1% Small Business Tax: A Bad Idea Returns

Liberals are proposing to slash Nova Scotia’s corporate income tax rate for small business from 5% to 1%.

We have seen this movie before. New Brunswick announced a 1% small business rate by 2007 only to instead restore a 5% rate that year. Nova Scotians might reasonably ask why their provincial neighbour abandoned the 1% plan.

Part of the story is that New Brunswick’s 2007-08 budget increased taxes overall, including personal income taxes and general corporate taxes. However, New Brunswick has since unveiled a tax-cutting binge that notably maintains the small business rate at 5%.

There are solid public-policy reasons for not slashing small business rates. A major purpose of corporate income taxes is to prevent business owners from incorporating simply to avoid paying personal income taxes.

If corporate tax rates equal personal tax rates, then the government collects the same revenue regardless of whether income is generated inside or outside a corporation. By contrast, a 1% tax rate gives small business owners a strong incentive to keep income within their corporations to avoid or delay paying significantly higher personal tax rates.

An ultra-low small business tax also encourages business to organize itself as many small corporations rather than fewer large corporations. In particular, it provides an incentive for large corporations to contract out activity rather than performing it in-house. Such contracting to small business not only reduces tax revenues for the public, but usually also reduces wages and benefits for the workers involved.

Even the C. D. Howe Institute’s tax-cutting gurus recognize the perils of an excessively low small business rate:

Tax reductions have also been targeted to small businesses, thereby creating greater opportunities for personal and corporate tax avoidance. A notable exception: New Brunswick, which is revising its far-too-low small business corporate income tax rate, boosting it from 1 to 5 percent.

The small business rate applies to every Canadian-controlled private company’s first half-million dollars of profit. (Nova Scotia’s threshold is currently $400,000, but the upcoming provincial budget will almost certainly raise it to $500,000 in line with the last federal budget.) Therefore, a lower “small business” rate delivers the largest tax breaks to relatively large and profitable private companies.

Why have Nova Scotia Liberals put forward this policy? One explanation is that they are heading toward a provincial election and small business is a very vocal and popular political constituency. The third paragraph of their press release provides another explanation: “a broad-based tax cut will do more to stimulate the economy than a tax credit for manufacturers alone.”

This shot is obviously aimed at the Nova Scotia NDP’s proposed manufacturing and processing tax credit. Such a refundable credit is, in fact, a far superior policy because it is tied to tangible investment and available to enterprises that are not currently profitable. Increased manufacturing investment would expand opportunities for small business to sell goods and services to manufacturers and their employees.

The NDP would provide a refund to every corporation that invests in Nova Scotia manufacturing, regardless of whether it is private or publicly traded. The Liberals would provide a tax break to every profitable private corporation, regardless of whether or not it invests in Nova Scotia.