Don’t tax homeowners’ equity
The idea of eliminating the capital gains exemption on the sale of a principal residence is once again being floated as a panacea policy from Ottawa. It supposedly would lower the federal deficit, reduce inequalities, inhibit house-flipping and limit Canadians’ overinvestment in real estate rather than other forms of capital. But it would also harm most Canadians. And it very likely wouldn’t generate the benefits claimed for it.
Unexpectedly changing a long-established tax rule that has shaped the behaviour of Canadian households over decades would be deeply disruptive. It would expropriate substantial wealth that had been accumulated prudently and honestly over the years and would do so in a cavalier and discriminatory manner. Not only would it breach the social contract, it would be political suicide. Reducing the advantages of home ownership would necessarily lead to a general drop in house prices. Prospective buyers would benefit. But they would be a minority: twothirds of Canadian households own homes, virtually all of which were bought under the current rule.
Taxing the sale of a home would also create inequities across homeowners. Baby boomers who recently sold their homes would have avoided both the tax and the ensuing real estate slump; anyone who hasn’t yet sold would be hit by both the tax and the devaluation of their property. People planning to use money from the sale of their home to finance their retirement would be especially hard hit — and would feel especially betrayed. Even worse, this big, onetime capital gain could push many homeowners into a higher tax bracket. Imagine their tax bill if at the same time the government also increased the capital gains tax rate, a measure it is also rumoured to be contemplating.
Because of the pandemic many homeowners are already having trouble servicing their mortgages. With a new tax on capital gains from the sale of principal residences, others could see the value of their home suddenly drop below their mortgage balance. By selling at a loss or, as many Floridians did in 2008- 09, simply dropping their keys on the kitchen counter, a growing number of defaulting homeowners would undermine an already weakened financial system. Do we really want another government bank bailout in our future?
Younger, more recent and more indebted buyers would be particularly in danger. A sudden drop in real estate prices could rob them of their home, savings and future ability to borrow. Richer households would be hit, too, but their residence often represents a smaller fraction of their wealth, so they would be less disadvantaged by the tax and might in any case be able to use creative legal loopholes to avoid it.
No doubt many people would postpone selling their homes to defer the tax — a “lock- in effect” seen with other assets on which capital gains are due on realization. Unemployed homeowners might even decline job offers in other regions so as to avoid tax on the sale of their home. This would be a lost opportunity for both the jobless and their prospective employers — not to mention the government, which would be deprived of tax revenues on the capital gain itself, the employee’s earned income from a new job and the hiring firm’s increased profits; and beyond that, it would have to keep supporting the unemployed homeowner.
Prospective buyers would face lower home prices, to be sure. But, with the capital gains tax exemption gone, owning a home will have become less profitable. If the goal of policy is to make home ownership more accessible, causing housing to be a less attractive investment is a strange way to go about it.
To be fair, there is some truth to claims that the current exemption encourages house- flipping and speculation, inflates home prices and, in general, causes too much capital to flow into housing. If this were 1972 and we were inventing Canadian capital gains taxation all over again from scratch, it might be better to treat housing on a more equal footing with other forms of capital. But we are not starting from scratch. Millions of Canadians have bought homes on the assumption that the difference between their home’s selling price and the price they bought it for would not be taxed. Even if a new capital gains tax exempted the gain in house prices due solely to inflation, it would seriously reduce people’s wealth and disrupt their financial plans.
Rather than cause worried homeowners to sell prematurely on the rumours of a bad tax, the government would do better to lay the foundations of a sound, credible and fair-minded capital gains tax reform. In 2015, Quebec’s Godbout Commission recommended an overhaul of capital gains tax that would tax only new capital gains on residences, i.e., those earned after the reform was introduced, would control for inflation, would limit the lifetime exemption and would tighten rules to contain speculation. It would be a start.
But it would not be a money grab. Revenues would only appear gradually. It would help reduce deficits in future decades, not this one. It’s hard to believe today- focused politicians will be interested.
NOT ONLY WOULD IT BREACH THE SOCIAL CONTRACT, IT WOULD BE POLITICAL SUICIDE.