The number of new businesses opening shop in Canada, as measured by the business entry-rate, has been declining over the past thirty years. And according to a new report published by the Fraser Institute, changes in the top personal income tax rates could be part of the problem.
“[E]ntrepreneurs pay significant taxes on all their incomes … However, when they incur a loss, the tax savings are quite limited,” wrote Ergete Ferede, _ associate professor of economics at MacEwan University and author of the report. “Consequently, higher personal income tax can be viewed as a tax on ‘success’ and may discourage entrepreneurial activity.”
Ferede noted that the federal government, as well as some provinces, has raised top marginal income tax rates and increased the progressivity of the personal income tax system. Those increases in top income taxes also cover earnings from entrepreneurship such as capital gains, effectively resulting in larger capital gains taxes.
To examine how progressive income taxation could affect entrepreneurship, the study used data from Canadian provinces covering the period 1984-2015 while controlling for factors that are deemed as important determinants of entrepreneurship.
Based on the results, Ferede said, increasing the top statutory marginal income tax rate by 1% leads to a 0.06 percentage-point decrease in the business entry rate in the short-term, and a 0.21 decrease in the long-term. The decrease in new businesses ranges from 14 in Prince Edward Island to 696 in Ontario.
“Notably, in recent years, many provinces have raised their top personal income tax rates—Alberta raised its top rate by five percentage points, Ontario raised its top rate by 3.1 percentage points, and BC raised its top rate by 2.1 points,” he wrote. “The federal government’s recent four percentage point hike to its top rate will only serve to exacerbate the provincial increases.”
Based on the results, Ferede concluded that the negative effects of higher income tax rates outweigh the tax-planning opportunities that entrepreneurs may have access to. To spur new business formation, which is associated with productivity and employment growth, he said Canadian governments can cut their personal income tax rates.
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