December 2, 2021

By Jonas Goldman, Anik Islam & John McNally

Canada’s drive towards net-zero emissions will require investment into low-carbon and clean technology solutions and companies. The scale of the opportunity is enormous, as Canada considers how to best position itself to attract capital for a U$26 trillion global market opportunity by 2030.

One way is to ensure the country’s tax environment is conducive to growing companies and attracting investment. Designing tax instruments that do this, however, needs to be done thoughtfully and carefully, or it risks over-subsidizing sectors and negatively impacting growth. As Canada considers what policies can support its net-zero future, it should ensure it remains focussed on what the country wants to achieve before cutting cheques to all who ask.

Why does Canada need to think about a clean economy tax policy?

Previous work from Smart Prosperity Institute has identified that policies can help address two distinct market failures when it comes to clean innovation: negative externalities from pollution, where negative impacts that occur externally and impose costs on society are not priced properly; and knowledge spillovers, wherein companies cannot fully capture the benefits from their innovations. While carbon pricing gets to the first market failure, it does not address the second problem at the pace required to achieve Canada’s environmental and economic objectives. This creates the need for complementary policy tools.

One of the available policy tools is tax instruments. Taxation underpins the economy, and its application or removal can help guide capital towards societally designated priorities. As Ken Boessenkol has previously written, the tax system can be an efficient, fair and relatively simple delivery mechanism for governments to advance their policy goals. Tax instruments that are aimed at supporting clean technologies have proven to be effective in supporting emerging and available low-carbon or net-zero technologies in other countries. Because of their historic and international success, the Economic Strategy Tables and the Industry Strategy Council have set them as priorities to implement as Canada’s clean economy grows and its GHG emissions decline. Most recently, a number of individual tax instruments have been a part of the federal Budget 2021 and Liberal Party’s election platform commitments. 

The risks of getting it wrong

Tax instruments could be useful for crowding in the investment required to meet net-zero emissions and other environmental goals. If tax policies are not well designed and targeted, it can create a situation where money is given away without necessarily affecting investment decisions and market adoption. A recent example of non-effective tax policy can be found in the U.S. Opportunity Zones, a U.S. federal policy aimed at achieving economic development in low income communities. One element of the U.S. Opportunity Zones is a special zoning designation that provides a deferral on the income tax for capital gains from projects invested within the zones boundaries. The U.S. Opportunity Zones were created with the intention to support investment in lower-income communities within the zone boundaries. However, a lack of specificity determining project and zone eligibility meant that many benefits did not go to lower-income communities. Instead, the benefits were realized by development companies which ended up receiving additional tax relief, without supporting the policy objective.

Beyond simply selecting which instruments to use, the design of programs can also support or impede their effectiveness in driving outcomes, or play a role in worsening existing social inequities. It is therefore crucial that the design of tax instruments is well thought out to ensure additionality of investment towards net-zero objectives.

Let’s focus on policy objectives and clean economic growth

Tax policies can be a powerful tool. However, it will not solve all the challenges, especially financing gaps, faced by the cleantech stakeholders. For tax measures to be effective, it needs to be used as a complementary policy to existing ones, like carbon pricing, and other policies that support aspects of the clean innovation system, like regulatory reform, intellectual property protections and skills training.

Countries such as the U.S. and in the E.U. have used tax policies to drive cleantech development and market adoption. However, in order for Canadian policymakers to design instruments that work well for Canada, they must first better understand what the country wants to achieve, and how tax policy can support those goals. Upcoming research from the Smart Prosperity Institute will aim to answer these questions in the coming year, and we look forward to sharing our future results.