Economic Freedom of North America: 2005 Annual Report

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This is the third edition of the annual report, Economic Freedom of North America . The statistical results of this year's study persuasively confirm those published in the previous two editions: 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.

Economic Freedom of North America rates economic freedom on a 10-point scale for two indexes. An all-government index captures the impact of restrictions on freedom by all levels of government. A subnational index captures the impact of restrictions by state or provincial and local governments. Economic Freedom of North America employs 10 variables in three areas:

  1. Size of Government;
  2. Takings and Discriminatory Taxation;
  3. Labor Market Freedom.

Not only is economic freedom important for the level of prosperity, growth in economic freedom spurs economic growth. As expected, the impact of economic freedom at the all-government level is greater than the impact at the subnational level since the first index captures a broader range of limitations on economic freedom than the second.

The results show that, while economic freedom has a powerful impact in Canada, its impact on US states is far greater. This is likely because of Canada's fiscal federalism. This sytem transfers money from rich to poor provinces. Since economic freedom spurs prosperity and growth, fiscal federalism in effect transfers money from relatively free provinces to relatively unfree provinces, muting the impact of economic freedom and perversely creating incentives for provincial politicians to limit economic freedom and, thus, economic growth since this increases the flow of federal transfers, which are directly controlled by these politicians. This enhances their power and their ability to reward friends and penalize enemies.

Generally, US states have been able to realize the gains economic freedom generates while Canadian provinces have lost opportunity due to weak levels of economic freedom and the structure of Canadian federalism.

All provinces, except Alberta, are clustered at the bottom of the rankings of both the all-government and the subnational economic freedom indexes and also have low levels of prosperity. Alberta is tied for 13th in the subnational index and for 4th in the all-government index. The higher score in the latter index, which includes federal spending, is because Ottawa's expenditures in Alberta are very low, much lower than the tax take from Alberta. This lower level of spending increases economic freedom by leaving more economic space for transactions to which individuals and firms voluntarily agree.

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