FINA Committee Report

*	The revenue loss is assumed to be recovered through lump-sum taxation.

Source:

Department of Finance, Tax Expenditures and Evaluations — 2004, p. 71.

The model used by the Department of Finance, however, may underestimate the beneficial impact of reducing corporate income tax rates, since it does not take into account the tax planning effect on potential foreign investors. The international competitiveness of the Canadian business tax system was one of the main principles underlying the introduction of the 2000 federal tax reduction plan for corporate income, as other jurisdictions had already reduced — or were in the process of reducing — their taxes on corporate income.

Corporate taxes have important policy implications for Canada, which is an open economy that relies heavily on international trade and global capital markets. Higher and less competitive tax rates may lead to erosion in the tax base as corporations shift income from high- to low-taxed jurisdictions. As well, it is thought that more internationally competitive tax rates result in increasing inflows of foreign direct investment.

The most significant tax on Canadian companies is the corporate income tax, which is imposed by the federal and provincial/territorial governments. Corporate income taxes accounted for about 14% of total federal tax revenues in 2003-2004, as shown in Table 3.1.⁶⁹

In 2000, the federal government announced a five-year, $100 billion tax reduction plan for individuals and businesses.⁷⁰ As part of that plan, the general federal corporate tax rate was reduced by 7%, falling from 28% in 2000 to 21% in 2004; with the addition of the 1.12% federal corporate surtax, the rate fell from 29.12% to 22.12% over the period, as shown in Table 3.2. The tax reduction plan did not eliminate the federal corporate surtax, which was initially introduced in order to reduce the federal budgetary deficit. Over the 2000-2001 to 2004-2005 period, these tax reductions were expected to cost more than $10 billion.⁷¹

Table 3.2: Federal Income Tax Rates on Corporate Income, 2000-2005

	Tax Rate (including 1.12% Surtax) (%)
Year	2000	2001	2002	2003	2004	2005
General Corporate Income	29.12	28.12	26.12	24.12	22.12	22.12
Small Business Income
Up to $200,000	13.12	13.12*	13.12*
Up to $225,000				13.12*
Up to $250,000					13.12
Up to $300,000						13.12

*	22.12% tax rate (including surtax) is applied to income up to $300,000.

Source:

Department of Finance, October 2000 Economic Statement and Budget Update, p. 101-102 and The Budget Plan 2004, Table A1.2.

In addition, the 2003 federal budget announced changes to the taxation of the resource sector. The changes, to be phased in over five years, include:

•	a reduction in the federal corporate tax rate on income from resource activities from 28% to 21%, plus the 1.12% corporate surtax;

•	a deduction for income tax purposes of actual provincial and other Crown royalties and mining taxes paid;

•	the elimination of the existing 25% resource allowance; and

•	a new 10% investment tax credit for corporations with qualifying mineral exploration expenditures in Canada.

These tax changes for the resource sector are among the most significant changes in tax policy for the sector since the 1970s. According to the Department of Finance’s 2003 Technical Paper on Improving the Income Taxation of the Resource Sector in Canada, the tax changes will improve the international competitiveness of the Canadian resource sector, in particular relative to the United States. The changes will also simplify and streamline compliance and administration, treat all costs in a more consistent manner and preserve incentives for mineral exploration.⁷²

Moreover, the 2003 federal budget announced that the amount of annual qualifying income eligible for the 12% federal tax rate for small business corporations will be increased from $200,000 to $250,000 by 2004 and to $300,000 by 2006; the 2004 budget accelerated the latter measure, so that the $300,000 threshold amount will be reached by 2005. This small business deduction is available to all Canadian-controlled private corporations with capital not exceeding $10 million.

Revenues from corporate income taxation are difficult to forecast. Corporate profits can vary significantly from year to year. As well, the existing system of tax loss offsetting, which allows corporations to carry backward or forward negative tax liabilities over years in which taxable income is positive, means that corporate tax receipts in a given year may be lower than otherwise expected because of deferred or current tax losses.

Source:

Department of Finance, Fiscal Reference Tables, October 2004 and November 2004 Economic and Fiscal Update.

As shown in Figure 3.2, over the 1996-1997 to 2003-2004 period, federal corporate income tax revenues as a share of GDP were at their highest level in 2000-2001, which is not surprising given that corporate profits as a percentage of GDP reached 12.6% in 2000, a level that had not been realized since the 1970s. Over the 1996-1997 to 2000-2001 period, corporate income tax revenues as a share of GDP averaged 2.3%, a rate equal to that of 2003-2004. Private sector forecasters consulted by the Department of Finance project that, on average, the federal budgetary revenues from the federal corporate income tax will be 2.2% of GDP in 2004-2005, and 2.1% and 2.0% in 2005-2006 and 2006-2007 respectively.⁷³

In 2002, all Canadian corporations were subject to the federal large corporations tax (LCT) of 0.225% applied to paid-up capital in excess of $10 million. In addition, financial institutions are subject to a tax of 1.25% applied to paid-up capital exceeding $200 million employed in Canada. Unlike corporate income taxes, which are paid when a corporation has taxable income, capital taxes must be paid regardless of whether a corporation is profitable.

The 2003 federal budget announced the elimination of the federal LCT over five years, and an increase in the capital threshold to $50 million effective 2004. Consequently, starting in 2004, the tax is completely eliminated for medium-sized corporations, or those with less than $50 million in taxable capital. The capital tax on financial institutions has been maintained, and ensures that large financial institutions pay some minimum amount of tax to the federal government.⁷⁴

Although Canada’s average corporate income tax rate is now lower than that of the United States, when other factors such as capital depreciation, capital taxes and provincial/territorial sales taxes are considered, Canada’s average effective tax rate on capital investment for medium- and large-sized companies is about 6% above that of the United States, as shown in Table 3.3. Table 3.3 shows that, with the elimination of the federal large corporations tax and other provincial/territorial tax changes, in 2008 Canada’s average effective tax rate on capital is expected to be about 3% lower than is currently the case. Assuming that corporate tax changes do not occur in Canada or the United States,⁷⁵ however, Canada’s average effective tax rate on capital investment for medium- and large-sized companies would be about 3% higher than the rate in the United States in 2008, as shown in Table 3.3.

Table 3.3: Average Effective Tax Rate on Capital Investment for Medium- and Large-Sized Companies

Year	Canada	United States
2004	31.7	25.8
2008	28.9*	25.8*

*	Assuming no corporate tax changes occur.

Source:

Duanjie Chen and Jack M. Mintz, “Corporate Tax Changes, 2004: Federal and Provincial Governments Part Ways,” C.D. Howe Institute, e-brief, 6 October 2004.

B.        What the Witnesses Said

Many of the Committee’s witnesses shared their view that Canada’s effective corporate tax rate on capital investment is still too high. We were told that the Department of Finance provides incomplete information on its Web site about the competitiveness of the Canadian corporate tax system, and considers only statutory corporate income tax rates and capital taxes; in particular, the Department does not consider depreciation, inventory deductions, provincial/territorial sales taxes on capital inputs, and other taxes that affect capital investment. In the view of witnesses, if the full range of taxes are considered, Canada has one of the highest effective tax rates on capital investment in the world, even though good progress has been realized over the past five years.

The Committee was told that there is a great deal of evidence showing a lack of private sector investment in Canada. It was argued that productivity and competitiveness are enhanced when businesses are able to adopt new technologies through the acquisition of capital goods; greater productivity and competitiveness mean that businesses are in a better position to provide higher compensation to their employees.

A number of witnesses maintained that reducing corporate taxation — thereby reducing the effective rate of taxation on capital investment — would encourage more domestic capital investment to take place and would lead to more foreign direct investment in Canada. In turn, it was argued, higher rates of private investment would result in higher productivity growth and higher incomes. The Committee was told that the per capita income difference between Canada and the United States is approximately $6,000 per person, and that this gap could be entirely due to the lower level of labour productivity in Canada.

The Committee was informed that the aging population will, in the future, place greater demands on public services, resulting in increased public spending of at least 6% of GDP in the next 35 years. At the same time, personal taxes as a share of GDP will decline by about 1% because post-retirement incomes typically are lower than incomes earned during working lives. Witnesses told us that the federal government should adopt long-term fiscal policies that will provide opportunities for Canadians to accumulate resources more quickly in order to fund age-related public spending; otherwise, future working-age Canadians will face significant fiscal pressures to fund public services for the elderly. The point was made that both productivity and demographic issues indicate a need for tax reform designed to lower taxes on investments.

