The Politics of Regional Development Inevitably, the way in which subsidy programs are allocated among companies and localities in the eligible regions is at the discretion of officials, and decisions on allocation are rarely transparent. This raises the spectre that funding decisions reflect the political calculus of the government of the day as much as legitimate economic development objectives … Grants vs. Tax Cuts If discretionary spending programs are a bad way to deliver regional development assistance, then what is the alternative Some commentators have suggested that direct spending programs be replaced by tax reductions for companies investing in the region.
Admittedly, tax measures have costs as well as benefits when compared to direct spending. The case for tax cuts in place of grant programs depends, in part, on the type of tax cut being considered – targeted or broad-based.
Some tax cuts, such as investment-tax credits, tax holidays, flow-through shares or tax-free zones, can be targeted to specific companies, activities, and types of investment. Consequently, they may share some of the economic costs arising in grant programs.
Like grants, targeted tax cuts are chosen by governments trying to pick winners or gain votes. Instead, targeted cuts possibly result in the subsidization of uneconomic activity that replaces unsubsidized profitable activity. They may also lead to higher asset prices, without spurring new activity and leave less revenue available to fund basic public expenditures like education and health.
Broad–based tax cuts are not aimed at particular activities and therefore benefit the economy more generally. However, as an instrument to achieve certain aims, such as building infrastructure or supporting education, the broad-based tax cut is unable to achieve certain aims without costing significant revenue.
Grants vs. Targeted Tax Cuts Grant programs provide certain advantages over targeted tax cuts for three reasons: accountability, broader application, and cost control.
• Grant programs are scrutinized by Parliament.
• Grants support projects regardless of the taxpaying status of the company.
• The program costs are fixed.
The case for targeted tax cuts is argued on other grounds, as well. For one thing, tax relief benefits the successful enterprises because only profitable companies pay taxes … However, the open-endedness of tax-cut programs leads to a different concern. When governments provide tax assistance to fledgling companies to offset capital-market failures, the resulting new entry into the market can undermine the profitability of existing, high quality businesses.
Grants vs Broad–Based Tax Cuts Cogent arguments can be made both for and against grants or targeted tax cuts. But a better alternative than either, we argue, is to replace ACOA with a broad-based corporate tax cut in the Atlantic region.
Universal tax cuts are appealing for several reasons. The cut applies more generally and neutrally so that many taxpayers are given incentives to work, make investments and heighten productivity.
Supporting arguments are based on the principle that the tax system is most efficient and fair if businesses bear similar tax burdens … Recent experience in Ireland where the government cut corporate taxes for manufacturing and financial-services income in the 1980s, and more generally for all businesses in the 1990s, indicates that broad–based tax cuts could be critical to improving per capita incomes.
Looking for a Better Way – In our search.
In our search for a better approach to regional economic development, we have come to the conclusion that a more neutral, broad–based tax cut would achieve more balanced growth in the Atlantic, compared with targeted funding of certain virtuous businesses selected by the government of the day. Such a reform could be implemented two ways – as a general cut in federal statutory tax rates applied to Atlantic income, or as a broad-based incentive for capital investments in the region.
REVITALIZING THE MARITIMES (National Post Newspaper, June 4, 2004 – Don McIver, Halifax, Nova Scotia) The need to revitalize Canada’s underperforming Maritime economies is garnering little attention during this [federal] election campaign. Thank God. Far better the focus be on the state of health care, the tax-spending balance and even the needs of municipalities.
For decades, federal politicians have shown up at election-time, declaring they are ‘here to help’, thus presaging a disastrous policy outcome. Their well-meaning efforts, with promises to close the prosperity gap with the rest of the country, have retarded the Maritimes’ economic convergence with the rest of Canada.
A few weeks ago, the Atlantic Institute for Market Studies released a comprehensive study [see next heading below] detailing the perversity of such programs as Employment insurance, which subsidizes seasonal work, discourages education and causes labour shortages; an equalization formula that discourages local initiatives and distorts taxes; and the regional development arm of Ottawa, the Atlantic Canada Opportunities Agency (ACOA), through which the taxes of successful businesses are used to subsidize the unsuccessful.
For too long, ‘economic development policy’ has been based on the government-knows-best model – a concept that presumes mandarins, rather than entrepreneurs and investors, are the best judge of which business opportunities should be capitalized.
The argument for government intervention is based on the erroneous presumption that markets just aren’t working in this region.
Government planners believe that investors are somehow systematically ignoring profit-making opportunities – opportunities that planners funded by Ottawa can identify and nurture.
This vision of how to achieve growth and convergence is dead wrong. It is contradicted by international experience and by Atlantic Canada’s own history.
In the postwar era up to 1971, Atlantic Canada’s per capita economic growth was strong, consistently outpacing the rest of the nation. Then, when Ottawa dramatically increased regional subsidies in the early 1970s, the region’s growth began to falter. The reason is clear: Bureaucrats have neither the insight nor the experience to choose winners more effectively than the marketplace, and the track record of grants and loans targeted at specific projects is decidedly spotty.
Bricklin Motors is one of the most famous examples. Lured by millions in loans guaranteed by the province of New Brunswick, an American sports car producer opened up shop in the province in the 1970s only to go bankrupt, leaving taxpayers to foot the bill.
Another example can be found in Nova Scotia’s Sydney Steel Corporation, which received $275-million in government financing in 1987 to no avail. The company’s plant fell into the hands of the Nova scotia government, which eventually had to sell it at great cost to taxpayers.
Adding insult to injury, there is a real risk that publicly subsidized operations drive competing firms created with private capital out of business.
