Small Business Taxation: Revamping Incentives to Encourage Growth
Authors: Chen Duanjie , Mintz Jack M. 
Published: August 2024

This study adopts a new approach in assessing the impact of taxes on small business growth and suggests the need to consider new incentives that would be more effective in encouraging small business growth and would also improve the neutrality of the existing tax system. In recent years, federal and provincial governments have provided various corporate tax incentives to small businesses with the aim of helping them grow. While it is commonly believed that small businesses are responsible for most job creation, unfortunately the only study available has shown that while many small businesses are created, few grow. Yet many governments believe that the incentives are important even though little evidence supports the effectiveness of small business corporate concessions. Some provinces have actually eliminated corporate taxes on small businesses or reduced such taxes to a symbolic level (e.g., one to two percent) without there being any empirical support in favour of the effectiveness of such actions.In contradiction to the widely held view that small business tax concessions encourage growth, such small business tax relief could actually be antithetical to growth by creating a “taxation wall.” First, it could result in the breakup of companies into smaller, less efficient-sized units in order to take advantage of tax benefits even if there are economic gains to growing in size. Second, it could encourage individuals to create small corporations in order to reduce their personal tax liabilities rather than grow companies. And third, it could lead to a “threshold effect” that holds back small business from growing beyond the official definition of “smallness,” regardless of the criteria for measuring size (e.g., the size of revenue or assets, or the number of employees). In this paper, we evaluate the impact of both corporate and personal taxes on the growth of small business and we focus in particular on the likely consequences of the aforementioned threshold effect. We use a new approach in assessing the impact of taxes on small business growth by estimating the amount of tax paid on the rate of return to capital as a small business grows in size. We show that small business growth is hampered by the existing tax system. As a business grows, effective tax rates on capital investments made by entrepreneurs virtually double when the business grows from as a little as $1 million to over $30 million in asset size. The issue is particularly important to the provinces that have been creating greater gaps between large and small business tax rates.The aim of tax incentives should be to try to avoid creating a wall that inhibits growth in small businesses, but instead flattens corporate and personal taxes with respect to incentives structured to induce growth. We provide some specific recommendations for growth-enhancing incentives that are superior to the small business tax deduction and other incentives of a similar type. Incentives associated with size should be avoided as much as possible, a proposal that is consistent with International Monetary Fund (IMF) recommendations.