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The dubious policy of small-business tax breaks

No one likes paying taxes. That's a given.

Many Canadians also want the federal government to stop spending more than it collects in revenue.

The Canadian Federation of Independent Business wants both this holiday season: lower taxes and deficit reduction. During a recent round of pre-budget consultations, the powerful business lobby urged Ottawa to stick to its current target of wiping out the deficit by 2016.

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It just doesn't want its members to bear any of the burden for getting there.

In comments filed with the House of Commons finance committee, the CFIB outlined a series of targeted tax breaks for small businesses that it wants to see in the next budget. These include a gradual reduction in the small business tax rate and the reinstatement of a tax break for acquiring new technology.

The CFIB is also seeking another extension of the hiring credit for small business. Finance Minister Jim Flaherty introduced the credit in the 2011 budget as a one-time measure to help small businesses absorb a premium hike in employment insurance. The credit gave small employers up to $1,000 if their total EI premiums were higher in 2011 than 2010.

The tax break was extended for another year in March's budget after lobbying by the CFIB. Now the group wants it to remain in place as long as EI premiums are on an upward trajectory.

The credit isn't breaking the federal bank. But it's not inconsequential for a government struggling mightily to eliminate a deficit. The credit cost Ottawa $165-million in 2011 and an estimated $205-million this year.

Mr. Flaherty has vigorously defended the expense. In his March budget speech, he called the credit "a practical, proven measure which encourages businesses to hire more workers."

Notice he doesn't say the credit rewards companies that actually hire more workers. That's because businesses don't have to hire a single worker to earn the credit. An employer must simply pay more in premiums than the previous year. So the job-creation potential is purely theoretical.

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Before another extension is granted, Ottawa should get some assurance that small businesses are actually using the hiring credit to add jobs. Who's to say most aren't just pocketing the $1,000?

The more significant question for Ottawa to ponder is whether it really wants to stay locked in to the notion that smaller businesses should always pay lower taxes than larger ones.

Ottawa has cut the overall corporate tax rate to 15 per cent from 21 per cent since 2006, when the Conservative government came to power. That compares with a federal rate for small businesses (income of less than $500,000 a year) of 11 per cent.

The rate differential is just one of the benefits of being small that's imbedded in the tax system. Small companies also earn a heftier credit on the money they spend on research – 35 per cent, compared with 20 per cent for large companies – and it's refundable.

The CFIB complains in its comments to the finance committee that lowering the overall business tax rate is bad for its members because it has eroded the "value" of the lower small business tax rate. So the group wants Ottawa to cut the 11-per-cent small business rate even more.

Mr. Flaherty should think long and hard before bowing to this latest demand by the CFIB.

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There's a compelling case to made that lower tax rates for small businesses reward companies for being small, and may actually discourage them from getting bigger. Don Drummond, the former Toronto-Dominion Bank chief economist and federal finance official, has long complained of an unusual clustering of Canadian companies just below the income threshold where the higher tax rate kicks in.

Staying small to get the lower tax rate makes no sense. But the evidence suggests many companies do it anyway.

Tax breaks for small companies are politically seductive. Small businesses are everywhere and they are major employers in the economy.

But these breaks are dubious public policy.

The tax regime should reward growth, not size. Fast-growing companies drive the economy. They are also more likely than smaller companies to do the kinds of things that the best-performing corporations do – including exporting, investing in R&D, and hiring more Canadians.

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More


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