How Well Tax Incentives Work for Quebec Companies (2009)
Reference Article (>5 Years Old)
At SREDucation, we’re taking the time to document all of the changes that have occurred to the SR&ED program over the years. In our “From the Archives” series, you’ll be able to see how the program has evolved since its inception in 1986. For a timeline of these events, check out the SR&ED Tax Credit page on Facebook. Stay current with the program by understanding the historical context.
In 2009, a paper in Small Business Economics evaluated the effectiveness of tax incentives in Quebec, particularly focusing on the Scientific Research & Experimental Development (SR&ED) tax credit program. In the analysis the authors used manufacturing company data from 1997 to 2003, which included surveys and administrative data.
“We show that there is a deadweight loss associated with level-based R&D tax incentives that is particularly acute for large firms,” the authors wrote.
“For small firms it is not sizeable enough to suppress the R&D additionality, at least not for quite a number of years after the initial tax change. Incremental R&D tax credits do not suffer from this deadweight loss and are from that perspective preferable to level-based tax incentives.”
This article summarizes the report below.
Generosity of Quebec’s Tax Incentives
While Canada is generous with its tax incentives, the authors wrote, the province of Quebec surpasses other provinces in the country. Provincial payments for assistance totalled $538 million in 2005. In Quebec, the province prefers to focus on the type of company that receives the funding rather than individual projects, the authors noted.
“This virtue could also be seen as a weakness, in so far as it might be socially preferable to steer R&D towards projects with high spillovers. Many countries try to focus their support on small- and medium-sized enterprises, which are, more than big firms, plagued by the market failure of financing intangible investment,” they wrote.
The authors’ methodology for determining the effectiveness of tax incentives in Quebec focuses on R&D tax credits received by every company, rather than looking at factors such as statutory tax rates.
“Indeed, many firms may either not know of the existence of tax incentives (especially small firms) or decide not to apply for R&D tax credits because of administration costs, inexperience or apprehension about dealing with the tax authorities,” the authors noted.
Focusing on SR&ED
The authors called SR&ED “the main R&D fiscal incentive in Quebec”. The early days of the credit in the 1980s saw an emphasis on researcher salaries, but in later years the Quebec government added co-operation and human capital as other factors in determining the credit.
These days, the credit in Quebec focuses on four major components:
- Refundable tax credit for salaries and wages of researchers;
- Refundable tax credit for university research or research carried out by a public research centre or a research consortium;
- Refundable tax credit for pre-competitive research;
- Dues or contributions paid to a research consortium.
Quebec also offered and then withdrew two other reductions for R&D:
- Super-deductions (1999-2000). “Firms choosing the super-deductions could reduce substantially their net investment cost because the Federal government applied different rules in the treatment of refundable tax credits and super-deductions for R&D,” the authors noted.
- A refundable tax credit based on more R&D spending (1999-2004). It was supposed to increase the performance of R&D with respect to GDP. Small- and medium-sized enterprises (companies with assets below $25 million) were the only ones eligible.
Crunching the Data
The authors used three data sets in their calculations: Statistics Canada’s Research and Development in Canadian Industry survey, Statistics Canada’s Annual Survey of Manufactures, and administrative data from Revenu Québec.
Among their findings, they discovered that most applications for R&D tax credits come from small firms, but it is the large firms that get “the greater part of the amount” of tax credits tracked. Specifically, about 65% of the tax claimants are small firms, but they receive about 28.5% of attributed tax credits.
The researchers then applied a mathematical model to estimate R&D elasticity compared to its user cost. When they arrived at those numbers, they then compared that information to a fictitious scenario when the government makes changes in its R&D credits.
A Scenario For Review
“The usual way to assess the effectiveness of R&D tax incentives consists in computing the so-called ‘bang for the buck’,” the researchers wrote. “By that, is meant how much private R&D increases per dollar of R&D tax receipts foregone. If it is greater than 1, R&D tax incentives are considered to be effective in stimulating additional R&D; a value smaller than 1 means that part of the money received from tax incentives substitutes for private financing.”
They continued by explaining their methodology:
“We start from an old scenario where firms invest in R&D every year to keep the R&D stock constant and/or to expand that stock. In the new scenario, the government decides to increase the tax incentives, which leads to a decrease in the user cost of R&D and to increases in the R&D stock of knowledge until a new desired R&D stock is reached. As firms invest more in R&D, the government needs to spend more on R&D tax incentives.”
Interpreting the Results
The researchers ran two experiments:
- Increasing level-based provincial tax incentives by 10%. They found that for small firms, the ratio of cumulative R&D to cumulative government expenses to support R&D stayed above 1 even after 20 years. More research dollars were being generated than what the government was spending on R&D. This shows that R&D tax incentives do work for small firms, the researchers stated. Large firms, however, don’t benefit.
- Increasing the increment-based provincial R&D tax credit by 10%. In this case, both small and large firms had a ratio that was closer to 3 to 1. “The incremental R&D tax credit is much more effective than the level-based tax credit, and its effectiveness does not vary much by firm size,” the researchers noted.
As such, the researchers recommend the province of Quebec use the incremental R&D tax credit for companies of all sizes and continue offering level-based tax credits to smaller firms.
“Of course, effectiveness is not the only nor the ultimate goal in giving R&D tax credits. An important consideration is the social rate of return on tax-supported R&D,” the authors added.
“It would be interesting in future work to compare the social returns on government-supported R&D via tax credits and direct subsidies, on government-supported and non-supported R&D, and on R&D support for large and small firms.”
This article is based upon a Small Business Economics journal article: Effectiveness of R&D tax incentives in small and large enterprises in Québec. The report was written by Rufin Baghana from the Ministère des Finances in Quebec, and Pierre Mohnen, who is with Maastricht University CIRANO, and UNU-MERIT, in the Netherlands.