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by Daniel Gloade on June 15, 2015

As you know, I every second week I try to write about being a small business owner in Kitchener-Waterloo.  This week, in stead of focusing on the Waterloo Region, I would like to focus on small business in Canada generally.

The C.D. Howe Institute drafted a report titled: “Small Business Practices as a Barrier to Growth: Not so Tall After All”.  The report is written by Benjamin Dachis and John Lester.

The article starts by saying that Small Businesses have tax breaks not available to larger corporations.  One is the Small Business Deduction.  The other is the Scientific Research and Experimental Development (SR&ED) investment tax credit.

The fear is that tax incentives to small business creates a disincentive for businesses to grow.  Businesses will either keep their incomes small or not invest in assets in order to retain the Small Business Deduction.  The report writers argue, however, that both the threshold for losing the tax breaks are sufficiently high and the financial benefits of the tax breaks are sufficiently small that the Small Business Deduction only affects a small number of firms.

Dachis and Lester argue, however, that the Canadian and provincial governments should remove these tax incentives anyway because the costs of the program are two high.  The writers assume that a higher corporate tax rate finances the Small Business Deduction They argue that the higher tax corporate tax rate creates an incentive for investors to invest in foreign businesses.

The main cost of the Small Business Deduction, however, is reduced productivity.  According to research, workers in small firms are far less productive than in large firms.  The evidence is seen in the paper: “Canada–United States Labour Productivity Gap Across Firm Size Classes” by John R. Baldwin, Danny Leung, and Luke Rispoli 

This labour paper compared the United States and Canada.  It notes that in both the U.S. and Canada small business labour was more inefficient than labour in large corporations.  Canadian small business labour was more inefficient that the American counterpart, however.  To compound the problem, a larger share of Canada’s GDP consists of small business.  This labour paper concludes that small business disadvantage goes a long way to explain the different productivity numbers between Canada and the United States.

I’m not entirely convinced, however.

First, with regard to the tax rate.  Tax incentives may be necessary to generate small business in Canada.  A flat rate corporate tax rate may not be a good idea.  Small businesses and start-ups often have low liquidity.  They need a tax break more that the larger, established corporate counterparts.  Put another way, 17% of your revenues going to taxes has a much larger impact on your behaviour if you are small business owner than if you are part of a large corporation.

Regarding the labour argument, the workers are more efficient in large corporations often because of economies of scale.   Larger companies get more investment in labour-saving devices.  The workers in the factory floor or stringing cable for telecoms are far more efficient because they can specialize in specific tasks.

Even with a lower tax bracket, however, there are still large barriers for large corporations in Canada.  The first Canada’s small population.  The second is the declining manufacturing sector in all of North America.  I feel that eliminating the small business tax incentives would harm those businesses that are generating new jobs, especially when the labour market is so barren.

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