On July 17th, Canada’s Finance Minister, Bill Morneau, issued a package of tax proposals with the intention of closing “loopholes” being used by the wealthiest Canadians. Such loopholes are believed to allow private corporations to be advantaged over other working Canadians. His proposal contains three notable changes:
Income splitting: the allocation of income to family members in a lower marginal tax bracket, must now be subject to a “reasonableness” test based on labour and capital deployed.
Tighten rules on retaining passive investments inside a company that are taxed at the small business rate as opposed to the higher personal tax rate.
Limit the conversion of a corporation’s business income into capital gains which receives preferential tax treatment.
These proposed changes, which attempt to align the taxes paid by business owners with those of their salaried employees, if passed, will pretty much destroy any incentive to start a business in Canada. This is a huge concern given that new businesses are the largest creators of new jobs in any economy and good government should be focused on creating jobs, not destroying them. Furthermore, this proposal shows a complete lack of empathy for the risks that anybody starting a business must assume. Allow us to offer a few observations that we believe were overlooked by our entitled leaders, who thanks to wonderful inheritances as well as juicy guaranteed pensions on the back of all tax payers, have never had to make any sacrifices in order to ensure security of their future:
Many of the most impacted professions (legal, medical) demand skill sets that require rigorous and costly education. These individuals start out with large amounts of student debt, inevitably delaying their ability to save for retirement.
As opposed to well paying 9 to 5 jobs, when starting a new business of any type, quality of life must always be sacrificed in order to succeed and this has an impact on family life. Therefore every member of a family has the right to be compensated for this through income sprinkling.
Business owners are not entitled to the same essential benefits as their employees. Does the fairness equation consider the out of pocket costs for these key benefits such as maternity/paternity leave, healthcare benefits, job security and pension?
Unfortunately not all business owners are created equally and although it is very popular to go after the professions considered to be highly paid, it is important to remember that the vast majority of small businesses struggle to break even.
Small businesses are the biggest creators of new jobs. If there is no extra benefit to owning a business, only risk, the creation of new business will fall. This is a great way to kill growth.
When you tax too much, people lose the incentive to work. Already the talk is that most doctors will react to this proposal by working less hours even though demand already outstrips supply and this will only get worse given the demographics of the population. Others are investigating leaving for more favourable tax jurisdictions.
Perhaps what should be considered is the fact that current tax rates for ALL Canadians are extremely unfair given at no time is there justification for the government to be taking more money than the individual that is making it. In fact, the biggest problem Canadians have when it comes to fairness and equality, actually comes down to our government itself.
To this end, we would like to shine a light on what is truly the most advantaged part of Canadian society today: the government worker.
According to the Fraser Institute (2015):
Canada’s government sector workers were found to enjoy a 10.6% wage premium, on average, over their private sector counterparts.
On non-wage benefits, 89.3% of government workers are covered by a registered pension plan vs. 23.8% of private sector workers. Of those covered, 93.7% of government workers enjoyed a defined benefit pension vs. just under half of private sector workers.
Government workers retire earlier than their private sector counterparts— about 2.3 years earlier on average—and are much less likely to lose their jobs (3.8% in the private sector vs. 0.5% in the public sector).
Full-time workers in the government sector lost more work time in 2015 for personal reasons (12.7 days on average) than their private sector counterparts (7.8 days).
So to be clear, this means a small business owner as well as every one of their employees, stands to make less than somebody doing the same job in the public sector, yet will work more hours, is more at risk of losing their job (if the business does not make money people get fired, in the government they just raise what they charge the tax payers), will have to work longer before they retire, and to add insult to injury, rarely do they have a pension fund.
The government worker despite having a better income and quality of life at work however, does not have to save a cent, as they enjoy some of the best pension plans, at the expense of all other tax payers, in the country. According to a government website a government worker is entitled to an annual lifetime pension, calculated based on their average salary of five consecutive years of highest paid service.
So let’s assume for the sake of argument your average salary for those five years was $63,000. It appears you will then retire with a nice salary at the wonderful age of 58 with an income of $43,519 per year.
So basically every other tax payer in the nation, has to work twice as hard to make sure an average government employee gets his $43,519 per year. Add in the reduced productivity of government workers, with no unpaid overtime and extensive vacation periods and it’s an outrage, never mind unfair, to hard working Canadians everywhere.
The value of that $43,519 pension the equivalent government worker gets upon retirement at today’s risk free rate of 2%, is the equivalent of having about $675,826 in the bank when you retire. This assumes you retire at 65 and live to the average age expectancy of 85 years and pay 29.6% in combined federal and provincial taxes per year on that pension income. It is highly unlikely that somebody making just over $60,000 per year in the private sector would be able to save this much in their life time.
In order for a small business owner to have the same pension, at today’s interest rates and assuming his business is profitable enough, he or she would have to save over $18,734 (after tax) each year for at least 30 years. This requires an additional $30,216 (pre-tax) more each year just to save enough to have a pension equal to an average government worker. In other words a government job paying $63,000 a year is the equivalent of a private sector job with no pension benefits paying $93,216 a year. In fact adjusting for both the pension benefit and the 10.6% wage premium the average government worker is getting paid over 60% more than the worker in the private sector for the same work.
Very few small businesses make this kind of profit above and beyond what they require to cover their living costs as most businesses are highly cyclical. Regardless of economic circumstances, government workers get these nice pensions at the expense of all other tax payers. It is also important to remember that a lot of those on the government payroll, such as Members of Parliament, have pensions well north of $100,000. That means working Canadians are on the hook for at least $1,552,946 to cover each one of these pensions.
So Mr. Morneau’s idea that he is going to increasingly tax the so called wealthy small business owner, while continuing to fund their generous government pensions and secure retirement lifestyles at the expense of every other Canadian, is not fairness, it’s injustice. Small business owners make sacrifices, take risks and spend many unprofitable years struggling to launch their business, then have to scrimp and save for their retirement. These job creators need to be rewarded for their sacrifices NOT penalized.
Margaret Thatcher famously said that “the problem with socialism is that you eventually run out of other people’s money”. Instead of over taxing hard working Canadians, this government needs to learn to spend within its means, and if it cannot do that, it should have to do like every other Canadian business and individual: cut what you cannot afford.
The Summerhill Team