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Editorials Globe editorial: On small business taxes, the Liberals are mostly right – in theory

In a perfect world, there would be no tax accountants, no tax lawyers and no tax minimization strategies. That's because the theoretically perfect tax code – not something we'll ever see, but bear with us – would be simple, clear compact and without contradictions. It would leave so little room for argument over how much tax each of us owed, that all of Canada's highly-trained and compensated tax professionals would be left searching for other employment. There'd be no tax work left for them.

In the theoretically perfect tax system, there would be no experts offering to guide you to low-tax nirvana, through the system's maze of dark and secret passageways. The perfect tax code would have none. Nor could your local tax shaman magically transubstantiate earnings into dividends, capital gains or income for a spouse or child. The theoretically perfect tax code would offer no such opportunities.

Which brings us to the Trudeau government's proposed changes to the tax code.

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Does Ottawa's plan simplify and clarify the code, removing opportunities to game it? Does it eliminate unintended tax benefits that came about as accidental byproducts of the tax system's competing goals and extreme complexity? Are the Liberals making an imperfect system a tiny bit less imperfect? In theory, yes. But the details of how they put it all into practice will tell the tale.

The government's contention is that a relatively small number of Canadians are taking advantage of a structure known as a Canadian Controlled Private Corporation (CCPC). And on the evidence, the government has a point.

Incorporation exists to allow companies to operate as legal entities distinct from their owners, limiting the latter's legal and financial liability. There are many good reasons for someone to incorporate; tax reduction isn't supposed to be among them. Your taxes shouldn't be lower simply by virtue of signing papers changing your legal structure from J. Smith, Sole Proprietor, to J. Smith, Inc.

However, it appears that's exactly what a good number of Canadians, generally with incomes well-above average, are doing. All things considered, you can't blame them. If our complex tax code offers entirely legal tax-saving opportunities, people are going to take advantage of them.

Family doctors have been the most vocal about Ottawa's proposed changes. According to economist Michael Wolfson, whose 2016 study on CCPCs appears to form the basis of much of the government's policy, the number of incorporated doctor businesses in Ontario has grown from fewer than 1,500 in 2004 to 20,000 today. The reason isn't hard to find: A little over a decade ago, Ontario's provincial government allowed and even encouraged many doctors to incorporate. A cash-strapped Queen's Park didn't want to pay physicians more money, so instead it gave them a vehicle to pay Ottawa less tax.

The tax system is often used to encourage certain types of behaviour. Anyone who saves for retirement can enjoy the tax breaks available through RRSPs and TFSAs, for example. But a family physician who just created a CCPC isn't practising medicine any differently than she was yesterday, when she was an unincorporated sole proprietor. Yet the corporation structure opens the door to all sorts of tax-lowering strategies, from "income sprinkling" to a spouse and children, to transforming some earned income into lower-taxed dividends or capital gains.

In a perfect tax system, or at least a better one, these kinds of artificial tax advantages wouldn't exist. But they do, which is why anyone currently using them is complaining, loudly. The government may not be calling this a tax increase, but for some Canadians – and yes, most of them make more than the average annual income of roughly $50,000 – it's going to feel like one.

Nevertheless, the Liberal government has a strong case in favour of restricting how CCPC are used. But at the same time, critics who worry that a sloppy or rushed reform could usher in new types of unfairness are not wrong. The government should be listening.

For example, the Liberals want to discourage people from creating tax-sheltered investment accounts inside their CCPCs. Fair enough. But as critics have pointed out, Ottawa's plan, rather than simply levelling the tax playing field, appears to involve imposing prohibitively high taxes on money appreciating inside a corporation.

And new rules to discourage income sprinkling are so complex as to threaten more uncertainty and costs for taxpayers and tax auditors. (And possibly create even more work for tax litigators and accountants. How's that a good thing?)

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The government's case is strongest when it argues that it is closing unintended loopholes within the tax system. But it has to be careful that, in rushing to fill those holes, it does not create new forms of tax injustice and excessive complexity. That Ottawa launched its consultation on these changes in the dead of summer, and aims to wrap them up in a few weeks, is cause for worry. Slow down. If it's worth doing, it's worth doing cautiously.

The last time the Liberals promised to raise taxes on upper-income earners was during the 2015 election. The plan helped them to win. That's because it wasn't just about whacking the rich. Instead, a tax increase in the top bracket was used to help fund a tax cut for almost everyone else.

This latest proposal would be a lot more politically saleable if what is effectively another tax hike on some high-end earners were used to finance even a small cut to the middle-class tax bracket. In 2015, that was the winning pitch.

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