Equalization payments refer to monies that a federal government transfers to a lower level government so the standard of living in that location can be comparable to the standard of living in surrounding locations. Canada, Australia, and Germany are examples of countries that have established equalization programs. Each federal government may structure its program in a different manner, but generally, the principles are similar.
Canada’s Department of Finance says its equalization payments address fiscal disparities among provinces. Fiscal disparities are revenue differences. When one province has substantially more money than another province, it is unlikely that the quality of public services can be equal in both locations unless people in the poor location are heavily taxed. Equalization payment systems are established with the goal of helping ensure a consistent standard of public services in a nation without overburdening its citizens with the costs.
Fiscal capacity is a term used to refer to the ability to generate revenue. This is generally considered before a federal government makes such payments. If there are five states in a country, for example, and three of them have a similar fiscal capacity while the remaining two states have a fiscal capacity that is 20 percent less, the federal government may decide to issue equalization payments for the 20 percent disparity to the two low revenue states to afford them the opportunity to offer an equal standard of living as the three high revenue states.
In many cases, when a federal government gives money, there are numerous conditions attached. The receiver may be obligated to use the money for a certain purpose. The receiver may risk losing future funding or risk a demand for repayment if certain things are not done. However, equalization payments are issued for public benefit. As such, these funds are commonly unconditional. This means that the federal government will not dictate how they are used and will not withhold them as a penalty for any of the receiver’s actions.
In many cases, equalization payments are not permanently set. To do so would defeat efforts of maintaining an equal standard. These funds usually fluctuate with need. If a low revenue state becomes a high revenue state, the payments are likely to be discontinued. If the cost of living rises or the high revenue states become drastically richer, the equalization payments are likely to increase.