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Not all small businesses deserve a tax break

Nadezda Bugaeva/Nadezda Bugaeva/iStockphoto

As part of the NDP job creation plan, Jack Layton has promised to lower the corporate income tax rate on small businesses from 11 per cent to 9 per cent, justified on the grounds that small businesses are more likely to create new jobs than larger ones. Unfortunately, the plan is based on a false premise and will likely do little more than put more money in the pockets of wealthy Canadians.

The idea that small businesses create more jobs than larger ones is commonly held, but it is misleading.

In a recent NBER study, three U.S. economists found that there is no relationship at all between firm size and job creation, once you take into account the age of the firm. It is not small firms that create new jobs, rather it is young firms. They find that there is an "up or out" dynamic with young firms -- most either expand quickly or go out of business.

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Due to this effect, young firms face much higher rates of both job growth and job destruction than mature firms. The statistical relationship between small firms and job growth is due solely to the fact that younger firms tend to be smaller; a 15-year old firm with three employees is not likely to be creating many jobs any time soon.

If we are to use corporate tax rates as a tool to create jobs, a more targeted approach would be to lower the tax rate on new businesses, rather than on small businesses. Though it is not clear this would be the best approach either, as changes in corporate tax rates are not the most effective tool to use in job creation.

We need to also consider that many self-employed higher-income Canadians self-incorporate as a way to reduce their tax bill. The Canada Revenue Agency (CRA) does have some rules in place which deter this (such as making 'personal service businesses' exempt from the small business rate), but there are plenty of scenarios that do not violate the CRA's rules, and when the rules are being violated the CRA cannot possibly catch them all.

There is not a lot of evidence to suggest cutting the small business rate will create many jobs. It is clear, however, that it would provide a generous tax break to the wealthiest 1 per cent of the population -- a self-incorporated person making $400,000 a year would receive an $8,000 tax cut. This has to be considered more than a little ironic, as it is hard to imagine too many of those people being NDP voters in the first place.

Mike Moffatt is a chemical industry consultant and a Lecturer in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business

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About the Author

Mike Moffatt is an Assistant Professor in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business – Western University. Mike also does private sector consulting for the chemical industry. More

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