Self-Interest of Wealthy Investors Explains Over-the-Top Reaction to Capital Gains Reform

The federal government’s 2024-25 budget included an important reform to the taxation of capital gains. Capital gains occur when an asset is sold for more than it cost to acquire. Capital gains are heavily concentrated among high-income Canadians – more so than any other form of income. And making matters worse, they receive lucrative tax preferences: until this year, recipients only had to declare half their gains on their income tax (for a so-called ‘inclusion rate’ of 50%). The other half was entirely tax-free. In contrast, other forms of income (like wages and salaries) must all be reported on a tax return: that is, their ‘inclusion rate’ is 100%!

The federal budget announced a change in the capital gains inclusion rate: rising to 66% for corporations, and for individuals above a threshold of $250,000 capital gains in any single year. The number of individuals directly affected by this change will be very small. But they are also very powerful (given the concentrated wealth in the hands of the largest capital gains recipients, and their powerful allies in the financial sector). So this provision is being aggressively resisted by an alliance of wealth-owners, financial advisers, and Conservatives – the latter hoping that rolling back capital gains taxes can be the spark for a broader revolt against general taxation (and the public programs that taxes pay for).

Below is a version of a column by Centre for Future Work Director Jim Stanford, originally published in the Toronto Star, debunking some of the most common myths about capital gains and the proposed tax reform. Dr. Stanford also appeared as a witness in the first hearing into this measure hosted by the House of Commons Standing Committee on Finance; see his opening remarks here.

Capital Gains Reform is Hardly Cause for a Tax Revolt

By Jim Stanford

Finance Minister Chrystia Freeland tabled legislation last week with details on a key feature of her recent budget: reforming the tax treatment of capital gains. At present, individuals and corporations only include half of their capital gains (profits captured by selling an asset for more than it cost) on their income tax returns.

In future, individuals will have to declare two-thirds of those gains in excess of $250,000 in a year (below that threshold, the inclusion rate remains 50%). Corporations will also have to include two-thirds of capital gains in calculating corporate tax (although only one in eight corporations report capital gains at all). Important exemptions (for small business owners, farmers, and start-ups) will be maintained and expanded.

A capital gain results not from producing and selling a product or service, but rather from acquiring and re-selling an asset. It reflects speculation, not production. Other forms of income (like wages for workers) must be fully declared. Granting asset owners this unique preference is morally unfair, and fiscally wasteful.

Since the wealthy, by definition, own most wealth, the benefits of the capital gains exemption are captured overwhelmingly by very well-off Canadians. Indeed, there’s probably no other tax loophole so targeted at the wealthiest Canadians. In 2021 (most recent Canada Revenue data), Canadians with over $250,000 in taxable income made up 1.5% of all taxfilers, yet they pocketed 61% of capital gains exemptions – worth a cool $180,000, on average, to each.

The government cleverly split off this measure from legislation implementing the rest of its budget, in hopes of revealing who in Parliament aligns with the interests of this favoured minority. Ending weeks of speculation, Conservative leader Pierre Poilievre took the bait and voted against the reform. Worried this will show he supports rich “elites,” despite his ostentatious criticisms of them, Poilievre frames his opposition as just the opening salvo in a bigger crusade against overtaxation.

But it’s hard to even interpret this change as a ‘tax increase’. The tax rate on declared capital gains won’t change. It’s the mere fact they’ll have to pay tax at all on an additional one-sixth of their gains (the difference between 50% and 66%) that has the well-heeled reaching for torches and pitchforks. Meanwhile, the rest of us somehow manage to go through life with a 100% inclusion rate for our hard-won incomes.

Finance Canada analysis suggests a tiny fraction of individual taxpayers (0.1%) will be directly affected by this change each year. But powerful voices want to defend this rich loophole for rich people, and are trying hard to portray it as a wider-ranging tax grab. These are some of the most disingenuous myths propagated in this fear campaign:

It Will Undermine Entrepreneurship: A capital gain is not generated by starting and running a business; it’s generated by selling it. If your goal is to profit from running a successful productive business, please keep doing that with no change in your taxes. Generous new exemptions for start-ups mean capital gains taxes will actually fall, not rise, for genuine entrepreneurs.

It Will Discourage Innovation and Productivity: Spending by Canadian business on machinery and innovation has been falling since the 1990s – the exact time when corporate taxes (including on capital gains) were slashed dramatically. Cutting the capital gains inclusion rate (it used to be 75%) didn’t boost productivity; raising it won’t reduce it.

Punishing doctors: Most professionals incorporate to obtain generous tax and liability benefits. Capital gains exemptions are just the icing on that very sweet cake — and most of the icing is still there. Doctors and other professionals can fund retirement like the rest of us (via CPP, RRSPs, TFSAs and savings) despite a smaller capital gains loophole.

What About the Family Cottage?: Any modestly intelligent accountant will easily avoid most or all higher capital gains inclusion on family cottages and farms. Farms have a $1.25 million lifetime exemption. The $250,000 annual threshold can be claimed by each member of a family with shared ownership. And by staging property sale over several years (through a capital gains reserve) that threshold can be invoked five times over.

Most academic economists support this reform because it creates a more level playing field between different types of capital income. But the best argument for it is the $20 billion in additional revenue it will raise over five years, overwhelmingly from Canadians of ample means, to fund important new programs also announced in this budget. This revenue will help Ms. Freeland fund school lunches, affordable housing initiatives, dental care, and disability benefits – while still staying within her fiscal ‘guardrails’.

It’s not just how this revenue is raised, but how it will be spent, that will make Canada a somewhat fairer, healthier place. And make no mistake: wanting to defund those programs is the main motivation for Mr. Poilievre’s opposition to this tax measure, and taxes in general.