There’s a better way to support the regions

Hardly anyone noticed in Montreal when a task force commissioned by the Quebec government recommended last week an overhaul of a tax subsidy program to the so-called “resource regions.” Businesspeople cheered in the Beauce, while others howled from the Gaspé to Abitibi.

For years, businesses in seven resource regions have been able to claim tax credits on the basis of their payroll size. The goal was, of course, to encourage job creation in areas where poverty and unemployment is higher and where many people leave for the big cities to find work. But like many well-intentioned government interventions, it had perverse effects.

A manufacturing firm in the prosperous and industrialized area of Ste. Marie de Beauce would thus not be able to benefit from the program. But move only a few kilometres east into the Lower St. Lawrence region, and the same type of firm would get a 30-per-cent to 40-per-cent credit on salaries paid to its employees. With dramatically lower labour costs, the second firm would of course be able to offer better prices for its products and undercut its competitors in the non-privileged region.

It’s no wonder that people in the Beauce got together to fight against what they perceived as a particularly unfair program – to the point where former Beauce-Sud MNA and Bourassa government minister Robert Dutil even founded a new political party solely devoted to solving this problem.

Such subsidies programs rarely face opposition. Governments are under constant pressure from small and concentrated group of beneficiaries for whom it is worth spending money on lobbying to maintain those programs. But those who pay for them, the millions of taxpayers dispersed across society, often do not even know of their existence and couldn’t care less. So no one will object to them.

But in this case, the program created a very vocal group of opponents. And that’s why Finance Minister Monique Jérôme-Forget asked HEC Montreal economist Robert Gagné and two other academics to review it two years before it was due to expire.

The task force made some sensible recommendations that would remove the worst distortions caused by the program. It proposes to maintain tax assistance to businesses in the resource regions until 2015, but on a different basis, replacing tax credits calculated on the basis of the number of jobs with an investment tax credit.

Between 1998 and 2005, productivity growth in the manufacturing sector has averaged 3.5 per cent in urban areas, and only 0.2 per cent in the resource regions. What is needed to bring prosperity to these regions is more investments and not artificial job creation, especially as we enter a period of increasing scarcity of manpower in an aging society. Firms would only get a tax break if they took measures to improve their productivity.

Also, the task force notes that the primary cause of the outlying regions’ economic problems is their remoteness from the major urban centres. It proposes to define assistance on this more objective basis instead. The investment tax credits would be made available to small and medium manufacturing firms at a rate of 40 per cent in the most remote zone and at a rate of 20 per cent in the intermediate zone.

Although this is a step in the right direction, there would still remain a number of dividing lines on the map, either side of which two manufacturers of any widget would benefit from different levels of tax subsidies. All such subsidies distort market outcomes, because they treat economic actors differently and create incentives for them to do things they otherwise would not.

If the goal is to promote investment, there is a much simpler way: scrap the capital tax now. This tax, which raises close to $900-million a year, is levied on capital invested by firms. It is one of the taxes most harmful to economic growth. The federal government abolished it last year, and it is slated to disappear in three years in Quebec.

Meanwhile, the government spends over $2.4-billion a year in fiscal aid and direct subsidies to businesses through various programs. A true market-driven approach would be to abolish the capital tax and scale down the various subsidy programs by a corresponding amount. This would reduce opportunities for politicians to take credit for their largesse to specific industries or regions, but it would help all businesses, whatever they do and wherever they are located.

Paul Daniel Muller is President of the Montreal Economic Institute.