Many witnesses supported reductions in the general corporate income tax rate, and argued that the recent corporate tax rate reductions have resulted in improved economic performance and net increases in federal fiscal revenues. It was felt that the general corporate income tax rate should be reduced to 17% by 2008. As well, the Committee was told that, dollar for dollar, no other form of tax reduction is more effective in accelerating economic growth than a reduction in corporate taxes. Moreover, we were told that the federal government should eliminate the corporate surtax, since the surtax was originally introduced to combat federal budgetary deficits, and the federal budget has had a surplus for a number of years.

For their part, witnesses from the resource sector requested that the federal government accelerate the phased-in reduction of the corporate tax rate on income from resource activities. Also, witnesses from the manufacturing sector reminded the Committee that the corporate income tax rate for their industry was not affected by the recent reductions.

Witnesses’ concerns also focused on federal capital taxes, with many urging an acceleration in the phased-in elimination of the federal large corporations tax, since the detrimental effects of this tax on investment and the economy are clearly recognized. It was also recommended that the federal capital tax on large financial institutions be gradually eliminated.

Witnesses also urged changes to the non-resident withholding tax regime to ensure that Canada remains competitive. It was suggested, for example, that the Department of Finance negotiate a new provision with the United States eliminating withholding taxes on all dividends and interest payments to both related and unrelated parties. They mentioned a recent study that claims that the elimination of withholding taxes on all dividends and interest payments would result in increased capital investment in Canada of $28 billion, and an increased income of $7.5 billion annually. It was pointed out that while there would be a federal fiscal cost associated with eliminating withholding taxes, the economy would benefit in the long run.

Another aspect of corporate taxation presented to the Committee was the taxation of dividends. We were told that the current tax system discriminates against dividend-paying large and medium-sized corporations. Dividends are taxed more highly than capital gains, as well as other sources of income, once both corporate and personal taxes have been taken into account. This result may cause businesses to avoid paying dividends to shareholders in favour of retained earnings. The Committee also heard that Canada's dividend tax rate is now much higher than the U.S. federal 15% tax rate.

Moreover, a number of witnesses were concerned about the Department of Finance’s draft legislation regarding the deductibility of interest and other expenses. Some thought that the draft legislation, if enacted, would reduce entrepreneurial activity in Canada. The draft legislation was described as problematic.

The Committee was urged to support a recommendation with respect to automobile dealers, who finance their inventory with lien notes; these notes are considered taxable capital under the Income Tax Act. In order to qualify for the 12% small business tax rate on income of up to $250,000,⁷⁶ taxable capital must not exceed $10 million. Because of the manner in which capital is defined, many automobile dealers do not qualify for the lower rate; consequently, it was recommended that the definition of taxable capital in subsection 181.2(3) of the Income Tax Act be amended to exclude “lien notes.”

Finally, the Committee was told that foreign-owned property and casualty insurance companies doing business in Canada often benefit from tax provisions in other countries that allow them to set aside, free from income tax, reserves to meet their obligations in cases of catastrophes. The establishment of catastrophe reserves in Canada, free from income tax and similar to the catastrophe reserves found in many European countries, was urged in order that the Canadian mutual insurance industry can compete with foreign competitors on a level playing field.

C.        What the Committee Believes

The Committee recognizes that a country’s tax environment is only one of many elements that influence investment flows and economic activity. Among other influences, a healthy, educated and skilled workforce, well-maintained and adequate infrastructure, and a stable political climate all contribute to a positive business climate.

That being said, Canada’s tax environment for businesses is, undeniably, important to our economic prosperity as a nation and, consequently, to Canadians’ standard of living and the sustainability of public finances. The federal government has a role to play in this area, and should ensure that the tax environment contributes to business success. We believe that the five-year tax reduction plan introduced in 2000 has had beneficial effects, and feel that further tax reductions should occur. Like a number of our witnesses, the Committee believes that our tax environment should be competitive with that of the United States, recognizing that competitive does not mean identical. Otherwise, there is a danger that Canadian businesses will not prosper to the extent that they can, and to the extent that they should. Ultimately, the Canadian economy and Canadians’ standard of living will also suffer.

The Committee feels that lower corporate taxes on capital investment have many beneficial effects: greater employment opportunities for Canadians as businesses decide to invest and locate here; enhanced productivity for businesses that in turn might lead to higher levels of profitability; more generous compensation for employees and larger contributions to the communities within which the businesses operate and the employees live; and a more prosperous nation as a consequence of these factors. It is from this perspective that the Committee recommends that:

RECOMMENDATION 12

The federal government ensure that the effective tax rate for Canadian corporations is competitive with that in the United States and elsewhere. Within that context, the government should:

•	review the timetable for elimination of the federal large corporations tax;

•	review the timetable for the tax changes for the resource sector;

•	consider immediate elimination of the corporate surtax; and

•	review the corporate income tax rates and other taxes paid by corporations.

The Committee is concerned about the current tax treatment of dividend income, which results in dividends being taxed at a higher rate than capital gains and at a higher rate than in the United States. We believe that a review of the tax treatment of dividends is needed in order to ensure that Canada’s treatment of dividend income is competitive with that of the rest of the world, particularly the United States; that the ability of Canadian companies to attract capital investment is not impeded; and that capital gains, interest payments and dividend income are treated similarly. Therefore, the Committee recommends that:

RECOMMENDATION 13

The federal government, bearing in mind Recommendation 16 regarding a review of capital gains, review the current federal tax treatment of dividend income and non-resident withholding taxes with a view to ensuring that the tax treatment in Canada remains competitive with the rest of the world, particularly the United States, and that the tax treatment does not distort investment decisions.

CAPITAL COST ALLOWANCE RATES

A.        What the Federal Government Provides

The capital cost allowance (CCA) is a tax deduction for business-related capital property that provides for the depreciation of these assets. Businesses can deduct up to a fixed percentage of the depreciated cost each year, with 44 CCA classes described in the Income Tax Act. The CCA rate applicable to each class is usually intended to “reflect, as closely as possible, the useful lives of the assets.”⁷⁷

The 2000 federal budget improved the treatment of several classes of assets. This budget, as well as the 2003 budget, also implemented changes to Class 43.1, which addresses renewable and alternative energies. Moreover, in the 2003 budget, the federal government committed to assessing “in particular, the appropriateness of capital cost allowance rates that, as a general principle, should reflect the useful life of assets and thus provide adequate recognition of capital costs.”⁷⁸

The 2004 federal budget increased the capital cost allowance rate for computer equipment to 45% from 30% and for broadband, Internet and other data network infrastructure equipment to 30% from 20%. To date, no other changes to the CCA rate schedule have been announced.

B.        What the Witnesses Said

As in past years, witnesses spoke to the Committee about the federal government’s capital cost allowance rate structure, and often provided specific proposals about what they believe the rates should be. Many witnesses indicated that the rates are inconsistent with the economic lives of some assets. For example, we were told that the current rates for Canadian railways and for rail leasing companies are considerably lower than those for U.S. railroads, and that the rate for rail equipment is also considerably lower than that for Canadian trucks and marine vessels.

Other industries are also negatively affected by the current CCA rate structure, according to witnesses. The Committee was told that the electricity industry is the only sector that does not receive adequate tax treatment for the depreciation of used and new assets, and that the printing industry is disadvantaged since the rate applied to computers does not apply to computer equipment. The agriculture industry also believes that rates must be updated in order to encourage greater investments in farm capital.

Furthermore, the Committee was told that harmonizing rates and the method of calculating capital cost allowances with those in the United States would provide additional incentives for business investment in Canada. They urged a review of the rates applicable to all asset classes in order to align capital cost allowance rates with the true economic life of the assets.

C.        What the Committee Believes

The Committee believes that capital cost allowance rates must be reviewed as soon as possible. We are reminded of the announcement in the 2003 federal budget that these rates should be assessed and that they should, as a general principle, reflect the useful life of the asset in question. Moreover, while we recognize that the 2004 budget announced changes for certain asset classes, much more remains to be done. In our view, changes are needed to ensure both that similar asset classes are treated in a similar manner and that Canadian companies are not disadvantaged relative to their international competitors, particularly those in the United States.

