Labour-sponsored venture capital funds cost Canadian taxpayers $300 million a year but do not increase the amount of funding available to entrepreneurs, the Fraser Institute argues in a new report.

The institute calls on governments to eliminate tax subsidies for the funds.

The paper is based on a study of labour-sponsored funds by Douglas Cumming, Ontario research chair in economics and public policy at York University, Schulich School of Business, and Jeffrey MacIntosh, Toronto Stock Exchange professor of capital markets at University of Toronto.

It finds that the federal tax credit for LSFs 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 LSFs was approximately $300 million in 2006.

Cumming found, however, that the generous tax credits provided to investors in LSFs do not actually increase the total amount of money available for Canadian entrepreneurs. Rather, he argues, the credits displace money from private-venture capital funds. The report estimates that the credits 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, the report states, adding that the shift is unfortunate because the subsidized funds have performed so poorly. It finds that their returns are consistently below those that are considered risk-free, such as 30-day government treasury bills.

The study also found that LSFs maintain large amounts of cash, since they tend to raise more money than they actually invest, in part because of the capital requirements they face.

“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 LSFs, 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.

“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,” said Cumming.