Cutting through the Gordian Knot

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Cutting Through the Gordian Knot – An Objective Assessment of theEqualization Implications for Newfoundland and Labrador of the 2007Federal Budget: 

Cutting Through the Gordian Knot – An Objective Assessment of the Equalization Implications for Newfoundland and Labrador of the 2007 Federal Budget A Presentation Sponsored by the Faculty of Arts Wade Locke Department of Economics April 4, 2007 St. John’s, NL

Presentation Outline: 

Presentation Outline Introduction Options Explained Equalization Calculations Under Each Option Results Interpretation of Results Conclusion

Introduction: 

Introduction This is part of bigger project on Atlantic Canada currently being undertaken with Acadia economist Dr. Paul Hobson I come at this as an economist, not a politician nor political scientist The views in this presentation, like all academic presentations by faculty members at Memorial University do not necessarily represent the view of either the Faculty of Arts or Memorial University This presentation will be available tomorrow at www.mun.ca/arts

Introduction: 

Introduction This is not an attempt to determine whether a promise was made and broken or fulfilled for that matter There are others with more sophistication and expertise who are perfectly capable of addressing this issue It is, however, an attempt to illustrate the implications for the NL treasury of each of the three options andamp; to facilitate public debate on a more informed basis This is extremely complicated and I am at the edge of my analytical capabilities

Equalization Options in 2007 Budget: 

Equalization Options in 2007 Budget Old Option (Status Quo) 50% Resource Option (O’Brien Panel) 0% Resource Option (Harper Letter)

Equalization Options in 2007 Budget: 

Equalization Options in 2007 Budget Old Option (Status quo) 100% revenues count in calculating equalization (100% of offshore oil included in equalization formula unless Generic Solution invoked, but Atlantic Accords offset losses from oil revenue) 33 separate revenue categories, including shared revenues offshore 3 year moving average, delayed one year (eg. 2007-08 calculations are based on average of fiscal years 2004-05 to 2006-07, inclusive)

Equalization Options in 2007 Budget: 

Equalization Options in 2007 Budget Old Option (Status quo) Atlantic Accords protect NL against losses due to oil revenues 2005 Accord renewed in 2012/13 to 2019/20 if equalization receiving province in 2010/11 or 2011/12 andamp; debt service cost per capita not lower than at least 4 provinces If outside of equalization in any year prior to renewal, no payment under 2005 Accord but 1985 Accord still relevant

Equalization Options in 2007 Budget: 

Equalization Options in 2007 Budget Old Option (Status quo) – Key Features Fiscal capacity The level of revenue that a province could raise in per capita terms by applying the national average tax rate for each of the 33 revenue categories to the size of the base that exists within the province. (100% of oil revenue counts) Equalization standard The standard is determined residually. That is, given the fiscal capacities of all ten provinces how large would the standard have to be in order to ensure that total equalization payments matched exactly the pool of funds available for distribution in that particular year Equalization pool Funds available for equalization that grow at 3.5% per year, starting at $10.9 B in 2005. This has a value of $11.7 B in 2007. Atlantic Accords Both 1985 and 2005 Accords still operate so long as equalization-receiving province

The Atlantic Accords: 

The Atlantic Accords 1985 Accord provided offset payments to mitigate equalization claw back for 12 years from 1999-00 to 2010-11 (Part I extended to 2011/12 with the 2005 Accord) Part I – ensures that equalization plus Part I payments do not fall dramatically from between adjacent years (percentage protection determined by relative fiscal capacity) Part II – ensures province is compensated for percentage of any decrease in equalization entitlements plus Part I payments 2005 Accord calculates equalization with and without oil revenues and the difference defines the maximum payout under the 2005 Accord. Any payment under the 1985 Accord is deducted to give the actual payment under 2005 Accord 2005 Accord renewed after 2012 if certain conditions met

Atlantic Accord – New Options: 

Atlantic Accord – New Options For continuance of the ACCORD, the province must qualify for receipt of an equalization payment in 2010-11 or 2011-12 Question to federal Finance In calculating the accord under the new arrangement, is it the case that NL receives the accord if it qualifies for equalization on the new arrangement prior to the cap being imposed?  In other words, while the cap can remove all equalization payments, but before that happens, the province could qualify to receive equalization pre-cap and as such be eligible to receive the accord. Is that correct?