In particular, the Committee was struck by what we perceive to be certain anomalies in the current treatment of some asset classes, and we believe that these anomalies should be corrected immediately. More generally, however, we are of the view that the long-awaited assessment must occur. Consequently, the Committee recommends that:

RECOMMENDATION 14

The federal government revise Canada’s capital cost allowance rates by 31 March 2005 such that they meet three criteria:

•	similar asset classes are treated similarly;

•	Canadian rates are similar to the rates for comparable asset classes in the United States and other countries; and

•	Canadian rates reflect the useful life of the assets.

Moreover, the government should review these rates annually to ensure that they continue to meet the three criteria identified.

ACCESS TO CAPITAL

A.        What the Federal Government Provides

Businesses can finance capital investments through debt, equity or a combination of the two. Smaller businesses, however, may be limited in their ability to access traditional sources of capital because of their financial situation and the availability of risk capital. Traditional creditors may view such businesses as relatively riskier, particularly if they operate in knowledge-intensive industries. For these businesses and in these types of industries, traditional debt financing may not be readily available because they lack sufficient equity, machinery or inventory to use as collateral.

Since the 2000 federal budget, the federal government has implemented a range of tax measures to help facilitate the growth of small companies, entrepreneurship and the commercialization of innovative ideas, including:⁷⁹

•	a reduction in the capital gains inclusion rate from 75% to 66.6% to 50%;

•	the introduction of a small business capital gains rollover provision;

•	a measure permitting the deferral of the income inclusion from exercising qualifying stock options until disposition;

•	a reduction in the general corporate income tax rate from 28% in 2000 to 21% in 2004;

•	an increase in the small business deduction limit from $200,000 to $300,000 in 2005;

•	improvements to capital cost allowance rates for certain asset classes;

•	extension of the non-capital loss carry-forward period from 7 years to 10 years; and

•	elimination of the federal large corporations tax over 5 years.

Moreover, in recent years the federal government has removed certain regulatory impediments and committed additional funding in order to enlarge the pool of risk capital for promising start ups and small businesses, including:⁸⁰

•	the removal of tax-related impediments to venture capital investment in Canada through the use of partnerships by Canadian pension plans and by foreign investors;

•	the removal of impediments to the use of qualifying limited partnerships as investment vehicles for Canadian venture capital funds;

•	amendments to the Scientific Research and Experimental Development investment tax credit rules so that small Canadian-controlled private corporations that have a common group of shareholders who are not acting together will not have to share the $2-million expenditure limit; and

•	additional federal funding for venture capital financing by the Business Development Bank of Canada and by Farm Credit Canada.

As well, the federal government, through the Canada Small Business Financing Act, increases the availability of financing for small businesses through access to debt financing. Through this legislation, the federal government partially guarantees loans up to $250,000 to eligible new and established small businesses with annual gross revenues of less than $5 million. Although banks and other financial institutions make the loans, the federal government bears a significant portion of any loss incurred as a consequence of default. The term loans are for the purchase or improvement of fixed assets, which may limit the usefulness for start-up companies, particularly those that require few fixed assets.

The Business Development Bank of Canada (BDC) offers financial and consulting services to small businesses, both individually and jointly with other institutions. It provides venture capital in exchange for equity participation of between 15% and 49% or unsecured convertible debt financing, venture loans where repayment is a combination of interest payments and royalties tailored to the company`s cash flow, and seed capital. Initial investments typically range from $500,000 to $3 million as part of a package of financing that may total $1 million to $10 million. The BDC will reinvest to maintain its pro-rata share of the investment along with other investors. The nature of its support means that new firms are not overburdened with higher interest payments on debt.

Microcredit funds are also available from the BDC for entrepreneurs who do not have access to bank credit. Local economic development centres offer security to lending institutions and will primarily support community projects that promote employment for specific target clienteles. These loans are under $25,000 and are to be used to finance the start-up of businesses with fewer than five employees and gross revenues of less than $500,000. As well, the BDC has a Venture Capital Division and offers Co-Vision start-up financing for term financing of up to $100,000.

Through the labour-sponsored venture capital corporation (LSVCC) program, the federal government has been involved in venture capital financing. This program provides small individual investors with federal and provincial/territorial tax credits for investing in eligible, union-sponsored funds mandated to make investments in smaller businesses. In the 1980s, the federal government offered a tax credit of 20% on investments up to $5,000; these amounts were subsequently changed to 15% on investments up to $3,500, and later to 15% on investments up to $5,000.⁸¹ According to the Department of Finance, the federal fiscal cost of the LSVCC tax credit in 2003 was about $155 million.⁸²

The creation of the LSVCC program has been important to the development of the Canadian venture capital industry; in some periods, the LSVCCs were raising the majority of all new venture capital in Canada. In recent years, their share of the Canadian venture capital market has declined to about 40%.⁸³ Moreover, the federal government has been directly involved in venture capital through the Business Development Bank of Canada and, more recently, Farm Credit Canada. At the end of 2003, the amount of venture capital under management in Canada exceeded $22 billion.⁸⁴ According to the Organisation for Economic Co-operation and Development, the size of the Canadian venture capital market as a share of GDP ranked third among the G-7 countries in 2001, behind the United Kingdom and the United States.⁸⁵

B.        What the Witnesses Said

Witnesses shared with the Committee a number of concerns about access to capital and made recommendations that they believe would facilitate access. Some, for example, urged further increases in the small business deduction threshold, and suggested that it be increased to $400,000 or $500,000, depending on the witness. According to witnesses, an increase in the threshold would encourage small business owners to invest and grow their businesses.

As noted earlier, the Committee was also informed that Canada's dividend tax rate is much higher than the U.S. federal 15% tax rate, thereby making Canadian equity markets less competitive as businesses find it less expensive to issue shares in the United States. In addition, we were told that the Canadian tax treatment of dividends discriminates against dividend-paying large and medium-sized corporations, with the result that tax planning opportunities are created and the effectiveness of Canada’s capital markets is reduced. Aligning the effective taxation of dividends to that of capital gains would eventually reduce the cost of capital for small businesses by eliminating opportunities for market distortions and increasing the expected after-tax rate of return on investment in shares of small companies.

Moreover, the Committee was told that the Lifetime Capital Gains Exemption for small businesses is an important incentive for business growth and expansion. Several witnesses recommended that the federal government increase the exemption limit from $500,000 to $1 million, possibly phased in over time. A similar proposal was made with respect to agricultural property that continues to be operated as a farm. This new threshold would facilitate the intergenerational transfer of farms by better reflecting the current farming environment.

The Committee was told that small and medium-sized businesses face great challenges in financing their growth using private sources of equity. We were informed that, last year, the market for venture capital financing fell to its lowest level in five years. Witnesses suggested that reducing the capital gains inclusion rate from 50% to 25% on shares of small publicly listed companies would increase the availability of risk capital for businesses at their early stages.

A proposal to increase the maximum amount eligible for the 15% tax credit for investment in labour-sponsored venture capital corporations — to $15,000 from the current $5,000 — was presented to the Committee. It was also mentioned that the Income Tax Act inhibits labour-sponsored venture capital corporations from making “sub-debt” investments, which are loans with equity characteristics; in this regard, it was recommended that the Income Tax Act be amended to allow labour-sponsored venture capital corporations to make such investments.

The Committee was also informed about deficiencies in Canada’s capitalization environment for technology start-up companies. In particular, we were told that there is a shortage of seed and pre-seed investment capital; this shortage may be as large as $5 billion. This type of investment is generally made by private “angel” investors, and it was recommended that the federal government introduce a tax incentive for early-stage private equity investments to enhance access to this type of equity capital for start-up technology companies.

C.        What the Committee Believes

The Committee believes that access to capital is critical to business success: it is needed in order for businesses to form, grow and prosper. We feel that insufficient entrepreneurial activity is being financed, particularly at the start-up and early stages of businesses, despite actions that have been taken by the federal government in recent federal budgets. A lack of entrepreneurial activity, and financing for it, may have particularly negative consequences in the future, since it may mean insufficient investment in — to mirror the October 2004 Speech from the Throne — “Canadian capabilities in key enabling technologies … which will be the drivers of innovation and productivity” as we move forward.

Moreover, in the Committee’s view, as long as businesses continue to face challenges in accessing the capital they need, labour-sponsored venture capital corporations will play an important role in the venture capital market, providing stability of supply, regional diversity, an emphasis on start-up financing and funds to market niches currently underserved.

