Innovation, Human Capital, and Taxation: Evidence from a Structural Model of the Canadian Economy

Canada’s innovation performance has been strong but shows limited upward momentum despite generous research and development (R&D) subsidies. This paper develops an endogenous innovation, multisector, heterogeneous-agent model calibrated to the Canadian economy to evaluate fiscal policies that promote innovation and growth. The impact of R&D subsidies depends critically on the supply of high-skilled labor. When the supply of scientists is inelastic, subsidies raise research wages, crowd out private R&D, and can reduce long-run growth. When labor supply is more elastic, subsidies generate substantial gains in innovation and output. The analysis also compares alternative policy instruments. Investment tax reductions and education spending foster innovation through capital deepening and an expanded supply of highskilled labor, delivering more robust gains when talent constraints bind, while personal income tax changes have more limited effects. R&D subsidies also increase inequality by disproportionately benefiting high-skilled workers, although these effects are mitigated when labor supply responds. Overall, effective innovation policy requires combining R&D incentives with policies that expand human capital and reduce distortions to investment.