Should government discriminate in favour of small businesses?

Recently, the Canadian government introduced a new Small Business Job Credit which is “expected to save small businesses more than $550 million over the next two years.”  This saving is being provided as a cut in the Employment Insurance tax that small businesses pay based on the earnings of their employees.[1]
 

Now any cut in payroll taxes is welcome since these taxes are, in effect, a “tax on jobs”. Such taxes add to the wage cost that employers must pay. Since companies can afford to hire people only when the net revenue that can be generated  from the product or service these people produce is more than the cost of wages paid (including all taxes), any reduction in payroll taxes will make it possible for companies to create more jobs.

The question is, however, why provide this cut only for small businesses—why not for all? The new credit is not the first incentive provided for small businesses. In 2011, the government introduced a Hiring Credit for Small Business. Both federal and provincial corporate income taxes are also lower for small companies. In fact, both the federal and provincial governments have, for years zealously provided tax relief for small companies in an effort to shore up political support[2]. Can this bias in favour of small businesses be justified economically? Are they really better at creating new jobs than large companies?  If that were true, a stewardship perspective--which favours putting people to work--would certainly support our government’s bias.

On announcing, the new incentive, Joe Oliver, Canada’s Minister of Finance, stated:

 Small businesses drive Canadian prosperity, representing about 50% of jobs in the private sector and a third of Canada’s gross domestic product. That is why we are taking action to make small businesses stronger. Our new Small Business Job Credit will lower taxes for business owners and make it easier for them to create jobs for Canadians.

 In similar vein, Kevin Sorenson, Minister of State (Finance), is quoted:

Small businesses are crucial to Canada’s long-term prosperity. Canadian families depend on the jobs they create and the services they provide. That is why the Harper Government will continue to foster an environment for small businesses to grow and prosper.

However, if small businesses really provide 50% of the jobs, then, don't large companies provide the remaining 50%? And aren't they at least as important? What is the evidence that small companies are the engine of growth?

Small businesses depend on large businesses-William Watson, in a National Post editorial entitled “Small business good, big business bad”[3] ascribes this bias towards small businesses to the fact that there are just so many of them and, by implication, that they generate a lot of votes.Moreover, we all “know” from the media that big businesses are bad: they “mainly exist to pollute the environment, harass and exploit workers, and endanger everyone’s health by forcing us to eat, work with or live beside dangerous products”. Small businesses, in the public mind, apparently escape this condemnation and are generally considered “good”—the “political equivalent of cuddly puppies.”[4]. Economists, however, tend to push the concept of neutral taxes, ones that don’t discriminate between different business forms and sizes. Believing that good stewardship includes a preference for the market, I share that point of view.

Watson’s main theme, however, is that many small businesses are dependent on the large businesses. The small canteen truck that drops in at large construction sites depends on the large construction company.  The employees of large companies,” make use of all sorts of small businesses: coffee shops, restaurants, dry cleaners, print shops, bicycle delivery guys and girls, taxis, boutiques of all kinds. Most small businesses create jobs by hiring people both to provide services to large businesses directly and to meet the consumption needs of the employees of those businesses! If the small businesses’ ability to hire new workers depends on increasing needs of the larger businesses, why should tax policy not favour the large companies?

Good Stewardship-In an earlier post, I noted that good stewardship also means that we need to use our God-given resources as effectively and efficiently as possible. Unfair tax breaks for small business, as Jack Mintz has pointed out,  in fact, “produce an excess of inefficient firms” and “reward stagnation”.[5] Larger businesses tend to have a higher productivity[6]—they can produce at a lower cost due to economies of scale and specialization. That is, they can use more expensive automated equipment since they produce at a higher volume. Since Canada appears to be lagging behind some of its major trading partners in productivity, our ability to export (with related jobs) is already reduced. Favouring small business even more, further reduces our export competitiveness. 

 

 Moreover, larger companies also do more research and development than small ones[7]. They innovate more. They export more[8]. Moreover, although layoffs at large companies attract wide news coverage, small companies shed jobs at a faster rate in economic downturns and are more likely to go out of business altogether[9]. Furthermore, the contribution that large companies make to the economy is larger than their total (very significant) employment levels. They also tend to pay higher wages and better benefits—pensions, medical insurance etc.—and contribute a larger proportion of the total government tax revenues. Overall, good stewardship does not favour extra incentives for small businesses.

 

Regulatory/Tax Burden- One valid reason to help small businesses does, however, exist. The burden of complying with the myriad of government regulations and tax policies falls disproportionally heavily on smaller businesses. For example, the collection and remittance of sales taxes from customers and payroll taxes from employees requires the same basic efforts—learning and keeping up with the requirements, devising and maintaining processes (computer programs, etc)—for all companies. While these costs increase with the size of the company, they become relatively less significant in total as the size of the company increases. All companies need a basic system to deal with them; larger companies are better able to bear that basic cost. Governments, however, already make some adjustment for this. Sales tax (HST), for example does not have to be collected by businesses having sales of less than $30,000 annually. It is possible that compensation for complying with these programs may need to be increase. It is, however, unlikely, that these compliance costs justify the significant incentives currently in place for small businesses.

Conclusion—Although small businesses no doubt are important for employment, it is questionable to say that they are better at generating new jobs than large companies. We need them all- small, medium and large. Government incentives for business to create jobs should be offered to them all. Payroll taxes should be reduced for all—to the extent that we can afford it.

P.S. Focusing only on small businesses also creates a problem at the cut-off point between large and small. In the case of the current employment tax cut, when a company hits the $15,000 cut-off point, it loses the whole credit. Thus, at the cut-off point, there is an incentive of $2,234 for companies to fire a few people just to keep under the $15,000 cut off point.[10] It is unlikely, however, that a lot of companies would be just at that cut-off point. However, this problem and that of defining what is a small company is real for all such incentives.

---

[1] From the current legislated rate of $1.88 to $1.60 per $100 of insurable earnings in 2015 and 2016.  The credit applies to any firm that pays employer EI premiums equal to or less than $15,000 in those years.

[2] Jack M. Mintz, “Rewarding Stagnation”, National Post, Feb. 8, 2008, FP13

[3] National Post, Sept. 23,2014

[4] William Watson, “Only in Canada, National Post, Apr. 28,2005, FP.23.

[5] Jack Mintz, “Rewarding stagnation”, National Post, Feb. 8, 2008, FP13

[6]  William Watson “Small beautiful but big works”, National Post ,Aug. 28,2013,  FP.9 with reference to  Statistics Canada study by John Baldwin, Danny Leung and Luke Rispoli.

[7] See also Jack M. Mintz, “Small-minded R&D”, National Post, Apr. 3, 2012, FP11

[8]  Watson, 2005.

[9] Jock Finalyson, “Where the jobs aren’t”, National Post, Nov. 8, 2003, FP11

[10]Mike Moffatt,September 15, 2014, http://www.macleans.ca/economy/economicanalysis/the-dangerous-misguided-flaw-in-the-small-business-tax-credit/