One of the good news in yesterday's budget was Jim Flaherty's decision to get rid of one of the least efficient tax loopholes, the tax credit for contributions to labour-sponsored funds.
Mind you, I'm all in favour of measures to reduce our tax burden, but not when it creates such distortions in the economy as to defeat the purpose.
Although there are such funds in seven provinces, the two largest ones are in Quebec and account for 84% of net Canadian assets. The largest by far, the Fonds de solidarité, was set up in 1983 and has almost $9-billion under management.
Anyone investing in the funds gets at least 30% in tax credit – half of it from the federal government. That cost Ottawa $145-million in lost revenues in 2012. In addition, these investments are eligible to be held inside an RRSP, with the corresponding tax advantages.
The rationale was to encourage union organizations to provide development capital to small and mid-sized businesses. In effect, it was an indirect way to subsidize local economic development.
But there are only so many such projects you can invest in. And as labour-sponsored funds kept growing, they became all-purpose venture funds that invest in all kinds of assets, from equity in large established companies to real estate, government bonds and even business ventures in other countries.
According to its annual report, the Fonds de solidarité devotes 11% of its assets under management to privately held business start-ups. This is the only area where it may (and I insist here on the word "may") be justifiable to offer some government support, if one believes such projects should be encouraged. Everything else they do is just regular investment.
Predictably, labour-sponsored funds have been taking up a growing share of the industry – they now account for about 40% of all venture capital in Canada – and are crowding out other conventional investment funds that do not benefit from the same preferential tax treatment.
Moreover, labour-sponsored funds are not particularly efficient at making a good return. Most observers agree that they have underperformed, for example compared with the TSX market index. It's likely that without the special tax breaks, few people would want to invest in them.
Instead of subsidizing start-ups, the tax credit actually subsidizes union apparatchiks who want to pretend they're capitalists. There is no justification for the government to favour them.
Michel Kelly-Gagnon is President and CEO of the Montreal Economic Institute. The views reflected in this column are his own.