John Ivison: Canada spends $29B a year on business subsidies — and half of it is wasted

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An important new study has for the first time calculated the total amount the federal government and four largest provinces spend on subsidizing businesses — a staggering $29 billion a year — and it estimates more than half of that spending is wasted.

The aim of the spending in most cases is to improve economic performance. But the analysis by John Lester, an executive fellow at the University of Calgary’s School of Public Policy, suggests programs like subsidies to attract foreign companies to shoot movies in Canada don’t work.

“Because government intervention is costly … just under half of overall business subsidies fail to improve economic performance,” he says.

Since nearly one third of all subsidies are not even aimed at economic development — but rather at achieving social objectives like supporting specific industries or regions — the proportion of “questionable” spending reaches 60 per cent of the total, Lester said.

The governments in question — Ottawa, Ontario, Quebec, British Columbia and Alberta — probably know this. (The report suggests the federal government spent $14 billion in 2014-15, the last year for which statistics are available; the four largest provinces spent $14.6 billion. On a per capita basis, Alberta was the biggest per capita spender, offering businesses $640 in subsidies for every resident of the province.)

But the problem for any Canadian government is not only in identifying new sources of revenue to spend on its priorities, but also in taking on the special interest groups who benefit from the subsidies. The federal government discovered this to its cost recently, with its attempts to reform small business taxation.

There are clear political problems in reforming the business subsidy regime but Lester’s report is a must-read for any government keen to divert wasteful spending toward more productive use.

For the first time, Canadians have a comprehensive analysis of subsidies delivered through direct spending, through the tax system, through direct investments in firms, through loan-guarantee programs and through the activities of government business enterprises, like the Business Development Bank.

What Lester concludes is that markets do a pretty good job at allocating labour and capital to their best use and that governments intervene at their peril.

Industrial policies to create “good jobs” rarely result in a positive outcome for real income, according to Lester.

The reason is that subsidies are funded by either raising taxes or cutting program spending, both of which hurt economic performance.

The exceptions to the wasteful spending, in Lester’s opinion, are research and development tax credits governments provide to large firms, accounting for just over $2 billion of the $29 billion total.

The analysis is not good news for the federal Liberals, who are in the process of choosing a handful of promising industry “clusters” for special federal support, having earmarked $800 million for a “cluster networks strategy.”

Lester is not optimistic about its chances. “You have to make sure you don’t subsidize more than is warranted. If you have to raise taxes to pay for subsidies, you are harming the economy. The likelihood of coming out ahead is quite small,” he said in an interview. “There is an intellectual case for this kind of industrial policy but developing it successfully is a different story. If it is such a good deal, someone in the private sector would have worked it out.”

He said if the government is determined to go ahead with its clusters strategy, it should scale back existing subsidies.

But, having had its knuckles rapped over the recent small business taxation reforms, that seems unlikely. Far and away the largest subsidy program is a $7-billion small-business deduction, which offers companies a reduced rate of tax on income, provided it is used to finance investment.

Lester suggested such a broad-based program ends up transferring wealth from more-productive large firms to less-productive smaller companies. “That’s a loss to society,” he said.

The deduction should be targeted at a smaller number of start-ups and highly innovative companies, he said. “Subsidizing corner grocery stories, restaurants and retail stores is not how you create a wealthier society,” he said, with the enthusiasm of an economist who does not need to get re-elected.

Governments of all stripes choose degrees of equity over efficiency — regional development subsidies generally result in lower overall income, as do policies aimed at sustaining agricultural production.

But Lester’s study suggests that in 2014-15, business subsidies cost half of the money raised in corporate income tax revenues — and were largely ineffectual.

The case is there to argue for a recalibration.

Lester’s paper should be read widely and form the bulwark of a general-interest revolt against the special interests in the aerospace, agriculture, auto, film production and small business lobbies that will fight to preserve subsidies that provide no net benefit for taxpayers.

Source: National Post