Finance Committee on Sept. 17th, 2024

[François Bélanger]

Okay. I'll go on.

The biggest sector is the financial sector, primarily through financial intermediation. That means selling, purchasing and quickly reselling to hit the arbitrage spread between rising and falling prices, which leads to making very large profits in very short periods of time. It doesn't really have any ripple effect on the real economy, economic production, or productivity; in short, everything that matters and is real to people. It therefore directly contributes to a kind of financialization of the economy.

According to that analysis, real estate is another important sector in terms of capital gains. Obviously, with the inflationary explosion we saw over the last few years, it accelerated even further and now represents 25% of capital gains. Again, these are significant gains and half are not taxed. Currently, they are taxed at 50%. Our current proposal is to increase it to 66.7%. I want to point out that it does not lead to any social gain. These gains are made exclusively through financial transactions.

Both of these sectors represent 60% of capital gains in Canada. For the rest, it goes down very quickly.

People say it has a negative impact on the growth of technological start-ups. However, the analysis shows that in 2022, the professional, technical and scientific services sector received less than 3% of all businesses' capital gains in Canada. That means it's certainly not one of the main sources of funding.

As the previous speaker, Mr. Lee, said, specific measures are needed to achieve this objective, such as targeted tax credits to encourage real initiatives. They might look like the federal government's measures in recent years' budgets: green economy incentives, for example.

[The Chair, Liberal, Peter Fonseca]

Thank you, Mr. Ste‑Marie.

Next is MP Davies, please.

[Don Davies, NDP, Vancouver Kingsway, BC]

Thank you, Mr. Chair.

I'm going to pick that up and go back to you, Mr. Lee.

Again quoting from this report, it says:

Since the introduction of capital gains taxes in 1972...the federal government has adjusted the inclusion rate on capital gains several times: lifting it from 50% to 66.7% and then to 75%, and then reducing it in reverse increments.

I would note, by the way, that both of those increases, to 66% and then 75%, were done by Conservatives. The Mulroney government increased the capital gains inclusion rate.

The report goes on:

There is no evidence of a predictable impact of capital gains inclusion on the rate of investment by Canadian businesses in new technology—whether tangible machinery and equipment, or intangible investments in research and intellectual property.

Ironically, the study found:

Both types of business technology investment increased after the capital gains tax was introduced (first at 50% inclusion), and then both increased again when the rate was raised to 66.7%.

The conclusion is:

The strongest sustained technology investment recorded [in Canada] was in the period from 1988 through 2000, when the inclusion rate was either 66.7% or 75%.

Mr. Lee, can you help us understand that?

[Marc Lee]

I think that Jim Stanford in that case didn't do a regression analysis to try to find all of the possible explanatory variables. What he's pointing out is that there's no prima facie case that lowering the inclusion rate led to increased business investment and vice versa in the times when the inclusion rate was—

[Don Davies, NDP, Vancouver Kingsway, BC]

I want to jump in and ask you, Mr. Lee, about jobs.

The report says:

The biggest recipients of corporate capital gains, in general, have very poor job-creation records. In the last five years, the two biggest recipients (Miscellaneous Intermediation and Real Estate) received over half of all corporate capital gains, but created no net new jobs.

Can you explain what you know, if anything, about the impact on capital gains inclusion rates and job creation?

[Marc Lee]

Yes. I think it's related to my comments earlier that a lot of capital gains, as realized, are from speculative activities that don't improve our productivity and long-term economic prospects. In some cases of financial intermediation....

There's a lot of literature in recent years from Joseph Stiglitz and Mariana Mazzucato, who largely see the growing profits in the financial sector as being almost parasitic on the real economy. The extent to which these types of provisions encourage capital into more speculative forms of activity—as opposed to real investment that builds our productivity over the long run, like investment in machinery, equipment, factories, buildings and that sort of thing—is problematic.

We should be careful to distinguish those, particularly because economists have a very specific definition of what they're talking about when they say “investment”. It's very different from “investment” on the front page of The Globe and Mail, which tends to be much more about speculation in financial assets and real estate.

[Don Davies, NDP, Vancouver Kingsway, BC]

Thank you.

[The Chair, Liberal, Peter Fonseca]

Thank you, MP Davies.

Now we'll go to MP Berthold. Welcome to our committee.

[Luc Berthold, Conservative, Mégantic—L'Érable, QC]

Thank you very much, Mr. Chair.

I thank all my colleagues who welcomed me. I hope they will still be happy to see me today, after I’ve finished asking my questions.

Just so the witnesses understand why I’m here today, I want to say that I represent a very rural and very touristic riding: the riding of Mégantic—L’Érable, in the Appalachian region. We have mountains. We have lakes. Around those lakes, there are many cottages. Around Mégantic Lake, there are also many holiday resorts. You should come see it. It’s quite incredible. It’s absolutely beautiful. I invite all of you to come and see just how beautiful our region is.

We’re also next door to Beauce. Thetford Mines is a city that used to be a mining town; it now holds a large number of SMEs. If we are still living in the region, it’s thanks to those SMEs. It’s the first time a government measure generated so many reactions in my constituency office. I just explained why.

