Discontent is rising against Finance Minister Bill Morneau’s tax reform, as it should.
The reform’s rhetoric, repeated in the minister’s open letter on Tuesday, claims it targets high-income earners, to make them pay effective tax rates that are in line with what regular salaried income earners pay. To do that, it will make significant changes and ratchet up taxes with regard to income splitting, passive investment, and converting business income to capital gains.
As is often the case when government intervenes, the actual effects will be quite different from the stated objectives. Many might be shocked to learn that a tax hike targeting small businesses’ financial strategies will, lo and behold, hike taxes on small business.
This tax will hit small business owners, not rich one-percenters.
The government uses the language of “loopholes” which conjures up the image of a scam artist, hiding terrible things in the small print of a contract. But while it is easy to claim that certain tax strategies take advantage of loopholes, it is a completely different thing to claim that such loopholes are bad, and must be closed. In particular, any gain in tax equity that this proposed reform might bring must be balanced against how it affects economic efficiency, and the burden of proof lies with the government.
Second, some of the “loopholes” in question have existed for nearly as long as our tax system has, and it would be naive to think that the government has been sitting idly all this time. To take one area of the reform, for example, income splitting with children under 18 has already been dealt with and taxed accordingly a long time ago, and income splitting with a spouse has been tested by courts for even longer. There are ample safeguards already in place to prevent abuse, and they can very well be improved upon without turning our tax system completely upside down.
These specific issues can, and should, be addressed by laws that are targeted and that respect the fact that there are honest and legitimate uses for all of these practices.
Which bring us to the third point. The truth of the matter is that each of these so-called “loopholes” has an important place in our tax system and small business environment today. Without them, small businesses will pay more taxes, and have access to less financing from investors. In some cases, they might be able to change their practices, and have more aggressive tax planning, with associated higher administrative costs. In all of these cases, however, the rate of economic growth will be negatively affected for all Canadians.
One of the unintended consequence of this reform might be to make it more rewarding for business owners to sell their companies rather than pass them down to the next generation. In Quebec, the loss of companies to foreign buyers has been a major issue recently, with fears of losing our flagship companies. These fears are often exaggerated, as it is perfectly normal for Canadian businesses to be sold to the highest bidders, be they Canadian or foreign. But that doesn’t mean the law should actively encourage this.
The leap from the blackboard to the real world is a large one when it comes to taxation. Among other things, people adapt to rule changes. Whether through increased recourse to inventive tax planning, the underground economy, less diversification and preparation against economic downturns, or businesses not being passed down through succession, small business will adapt. But we might not like the results.
Everyone wants tax equity. But if you want a reform to increase equity, then reduce taxes, don’t increase them. The United States is currently debating a reform that might significantly lower their corporate tax, and taxation is one of the few areas where doing business is easier here. It’s never a good time to increase taxes paid by corporations, even in the name of equity, but right now, it’s just reckless.
It’s important to see past the lens of government rhetoric in this reform. Class warfare is a distraction. If it looks like a duck and quacks like a duck, it’s most likely a duck; if it increases taxes on small businesses, it is most likely a tax increase on small businesses.
Mathieu Bédard is Economist at the Montreal Economic Institute. The views reflected in this op-ed are his own. Also published in the Huffington Post.
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