Trudeau’s tax hit to small business

When I was an undergraduate studying t ax policy, I remember John Bulloch’s vicious attack on Pierre Elliott Trudeau’s tax reform package, which was particularly threatening to small businesses and investors. Bulloch, head of the Canadian Federation of Independent Business, was successful in paring back proposals that would have squeezed many Canadian entrepreneurs hard. As a result, the CFIB developed a very large membership and became one of the most powerful advocacy groups in Ottawa.

Dan Kelly, the current head of the CFIB, has a difficult challenge on his hand with Trudeau II, whose upcoming budget promises to curtail tax “loopholes” that encourage professionals and businesspeople to avoid personal income taxes by creating small corporations. With proposed CPP expansion, the introduction of Ontario’s pension plan and municipal business- property- tax increases, Kelly and his membership face a storm of cost increases brought on by taxhappy governments.

Actually, there is another whammy that has already hit small-business owners without sufficient comment: the Trudeau four- point hike in the top personal income tax rates. While Trudeau promises to deliver Harper’s proposed small-business corporate rate cut from 11 to nine per cent on up to $500,000 in profits, he has already raised 2016 personal taxes on profits in excess of $200,000 derived by owners from their corporations.

These personal tax hikes more than swamp the advantages of the corporate tax cuts on new investments. As shown in the nearby table based on my recent work with V. B. Venkatachalam, the effective tax rate on new investment rises one percentage point for Canada as a whole, with the largest increase in Alberta due to the Notley NDP’s simultaneous personal tax hikes. Small businesses are generally taxed more highly on their investments in most provinces in 2016 except British Columbia and New Brunswick, which reduced their own top personal tax rates (New Brunswick was reversing its ill- advised personal tax increase in the previous year).

Kelly should be concerned as his membership is now taxed more heavily in 2016 than in 2015.

None of this is good news for economic growth. Startups generate many jobs and potential innovations that can have lasting effects on the economy. The recent mess- up in tax policy that sees higher federal marginal tax rates could be compounded by poorly thoughtthrough policies such as a proposed full taxation of stock options (which at least the Liberals now are reportedly wisely reconsidering).

In the past I have been critical of some incentives that impede small- business growth, particularly the excessively low small-business tax rate, especially at the provincial level. When a small business grows to become a large firm, it becomes more heavily taxed. To avoid growth in high- taxed profits beyond $ 500,000, many small businesses pass out income as highly taxed wages and salaries, interest or royalties to owners. Whatever strategy is used, growing small businesses are zapped by higher taxes if they succeed.

A s mart government would have not increased the top personal tax rates, which stultify the incentive to invest, work and take on risks. Instead, it would have cleaned up the tax system to reduce tax rates, complexity and distortions. A single corporate income tax rate on large and small business would be hugely successful in improving the tax system, allowing Canada to simplify its now highly complex dividend-tax-credit regime. This would tilt back the tax wall i mpeding small- business growth.

Now, this proposal would draw Dan Kelly’s ire, since it sounds like another hit on small business. However, what would make more sense for small businesses are incentives that encourage their growth by flattening tax walls rather than making them more steep. Various studies have shown that Canada’s economic growth has been hurt by policies that inhibit growth as firms have less incentive to grow.

The U. K. has introduced 100 per cent tax depreciation for capital up to roughly $ 1 million in expenditure when it pushed its top corporate rate down to the small business rate. Expending capital benefits small businesses without hurting growth since the incentive is provided even when the small fish becomes a whale.

The U. S. provides a capital-gains tax cut to owners of small- business shares going public for the first time. This type of incentive clearly encourages growth rather than curtails it.

Some smarter ideas could also be considered. One possibility is moving to a low, flat tax on dividends, capital gains and corporate income, as found in Scandinavia and some other European countries.

The point is that Canada needs to revamp its treatment of small businesses to create incentives to grow rather than stay small. Right now, the federal government is on the wrong track; it needs to focus on what makes economies tick.

THESE HIKES MORE THAN SWAMP THE ADVANTAGES OF THE CORPORATE TAX CUTS ON NEW INVESTMENTS.