Stop Canada's War On 'Passive' Investment
By Lee Friday | November 07, 2017 |

While an unhampered market remains elusive in both countries, government policies are more anti-business in Canada than in the United States, and the gap appears to be widening. As state governments in the U.S. are trying to attract business investment, Canadian governments seem intent on granting their wishes.

As an example, Ontario’s Liberal government is responsible for high electricity costs, new labour laws (including a huge increase in the minimum wage), a cap-and-trade program, and other regulations which are prompting many businesses, including Magna International, to reconsider their plans. A report published by the Fraser Institute on October 12th tells us:

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In July 2017 Magna testified at a government hearing on the proposed overhaul of labour legislation that the high cost of operating in Ontario had led it to reconsider future investments and production in the province, especially as neighboring states in the US are pursuing policies to attract investment.

Bill Morneau, Canada’s Minister of Finance, is preparing to impose further restrictions on business investment. His proposed policy will limit “passive investment” within a small business, because in his view this money should only be invested in “active business” i.e. the actual business conducted by the small business corporation.

Political Rhetoric -- 'Active' Versus 'Passive' Investment
Suppose you are an electrician and you operate your small business through a private corporation. As you accumulate income beyond what you feel would be prudent to reinvest in your business at the present time, what do you do with the extra money? You have already withdrawn what you need for living expenses and you don’t want to withdraw any more money from the company because the personal income tax rate is much higher than the small business tax rate. So, you leave the money in the company and invest it in the bonds or shares of a major corporation. However, Bill Morneau says this is a “passive investment” and he doesn’t want you to do that.

Instead, the Finance Minister wants you to either (a) invest the money back into your electrician business, or (b) withdraw the money from the company, which triggers a high rate of personal income tax in favour of the government. I’m pretty sure he expects more of (b) than of (a). He wants Canadians to believe his policy is designed to promote economic growth, not the growth of government revenues, though it seems obvious he craves the latter. Bill wants to collect the bill. However, economic growth is hampered when money is diverted from private investment to government spending. As Frank Shostak wrote, “government is not a wealth generating entity — the more it spends the more resources it has to take from wealth generators. This in turn undermines the wealth generating process of the economy.”

During a media interview, Morneau said he wants “people to invest in business so that we grow the economy.” Fair enough, but there is no economic justification for making a distinction between so-called ‘active’ and ‘passive’ investments. The goal should be business investment, period. The small business owner will invest his money in whatever business he feels will yield the highest return, given his appetite for risk. At any given time, market conditions may be more favorable to an investment in the bonds or shares of a major corporation (passive investment) than they are to an investment in his “active business.” The investment that should be made is the one that holds the greatest appeal for the investor. Decisions must remain in the hands of those affected by the decisions.

Morneau claims to “know that there is significant economic opportunity for us to have more investment in active businesses.” Sorry Minister Morneau, but it is the small business owner himself who is uniquely qualified to make that decision. As long as market participants are unconstrained by the government’s arbitrary rules, there is an overwhelming tendency for money to flow into enterprises offering a higher certainty of greater profitability, which bodes well for economic growth. This is a state of affairs the Minister of Finance should welcome if he really means what he says about wanting to grow the economy.

Morneau says it is bad that a lower business tax rate (as compared to the personal income tax rate) is encouraging all this “passive investment.” But why is this a bad thing? When lower taxes produce a greater level of business investment, this can only be a good thing. If he really wants economic growth, Morneau should stop criticizing passive investment, and start celebrating business investment.

Conclusion
Intense criticism has forced Canada’s Finance Minister to modify his plans. He says he will now allow a threshold of $50,000 of passive income to be sheltered each year. However, this still means that future income on more than $200 billion in passive investments will be subjected to a much higher tax rate.

Economic growth in Canada will continue to be hampered as long as the government continues to erect roadblocks to business investment. It is likely that many businesses are already preparing to leave Ontario. Further economic deterioration will follow as Morneau eliminates some of those evil passive investments. The U.S. economy will benefit.

According to the October 12th Fraser report referenced earlier:

Business investment is central to long-term economic growth and rising living standards. . . . it is shocking that Canada invests less of its GDP in services and about the same in manufacturing as a poor nation such as Greece...

Morneau should read the Fraser report, and he should do so immediately, while there are still a few businesses operating in Canada.

This article originally appeared on Mises.org.

 

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