The Broadbent Blog

Tax credits are not the way to boost innovation


There is a lot of talk about the need to build a “knowledge-based economy” if we are to retain and create good jobs in a world where production is shifting in a major way to lower wage developing countries.

To compete, Canada must indeed produce high value-added goods and services commanding a price premium in world markets because they are sophisticated and unique. But, there are few signs of a sustained transition to a more innovative economy in Canada. Indeed, we are moving in the wrong direction.

One key indicator is the decline from about 2000 in the level and share of advanced manufactured products (machinery and equipment, aerospace, autos, final consumer goods) in Canada's GDP and exports as resource extraction has grown. Another is our dismal level of investment in research and development.

OECD data show that, in 2011, Canada spent just 1.7% of GDP on R&D, well below the level of 2.8% in leading industrial countries like the United States and Germany, and almost one third less than the advanced economies average of 2.4%. Our relative position has been declining. Since 2004, our spending has slipped from 2.1% of GDP to 1.7%, while the OECD average has increased from 2.2% to 2.4%.

This slippage is largely a result of the relative decline of Canadian manufacturing, which still accounts for about one half of all business spending on R&D. Canada's information and communications technology sector has also shrunk significantly, as exemplified by the declining fortunes of Nortel and BlackBerry. Our other big R&D spenders include the pharmaceutical and bio science industries, and aerospace.

Meanwhile, Canada's mining and oil and gas sector accounts for just one in every twenty dollars of business spending on R&D. Our relative performance is even worse when one considers only business investment in R&D, which makes up about one half of the total, with governments and the higher education sector contributing the other one half. Statistics Canada data show that business funded R&D fell from a peak of $15.3 billion in 2006 to $13.5 billion in 2012.

In its recent report to the federal government on federal support for R&D , an advisory panel headed by high-tech executive Thomas Jenkins underlined the critical importance of improving Canada's innovation performance, and the need to rethink policies which have failed to make a difference: “Studies have repeatedly documented that business innovation in Canada lags behind other highly developed countries. This gap is of vital concern because innovation is the ultimate source of the long-term competitiveness of businesses and the quality of life of Canadians. The ability to conjure up new products and services, to find novel uses for existing products and to develop new markets – these fruits of innovation are the tools that will ensure Canada's success in the twenty-first century.”

The panel identified key weaknesses in Canada's innovation system, including a shortage of patient equity capital for new ventures, and a long-standing tilt in government policy towards supporting business R&D through the SR&ED tax credit, rather than though more direct measures: “Canada's program mix is heavily weighted toward the SR&ED program and, during our consultations, we heard many calls for increased direct expenditure support. As well, many leading countries in innovation rely much less than Canada on indirect tax incentives as opposed to direct measures.”

It is, to say the least, rare for a business-dominated advisory panel to the Harper government to suggest that targeted spending programs are more efficient than tax cuts.

Jenkins effectively endorsed the increasingly influential view of University of Sussex economist Mariana Mazzucato that strategic government leadership and public investments are central to building innovative economies.

The existing tax credit was criticized by the panel for being of limited benefit to large companies and for covering too wide a range of costs. Accordingly, it said the government should “simplify the Scientific Research and Experimental Development (SR&ED) program by basing the tax credit for small and medium sized enterprises (SMEs) on labour-related costs (and should) redeploy funds from the tax credit to a more complete set of direct support initiatives.”

In the 2014 budget, the federal government announced new support of $1.6 billion over five years in additional direct support for innovation, which is indeed welcome. However, seemingly under pressure from existing beneficiaries of the $3.5 billion per year SR&ED tax credit and the large consulting industry it supports, the federal government has still done little to date to reform the ineffective tax credit system.

Andrew Jackson is a senior policy advisor to the Broadbent Institute.

Photo: jubilo.  Used under a Creative Commons BY-NC-ND 2.0 licence