Atlantic Accord – New Options: 

Atlantic Accord – New Options Answer by federal Finance Your assumption is correct; it is the pre-cap equalization amounts that are used in the Accord calculations. The legislation before the House proposes that under the new arrangement, the test for determining whether or not NL qualifies for the 2005 Accord is whether or not it would receive Equalization payments under the base O’Brien formula – that is, 50% inclusion of resources plus the cap. If it receives EQ under that formula, then the next steps are taken to determine how much. In this case, the offsets are determined before the cap is applied.

Atlantic Accord – New Options: 

Atlantic Accord – New Options This implies that the Accord is calculated pre-cap and that is what all of our calculations are based on As well, provincial finance officials have the same interpretation Caveat: If this is changes because of changes in federal legislation, then the analysis for the 50% option presented below will have to be recalculated.

Equalization Options in 2007 Budget: 

Equalization Options in 2007 Budget 50% Resource Option (O’Brien Panel) 10 province standard 5 broad equalization bases (personal income taxes, business income taxes, consumption taxes, natural resources and property taxes andamp; miscellaneous) 50% of natural resource revenues count Atlantic Accords still function

Equalization Options in 2007 Budget: 

Equalization Options in 2007 Budget 50% Resource Option (O’Brien Panel) Based on 3 year weighted-average, delayed two years (eg., 2007-08 equalization payments depend on 2003-04 to 2005-06 and the weights are 50% of most recent year and 25% for two other years) In other words, economic performance this year and last year are unimportant for determining equalization, but what happened 5 years ago, surprisingly, is significant (cost of predictability in terms of reduced flexibility) Cap on total equalization (equalization payment reduced by the amount a province is over the cap) Combined per capita fiscal capacity with equalization and Atlantic Accord revenues cannot put equalization receiving province above any province not receiving equalization

Equalization Options in 2007 Budget: 

Equalization Options in 2007 Budget 50% Resource Option (O’Brien Panel) – Key Features Fiscal capacity The revenue that a province could raise in per capita terms by applying the national average tax rate for each of the 5 broad revenue categories to the base that exists within the province but only 50% of resource revenues count. Equalization standard The standard is a 10-province standard – it is the average across 10 provinces of the per capita fiscal capacity as determined above Equalization pool It is determined by whatever comes out of the formula. after the cap (no fixed pool). Equalization cap Equalization is reduced to ensure that no equalization-receiving province has, by the virtue of receiving equalization, a fiscal capacity that exceeds any non-receiving province Atlantic Accords Both 1985 and 2005 Accords still operate as long as equalization-receiving province

Equalization Options in 2007 Budget: 

Equalization Options in 2007 Budget 0% Resource Option (Harper Letter) Identical to the 50% option except: 100% of natural resource revenues are excluded rather than 50% Atlantic Accords function, but no longer relevant (i.e., 100% of resources excluded, 'including oil revenue' so recalculating assuming zero oil revenue does not change the result)

Revenue Assumptions: 

Revenue Assumptions Production profile for three operating projects taken from CNOLPB presentation on March 25, 2007 at PRAC’s Small Field Development conference Hebron not considered in revenue projections but Hibernia South included Sproule price forecast – Feb 28, 2007 2% inflation $0.87 US/Cdn Long term WTI $51 US/ bbl (2007 prices)

Production & Prices Utilized: 

Production andamp; Prices Utilized Hibernia 1,244 M bbl Terra Nova 354 million White Rose 283 million

Revenue Profile (Fiscal Year Estimates): 

Revenue Profile (Fiscal Year Estimates) Total Revenue = $18.6 B $1.37 B 2007-08

Equalization Assumptions: 