Like a number of our witnesses, the Committee feels that concerted efforts must be made to ensure that federal actions create an environment that fosters, rather than erects barriers to, the investments needed for business prosperity and, by extension, the prosperity of the Canadian economy and Canada’s citizens. Certainly, business prosperity should be enhanced through corporate tax changes and the revisions to capital cost allowance rates recommended above, but other actions could also be taken in an effort to support entrepreneurs — and others who need access to reasonably priced capital — within Canada. It is for this reason that the Committee recommends that:

RECOMMENDATION 15

The federal government work with venture capitalists to identify new sources of financing. As well, the government should increase its funding to the Business Development Bank of Canada and to Farm Credit Canada in order that they can increase their venture capital activities. Finally, changes should be made to the federal Small Business Loan Program to allow this funding source to be accessed for a range of other uses, including operating capital.

The Committee believes that the federal government must take the actions needed to ensure the best possible business climate for businesses of all sizes and in all sectors. Moreover, like some of our witnesses, we feel that more could — and should — be done to create a tax environment conducive to early-stage private equity investment in start-up companies, particularly the small technology companies involved in the research and development that will be important for our future growth and prosperity. At the early stages of development, the return on equity investments made by private investors usually occurs in the form of capital gains. Thus, the Committee recommends that:

RECOMMENDATION 16

The federal government review the tax treatment of capital gains in order to ensure that start-up technology and other small companies are able to access private equity capital at the lowest possible cost, and that the tax treatment of capital gains in Canada remains competitive with that of the rest of the world, particularly the United States.  

RESEARCH, INNOVATION AND COMMERCIALIZATION

A.        What the Federal Government Provides

Innovation is a key contributor to the productivity growth that is felt to be important for economic growth and rising standards of living. Moreover, technological advancements are important in enhancing the ability to produce more goods and services with fewer resources. The development of new ideas and processes does not, however, occur without cost, and this cost can sometimes be substantial. Moreover, both basic and applied research must be recognized for the contribution they make to technological advancement, as well as research undertaken by companies and research that occurs in universities, colleges, research hospitals and government laboratories.

As noted in the 2004 federal budget, “Canada now ranks among the top five in the Organisation for Economic Co-operation and Development (OECD) and is first in the Group of Seven (G-7) in terms of publicly performed research (at universities, research hospitals and government laboratories) as a proportion of gross domestic product (GDP).”⁸⁶ Businesses also provide research funding to universities and may perform their own research, although their involvement in research is mostly concentrated in applied research and product development, rather than in basic research. The knowledge that flows from basic research activities is the foundation for the applied research and new product development that occur.

The federal government has a role to play both in funding basic research and in ensuring an environment in which worthy ideas can be commercialized, whether by it or in partnership with the private sector. The government supports research, innovation and commercialization activities through a variety of policies, tax measures and spending programs.

In February 2002, the federal government announced its Innovation Strategy, which commits Canada to, by 2010:

•	rank among the top five countries in the world in terms of R&D performance;

•	at least double the federal government’s then-current investment in R&D;

•	rank among the world leaders in the share of private sector sales attributable to new innovations; and

•	raise venture capital investments per capita to prevailing U.S. levels.

Federal support for basic research occurs through funding for the three federal granting councils and research agencies, including universities and hospitals, among others. Table 3.4 below shows the major federal research funding agencies and their respective mandates.

Table 3.4:  Major Federal Research Funding Agencies, Canada

Institution	Description
Canada Foundation for Innovation	Funds the modernization of research infrastructure at Canadian universities and colleges, research hospitals and other not-for-profit research institutions
Federal Granting Councils
Canadian Institutes of Health Research	Funds research related to health
Social Sciences and Humanities Research Council of Canada	Funds research related to the social sciences
Natural Sciences and Engineering Research Council of Canada	Funds research related to science and engineering
Genome Canada	Has responsibility for developing and implementing a national genomics strategy
Canada Research Chairs	Establishes 2,000, research professorships in universities across Canada
National Research Council Canada	Delivers such programs as the Industrial Research Assistance Program, which assists small and medium-sized businesses in developing and using new technologies and processes
Technology Partnerships Canada	Works with the federal government and the private sector to make strategic, high-risk investments in R&D to achieve specific objectives
Canadian Institute for Advanced Research	Funds researchers, with about one-third of its budget coming from the federal government

Source:      Library of Parliament.

 

Canada’s three granting councils — the Natural Sciences and Engineering Research Council of Canada (NSERC), the Social Sciences and Humanities Research Council of Canada (SSHRC) and the Canadian Institutes of Health Research (CIHR) — as well as the Canadian Institute for Advanced Research (CIAR) and the Canada Foundation for Innovation (CFI), among others, are important if Canada is to realize its Innovation Strategy. As shown in Table 3.5, in recent years the federal government has markedly increased its funding to the higher education sector in order to strengthen research capacity at universities, colleges and research facilities.

Table 3.5:  Federal Funding for University-Based Research

	1998-1999	1999-2000	2000-2001	2001-2002	2002-2003	2003-2004	2004-2005	2005-2006
	(millions of dollars)
Canada Foundation for Innovation	30	115	185	240	480	360	450	550
Genome Canada				43	60	90	125	40
Canada Research Chairs			60	120	180	240	300	300
Canada Graduate Scholarships						25	55	85
Medical Research Council of Canada/Canadian Institutes of Health Research	40	72	145	255	330	385	385	385
Natural Sciences and Engineering Research Council of Canada	71	111	118	118	154	209	209	209
Social Sciences and Humanities Research Council of Canada	9	26	38	58	67	82	82	82
Indirect costs of research				200		225	225	225
Networks of Centres of Excellence		30	30	30	30	30	30	30
Total (annual)	150	354	576	1,064	1,301	1,646	1,861	1,906
Total (cumulative)	150	504	1,080	2,144	3,445	5,091	6,952	8,858

Source:      Department of Finance, The Budget Plan 2004, p. 134, 135, 160.

With increases to funding for the three granting councils announced in the 2004 federal budget, the annual budgets will total approximately $654 million for the CIHR, $654 million for the NSERC and $192 million for the SSHRC. Consequently, for 2004-2005, their combined annual federal funding is projected to be about $1.5 billion.⁸⁷

The 2003 federal budget commitment of $1.7 billion between 2002-2003 and 2004-2005 to research and development brought federal funding since 1998-1999 to more than $11 billion.⁸⁸ The 2003 budget also allocated an additional $500 million to the CFI to enhance health research facilities. Additional research and development support was identified in the 2004 budget, which announced a $60 million increase in funding for Genome Canada, adding to the $375 million already invested by the federal government. In 2005, Genome Canada’s original five-year mandate will end.⁸⁹

For some institutions, the indirect costs associated with research — libraries, infrastructure and other items — can be sizable, and may impose a significant cost burden, thereby forcing institutions to reallocate funds either from direct research grants or from core operating costs. As a result, the federal government allocated $200 million in 2001-2002 to fund a portion of the indirect costs of federally sponsored research, and in the 2003 federal budget established an annual program with a budget of $225 million per year to help alleviate these costs. The 2004 budget increased this amount by $20 million annually, with the result that the federal government will provide an annual allocation of $245 million to help fund the indirect costs of federally sponsored research.⁹⁰

The federal government also provides assistance to businesses in undertaking and commercializing research. The Scientific Research and Experimental Development (SR&ED) investment tax credit provides qualifying Canadian-controlled private corporations having less than $200,000 in taxable income during the previous year with a refundable investment tax credit of up to 35% for qualifying expenses, to a limit of $2 million; this limit is reduced by $10 for every $1 of taxable income between $200,000 and $400,000 in the preceding year. Other Canadian corporations, proprietorships, partnerships and trusts are eligible for a 20% non-refundable tax credit on qualifying expenses; they may be carried back 3 years or carried forward 10 years to reduce tax liability.⁹¹

The 2004 federal budget removed an impediment in accessing the SR&ED credit. Prior to the budget, two or more small businesses could not access the credit fully where associated through common investors, even when the investors did not act together. With the change, small businesses conducting SR&ED and raising funds from common investors not acting as a group can fully access the tax credit.⁹² According to the Department of Finance, the SR&ED investment tax credit is projected to involve a tax expenditure of $1,750 million in 2004.⁹³

Moreover, the Industrial Research Assistance Program (IRAP), which has existed for about 60 years and is available through National Research Council Canada, provides small and medium-sized businesses with technological and business advice, financial assistance and other innovation assistance, such as networking and partnerships, with a view to enhancing their innovation capacity.⁹⁴ The 2003 federal budget provided the Council with $25 million annually to expand the IRAP’s core programming, and $10 million annually to establish new regional innovation centres and to secure Canada’s participation in astronomy projects.⁹⁵ The 2004 budget allocated an additional $5 million annually to the IRAP to strengthen regional innovation and commercialization strategies.⁹⁶

Commercialization of research is important in order to ensure that consumers can access the best products, that businesses can profit from their investments, and that the Canadian economy can grow and prosper. The federal government supports commercialization, in part through funding for pre-commercial development and the Intellectual Property Management Program, the Proof of Principle and Proof of Principle Partnered Program, and the Idea to Innovation Program of the federal granting councils.

