Equalization and Stabilization

The federal Equalization transfer program makes fiscal resources of "have-not" provinces depend on fiscal conditions in "have" provinces, which tends to destabilize provincial finances: the data show that equalized revenues of receiving provinces are more volatile than own-source revenues. But this reflects the revenue risks facing the aggregate of all provinces, which an equalization program cannot insure. Controlling for aggregate risk, I find that the program has a significant stabilizing effect on provincial finances. Nevertheless, some improvements in revenue-sharing through the program might be contemplated. For example, a return to a national average capacity standard, from the five-province standard which has been in place since 1982, would increase insurance for idiosyncratic shocks by about one-third.