Mintz is Right on “Small” Business Tax

One of my main undertakings on this blog has been to debunk Jack Mintz’s relentless advocacy of tax cuts for large corporations. However, I also give him credit when he proposes good policy, such as raising potash royalties and the small-business corporate tax rate. This past week, he was out with a paper on the latter subject.

The small-business deduction provides a federal corporate tax rate of 11%, compared to a general rate of 15% by next year. All provinces and territories except Quebec have small-business rates of 5% or less, compared to general rates of 10% or more.

These small-business rates apply to the first $500,000 of annual profit collected by any Canadian-controlled private company with assets under $10 million. For provincial taxes in Nova Scotia and Manitoba, the profit threshold is $400,000. The small-business deduction is phased out between $10 million and $15 million of assets.

Problems

The Tax Expenditures and Evaluations projected that the lower rate for small business reduced federal corporate tax revenues by $4 billion in 2010, when it was 7% below the general rate (i.e. 18% versus 11%). Since the difference will be only 4% next year, the cost should be closer to $2 billion. Provincial governments also lose about that amount.

Beyond this significant loss of corporate tax revenue, Mintz and co-author Duanjie Chen identify the following problems with the small-business deduction:

First, it could result in the breakup of companies into smaller, less efficient-sized units in order to take advantage of tax benefits even if there are economic gains to growing in size. Second, it could encourage individuals to create small corporations in order to reduce their personal tax liabilities rather than grow companies. And third, it could lead to a “threshold effect” that holds back small business from growing beyond the official definition of “smallness” . . .

I have written before about the second point. Although the paper does not elaborate on it, Mintz deployed this point against the NDP during the federal election.

However, it is important to put the NDP platform in perspective. It proposed to raise the general corporate tax rate to 19.5%, increasing annual revenue by $9 billion.

It also proposed to lower the small-business rate to 9%, which would reduce annual corporate tax revenue by $1 billion and might also allow high-income professionals to avoid slightly more personal tax. Still, the NDP platform constitutes a huge improvement over the status quo for those of us concerned about fiscal capacity to fund public services.

The paper mostly focuses on a “taxation wall” deterring business growth beyond tax thresholds, a concern that may be overstated. But tax preferences for small businesses do create an artificial incentive for large enterprises to contract out functions to smaller firms and for investors to create new firms rather than expanding ones that already have $500,000 of profits and/or $10 million of assets.

Mintz and Chen reasonably object that this incentive reduces efficiency and productivity. I would add that, on average, smaller employers pay lower wages, provide fewer benefits and are harder to unionize.

Solutions

I support the paper’s calls for “eliminating the small-business deduction” and “abolition of the lifetime capital gains exemption.”

I am less keen on its proposed substitutes: expensing the first $70,000 of annual capital spending by all corporations, lower capital gains tax on shares issued when a small business goes public, and deferral of tax on capital gains from small business shares reinvested in other assets. Mintz and Chen offer no cost estimates for these recommendations.

Expensing $70,000 of capital spending would encourage investment by very small corporations and would not cost much for larger ones that invest far more anyway. Reducing capital-gains tax on initial public offerings does not seem useful, but could at least be fairly inexpensive.

The third proposal is clearly the thin edge of the wedge toward unlimited deferral of capital-gains tax, which would be quite costly and regressive. As the paper notes, “While we would suggest developing the capital gains deferral account to apply widely to all investors, it could be limited to owners of smaller public and private corporations on a limited basis to reduce the fiscal cost of the incentive.”

It’s worth recognizing that there is a strong political consensus across all parties in favour of the small-business deduction. This consensus is motivated by a desire to help genuinely small, local businesses.

However, as currently structured, the small-business deduction provides tax breaks to privately-held companies with assets up to $15 million on profits up to $500,000 per year. This profit threshold used to be a more reasonable $200,000. Mintz and Chen argue that raising it was “unjustified,” but do not explicitly propose to cut it back.

But if we cannot eliminate the small-business deduction, we should at least limit its fiscal cost and focus it on truly small businesses by reducing the profit and/or asset thresholds below which it applies. The federal NDP would be well-positioned to advance such a proposal given that the NDP provincial governments are the only two that did not go along with Ottawa’s latest boosting of the profit threshold from $400,000 to $500,000.

5 comments

  • My thinking has been modified by hearing Nasim Taleb talk about building “antifragility” into our economies. Many small companies being less fragile than a few big companies.

  • John Loukidelis

    “But tax preferences for small businesses do create an artificial incentive for large enterprises to contract out functions to smaller firms” Or for large enterprises like McDonald’s to “franchise out” those functions.

  • Two arguments that you didn’t address: First, all corporations enjoy limited liability, and in part the corporate tax is in payment for that. Small companies are less likely to need to use (or “hide behind”) that government-granted license.

    Second, corporate profits become someone’s income and will be taxed as personal income, but our system can’t track those connections easily because often the shareholder lives in another jurisdiction and enjoys loopholes and havens. This is more of an issue for large corporations than for small ones, who tend to be sole proprietorships and whose income gets taxed as normal in the same jurisdiction as the business is licensed in. (I don’t have evidence for this, just a contention.)

  • Denise Freedman

    I always wonder at the required INDIRECTNESS of job creation as the criterion for being considered SERIOUS and ADULT in these discussions.

    It has been accepted on this blog, certainly in the wake of Jim Stanford’s study, that corporate tax cuts do not create jobs–either in boom times or recession.

    At the recent Canadian Economics Association meeting in Ottawa Armine Yalnizyan presented statistics, not particularly novel, that income in the 1st, 2nd and 3rd quintiles has not recovered from its collapse in 1993, so I am not convinced that even when there is a RATIONAL reason (businesses big and small are, of course, RATIONAL) for business to expand and create jobs they will actually do it.

    Even with the neoliberal bribe of tax cuts.

    I was not happy with the NDP’s proposal of tax cuts.

    As we see the immanent cuts in federal government jobs, in addition to the ongoing restructuring of the overall economy, including the disappearance of manufacturing jobs, where will be the net aggregate demand that businesses big and small will RATIONALLY respond to come from?

    How effective has such neoliberal/neoconservative tax policy ever actually been?

    I am neither ADULT nor SERIOUS.

    The only policy that will work is direct job creation.

    But then, I’m not an economist; my concern is not with the abstract notion of an economy, but with the actual, living, breathing people who make up my country.

    If progressive economists, in hope of being taken seriously, buy into policies that have not worked, that RATIONALLY cannot, I mourn for the future of my country.

  • Lorna Schiralli

    I am an actuary. We have professional standards. We are obliged to correct any misuse of our work and to correct any errors in our work when brought to our attention. I have challenged D. Mintz on his article May 4, 2015 in the Financial Post. Althought he has admitted his error to me, he refuses to issue a correction. But his misstatements have been used in the CPC promotional material to imply that the LPC party has increased the marginal tax for families earning over $45,000. I have subsequently checked on his recent article on expanding the cpp and am bafflegabbed by what he is attempting to convey. This man is a dangerous academic who likes the sound of his voice and promotes junk science. He needs to be exposed for what he is.

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