Capital gains amnesia

As the Liberal government finalizes its 2017 budget, there are increasing rumours that it might increase taxes on capital gains. For a government squarely committed to improving economic growth and fostering innovation, doing so might just be the single most damaging policy change it could implement.

Unlike most taxes, capital gains are only incurred when a person sells an asset above its nominal purchase price. The fact that this makes them, to some extent, voluntary is the explanation for one of the most damaging aspects of capital gains taxes — they create an incentive for people to hold on to low performing assets. This “lock-in” effect, as it’s known, means that investors and entrepreneurs will often hang on to investments rather than selling them and investing in something new, such as an emerging business, in large part just to avoid the capital gains tax.

But that’s not all. Perhaps one of the least understood economic effects of capital gains taxes is its impact on entrepreneurship and innovation. Entrepreneurs risk their own capital and time in the hopes of profiting from the creation of a new product, an unproven service, or the introduction of a new technology.

Entrepreneurs typically accept low pay in the early stages of their enterprise so company revenues can be reinvested to meet the needs of their growing business. In return, they expect to be compensated when the business matures and is taken minister Paul Martin said about capital gains in the Liberal government’s 2000 budget: “The hightechnology sector and other fast-growing industries are particularly important to Canada’s future economic growth. Our tax system must be conducive to innovation, and must ensure that businesses have access to the capital they need in an economy that is becoming increasingly competitive and knowledge-based. An examination of the taxation of capital gains in Canada suggests that this objective would be better achieved with a reduction in the inclusion rate of capital gains”

The Chrétien/Martin Liberals reduced the capital gains inclusion rate (i.e.,