Is the government's small-business tax cut a flawed incentive?

While a relief for small-business owners, the measure could have bigger repercussions

Is the government's small-business tax cut a flawed incentive?
Business owners incensed over proposed tax changes for private corporations were soothed when the federal government confirmed it would reduce the small-business tax rate to 9% by 2019. However, one policy expert has spoken out against the measure.

“The objective of the SBD [small-business deduction] is to encourage business expansion and job creation by small and medium-sized businesses,” said Allan Lanthier, a former chair of the Canadian Tax Foundation, and a retired senior partner of Ernst & Young, in a commentary published by the Financial Post. “However, there is little evidence that the SBD contributes to this objective in any significant way.”

Declaring that the current differential between the highest personal income tax rate and the SBD rate for Canadian corporations is “already much too great,” Lanthier noted that the SBD is open to Canadian corporations that aim to grow, those that have no such interest, and high-income professionals who may incorporate solely to reap the tax benefits.

He also asserted that while many small-business owners do expend great effort, the SBD should encourage growth of small and medium-sized businesses. “But 700,000 CCPCs claim the SBD every year, whether their businesses are growing or not,” he said.

He cited a study by Duanjie Chen and Jack Mintz of the University of Calgary, which argues that the SBD may create a “taxation wall” that would discourage businesses from growing past a certain size. Given that, there would be more companies acting as smaller, less efficient-sized firms.

Lanthier noted that the SBD cuts down the federal tax rate on the first $500,000 of annual business income earned by a Canadian-controlled private corporation (CCPC); the federal government’s proposed reduction would cost it around $1 billion in annual revenue.

He added that other countries generally don’t have such concessions for small businesses. He cited the UK government, which repealed its small-business rate in 2015 to discourage individuals from “incorporating as small companies to avoid paying their due share of tax.” A general corporate-tax rate of 19% now applies to all UK corporations.

“Small businesses are critical to job creation and economic growth in Canada,” he said. “It is precisely because they are so critical that tax incentives must be as targeted and effective as possible. The small-business rate is neither.”

Lanthier also questioned the degree to which the proposed rate cut would benefit small-business owners. The government has suggested the rate reduction would help fund a kitchen upgrade for a small-restaurant owner with four employees and business revenues totalling $30,000 annually. But according to Lanthier, that person would save only $450 from the reduction.

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