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Article Excerpt
Economic dynamism--the combination of entrepreneurial drive and the economic institutions that channel it--is the hallmark of modem, successful economies. Having the right financial, fiscal and regulatory frameworks in place to ensure that businesses with the greatest potential are identified and nurtured is an essential element of facilitating overall growth. However, in Canada there exists a series of tax and regulatory policies aimed at improving the prospects of small businesses that may, in fact, be adversely affecting economic dynamism. These policies create incentives for firms to stay small and punish those that try to grow into large, successful businesses that are competitive at the international level.
Small businesses face many hardships simply because they are small. Natural economies of scale and scope dictate that the costs of tax and regulatory compliance are higher for smaller businesses. They also face reduced access to financing due to greater volatility in their performance and high failure rates. Raising capital is more expensive because of higher interest rates on loans and lower prices for equity issues (TCBT 1997).
In an effort to provide relief to small businesses and to allow them to be competitive despite their size, Ottawa and the provinces have instituted a preferential tax system. Numerous favourable tax exemptions, credits and deductions exist to help small business focus on growth rather than survival. However, while it is important to create an environment that allows small business to succeed, the current preferential tax scheme can have negative effects on aggregate growth within the overall economy.
As firms grow, they lose their small business benefits as their asset, employment and income levels surpass certain thresholds. As a result, the same incentives can both discourage and inhibit growth as preferential treatment creates an incentive to stay small. Adding to this problem is the fact that there are several regulatory policies that apply selectively to larger firms, affecting small firms' production choices and growth prospects.
Economic policy should aim to find the right balance between what are sometimes competing objectives: ensuring the competitiveness of small businesses and the facilitation of overall economic growth through smaller enterprises becoming larger, successful firms that compete at the international level.
The first part of this Commentary highlights some of the current tax and regulatory policies that affect small business growth and examine how they influence behaviour and innovative activity. The second section provides a series of policy recommendations aimed at encouraging further growth within the Canadian small business sector including:
* Instituting a flat, federal corporate income tax rate of 13 percent that applies to all businesses, regardless of their size.
* Eliminating the capital tax in all provinces.
* Increasing the scope of investors who can access the capital gains rollover exemption for investment in small business.
* Adjusting collective dismissal laws to ensure that they apply only to larger businesses, giving smaller firms the flexibility to take on new projects and employees without becoming subject to collective dismissal liabilities.
* Making health and safety committees voluntary for industries that are deemed low-risk and making them mandatory, but with reduced scope, for medium-risk industries while maintaining the status quo for high-risk industries.
Defining Terms: How Small is Small?
It is important to begin by defining what is meant by the term "small business." Firms are often categorized in terms of their operating revenues, annual sales and shipments, number of employees, total remuneration or output levels. For the purposes of this Commentary, a small business meets at least one of the following conditions: it has fewer than 100 employees, it has less than $10 million in taxable capital, or it has less than $1 million in annual payroll.
[FIGURE 1 OMITTED]
Because the tax and regulatory policies addressed below apply selectively when a firm's income, assets, number of employees or employee remuneration fall below certain thresholds, any definition of a small business based on one characteristic is unsatisfactory. Nevertheless, the tax and regulatory policies outlined below were designed specifically to help small businesses, and the definition of a small business provided herein encompasses these policies.
In general, businesses with fewer than 100 employees make up more than 99 percent of all employer businesses in Canada (1) and account for almost 50 percent of all private sector employment (Industry Canada 2008). They also make a significant contribution to the net growth in private sector paid employment. However, it is important to note that most of this growth was due to a sub-group of small enterprises known as hyper- and strong-growth businesses. (2) Outside of this sub-group, the majority of small businesses are not looking to expand. One study found that only 40 percent of small business owners are interested in growth, while the rest are content to stay small (Tal 2006). Therefore, any policy aimed at improving the growth prospects of small businesses must take this into account.
Given the right tax and regulatory policies, many small businesses can develop into large successful companies that are competitive at the international level. Why is this important? Larger businesses have many desirable characteristics for a healthy, robust economy. For example, larger firms are, in general, more productive than smaller businesses (Figure 1), they offer higher wages--beyond what their higher productivity would imply (3)--and provide more stable employment. Moreover, having a steady flow of new businesses rising to take the place of older companies is an important part of maintaining "creative destruction" in the upper echelons of Canadian business. (4)
[FIGURE 2 OMITTED]
Direct international comparisons are difficult, given differences in data collection and the definition of a business. Nevertheless, there is evidence to suggest that the distribution of businesses by firm size is skewed towards smaller businesses in Canada when compared to the United States. The US Census Bureau provides data on the size distribution for businesses in terms of firm and establishment, and neither definition of the business unit fits directly with the Statistics Canada definition of a business. (5) However, in comparing the Canadian data with US establishment data, it is clear that the Canadian economy has proportionately more small businesses than the US and, by the same metric, significantly fewer large (500+ employees) businesses (Figure 2). Is Canada a nation of small shopkeepers? The data is not entirely conclusive, but the Canadian system certainly discourages growth, an issue that policymakers call no longer afford to ignore.
Taxation
Economists argue that the resources smaller companies direct towards tax compliance are resources that could otherwise be used for reinvestment, facilitating future growth. Based on the belief that taxes, and a complex tax system, put disproportionate pressure on smaller businesses and that small businesses are an important part of the economy, a system of tax exemptions, credits and deductions exists in Canada to help small businesses become more competitive. Insofar as the preferential tax provisions have worked to promote a more favourable environment for small businesses--giving them reprieve from onerous tax requirements and allowing them to be competitive despite their size--they can be considered a success. Insofar as they have discouraged the retention of profits for increased internal investment, capital deepening and growth, they may be failing.
Tax provisions that provide targeted relief to smaller businesses create tax thresholds, which in turn create disincentives to growth, lest the subsidy be lost. Who benefits from the tax relief depends on the specific provision but, in general, they relate to asset, profit, employment or remuneration levels. Of particular interest, many of the...
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