Small Business Preferences as a Barrier to Growth: Not so Tall After All

Special supports for small businesses are a hallmark of both federal and provincial tax policy. There are two major federal programs: the Small Business Deduction (SBD), which provides small business a special lower income tax rate, and the enhanced Scientific Research and Experimental Development (SR&ED) investment tax credit. The purpose of these programs is to improve overall economic performance by mitigating inefficiencies in the market. However, since receiving benefits is conditional on staying small, these programs could act as a barrier to growth. This Commentary makes use of newly available tax data for individual firms to investigate the effect of the tax wall firms face as they grow. We find that the SR&ED thresholds are set high enough that their impact on investment decisions is negligible. Similarly, while the SBD thresholds affect more firms, that program has only a minor impact on investment by small firms. Nevertheless, such supports for small business have a social cost. The largest cost arises from the fact that the government must recoup forgone tax revenue by cutting spending or imposing higher taxes elsewhere. If the alternative to the SBD is a lower general corporate income tax rate, the net impact of the SBD will be an expansion of the small business sector at the expense of large businesses. Since small firms are less productive than large firms, overall economic performance would suffer as a result of the SBD. A more effective way of spurring economic growth is to reduce corporate income tax rates for all firms rather than providing preferential tax rates for small businesses.