From: Don Drummond
To: Canadian Budget Observers
Date: May 1, 2024
Re: The Political Convenience of the Capital Gains Tax Changes
Many have opined that the proposed increase in the capital gains inclusion rate is bad tax, and bad fiscal and economic policy.
We need to add to that refrain: The implementation scheme amounts to market manipulation that gives the government a face-saving one-year revenue boost by threatening a tax change without even enacting it.
In last month’s budget, Ottawa raised the taxable amount when selling capital assets such as stocks. For businesses, and for individuals beyond a threshold, two-thirds of capital gains would be taxed, up from half. The budget set June 25 as the effective date.
Why did the government set such a deadline?
One guess is that the government felt some guilt over this and offered a narrow window of escape.
But few points should be awarded for such thinking, as the escape is only available for certain assets. The June 25 window closing is too tight a timeline for most third-party dispositions of real property and private company shares.
What’s more likely to happen is a selloff for public company shares, which are more liquid. And this is why the leading guess regarding the government’s motive takes us into the territory of cynicism.
Without the “tax fairness measures,” the most significant being the increase in the capital gains inclusion rate, the deficit for 2024-25 would have been projected to be $46.7-billion, $8.3-billion higher than in the fall economic statement. The debt-to-GDP ratio would also have been higher than in the statement.
Triggering a disposition of investments and collecting the capital gains revenue is one of very few options to lower the deficit substantially and quickly.
And that may well have been why a window of 10 weeks was given. Many who have unrealized gains may decide to sell their assets prior to June 25 to avoid the higher taxation.
The budget shows a revenue gain of $6.9 billion in 2024-25, more than one-third of the five-year total. In other words, the amount the federal government plans to collect via the tax hike this year is nearly twice that of each of the other four years.
Clearly, the government expected its tax hike to induce a wave of pre-emptive selling – and expects to reap the resultant tax revenue.
Why? No doubt the government did not want to present a budget with worse fiscal outcomes than previously projected after committing to keeping the deficit this year under $40 billion.
But an additional $6.9 billion in tax revenue doesn’t make a dent in more than $1 trillion in total debt. And why this arbitrary figure of $40 billion anyway?
Even with the capital gains measure, we can only say the budget crawls over a questionable bar set by the government that has no standing in economics or public finance. With the economy operating at about full capacity and a high debt burden, there should not be any deficit at all. Whether it is a bit over or under $40-billion is of little consequence.
Yet there are many negative effects to come from the arbitrariness of this exercise. For one, it will likely depress the stock market prior to June 25. The budget emphasizes how few people are affected. But it also points out their large equity holdings. It’s not hard to picture the impact of the selloff.
Ultimately, the measure amounts to enforcing tax changes prior to legislation.
The capital gains measure joins two others in the budget – the Digital Services Tax (to raise $5.9 billion over five years beginning 2024-25) and the Global Minimum Tax ($6.6 billion over three years starting 2026-27) – on a list of measures counted on to reduce the deficit but for which legislation has not been passed by Parliament.
The government cannot collect the revenue from the other two measures until it actually passes the laws. But by announcing the capital-gains tax hike and inducing a selloff to avoid it, the government is effectively reaping its benefits before actually implementing it.
If there is no chance of the government walking back the capital-gains measure, a few tweaks could avoid some of the negative effects.
First, the effectiveness date could have been set later. There would still be a wave of pre-emptive selling, but it would be spread over a longer period, blunting the effects on the markets.
Second, investors could be permitted an elective disposition whereby they pay the tax on accrued gains but are not forced to dispose of the asset. This would raise Ottawa its money without affecting the markets.
Don Drummond is the Stauffer-Dunning Fellow at Queen’s University and a fellow-in-resident at the C.D. Howe Institute. He was previously chief economist at Toronto-Dominion Bank and associate deputy minister at Finance Canada.
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The views expressed here are those of the author. The C.D. Howe Institute does not take corporate positions on policy matters.
A version of this Memo first appeared in The Globe and Mail.
