Thursday, September 14, 2017

Caring About the Middle Class Means Caring (and Understanding) About Small Business

Recently (January), I made the leap from government to private sector, more specifically I made the leap to go from helping my husband run our business part-time to helping run it full-time. I can say without a doubt, I work more now than I did then (there's more flexibility, I'm generally happier, but no running a small business isn't an easy road to riches). I think there's a lot of misconceptions out there about these changes and what they will mean for the small business climate in British Columbia. As an economist, and now a small business co-owner, I think these changes are awful public policy driven by some academics who have failed to acquaint themselves fully with the pragmatic reasons these provisions are needed and used and what the real-world impact of these changes will be. I'll happily concede there are problems - but those problems merit a chisel not a shotgun, and the absence of fully understanding the impacts these changes will have is unnerving.

To put my comments on this in context - small business accounts for 30% of the economy across Canada, and some 33% here in BC. It employs more 8 million people, and of those more than half are employed in businesses with less than 20 people. Only 4 in 10 small business have ownership that is majority female. Keep in mind not all small businesses choose to incorporate, but many do, and there are good reasons to encourage incorporation. Most are owned by those who are over 40. A good chunk of them do not enjoy excessive profits and of note - they absolutely cannot use the strategies of large public corporations and I'm not sure that we really want to encourage large public corporations at the expense of small businesses.

What's important to remember, is that when it comes to small business - the tax picture is more complex and simply comparing business owners to employees is unfair. Employees have access to EI (including maternity savings), TFSAs, RRSPs, sometimes pensions, often disability insurance, often maternity leave top-ups, Employment Standards regulations and recourse, minimum wage, over time, etc. Small business owners often put their personal assets on the line to back the operations of their businesses, and at the end of the day must put the needs of their employees, the CRA and their clients ahead of themselves. The small business owner gets paid last and might well lose everything with their venture. It is also important to note that the business owner pays tax twice - a corporate tax (when the money remains in the company), and then personal income taxes (when the money is taken out of the company to fund personal needs - housing, food, clothing, etc.) Further, business owners have based many decisions on what is long standing tax law (more than 40 years) - and unlike individuals, they do not have the luxury of planning for a year, but often must plan for the decades ahead.

So let's say you decide to quit the day job and start a small business. Great! Now reality - what are the odds that you're going to be able to do that, and do it successfully without a supportive spouse? Keep in mind that a small business, and in particular a new small business is a demanding venture. (There's an apt saying, you have the "flexibility" to choose which 18 hours of the day you work). Who will take on the load to make sure you can focus on getting the business going and making it a success? Everything else doesn't stop - the kids still need to get to and from school, people need clean clothes, meals need to be made, bills need to paid (really true if it's the partner's day job that is mitigating the risk). Your long work hours take a toll - and now the government is telling you that you can't "share the income" from the business with the person who likely a) gave consent to start it in the first place. b) put family assets at risk for it. c) is taking on the load of the domestic duties (more so when there are kids involved). As an aside, what do you think will happen to the divorce rate among small business owners when the "sprinkling" provision is eliminated? Now, also a reality of small businesses is that they demand a redirection of resources. In part to mitigate the risk of an unforeseen contingency and in part to finance future growth. Are you going to sink funds into your personal TFSA and RRSP and RESPs - funds that can't be used easily by the business should the need arise, or are you going to be able to put all your money into the business? Under the current rules, the choice to direct funds to the business is defensible and reasonable - under the changes it won't be possible, business owners will have to choose to take the money personally (paying personal tax on it, and then if they do put it into a RRSP, or RESP they may not be able to withdraw it later for business needs). So, these small businesses will have less corporate resources available to fund unforeseen contingencies (some of which can be really expensive!) or future growth. Under the current rules, the business owner could be reassured that the funds in the business could be used later as a form of pension (and taxed when taken), disability insurance (taxed when taken as income), or to fund children's post secondary education (again taxed in the hands of the child). Businesses need this flexibility and ability to plan and pay for life events (note - if a business owner is wanting a family, then need to plan for their own maternity leave including paying to ensure the business can continue during that time) and business needs. On the note of tax fairness - I think it's fair that taxation occur at the "family level" - many benefits are based on "family income" so it makes sense that families be taxed as a family and the removal of income splitting from all families was a travesty of the current government.

That covers the passive income and sprinkling provisions that are proposed. Now turning to capital gains. These measures apply more to business succession planning, but what do you think will happen when it becomes much more expensive to pass the family business to the next generation than to sell it to an outside source? Fewer businesses (including family farms) will remain "family businesses" and more will be sold to larger corporate interests. I'll be blunt - we'd love if someday some or all of our children decided to carry on our firm, shouldn't the decision as to whether or not it's "passed along" within the family or sold to an outside interest be at least neutral? What do you think it does for a small business owner, and their approach to their business, when they are thinking that this is something that they are building for their children? If they are sold to large corporate interests, do you think those "shareholders" care about the employees in the same way that the small business owner does? What about caring about their community?

So why does this matter? Because the implications go beyond simple math - it changes the rules of the game entirely, with very little notice. The government has estimated that it will gain $250 million in revenue each year from these changes. If employment in small business is reduced by as little as 5% by these changes, and each of those lost jobs generating $5k in tax revenue (a low estimate) these changes will cost the government more than $2 billion in revenue. These changes mean fewer small businesses starting, fewer small businesses growing, fewer small businesses surviving, fewer small businesses led by women, more family instability among small business owners, and a raft of other consequences. This is bad public policy at its finest and we can stand together for the heart and spine of the Canadian economy - or we can watch this government rip it out and then wonder, why our economy just doesn't perform like it used to.

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