Ottawa doesn’t need to reward risk

The main argument against the federal government’s plan to get tough on income sprinkling and other tax-reduction devices used by small businesses seems to be that we shouldn’t raise taxes on people who own their own businesses because business owners run risks we wageslaves don’t. If they don’t face lower taxes than the rest of us, they won’t have an incentive to run those risks and we’ll all be worse off as a result.

As an economist I’m almost professionally obliged to buy into incentive arguments and that makes me favour low taxes for everyone. The lower the better. Still, there are at least a couple of things wrong with special low taxes for income sprinklers.

First thing wrong: Is it really true that all small businesses face risks the rest of us don’t? A lot of the opposition to Ottawa’s proposed tax changes seems to be coming from doctors and their associations. Is there really a lot of income risk to being a doctor in Canada? To try to control medicare spending, provincial governments limit the number of doctors who can bill their systems. Controlling the number of competitors is what oligopolies do. Marketing boards, too. I suppose if your bedside manner is egregiously bad, you can drive yourself out of the doctoring business. Very occasionally a misbehaving doctor is thrown out of the profession. But when governments are assuring that the demand for your services is permanently greater than their supply you have to be a lunkhead not to earn money. It’s not quite the case that if you get admitted to med school you can start picking out curtains for the cottage, but it’s not far from it.

It’s also true, of course, that owners of small businesses have costs the rest of us don’t. They may employ people. They may have overhead. They have to deal with suppliers and clients, who can be difficult. But nobody is arguing businesses should have to pay tax on their costs. They should pay only on their net incomes — though we should make sure their costs really are costs and not perks the rest of us have to buy using our after-tax income.

When the Montreal Canadiens moved from the Forum to the Bell Centre in 1996, we seasonticket holders (as I was then) had to line up to choose our new seats. On the day of my appointment I was the only one there acting as a private citizen, so far as I could tell. Everyone else was buying their tickets through their companies, which of course meant they could be at least partly written off.

The second and more important thing wrong with the higher-risk argument is the presumption that if the government doesn’t subsidize risk-taking by looking the other way when small businesses pay their taxes, people won’t take risks. But the government is not the only subsidizer of risk. The market subsidizes risk, too.

If an activity is risky, and if most people don’t like risk, then the activity must offer a higherthan-average reward to persuade people to undertake it. If a risky and a non-risky activity both pay the same, all of us risk-averse folk will opt for the non-risky activity, there will be a shortage of applicants for the risky job and a glut over here in the long line of us chicken-hearted. Compensation will adjust to reflect that. Risky activities will end up paying higher returns than non-risky ones. It’s not obvious governments need go beyond this to encourage risk.

The business owners I know all drive nicer cars than I do, go on more expensive vacations and have generally sent their kids to spiffier schools.

This is anecdote, not data, but it has always seemed to me that in this respect the market has been working. They have taken higher risks in life than I have as a tenured professor and they have been rewarded accordingly.

A third point, to be technical, is that taxation of income produced by risk-taking activity actually reduces the income risk by cutting off the tails of the income possibilities involved. Business owners can’t fly as high as they might have because income tax trims their upside. But by the same token, so long as losses can be written off, the tax system also trims their possible downside. Taxation narrows the range of possible income outcomes.

If small-business owners make more money than I do, I have no problem with that. They do take risks I don’t (some of them do, anyway). But given their higher income, I don’t see why we both shouldn’t pay tax the same way.