Imposing higher taxes on capital gains is counterproductive. We need policies that encourage, not discourage, investment and savings
We live in a mixed economy. The government does have a role to play beyond providing peace, order and good government. We expect government to provide needed infrastructure, education and healthcare. We also expect it to deal with social ills such as poverty and homelessness. There are differing opinions about how well the government has been fulfilling these mandates.
Of course, the government has to pay for the various services that we all want to receive. It needs to collect taxes which we really don’t like to have to pay. In a democracy like Canada, however, taxpayers are also voters, so the trick is to collect tax dollars without upsetting most voters.
One suggested solution to this dilemma is “Make Rich People Pay.” Almost all Canadians consider themselves middle class and see it as only fair that those better off than themselves bear the tax burden.
This was the thinking behind the recently announced (and, at the time of writing, not yet implemented) rise in the capital gains tax from half to two-thirds of the increase in the value of businesses, stocks, other financial assets, real estate, etc. Primary residences are exempt.
The increased tax rate would apply to all businesses but only apply to individuals on gains over $250,000. At first glance, this looks like a good case for making the rich pay. Any individual or business with enough capital to be concerned about the gains, especially if such gains are over a quarter of a million dollars, has to be rich – or do they?
Most businesses in Canada are small, but they are very important. In 2022, small businesses paid wages to 5.7 million employees in the private sector and provided 47 percent of those jobs. Small businesses are also growing faster than medium or large ones. Employment in 2021 increased by over 40 percent in small firms and less than 20 percent in medium-sized businesses. Even large firms were not growing as fast as the small ones, coming in at under 40 percent.
Small businesses experience a high rate of churn, with many opening and closing. Most small business operators do not get rich, but they provide needed goods, services, and jobs in their communities and earn enough to continue to operate. Small firms do not have pension plans.
Those who have worked hard all their lives to keep a business going often plan on selling it to fund their retirement. At best, small businesses do not sell for big bucks. If two-thirds of the value of the business (assuming it was started from scratch) now goes to taxes, there is not much left to fund a retirement. Entrepreneurs might start to wonder about the value of starting a business in the first place.
While the increased capital gains tax has not been implemented yet, large businesses and investors are already planning to reduce their activities in Canada. All investments involve the risk of loss. The prospects of gains usually offset this, but if the gains are to be mainly taxed away, the risk and, thus, the investment no longer make financial sense.
Not only are Canadian businesses moving more funds out of the country, but foreign investors no longer see Canada as a good place to do business. Even before the capital gains tax was proposed, we were already a high tax jurisdiction. Now, more dollars are leaving Canada than are coming in.
The increased capital gains tax will affect not only businesses but individuals as well. Consider the large number of baby boomers nearing retirement. Not all Canadians have adequate pensions, so many have wisely saved for their golden years. These savings could be in stock portfolios, real estate, or land. With higher capital gains taxes, the returns on these investments will be reduced, potentially jeopardizing their financial security in retirement.
After a long period of very low interest rates, these assets have only been able to maintain or slightly increase their value through capital gains. Hopefully, these assets have appreciated by more than $250,000 to fund many years of retirement in today’s inflationary environment. However, with the increased capital gains tax, will current workers even bother trying to save, knowing that the government will expropriate most of their gains?
The capital gains tax will do more than just increase the tax bill for those who can afford to pay. It will discourage saving and self-sufficiency among the general population. It has already led to reduced investment plans and job creation by both large and small businesses. These investments and jobs are crucial for reversing the downward trend in the standard of living for Canadians.
Rather than focusing on making rich people pay more, the government should develop tax and other policies that encourage businesses, investments, and savings. These measures will help improve everyone’s standard of living.
Instead of making the rich people pay, the government should be focusing on making more people rich.
Dr. Roslyn Kunin is a Troy Media columnist, public speaker and consulting economist.
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