Canada's R&D subsidies are too rich - "costs likely exceeding benefits" - report

CALGARY, Nov. 27, 2014 /CNW/ - Commercial research and development (R&D) is generally recognized in policy circles as having economic spinoffs that justify some government subsidization. However, there is a point at which subsidies become excessive, and their costs exceed benefits.

In a report released today by The School of Public Policy, authors John Lester and Jacek Warda argue that Canada's R&D subsidies for small firms are high by international standards, and require review.  The authors present an international comparison of R&D subsidies, and argue that the approach used is sounder than that used by the OECD, which tends to understate tax subsidies provided by governments. The authors note, however, that the OECD does not usually take caps and eligibility thresholds into account, causing estimates for a number of countries to be overstated. 

Using their own analysis, the report finds that a subsidy rate of over 25 per cent should give rise to concerns about excessive subsidization, where the costs — the largest of which is the higher federal taxes required to offset the subsidy — may exceed the benefits to the broader economy of any additional R&D incentivized by the higher rate. The report finds ten countries offering subsidies greater than or equal to 25 per cent: Chile, France, Spain, Canada, India, Portugal, Brazil, Hungary, Ireland and Turkey.

In fact, through the tax system, federal and provincial governments in Canada pick up 40.6 per cent of the cost of R&D undertaken by small firms, which is well above the 25 per cent recommended rate. The authors argue that this level of subsidy should be revisited. 

The report makes other recommendations to policy-makers, including:

• Setting a uniform R&D subsidy rate for all businesses regardless of age or size.  However, the authors concede that the strongest case for enhanced targeted subsidies could be made for young firms as opposed to all small businesses. Young firms are most likely to introduce radical innovations that will result in broader economic spinoff effects, and they are likelier to grow into large firms than are mature small businesses.
• Adjusting tax credits that cannot be used as they are earned to maintain their real value to firms. In principle, R&D subsidies should be refundable. As a practical matter however, refundability for large firms gives rise to concerns about loss of revenue from income shifting. Indexing unused credits is a reasonable compromise solution.

The report is available at www.policyschool.ucalgary.ca/publications

SOURCE: The School of Public Policy - University of Calgary

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