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Canada’s Budget basically cements structural deficits forever as the interest charges on Federal government debt soar to over $65 billion per year. Trudeau Jr. is clearly following in the footsteps of his father and aided by a highly complicit finance minister. If Canada stumbles into a worse economy than the rosy scenario laid out in the Budget for the next five years, then deficits will balloon, debt will rise even more, and the optimistic yield curve forecasts contained within the budget will deliver even more money paid to bondholders instead of other priorities.

That, folks, is not being generationally fair. Trudeau and Freeland are ripping off Canada’s youth who will be the ones left to face the bills for many years to come. It’s an insult to portray such a Budget as being in the best interests of Canada’s youth who have fled from the Liberals in droves.

Nevertheless, the show stealer in Tuesday’s Canadian Budget was that Canada dramatically jacked up capital gains taxes. Effective June 25th, capital gains taxes will rise in the following ways:

· For individuals, the inclusion rate on capital gains above $250k will be hiked from 50% to a whopping two-thirds before then multiplying by one’s tax bracket. Capital gains below $250,000 will continue to be taxed at the 50% inclusion rate times the marginal rate.

· For all companies and trusts, the capital gains inclusion rate will rise to two-thirds from 50%.

· Small businesses are once again treated preferentially with a lifetime capital gains exemption that has been raised to C$1.25 million from C$1.016 million, but unevenly applied which is sparking pushback. Above C$1.25 million of capital gains triggers the higher inclusion rate, therefore why the government calculates that targeted small businesses with less than C$2.25 million in capital gains will be better off on net but above that they will be worse off.

All this is an unwise move that takes Canada back to when capital gains were taxed more heavily decades ago in the aftermath of 2+ decades of irresponsible fiscal policy.

1. Why They Did It

The capital gains tax hike is estimated to raise about C$6.9 billion in the dying days of FY23–24 as investors are assumed to be in a rush to sell and just under $20 billion over the full five-year planning horizon. This is a massive tax grab, but how did they come up with the estimate especially for this year?

It’s simple. $6.9 billion was the magical plug figure to avoid having to break Minister Freeland’s promise to keep the deficit under C$40.1 billion this year in the wake of all of the heavy spending that has been announced at various photo ops of late. They are taxing savings to fund more program spending. Her numbers just barely achieve that promise, unless their revenues disappoint. Stay tuned. One possibility is that perhaps investors may defer realization of capital gains on the hope that a more sensible government will cut the inclusion rate in the future which would in turn probably have to be accompanied by sharp cuts to program spending and the bloated Federal civil service that escaped Tuesday’s Budget largely unscathed.

2. The ‘Fairness’ Fallacy

Minister Freeland says that a dramatic hike in capital gains taxation is motivated by the pursuit of tax fairness. She likes to argue that some earners can pay more in taxes than millionaires and billionaires because people who earn their income primarily from employment can get taxed at higher rates than people who earn more of their income from capital gains. This is a favourite argument of the left.

And yet at one time or another folks who used their savings to buy assets that hopefully generated capital gains were first taxed on their employment income and very possibly at the highest marginal rates of taxation.

Then they invested those after-tax savings into companies whose profits—if generated—were then taxed at relatively higher rates in Canada than the US.

Then companies that invest their after-tax profits into assets that generate capital gains will now have them taxed at a much higher inclusion rate of two-thirds and again taxed at higher rates of corporate taxation than the US.

Shareholder distributions out of any profits that remain through dividends and/or capital gains will be taxed again in the hands of the individual investor, the latter now taxed at more punitive levels.

Canada will now penalize capital gains with higher taxes than most other countries in the world.

Government has taken a slice at every stage of the wealth creation chain and that is where the total lack of fairness comes in.

And so I ask you why would you save and invest in such a country that penalizes work, effort, saving and investment at every possible stage? It’s confiscatory taxation. It’s a reason to sell Canada on top of other challenges such as overall competitiveness.

3. The Small But Mighty Few

The government downplays the tax hike by saying only an estimated 40,000 Canadians have capital gains of above $250k.

And yet the reality is that most saving in Canada is done by wealthier households that represent a minority of the population. Lower income cohorts dissave on net, leaving the supply of household savings to be delivered by relatively wealthier households.

