Better tax treatment of capital gains will improve economy

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Last week, I appeared as a witness before the House of Commons Finance Committee regarding the proposed capital gains inclusion rate increase, and it was not surprising to hear the Liberal and NDP committee members, and their witnesses, go on about how great the capital gains inclusion rate proposal is.

Frankly, it’s exhausting to listen to such nonsense. Some of that nonsense? “Studies have concluded that a high capital gains inclusion rate — or full taxation — of capital gains has no impact on a country’s economic results.” Yeah, right. For every such study, I’ll show you three that say otherwise.

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The most recent research, released by economist Jack Mintz last week, concludes that the inclusion rate increase will cause Canada’s capital stock to fall by $127 billion, employment will decline by 414,000, gross domestic product (GDP) will fall by almost $90 billion and real per-capita GDP will decline by three per cent. Troubling conclusions.

Others go on and on about “tax breaks” or “fairness” when it’s obvious they do not have a fulsome understanding of our country’s tax system.

But my favourite is “a buck is a buck is a buck.” That line is a summarized phrase from the recommendations of the Royal Commission on Taxation that was convened in 1962 to study the taxation system and make suggestions for improvement.

After four full years of study, the commission released its landmark report in 1966. Many of its recommendations were controversial. Some were ultimately implemented (with some modifications) and others were outright rejected.

The recommendation to move to a family taxation system is an example of one being outright rejected (wrongly, in my view). Very generous employment expense deductions was another that was rejected (rightly, in my view). The full taxation of capital gains recommendation was modified (rightly, again).

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In 1966, Canada’s population and economy were much smaller than they are today. Our taxation system was in its infancy. Capital gains were not taxable. There was much mischief involved in planning to create capital gains (that might otherwise be taxable income) or in taxpayers taking the position that certain economic wins were capital gains.

Accordingly, the commission said the following with respect to capital gains: “A dollar gained through the sale of a share, bond or piece of real property bestows exactly the same economic power as a dollar gained through employment or operating a business. The equity principles we hold dictate that both should be taxed in exactly the same way. To tax the gain on the disposal of property more lightly than other kinds of gains or not at all would be grossly unfair.”

Thus, the famous “a buck is a buck is a buck” line was born. This short-shrift summary of a complex topic is something I’ve never agreed with. I do agree that the result of various economic activities, “a buck,” is the same, but the efforts that go into creating that buck are certainly not the same.

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In 1969, the government of the day — gasp … the Liberals  — agreed that capital gains should indeed be taxable, but rejected the commission’s logic as documented in then finance minister Edgar Benson’s famous Proposals for Tax Reform paper released that year.

“The government rejects the proposition that every increase in economic power, no matter what its source, should be treated the same for tax purposes. This proposition, put forward forcefully by the Royal Commission on Taxation, has often been summarized rather inelegantly as ‘a buck is a buck is a buck.’ But although the government does not accept this theory in all its splendid simplicity, neither does it believe that the distinction between a so-called ‘capital gain’ and an income receipt is either great enough or clear enough to warrant the tremendous difference from being completely exempt and being completely taxable.”

I agree that phrase is rather inelegant and, again, too simplistic. It ignores a very important feature that other countries around the world recognize when treating capital gains preferentially from a tax perspective — risk.

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“Put me on record as an advocate for a low inclusion rate — like 50 per cent — since that lower inclusion rate provides incentive and acknowledgement of a key issue that most people experience when they originally invest capital to generate such gains. That key differentiator is ‘risk,’” I said in my opening remarks at the recent committee meeting.

“It takes guts to buy land, build a building and rent it out, buy a farm, start or buy a business. Most Canadians are not wired to accept that risk … (but) the ones that can hang on and make something out of their risky venture usually have spin-off benefits for a large number of Canadians. Canada needs to encourage the creation of more entrepreneurs and investment in our country, and a lower capital gains inclusion rate is one of those policy tools that has historically helped with that.”

Employment risk is not entrepreneurial or investor risk. It’s completely different. For those who say it is, I often challenge them to “put their money where their mouth is” and become an entrepreneur.

By that, I don’t mean your small, one-man-band consulting business. Invest your life savings into a real business. Get a bank loan to purchase your investment. Sweat a bit about making payroll or the mortgage payments on your building. Take some real business risk. If you accept my challenge, I’m guessing you’ll soon stop trumpeting your former rallying cries of “fairness” and “a buck is a buck is a buck.”

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You might then truly understand why it’s important to have governments that encourage entrepreneurship, with preferential treatment of capital gains being one of those policy tools to provide such encouragement.

Kim Moody, FCPA, FCA, TEP, is the founder of Moodys Tax/Moodys Private Client, a former chair of the Canadian Tax Foundation, former chair of the Society of Estate Practitioners (Canada) and has held many other leadership positions in the Canadian tax community. He can be reached at kgcm@kimgcmoody.com and his LinkedIn profile is https://www.linkedin.com/in/kimgcmoody. 

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