More unsettling is the use of ACOA to serve political objectives.
When it was created, ACOA was intended to be the lead agency in the region – the ‘local face’ of the federal government so–to–speak.
Having Ottawa pour tons of money into the region, during the lead–up to an election or at the time of a potentially unpopular policy decision, could be advantageous for the incumbent government, no matter what its political stripe. More particularly, it could be a boon for federal politicians either elected by a slim majority or those elected in response to a previous government’s mishandling of key regional policies.
There are concrete alternatives to ACOA. Lowering tax rates for all businesses, rather than relying on stimulative government spending, would remove the politics from regional development activity. Profitable businesses could then keep a larger share of their revenues, automatically rewarding successful enterprises and encouraging them to become even more successful. Government would no longer need to – or be able to – choose winners.
Regionally differentiated federal tax rates or possibly an Atlantic investment tax credit could achieve this goal. Alternatively, the Atlantic provinces could achieve additional fiscal flexibility if [the] federal government absorbed some provincial debt. The important objective is to develop a broad, tax-driven means of encouraging business development in Atlantic Canada – not one that targets particular industries or firms. That will help bring Atlantic Canada back into the economic mainstream.
4.12. Prospects of the Development of Atlantic Canada How Ottawa Can Put Atlantic Canada on the Road to Prosperity (Atlantic Institute for Market Studies, Halifax, April 2004 – Crowley & McIver) Misguided federal policies not only have failed to the economic discrepancy between the Atlantic provinces and the rest of Canada;
they have, in fact, held back the natural process of convergence, which could have closed the gap relatively quickly. Ottawa’s policies of regional development spending, equalization transfers, and regionally extended employment insurance benefits are wellintentioned failures.
They have left Atlantic Canada with per capita gross domestic product that is no more than three-quarters of the national average, well below average productivity levels, and unemployment that is high even as the region suffers from increasingly significant labour shortages., Moreover, excessive federal regulation and shortsighted bureaucratic interference have prevented key industries in the region, such as the fishery and offshore energy, from acting as catalysts of economic revitalization … Canada’s political leaders must recognize that improving Atlantic Canada’s economy will depend on reversing ill-considered measures and introducing effective new policies … At a minimum, a new federal government that wishes to put Atlantic Canada on a trajectory toward growth and prosperity should take the following steps:
1. Dismantle expensive, politicized, and distortionary regional development programs by • using broad, tax-based measures to foster a development-friendly business environment, and scrapping inefficient, politicized, project-specific incentives provided through agencies such as the Atlantic canada Opportunities Agnecy; and • replacing programs aimed at individual businesses with federally driven corporate tax reductions that allow consumers to choose which businesses will prosper.
2. Revise the equalization program to reduce its perverse incentives, by • re–establishing a ceiling on the total amount available for equalization;
• removing natural resources from the equalization formula; and • swapping equalization payments for a provincial debt– reduction plan.
3. Restore employment insurance (EI) to its original objective of protecting workers from unpredictable short-term interruptions in life-long attachment to the workforce, by • ratcheting down EI benefits significantly every year for annual repeat claimants;
• requiring first-time claimants to have at least one year of continuous work to qualify for EI benefits;
• making EI experience rated, so that employers pay higher premiums when they repeatedly lay off people who then claim EI;
• funneling a significant part of the savings generated by the EI reforms into vouchers to allow workers to gain access to a wide range of job skills and training; and • eliminating regionally extended EI benefits.
4. Develop a business climate and regulatory structure that promotes strong growth in industries, such as the fishery and offshore energy, where the region has comparative advantage, by Case Study # 1: The Fishery and Aquaculture • transferring ownership and control of the fishery to those who make their living from the resource, and making fish quotas fully transferable and tradable;
• passing a National Aquaculture Act that creates strong property rights in the ocean resources required for the aquaculture industry to expand and thrive; and • transferring jurisdiction over aquaculture from the Department of Fisheries and Oceans [federal] to an ‘industry-oriented’ department such as Agriculture or Industry [federal];
Case Study # 2: Offshore Energy • creating the conditions in which an internationally competitive oil and gas exploration and development industry can take root and grow by keeping regulatory and tax costs competitive with those in other jurisdictions;
• streamlining the regulatory process for oil and gas to match approval times in competitor regions, such as the North Sea, that are suitable benchmarks;
• eliminating jurisdictional overlap and coordinating policies to move toward a ‘one-window’ solution for the oil and gas industry; and • introducing ‘performance-based’ regulation.
5. Build a new, strong, and committed relationship with the US, Canada’s most important international partner, that reflects the interests of Atlantic Canada as well as those of the country as a whole, by • supporting Washington’s study of the transportation infrastructure in the northeastern part of the continent, stretching from Halifax to northern New York state;
• working with the US to create the needed infrastructure that ties Atlantic Canada more effectively into markets in the NAFTA heartland; and • building on the Smart Commerce initiative to accelerate and further simplify border-crossing procedures, and working with the US on integrated perimeter security, the harmonization of external tariffs, and mutually agreeable standards of entry for persons from third countries.
Introduction: Converging on the Future For decades, federal government policies have tried without success to narrow economic discrepancies between Atlantic Canada and the rest of the country – indeed, such policies have actually retarded economic convergence. Take unemployment, for example.
Studies published by the Atlantic Institute for market Studies (AIMS) have shown … that, although unemployment rates in Atlantic Canada were similar to the national rate until the end of the 1960s, with the liberalization of unemployment insurance rules in 1971 and the introduction of massive economic development policy spending in the 1970s and 1980s, unemployment and growth rates in Atlantic Canada and the country as a whole began to diverge.