Does Canada really need $16 billion in business subsidies?
NationalPost.com – Business/FP-Comment
February 18, 2016. John Lester
How much does the federal government spend on business subsidies? You can’t get an answer to that question from a single source. After combining the most recently available information from the government’s financial statements, its tax expenditure accounts and the annual reports of selected Crown corporations, I came up with an estimate of almost $16 billion in 2013.
Surprisingly, only about a quarter of that comes through spending programs. Tax incentives amounted to almost 60 per cent of the total. Losses on loans and equity investments (e.g., the Chrysler and GM bailouts) were six per cent of all subsidies. Federal agencies providing financial services to business at below-market prices accounted for about a sixth of business subsidies in 2013. The Business Development Bank of Canada (BDC) and Farm Credit Canada (FCC) consistently report profits, however they depend on access to cheap financing through the federal government. If we apply the same cost of capital as private businesses, the BDC and FCC experienced large losses in 2013.
Who benefits from subsidies? Small businesses and farmers, mostly. The small business share was just over 40 per cent while farmers received almost 20 per cent. Another 20 per cent was targeted at a variety of sectors. In terms of activities, R&D and innovation programs made up about a quarter of subsidy spending, regional development programs about a tenth and agricultural income support programs accounted for 7½ per cent.
The federal government should look closely at business subsidies when planning its return to budget balance. The first step in the review should be to classify programs into two categories: those programs intended to improve economic performance and those intended to provide income support.
For programs in the first category, it is crucial that the government determine why a subsidy is required to improve economic performance. If markets are functioning properly, capital and labour will be used as efficiently as possible, so a subsidy will harm rather than help performance and should be eliminated. Governments should ignore claims that subsidies create jobs. Subsidies have to be financed by higher taxes or lower government spending, both of which will result in commensurate job losses.
If we apply the same cost of capital as private businesses, the BDC and FCC experienced large losses
If markets are not working properly, using a subsidy to encourage a particular activity can help market efficiency. The classic example is spending on R&D. Firms performing R&D cannot retain all of the benefits for themselves. Some of the knowledge created inevitably spills over to help other firms. But in determining R&D investment, firms consider their own costs and benefits, not the broader social benefits from spillovers, so the amount of R&D undertaken is too low from society’s perspective.
However, even in this case caution is warranted. Raising taxes to finance a subsidy will harm economic performance by reducing incentives to work, save and invest. In addition, governments and business incur costs to administer and comply with conditions for receiving subsidies. As a result, all programs implemented to address a market failure should be evaluated to ensure that they result in a benefit to society after total costs have been considered.
Given their reputation as the engines of job growth, small business subsidies may be given a pass in any subsidy review. That would be a mistake. While small businesses do create most jobs in Canada, the contribution comes from a surprisingly small share of small businesses. There is ample evidence that the overwhelming majority of small businesses start small and stay small, or exit. That makes the small business deduction, which provides support for investment by all small businesses (at a cost of $3 billion in 2013), wasteful, since most of the benefits are received by firms that do not grow. So, while the small business deduction is improving access to finance, it is on balance harming rather than helping economic performance by encouraging less-efficient small-scale production. According to Statistics Canada, small firms are around 60 per cent as efficient as their larger counterparts.
There are also large savings to be made by tightening up on subsidies for R&D performed by small firms, which enjoys a 35 per cent federal subsidy rate compared to 15 per cent for large businesses. However, there is no evidence to support the implicit rationale that spillovers are higher for small R&D performers. Reducing the subsidy to the large-firm rate would save about $825 million a year.
Rethinking business subsidies, particularly for small businesses, would result in substantial fiscal savings and improved economic performance. Unfortunately, the new government is committed to widening the tax-rate gap between small and large businesses. In addition, recent mandate letters charge ministers with expanding support for innovative firms, with an emphasis on startups and other small firms. Let’s hope that these new initiatives are financed out of savings from reductions in other business subsidies rather than with new money.
John Lester is an Executive Fellow at The School of Public Policy at the University of Calgary.
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Tags: budget, economy, ideology, tax
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