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Business Commentary More tax relief for Quebeckers would raise ire of Western Canada

Premier Philippe Couillard was being coy this week in saying he "thinks" his fiscal margins will be strong enough to offer Quebeckers "more tax relief" in or around the next provincial budget.

He doesn't just think they are; he knows they are. Quebeckers can bank on tax cuts every bit as much as they can count on going to the polls in 2018. The government posted a $2.5-billion surplus in the 2016-17 fiscal year after tucking away an extra $2-billion in its debt-reduction fund. All signs point to an even stronger performance this year, as a buoyant economy propels tax revenue past budget projections.

Quebeckers, who pay the highest taxes in Canada, are owed some meaningful relief. This year's budget offered an unfulfilling taste of that by abolishing a much-despised health levy introduced by the Liberals under Jean Charest in 2010 and by raising the basic personal exemption. Together, the cuts lightened the tax burden of those earning between $40,000 and $135,000 by a modest $255.

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Larger tax cuts than that, however, are certain to further raise the ire of Western Canadian politicians who have been calling for a reform of the federal equalization program. Under the current formula, Quebec will receive more in equalization funding next year than the $11.1-billion it is getting this year – even though its economy is on a roll while those of Alberta and Saskatchewan continue to struggle.

Neither Saskatchewan Premier Brad Wall nor Brian Jean, who is running to become leader of Alberta's United Conservative Party, think that's fair and are demanding an overhaul of the system. Maxime Bernier took a similar position during the recent federal Conservative race.

The presumed front-runner in the Oct. 28 UCP leadership race, Jason Kenney, was a member of the federal Conservative government that adopted the current equalization formula. But he now argues that formula penalizes Alberta by including non-renewable resource revenue in calculating income disparities between have and have-not provinces. That widens the so-called fiscal-capacity gap between rich and poorer provinces that the equalization program aims to bridge, resulting in larger payments for the have-nots than would otherwise be the case.

Fiscal capacity measures a province's ability to raise revenue based on national average tax rates and resource revenue. At identical tax rates, provinces with lower average incomes raise less than richer ones.

"I would be prepared to hold a referendum on a question to force the federal government to renegotiate equalization to remove non-renewable resource revenues from the definition of fiscal capacity," Mr. Kenney said this week.

Former prime minister Stephen Harper was largely courting Quebec voters when he rejigged the program in 2007. But Mr. Charest, fighting for his political life in a provincial election campaign, promptly used $700-million of Quebec's sudden equalization windfall to cut provincial income taxes. Thus began a cold war between Mr. Harper and Mr. Charest that never truly ended.

Jake Enwright, a spokesman for federal Conservative Party Leader Andrew Scheer, said he "was not all that familiar" with criticisms of the equalization program raised by Mr. Bernier and Mr. Wall, even though the issue was repeatedly brought up during the Tory leadership race.

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But Mr. Scheer will need to refine his position soon. The equalization program comes up for automatic review in 2019 and Ottawa must begin discussing any proposed changes with the provinces well before then. Justin Trudeau's government has already rolled back federal health transfers. Equalization could be next as Ottawa is pressured to balance its own budget.

Ottawa distributed $18.2-billion in equalization payments this year, with more than 60 per cent of the total going to Quebec. That sum will rise to $18.9-billion next year. Since Ontario is expected to become once again ineligible for equalization as early as next year – its fiscal capacity meets or exceeds the national average – Quebec, Manitoba and the Maritime provinces will have even more to divide up among themselves.

Under the current formula, the equalization fund increases in line with the three-year rolling average of nominal economic growth. But critics argue that the fund should instead be shrinking in line with the fiscal capacity of the have provinces. A Fraser Institute study last month found that the average fiscal capacity of the four have provinces (Alberta, Saskatchewan, British Columbia and Newfoundland) exceeded that of equalization-receiving provinces by 42 per cent in 2014. By last year, the gap had shrunk to 32 per cent.

The Vancouver-based think tank argued that instead of growing in line with nominal GDP, the equalization envelope should expand and contract in line with disparities in fiscal capacity. "This reform would save the federal government money and reduce the threat of exacerbating regional tensions," the study insisted.

As Quebec prepares to cut taxes, it is practically proving the Fraser Institute's point.

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