Activities related to commercialization were enhanced in the 2004 federal budget, with an announcement that $50 million would be allocated over five years for a pilot competitive fund, managed by Industry Canada. The budget also committed $25 million over five years for a pilot program that will support proposals by federal science-based departments and agencies to improve their research commercialization activities, and funding of $270 million to enhance access to venture capital financing for companies turning research into new products and services.⁹⁷

The October 2004 Speech from the Throne reiterated the federal commitment to venture capital financing, and mentioned — in particular — early-stage businesses. The Speech also indicated the government’s commitment to “foster Canadian capabilities in key enabling technologies … which will be drivers of innovation and productivity in the 21st century economy.”⁹⁸

B.        What the Witnesses Said

Witnesses presented the Committee with testimony that could be interpreted as suggesting that, in some sense, federal granting councils are victims of their own success. Despite the relatively large increases in the budgets of the federal granting councils over time, as noted above, several witnesses advocated additional investments and informed us that the demand for funds continues to exceed supply by a sizable amount.

It was proposed that, by 2008-2009, the federal government double the base funding for the Social Sciences and Humanities Research Council to $460 million, increase the budget of the Canadian Institutes of Health Research to $1 billion and increase the budget of the Natural Sciences and Engineering Research Council to $1.2 billion. Witnesses also requested that the federal granting councils be permitted to carry over a minimum of 5% and a maximum of 10% of annual funding from one fiscal year to the next. It was also proposed that the federal government cease to invest in the Canada Foundation for Innovation and instead increase funding for the granting councils. The Committee was told that inadequate funding for research makes it difficult for Canada to attract and retain the talented personnel that are required to sustain a climate of innovation.

Particular comments were made with respect to the Social Sciences and Humanities Research Council. A number of witnesses commented that the SSHRC continues to be disproportionately underfunded relative to the other granting councils. The Committee was told that the SSHRC receives 12% of the total funding for the three federal granting councils, although it supports 69% of all undergraduate students, 67% of graduate students and 53% of permanent university faculty.

The importance of ensuring that all regions of Canada benefit from federal research and development funds was noted by witnesses. The Committee was asked to support the National Research Council’s role in the development of technology clusters in regions across the country. This effort, we were told, helps the commercialization of research and therefore benefits all Canadians. This year, the five-year funding for the Atlantic Technology Cluster initiative ends, and we were informed that the federal funding for it should be renewed.

The Committee was also told that funding from the Canadian Foundation for Innovation and the awarding of Canada Research Chairs is biased towards larger institutions and several provinces. It was recommended that the federal government conduct a review of research funding initiatives with the goal of modifying these programs to ensure greater equity, regionally and among institutions. Moreover, in developing any new programs, the government was urged to be sensitive to the particular needs of regions and smaller institutions.

As well, the Committee was told that significant declines in operating grants to universities have had detrimental impacts on research capacity. It was indicated that approximately one-third of all research and development in Canada occurs in post-secondary institutions; consequently, the federal government should increase its core funding for these institutions.

Some witnesses observed that the funds invested by the federal government in research ignore a substantial portion of the costs incurred by universities: the indirect costs of research. In the absence of federal funding for the indirect costs of research, universities must fund these costs from other sources. Several witnesses advocated funding the indirect costs proportionately to the level of direct research grants, while others recommended that the government increase funding for indirect costs associated with federally sponsored research to $400 million, effective in 2005.

Many witnesses shared the view that greater efforts should be directed toward the commercialization of research. It was argued that Canada is underperforming, relative to other nations, in bringing new knowledge and research discoveries to market, which prevents Canada from fully capitalizing on its research investments. The Committee was told that the federal government should introduce measures to help accelerate commercialization of research and to improve the commercialization environment in Canada.

For example, it was proposed that flow-through shares, as currently used in the oil and gas industry, could be available for technology companies to help them finance their research and development costs with private equity, rather than with government grants; the criteria used to determine the scope of eligible research activity could be modeled on the existing SR&ED program. Another suggestion was that the federal government should develop a version of the Québec program “bio-levier,” which was designed to enhance the equity capital financing of biotechnology corporations at their early stage of development.

Furthermore, several witnesses observed that the administrative aspects of the SR&ED initiative have become very complicated, and advocated simplification of the system as well as its expansion. The Committee was told that the credit would be more useful if the carry-forward period was extended to 15 or 20 years, and it was suggested that the current cap of $2 million on expenditures should be raised to at least $6 million by 2005. Some argued that reform of the SR&ED initiative should be a priority, since companies in the technology sector cannot take advantage of the tax credit because they do not have taxable income. They advocated measures that would allow companies to use their tax credits to offset other federal taxes, such as employment insurance premiums and capital taxes. In their view, these types of changes would encourage more R&D investment.

C.        What the Committee Believes

The Committee has long supported measures that improve productivity in Canada, believing that productivity improvements — that is, the ability to produce the same amount of goods or services using fewer resources or to produce more goods and services using the same amount of resources — will become increasingly important as demographic changes continue and as we continue to compete in the global marketplace.

Consistent with the views of some of our witnesses, the Committee believes that productivity growth is linked to research and development spending, and to a highly educated workforce that is able to access post-secondary education and lifelong learning opportunities. We note the goals contained in the federal Innovation Strategy, and the moneys allocated to federal granting councils and research agencies and for the indirect costs of research in recent federal budgets. In our view, investments in research and development are not an end unto themselves but — instead — a means to an end: raising business prosperity and the quality of life of Canadians through productivity growth and technological advances.

Significant funds from Canadian taxpayers have been allocated to research and development in recent years, and the Committee believes that accountability and responsible expenditure of these funds require that information be more widely disseminated about successes, since it is important to know whether the research and development funding is having the desired effects. Canadians must be assured that the expenditure of their tax dollars on research and development is resulting in more than employment for researchers. Thus, we urge federal research agencies to take every opportunity to publicize their accomplishments to date, the manner in which funds are allocated to regions and to institutions, and the effects of their investments on productivity and the quality of life of Canadians.

Like a number of our witnesses, the Committee sees commercialization as the final step in the research and development process, although it must be recognized that commercialization should not be the expected outcome with respect to all research. For example, research in the humanities and social sciences may offer few opportunities for commercialization.

That being said, however, the Committee feels that — wherever practicable — commercialization must occur for the benefit of all. In our view, the commercialization of research requires a particular skill set, one that is not typically found within universities themselves. We believe in the benefits of specialization: university researchers should specialize in the research activity, while others should specialize in the commercialization of that research. Commercialization must be seen as a priority since it is, in some sense, part of the return on the investment that Canadians make in research and development through the federal government.

Along with federal funding for federal granting councils and research agencies, as well as the Industrial Research Assistance Program, all of which have received increased funding in recent federal budgets, the Committee views the SR&ED tax credit as a useful means by which research and development — with its consequent benefits for productivity, business prosperity and the quality of life of Canadians — can be encouraged. Like a number of our witnesses, however, we feel that the credit could be improved so that more companies could benefit from it. Therefore, the Committee recommends that:

RECOMMENDATION 17

The federal government work with business to simplify the process by which firms access the Scientific Research and Experimental Development investment tax credit.

Moreover, the Committee agrees that flow-through shares, which are currently used successfully in the oil and gas industry, are useful for companies that want to finance their research and development with private equity investment. We believe that this mechanism could be useful for certain technologies that would have benefits in their own right but which could also help Canada to meet its environmental goals. Thus, the Committee recommends that:

RECOMMENDATION 18

The federal government review access to flow-through shares for specific expenses related to research and development with a view to expanding access for other sectors. This review should, in particular, consider early expansion of access for the fuel cell and hydrogen as well as the biotechnology industries.

