Raising capital gains taxes will harm Canada’s growth and deter crucial investments

Ian Madsen: Capital gains tax increase guarantees more stagflationLast month, Canadians were treated to the latest growth-strangling budget of our mushrooming federal government. Beyond the Trudeau government’s typical lavish spending plans, one particular change has sparked significant concern: the increase in capital gains inclusion rate from one-half to two-thirds.

For someone earning over $250,000 annually – the new proposed federal exclusion level – their marginal tax rate on capital gains will increase significantly. In Saskatchewan, for example, it will rise from roughly 24 percent to 32 percent; in British Columbia, it will jump from 26.5 percent to 35.5 percent,

It’s crucial to remember that these capital gains taxes are in addition to the taxes already levied on business profits. This increase affects large publicly traded corporations and small businesses, including physicians’ practices, which will be particularly hard hit.

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This issue extends beyond what some might dismiss as ‘rich people’s problems’; it represents a typical socialist solution that soon becomes a problem for everyone. Particularly affected are entrepreneurs and venture capitalists, who will be left with fewer resources to reinvest in new, innovative, and growing businesses.

Future ventures will become less attractive as potential profits from a business sale decline. Institutional investors and affluent individuals will have fewer dollars to invest in venture capital funds. Although these investors are not directly affected by the increase in capital gains inclusion rate, the entrepreneurs who manage these ventures and their companies are – and they are essential partners in these investments.

Trevor Tombe, an economics professor at the University of Calgary, has calculated that the effective marginal tax rate on capital gains – meaning the tax on the next dollar earned – would increase from approximately 27 percent to 35 percent, nearing the top marginal 40 percent income tax rate (varying by province). This change shifts Canada’s position from 13th to third worst in the Organization of Economic Cooperation and Development rankings and is significantly higher than in the U.S.

This last point is crucial because the U.S. boasts the world’s oldest, largest, deepest, broadest, and most diverse venture capital ecosystem. Although California taxes are high for the U.S., Canada’s are even higher. California also has generous re-investment features to lessen the tax blow on a business sale.

It’s challenging to quantify the wealth that has not been created over the past 10 years, a period during which Canada’s productivity growth rate has lagged significantly behind that of the U.S. This shortfall is reflected in Canada’s substantially lower per capita GDP, which stood at approximately US$20,800 in 2022 but is now 27 percent lower. Our current economic malaise will likely devalue our currency further, making Canadian assets – such as businesses, stocks, bonds, or real estate – more attractive to foreign investors, who can acquire them at bargain basement prices.

The Council of Canadian Innovators and the Venture Capital and Private Equity Association of Canada warn that increasing the capital gains inclusion rate will harm investment and growth. While the Trudeau government’s latest budget optimistically projects it will affect just 0.13 percent of taxpayers and raise $19 billion, there is substantial evidence that high-income individuals change behaviour in response to tax increases, with these types of tax hikes generally yielding less than forecasted in revenue.

It all seems utterly senseless to damage Canada’s growth prospects by raising capital gains taxes, especially as we already struggle to attract investments that could transform economic stagnation into robust growth and prosperity.

Interestingly, Donald Trump’s election platform includes cutting the U.S. capital gains tax to 15 percent.

Hopefully, this will finally set off some alarm bells in Ottawa, but don’t hold your breath.

Ian Madsen is the Senior Policy Analyst at the Frontier Centre for Public Policy.

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