Capital Gains — and Federal Revenue Losses
The federal finance department just released its Tax Expenditures and Evaluations report for 2007. This annual report includes the estimates and projections of revenues that the federal government loses from different tax credits, deductions, exemptions and other tax expenditures.Â
The number of these loopholes has proliferated in recent years as the Conservatives have used boutiquey tax cuts for a wide range of policy areas, despite evidence that they are much less effective than direct spending programs.Â
Some of the most startling figures are the estimates of revenues lost from the partial inclusion of capital gains in income and the related employee stock option deduction. These measures allow those with capital gains or stock options to only include half the value of the gains in their taxable income.Â
According to this report, the federal government will lose over $11 billion in revenue this year from these measures alone: over $1 billion for the stock option deduction and over $5 billion on the personal and corporate side each for partial inclusion of capital gains income. This amount is almost 50% higher than the projections of revenue losses for this year from the 2006 Tax Expenditure Report.Â
Clearly, this is an increasingly popular — and expensive — tax loophole. Â It is also a tax loophole that overwhelmingly favours the rich. A CCPA report by Ellen Russell and Sheila Block estimated that two-thirds of the value of a capital gains tax cut would go to the top 5% of families.Â
Tax returns from CRA for 2005 also show that over 66% of the value of all taxable capital gains were claimed by just 5.9% of taxpayers (those making over $100,000 a year) and 4% of all taxfilers (including those who had no tax owing).Â
The stock option deduction is even more egregious: most of high paid corporate executive compensation is granted in the form of stock options. This is taxed at half the rate of normal wage income and is worth many millions in lower taxes for these top executives. This is a major factor in the fact that the super rich pay a lower rate of tax than most other Canadians.Â
An original implicit rationale for taxing capital gains at a lower rate that capital gains included some inflationary component. Â But this rationale was lost when the taxable proportion of capital gains was cut at the same time that the trend rate of inflation was cut. Â The more recent rationale is that it encourages savings and capital investment and, in the case of executives, a focus on stock performance. Â But these arguments carry little water. The world has been awash in an excess of speculative capital in the wrong hands in recent years, and the stock option deduction has been widely abused.Â
Capital gains should be taxed at the same rate as other forms of income, with some adjustment for inflation.  This would raise about $8 billion or more in additional revenues each year, provide funding for more public programs and also encourage more productive long-term investments, instead of speculative short-term investments.Â
These types of revenue losses put the lie to Finance Minister Flaherty’s claim that he has no room to provide any significant spending or measures in next week’s budget.
This tax loophole gave me an idea for worker-owned co-operatives. Issue every member one share of non-voting stock, with a contract saying they have to sell it back for $1 if they leave the co-op.
Drop everyone’s pay to minimum wage, and issue bi-weekly dividends making up the difference. Suddenly everyone’s paying taxes like the big boys do–which is to say, much less.
I’m generally more pro-market and more government-skeptic than the CCPA, but the argument for taxing capital gains at 100% (after indexing the cost base to inflation, perhaps a little generously to allow for distortions in the index used) makes a lot of sense to me. The additional revenue could be used not just to supply more presently under-supplied public goods, but to lower the deadweight cost of taxation on earned income, with careful targeting towards lower-income earners. It would combine well with increasing carbon and other taxes bearing harder on “that to which value is added” than on “the addition of value” which I favour on ecological-economic grounds.
This view, by the way, is also one “from the trenches”. Although trained in economics, and very interested in the subject, I actually make my living as a public accountant, so I often calculate capital gains and I see a lot of tax returns each year.
Michael Barkusky
Re Capital gains taxation – one has to be careful about just slashing this program . Currently any gain ( a capital gain ) made upon the sale of one’s principal residence is tax free . Due to all the property taxes , upkeep , additions and maintenance on a residence , I’d be hard to convince this should be taxed . Stock Options should be addressed , but not slashed . Slashing a program that needs only some rule changes smacks of what Flaherty did to most Income Trusts and that move cost too many Canadians lost millions , not to mention taxable income . Slashing capital gains allowed on Family Farms , and smaller privately owned family business would have a drastic affect on passing these along to younger generations . This is just not acceptable to the majority of Canadians. In this case , tweeking might be a good thing , but slashing the program will certainly be a disaster .
Actually, Don, the figures and discussion above refer only to partial inclusion of capital gains for investment income and stock options. Exclusion of capital gains from principal residences is another matter and I wouldn’t suggest getting rid of that. It is already possible to defer capital gains for the intergenerational rollovers of family farms and woodlots, so it is also a completely different matter.
What I am proposing — full taxation, but indexed to inflation for capital investments — could be better for investments that are held for a long time, such as other family investments that may be passed on or for other long-term investments.
For instance, a 2% inflation rate cumulated over 30 years amounts to about 80%: this deduction would then be applied against the original investment amount. There would need to be some way of pro-rating the capital gains over the period.
I disagree with you about stock options. I don’t see why those who benefit from these (generally well-compensated executives) should pay a lower rate of tax than the rest of us.
Also, shouldn’t there be a dollar cap or a proportionate-to-original-cost-indexed-for-inflation on gains on principal residences too ? Making gains on principal residences CGT-free encourages people to “over-invest” in their homes, and allows people building or renovating homes serially, living in each one, to earn effectively tax-free income.
Of course, while I share Toby’s position on trimmiming back CGT concessions generally, and don’t think stock options deserve extraordinarily light taxation, I also favour low rates of income tax across the board (certainly up to $ 120,000 per annum or so) (which he may not). I do also favour retaining some incentives to encourage entrepreneurship. You can’t have a healthy economy in which everyone wants to be an employee and looks to “others” to be the employers. Someone has got to carry the risks of economic innovation ! We don’t want to rely exclusively on the public sector and big, established corporations to create jobs.