I will address the Fédération des chambres de commerce du Québec. My question is for Mr. Noël.

I saw that all of the chambers of commerce throughout these regions, such as Saguenay, commented on the government’s decision and the vote to pass the ways and means motion increasing taxes on capital gains.

Can you explain to me in a few words why there were so many strong reactions to this tax measure imposed by the Liberals on the local economy?

[Philippe Noël]

Yes.

I also said at the outset that we heard a lot of grumbling in our network. You spoke with chambers of commerce, as well as businesses who are direct members of the Fédération des chambres de commerce du Québec, or FCCQ. I’m thinking specifically of SMEs, or people involved in the SME sector. They say this measure completely discourages success and any incentive to invest in their own business.

Currently, the amount of investment into research and development is said to be very low. I just heard a few speakers say so. This will not, in fact, improve the situation. This tax measure will not help businesses get back on track.

As for Canada—which is at the bottom of the list of OECD countries in terms of investing in research and development and in developing its access to venture capital—this measure runs counter to the general principle of being able to access venture capital. A business will often benefit from selling shares to support its growth. We frequently hear those kinds of comments. We heard them well before the measure was announced in the last federal budget, back in April.

[Luc Berthold, Conservative, Mégantic—L'Érable, QC]

Every time the Liberals announce a measure to supposedly help people, it hurts them and leads to a great deal more negative impacts. The collateral damage is immense.

I can assure you that people with cottages around my region’s lakes and on its mountains are not all millionaires. They are people who inherited cottages from their parents and great-grandparents. They chose to continue investing, to renovate them and make them more attractive, so that they could also benefit from retirement, especially a retirement fund. It’s their way of investing.

You must have heard comments from your members too, because they include SMEs and workers. You said that the discontent is widespread. It’s not just coming from the big owners of huge businesses.

[Philippe Noël]

You are right. Even on the level of corporate taxation, we often hear this criticism. As you know, corporate tax rates on capital gains are high compared to those of states around us. This proposed measure therefore represents yet another burden on top of everything else.

As for cottage owners, as you said, they invest in their own dwelling, sometimes to improve it. It keeps the economy—and sometimes tourism—going in certain regions, including yours. Certainly, if we take all these factors into account, the proposed increase is not a decision that supports our economy. Furthermore, it often penalizes businesses that succeed. And these people are not necessarily multimillionaires, just people who may be on the verge of retiring and are specifically counting on that to supplement the next few years.

[Luc Berthold, Conservative, Mégantic—L'Érable, QC]

Have you done an analysis, or studied the effect of this measure’s negative impact on our economy?

[Philippe Noël]

Perhaps I could let my colleague Mr. Rioux respond, since he did quite a bit of digging into the issue.

[Hubert Rioux]

Quantitatively, it is difficult to determine the exact effect, because we do not yet have all the measure’s details. We will have them this fall. However, there are a number of things we can say already.

For example, the Canadian Entrepreneurs’ Incentive—which was set up to compensate somewhat for the effects of the increase—doesn’t apply to the arts and entertainment, recreation, hospitality or restaurant industries. I don’t think business owners in these types of industries are part of Canada’s wealthiest 1%. The same goes for those employed by those businesses. I say it very respectfully, but so much for fairness!

That said, coming back to a certain number of points raised about investments made by businesses, they do invest capital, especially to save for harder times, expansions or acquisitions.

The increase will therefore make businesses’ investment decisions more difficult. The acquisition of high value-added assets with potential for appreciation, such as intellectual property, even land or property, aren’t always passive or speculative investments. Economic studies are clear on the matter. Increasing the capital gains inclusion rate will negatively impact the mergers and acquisitions market that we need to increase the size of our businesses.

In Canada, we are lagging in this area compared to our competitors. Our businesses are generally a little smaller, which has an impact on their productivity rates.

[The Chair, Liberal, Peter Fonseca]

Thank you, gentlemen.

Thank you, Mr. Berthold.

Now we will go to MP Sorbara, please.

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Thank you, Chair, and welcome to the witnesses.

First, I'd just like to make a comment. We know that Canadians over the last several years have faced a very high cost of living due to global inflation. I know that many of the residents in my riding have voiced those concerns. It was obviously very good, solid economic news to have the inflation rate come in at 2% today. It's at the bank's target. It has been within the bank's target range for all of 2024.

We have seen three rate cuts, cumulatively 75 basis points. As an economist, and in my personal opinion, this sets up the Bank of Canada to pursue further rate cuts. I think we've achieved what's called a “soft landing”, in economic terms. Rates will be coming down. Canadian families know that. It's a good thing to do. We have much more work to do. We want to make sure we take care of all Canadians. That confidence continues to increase.

With that, Chair, I'd like to now turn to the subject matter at hand, the capital gains front and specifically the inclusion rate.

