Developing a better regime for the preferential taxation of small business

In Australia, small businesses have been generally subject to the same tax rules as larger enterprises, although for many decades, those operated as private companies were arguably more heavily taxed in respect of retained profits. However, since the mid-1980s, Australia has gradually shifted its approach and began adopting increasing numbers of tax concessions for small businesses, in contrast to the ordinary taxation regime applying to larger enterprises (and small businesses that did not qualify for any tax concessions). Australia’s government recognises and accounts for these concessions as tax expenditures, the equivalent of direct spending subsidies to support various activities of, and investments made by, small businesses. The concessional regime for small businesses is a unique subsidy system. First, the rationale for special treatment of the sector is uncertain. That is, viewed objectively, most explanations for such concessional treatment are difficult to sustain. Second, whatever the empirical studies may show, Australian politicians on all sides of the political spectrum believe there are social, economic and political benefits through the provision of tax concessions for small businesses and, as such, the continued use of concessions for this sector is inevitable. For the foreseeable future, concessions for small businesses appear to be ingrained as part of Australia’s tax system. The challenge, therefore, is to devise concessions that are efficiently targeted to provide appropriate subsidies where they are most likely to achieve the goals ascribed by policymakers and politicians enacting the measures. Efficiency, in this context, is synonymous with effective targeting. That is, tax expenditures should not deliver windfall benefits to those enterprises that can already operate profitably and expand in the market under the ordinary tax regime without the provision of concessional subsidies; similarly, concessions should not miss small businesses that require subsidies to generate the requisite social and economic benefits sought by the government. In this regard, current tax expenditures for small businesses fare poorly and, historically, Australia’s taxation system has been recognised as an impediment to the efficient growth of the small business sector. This is because concessions have not been the product of rational design, but instead have represented an amalgam of ad hoc measures subject to continual, often inconsistent, and sometimes contradictory changes. This thesis proposes an alternative approach to the design of tax concessions for small businesses based, first, identifying an optimal benchmark for evaluating the needs of the sector and, second, by the evaluation of alternative concessions in terms of that benchmark to ensure they operate efficiently by targeting those small businesses that most need the concessions. The proposed benchmark is based on the business ‘life-cycle’ model of small businesses, which examines the progression of the business as it moves through successive stages from start-up to decline. An evaluation of past, present and proposed tax concessions for small businesses, as well as variations used in other jurisdictions by reference to this model, finds that most are poorly targeted and thus inefficient as subsidy programs. A program for alternative and better-targeted small business concessions designed by reference to the benchmark life-cycle model is developed in the course of a chronological review of tax concessions afforded to small businesses in Australia.