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Caught between anger and indifference, Morneau faces real political test with tax changes

The Liberal government has been taking a beating on small-business tax changes. Now, Ottawa's counter-campaign to justify them is just beginning. And it is Finance Minister Bill Morneau's first real fight.

This Finance Minister has never been the centre of a sharp political controversy before. This time, he could get a bloody nose. But this is a test he is eager to take on, according to a source close to him.

So far, it has been nothing but headaches. His July 18 proposals for getting rid of tax strategies small-business owners use to pay less tax through private corporations led to a backlash from small-business groups and others. Liberal MPs are taken aback that influential constituents will not donate and are threatening to work to defeat them. Mr. Morneau has been the target of anger and personal insults.

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Read more: Liberals will not back down on small-business tax reform: Morneau

That is new: Until now, Mr. Morneau has been viewed as a colourless occupant of the second-most important office in the federal government. When he speaks, he rarely makes news. That started a narrative that he is a relatively uninfluential finance minister, even though his allies inside the Liberal government insist he is substantial behind the scenes, and had success in negotiations on pension reform and health transfers. This kind of political test could upend that perception – if he passes.

There is little doubt now the Liberals will go ahead, since Prime Minister Justin Trudeau said on Friday he would make "no apologies" for the plans. Tweaks are possible, but the political cost of reversing course is high. It is now Mr. Morneau's job to lead the campaign.

It is his campaign. The small-business tax changes were not dreamed up by Finance Department mandarins and dutifully approved by Mr. Morneau. This came straight out of the Liberal platform. Mr. Morneau might have been able to block it, as he killed the Liberal promise to curb deductions for stock options. But he did not.

He wanted this. He wants to take on the argument that if the government does not stop the use of private corporations for personal tax advantages, Canada will have a two-tier tax system – for incorporated business people and everybody else – and that the gap will grow bigger over time.

Some of the changes are small beer for the federal treasury. Blocking income sprinkling – paying dividends from a private corporation to spouses and adult children that do not work for the company – will raise federal revenue by only about $275-million a year.

But reducing the benefits of keeping a "passive" investment portfolio inside one's private corporation could raise $2-billion, depending on the still-undetermined details of how it is done, according to one government source. According to Finance Canada's consultation paper, those assets grew from $8.6-billion in 2002 to $28.6-billion in 2015. The tax advantage could grow rapidly.

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That is an argument for fairness, but it has big political downside: It takes money out of people's pockets, and those people are influential and angry. Small-business lobby groups and the Conservative opposition label it a tax grab – even if you believe in the "fairness" intentions of the policy, there is no denying it will raise revenue. Liberal government insiders are already hinting they are looking at potential tax breaks, either for small business or others, as a political counterweight.

But so far, Mr. Morneau is left making a case that this is only fair – but angering the people who really care. Maybe, as a well-to-do owner of a sizable business, he can give the impression that he is likely to have to make some financial sacrifice for this policy. But the real challenge is making ordinary Canadians who are unaffected by the small-business changes believe he is fighting their fight.

The Liberals' 2015 election promise to tax the 1 per cent was popular, but these changes are complex, and so far, most people do not care. Few groups are speaking up on the government's side, but there is an effort to find allies. Some in the Liberal government believe they can turn this issue into a political winner. But that is a big political test for Mr. Morneau.

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