Ottawa keeps telling us that its proposed reforms to the small-business tax rules are about fairness – making sure the rich pay their fair share. While that fits with the government's overworn looking-out-for-the-middle-class mantra, there's a much bigger economic concern at the core of this issue. It's a piece of the most crucial economic challenge this government faces. Getting this right could be a step to securing our long-term economic health.
At its heart, these reforms are about revitalizing this country's productivity growth.
Unlocking productivity is one of the enduring riddles of the Canadian economy, but it has become a more pressing issue as the population ages. As growth in the number of working-age Canadians slows to a crawl, that severely limits the economy's capacity to produce more goods and services – to grow. We're not going to be able to do much about this demographic slowdown in labour growth, it's inevitable.
Unless we can increase productivity – that is, find ways to produce more per worker – we are destined for a long era of stunted economic growth that threatens to erode Canadians' standard of living.
This government is staring this problem in the face, and much of its economic strategy since it took office two years ago must be viewed through this lens. This is the impetus behind its massive commitment to infrastructure investment in its first budget, and its focus on skills training and innovation in its second budget. These are all components to giving the economy the means to be more productive.
This is what Finance Minister Bill Morneau was getting at when he sat down with The Globe's editorial board last week. The goal of the tax changes, he indicated, was to encourage small-business owners to invest the hundreds of billions of dollars they collectively have sitting on their balance sheets into expanding their businesses and creating jobs – investments that could fuel significant additional economic growth.
Of course, he used the term "dead money," which gave small-business owners already upset at him a whole new reason to be upset with a minister who had already painted many of them (intentionally or not) as a bunch of unrepentant tax-avoiders. They don't see money invested passively through their companies to secure their family's financial future, to save for retirement, as "dead."
But this gets at the root of the debate about these tax changes. Many small-business owners see the current tax rules as compensation for the risks and sacrifices they make to be entrepreneurs; for their troubles, the small-business tax breaks allow them to keep more of the money the business earns. But the low tax rates afforded small businesses – 14.4 per cent, combined federally and provincially, on average, compared with a top marginal personal income tax rate of more than 50 per cent – weren't intended for this. They were supposed to keep more money in small businesses to fuel investment and growth. And the evidence suggests that under the current structure, it's not working.
This lack of investment and growth was the focus of a speech this week by Sylvain Leduc, deputy governor at the Bank of Canada. Mr. Leduc noted the unsettling decline in "business dynamism" in recent years. Both the rate of creation of new businesses and the creation of jobs by new firms is down significantly over the past decade.
It's striking that this has come during an era of progressively lower corporate tax rates in this country. It has also come as tax planners have grown increasingly adept at using the small-corporation tax rules to minimize the tax bills of their clients, particularly in professional fields such as doctors and lawyers. It appears these tax breaks, taken together, haven't created the incentive for investment, innovation and growth at all. Given the demographic headwinds Canada's economy faces in the coming years, this needs fixing.
But to say that this economic message has been muddled by the government would be an understatement. The government preferred to make this about getting rich business owners to stop using small-business loopholes to dodge the tax man. Maybe it thought the productivity argument was too complicated to explain to the average middle-class voter; it's easier to just repeat its go-to "it's all about the middle class" message over and over again.
It's abundantly clear that this amounted to a colossal communications failure that has divided and alienated voters – rich versus middle class, entrepreneurs versus employees. The government has ignited a tempest that has largely overlooked the more compelling economic imperative behind trying to get the small-business tax structure back to what we collectively, as a country, really need it to do – create incentives for small businesses to invest in growth and productivity.
By the same token, this also suggests that the issue is bigger than merely shutting down some tax breaks that have made it more attractive to some small-business owners to use the corporate structure to hold their retirement savings and make payouts to their families. Indeed, many economists agree with the principles behind the government's tax proposals, but they aren't convinced that the plan is the best way to address it.
The government needs to go back to the drawing board on small-business incentives, to find a structure that will meet the country's increasingly pressing productivity needs. If this is the long-term economic challenge our government needs to solve, let's take the time to get it right.