May 20, 2015 – Small business tax breaks do not create significant barriers to growth, but they still come with a high cost, says a report released today by the C.D. Howe Institute. In “Small Business Preferences as a Barrier to Growth: Not so Tall After All,” authors Benjamin Dachis and John Lester conclude that the tax breaks harm economic performance by encouraging the entry of more small firms, which are less productive than larger firms.
The authors make use of newly available tax data for individual firms to investigate the effect of the tax wall companies face as they grow. Dachis and Lester assess the two major federal programs: the Small Business Deduction (SBD), which provides small business a special lower income tax rate, and the enhanced Scientific Research and Experimental Development (SR&ED) investment tax credit, which provides a higher subsidy for R&D undertaken by small firms. These programs could be discouraging growth because firms have to stay small to receive benefits.
“The SR&ED thresholds are set high enough that their impact on investment decisions is negligible,” says Dachis. “Similarly, while the SBD thresholds affect more firms, that program has only a minor impact on the growth of small businesses,” he adds.
“Nevertheless, such support for small business has a social cost,” according to Lester. “The largest cost arises from the fact that the government must recoup forgone tax revenue by cutting spending or imposing higher taxes elsewhere.” If the alternative to the SBD is a lower general corporate income tax rate, the net impact of the SBD will be an expansion of the small business sector at the expense of large businesses. “Since small firms are less productive than large firms, overall economic performance suffers as a result of the SBD.”
The report concludes that the SBD is achieving its objective of allowing small business to finance more investment internally and it is inducing more investment by small firms. However, the adverse effects of raising taxes to finance the subsidy and the lower relative productivity of small firms are important obstacles to realizing a net social benefit from the subsidy. “Canada’s real income would be higher if governments reduced or eliminated the small-business tax advantage and used the savings to lower the general corporate income tax rate,” say the authors.
Click here for the report and accompanying appendix.
The C. D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. It is Canada’s trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review. It is considered by many to be Canada’s most influential think tank.
For more information contact: John Lester, Executive Fellow, School of Public Policy at the University of Calgary; or Benjamin Dachis, Senior Policy Analyst, C.D. Howe Institute; 416-865-1904, or email: amcbrien@cdhowe.org.