SMART REGULATION

A.        What the Federal Government Provides

Government regulations exist for a variety of purposes, including to protect the health and safety of Canadians; to protect the natural environment; and to ensure a fair and efficient marketplace for industry and consumers domestically and, to the extent possible, internationally. Other federal actions, such as taxation, program spending, legislation, standards, guidelines and codes might also be used to achieve these goals. Globalization and changing expectations require that regulations be adapted to ensure that the most effective and efficient means are used to provide the level of protection and governance desired. Effective regulation should have social, environmental and economic benefits.

The 2003 federal budget implemented a commitment made in the 2002 Speech from the Throne, which said: “The government will move forward with a smart regulation strategy to accelerate reforms in key areas to promote health and sustainability, to contribute to innovation and economic growth, and to reduce the administrative burden on business.”⁹⁹ To that end, the budget allocated $4 million over two years for the External Advisory Committee on Smart Regulation to examine and report on redesign of Canada’s regulatory approach “to create and maintain a Canadian advantage.”¹⁰⁰

In May 2003, the External Advisory Committee on Smart Regulation was established by the federal government in order to provide external advice on the redesign of Canada’s regulatory system in order to serve better the needs of Canadians and the country in the current century. The Committee, which was comprised of 10 members with knowledge of regulatory issues and a commitment to the public interest, held the view that smart regulation “is about finding better, more effective ways to provide a high level of protection to Canadians, promote the transition to sustainable development and foster an economic climate that is dynamic and conducive to innovation and investment. It must exist in a system that sets clear policy objectives and is transparent and predictable ….”¹⁰¹

The External Advisory Committee on Smart Regulation released its report, Smart Regulation: A Regulatory Strategy for Canada,¹⁰² in September 2004. The report proposed a new regulatory strategy for the 21st century, with cooperation — among governments and between government and such other parties as business and non-governmental entities — as an important requirement in a regulatory regime that will advance Canadian interests and national priorities. Recommendations in the report included a focus on:¹⁰³

•	international regulatory cooperation as a distinct component of Canadian foreign policy;

•	federal-provincial-territorial regulatory cooperation, formalized in a discussion by First Ministers and the conclusion of a joint arrangement;

•	federal regulatory cooperation among federal departments and agencies, with overarching strategic frameworks with clear policy objectives;

•	risk management, involving a government-wide approach to risk prioritization, assessment and communication;

•	instruments for government action, with a framework to guide their design and use;

•

the regulatory process, with the development of a new federal Regulatory Policy to include performance measurement, compliance, enforcement plans, approaches for timely development of regulations, improved consultation practices, independent recourse mechanisms and task teams to lead regulatory reform processes; and

•	government capacity to support a regulatory cultural change within government, to include comprehensive learning strategies as well as regulatory policy research and development agendas.

In response to the External Advisory Committee on Smart Regulation’s report, the Prime Minister has asked the President of the Treasury Board, in his capacity as the Minister responsible for the Government of Canada Regulatory Policy, to lead the development of a regulatory government framework for this century. The President of the Treasury Board will work with other federal Ministers, representatives of provincial/territorial governments, industry representatives, members representing civil society and citizens as changes are made to modernize regulation in areas that might include natural resources, the environment, biotechnology, health, food safety and transportation.¹⁰⁴

Finally, in terms of the regulation of securities in Canada, the December 2003 release of the report by the Wise Persons’ Committee to Review the Structure of Securities Regulation in Canada, It’s Time, is important.¹⁰⁵ The Committee, which was established by the then-Minister of Finance in March 2003, undertook an independent, objective review of the current regulatory framework for securities in Canada, and made recommendations about what might be an appropriate regulatory model.

The report by the Wise Persons’ Committee advocated the creation of a single regulator using a joint federal-provincial/territorial model; at this time, Canada is the only major industrialized country without a national regulator. The proposed Canada Securities Commission would have nine regionally representative commissioners appointed by the Minister of Finance, and a framework for provincial/territorial input to securities policy. The system’s administration would be provided by a securities policy ministerial committee comprised of the provincial ministers responsible for securities regulation as well as the Minister of Finance.

It is thought that a single regulator would result in strengthened enforcement, better policy innovation and development, enhanced branding of Canadian securities regulation internationally and, ultimately, better protection for investors and improved access to capital for companies.

The 2004 federal budget supported the recommendation by the Wise Persons’ Committee for a single securities regulator, and committed the federal government to working with “provincial and territorial governments to … act quickly or run the risk that our capital markets will be left behind.”¹⁰⁶

B.        What the Witnesses Said

Many of the Committee’s witnesses supported the work of the External Advisory Committee on Smart Regulation, and urged early review and implementation of the Advisory Committee’s recommendations by the federal government. It was observed that the overall regulatory burden on businesses must be reduced, and that government commitments about smart regulation offer a low-cost opportunity to enhance significantly the Canadian business environment, thereby attracting more investment, raising productivity and increasing competitiveness.

Furthermore, a number of witnesses argued that Canada should establish a single national securities regulator to lower administrative and compliance costs and to provide consistent interpretation and enforcement of rules.

C.        What the Committee Believes

The Committee has long supported the benefits of regulatory improvement as a contributor to Canadian productivity. We believe that while regulations must provide Canadians with a stable and fair economic environment and protect their health and safety, an appropriate level of regulation is needed in order that Canadian business is not unnecessarily impeded.

A regulatory regime that is too burdensome can impede both productivity improvements and prosperity, and thereby limit opportunities and prosperity for Canadian businesses and Canada’s citizens. Striking the appropriate balance between beneficial regulation and reducing red tape can be difficult to achieve. Difficulty in achieving the balance is not, however, an excuse to avoid the attempt. A number of the Committee’s witnesses commented on the report by the External Advisory Committee on Smart Regulation, and we join them in believing that the External Advisory Committee’s recommendations should be reviewed and adopted as soon as possible. It is for this reason that the Committee recommends that:

RECOMMENDATION 19

The federal government review and implement, on an expeditious basis, the recommendations made by the External Advisory Committee on Smart Regulation.

Regarding securities regulation, the Committee agrees with witnesses that a more streamlined, coordinated and harmonized securities regulation process is needed. Unnecessary duplication increases costs and harms the capital markets that are vital to our prosperity as a nation. In supporting the notion of a national securities regulator, we believe that all provinces must play a role, since they are closer to the markets and each has a different perspective. Consequently, the Committee recommends that:

RECOMMENDATION 20

The federal government take a leadership role and meet with provincial/territorial governments no later than 28 February 2005 with a view to adoption of a national securities regulator scheme no later than 30 June 2005.

TRADE

A.        What the Federal Government Provides

Canada is a trading nation.¹⁰⁷ In 2003, Canadian exports of goods and services had a value of $457.8 billion, representing 37.7% of GDP, and Canadian imports of goods and services were $409.1 billion, representing 33.7% of GDP. The United States is the most important destination for Canadian exports, as shown in Figure 3.3. In 2003, the United States received $364.8 billion in Canadian goods and services, representing 79.7% of total Canadian exports.

Source:      Department of Foreign Affairs and International Trade.

For countries such as Canada, which relies heavily on trade, effective and properly enforced international trade rules are critically important. Canada’s future economic prosperity continues to be tied to an open, transparent, rules-based international trading system with predictable and enforceable trade rules, improved access to global markets and openness to world trade while maintaining fundamental Canadian interests and values.

In 1999, in Seattle, a new round of multilateral trade negotiations was launched, with agriculture and service negotiations beginning in 2000 and a new, comprehensive round of negotiations announced in November 2001 at Doha, Qatar. Known as the Doha Development Agenda, although the round was to have been completed by 1 January 2005, it is unlikely that an agreement will be concluded by that date. In general terms, negotiations are aimed at further trade liberalization, strengthened multilateral rules and increased integration of developing nations into the world trading system.

Conceived in principle in September 1994 at the inaugural Summit of the Americas, the Free Trade Area of the Americas (FTAA) negotiations are a part of the larger Summit process, which is aimed at strengthening democracy, promoting human rights and creating prosperity. The negotiations themselves were launched at the second Summit in April 1998. For Canada, strengthening economic ties with the region is a priority, since the Americas region is Canada’s most important market. It is unlikely that the original deadline for the conclusion of negotiations — 1 January 2005 — will be met.

