Thank you very much, Mr. Chair. It's a pleasure to be before the finance committee. Over the years, I have done this a number of times, so it's always nice to see you again.
“Corporate welfare” is a loaded term that most economists would simply define as business subsidies or grants. Tax incentives can also be included, since they are simply an alternative method of providing grant support, although with different implications.
Why do governments provide targeted business subsidies? Three arguments can be made.
First, businesses tend to underinvest in innovation if they cannot capture all the returns from their activities, even though they bear the full cost. While patents protect a significant amount of the return since other businesses must license the knowledge, some innovation is simply widespread and can be used by others without paying for the cost. To encourage an optimal amount of innovation, tax credits or grants are justified. The question is how much innovation support should be provided. Obviously, if patents are available, less support is needed.
Second, an argument has been made to subsidize infant industries where learning-by-doing, scale and risk may deter investment activity. It is not clear why the market cannot support an infant industry; large companies can easily invest capital in new projects and bear the risk themselves, and venture capital investors may support many small firms as well.
Third, support may be provided if smaller companies have difficulty raising risk capital. This argument relies on information asymmetries that occur when outside investors cannot easily distinguish between good- and poor-quality firms. It results in good firms underinvesting in capital, since the cost of capital is too high. While good firms may convey that they have certain strengths, such as a low leverage ratio, to separate themselves from bad firms, it still will not eliminate the problem of high financing costs due to informational asymmetry. The economic answer is to provide investment grants or tax credits that benefit stronger firms more, and not subsidize equity, since the latter encourages too many poor-quality firms to enter the industry.
Politically, governments often provide business subsidies simply to favour activities deemed to be important. Instead, these subsidies create three economic costs.
The first is a misallocation of resources, as capital is subsidized to support low-productivity enterprises that should naturally decline, rather than those with strong opportunities. Too many poor economic projects become supported, leading to a decline in economic growth. Although economic impact analysis is often conducted to support some subsidy programs by measuring direct and indirect job gains, these studies are based on poor economic assumptions, since they typically assume that indirect jobs come from unemployed resources—in other words, people who are just sitting on park benches—when in fact they are drawn from other productive parts of the economy.
The second is that business subsidies might increase the demand for inputs and hence cause rising input prices. The impact of tax credits for investments in fishing, for example, can be offset by higher boat prices. Little or no activity might be generated, as owners of land, capital or labour might capture the value of the subsidy through higher rents, profits and wages.
The third is that business subsidies are a cost to government budgets. A government may have to raise taxes. That has a cost of its own—corporate and land transfer taxes having the highest economic burden, followed by personal income taxes and then sales and property taxes—or the subsidy is paid by cutting back other expenditures, such as education and training, which might have bigger returns to society.
In a recent publication, Elizabeth Pringle of EY Canada provides a review of government incentives for targeted businesses, taken from an international database, wavteq. This does not include broad subsidies, such as research and development tax credits, but it tracks various announcements by governments to support specific firms. Subsidies include loan guarantees, grants, tax concessions, training grants, etc.
I'm going to use U.S. dollars for all this, because that's what the publication used. Besides, the exchange rate moves them up and down anyway.
From 2014 to 2018, Canadian federal and provincial governments provided $5.2 billion U.S.—or right now, roughly $7 billion Canadian—in incentives to support $31.6 billion U.S. in capital expenditure. This is a subsidy rate of 14.9% of capital expenditures for those firms that benefit from these subsidies.
The largest subsidies accrued to the automotive sector—that's $834 million—which is almost one-fifth, followed by consumer goods, $465 million; and non-renewable energy at $391 million. The highest subsidy rates as a percentage of capital expenditure were in consumer goods, 30%; electronics, 25%; services, 21%; and industrial goods, 19%.
The largest subsidies are paid to companies in Ontario and Quebec, with $2.5 billion in Ontario and $1.8 billion in Quebec, making up 82% of all subsidies provided in Canada. However, the biggest subsidy rates are in Newfoundland and Labrador, at 57%, and Saskatchewan, at 50%; while Alberta and Manitoba have the least, at 5%, as percentages of their capital expenditures, or CapEx.
In comparison to other countries, Canada has a lower subsidy rate for specific companies than Brazil or the Czech Republic, but we have a higher subsidy rate, which is more than the U.S. rate of 10% or Australia at 10% or the U.K. at 4%. We're at 15%, as I mentioned earlier.
I think we should be asking ourselves whether our business support programs make sense. Are they helping to grow the economy, or are they reducing productivity? Many subsidies are directed to companies that could be failing or have low economic returns. If that is the case, it would be better to reduce expenditure and direct funds to broad tax relief or program spending, which matters most to productivity.
Let me just add a few things.
Recently I wrote a piece on equity-based tax incentives. These include things like labour-sponsored venture capital credit, Quebec stock savings plans, the B.C. investor tax credit, the Alberta investor tax credit and a lot of these things.
Theory would predict that you'd end up getting too many bad projects entering the industry: Investors don't really pay as much attention to the economic returns because they're just looking at the tax benefits they get from that. Also, they can get very significant tax benefits, not only from the individual credits but also by using RRSP deductions, flow-through shares, donation credits, and things like that, which play a role.
What every study has shown is that the economic returns—this is when you take away the tax benefits—are close to zero. That's why I've been very much against many of these equity-based incentives. In fact, I would argue more strongly for investment-based incentives such as grants and investment tax credits and the R and D tax credit, which I think can have positive impacts.
Thank you.