The Fraser Institute

The Fraser Institute

September 18, 2007 06:00 ET

The Fraser Institute: Labour Sponsored Funds Cost Canadian Taxpayers $300 Million Per Year and Provide Little or No Benefit

VANCOUVER, BRITISH COLUMBIA--(Marketwire - Sept. 18, 2007) - Labour sponsored venture capital funds are costing Canadian taxpayers $300 million per year and do not increase the amount of funding available to entrepreneurs, says a new paper from independent research organization The Fraser Institute.

"These labour sponsored funds rely heavily on federal and provincial tax credits, thereby draining millions of dollars from Canada's tax system," said Douglas Cumming, co-author of the paper and Ontario Research Chair in Economics and Public Policy at York University, Schulich School of Business.

"While the primary objective of these tax subsidized investment funds is to help finance Canadian entrepreneurial businesses, empirical evidence indicates they don't increase the overall amount of new money to entrepreneurs."

The paper, Crowding Out Private Equity: Canadian Evidence, is based on a peer-reviewed study of Labour Sponsored Venture Capital Corporations, more commonly known as labour sponsored funds, by Cumming and Jeffrey MacIntosh, Toronto Stock Exchange Professor of Capital Markets at the University of Toronto.

Labour sponsored funds are tax-subsidized investment funds that attract contributions from individual investors through generous tax incentives and invest in entrepreneurial businesses.

The study shows the federal tax credit for labour sponsored funds cost the federal government $150 million in 2006. Quebec spent significantly more credits than any other province at $98 million, while Ontario and British Columbia both spent $20 million. The total spent by Canadian governments to support labour sponsored funds was approximately $300 million in 2006.

But Cumming found that the generous tax credits provided to investors of labour sponsored funds do not actually increase the total amount of money available for Canadian entrepreneurs. Rather, they displace money from private venture capital funds and statistical estimates in the study suggest that they may have even lowered the total amount of money available to entrepreneurs.

Tax subsidized labour funds discourage the presence of non-tax subsidized private venture capital funds. This is highly unfortunate due to the extraordinarily poor performance of the tax subsidized labour funds, Cumming added.

The study also found that labour sponsored funds maintain large amounts of cash (uninvested capital) since they tend to raise more money than they actually invest. This is the case because they are required by legislation to hold 20 to 40 per cent of their capital under administration in case there are large calls for redemption.

"The gap between the amount of money raised and the amount actually invested is important. If venture capitalists are raising funds but not investing them, then the money is stranded and fewer new businesses are being created," Cumming said.

The study also found a host of other problems with labour sponsored funds, including poor organization and structure; convoluted and restrictive rules that govern the size and nature of the funds' investments; limits on who can invest in the funds; restrictions on investment time limits; and a poor track record of successful exits.

As a result of their organizational problems and large amounts of uninvested capital, labour sponsored funds yield poor rates of return, consistently below those that are considered risk-free such as 30-day government treasury bills.

"Canadians are investing in labour sponsored funds to get generous tax credits, not because the want to invest in Canadian entrepreneurs or expect to earn a high rate of return," Cumming said.

"If Canada is to create a truly vigorous venture capital market that stimulates investment in entrepreneurial activity, then governments should eliminate tax subsidies to labour sponsored venture capital funds and consider other more effective policy options."

The Fraser Institute is an independent research and educational organization based in Canada. Its mission is to measure, study, and communicate the impact of competitive markets and government intervention on the welfare of individuals. To protect the Institute's independence, it does not accept grants from governments or contracts for research.

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