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Ian MadsenInstead of clamping down on the entrepreneurs who drive Canada’s economy, the federal government needs to back off on all taxation.

The federal government is determined to eliminate the perceived income tax benefit provided to people who incorporate. The argument is that those who incorporate get an unfair benefit at the expense of Canadians who file tax returns as individuals, usually as employees.

The Finance Department proposes to eliminate exclusions and oddities so that incorporated professionals, farmers and entrepreneurs pay more tax and at rates comparable to employed individuals.

Several other analysts have detailed the tax code peculiarities that supposed tax-gamers use to ensure higher after-tax income than the rest of us.

But would these changes, if made, really result in tax-minimizing individuals (as identified by Ottawa and the fairness police) paying more taxes?

When taxes are raised for the top half of tax-filers, the take often falls far short of expectations. Sometimes, despite the hopeful projections of Finance Department mandarins, the take is even less than before the changes.

After changes, the tax take won’t reliably rise simply because many entrepreneurs (including many professionals and farmers) will find ways to minimize their taxes by engaging in activities that are taxed more lightly, work or invest less, retire or leave the country entirely.

Canada is certainly not an irresistible paradise. The U.S .Congress’s draft tax reform features a 25 percent rate for ‘pass-through’ business income. So entrepreneurs could simply take their money and their ideas elsewhere.

Personal income taxes are steeply progressive in Canada, rising rather rapidly to the top rate at just an upper-middle class income level.

To encourage capital formation, new ventures and job growth, and to compete against low-tax jurisdictions such as Ireland, corporate income taxes in Canada have been declining (except in some provinces).

So it’s attractive for many people who work for themselves to incorporate, ensuring a lower top tax rate, especially on the first $500,000 earned by a business. However, when income is distributed to them, as salary or dividends, they still pay tax at the individual level.

When a shareholder receives dividends from an eligible Canadian corporation, they can use the dividend tax credit against their income tax liability, because the corporation has already paid income tax at the corporate level.

Corporations can also carry forward losses from previous years, to shelter positive income when the company becomes profitable.

All these features help nurture new companies and the entrepreneurs responsible for them. They in turn build small firms into large ones. And those large firms create broad employee and corporate income that’s taxed and funds all the government services we use.

Certainly, some people are overly enthusiastic in exploiting aspects of the tax system. If it’s excessive, it’s fraud and can be penalized. To minimize tax trickery, the U.S. proposes a 70/30 rule to ensure most business income going to an owner is taxed at the individual rate. Canada could emulate this.

People feel compelled to use the existing quirky tax rules because personal income tax rates are effectively much higher than corporate ones (and corporate rates can’t be raised without risking capital flight and economic stagnation).

The real villain here is a greedy government class that’s unwilling or unable to live within its means.

It’s time the federal government realized that it could actually raise more revenue by leaving the wealth generators alone, lowering overall taxes and freeing up economic growth.

Ian Madsen is a senior policy analyst for the think-tank Frontier Centre for Public Policy.

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tax reforms, economic growth

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