Equalization Assumptions Population assumed to remain constant at 2006 levels Note: if population declines relative to other provinces, then this will affect the calculation, but for reasonable assumptions, the basic result should be unaltered NL oil revenue and NS gas revenue calculated separately Per capita fiscal capacity in all other provinces and non-oil and gas per capita fiscal capacity in NL and NS also grows at 1.4% per annum Over last 10 years, average per capita fiscal capacity has grown at 1.4% per year Note: if per capita bases in each province change at different rates, then will affect the precise calculations, but for reasonable assumptions, the basic result should be unaltered. $150 million per year added to NL mining revenue to reflect improved mining picture (higher prices, Voisey’s Bay andamp; new mines)

Illustration of Equalization – Status Quo 2007-08 Fiscal Year: 

Illustration of Equalization – Status Quo 2007-08 Fiscal Year Equalization Standard = $6,776 Equalization pool = $11.7 B NL under by $870 per capita. With pop of 514,000, Equal. Entitlement is $447 M andamp; $527 M from Accords. Differs from fed budget because 2006 oil revenue $100 M more than budget used for 2006/07

Illustration of Pre-Cap Equalization – 50% Option 2007-08 Fiscal Year: 

Illustration of Pre-Cap Equalization – 50% Option 2007-08 Fiscal Year Equalization Standard = $6,321 NL under by $1,600 per capita. With pop of 516,000, equal. Entitlement pre-cap is $820 M

Illustration of Cap – 50% Option 2007-08 Fiscal Year: 

Illustration of Cap – 50% Option 2007-08 Fiscal Year $7,215 Cap $6,630 NL over by $584 per capita. With pop of 516,000, equal. reduced by $300 M leaving $520 M

NL Capacity Before Equalization and After the Cap – 50% Option: 2007-08 : 

NL Capacity Before Equalization and After the Cap – 50% Option: 2007-08 $3,257 Eq. Std. $3,422 CAP

Illustration of Pre-Cap Equalization – 0% Option 2007-08 Fiscal Year: 

Illustration of Pre-Cap Equalization – 0% Option 2007-08 Fiscal Year Equalization Standard = $5,971 NL under by $1,744 per capita. With pop of 516,000, equal. Entitlement pre-cap is $899 M

Illustration of Cap – 0% Option 2007-08 Fiscal Year: 

Illustration of Cap – 0% Option 2007-08 Fiscal Year $6,955 Cap $6,630 NL over by $324 per capita. With pop of 516,000, equal. reduced by $167 M leaving $732 M

NL Capacity Before Equalization and After the Cap – 0% Option: 2007-08 : 

NL Capacity Before Equalization and After the Cap – 0% Option: 2007-08 $3,081 Eq. Std. $3,422 CAP

Status Quo Equalization CalculationsNL Option in 2007 Budget – Pre-Accords: 

Status Quo Equalization Calculations NL Option in 2007 Budget – Pre-Accords Equal. Oil Rev.

Status Quo Equalization CalculationsNL Option in 2007 Budget–Adding Accords: 

Status Quo Equalization Calculations NL Option in 2007 Budget–Adding Accords Accord

Status Quo Equalization CalculationsNL Option in 2007 Budget – Post Accords: 

Status Quo Equalization Calculations NL Option in 2007 Budget – Post Accords Equal. + Accord

Status Quo Equalization CalculationsNL Option in 2007 Budget - Impact: 

Status Quo Equalization Calculations NL Option in 2007 Budget - Impact Net Rev.

50% Resource Option CalculationsNL Option in 2007 Budget – Pre-Accords: 

50% Resource Option Calculations NL Option in 2007 Budget – Pre-Accords Equal. Oil Rev.

50% Resource Option CalculationsNL Option in 2007 Budget-Adding Accords: 

50% Resource Option Calculations NL Option in 2007 Budget-Adding Accords Accords

50% Resource Option CalculationsNL Option in 2007 Budget-Adding CAP: 

50% Resource Option Calculations NL Option in 2007 Budget-Adding CAP CAP Impact

50% Resource Option CalculationsNL Option in 2007 Budget-Post Cap: 

50% Resource Option Calculations NL Option in 2007 Budget-Post Cap Post CAP Equal.

