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Canada’s Historic Aversion to Risk: Why Aggressive Tax Policy is the Best Solution
October 15, 2017
Canada’s DNA is more risk averse than in the U.S., and the challenge of encouraging people who have the ability to strike out on their own is bigger here. I think there are good reasons for this. In my first full time job, like many others of my generation, I worked for an American company. I remember going down to the US for training, with a group of Canadians, to a facility where a huge cohort of Americans was also being trained. We spent three weeks there, total immersion, in close proximity with each other.
I came away with the strong impression that my Canadian colleagues were generally better educated and smarter than the Americans being employed at the same level. Eventually I theorized that the smarter, better educated Americans had been recruited to higher level jobs, in a head office where important decisions were made. Canada, I surmised, didn’t have enough head offices to absorb our best candidates, so many very able people were underemployed here. The term you heard a lot in those days was “branch plant economy”. Even the American companies that maintained Canadian head offices, even where they had some autonomy, were there to localize strategies they did not develop themselves. People with executive titles were, in fact, senior managers, not in enterprises with proprietary technology, but essentially in dealerships and factories.
This was a result of conscious choices made after the Second World War, when the need to employ the large numbers of returning soldiers was a government priority. Canada had punched above its weight in World War II, with a much higher percentage of its population in the service than many other Allies, and the challenge government faced was how to absorb this returning productive capacity. Attracting American (and sometimes British or French or other countries’) branch plants was a key tactic for addressing this. C.D. Howe was a key figure in this strategy, which led to the arrangements like the Auto Pact, where American companies were required to build as many cars in Canada as they sold here. It was an approach that aligned well with Canada’s immaturity as an economy at the time, and with the strong preference for security over risk that many still see as a differentiator vis a vis our southern neighbours.
There was an economic nationalism backlash to this, and government policies against foreign investment did emerge over time. Over the course of my career however I observed that many of my contemporaries, who had cut their teeth in the employ of American Fortune 500 companies’ Canadian operations, left the country.
Some however became independent businesspeople: their career opportunities to stay in Canada and advance and be challenged were simply too limited. Many of these people had seen how a business could be run, how it could grow, had been well trained by their American employers in business practices. Some thought they could make more money on their own, others, that they could run a more efficient business that better reflected their values, and still others that they simply needed more challenge than the promotions available without going to the U.S. A few had a burning idea that they thought would give them a competitive edge, and wanted to own the results of their inspiration. In some cases, like my own, it was a combination of these things.
Canada’s economy has matured a great deal since the early days of my career. At the same time, the branch plant Fortune 500 approach to security is no longer adapted to the rapid technological, social, environmental and global change that we face. In the modern environment, we need bold people to guess where things will go and bet their lives on it. Canada’s DNA is still risk averse, though much less so than before, and government needs to facilitate starting enterprises: though many will fail, or have only short periods of success, it is a highly flexible assortment of smaller businesses that can, in the aggregate, create economic stability and thus real security for Canadians, and reduce our dependency on resource extraction and branch plants.
Full Disclosure: I was an entrepreneur and owner operator of my own business for 25 years. We employed 200 Canadians at our peak, had a positive impact on carbon footprint, and were an import replacement as well as an exporter, and a positive contributor to the balance of trade. During that time, we personally, the company, and all the employees paid many millions in taxes, which helped to pay for schools, hospitals and roads. We spawned many imitators who also contributed to the Canadian economy and society. However, at the start, we were a completely bootstrap operation, very resource challenged: as soon as we experienced some growth, we were even more cash-strapped, as we had to expand inventory and hire people before the money came in from our customers. We were very creative, and gratefully used every tax advantage we could find to give us more runway for expansion. In particular, those which meant my own expense to the business was as small as possible.
I had been reluctant to leave a secure “executive” role in a large company and strike out on my own. It was easier in my case than for many others. The challenge would have been much greater for those with children and mortgages. Nevertheless, it was a huge leap of faith for me as for all other entrepreneurs: the most apt description I have heard is that it is akin to jumping out of an airplane knowing that you have to make your parachute on your way down.
That is just the start. It gets harder from there. Starting the business takes longer and costs more than you think it will. I had to eat humble pie and work contracts with my old employer on the side to make ends meet for a long time. Cash constraints also slowed down the growth of the company: we had to wait before hiring and taking advantage of a market opportunity we had clearly identified. In those days, there was not the Angel Capital ecosystem that exists today, and what we now call “burn rate” was then referred to as “losing money”: no one would help you finance that!
Even though for many years I made less than my key employees, I still found the burden of paying myself a huge drain on the business. For every dollar I needed to live, I had to take about $1.60 out of the company to get to that net amount.
I remember thinking if I were in government, I would do something about that: give entrepreneurs a personal tax break on their own income drawings for every person they hired, for example, for the first ten years perhaps, so that if they grew the business they could support their own needs while leaving more money to fuel the business’s expansion. The beauty of tax breaks to help a business conserve cash is they only go to businesses that are succeeding: much better, I thought, than the government trying to pick winners in industries whose dynamics could only be understood by those intimately involved in them.
From my own experience, I think we need to encourage people with some business background as managers and executives to take the leap. Such people often have mortgages and children, and are successful enough that they live at a middle-class level, with all the costs of raising families. While they can reduce their income to a degree, to maintain their lives they will be a significant cost in the early years of a new business. These are the people we want to abandon the security of their successful careers to make a more significant contribution to the economy through entrepreneurship. If we were designing a tax policy specifically to encourage people who already have family obligations to take a chance and start their own businesses, “sprinkling” for example would probably be a tactic we would consider.
(Further, once we have a successful private business, and the knowhow to run it has been passed to another generation, the transfer of that business within a family is in the best interests of the economy and the country. The sale of the business to a public company, often not Canadian, will almost certainly result in a loss of jobs and consign the company to the quarterly pressures and executive compensation driven strategy common to such organizations. Within the fold of the larger organization, the innovative, nimble virtues of private companies, which collectively create economic stability, will be lost.)
In Canada, becoming an entrepreneur is a huge challenge. Our home market is small, our ecosystem for finance and guidance less developed than in the United States, and our aversion to risk deep-rooted. We need aggressive tax policies to help people start businesses. We need people with mortgages and kids, who have already shown they can work effectively for others, and have some experience to bring to the table, to start private businesses, and to be able to invest in them. It is not easy for people to do this. If it is a policy objective worth pursuing, we should seek every available incentive to make it attractive for people to take the chance. Once they have done so and been successful, when they pay less personal tax they can leave more money in the businesses, helping it to grow and hire more Canadians.
The current provisions, including sprinkling, make it easier for people with spouses and children to start and to grow companies. Such people are deeply personally committed to their businesses: they become dependent on them for their livelihoods, they are the most significant component of their net worth, and they therefore create stable employment. Private businesses have their head offices in Canada, and create opportunities for more of our best to stay here.
The rhetoric around the proposed tax reforms notwithstanding, it is to be hoped that the government has been listening as the private business community has reminded it of the benefits to the economy of the tax policies prior governments of both stripes have introduced and reaffirmed over decades, and which have contributed to the country’s increasing independence from its branch plant past. Canada has become a good place to start a business, and is developing an innovative, risk taking entrepreneurial culture that should be nurtured in every way possible. If people who start businesses and succeed have good lifestyles and the trappings of success, more will want to emulate them, and that is a good thing, not a reason, out of jealousy or a misguided sense of fairness, to undo the structures that enabled their prosperity.