Innovation Canada: A Call to Action

Program Mix and DesignBox 6.1 Direct Support Versus Indirect SupportThe OECD (2010a, p. 76) defines direct and indirect funding as follows: “Government directR&D funding includes grants, loans and procurement. Government indirect R&D fundingincludes tax incentives such as R&D tax credits.” In practical terms, the main distinctionbetween direct and indirect support is that the latter is open ended and is available to allfirms, whereas the former is limited in overall funding and is allocated by programadministrators to specific projects, industries or regions. Direct support can therefore betargeted to specific areas, contrary to more neutral indirect measures.It follows that the principal advantage of direct instruments lies in the ability to focussupport on actors or activities considered more likely to achieve high social returns or toadvance specific policy goals. Notwithstanding the benefits associated with this ability tostrategically target resources, there are also some drawbacks to direct support measures. Inparticular, they generally involve more rigorous selection and evaluation processes, whichcan translate into higher administration costs for government and compliance costs forbeneficiaries. Moreover, they can raise some concerns around the desirability of governments“picking winners” in the marketplace.Conversely, indirect measures are advantageous for the opposite reason. Since they arenon-discriminatory and widely available across firms, sectors, fields and activities, theymore closely conform to market rationality. Indirect measures are also generally easier andcheaper to implement. The flip side, however, is that they are less amenable to being steeredtoward specific policy objectives.combination of federal and provincial tax creditsin Canada provides much higher subsidy ratesfor R&D than are available, for example, in USstates.The question therefore is whether Canada isrelying too heavily on “indirect” tax expenditurein its overall mix of business innovation/R&Dsupport. The great advantage of a tax-basedapproach is that, once basic eligibility criteria aremet, it does not discriminate on the basis ofsector, region or specific opportunity. Since theSR&ED program is based on the tax system, itoperates “automatically.” The tax incentivestimulates R&D generally, but leaves projectselection decisions to individual firms. Thegovernment does not try to pick the winners —the companies do. The strength of the programis also potentially its weakness. The tax credit isa blunt instrument. Not every R&D project willgenerate the same rate of social return; notevery R&D performer is equally in need ofstimulus or equally likely to be successful; andgovernments will often be well justified inseeking to promote, through targeted support,certain domains of innovation and R&D forstrategic purposes.Changing the Mix:More Direct SupportThe SR&ED program plays a fundamental role inlowering the costs of industrial R&D for firms,enhancing investment in R&D, and makingCanada a more attractive place to locate R&Dactivity. However, a key implication of this heavyreliance on the program is that federal supportfor innovation may be overweighted towardsubsidizing the cost of business R&D rather thanother important aspects of innovation. Inparticular, the Panel believes the federal6-3