Hot! Ontario’s bad tax credits

NationalPost.com – FP Comment -Tax incentives such as R&D credits don’t work. Ontario should instead lower tax rates and regulations
06/11/13.   Jack M. Mintz

With Ontario in fiscal tatters, you wouldn’t expect Charles Sousa, the province’s Minister of Finance, to introduce new tax credits rather than get rid of barriers to doing business in Ontario. Yet the other day he argued that new R&D tax credits are the panacea for Ontario’s economic growth woes.

The BlackBerry debacle should have given him pause. Like Nortel over a decade ago, BlackBerry was one of the largest demanders of research R&D tax credits. Certainly, the tax incentive helped both Nortel and BlackBerry develop their new technologies but none of these subsidies propelled better management. With Nortel now dead and BlackBerry looking to repeat the experience, wealth stored up in tax-supported patents will be sold to compensate shareholders for their losses. Federal and provincial governments that squandered taxpayer money over the years to support business research will get little other than a bigger bill to support laid off workers.

The large tax support provided by Canadian governments has done little to spur high levels of business R&D in Canada, which remains one of the OECD underperformers over the years. This observation, made by a panel headed by Tom Jenkins, led to some recent scaling back of R&D tax credits by the federal government in favour of grants targeted at specific industries or firms. Whether this new approach to economic success will do any better is unclear.

The primary argument in favour of R&D tax support is that firms fail to undertake sufficient innovation since their innovative expenditures spill over to other businesses, making others more successful. This is particularly true for non-patented innovation but less so for patented R&D since the latter enables the innovators to capture a larger share of economic benefits for themselves. Yet, R&D tax credits are the same whether the innovation is patented or not.

Tax support is focused on a specific OECD definition of R&D. This definition includes the discovery of qualifying new products but not other discoveries associated with exploration and development, marketing, financing and operational efficiency. For example, exploration and development by mining and oil and gas firms is almost twice the level of R&D in Canada without the same level of government support, which has been appropriately reduced in recent federal budgets by scaling back of accelerated capital cost allowances and investment tax credits. The main point is that there are other innovation drivers than simply supporting the cost of hiring scientists doing qualifying research.

R&D tax credits are the same whether the innovation is patented or not

Countries that have successful R&D rates often benefit from being close to large markets such as the United States and Germany. Ken McKenzie of the University of Calgary has shown that another lever that encourages R&D is the demand for innovation by the business sector. If taxes and regulations impede demand by users, one should not expect high levels of R&D performance.

Which gets us to the sad fiscal state of affairs in Ontario with its rather slow economic growth. The Minister chided corporations for hoarding their cash rather than investing in recent years. Although investment performance has improved in the past decade and a half in part due to corporate tax reductions, investment has been slow to recover recently in face of slow growing demand in Ontario’s domestic and export markets. Any smart innovative corporate leader will not commit billions of dollars without knowing that there is a market to purchase goods and services generated from new capacity.

So if recent corporate rate reductions in the presence of slow recovery have been insufficient to spur corporate investment, why would a Minister believe investment tax credits would do any better? Recent accelerated depreciation deductions in the United States have had little impact on investment demand during the economic recovery.

Besides, targeted incentives have not done well. Canada has had years of accelerated depreciation for manufacturing equipment that has done little to arrest the decline of the industry over the past 40 years. Instead, Ontario would be better off with general incentives for all businesses, letting the market figure out which firms will succeed. It therefore makes sense to lower the corporate tax rate from 11.5% to 10% — a legislative promise that Ontario failed to carry through on in 2009 as part of its HST reform.

It is often argued that investment tax credits are cheaper to spur investment than corporate rate cuts. However, recent economic analysis suggests that corporate tax rate reductions cost much less than anticipated due to multinational profit shifting. If Ontario reduces its corporate income tax rate, multinational companies adjust transfer prices and financial policies to shift income from high tax jurisdictions to Ontario. As Duanjie Chen and I have shown in the past, the 17-point federal and provincial corporate tax rate reductions have had little impact in the past decade on corporate revenues as a share of GDP. Taxable income even grew during the 2008-9 recession, unlike profits as corporate tax rates declined.

Corporate tax reductions are a cheap way to not only generate business investment in the long run but also to encourage the general adoption of R&D embodied in new capital. Other policies that improve corporate performance should be considered, including the reversal of expensive green power subsidies that are contributing to excessively high electricity prices.

With no plan to balance the budget, the Ontario Minister of Finance should instead be looking at tightening ineffective tax incentives that fail to improve economy. He need not look far if he examines the Ontario corporate tax form. The endless list of tax credits only creates jobs for accountants.

Instead of looking for magic bullets like new R&D tax credits, Ontario’s Minister of Finance should spend time cutting wasteful spending, reducing tax rates and removing regulatory obstacles to growth. That is a big enough agenda for him.

Jack M. Mintz is the Palmer Chair, School of Public Policy, University of Calgary.

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