Research and Development

This afternoon, I attended Kenneth McKenzie’s presentation at Industry Canada on “Taxes, R&D and Enterprise Formation.” To a large extent, it was based on his C. D. Howe Institute Commentary.

His main message is that governments seeking to promote R&D can “push” by reducing its cost through incentives (i.e. subsidies) or “pull” by increasing its benefit through lower taxes on profits. While Canada has generous tax incentives for R&D, our allegedly high marginal effective tax rates on capital partly explain our relatively low levels of R&D. By contrast, Sweden has few subsidies for R&D, low taxes on profits, and high levels of R&D.

McKenzie’s conclusion is that Canadian governments “should focus less on targeted tax incentives for R&D (and other activities) and focus more on the competitiveness of our overall production tax regime.” In other words, the objective of promoting R&D becomes just another argument for across-the-board tax cuts.

The Commentary suggests reducing existing federal R&D incentives. Today, McKenzie indicated that he favours maintaining these incentives, but cutting federal tax rates instead of expanding federal incentives on a “go-forward basis.” He correctly noted that, since the funds saved by eliminating R&D incentives could not finance much of an across-the-board tax cut, we might as well retain the incentives.

However, it seems to me that this logic applies on a “go-forward basis” just as much as it does to existing incentives. The government can promote R&D far more strongly by using a given number of surplus dollars for R&D incentives than by using the same number of dollars for across-the-board tax cuts. (Economists of McKenzie’s persuasion certainly invoke this cost-effectiveness rationale in favour of targeted social programs as opposed to universal ones.) Of course, there may be other benefits from across-the-board tax cuts, but then R&D is not really the argument for them.

Another point is that Canadian governments have already done a great deal in recent years to “pull” R&D through across-the-board tax cuts. Have these cuts increased R&D?

Note: To his credit, McKenzie made fun of the “go-forward basis” phrase.