Will the federal budget reduce income taxes or increase capital gains?

TOP COMBINED INCOME TAX RATE 54%

Speculation is rampant in the tax community as to both when the government will deliver its final federal budget before the October election and, more importantly, what tax measures it might contain.

THE DATE

COMMENT rates, where the top U.S. federal rate is 37 per cent and is reached only when income tops US$510,300 (about $675,000 in Canadian dollars). With some states, such as Florida, imposing no state personal income tax, the top rate for a high-income Tampa taxpayer is a mere 37 per cent vs. 54 per cent for a toprate Halifax resident.

During the consultation process, the Business Council of Canada supported increasing the federal personal income tax brackets to “more closely align them with the U. S. tax brackets.” The Canadian Vehicle Manufacturers’ Association advocated lowering the personal tax rate to “encourage the attraction and retention of a highly skilled labour force.” Accounting firm MNP LLP recommended that the personal income tax bracket thresholds should be expanded “based on a higher multiple of the bottom bracket’s threshold” and that the combined federal/ provincial marginal tax rate of Canadians should not exceed 50 per cent.

And in the C.D. Howe’s annual shadow budget released last week, co-authors William Robson and Alexandre Laurin recommended doubling the threshold at which the top federal tax rate applies as “longer-term, heavy taxes on high earners depress entrepreneurial activity and private investment. Excessively taxing the talent that fuels a more innovative, creative and successful economy is counterproductive.”

CAPITAL GAINS INCLUSION RATE

Finally, what pre-budget punditry would be complete without speculation as to whether the government might increase the capital gains inclusion rate? Under current rules, capital gains are taxed at a 50 per cent inclusion rate. Historically, the inclusion rate was 66.67 per cent in 1988 and 75 per cent from 1990 to 2000. An increase in the inclusion rate would increase the tax arising on the sale of nonregistered stocks, bonds and mutual funds.

During the consultations, the Canadian Centre for Policy Alternatives advocated the “elimination of tax measures that disproportionately benefit the wealthiest Canadians, such as … the preferential tax treatment of capital gains.” The Confédération des syndicats nationaux agreed that the capital gains inclusion rate should be reassessed.

Increasing the inclusion rate would bring the tax rate on capital gains closer to the rate on dividend income. For example, in Ontario, the top rate on a capital gain is currently 27 per cent, while the top rate on Canadian dividend income is 39 per cent for eligible dividends (47 per cent for non-eligible dividends.)

Raising the capital gains inclusion rate may be something the government considers to stop some of the surplus stripping transactions currently being contemplated by private companies looking to extract surplus from their corporations at capital gains rates instead of dividend rates. This type of behaviour was acknowledged in the C.D. Howe report, which observed that high-income taxpayers “can respond to tax-rate increases by converting their income to different, lowertaxed forms” which “shrink the tax base and reduce tax receipts.”

That being said, increasing the inclusion rate could have negative repercussions on Canadians’ savings and investment rates and make Canada less attractive compared to other countries, many of which have preferential tax rates for capital gains. According to the Report of Federal Tax Expenditures (2018), the lower inclusion rate provides “incentives to Canadians to save and invest, and ensures that Canada’s treatment of capital gains is broadly comparable to that of other countries.”

HEAVY TAXES ON HIGH EARNERS DEPRESS ... INVESTMENT.