The policy of using preferential small-business tax rates could actually stifle the economy
To encourage entrepreneurial financing and activity, the best move for Canada would be to eliminate or at least lower its tax rate on capital gains.
That was the idea put forth in a recent book published by the Fraser Institute. One chapter, titled Financial Markets, Laws, and Entrepreneurship, sheds some light on the issues that weigh on Canada’s competitiveness for small businesses.
“Governments across Canada have tried all sorts of different policies to encourage small business financing and entrepreneurship, but the best policy lever at government’s disposal is lowering the capital gains tax rate,” said Douglas Cumming, professor of finance and entrepreneurship at York University’s Schulich School of Business and co-author of the chapter, in a statement.
The chapter notes the absence of capital gains taxes in several developed countries including New Zealand, Switzerland, and Belgium. Other countries such as Australia, Britain, Germany, and Japan still levy capital-gains taxes, but at a lower rate than Canada; as of 2015/16, the country’s top personal marginal capital gains tax rate stood at 26.5%, topping the OECD average of 25.5%.
The chapter also highlighted numerous troubling aspects of capital-gains taxes. Aside from being a form of double taxation, they usually don’t allow adjustments for inflation, opening the door to taxes on properties that get sold for no real gains in value. The levy can also be avoided by entrepreneurs who choose not to sell, creating a “lock-in” effect that hinders the overall economy.
Cummings’ work finds that the preferential tax rate for small businesses does not encourage entrepreneurship. In fact, it could act as a barrier for small business growth into medium and large businesses, particularly as entrepreneurs seek to avoid the associated tax increase.
Another vehicle for entrepreneurship, labour-sponsored venture capital corporations (LSVCC), has been reintroduced by the current federal government. But according to the Fraser Institute, LSVCCs are largely harnessed for their generous tax credits, and they often fail to deliver financing to entrepreneurs.
“With the rate of small business startups on the decline and venture capital near anemic levels, Ottawa and the provinces should lower capital gains tax rates to improve entrepreneurial finance,” Cumming said.