Capital-gains tax hike was needed
The firestorm of criticism unleashed by last week’s federal budget has few equals in modern times. And it’s uncalled for.
The outrage is focused on a budget provision that raises the portion of capital gains from the sale of an asset that is subject to taxation to 66.7 per cent from 50 per cent.
It applies to capital gains of more than $250,000 for individuals, and to all capital gains by corporations and trusts.
The change takes effect June 25. Opposition to that reform has come from business lobby groups, doctors, premiers, bank economists, corporate CEOs and an entrepreneurs’ group that calls on Ottawa to “scrap this disastrous take hike on investment.”
Big business isn’t happy either. The tax reform “does not send the right signal for risk-taking, for investments, innovation or longterm wealth creation and ultimately for the social fabric of our country,” Laurent Ferreira, CEO of National Bank of Canada, declared last week.
In fact, raising the inclusion rate on capital gains strengthens the country’s social fabric by making the tax system a bit fairer at a time of punishing income inequality.
“We don’t think it’s fair that a teacher or electrician pays taxes on 100 per cent of their income while a multimillionaire pays taxes on only 50 per cent of the passive income they make on capital gains,” Justin Trudeau, the prime minister, has said.
To be sure, tax fairness is not Ottawa’s only goal. It needs more money to fund its spending priorities.
Yet, Ottawa hasn’t touched middle-class tax breaks like RRSPs, TFSAs and the tax exemption from capital gains on the sale of a principal residence.
And there is a modest middleclass tax cut in the budget that Ottawa calculates will save more than 20 million Canadians about $450 in 2024 income taxes.
The latest budget also provides an exemption of at least $3.25 million for entrepreneurs selling part or all their businesses.
The new capital gains measure, which Ottawa says will affect just 0.13 per cent of individual Canadians, or about 40,000 people, is expected to raise about $19.4 billion over five years.
There have long been experts who regard the capital gains regime as unfair to everyday Canadians.
The current 50 per cent inclusion rate is a “regressive tax measure that increases inequality, benefits few, and has additional negative externalities such as fuelling the increase in already high real estate prices,” Amir Barnea, an associate professor of finance at HEC Montréal, argued in these pages in 2022.
On that 50th anniversary of the capital gains tax, Barnea proposed a 75 per cent inclusion rate to achieve greater tax fairness.
A group of well-to-do folks echoing that sentiment recently issued an open letter calling for still higher taxes on the wealthy.
Critics claim the higher inclusion rate will make Canada less attractive for business investment. That’s unlikely.
Canada’s marginal effective tax rate (METR), which accounts for all business taxes and tax deductions by federal, provincial and territorial governments, is the lowest in the G7.
Canada’s METR is 14.5 per cent compared to America’s 19.7 per cent and Japan’s 31.4 per cent.
Economists regard capital gains as “unearned income,” profit from appreciation of an asset that exceeds value the owner added to it.
For those who flip houses or companies, capital gains is often a profit on the passage of time.
The new inclusion rate on capital gains is not forever. The rate has been raised to 75 per cent in times of federal deficit (in 1990) and lowered to 50 per in times of fiscal surplus (in 2000).
Most critics of the capital gains reform say it will worsen Canada’s laggard productivity growth.
Those critics must answer for the chronic underinvestment by Canadian business in productivity enhancing plant, machinery, R&D and skills training during the past 24 years when the inclusion rate was just 50 per cent.
Meanwhile, businesses have found the money for stock buybacks that inflate the price of shares to which executive pay is tied.
The anemic rate of business investment has so undermined productivity growth that the Bank of Canada recently called the situation an “emergency.”
It’s as if Ottawa decided that since the lower inclusion rate wasn’t boosting productivity, the government might as well tax a larger share of those idle profits.
And to use that money to finance its ambitious $8.5-billion housing plan, a new $1.5-billion pharmacare program, funding for more daycare spaces, one of the biggest-ever increases in defence spending ($8.1 billion) and a new $1-billion school lunch program.
And to make those additional investments without increasing the deficit, which is projected at $39.8 billion in fiscal 2024-25, basically unchanged from the previous year’s $40-billion deficit.
No one likes higher taxes. But in its reform of capital gains taxes, Ottawa has settled on a least-bad way of financing improvements to Canadian quality of life.