Many have criticized the proposed increase in the capital gains inclusion rate as bad tax, fiscal, and economic policy. They also argue that the implementation scheme amounts to market manipulation for insignificant and arbitrary fiscal goals through cynical pre-legislation enforcement.
In last week’s budget, Ottawa raised the taxable amount when selling capital assets such as stocks. For businesses and individuals beyond a threshold, two-thirds of capital gains would be taxed, up from half. The budget set June 25 as the effective date.
One possible reason for the government setting such a deadline is that it may have felt some guilt over the tax hike and offered a narrow window of escape. However, this escape is only available for certain assets, and the window is generally too tight for third-party dispositions of real property and private company shares.
What is more likely to happen is a mass disposition of public company shares, which are more liquid. This leads to the theory that the government’s motive is cynical.
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 the few options to lower the deficit substantially and quickly. This may be the reason why a window of 10 weeks was given.
Many who have unrealized gains may decide to sell their assets before 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.
The government likely 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. However, an additional $6.9-billion in tax revenue doesn’t make a dent in more than $1-trillion in total debt.
Even with the capital gains measure, 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 the capital gains measure. 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 is 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 revenue from the other two measures until it passes the laws. However, by announcing the capital-gains tax hike and inducing a selloff to avoid it, the government effectively reaps its benefits before 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 the tax revenue without affecting the markets.
