Eat the Rich or Stomp Out the Little Guy: A Roadmap to Capital Gains

It’s a question as old as time in Western society. Are the wealthy paying their fair share of taxes? Justin Trudeau’s Liberal government – the same government that has spent the last year at least 15 points behind in federal polls – certainly seems to think that additional taxes are necessary.

The government of Canada introduced its newest budget in the Spring of 2024, positioning its newest policies as part of a broader effort to empower young Canadians and bring forth what they call “economic justice”. Amongst these changes – and arguably the most significant – are the proposed changes to Canada’s capital gains tax inclusion rates.

Prime Minister Justin Trudeau, whose party recently suffered a devastating by-election loss in the ruby-red liberal stronghold of Toronto St. Paul’s earlier this summer, has made every effort to reassure Canadians that this proposed tax hike is meant to target the ultra-rich. This has not deferred outspoken concerns amongst business leaders, doctors, and farmers, however, who feel that this tax punishes the success of hardworking business owners and deters investments away from Canada.

So what are these proposed changes and how will they impact the Canadian business environment? How will individual Canadians and their investing patterns change? This article will be your simplified roadmap to a contentious issue in the world of Canadian economic policy, peeling off the layers of political posturing to uncover the true impact on the Canadian economy.

What are Capital Gains?

In the simplest terms, capital gains are the profits an investor makes from selling assets such as properties, stocks, and bonds. The profit made from these investments can then be subjected to taxes, often referred to as capital gains taxes. However, seeing as the threshold for capital gains that are taxed are a little bit more complicated, the following example will help break down how capital gains taxes worked before the budget’s proposed changes.

Suppose Investor A owns Stock X, which they purchased for $1,000. Since the purchase, the value of the stock has increased to $2,000, a profit of $1,000. In Canada, 50% of capital gains were previously treated as income, meaning that they were accounted for in the investor’s income tax filings and subject to their regular income tax rate. In our example, $500 would be subjected to taxation. Assuming an income tax rate of 20%, the investor would be paying $100 in taxes on their profits. 

A Tax-Focused Budget: Proposed Changes by Trudeau’s Liberals

The government’s budget seeks to increase what is commonly referred to as the Inclusion Rate (the portion of profits that are subject to taxes) from 50% to 66.6%. Using our previous example, of the $1,000 of profit, $666 would be subject to taxes instead of just $500. This means that $133 or 13% of the investor’s profit will now be paid to the government.

Recognizing the unpopularity of taxes and their record-low polling numbers, the government is suggesting to put in place a $250,000 individual exemption. This means that an individual earning less than $250,000 per year in capital gains would still be paying capital gains taxes on only 50% of those profits. So, does this exemption mean that only the “ultra-rich” will face this tax increase, as Trudeau’s government claims?

The reality may be a little different than what the Prime Minister would like you to believe. Presenting capital gains as a tax on the ultra-rich relies on the fact that year over year, few Canadians will earn more than $250,000 in capital gains. While this is true, to truly measure how capital gains will impact individuals, one must consider how many Canadians will participate in a capital gains transaction at some point in their lives.

Impact on the Individuals: Personal Investments and Capital Gains

Finance Minister Chrystia Freeland has stated that due to the $250,000 threshold, the tax hike will only impact 0.13% of Canadian taxpayers or 40,000 individuals, as well as 12.7% of corporations or about 307,000 corporations. Objectively, that’s not very many people, and at first glance, these numbers indicate that the changes won’t impact middle-class Canadians during a cost-of-living crisis. Now, if you tag on the $19.4 billion in added tax revenue over 5 years of this proposal that could be invested back into government programs, these changes begin to look like lucrative economic policy.

However, this all assumes that the numbers provided by the government truly consider all circumstances in which Canadians pay capital gains. According to Jack Mintz from the University of Calgary’s School of Public Policy, considering lifetime sales of properties and other assets would drastically increase the number of people expected to be impacted by the tax.

According to a study by Mintz of 10 years of Statistics Canada data, the reality is that everyday Canadians make once-in-a-lifetime investments in homes or cottages and are likely to exceed the $250,000 of capital gains when cashing out on those investments. Mintz’s study found that out of a total number of tax filers with capital gains of over $250,000 in 2011, 66.3% of them only reported having capital gains above that threshold in only one year between 2011-2021.

