For nearly a quarter of a century, Canada’s capital gains tax rate remained largely unchanged at 50 percent. But that changed this year when the federal government proposed a new tax rate of 66.7 percent in its latest budget.

While this move could lead to higher government revenues, it could delay the necessary economic recovery in Canada by temporarily hampering investment.

The reason for the tax increase is simple: the government needs the money. It is facing a deficit of 40 billion dollars in the current fiscal year.

The tax applies to all sales of capital assets by corporations and most trusts, as well as capital gains of individual taxpayers, graduated-rate estates, and qualified disability trusts that exceed an annual threshold of $250,000. The tax took effect on June 25, but the effective date and final legislative language are subject to change as the legislative process concludes.

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Ultimately, the increase in the tax rate has reignited the debate about capital gains tax and its role in promoting economic growth and increasing government revenue.

Opponents of the tax say that two years of high interest rates have dampened the desire to invest and slowed down the economy. The increase in capital gains tax and its brake on growth are therefore unfavorable. Proponents of the increase, however, point to the state’s growing budget deficit and the need for higher revenues.

Economic impact

One intention of the law was to raise revenue by encouraging businesses and individuals to sell their assets and realize their capital gains at the lower tax rate between April and June 10, rather than waiting. With this provision, the government hoped to generate several billion in additional tax revenue to reduce the deficit.

In the long term, the government hopes to raise more revenue from the higher tax rate. The government said the higher tax rate will increase revenue by $19.4 billion over five years and also improve tax fairness by targeting large corporations and the wealthiest individuals.

Finally, government spending has increased with the economic slowdown.

Expanding social services, such as subsidizing $10-a-day child care or increasing funding for health care, is critical to the functioning of society and the economy. But these programs cost money, and inflation has driven up costs across the economy, from infrastructure to wages.

Added to this are the restrictive interest rates. Companies and households have felt the cost increases in the form of higher interest rates on business loans or mortgages. The same applies to the state, which has to pay higher interest on its debts due to the increased interest rates.

By adopting the plan, the government assumes that the increase in the capital gains tax rate will not significantly affect already declining productivity and investment.

Historical data supports this view: In the 1990s, the inclusion rate for capital gains was 75 percent, yet innovation and investment flourished and were higher than after 2000, when the inclusion rate was 50 percent.

Corporate investment decisions are influenced by tax rates, interest rates, expected growth, the regulatory environment and economic stability. While taxes are one aspect, they are only one piece of the puzzle.

However, the Canadian economy is in a short-term crisis. The economy has only seen limited growth this year as restrictive monetary policy has slowed spending and investment.

Higher investment is necessary for economic recovery, and a cycle of interest rate cuts could facilitate this. However, the increased capital gains tax rate could deter some companies from investing in the short term.

It is also unclear whether the additional $20 billion in tax revenue will actually be realized. Companies and investors could shift their investments overseas to avoid higher taxes, which would undermine the goal of raising revenue. While improving equity by taxing the wealthiest individuals is one goal, these individuals often have the best opportunities to shift their investments overseas.

An alternative

A potentially more effective approach to improving fairness and raising revenue would be to combat tax avoidance in offshore jurisdictions. The Canada Revenue Agency estimates that the government could lose billions annually to offshore investments. Focusing on closing these loopholes could lead to a more stable and equitable revenue increase.