A recent report released by the Fraser Institute and the National Center for Policy Analysis shows that by and large, U.S. states outperform Canadian provinces on various measures of economic freedom. While the very concept of economic freedom proves inevitably difficult to measure, especially at the subnational level, researchers examined ten variables divided into three categories to formulate an index thereof. Because several categories of the world index, including legal system stability, banking policies, and trade policies, vary little among states and provinces, researchers eliminated them from this analysis and focused primarily upon variances in size of government, takings and discriminatory taxation, and labor market freedom.
Ultimately, the report finds that Canada’s fiscal federalism nullifies any improvements in economic freedom that do occur within Canadian provinces, and this phenomenon helps to explain economic disparities between most American states and their northern neighbors:
…if a [Canadian] province increases economic freedom, for example by reducing taxes, and its economy grows, the result is an increased outflow of government revenues to other jurisdictions and a heavier tax burden, given the progressivity of Canadian taxes, which in turn suppresses increases in economic freedom and economic growth. In other words, fiscal federalism mutes the effect of economic freedom in Canada.
This “economic drain” phenomenon proves notably absent among U.S. states. Indeed, although most states have maintained high degrees of economic freedom over time, a few have failed to do so. However, these few states, whose GDP’s and real-term growth rates have consistently fallen below national averages for more than two decades, have yet to impact wealthier ones. Contrary to the expectation that “richer states should grow more slowly than poorer states due to the convergence effect,” those states with particularly high economic freedom scores have maintained such scores for the last two decades. The absence of fiscal federalism, then, largely explains why “a one-point improvement in economic freedom…increases per-capita GDP by $5,907 for U.S. states and by [only] $2,975…for Canadian provinces,” while a “1.00% increase in the growth rate of economic freedom…will induce an increase of 1.05% in the growth rate of per-capita GDP for U.S. states and an increase of 0.54% in the growth rate of per-capita GDP for Canadian provinces.”
However, despite the high performance of most U.S. states, the repeated subordinance of several states (West Virginia, Hawaii, Maine, Montana, New Mexico, North Dakota, and Rhode Island) brings about the question of how to improve their economic conditions without damaging the economies of their more prosperous neighbors, and further, why their failing performances persist in the first place. Indeed, repeated inferior economic freedom scores prove “particularly remarkable because poorer states under normal conditions will grow faster than rich states due to the well-known and empirically verified ‘convergence’ effect.”
Unfortunately, this convergence effect has already occurred across the border; eight of the ten Canadian provinces scored in the bottom fifth of the economic freedom index devised for this study. The states and provinces in this quintile have an average per-capita GDP of just $21,936, while the average of the top quintile proves nearly twice as large at $38,305, plainly demonstrating that “economic freedom is a powerful driver of growth and prosperity and those provinces and states that have low levels of economic freedom continue to leave their citizens poorer than they need or should be.”
The Fraser/NCPA report ultimately concludes that
Canadian provinces are poorly positioned to take advantage of economic opportunity. The provinces are clustered near the bottom of the rankings in all three areas, indicating that their governments have consumed and transferred more resources, imposed higher tax rates, and created more rigid labor markets than the governments of US states.
The central government of Canada, through its taxation policies that, in effect, distribute revenues from wealthy provinces to poor provinces, hinders any economic growth. As the report explains, a province that cuts taxes to spur growth will have the effects of that cut negated because the federal government will use that added revenue to assist poorer provinces.
Canada’s policies and the results show that the best way to spur growth in underperforming states or provinces is for the federal government to leave them alone. A policy the distributes funds from, as the report calls them, “have” entities to “have-not” entities kills any competitiveness that will drive growth and create wealth.