So, what does this mean in practice? It means that there is a revolving door of middle-class Canadians who in any given tax year, may cash out that investment. This can include an elderly couple looking to downsize or a family looking to move into a larger family home. While those Canadians are not “wealthy” as per their lifetime profits, they will still face a tax hike on their profits in that given year.

Taking into account these distributions of one-time filers, Mintz concluded that 1.26 million Canadians or 4.3% of the population, would be impacted by the budget’s changes.

One woman’s particular capital gains story has sparked outrage. 93-year-old Liz Dachund hoped to gift her daughter and grandson two lots on her farm property. Totalling $270,000 in market value, Dachund was shocked to learn that this gift would be accompanied by a $40,000 capital gains tax price tag. As a pensioner without the disposable income to pay the tax bill, she has been unable to gift the properties despite no sale being made or money exchanging hands.

Impact on Industry: Businesses, Economy, and Capital Gains

When businesses pay capital gains, the $250,000 individual exemption is gone and business owners will have to pay taxes on 66.6% of all income. Capital gains taxes impact small business owners wishing to sell their business, farmers seeking to pass their land to the next generation, and doctors hoping to cash out on their retirement. Organizations representing the above three groups (and others) have been some of the most vocal critics of the proposal.

Business owners face capital gains taxes when selling their business. Through the proposed changes, any capital gains above $250,000 will see the inclusion rate increase to 66.6%. A business owner that would have previously made $1 million in profit from capital gains would see their profits drop by nearly $100,000. This, the Canadian Federation of Independent Businesses argues, may deter entrepreneurship in Canada.

Dr. Joss Reimer, President of the Canadian Medical Association, expressed deep concerns over the impact of tax increases on the medical profession. Seeing as many doctors in Ontario incorporate and pay small business tax rates on their income, they must pay capital gains when they choose to retire and cash out all of the business’ income that they have invested in place of a pension. Reimer points to the healthcare crisis and shortage of medical personnel in Canada as a prime reason to fight these changes, as they risk losing physicians to other labour markets with more attractive tax conditions.

Dr. Joss Reimer. Source: Canadian Medical Association

Grain Farmers of Ontario expresses very similar concerns. Farmers in Canada traditionally choose to invest in their farms to plan for retirement. Farming is an intergenerational practice that requires passing down property, which may now be subject to higher taxes. Despite the government increasing the Lifetime Capital Gains Exemption to $1.25 million, a study by the Grain Growers of Canada concluded that farmers who bought a farm in 1996 and choose to sell it after these changes came into effect would pay 31% more tax on average in several provinces.

Source: Grain Growers of Canada

The same study conducted by Jack Mintz also projected the overall impact these changes would have on the Canadian economy. Mintz argues that due to the “home bias” of Canadian investors, who hold about 50% of their equity portfolios in Canadian equities, an increase in capital gains may lower the equity valuations of large corporations as they increase the cost of capital. With capital gains taxes cutting into investor profits, each equity in a corporation may lower in value. Seeing as in 2021, 15.8% of tax filers received dividends from Canadian corporations, a tax hike is likely to impact individual investors as well.

However, it is difficult to quantify the impact this would have on Canadian jobs. While it is possible that increased costs of financing for businesses and the deterrence of investment caused by the tax hike provide another reason for entrepreneurs to start businesses elsewhere, more data may be required to assess the impact on the labour market.

Final Thoughts

Taxes aren’t popular. That’s not a new revelation, and while the government’s desire to increase revenues – particularly in the wake of large government deficits – is not unreasonable, the public response to the capital gain tax hike and its impact on the Canadian economy will be determined by the answer to one question: How many Canadians will be impacted? Trudeau and Freeland say 0.13% of individuals and 12.7% of corporations. Mintz projects that 4.3% of individuals will be directly impacted, while 15.8% will be impacted through their investments in Canadian corporations.

The average Canadian supports a staggered tax system in which the rich are forced to pay their fair share. This is widely recognized as a means of paying for crucial government services and programs. However, the execution of such taxes must protect middle-class Canadians, business owners, and the domestic and foreign investments that drive the Canadian economy.

The budget’s proposal came into effect on June 25th. Only time will tell us what the economic ramifications are going to be. What is certain, however, is that Trudeau’s government has managed to unite stakeholders from several industries across the country in opposition to this budget.