Capital gains are an extension of this. The vast majority of capital gains are indeed held by relatively wealthy households that do the investing. Those who save more generate more capital gains. This saving and investing from a relatively few is important to funding investment.

Targeting the households with the gains is not only an unfair approach that applies tax upon tax upon tax as already explained, but it also strikes to the heart of the reality that the Canadian economy needs savings and it’s the relatively wealthy that now have less incentive to save—or more incentive to move those savings out of the country.

4. Canada is Diverting More Savings to Current Government Consumption

In jacking up taxes, Canada is using the proceeds to fund more government spending on shiny, flashy things that meet political goals. Not only does the government take from incomes, they are now digging deeper to take more of your savings to fund their spending.

5. Forced Selling

Who benefits here? The folks who will generate commissions and fees related to any forced selling of assets ahead of the June 25th implementation in order to avoid the higher capital gains inclusion rate that kicks in afterward. That could put pressure upon the Canadian dollar, credit, equities, non-primary housing, and commercial real estate.

6. Internationally Uncompetitive

Canada is now decisively uncompetitive on taxes. This international summary of capital gains taxation would now probably put Canada toward the top of the list of high rates alongside having lost its relative advantage on corporate taxation to the US about six years ago. This will harm Canada.

7. Someone Else Will Pay

A cardinal rule of tax policy is to consider that the initial target won’t necessarily be the one who ultimately bears the burden. Tax incidence effects entail assessing on whose shoulders higher taxes will fall. Higher capital gains taxation will ultimately be paid for by a combination of stakeholders from investors to workers to consumers and other businesses.

8. A Fundamental Shock to Trusts

Family tax planning took a major blow in the Budget because of the hike from 50% to two-thirds for the capital gains inclusion rate applied to trusts. Trusts are used by families to bequeath assets resulting from investments that have been taxed at multiple stages to future generations. In some cases, this can help those future generations cope with strained housing affordability.

Raising capital gains taxation is likely to further incentivize movement of savings out of Canada into lower taxed jurisdictions, like the long list of other countries that won’t tax capital gains at the same punitive rate Canada will going forward.

9. Vacation and Other Properties at Risk

About that family cottage you bought years ago, perhaps many years ago. Even if you planned for the tax burden that would be triggered for one reason or another, the tax burden just went up by quite a lot. Ditto for any non-primary residence. Two-thirds of that capital gain will now be taxed at whatever relevant marginal rate versus 50%. That could be exceptionally unfair to many households that don’t have the cash flow to foot such a higher bill in relation to their retirement needs. The same applies to investors who have provided capital to the condo market to feed rentals after decades of ill-advised rent controls destroyed the availability of affordable apartments.

10. More risk aversion

Less reward after-tax is likely to discourage risk-taking. Discourage investment. Discourage anything that might address Canada’s productivity problems.

11. Just Plow it All Into Housing

In the short-term, dramatically raising capital gains taxation may encourage more dumping of various assets like non-primary housing including many condos before the highest capital gains rate kicks in. But then what happens? The tax incentives to invest have been tilted even more toward illiquid housing and away from other investments that might have helped to generate greater productivity and improvements in longer-run living standards as opposed to current consumption.

In short, the government is using tax policy to dramatically favour further investment in housing and thereby encourage purchase of bigger, more expensive homes at the expense of diversification. At least for now. I still worry about how the Trudeau Government began collecting data on home sales with your tax filings starting years ago. They are establishing the infrastructure to maximize future policy flexibility toward the tax treatment of home equity. Would this government, for instance, tax home equity gains on primary residences held by relatively wealth folks? I wouldn’t trust them.

12. Trapped Gains

Higher rates of capital gains taxation can result in trapped capital. The decision to take profits on gains can be negatively impacted by higher taxation of capital gains. The result can be that capital is inefficiently tied up for longer than is optimal instead of being redeployed more rapidly toward more profitable purposes.

Furthermore, the discrete jump in the capital gains inclusion rate from 50% to two-thirds at the C$250k gains trigger point will create a barrier to growth and incentivize efforts to avoid the jump.

Derek Holt is vice-president and head of capital markets economics for Scotiabank

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