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Ottawa embraces notion that governments can pick innovation winners and losers

Stephen Harper's Conservative government is delivering on its vow to fix Canada's failing innovation model with a decidedly un-conservative prescription.

Finance Minister Jim Flaherty laid out a significant shift Thursday in how Ottawa funds business research and development – more grants and fewer tax breaks – in a bid to tackle the country's chronically lagging R&D performance.

In essence, Ottawa is embracing the notion that governments can successfully pick innovation winners and losers. And under this new regime, the winners are more likely to be small businesses than larger ones.

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The big question now: Will it work?

The government is cutting what it gives to businesses via its popular R&D tax credit program by roughly half a billion dollars a year, and putting half the savings back into direct grants to companies. Ottawa is also creating a new $400-million venture capital pool, though details are sparse on how the money will be doled out.

"It's becoming more of a planned economy and less of a capitalist economy," argued Andrew Dunn, a managing partner and tax expert at Deloitte Touche.

The approach may be politically appealing, Mr. Dunn said, but it's not clear it will be good for businesses or the economy. He characterized the overhaul as the "single biggest gamble in the budget."

The government will be hard-pressed to demonstrate how spending less on innovation will result in better outcomes, said Jayson Myers, chief executive of the Canadian Manufacturers and Exporters. The changes, he insisted, will make Canada a less attractive place to produce goods for the global marketplace and discourage multinationals from investing here. "This will hit the top R&D performers the most," Mr. Myers predicted.

Meanwhile, the bulk of the new federal subsidies will go to small and medium-sized businesses – a favourite recipient of the Conservatives' largesse.

Ottawa's R&D tax credits are already much more generous to small, private companies than to large multinationals or public companies. And the budget tilts the balance even more.

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The quandary facing the government, however, is that what it's doing now isn't working. Canada currently offers some of the most generous tax incentives in the world, but business investment in R&D continues to fall – both in total spending and as a percentage of gross domestic product.

As Mr. Flaherty lamented in his budget speech: "Canada is not keeping up with other advanced economies on this crucial front."

With a few exceptions, the budget follows the script laid out in a recent federal task force report, headed by Open Text Corp. chairman Tom Jenkins. The report pointed out that Canada invests proportionately more in tax credits (about $3.6-billion in 2011) versus direct grants than virtually all other developed countries.

The answer, according to Mr. Jenkins, is a better balance, with more grants and fewer R&D credits.

Overhauling the Scientific Research and Experimental Development (SR&ED) tax credit will save the government $520-million a year. The main changes include a cut in 2014 to 15 per cent from 20 per cent in the tax credit rate, and a restriction on what expenditures are counted for the credit. For example, capital expenditures – buildings, equipment and product prototypes – will no longer be eligible. The amount of eligible overhead expenses will also be cut.

The 35-per-cent refundable credit for Canadian-controlled private companies remains untouched, widening the relative gap in benefits between large and small companies.

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The government insisted the changes would make the SR&ED less complex and easier to administer.

Some of the savings will go to a doubling of the National Research Council's Industrial Research Assistance Program, which doles out cash and advice to R&D projects by mainly small businesses. The government is also giving the NRC, which runs a network of specialized labs across the country, a one-time injection of $67-million to help it concentrate on "business-driven, industry-relevant applied research" and move away from pure research.

But Ottawa skipped over a couple of crucial recommendations in the Jenkins report. Mr. Jenkins urged Ottawa to make its tax credit scheme simpler and less prone to abuse – problems the changes don't address. And he insisted they should be revenue neutral.

Instead, the Harper government has delivered an innovation overhaul that saves money. Maybe not so un-conservative after all.

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More

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