Businesses and Public Policy in Canada…Apparently Smaller is Better

The latest federal budget confirms and reinforces a prevailing belief among Canadian policy-makers that it is better for enterprises to stay small instead of expanding their top lines, bottom lines and employee head count. Budget 2015 signals that the Conservative government plans to lower the federal small business income tax rate from 11% to 9% 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 that applies to income above the small business threshold ($500,000) – that rate remains at 15%.

All of the provinces follow the same general approach as Ottawa, setting their small business tax rates below the rates charged to medium-sized and larger firms. British Columbia, to take one example, has a 2.5% small business income tax rate, while levying a tax of 11% on income above the threshold amount. The net result is summarized in the accompanying table: the combined federal/BC tax rate on small business income is dramatically lower than the rate that applies to the income earned by larger enterprises. At the margin, this feature of the business tax regime acts as an incentive for many small firms to steer clear of growth. And as it happens, the data show that the vast majority of new businesses formed in Canada either disappear within five years or – assuming they survive – never grow beyond the 1-10 employee size category. Very few small businesses ever become mid-sized firms.

Corporate and Small Business Income Tax Rates, BC Example
(based on measures proposed in the 2015 federal budget)
Small business rateGeneral business rate
Federal tax rate9% (by 2019)15%
BC tax rate2.5%11%
Combined rate11.5%26%

While small business advocates were quick to applaud the federal government’s move, and one can anticipate that some economic benefits will result from a reduced tax burden on the small firm sector, the whole concept of differential tax treatment based on company size is problematic on policy grounds. Canada has done a good job establishing an environment that is conducive to business start-ups and new company formation. This is a strength. But we have been notably less successful in nurturing business growth.

Rather than a shortage of micro-businesses and start-ups, Canada has both too few large firms and a worrisome paucity of “middle-market” companies. Instead of incenting firms to stay smallish, wise governments should be looking to stimulate business growth and boosting the rewards for entrepreneurial ambition. If policymakers want to encourage more Canadian companies to export, to participate in global markets, to increase productivity, to innovate, and to pay their employees more, trimming small business income taxes while leaving tax rates unchanged for other businesses is the wrong strategy.