independent body to give ongoing advice. Has the department has given some thought to this? If so, what is your thought on whether there should be a permanent panel set up to give advice on the changes needed in the formula?

Mr. McKay: It is clear that the department and the minister have given it a lot of thought, because they put that in the terms of reference. I do not know how the panel will report on that aspect of their terms of reference.

It is a fairly complex area and it may well be that the level of complexity is such that the government wants to remove itself from figuring out who is entitled to what at any given time. I suppose it could be almost like a commission. We have all kinds of rate-setting commissions that measure all kinds of things. Clearly the minister has thought about whether he might want to go down that path.

The Chairman: We hear a lot about blue ribbon panels that give advice.

Mr. Keenan or Mr. Delorme, do you want to comment on the current thinking within the department about whether that would be useful?

Mr. Delorme: It was put there because we wanted to learn from other experiences. In Australia, there is a separation between the determination of the overall amount and the allocation, and we thought it would be good for the panel to assess that to see whether it could be applied in Canada. We thought they could look at the experiences of other countries as well.

Senator Massicotte: I read in the materials that 3.5 per cent represents historic experience; in other words, nominal GDP growth minus 2 per cent, which means that equalization is effectively happening. In other words, we are levelling out. It also means that while the nominal sum of equalization payments is going up, relative to GDP it is going down. Is my comprehension accurate?

Mr. McKay: It is going down relative to nominal GDP, but it is not going down compared to real GDP.

Senator Massicotte: It should though.

Mr. McKay: At 3.5 per cent.

Senator Massicotte: It is a 3.5 nominal increase, and GDP growth has been averaging 3 per cent to 3.5 per cent.

Mr. McKay: Although the minister just announced 2.9 per cent.

Senator Massicotte: It is 3 to 3.5 per cent GDP net of inflation. Nominal GDP is probably close to 5.5 per cent.

Mr. McKay: Is your argument that we should have built in an inflation number?

Senator Massicotte: No. The argument I saw is that history has proven that the increase in equalization payments has been approximately equal to nominal GDP minus 2 per cent. If that is true, obviously two things arise from it. First, equalization is occurring; we are all arriving at the same level. Second, I assume that relative to GDP the payments must be going down.

Mr. McKay: I do not follow how that is going down.

Senator Massicotte: Pure math tells you that.

Mr. Keenan: It is true that as a share of the overall economy equalization payments have been declining, and we would anticipate that because, due to declines in disparities, the population share of the receiving provinces has declined over time.

Senator Massicotte: There is a decline in disparities. That is obviously what it means.

Mr. Keenan: Provincial revenues as a share of GDP are declining as well.

Mr. Delorme: We see that as well in relative income and interprovincial differences in unemployment rates. Most of the measures that we rely on indicate a narrowing of fiscal disparities over the last 20 years.

Senator Massicotte: That is good news. In 30 or 40 years, the payments will be nominal.

Mr. Delorme: You can say that less equalization is good news.

The Chairman: You must have long-term charts that show that curve.

Mr. Delorme: Yes, we do.

Senator Downe: Part of the so-called lessening of the disparity is because most areas in rural Canada have been depopulated. Rather than lessening disparity, more people are moving to the larger centres for opportunities.

Senator Massicotte: They are moving for jobs.

Senator Downe: That is not correcting the disparity.

Senator Massicotte: Sure it is. That is a very normal process.

Senator Murray: What was supposed to be equalized is fiscal capacity, and if you take a national average, none of the recipient provinces is being brought up to 100 per cent. They are all in the 90s.

Some of us were in Australia a few years ago where we talked to what they call the Commonwealth government and to the state governments. People in the state governments told us that the commission goes around to the states to try to measure not only their fiscal needs but also their expenditure needs. One state politician told us that they take the commission by bus over the worst possible roads in the state and show them the most miserable facilities in order to point out their greater needs. That would be very interesting if we tried it here.

Mr. McKay: I take it you will not be volunteering for this commission?

Senator Murray: No, sir, and I do not think anyone else with any sense would.

I followed the debate in the House of Commons, Mr. McKay. You had carriage of the bill, and you engaged fully with the opposition, who had a lot to say and asked a lot of questions. There was one aspect, and I raised it in the debate in the Senate yesterday, on which I did not see your reply. It was a concern expressed by Ms. Ambrose, the official opposition critic, to the effect that the new floor — by which I take she means the $10.9 billion plus the 3.5-3.5 — is fiscally imprudent. Her fear seems to be that if the economy goes on a downer the recipient provinces would be equalized above the national average. As I said, that has not happened, but it is conceivable it could happen.

I do not know how real that possibility is, or whether you or the government have considered it in that light. As you say, it is a transfer of risk. You have the stabilization program already, under which Ontario, over a period of four years, got $1 billion and Alberta $500 million or so when the economy was going down and their revenues decreased.

What do you say to her concern that the old floor was enough and this new floor is fiscally imprudent?

Mr. McKay: She spoke to me privately about that as well. The Government of Canada has made its calculation and has said that we will assume this risk, not knowing what will happen five year hence. We had an interesting meeting in the Finance Committee yesterday with all the fiscal forecasters. The spreads were pretty interesting. There was a spread of $7 billion in the coming fiscal year and a little less than $7 billion the year following. That was on the ``surplus.''

There are a lot of unknowns, but the bottom line is that we have bought the risk. At the end of five years, it is up for grabs again. I suppose that it may turn out that this is not a good thing for the federal government.

Senator Murray: Did you decline to answer at the time because you think there is merit in her concern?

Mr. McKay: I remember her asking questions in the House, but I do not remember that question in particular. I remember her asking me privately but not publicly.

Senator Murray: She raised it in her speech. Experience indicates that her concern is not well founded.

Mr. McKay: Recent experience, certainly after running eight balanced surplus budgets in a row.

Senator Murray: Equalization has never been such a terrible relative burden on the federal fisc, although you fellows think it is.

Mr. McKay: In relative terms, it is equivalent to the Canada child tax benefit.

The Chairman: Mr. McKay, on behalf of the committee, I should like to thank you and the officials from the department who have come here tonight and answered some questions on difficult legislation. It is highly complicated, but you have given your answers with great dignity and a lot of clarity.

The committee adjourned.