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Business Commentary David Rosenberg: Small-business tax changes could tip economy into recession

If I had a wish list from the federal government, the focus of it would be squarely on measures that will enhance domestic competitiveness, and to refrain from initiatives that will curb profitable and job-creating investment such as the tax proposals that seemed to come out of thin air in mid-July. I fear that Ottawa may shoot itself in the foot on this score.

How can you claim to be the party of small business, to have made so much noise over the need to promote entrepreneurship, and then invoke changes to the tax system that will remove the tax incentives to actually take on the risk of being a small business operator?

The self-employed deserve better tax treatment because of the inherent risks they take on compared with an at-will worker, full stop. Comparing tax structures between the two is truly dangerous and making any rash changes, as seems likely, could very well tip the economy into recession. From what I see and hear, this is a very poorly thought-out strategy and one that can end up having far-reaching negative impacts. Keep in mind that the federal government seems intent on moving to a system that will level the playing field between small private businesses and the working class, something that is very rare around the world, and for good reason.

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Not all of the Liberal government policies are anti-growth, and I wholeheartedly supported the policies aimed at encouraging a freer inflow of entrepreneurial immigration into the country. But why then offset this with an increasingly unattractive tax structure? The problem as I see it is that Ottawa is far too consumed with distributing the economic pie rather than enticing the private sector to expand it. In the past five years, the top marginal personal income tax rate in Ontario has jumped from 48 per cent to 53.5 per cent.

And if the Finance Minister ends up carrying through with his pledged tax attack on the self-employed, I guarantee that all we will be left with is less economic activity, and therefore a more depleted revenue base, because companies that have mobility will pick up and leave and establish their operation in a friendlier policy climate.

Anything Ottawa does also has to be taken in the context of the Bank of Canada entering a new regime of higher interest rates, and coupled with that, a 13-per-cent surge in the Canadian dollar in the past several months. That will perhaps help pull down import costs, which is a positive, but will still be a shock to exports and a clear hit to our cost competitiveness.

Tack on the planned minimum wage hikes in Ontario (unbelievably, from $11.40/hour to $14 in January, 2018, and then to $15 by January, 2019, for a 32-per-cent increase), Alberta and B.C., and one can envisage some really tough times ahead for the small-business entrepreneur. This is the provincial government's way of helping out the low-end worker, but instead what happens is either less employment or higher prices, which then pinches real incomes and defeats the whole purpose – and again, a negative hit to profits in the small-business sector.

All this comes at a time when we have NAFTA uncertainties as well, not to mention an incoherent energy policy. (This is no time to be curbing pipeline expansion through stricter regulatory rules, when they are being eased south of the border, but that is exactly what is being done.) In coming months, we will also be feeling the effects from the Fed's shift to quantitative tapering south of the border, which could represent a significant pullback in liquidity and risk appetite on its own. The Bank of Canada, even as it tightened policy a few weeks back, and hinted at more, did mention a series of risks in its news release that should not be ignored, including the impact of the rate hikes themselves on debt-heavy consumer balance sheets, as well as global geopolitical uncertainties.

Frankly, what would get me excited is if the government just sat on its hands and did nothing. I am deeply disappointed in what has already been done with respect to taxes and the road back to runaway deficits. I have yet to be convinced that this government has attempted to make the distinction between debt used to finance spurious consumption and debt used for profitable investment. And the budgetary moves, both actual and planned, to tax capital in all its forms , are only going to act as major constraints on growth. Yes, we may well get more fairness, but in return, less economic activity. I'm not convinced that's a very effective strategy if the aim in the end is for the tide to lift all the boats. And if Ottawa actually does penalize these Canadian Controlled Private Corporations by making good on its proposal to reverse the tax benefits these entities enjoy, for the benefit of the national economy, then we can expect to see negative fallout on business investment, job creation and overall economic activity.

The tax system should be used in a way that rewards risk. But the federal government's proposals will instead retard risk and retard growth in the process. If Ottawa wants to reduce the tax burden on the working man, then cut personal income tax rates instead of trying to level a playing field that has no rationale for being levelled. Why it is that the government wants to level a playing field by effectively raising taxes and reducing incentives to invest is anyone's guess. As far as I know, we are the only industrialized country in the world moving in such a direction.

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‎While there has been no shortage of submissions and reports published by accountants, lawyers, tax experts and small business advocates advising against Bill Morneau's tax proposals, I have yet to see any economic impact studies, from Bay Street to think tanks to the Bank of Canada or to the Finance Department itself. And we are just a short three weeks from end of the consultation period. Can 75 days of public examination really be enough time to debate the most significant tax shift since the GST was introduced nearly three decades ago?

Indeed, go back to that time period in the late 1980s/early 1990s and see what happened – a tax shock that occurred on top of a trade shock (FTA back then and now it's the possible unravelling of NAFTA), a tighter Bank of Canada policy, a screamingly strong Canadian dollar, an interventionist and anti-business government at Queen's Park and a housing bubble burst in the GTA. Does that have a familiar ring to it? What came next was a recession that was completely policy-induced and unnecessary.

Through my lens, reducing tax incentives for risk taking means we will get less of that risk taking and sweat equity, which in turn means we get less capital formation, less productivity, less job creation and less aggregate demand. The only question will be one of magnitude. Just as the economy is starting to show some verve following the 2015-16 energy-related slump, it would be a shame to impose a potentially destabilizing and deflationary tax shock to the backbone of the economy otherwise known as the small-business sector.

David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.

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