(This column originally appeared on the Toronto Sun)
Finance Minister Bill Morneau recently announced a plan to crack down on “tax planning using private corporations” by closing “loopholes.”
Given the chosen wording, you would be forgiven for assuming these were of interest only to a handful of high powered tax lawyers and accountants. Yet if adopted, these changes would mean a dramatic tax hike for millions of Canadians and impact countless small businesses.
The government’s proposals focus on three practices employed by small businesses to achieve, in the government’s words, “unfair tax advantages:” income sprinkling (where a business owner pays family members a salary or dividend solely for the purpose of reducing the owner’s total tax burden); passive investment retention (where the owner invests income for purposes other than immediate reinvestment into the business); and income conversion to capital gains (essentially declaring income in a form that results in a lower tax burden).
The government’s position is that these practices are unfair because they allow small business owners to pay less tax. Their solution is to make small businesses pay up by raising their taxes to a level comparable to what a salaried wage earner would pay. Why, they argue, should a small business owner earning $200,000 pay less tax than a salaried employee earning $200,000?
There are many reasons why, which have to do with the vastly different ways in which these incomes are generated and the additional costs and risks borne by small business owners. The government’s failure to consider them is a fundamental mistake.
For example, salaried employees receive guaranteed pay and health benefits. Salaried employees receive paid vacation, sick days, overtime pay, severance pay if laid off and sometimes a pension. Business owners get none of these things. Business owners only get paid if they make money and they have to pay for other things like health coverage out of their pocket or buy insurance for themselves.
Viewed in this light, some of the “unfair” practices identified by Morneau should instead be seen as important incentives to encourage more people to set up and grow small businesses. For example, passive investments allow business owners (who have no pension) to save for their retirement, as well as to build a cushion to protect their business should it have a rough year in the future.
Eliminating these “loopholes” would make it harder for business owners to save for retirement and harder for them to survive economic downturns. Is that really what the government wants?
If the government’s goal is to reduce the benefits of entrepreneurial activity by ensuring business owners pay more tax, they will quickly find fewer people interested in bothering with becoming business owners in the first place.
For a government that insists it is looking out for the middle class, this cannot be overstated. The victims of these policy changes will not be wealthy millionaires working on Bay St. The victims will be the very people this government claims it is trying to help: mom and pop operations in small towns across the country, including farmers, mechanics and electricians. Are these really the people the government wants to castigate as tax villains – right before they help put them out of business?
Morneau is right to be seized with fairness and right to want to fix the tax code. But the proposals he has put on the table miss the mark, and are the worst of both worlds: they don’t address the fundamental problem with the tax code (it is far too complex) and are likely to be the equivalent of attempting to kill a fly with a cannon: the government may very well get their fly, but there will be tremendous unintended collateral damage to go along with it.
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