50% Resource Option CalculationsNL Option in 2007 Budget-Post Cap/Accords: 

50% Resource Option Calculations NL Option in 2007 Budget-Post Cap/Accords Post Cap Equal. andamp; Accords

50% Resource Option CalculationsNL Option in 2007 Budget - Impact: 

50% Resource Option Calculations NL Option in 2007 Budget - Impact Net Rev.

0% Resource Option CalculationsNL Option in 2007 Budget – Pre-Accords : 

0% Resource Option Calculations NL Option in 2007 Budget – Pre-Accords Equal. Oil Rev.

0% Resource Option CalculationsNL Option in 2007 Budget-Adding Accords: 

0% Resource Option Calculations NL Option in 2007 Budget-Adding Accords Accords

0% Resource Option CalculationsNL Option in 2007 Budget-Adding Cap: 

0% Resource Option Calculations NL Option in 2007 Budget-Adding Cap Impact of Cap

0% Resource Option CalculationsNL Option in 2007 Budget- Post Cap: 

0% Resource Option Calculations NL Option in 2007 Budget- Post Cap Post Cap Equal.

0% Resource Option CalculationsNL Option in 2007 Budget – Post CAP/Accords: 

0% Resource Option Calculations NL Option in 2007 Budget – Post CAP/Accords Equal + Accords.

0% Resource Option CalculationsNL Option in 2007 Budget - Impact: 

0% Resource Option Calculations NL Option in 2007 Budget - Impact Net Rev.

Provincial Net Revenue Implications of the Three Options: 

Provincial Net Revenue Implications of the Three Options

Comparison of Treasury Impacts for 2007/08 to 2019/20: 

Comparison of Treasury Impacts for 2007/08 to 2019/20

Optimal Approach Provincial Treasury: 

Optimal Approach Provincial Treasury Go with Status Quo for this year and next and switch to O’Brien in 2009 onward.

Implications of Optimal Approach on Provincial Treasury for 2007/08 to 2019/20: 

Implications of Optimal Approach on Provincial Treasury for 2007/08 to 2019/20

Comparison of Treasury Impacts for 2007/08 to 2019/20 Without CAP: 

Comparison of Treasury Impacts for 2007/08 to 2019/20 Without CAP

Implications for Treasury: 

Implications for Treasury $4.5 B difference ($28.6 B - $24.1 B) Maybe this is the real issue But, one needs to look how this affects NL’s per capita fiscal capacity relative to next lowest non-receiving province when the province receives equalization with no cap

NL Per Capita Fiscal Capacity as a Percentage of the Lowest Non-Receiving Province: 

NL Per Capita Fiscal Capacity as a Percentage of the Lowest Non-Receiving Province

Implications for Long-term Support of Equalization Program: 

Implications for Long-term Support of Equalization Program This could put long term support for the equalization program in jeopardy Although the principle is enshrined in constitution, the formula is not and the program is not, just the commitment to the principle

Conclusion: 

Conclusion Clearly, more information is needed to facilitate public debate on issues that are so crucial for the well-being of the people of the province This is not easy analysis to do, it stretched my abilities and I have been doing this type of analysis for a long time Does not lend itself to quick reaction. Another complication is that the self-interest of each province is different and this makes it difficult to satisfy every legitimate interest

Conclusion: 

Conclusion Constitutional commitment is a commitment to a principle, not to a program and definitely not to formula Accords are outside the equalization program Accords do not disappear. They stays in effect What is best depends on the time period considered.

Conclusion: 

Conclusion Core result for the next two years the status quo is the best option for NL and thereafter the O’Brien (50%) formula is a better deal for NL Moreover, the 50% option allows NL to keep the Accord longer than would not have been possible under the status quo The federal budget option was a substantial improvement over the status quo but it is not the deal the NL government wanted Thank You Questions/Comments

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