Evaluating the Efficiency and Equity of Federal Fiscal Equalization

In theory, federal transfers that make household location decisions efficient should ignore local cost differences, subsidize positive externalities, and offset differences in federal-tax payments and local taxes levied on non-residents, but not local tax revenues from residents. Transfers that redistribute resources equitably across regions will likely target areas with individuals of low earnings potential or low real incomes. Applying these criteria empirically, Canadian equalization policy appears neither efficient nor equitable, but exacerbates pre-existing inefficiencies and underfunds minorities. Locational inefficiencies cost Canada 0.41 percent of income annually and cause over-funded provinces to have populations 31 percent beyond their efficient long-run levels.

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