Wednesday, September 28, 2005

What's best for Joe

A Blogging Tory gets angry about my not appreciating proposed corporate tax cuts, arguing that my dislike of "indiscriminate corporatism" is really a slam at small business.

Needless to say, gdowler has it all wrong. In fact, I'd love to see policies put in place that genuinely help to encourage small business in Canada. The problem is that corporate tax cuts systematically give larger businesses an advantage over smaller ones - and that's why I'd sooner see the money applied elsewhere.

Consider the Joe in gdowler's example, and assume that there's a different Joe making signs in each of hundreds of communities. When each Joe first sees his tax cut, he'll be happy with it to be sure. But then, Joe probably doesn't have a lot of spare capacity to decide what to do with it - the cost of hiring a professional to decide how to use it most productively would wipe out the benefit entirely. Maybe he'll use it for himself, maybe he'll use it for capital investments, maybe he'll put it toward employees. But unless a given Joe is either a downright clairvoyant businessman or just extremely lucky, he probably won't wind up using the money in the optimal way to benefit his Sign Shop - not because he's a poor businessman, but because he doesn't have access to the same resources.

Contrast this with SignCo, the big-box sign-maker competing for the same business as Joe's. SignCo nets millions of dollars in profits in Canada, meaning that when the tax cut comes in, an army of lawyers, accountants and planners goes to work analyzing how best to handle the increased revenue. In at least a few communities, SignCo will decide to invest enough resources to put Joe's out of business entirely - be it through capital investment, through an advertising blitz or by hiring away Joe's employees. In others, it puts in less resources, but still gets a better return on them thanks to its greater purchasing power and closer analysis.

On the balance, the SignCo gains incrementally on the local Joe's in all but a few communities based solely on the added income. And in a competitive market, a gain for SignCo is a loss for Joe.

But it doesn't stop there. We should be familiar with the fact that the Bank of Canada will tend to match an increase in inflation with an increase in interest rates. To the extent that corporate tax cuts add new money to the marketplace, interest rates then go up to compensate. That's not a huge problem for a SignCo, a multinational corporation with the ability to seek out lenders globally and fund any number of share or debt offerings. It's a much bigger problem for Joe, who's too busy running his sign store to get his capital anywhere but at a local bank whose rate is closely tied to that of the Bank of Canada. (Never mind that it's an even bigger problem for consumers generally; we'll stick to the business comparison for now.)

The end result is that while Joe gets some momentary tax relief, he doesn't have the resources to apply it as efficiently as his competitors, and he also ends up with increased borrowing costs which don't affect SignCo to the same extent. In the long run, all but the luckiest of the local Joes end up being hurt by the competitive effects of the tax cut. And those numbers that gdowler cites as to the importance of small-business employment get driven downward.

I presume gdowler would argue that taking into account other industries, the net result would be an increase in economic growth which would help both businesses do better. To which I'd have to respond in two ways: first by pointing out that the big-business advantage would take place in all those industries as well, and surely nobody will be so naive as to claim that the bigger businesses won't try to make use of their comparative advantage; and second by pointing out that increased growth would similarly be generated by consumption tax cuts or increased social spending which wouldn't have the same negative effects on the smaller business. And if the same resources were dedicated instead to a revenue-neutral small-business growth fund...well, then Joe would have a genuine advantage.

None of the above is to say that corporate tax rates should generally be raised. Indeed, an upward fluctuation would also give at least some benefit to the corporations most able to analyze the implications in advance. In general the more the rules change, the more advantage there is to those with the resources to better anticipate the effects of those changes.

Nor would I describe SignCo as an "evil corporation", as gdowler suggests. What SignCo is, rather, is a corporation with sufficent resources on its own that it doesn't need public policy tilted in its favour. It has potential positive effects (employment, wealth generation) and potential negative effects (taking advantage of externalities, tendency toward monopoly), and the proper governmental regime is one which helps to maximize the former while minimizing the latter. Hence my dislike of "indiscriminate corporatism", which I see as policy which is so caught up in the benefits of big business as to neglect the potential harms.

Meanwhile, the best situation for small businesses is a relatively stable environment with relatively equal access to resources. If the tax and regulatory environments are at reasonable levels to begin with and stay stable, if wages are able to stay at a relatively consistent level rather than facing a Wal-Mart (SignCo?) push downward, and if there's a local bank or credit union which provides Joe's capital at a rate not too different from that available to SignCo, then Joe will have a much better chance of building a successful business in the long run.

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