The Ultimate Tax On Economic Growth

Commentary, Frontier Centre, Local Government, Taxation, Worth A Look

In the 2006 federal election, the Conservatives promised to eliminate capital gains taxes for people who reinvested their gains within six months of earning them. The Tories haven’t yet kept this promise. Now, though, they have a marvellous opportunity to do so. For marginal cost in lost revenue, they can set a dramatic example for the entire recession-hammered world by abandoning a destructive tax that inhibits economic growth.

Even in the best of times, Canada’s capital gains taxes produce insignificant revenue. In 2006, a good year, federal and provincial governments collected $3.5-billion in capital-gain tax revenue – less than 1 per cent of total tax revenue. In tougher times, these taxes produce less revenue still because most people report capital losses, not capital gains. In tougher times, the high cost of administering these taxes almost certainly exceeds the revenue they produce.

The Vancouver-based Fraser Institute observed (in a 2007 report) that capital gains taxes are extraordinarily inefficient. The rules governing them are complex and – in many cases – subjective. “A large part of Canada’s tax code consists of regulations designed to clarify the evaluation and timing of capital gains,” the conservative think tank said. “The government requires many agents, accountants and lawyers to monitor and enforce [them].” And taxpayers do, too – effectively paying administration costs twice.

We’ve grown accustomed to these taxes, of course – though they are, for Canadians, a relatively recent innovation. Liberal Prime Minister Pierre Trudeau introduced them in 1971, mostly as a new soak-the-rich tax to finance increases in social spending. It’s not clear from the historical record that he knew he was imposing a significant tax on economic growth. (In his memoirs, Mr. Trudeau listed three spending programs as his principal achievements in 1971: Youth Perspectives, which provided summer jobs for university students; New Horizons, which provided exercise facilities for the elderly; and creation of Canada Development Corp., the agency that made the federal government an equity investor in the resource industries. Conservative Prime Minister Brian Mulroney dismantled the CDC in the 1980s.)

You might think, retrospectively, that capital gains taxes in the 1960s, when Britain adopted them for the first time, simply reflect stereotypical assumptions across the political spectrum – that liberals (presumably seeking to help the poor) favoured them and that conservatives (presumably seeking to help the rich) did not. But you would be wrong. As best exemplified by Democratic President John F. