Fear of bad taxes
The argument that the federal government should limit tax breaks that favour high- i ncome earners has recently been circulating in the media.
Further increasing already high tax rates would hinder Canada’s capacity to attract and retain talent. Without more skilled workers, both economic growth and the tax base will erode and less mobile workers will be left holding the bag.
At a time when the United States is considering lowering taxes, it is imperative that the Canadian tax regime remains competitive.
In addition, modifying long standing arrangements that form the basis of Canadian household retirement plans would be a game changer for older households. It would also likely incite some productive and younger workers to leave the labour force, if not the country.
Proponents of these kinds of changes suggest that income splitting be eliminated and that the government tax the capital gains made on the sale of a principal residence.
Such proposals omit important considerations.
For e xample, i ncome splitting exists because it rightly appears unfair that the tax bill of a couple with two $ 50,000 income earners would be lower than that of a couple with only one $100,000 income.
Taxing gains from the sale of a principal residence would, in all likelihood, cause a collapse of the Canadian housing market. It would make buying and selling a home particularly onerous.
Highly l everaged new homeowners could see the value of their home fall below their mortgage and suffer a capital loss.
For others who plan to use the proceeds of the sale of their home for retirement, the consequences of such a tax and resulting lower home prices would be devastating. Worse, for many, the onetime gain would move them into a higher tax bracket. A loss, on the other hand, could not be deducted unless there were offsetting capital gains.
Since a vast proportion of Canadians save for retirement through home ownership, the measure could lead to an increasing number of households without enough retirement savings, increasing government liabilities.
Another major problem is that inflation has contributed to substantial home price appreciation over the last half-century; yet often without any appreciation in real terms.
Consider the case of a household which bought a house in 1965 for $ 15,000 and sold it for $140,000 thirty years later. Most likely, with inflation raging throughout the seventies, the $ 125,000 gain would pale in comparison with the money spent over three decades to maintain the house. Would it have been fair to tax that nominal capital gain, which was likely a loss in real terms? A tax on the sale of a home upon retirement would also be an intergenerational inequity.
Many retirees from the baby boom generation who have recently sold their homes would have avoided the tax; current homeowners from the next generations would not. Their taxes would continue funding the generous social benefits baby boomers provided themselves; until these run out when it will be time for the next generations to retire.
Other proposed measures include taxing capital gains in full and eliminating the preferential tax credit on dividends paid by corporations. The reduced tax rate applied to capital gains was mainly enacted to lessen the damaging impact of inflation on financial returns.
Even if inflation is lower today than in the seventies, real returns on equity have also come down in the past decade — and the return on bonds are mostly negative.
Recent dismal productivity growth points to even lower real returns in the future. Today, with expectations of 2 per cent annual inflation and 4 per cent nominal capital gains, the real return of equity would effectively be 2 per cent. This is still consistent with the logic of including only 50 per cent of capital gains into one’s taxable income as it yields a meagre after-tax annual real return of 1 per cent.
Increasing tax rates on dividends and fully taxing capital gains as regular income would likely provoke a sharp drop in the value of Canadian equity.
This would also likely increase the cost of capital for businesses, leading to reduced investment. A higher cost of capital and less investment are a recipe for an even deeper decline in returns and faltering economic growth.
Finally, lower equity value and home prices, as well as a reduced number of transactions, would bring significantly lower taxes than anticipated, weakening the case for a tax increase.
Because stocks and homes are widely held, such measures would be deeply unpopular with a significant portion of the population, not only high income earners. Adopting a political platform at the expense of citizens who have accepted the rules of the game and honestly played by them would not be a winning strategy.
It may thus be an opportune moment for the federal government to set the record straight and comfort Canadians that it is not behind such suggestions for tax reform.
Otherwise, the uncertainty that these rumours are generating will continue inhibiting economic growth, adding to the uncertainty already coming from south of the border concerning taxes and trade. They may also start triggering human and capital flight out of this wonderful but cold country of ours.
TAXING GAINS FROM HOUSE SALES COULD COLLAPSE THE MARKET.