Recognizing that Canada is a trading nation that needs secure and expanding access to markets, the October 2004 Speech from the Throne committed the federal government to continuing to “push for an open, rules-based international trading system and a successful conclusion of the Doha Round of global trade negotiations,” to “build on the successful Smart Borders initiative and on measures designed to develop a more sophisticated and informed relationship involving business and government officials in the United States,” and to enhance government’s “capacity to expand international trade and commerce, with a particular focus on North America and emerging markets.”¹⁰⁸

Interprovincial trade is governed by the Agreement on Internal Trade signed by First Ministers in July 1994. The Agreement, whose goal is to “reduce barriers to the movement of persons, goods, services and investments within Canada,”¹⁰⁹ provides for:

•	rules that prevent governments from erecting new barriers to trade and that require the reduction of barriers in areas covered by the Agreement;

•	specific obligations in identified sectors;

•	the streamlining and harmonization of regulations and standards;

•	a formal dispute resolution mechanism that can be used by individuals, businesses and governments; and

•	commitments to further liberalization, with continuing negotiations and specified work programs.

Finally, the October 2004 Speech from the Throne indicated that, as a complement to international commerce initiatives, the federal government “is determined to forge a stronger Canadian economic union, free of the internal barriers that still diminish opportunities and reduce our competitiveness.”¹¹⁰

B.        What the Witnesses Said

A number of the Committee’s witnesses mentioned our trading relationship with the United States, and stressed both the importance of ensuring a secure and efficient border and the need to resolve bilateral trade irritants as they arise. Regarding the border, comments were made about the priority that should be given to enhanced border and trade infrastructure, in part to minimize the cost of congestion and delays.

On the issue of resolving bilateral trade irritants, some witnesses highlighted the need to work toward the resumption of normalized trade in live cattle and beef in the North American market in the aftermath of a single case of mad cow disease in Canada. Comments about the closed border for cattle and beef prompted requests for increased federal assistance for the cattle and beef industry, including slaughter and processing capacity. The current dispute with respect to hogs and the ongoing softwood lumber dispute with the United States were also noted.

The Committee also heard concerns about trade friction more generally, with the United States and with Europe, and about the importance of protecting certain industries during trade negotiations while at the same time securing market access. In particular, we were told that the federal government must protect Canada’s agricultural supply management systems and ensure transparent market access. Concerns were also voiced about the extent to which Canadian agricultural producers suffer as a consequence of significant agricultural support in the United States and the European Union. One example that was brought to our attention involved the Canadian dehydrator industry, which exports about 80% of its production. This industry is experiencing plant closures, job losses and reduced exports, in part because subsidized European Union products entered the industry’s largest export market. Federal assistance for the dehydrator industry was requested.

More generally, the suggestion was made that the federal government should work with producers to diversify export markets for Canadian products; this diversification would reduce vulnerability to unforeseen events and trade actions. As well, more effective financing mechanisms were advocated for Canadian exporters engaged in new market development efforts worldwide.

Witnesses also noted the importance of adequate and timely trade dispute mechanisms, mentioned the need to ensure that bulk water exports do not occur, and identified the priority that must be given to protecting Canadian producers against unfairly traded and unfairly priced steel imports.

Moreover, the Committee was told that while most Canadian companies do not charge the Goods and Services Tax when they export goods or services, this exemption does not apply to certain types of intangible property. Moreover, the exemption on exports of telecommunications services applies only if the customer also supplies telecommunications services. To correct the narrowness of these exemptions — which place Canadian companies at a competitive disadvantage — it was recommended that the federal government expand export rules to cover all types of intangible property and to extend the exemption to all customers of telecommunications services.

Support was expressed for the role taken by the federal government as the International Convention on the Protection of the Diversity of Cultural Content and Artistic Expression is being developed at UNESCO. In particular, culture would be exempted from international trade agreements.

While some witnesses identified federal government support regarding international undertakings, as indicated above, federal support was found to be lacking with respect to other international commitments. For example, the Committee was told that the government is retreating from the Beijing Platform for Action commitments, which it made in 1995 and recommitted to in 2000. Canada made a national and international commitment to ensuring that women’s equality was protected and enhanced. In the view of these witnesses, government actions in the last decade have been directed to initiatives that neither directly nor indirectly advance the Beijing commitments, despite the fiscal ability of the government to take action. We were also informed that more resources are required if Canada is to meet its international human rights obligations to women  consistent with the United Nations Convention on the Elimination of All Forms of Discrimination Against Women.

Positive comments were made by witnesses regarding tourism, and about the need to support tourism in Canada. In the view of witnesses, Canada has much to offer as a destination for foreign tourists, and their contribution to the Canadian economy — and the effect of their visits on employment in Canada’s tourism industry — were noted.

C.        What the Committee Believes

The Committee believes in the value of transparent and predictable rules governing trade, both within our country and with other countries. It is these types of rules that will ensure our ongoing prosperity as a nation. We are a trading nation, and to maximize the extent to which our providers of goods and services can export their products for their own good and the good of Canada, progress must be made — on an ongoing basis — in securing market access and in ensuring that our trading partners are meeting their international trading obligations. Where this latter circumstance does not occur, we believe that the government must be tireless in its efforts to defend Canadian interests against unfair challenges. The negotiation of bilateral and multilateral trade agreements is critically important as we move forward, as are labour and environmental standards within those agreements. It is from this perspective that the Committee recommends that:

RECOMMENDATION 21

The federal government continue to work toward the conclusion of international trade agreement negotiations, including through the World Trade Organization, the Free Trade Area of the Americas and other bilateral initiatives, to enhance international market access for Canadian products. Labour and environmental standards should be part of all trade negotiations.

Moreover, the government should vigorously defend Canadian interests against unfair trade actions initiated by our trading partners. Where Canadian producers are harmed by unfair trade actions taken by trading partners, including high levels of subsidies by those countries, the government should consider appropriate support for affected sectors.

While the Committee certainly supports efforts to enhance the ability of producers of Canadian goods and services to access international markets, we also believe that impediments to trade across our provincial/territorial borders must be removed. Canadian businesses — for their prosperity and in order that they can maximize their contribution to the Canadian economy and the quality of life of Canadian citizens — must operate within an environment where goods and services flow at least as easily across our internal borders as they do across our international borders. Thus, the Committee recommends that:

RECOMMENDATION 22

The federal government take a leadership role and meet with provincial/territorial governments with a view to eliminating the barriers to interprovincial/interterritorial trade.

EMPLOYMENT INSURANCE CONTRIBUTIONS

A.        What the Federal Government Provides

The Employment Insurance (EI) program provides temporary financial assistance to eligible unemployed Canadians who are: looking for work or upgrading their skills; pregnant or caring for a newborn or adopted child; sick; or providing temporary compassionate care or support to a family member who is gravely ill with a significant risk of death. The program is financed by employers and employees, with employers contributing 1.4 times the contribution made by employees. Contributions are subject to an annual maximum, and are calculated by applying the contribution rate to insurable earnings up to a certain earnings level. Unlike the Canada/Quebec Pension Plan, contributions are made on all earnings up to that earnings level.

For 2004, the employee and employer contribution rates are, respectively, $1.98 and just over $2.77 for every $100 of insurable earnings up to $39,000 in insurable earnings.¹¹¹ For 2005, employees and employers will contribute at the rate of $1.95 and $2.73 respectively for every $100 of insurable earnings up to $39,000 in insurable earnings. As shown in Figure 3.4, EI premium rates have declined each year since 1994, when the employee and employer rates per $100 of insurable earnings were $3.07 and $4.30 respectively.¹¹²

 

Source:      Human Resources and Skills Development Canada, Chief Actuary's Report on Employment Insurance Premium Rates and Library of Parliament.

The annual maximum contribution for insurable earnings applies to each job held by the employee with different employers. While contributions made above this annual maximum by employees who hold a number of jobs in a year are refunded to them, the same is not true for employers.

The Employment Insurance Account, which is a Specified Purpose Account in the Accounts of Canada, has had a surplus for many years, as shown in Figure 3.5, and is expected to have a cumulative surplus of $47.2 billion in 2004-2005. The Minister of Finance determines the interest rate that will be applied to any Account surplus.¹¹³

 

Sources:    Public Accounts of Canada and Library of Parliament.

B.        What the Witnesses Said

Witnesses shared their concerns with the Committee about a range of Employment Insurance issues, including the EI Account surplus, premium rates, the sharing of program costs, the absence of a Yearly Basic Exemption in the program, the treatment of employer overcontributions in respect of an employee having several employers during the course of a year and experience rating, among others.

