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Finlayson Op-Ed: Tax policies discourage small business from getting bigger (Troy Media)

The latest federal budget confirms and reinforces what seems to be an enduring belief among many Canadian policy-makers that it is better for enterprises to stay small than to build up their top lines, bottom lines and employee head counts.  According to Budget 2015, the Conservative government plans to lower the federal small business income tax rate from 11 per cent to 9 per cent by 2019.  The rate reductions will come in four half-point steps, starting in January 2016.  There is to be no change in the general federal corporate tax rate on income above the small business threshold level ($500,000) – that rate remains at 15 per cent.

All of the provinces follow the same general approach as Ottawa, by setting their small business tax rates below the rates charged to medium-sized and larger firms.  British Columbia, to take one example, presently levies a 2.5 per cent small business tax, while imposing an 11.0 per cent tax on earned income above the threshold amount.  The net result is summarized in the accompanying table: the combined federal/B.C. tax rate on small business income is currently about half of the rate on other income, with the gap set to widen over the next few years. 

Current and Proposed Business Tax Rates

 

2015

2019*

Federal small business tax rate

11.0%

9.0%

Federal general business tax rate

15.0%

15.0%

B.C. small business tax rate

2.5%

2.5%

B.C. general business tax rate

11.0%

11.0%

Combined federal/B.C. small business tax rate

13.5%

11.5%

Combined federal/B.C. general business tax rate

26%

26%

*based on 2015 federal budget

At the margin, this feature of the Canadian business tax regime acts as a disincentive for many small firms to grow, as noted in numerous studies by think tanks and academic economists over the years.  In some cases entrepreneurs game the tax rules by incorporating a second small company as soon as an existing one bumps up against the $500,000 income threshold where the small business tax rate ceases to apply.   

As it happens, the data show that the vast majority of new businesses in Canada either disappear within five years or – assuming they survive – never grow beyond the 1-10 employee size category.   In fact, as an empirical matter, very few small firms ever evolve into medium-sized enterprises.  But the tiny slice of small companies that do qualify as “fast-growing” make disproportionate contributions to the economy through robust job creation and by introducing into the market innovative products, technologies, and services.   

While small business advocates were quick to applaud Ottawa’s decision to trim the federal small business tax rate and one can anticipate that some economic benefits will result from this measure, the whole concept of differential tax treatment based on company size is problematic on policy grounds.  Unlike Canada, most other developed countries have not designed their income tax systems to discourage business expansion. 

Canada has done a good job establishing an environment that is conducive to business start-ups and new company formation.  That is a strength.  But we have been notably less successful in nurturing business growth – and this where policy-makers should be directing their attention.   

Rather than a shortage of micro-businesses and start-ups, Canada’s problem is that we have both too few global-scale firms and a worrisome paucity of “middle-market” companies.  This matters to our long-term economic prosperity.  Larger enterprises have a number of attractive features – on average, they are more productive than small firms and pay higher wages and salaries, for example.  In addition, the 500 biggest companies collectively account for most of the research and development done by the Canadian business sector as well as for a sizable majority of the country’s exports.

Instead of incenting firms to stay smallish, wise governments should be looking to stimulate business growth and to boost the rewards for entrepreneurial ambition.  If policy-makers want more Canadian companies to export, to participate in global markets, to improve productivity, to innovate, and to increase real wages for their employees, then cutting small business income tax rates while leaving the tax burden unchanged for other businesses is the wrong way to proceed.  

By Jock Finlayson, Executive Vice President and Chief Policy Officer, Business Council of British Columbia

As published online in Troy Media