Bay Street in Canada's financial district in Toronto.Nathan Denette/The Canadian Press
One of the most basic principles of tax policy is cutting taxes on the thing you want more of (with the other of course being hiking taxes on the thing you want less of).
Based on that principle, the debate over the last couple of decades about whether the corporate tax rate should rise or fall has been a waste of time, at least in terms of finding the most direct path to spurring business investment in Canada.
There are any number of other reasons to want to keep a lid on corporate taxes, starting with the premise that the government ought not to expropriate profits unless it has no other option. Preserving the rewards from entrepreneurial risk-taking and remaining competitive for foreign investment are other excellent rationales.
The Prosperity Problem
This is part of a series on Canada’s economic challenges. Follow our editorials page to see more instalments as they are published.
The challenge: How Canada can build a better future
Labour: Don’t fight the crunch
Regulation: Measure the cost of red tape first, then cut to fit
But if increasing domestic investment is policy-makers’ overriding goal, then cutting taxes on that investment should be their focus. This avoids the roundabout approach of a broad corporate tax reduction, in which the government pins its hopes on firms channelling tax savings into investment rather than into dividends or stock buybacks.
Happily, the federal government already has two major initiatives that provide direct incentives for domestic investment: the 76-year-old Scientific Research and Experimental Development tax incentive, or SR&ED, and the (much more youthful) accelerated capital cost allowance program, which the Liberals launched in 2018.
The first gives companies tax credits based on eligible research spending. The second allows firms to write off the cost of certain kinds of equipment more quickly, trimming their taxable income.
The SR&ED program is badly outdated, something that the Department of Finance has acknowledged by launching a consultation last month. More worrisome, the accelerated capital cost allowance program is winding down and is set to expire by 2028. There, at least, the solution is straightforward: Ottawa should make the program permanent.
Fixing the research credit program – which costs $4-billion a year – will be trickier, but it has more potential, particularly in a world where intellectual property is fast becoming the key driver of prosperity (more on that tomorrow). A program first conceived of before Elvis hit the charts is, understandably, not quite up to speed.
The most obvious flaw is that foreign-owned companies are eligible for the program. That may have made sense when research was something conducted in branch-plant laboratories. Not so in today’s economy: the inclusion of foreign corporations subsidizes another nations’ success.
Restricting the SR&ED program to Canadian corporations is only a start; more fundamental reforms are needed. Tax credits are based on how much a company spends on research and development. Those credits amount to 35 per cent for up to $3-million in eligible expenses for domestic companies, with the rate then falling to 15 per cent. But the $3-million ceiling falls as a company’s taxable capital rises above $10-million.
The result is a counterproductive incentive to remain small, or at least a disincentive to grow, even though there is ample analysis to show that R&D from larger companies delivers much greater economic benefits.
There is also a conceptual problem at the heart of the SR&ED program: it is tied to inputs rather than outcomes. Many countries, facing the same innovation challenges as Canada, have opted for a much different strategy that hinges on commercial success – the so-called patent box approach that reduces tax rates on income tied to intellectual property. It’s an overdue change in Canada, where the failure to commercialize technology is a longstanding problem.
To the government’s credit, the Finance department is grappling with these issues, albeit under the proviso that any changes are cost-neutral (a rare outbreak of thriftiness on the part of the Liberals). The government should scrap that proviso, and instead focus on designing world-leading innovation incentives.
If a few billion dollars more are needed, there is a long, long list of federal programs that can be squeezed instead. Innovation-fuelled prosperity should be the priority.