By Mike Moffatt
March 10, 2020
How can Budget 2020 help build a stronger, cleaner economy? This month SPI draws on the latest research to highlight four good bets for how Budget 2020 can launch us in the right direction. See all four bets here.
When we think of the tax system and climate change, our immediate thought is carbon pricing. That’s not surprising; carbon pricing is one of our most important tools when it comes to reducing greenhouse gas emissions. If we think a bit longer, we might think of consumer-facing policies, such as electric vehicle tax credits. But we should not ignore other tax tools in our fight against climate change, including those targeted at businesses and investors.
Naturally, we use these tools as a way to reduce greenhouse gas emissions, but that can happen through a variety of different mechanisms, which can include (but are not limited to):
As Will Scott and Stewart Elgie have written, a carbon tax alone may not be sufficient:
“Clean innovation faces particular barriers that other types of innovation do not encounter. Most notably, the environmental externality market failure, because the cost imposed on society by environmental damage is not currently accurately reflected in the price of goods and services. The result is that there is less market demand (and economic reward) for cleaner goods and services. While carbon pricing helps to correct this market failure, until it reaches a sufficient level of stringency to reflect the social costs, a gap remains.”
There are other advantages as well. Carbon pricing can be prone to carbon leakage; a poorly designed cap-and-trade or carbon tax system could cause emitting activities to simply shift from Canada to another country (e.g. a refinery moves from Sarnia, Ontario to Port Huron, Michigan in response to the carbon price). Although emissions are reduced in Canada, global emissions are unchanged, as emissions are just shifted, but not reduced.
This is less of a concern with alternative tax instruments; in fact, they can cause emissions outside of Canada to decrease. Developed-in-Canada cleantech can be sold around the world, reducing emissions outside of Canada’s borders. Canadian companies purchasing clean technologies (regardless of their country of origin) will, over time, reduce the price of these technologies through learning-by-doing and the creation of economies of scale, which we have seen in the solar and battery markets (just to name two).
There are any number of tax measures the federal government could introduce in Budget 2020 to accelerate the development and deployment of clean technology. There are four, in particular, we believe show promise:
The Smart Prosperity report, Investor Tax Credits and Flow-Through Shares by Scott and Elgie provides details on how a federal tax credit for cleantech investments could work. They provide the following simple example:
“Take, for example, an angel investor considering making a $100,000 investment in a small company for a 10% equity share. If the small company qualifies for an investor tax credit, the investor not only receives the 10% share in the company, they are also able to claim 30% of that investment against their personal income tax, in this case $30,000. In effect, this decreases the cost of investment to $70,000, reducing the risk and increasing the likelihood of future profits.”
By reducing the cost of the investment, the federal government can attract much-needed capital to the sector. There is existing Canadian experience to draw from, as British Columbia’s Small Business Venture Capital Tax Credit offers a 30% tax credit to six priority areas, with one of them being cleantech. A 2010 study found that the tax credit generated more tax revenue for the government than it cost and generated jobs for the sectors. Other provinces are adopting similar models, such as the Alberta Investor Tax Credit. These tax credits typically operate on an application basis, allowing a government to control the cost of the program by providing a limited pool of money.
Purpose of measure: Increased access to capital for cleantech start-ups.
Another option for the federal government is to expand the use of flow-through shares for companies that invest in cleantech. A flow-through share allows a firm the option of renouncing and passing along tax deductions to equity investors. This is of particular advantage to companies in a pre-profit state (and their investors), as without it investment in cleantech cannot reduce the tax bills of those companies, since they are pre-profit. By allowing eligible expenditures to “flow-through” to the personal income tax of the investors of a company, companies have greater incentive to make those investments.
Although this may sound similar to investor tax credits, Scott and Elgie explain that they serve different purposes:
“Investor tax credits are for investments in a firm that would need to be defined as cleantech, which would be simpler to administer but may not support firms in other sectors that are developing technology with improved environmental performance. Flow-through shares are a tool for firms to incentivize equity investment and pass along savings from eligible investments which could include resource and energy efficiency investments by non-cleantech firms… In short, investor tax credits define the firm as cleantech, whereas flow-through shares define the investment as cleantech.”
In short, Budget 2020 could accelerate the investment in cleantech by pre-profit firms by expanding flow-through share eligibility.
Purpose of measure: Increase business investment by pre-profit firms in cleantech.
The report Accelerated Capital Cost Allowance by Scott, Elgie and Monahan examines the announcement in the 2018 Fall Economic Statement to increase in the eligible write-off, for tax purposes, for investments (ACCA) in clean energy and manufacturing equipment to 100% in the first year. The goal of this measure is to accelerate the adoption of clean (or cleaner) technologies by Canadian companies, by allowing them to achieve the full tax benefits of that investment in the year the equipment was purchased. However, the list of clean technologies that are eligible for 100% ACCA is quite limited. Budget 2020 could expand the list of eligible technologies, either through an accelerated expansion of the technologies list or by setting a performance standard for cleantech, or a hybrid approach which combines the two.
Purpose of measure: Increase business investment by profitable firms in cleantech.
In a forthcoming release, the Smart Prosperity Institute worked with the Toronto Region Board of Trade on a project to provide recommendations on how to modernize Canada’s Custom Tariff. One area the government could consider is eliminating (by setting their rate to zero) tariffs on components used by Canadian cleantech manufacturers. There are currently several dozen classes of goods, such as thermostats, that Canadian manufacturers use in the production of cleantech but are forced to pay tariffs on, increasing the costs of their products. Even when companies can import these products tariff free under a trade deal, they must comply with complicated “country of origin” laws; these compliance costs can be 1% or more of the value of the imports.
Consider the good “reservoirs, tanks, vats, etc, of a capacity exceeding 300L, of plastics”, an input used in some Canadian cleantech. In 2018, almost all of these entered the country tariff free, causing the federal government to collect less than $85,000 in revenue on $74 million worth of imports. But the compliance costs to import tariff-free cost Canadian companies over $700,000 in compliance costs. Eliminating this tariff would cost the federal government very little in revenue while significantly reducing regulatory burdens for our cleantech companies, which would allow them to do what they do best: develop, produce and market the technologies that are desperately needed to win the fight against climate change.
Purpose of measure: Reduce the cost of manufacturing cleantech products in Canada by reducing taxes and compliance costs.
The federal government has a significant number of tax tools they can use to assist businesses and investors with the development and adoption of clean technology. Let’s hope they use one or more of them in Budget 2020!
Want to learn more about how Budget 2020 can build a stronger, cleaner economy? Join SPI for a free webinar on March 11th about Introducing New Tax Incentives for Clean Innovation.