R&D tax credits and “clusters”

Note to readers: I wrote this column nearly two decades ago to review the debate over R&D tax credits for business, and the effort by politicians to create “clusters”. That issue is back in the news. As you will read, economist Dr. Jack Mintz and his colleagues addressed that cluster issue quite comprehensively in a 1998 report to Finance.

My column summarized that report and the problem which is again relevant: If politicians want tens of thousands of new jobs, that won’t come from subsidies. Instead business tax rates have to be low and competitive. (Caveat: An additional problem for businesses today is the existence of much higher input costs that have soared due to government policies; think of higher power bills even after inflation due to political interference.) Throwing money at businesses through R&D credits or super-cluster funding won’t work as intended.

R&D tax credits and “clusters”

Mark Milke, April 25, 2000

After the recent federal and provincial budgets, it appears Canada is finally on the tax cuts highway. True, the movement on that highway is turtle-like, and if Canada's long-term economic, employment and wage growth is to be substantial, deeper and quicker cuts to Canada's taxes are imperative but at least governments are finally on the right track.

Given that tax cuts are now inevitable for most Canadians, it is worth some serious thought as to the form those tax cuts should take. For example, be they business or personal taxes, taxes can be lowered in one of two ways: through an overall reduction of tax rates or via more generous credits and deductions, which have the effect of reducing the amount of tax payable.

Enter research and development (R&D) tax credits. Canadians may not realize it, but Canada provides some of the most generous R&D tax credits among G-7 countries. The R&D credits are justified on the basis that such tax incentives will help spark job creation and draw "clusters" of high-tech industries to Canada. In addition to federal credits, many of the provinces provide an additional credit depending on the industry. BC for example, introduced a new tax credit program for research and development last year.

Despite the tax credit advantage however, Canada's private sector still lags behind in R&D investment. As to why that is, The Report of the Technical Committee on Business Taxation, prepared for federal Finance Minister Paul Martin and released in 1998, found that R&D tax credits play only a small role in creating high-tech clusters. Quality of life and the reputation of the local university were found to be more important.

What is important in creating such high-tech clusters, according to the study chaired by tax policy expert Jack Mintz and authored by some of Canada's top economists, is the overall rate of taxation. The authors argued that the biggest economic benefits (including jobs) don't come from tax credits that lower the cost of discovering or developing an invention. The biggest bang for the buck occurs when governments make it easy for that invention to be built, shipped, and sold.

"It is the widespread adoption of innovations within a domestic economy, and not their initial discovery, that provides the greatest benefit to that economy," argued the Mintz Report. "Examples include the widespread adoption of new drilling techniques in the petroleum industry and the rapid spread of new processes and equipment in computers - each leapfrogging on previous advances."

In other words, if a country wants to attract the companies that will create the next technological marvel, say a 'supercomputer' and employ 10 people in the process, R&D tax credits are of some use though the economic return to the economy is marginal. But if Canada wants to attract the companies that will actually build the 'supercomputer' (or any invention that could be mass-produced) and employ one thousand people in the process - create a low-tax environment.

Made in BC tax credits, of the sort introduced last fall, would certainly boost research here, but it is an open question whether Canada's ability to attract R&D investment as a whole would be any better off. Investment and jobs may merely shift from one province to another depending on the tax credits offered.

As Canada attempts to head toward a lower-tax environment, the Mintz Report argued that fewer and less generous tax credits should be offered in exchange for lower overall business rates. BC's government recently reduced the small business rate - a positive move - and that is where the business tax reduction focus should be, not more tax credits, which may be of only marginal value.

~Photo credit: Pixabay, Geralt.