When you buy a share of a publicly traded firm for $100 and sell it a year later for $120, you made a “capital gain” of $20.
As opposed to employment income, which is fully taxable based on one’s marginal tax rate, capital gains get a special treatment — only half of them are considered as income. Hence, in the above example, only $10 of the gains would be taxable, and the other $10 would be pure profit, tax free.
Taxation on capital gains was implemented in Canada exactly 50 years ago. After almost a decade of study and debate, E.J. Benson, then-minister of finance in Pierre Trudeau’s government, introduced the measure as part of an overall reform of the Canadian tax system.
In a white paper titled “Proposals for Tax Reform,” Benson outlined the rationale for taxing capital gains: “A Canadian who is able to realize a substantial stock market profit or real estate gain … is better able to pay for a new car, or to pay for stocks and bonds, or to pay income taxes, than is his neighbour who has not had such a gain. As a result, some very well-to-do Canadians pay far less tax than others with similar abilities to pay, and less even than others with much lower incomes,” he wrotein 1969.
Benson’s interpretation makes perfect sense — taxing capital gains is only fair.
Before its adoption as a law, the long debate was around the question of whether a full inclusion of capital gains is appropriate, and whether specific exemptions should be given. Eventually, it was decided that the inclusion rate would be set at 50 per cent — similarly to the rates in the U.S. and the U.K. at the time — with some exemptions, for example, on the sale of principal residence ownership.
After 15 years in which the inclusion rate stood at 50 per cent, it was increased to 66.66 per cent in 1987 and then to 75 per cent in 1990. Interestingly, it was Brian Mulroney’s conservative government that pushed the inclusion rate higher. Then, in 2000, Jean Chrtien’s liberal government reduced it back to 50 per cent, its current level.
One of the strongest arguments in favour of a lower inclusion rate is that it incentivizes individuals and corporations to make investments and take-on risk. This, supporters of the tax break argue, enhances economic activity and generates wealth.
The argument has some merit. Clearly, investments are more appealing if you’re going to get a tax exemption on half of the gains. But the reality is that since the source of capital gains is wealth, almost by construction those who have more of it, will benefit more from it.
A recent report by Canadians for Tax Fairness, an Ottawa based advocacy group, supports this claim. “Over 90 per cent of the value of this tax break goes to the top 10 per cent, and an estimated 85 per cent of the value goes to the top one per cent of income recipients,” the study reads.
The same report estimates that the cost of the tax exemption to the federal government is more than $22 billion annually, and the cost for provincial governments is also in the billions.
These dramatic figures tell a very simple story: Capital gains are taxed unfairly in Canada and benefit mostly the rich.
D.T. Cochrane, an economist with Canadians for Tax Fairness, strongly agrees with this assessment. In fact, he views the 50 per cent inclusion rate on capital gains as a tax loophole, no less.
“This is a loophole that the government has provided. The government has facilitated wealthy people, who are overwhelmingly the beneficiaries of these tax breaks, to avoid paying taxes that they should have paid otherwise,” he tells me over Zoom.
Cochrane supports increasing the inclusion rate to 75 per cent at least as a first step and isn’t worried that such a measure will hurt the economy. “It was already at 75 per cent before and there’s no evidence that raising it to 75 per cent was the cause of some massive disinvestment. There’s also no evidence that dropping it down from 75 per cent (back to 50 per cent) led to some boom in investment, so let’s bump it up to 75 per cent,” he concludes.
Fairness was the theme in E.J. Benson’s report and the Carter Commission on Taxation that preceded it.
The 50th year anniversary of the tax reform, marks an excellent opportunity to recognize that the 50 per cent capital gain inclusion rate is simply unfair, and correct it. In practice, it’s 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.
With Ottawa running a huge deficit due to the pandemic, there is no better time to increase the inclusion rate to 75 per cent. Such a policy will generate some well needed tax dollars, reintroduce the concept of fairness into our tax system, and create a healthier, more egalitarian Canada.