Alberta’s Revenue Problem

I recently had the pleasure of making a couple of presentations on public finances in Alberta. In February, I spoke at the “Remaking Alberta” conference in Edmonton. This past week, I served on an Alberta Federation of Labour (AFL) panel in Calgary with Todd Hirsch from ATB Financial and Roger Gibbins from the Canada West Foundation.

Like other provinces, Alberta is currently focussed on cutting provincial public services to balance the budget. The AFL used the Calgary event to launch a paper making the case for more, and better managed, revenues to balance the budget and enhance public services.

In particular, the AFL is quite rightly pushing to reinstate a progressive personal income tax instead of Alberta’s current flat tax. My presentation focussed on two other revenue sources covered by the paper: resource royalties and corporate taxes.

Alberta’s Revenue Potential

Statistics Canada’s latest provincial figures are for 2008. The 2009 figures will be released in November. (It seems that Statistics Canada has stopped releasing preliminary provincial figures in the spring.)

In 2008, corporate profits were larger in Alberta than in Ontario: $66 billion versus $58 billion. This comparison is striking because Ontario has more than three times the population and is the centre of Canada’s highly profitable financial sector. The obvious explanation of Alberta’s massive profits is the oil and gas industry.

This industry is so profitable partly because the Alberta government gives away its oil and gas reserves for less than they are worth. Roughly half the value of Alberta’s oil and gas goes into the provincial budget as royalty revenue. The other half goes onto corporate balance sheets as extra profits.

In other words, if the oil and gas industry’s exploration, development and operating costs are subtracted from its revenues, it is left not only with the normal profit needed to justify investments and risks, but also excess profits. The Alberta government’s recent royalty cuts aggravated this giveaway.

Another mechanism to collect these funds is the corporate income tax (CIT). But Alberta has a CIT of just 10%, the lowest of any province. In the 2008-09 fiscal year, provincial CIT revenues were $4 billion in Alberta compared to $7 billion in Ontario.

Therefore, the Alberta government has tremendous potential to collect more revenue through resource royalties and corporate taxes. The usual objection is that higher royalties or taxes would destroy Alberta’s competitiveness. This objection is flawed in at least four ways.

Debunking Competitiveness

First, Alberta’s oil and gas reserves are immobile. They are not like a factory that can relocate anywhere in pursuit of lower costs.

The worst that higher royalties and taxes could do for conventional oil and gas is to shift some marginal development to other jurisdictions. However, as reserves are depleted elsewhere and commodity prices rise, this development would return to Alberta. Delaying some marginal development seems like a small price to pay for a better return on existing production and on more lucrative development.

The Athabasca oil sands, a far larger source of new development, has few viable competitors. The only comparable geology is the Orinoco oil sands in Venezuela. But Alberta has plenty of room to charge higher royalties and taxes while remaining more business-friendly than Hugo Chavez.

Second, there is little empirical evidence that low royalties and corporate tax cuts increased investment. Alberta slashed its CIT rate by one-third, from 15.5% in 2001 to 10% in 2006. Business investment in Alberta did boom over the past decade, but mostly due to skyrocketing commodity prices.

The wider Canadian economy is less sensitive to commodity prices. The federal government also cut its CIT rate by a third, from 29% in 2000 to 18% today. But business investment actually decreased as a share of Canada’s economy, even before the financial crisis.

Third, not all of the money forgone by the provincial government through low corporate taxes and low royalties actually goes to business operations in Alberta. Many Alberta corporations are affiliates of American-based corporations.

When they repatriate profits to the US, they pay the American federal CIT rate minus a credit for CIT paid in Canada. As Ottawa and Edmonton cut their combined CIT rate below the American rate, these corporations must pay the difference to Washington.

The American federal CIT rate is 35%. Alberta’s provincial rate is 10% and Canada’s federal rate is falling to 15%. Profits repatriated from Alberta to the US will be taxed at 35%, minus a 25% credit, giving the US government 10%.

Each dollar of royalty cuts increases the industry’s taxable profits by a dollar. Of that, 10 cents comes back to the Alberta government through provincial CIT and 15 cents will be paid as federal CIT. If the corporation is American, a further 10 cents will be paid as American CIT. So, of each royalty dollar forgone by the Alberta government, up to 35 cents goes to Ottawa and Washington.

Fourth, other provincial governments react to Alberta’s policies. Competitiveness is by definition a relative concept. The “Alberta Advantage” was about having lower royalties and taxes than other provinces.

Because Alberta produces more oil and gas and has more corporate profits than any other province, it sets the standard. Other provinces feel compelled to match Alberta. For years, Saskatchewan and BC cut their resource royalties to compete with Alberta.

Alberta is currently the only province with a 10% CIT. However, BC, Ontario and New Brunswick have scheduled corporate tax cuts that will get them to 10% in the next few years.

The “Alberta Advantage” was a self-defeating strategy. It did not create a durable competitive advantage, but left Alberta and other provinces with less public revenue. Because Alberta has the most fossil fuels and corporate profits, it is well positioned to show leadership in reversing this race to the bottom.