Several witnesses expressed concern about the use of the EI Account surplus for such purposes as reducing the federal debt rather than for increasing benefits, while others suggested that the sizable EI Account surplus is an indication that premium rates are too high and should be reduced. The Committee was told that since eligibility criteria have been tightened, 35% of unemployed workers are able to qualify for EI benefits; in their view, eligibility criteria should be changed in a manner that would allow at least 70% of unemployed workers to be able to access benefits. Proposals were also made regarding the establishment of a dedicated EI trust fund operated at arm’s length from the federal government, and a more equal sharing of program premiums and costs. The Committee also heard a proposal urging the extension of the Employment Insurance program to self-employed workers, including artists.

Finally, as in previous years, some witnesses advocated the creation of a Yearly Basic Exemption (YBE) for the Employment Insurance program, similar to the exemption that exists with respect to contributions to the Canada Pension Plan. A YBE would mean that employees and employers would not pay premiums on some portion of earnings, a measure that could provide assistance to low-income employees and labour-intensive businesses. A YBE of $3,000 was suggested.

C.        What the Committee Believes

The Committee believes that the Employment Insurance program is an important initiative in helping those who are unemployed in a variety of circumstances to meet their income — and, in some cases, training — needs. We are cognizant of the study underway by the Subcommittee on the Employment Insurance Funds of the House of Commons Standing Committee on Human Resources, Skills Development and the Status of Persons with Disabilities, and are anxious to read the Subcommittee’s recommendations. The Subcommittee held quite extensive consultations prior to preparing its report, and is likely to have a much more extensive and considered plan for reform. Consequently, the Committee’s recommendations regarding the Employment Insurance program — which appear in Chapter Four — are likely to be considerably more general.

SECURITY, DEFENCE AND THE SHARED BORDER

A.        What the Federal Government Provides

Increased spending on security, at the Canada-U.S. border as well as at ports and airports, has been partly aimed at responding to the desire by the United States for more secure borders following the terrorist attacks of 11 September 2001. This desire must be weighed against the Canadian economic need for more open borders. Canada and the United States have one of the closest, and one of the closest trading, relationships in the world, and events of 11 September 2001 reinforced the need to work together to secure North America, since our security and prosperity are inextricably linked.¹¹⁴

The 2001 federal budget allocated $7.7 billion over five years for security-related measures, as well as $345 million over five years for a security contingency reserve for unforeseen future security needs. These funding initiatives were in addition to the $280 million in security-related spending announcements made prior to the budget. The 2003 budget allocated an additional $75 million over two years to this reserve, and an additional $605 million over five years was announced in the 2004 budget.¹¹⁵

The Smart Border Declaration, signed by Canada and the United States on 12 December 2001, includes a 30-point Action Plan based on four pillars: the secure flow of people; the secure flow of goods; secure infrastructure; and coordination and information sharing. The Action Plan focuses on risk management, allowing both countries to concentrate on unknown and high-risk traffic while facilitating the flow of legitimate commerce. The 2001 federal budget announced funding of $1.2 billion over five years to strengthen border security and infrastructure and, according to the 2003 budget, an additional $286 million was allocated from the security contingency reserve for the development and implementation of key border management programs. The 2003 budget also provided $600 million in funding for the Border Infrastructure Fund.¹¹⁶ As well, it reduced the Air Travellers Security Charge from $12 to $7 for one-way travel and from $24 to $14 for round-trip travel; this Charge was further reduced in the 2004 budget.¹¹⁷

Several programs have been put in place to ease congestion and delays, and thereby facilitate the flow of goods and people, at the shared border in the context of tighter security measures. For example, the NEXUS program provides dedicated/fast lanes for pre-approved, low-risk travelers, and the Free and Secure Trade (FAST) program partners Canada and the United States with the private sector to ensure a secure supply chain for low-risk goods. In particular, pre-approved importers, carriers and drivers process low-risk goods using dedicated FAST lanes, with the result that cross-border commercial shipments are easier, less expensive, and subject to fewer delays while still ensuring a high level of security.

As well, the number of Integrated Border Enforcement Teams (IBETs) has been increased. The IBETs, which are overseen by police and customs agencies on both sides of the border, protect national security, combat organized crime and address other border criminality.

Other areas where bilateral progress has been, or is being made, include:

•	developing commons standards for biometric identifiers;

•	coordinating visa policy;

•	sharing advance passenger information; and

•	establishing joint customs teams to examine container cargo.

More recent actions have also been taken in Canada to enhance security:

•

the Department of Public Safety and Emergency Preparedness will integrate and enhance coordination of intelligence gathering, assessment and dissemination across a number of agencies, including the Royal Canadian Mounted Police, the Canadian Security Intelligence Service, and the immigration and customs intelligence functions of the Canadian Border Security Agency under one Minister;

•

the position of National Security Advisor to the Prime Minister has been created, and this Advisor is responsible for intelligence and threat assessment integration and interagency cooperation as well as for assisting in the development and overall coordination of an integrated policy for national security and emergencies; and

•	a comprehensive National Security Policy has been released, with an addition $690 million in new security investments.

The 2004 federal budget noted the launch of the International Policy Review, which is designed to reassess Canada’s foreign policy objectives and defence requirements, among other elements. The current defence policy objectives, for example, were established in 1994. Recent budgets have allocated resources to defence, including the 2000, 2001 and 2003 federal budgets.¹¹⁸

The 2003 federal budget allocated $270 million for Operation Apollo in Afghanistan, as well as for urgent capital and other requirements, $800 million annually in new funding, and a $125 million reserve for contingencies in 2002-2003 and $200 million in 2003-2004. It also announced funding of $94.6 million to the Canadian Coast Guard for major repairs to its fleet for shore-based infrastructure and capital replacement purchases.¹¹⁹

Moreover, the 2004 federal budget announced an additional $250 million over two years for Canada’s participation in peacekeeping missions in Afghanistan and the fight against terrorism, and an additional $50 million for Canada’s participation in the peacekeeping force in Haiti. The budget also made income earned by Canadian Forces personnel and police while serving on high-risk international missions exempt from taxation.¹²⁰

B.        What the Witnesses Said

Several of the Committee’s witnesses observed that the implementation of the Smart Border Declaration has proceeded smoothly, and urged the federal government to ensure that further improvements are made to the security and efficiency of our shared border. We were told that congestion at the Canada-U.S. border costs Canadian businesses billions of dollars annually in lost productivity. A new border crossing in southern Ontario was identified as a particular priority requiring early implementation.

Other witnesses urged the federal government to increase its spending on various aspects of defence, including the Department of National Defence, the Canadian Coast Guard and marine security. Adequate funding in these areas is important in its own right; however, it is also important to our relationship with the United States.

Finally, the Committee was told that inadequate funding in certain areas and an inability to access funds in others make it difficult for fire departments to be as fully prepared in the event of an emergency as Canadians might wish. The federal government was urged to commit itself to the principle that federal funding is required for all Canadians to receive basic fire protection services.

C.        What the Committee Believes

The security of our nation — both physical and economic — is of vital importance to the Committee. Canada has a long and proud history of defending Canada’s citizens, Canada’s interests and Canada’s allies, both domestically and internationally. To be effective — and to be respected worldwide — it is, however, important that our military be properly funded, both generally and when peacekeeping missions arise. Defence has taken on greater importance since the terrorist attacks on 11 September 2001, and we hold the view that the United States wants Canada to do more in terms of both defence spending and defence activities in fighting terrorism.

In the Committee’s view, it is particularly important that adequate attention be paid to security and defence at our shared border with the United States. That shared border — its defence and facilitation — is critically important in assuring our American neighbours that they will not face a threat coming from Canada. Moreover, we believe that border facilitation is also important from a trade perspective, since the United States is the largest export market for Canadian products. It is from this perspective that the Committee recommends that:

RECOMMENDATION 23

The federal government ensure that the funds current allocated for Canada’s defence, emergency response and security needs are being properly allocated and used effectively and efficiently. Following this review, the government should ensure that adequate funds are allocated to meet the country’s defence, emergency response and security needs, including port security.

Moreover, the government should ensure that sufficient resources are committed to meet the needs at the shared border with the United States, including any funds required to implement the Smart Border Declaration between Canada and the United States.

Finally, the government should provide the funds immediately needed to re-capitalize the Canadian Coast Guard, as well as annual, secure, stable funding for future Coast Guard operations.