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Equalization payment

 

In a country with no provincial public services, free migration would lead to an efficient allocation of labor resources across provinces. Efficiency would require marginal product of labor, which is the real wage rate, be equalized across provinces. And since labor would migrant till real wage rate is the same across regions, free migration of labor would result in an efficient allocation of labor. With migration costs, efficient labor allocation is that the marginal product of labor net of migration costs be equalized across provinces. .
             Once provinces are collecting taxes and providing public services in a decentralized federation, free migration of labor is no longer efficient. A person's real income is his or her real wage minus taxes, plus everything he or she can get from the provincial government, including both goods and services. Every province has different public services depending on their tax revenues and government's own decisions. And a person would choose to reside where he or she can get the highest real income, which is real wage minus tax and plus public services. If real wage is the same across provinces, then the difference is public services minus tax, which is called the net fiscal benefit. Now, free migration results in net fiscal benefit being equalized instead of real wage. So anything that causes net fiscal benefit to be different will raise an incentive to inefficient migration. .
             Robin Boadway listed three prominent sources from which net fiscal benefit differentials across provinces may arise. The first one is from the differences in source-based tax revenues. Under Canadian constitution, provinces have access to revenues from non-renewable resources within their own borders. Oil and gas revenues are of the most contentious issues surrounding equalization. For provinces that are rich in resources, the net fiscal benefit is higher than other provinces. When the province imposes a tax on the resources, everyone in the province gets a share of the revenues; and so the province is able to provide public service of an amount that exceeds the per capita tax.


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