LSVCC Tax Credit is Bad Tax Policy

Justin Trudeau today unveiled his party’s economic platform going into the 2015 federal election. There are lots of interesting pieces in the platform, but one particularly has caught the eye of many economists. Trudeau is going to bring back the Labour Sponsored Venture Capital (LSVCC) tax credit. That is bad tax policy and means the Liberals now join my wall of Stupid Tax Policy Initiatives. I have a fair bit of knowledge in this area as I had this file for many years when I worked at the Department of Finance in Ottawa. The background is also detailed here.

LSVCCs were the original creation of the Quebec government in 1983. On the heels of the 1981-1983 recession the Quebec government created the Fonds de solidarite des travailleurs de Quebec (FSTQ), which was a venture capital mutual fund directed by the Federation du Travalleurs de Quebec (FTQ), a very large trade union, to invest in Quebec small and medium-sized enterprises (SMEs). The idea was that labour should be more directly involved in capital markets with the goal to assist with job and business creation (or perhaps more aptly, preservation). Again, this was on the heels of a very sharp and deep recession which had hit Quebec particularly bad. This came with a maximum $1225 provincial tax credit (35% on a maximum investment of $3500). Over time the tax credit was reduced and the maximum investment increased.

In 1985, the federal government introduced a number of measures to stimulate venture capital, including a matching federal tax credit for individuals who invested in provincial LSVCCs (despite there only being one in existence at the time). It also encouraged other provinces to follow Quebec’s lead and establish LSVCCs and many followed suit. In 1988, the federal government permitted federal LSVCCs. The first federal LSVCC was the Working Ventures Canadian sponsored by the Canadian Federation of Labour and funded with a $14.55 million federal grant.

In 1992, the federal tax credit was increased to 20% on a maximum investment of $5000 and that tax credit was also available if the investment was made through an individual’s RRSP. This latest regime is what really caused the investments to take off. Through the various tax credits and RRSP deduction, investors actually shouldered very little of the investment cost (~20%), with the bulk of the cost (~80%) shouldered by tax payers. The end result was a massive uptake in LSVCC investments (via the RRSP route) and a corresponding drain on the treasury.

In 1996, then Finance Minister Paul Martin attempted to plug the drain by reducing the tax credit to 15% on a maximum investment of $3500, but political lobbying resulted in the maximum being increased to $5000 in 1999. By 2002, the federal government was foregoing $260 million in tax revenues as a result of the tax treatment of LSVCCs .

This regime remained largely in place until Budget 2013 which announced the phase out of all LSVCC federal tax credits. The credit was reduced to 10% in 2015, will be 5% in 2016, and eliminated starting in 2017. The rationale for the phase out was that:

“the economic environment and structure of the venture capital market have changed significantly…[and] the LSVCC tax credit has been criticized by academics, international organization as well as venture capital industry stakeholders as being an ineffective means of stimulating a health venture capital sector. Recently, several commentators, including the Organisation for Economic Co-operation and Development (OECD), have called for the elimination of the tax credit.” (Budget 2013, page 207-208).

Ontario also began the phase out of its tax credit in 2012, something it had threatened to do since 2005. PEI was the first to see the writing on the wall, eliminating its tax credit in 1997.

What were the critiques of the tax credit regime? Well, they are essentially the same as those levied against the Mineral Exploration Tax Credit. Those criticizing the tax credit as being detrimental include many of our top business academics, including:

  • Alan Riding and Miwako Nitani at the Tefler School (U of Ottawa),
  • Douglas Cumming at the Schulich School (York U),
  • James Brander at the Sauder School (UBC), and
  • Jack Mintz at the School of Public Policy (Calgary).
  • Jeffrey MacIntosh in the Faculty of Law (Toronto)

Douglas Cumming wrote a very detailed critique for the C.D. Howe Institute and Jeffrey Macintosh wrote one for the School of Public Policy at Calgary, saying it represents a “squandering of both federal and provincial resources.”

LSVCC funds have usually posted negative returns on pre-tax capital in Canada and only make money (if at all) through the generous instituted tax breaks. The low returns were the combined result of very high management fees, commissions, bad management, and the poor exits (usually through buybacks or write-offs which are two of the worst exists for venture capital funds). In fact, many LSVCCs went insolvent and many investors lost most if not all of their investment (and hence, the tax payer was never repaid). You might also remember the Crocus Fund scandal, where very bad management led to its shut down.LSVCCs have underperformed the easiest asset class to beat: 30-day risk free T-bills. There is no evidence these LSVCCs helped create jobs or SMEs. The worst side of these funds, outside of the tax sink, is that they crowd out investments in other, and likely more productive, areas. Those investing in LSVCCs were either naïve investors, many of who lost of lot of money, or wealthy sophisticated investors who invested solely for the tax benefits (much like the METC). It is also interesting to note that no other country followed suit with similar tax policy.

I would like to know why, in the face of academic and international evidence, Justin Trudeau wants to breathe new life into something a putrid as the LSVCC tax credit. What does he know that the experts in the field don’t know? What evidence does he has to support this revitalization?

Advertisements

5 thoughts on “LSVCC Tax Credit is Bad Tax Policy

    • Poorly written article and misinformed
      Firstly the uk government has a tax credit of 30 percent for retail investors that has been hugely successful for investors and the economy.
      Secondly it is absurd to suggest that their is no evidence to suggest lsif investments create jobs. By investing in small businesses, where the money is used to buy materials, new equipment, research and development etc how could this not directly and indirectly create jobs?
      Finally it is laughable to suggest lsif crowd out other investing sources. What’s to crowd out! There is almost no venture capital money invested in small companies today in Canada.

      This is both smart politics and policy

  1. […] At his big economic speech in Montreal, Thomas Mulcair promised to reinstate the labour-sponsored venture capital tax credit, which has been proven to be bad policy. […]

  2. […] but then proceeded to introduce similar poorly targeted an inefficient tax measures, namely the LSVCC tax credit and the one directed to teachers for teachers for supplies. With respect to the tax credits for […]

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s