Canada’s productivity was higher during periods when capital gains taxes were higher

By Katrina Miller
and Ryan Romard

The recent furor over the federal government’s capital gains tax increase has shone a light on the fact that, since 2000, the wealthiest Canadians have enjoyed a tax holiday on half of their income made through selling investments like stock and property while workers pay taxes on 100 percent of their earnings.

The 2024 Federal Budget proposes an increase of capital gains included on the income tax bill from one-half to two-thirds for corporations, trusts, and all gains over $250,000 for individuals. It’s a modest but necessary step towards making Canada’s tax system more fair at a time when new research shows the wealthiest face a lower tax burden than almost everyone else.

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Taxing capital gains doesn’t hurt productivity, but inequality certainly does

Conservative economists and lobbyists are emphatically lamenting the proposed change in light of the Bank of Canada’s claim that we are facing a productivity emergency in our economy. This impending crisis, we are implored to believe, will be amplified by a tax change that impacts only 0.13 percent of Canadians.

This claim, coming from some of the highest-earning industries and individuals in the country, asserts that any tax increase on capital income will harm productivity by discouraging investment. It amounts to baseless fear-mongering. The notion that capital gains taxation hurts productivity is simply untrue. In fact, when looking at productivity rates in Canada over the decades, an entirely different picture becomes clear.

Canadian historical data shows that the level of capital gains taxation has no correlation with productivity. Our research shows that Canada’s productivity was actually better during periods when capital gains were taxed at higher rates. That’s because of macroeconomic factors: the natural boom and bust cycle of our economy and a global trend of slowed productivity in advanced economies are far too powerful to be impacted by shifts in the capital gains inclusion rate.

For example, Canada’s highest productivity rate in recent history occurred during the tech boom of the 1990s, when the capital gains inclusion rate was at its historical high of three-quarters. So much for the tech world’s assertion that their success depends on tax breaks for wealthy investors.

Prolonged productivity decline is a well-studied global trend that is impacting all of the advanced industrial economies across the world. Labour productivity gains shrink as mature economies grow. In economics, this is commonly referred to as the “productivity puzzle” – an indication that economists do not fully understand why it occurs. Interestingly, lagging productivity in Canada lines up with the end of the late 1990s and early 2000s technology boom. At this point, numerous tax cuts were instituted with the promise of improving productivity, including a reduction of the capital gains inclusion rate from its historic high of 75 percent down to its lowest level since inception, 50 percent.

Instead of boosting productivity, lowering capital gains and other taxes actually heralded a long age of decline.

If corporate taxes aren’t behind low productivity, what is?

Countries with lower income inequality tend to have much higher productivity, and vice versa.

Studies and data reviewed in our most recent report show that rising inequality causes productivity levels to worsen. As income inequality rises, educational and employment opportunities for those on the bottom end of income distribution worsen. Higher-income inequality leads to poorer health, and workforce health has a large impact on productivity.

The destructive impact of wage inequality on productivity is also demonstrated by evidence that unequal wages within businesses reduce productivity. Low wages result in low effort; it’s common sense backed by evidence.

For all of the fear-mongering over the capital gains increase, evidence points to Canada’s growing inequality as a substantial component of our productivity problem.

From that starting point, the outlines of a progressive solution for dealing with the productivity challenge become clear. It begins with tackling inequality, reversing underinvestment in public services and promoting wage growth.

To accomplish this, Canada must take many more steps to undo decades of unfair, regressive taxation. The concentration of wealth and income abetted by unfair taxation has been a central driver of rising inequality.

With this understanding, the increase in capital gains can be a step towards more productivity in Canada, not less.

Katrina Miller is the executive director of Canadians for Tax Fairness, and Ryan Romard is a research associate with Canadians for Tax Fairness.

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