Growing Small Businesses in Canada: Removing the Tax Barrier

This paper examines a barrier to the growth of small businesses in Canada. As businesses grow beyond what is deemed to be small business (income in excess of $300,000 to $450,000 depending on location) they face large increases in business income-tax rates. Economic research outlined in this paper indicates that such increases act as a strong disincentive for growth and expansion.

The federal government and every province except Quebec currently (2005) offer reduced business income-tax rates to eligible small businesses. Quebec will implement preferential treatment in 2006. The current preferential income-tax rates for small business range from a low of 2.0% in New Brunswick to 6.5% in Prince Edward Island. This compares with general business income-tax rates ranging from 11.5% in Alberta to 17.0% in Saskatchewan. The federal government also offers a substantial discount: 12.0% for small businesses compared to 21.0% for general businesses.

The combined federal and provincial preferential small business income-tax rates, while designed with good intentions, have resulted in steep increases in statutory business income-tax rates for successful businesses that grow and expand. The smallest increase experienced by growing firms that move from the preferential small business income-tax rate to the general business income-tax rate occurs in British Columbia, Ontario, and Prince Edward Island, where the applicable statutory rates double. The largest increase occurs in New Brunswick where the statutory rate jumps 142.9%.

Published research indicates that such steep increases in business income-tax rates create a powerful barrier, or disincentive, for entrepreneurs to expand their businesses. The large increases in business income-tax rates as firms move from the small business income-tax rate to the general business income-tax rate creates strong incentives for firms to avoid increases in taxation by reorganizing or by paying out additional monies in salaries and bonuses rather than growing and expanding.

The way to remove this barrier is to eliminate the preferential business income-tax rate for small businesses by reducing the general business income-tax rate. Given the overwhelming evidence of the damaging and costly impacts of business taxes on an economy, it makes little sense to equalize general and small business income-tax rates by raising the small business income-tax rate. The optimal solution is to reduce the general business income-tax rate while aggressively increasing the small business income eligibility threshold in order to reduce the steep increases in business income-tax rates at both the federal and provincial levels.