I thank you, gentlemen, for your viewpoints. As we know, our tax system is design to raise revenue to pay for services and programs that Canadians depend on, be it old age security, be it today the Canada child benefit or be it the national early learning and child care plan. However, we must also design a tax system that does not distort and that does not provide perverse incentives for certain behaviour to occur. With differing tax rates for interest, dividends and capital gains, that is what happens with the capital gains inclusion rate being at the level it was. “Economic actors”, to use that term, would pursue such policies as surplus stripping. I won't get into the specifics of that, as that would take a little longer, but surplus stripping is a tax avoidance strategy used to garner capital gains instead of other forms of income.

We need to have a tax system that promotes fairness and neutrality or integration. The step we've taken on the increase to the capital gains inclusion rate is something that answers and does all of those to a certain extent. What we don't want is a system that purports to provide incentives for tax avoidance strategies to take place, distorts economic activity and leads to an extreme accumulation and concentration of wealth. That is not good for our society. That is not good for our children. That is not the Canada I fundamentally believe in.

Going from an effective tax rate that is currently 25% and moving the effective tax rate up to a certain number higher, depending on the province you live in, but still being allowed to generate a lot of economic wealth is something that I believe is fair. It provides more for a neutral tax system that is progressive. It allows us to fund a number of programs that Canadians depend on, such as the Canadian dental care plan, the early learning and national day care plan, the workers benefit and the seniors benefit, which goes to thousands of seniors in my riding.

With that, I have a question for Marc Lee.

Would you not agree that the inclusion rate change results in a more progressive, fair and neutral tax system?

[Marc Lee]

Yes. The increase in the inclusion rate to 66.7% for capital gains above $250,000 is very narrowly targeted. It will fall on only a very small handful of very well-off individuals and only upon the time when they sell their assets. It's likely to have very few distortions as a result. In fact, economists have argued that by making this particular change, it actually reduces the distortion between that and dividend income.

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Yes.

[Marc Lee]

That is one of the things we want. We want to have neutrality so that people aren't going through complicated economic endeavours in order to make income look like capital gains so that it gets preferential tax treatment.

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Exactly, Marc.

In my remaining time, the argument that somehow research and development or productivity over the last three decades has been.... There's a causation role between the level of capital gains rate and the level of productivity in our country. Many factors determine total productivity, with human capital being one, capital being another, and other components.

I've heard some of those arguments. I will disagree with those fundamentally. Our productivity for the last three decades here in Canada has been affected by a number of variables, not solely on what the inclusion rate is. Would you agree with that?

[Marc Lee]

Yes, I would. I mean, there are many factors that determine investment and productivity. If anything, these are the broader macroeconomic factors: the overall level of interest rates and the state of government debt and deficits. These tend to drive economic factors much more than those looking for narrow efficiency gains through tweaks in the tax system.

[The Chair, Liberal, Peter Fonseca]

Thank you, MP Sorbara.

We're getting close to the end of our time; we just have a few minutes left. I understand that there is agreement to have MP Morrice ask the last number of questions before we conclude today.

MP Morrice, go ahead, please.

[Mike Morrice, Green, Kitchener Centre, ON]

Thank you, Chair.

Thank you, colleagues.

My question is for Mr. Lee.

Mr. Lee, I really appreciate your making clear how very high-income earners do receive the most capital gains, so they obviously disproportionately benefit from the tax savings of partial tax inclusion. It's a big part of why I've supported this government's change to the capital gains inclusion rate. It's because it gets us closer to ensuring that the wealthiest in our country pay their fair share, so that we can then address the crises that communities like mine are facing, from the climate crisis to housing.

That said, I did hear questions from moderate-income earners in my community this summer. I'd like to share an example with you and get your take on it. Ken shared with me that he purchased a property decades ago that has grown significantly in value. He hopes to leave his property to his daughter when he passes, but as a result of the transfer, his daughter would be left with a significant capital gain tax liability without any increased cash flow. That's, of course, increased due to this change. Ken shared with me that he's not sure how his family would pay for that without being forced to sell a property that has significant sentimental value to them.

My question for Mr. Lee is this: Do you feel the government considered this impact on more moderate-income earners like Ken and his daughter? Do you recommend any supplemental measures that could avoid unintended impacts of this potential loss of a property that holds, like I said, some significant sentimental value for the family?

[Marc Lee]

I think it's important to first point out that people who are declaring large capital gains are in an incredibly privileged position in our society. On the back of the napkin, so to speak, looking at $1 million in capital gains in Canada, under the new rules, $625,000 of that million would need to be declared for income tax purposes, whereas previously $500,000 would have to be declared for income tax purposes. At the top marginal tax rate, if you're looking at a 50% federal and provincial income tax rate, the difference is $60,000 on $1 million of income.

Maybe if you're talking about a situation where you're getting into millions and millions of dollars and it's all declared in one year, there may be some issues with that, but again, we're talking about how much of a discount we're providing compared to the 100% inclusion rate for earning income through wages and salaries, so I don't know that that's necessarily the core thing we need to be thinking about. I'd be interested in seeing specific examples of where this happens.

There are provisions in the tax code for farms and fishing properties. When you transfer them to your child, they can be spread over up to nine years, thereby reducing the likelihood of amounts and capital gains going above that $250,000 threshold. In situations like that, to the extent that we consider them a public policy problem, allowing folks to average out those gains over a number of years is generally a good way of doing it.