Do federal green corporate subsidies make good climate sense?

The federal Liberals have made it clear that Canada's road to a greener economy will be paved with billions of dollars in corporate subsidies.

Proponents say these may be necessary for Canada to attract investment, especially in competition with the United States — but others are expressing doubts that the hefty handouts will be effective or efficient in the long run.

The 2023 federal budget put the green economy front and centre, investing more than $80 billion over the next decade in everything from clean electricity to critical minerals, delivering a much-expected response to the package of investments made in the U.S. Inflation Reduction Act.

Finance Minister Chrystia Freeland argued that Canada must either meet the moment or be left behind as the world races toward building the clean economy of the 21st century.

For the Liberal government, meeting the moment recently meant making some big promises to German auto giant Volkswagen, which aims to build an electric-vehicle battery plant in southwestern Ontario.

The exclusive contract with Canada will include an upfront capital investment of $700 million and production subsidies for every battery the company makes and sells, which could cost up to $13 billion over a decade.

Ottawa is clearly betting on offering substantial incentives for the corporate sector to get greener.

But will it work?

John Lester, an executive fellow at the University of Calgary's School of Public Policy, said there are various reasons why governments choose to subsidize businesses. A classic example is research and development, an endeavour with benefits that spill over to others in society, he said.

But economists and experts warn that subsidies don't always work the way they're intended to, and can be inefficient when they incentivize companies to do something they were already planning to do.

Freeland has also appeared aware of some of the dangers that could come with that approach, sharing concerns last month during a speech in Washington, D.C.

"We all know that building a clean economy and creating good, middle-class jobs will require a lot of capital. So let us be aware of one danger: it will be all too easy for us to get drawn into a race to the bottom to attract it," Freeland said.

The finance minister warned that past efforts to promote investment and jump-start economic growth ended up driving down corporate tax rates, undermining the domestic tax bases that are so essential to nurturing a thriving middle class.

"A corporate subsidy war might be good for some shareholders, but it would deplete our national treasuries and weaken the social safety nets that are the foundation of effective democracies," Freeland said.

"It is in our collective interest as friends, as partners and as allies to work together to ensure that our incentives drive innovation and investment, rather than create a vicious spiral."

But Lester said the subsidies offered in Canada are already excessive, and called on Ottawa to rethink its approach to business subsidies in a recent blog post on the University of Calgary website.

He argued that the recent budget measures layer on top of two other programs — the net-zero accelerator initiative and the strategic innovation fund — to provide more subsidies as a share of GDP than the U.S. is offering.

"Canada is clearly not lagging the U.S in the clean economy subsidy 'race,'" Lester wrote.

The researcher also said a "broader assessment of business subsidies is needed."

According to his calculations, spending on subsidies in the current fiscal year will be $8.7 billion, up almost 140 percent since 2019-20, and is projected to rise to $9.8 billion by 2025-26.

In the case of the Volkswagen deal, the federal government has argued that the incentive will pay for itself within five years because of the jobs the prospective plant would create and other spillover effects on the economy.

That claim has been met with skepticism by some economists who say the benefits of subsidies are difficult to calculate.

Hadrian Mertins-Kirkwood, a senior researcher at the Canadian Centre for Policy Alternatives, said the Volkswagen deal illustrates the loss in efficiency that comes from countries competing for the same investment.

"From a global perspective and certainly from a climate perspective, that's a huge waste of money. So it's only really justifiable (if) it makes us better off compared to our neighbours, perhaps. But it's not very economically efficient in the grand scheme of things," he said.

In 2021, a consortium of more than 130 countries signed on to a plan to implement a 15 per cent minimum corporate tax rate, in an apparent acknowledgment of the losses they were collectively incurring by slashing taxes to attract business.

Glen Hodgson, a fellow-in-residence at the C.D. Howe Institute, said establishing international common practices could help mitigate a new race to the bottom when it comes to the green economy transition.

"Creating sort of common practices is usually the best way to proceed internationally," he said.

This report by The Canadian Press was first published May 11, 2023.