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Finlayson: Rethinking Canada's anti-big business tax policy (Troy Media)

Canada ranks as one of the best places in the world to start a new business, according to an annual survey by the World Bank. But the country does less well in encouraging businesses to grow – and in generating private sector innovation.

The two phenomena are linked: an economic environment that supports business growth should also produce a high level of innovation, since growth-oriented companies are more likely to adopt innovative business strategies.

In thinking about these issues, Canadian policymakers would be wise to focus on the outsized economic contributions made by the sub-group of rapidly-growing small- and medium-sized enterprises. A 2010 study by the Kauffman Foundation for Entrepreneurship estimates that, in a typical year, the top-performing five per cent of American businesses – measured by their rates of employment growth – create two-thirds of all new jobs. And the top one per cent of firms are responsible for a remarkable 40 per cent of net new jobs.

The picture that emerges from this research is that, over a period of several years, a few thousand U.S. companies grow from small to reach substantial size, employing 2,000 to 10,000 people each. The story is broadly similar in Canada, although there are no published studies based on the same methodology as that used by the Kauffman Foundation.

Fast-growing firms exist in many industries (not just high-technology, software, etc.), but they are far from being the norm. Indeed, only a tiny share of small businesses ever evolve to reach medium-size, and among medium-sized enterprises an even thinner slice – 1.4 per cent a year, according to a recent Business Development Bank of Canada report – graduate to the large business category.

British Columbia has 391,500 registered businesses. Of these, 98 per cent have fewer than 50 employees – and more than half have fewer than five. Some 200,000 of all B.C. businesses consist of self-employed individuals with no paid staff. As of 2011, only 6,400 enterprises in the province employed more than 50 people – and, of these, I estimate that just 700 to 800 have 500 or more workers. To build a more productive private sector economy, the challenge for B.C. is not to engineer more start-ups and micro-businesses. Instead, it is to grow more large-scale enterprises and to support the development of a healthy mix of medium-sized firms with solid roots in the province.

Why should we want more of our businesses to get bigger? There are several reasons.

First, on average, larger companies pay their workers more (wages and benefits) – in part because they deploy more capital per employee and are able to reap various other advantages associated with size and scale.

Second, as they expand, businesses have a greater propensity to participate in international markets via exporting, which is a principal means by which small jurisdictions like B.C. become richer over time.

Third, a substantial body of research shows that the presence of both large “anchor” firms and growing medium-sized companies in a region boosts productivity and innovation, including in knowledge-intensive sectors. While many small companies are highly innovative, globally big firms are responsible for 80 to 90 per cent of private sector research and development, according to the Organization for Economic Cooperation and Development. Larger companies have a greater capacity to finance innovation; to commercialize new ideas; to hire and develop scientists, engineers, and product managers; and to participate in collaborative arrangements with universities and external research organizations.

The good news is that government policy can help to shape an economic environment in which companies are more likely to grow, to export and to innovate. Making it simple to start a new business is a good first step. Ensuring that capital is available to fund start-ups and to enable the further development of growth-oriented businesses is vitally important. This includes not only venture capital, but also other sources of financing (mezzanine capital, private/public equity, bank loans, strong “angel’ investor networks, etc.).

Finally, implementing tax policies that reward success and incent companies to invest, expand, and employ more people is also crucial. Here, the record in Canada is decidedly mixed. The tax system as presently constituted creates incentives for businesses not to grow, via significantly lower income tax rates and more generous R&D incentives for small firms. Some provinces, such as Ontario and Manitoba, also impose higher payroll tax rates on enterprises that add more employees.

This feature of Canadian business tax policy requires a re-think if governments are keen to see more companies grow. Unfortunately, the B.C. government’s latest budget takes a step in the wrong direction by hiking the basic corporate tax rate from 10 to 11 per cent, while leaving the preferential small business tax rate at 2.5 per cent. For some B.C. firms, this will compound the tax advantages of remaining small.

Jock Finlayson is Executive Vice President of the Business Council of British Columbia.

As posted on Troy Media: