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The downside of Canada’s love affair with small business

January 28, 2015

2-minute read

It is not difficult to understand the motivation behind the federal NDP’s decision to make a tax cut for small business a centerpiece of its pre-election policy roll out.

As touted by what must be the most consistently effective political lobbying force in Canadian history, small business is perceived to be an important engine of economic growth and job creation.

And while supporting small business doesn’t have the easily identifiable upside that goes with investing in large-scale projects of multinational corporations that have big job numbers attached to them, it has the virtue of avoiding the red-faced problem when those big jobs go south.

Nobody notices, particularly, when employment in a small business goes up. And nobody notices when a small business lays off employees or shuts down.

The problem is that the small business of the imagination ­– the mom and pop operation innovating like mad and plowing every cent it earns back into the business to make it grow – is not at all representative of the corporations that benefit from the small business tax rate.

Research by Jack Mintz of the University of Calgary – certainly no one’s idea of a left-wing economist – has found that 60 per cent of the benefit from the small business deduction goes to taxpayers with incomes of over $150,000 a year.

A 2014 paper by Michael Wolfson (formerly of Statistics Canada), Michael Veall (McMaster University), and Neil Brooks (Osgoode Hall Law School) highlighted the role that Canadian controlled private corporations (CCPCs) – the class of corporations that qualify for the small business rate – in the tax planning (avoidance) strategies of very high income earners in Canada.

They found that adding in the income earned by the top 1% through CCPCs increases the income threshold for the top 1% from $360,000 to $500,000. Adding CCPC income to the incomes of the top 0.01% nearly doubles the threshold from $4.6 million to $8.0 million (2011 data).

The widespread use of preferential CCPC rates as a tax avoidance strategy highlights an oddity in the way we think about equity in the tax system.

We tend to think of someone with an income of $500,000 as having a very high income. And based on equity principles, we tend to think that someone with a very high income should pay a higher rate of tax.

Here’s the rub: that same income level, earned through a corporation, is considered in Canada’s political reality today to be “small” and deserving of a much lower rate of tax than the norm.

In policyspeak, while a tax break for a real small business delivered via the mechanism of a preferential corporate income tax rate may or may not be effective in supporting small businesses that are actually growing and creating jobs in Canada – and there’s lots of room for debate there too – it is incredibly poorly targeted.

The evidence suggests that most of the benefit goes to individuals who use a corporate structure to avoid paying personal income taxes and that most of those individuals are at the top of the income distribution.

In other words, the substantial portion of the value of the preferential tax rate for small business completely misses its intended target and actually contributes to the growth in income inequality in Canada.

It’s time to pause and reflect on our policy love affair with small business.

Economist Hugh Mackenzie is a CCPA Research Associate. Follow Hugh on Twitter: @mackhugh

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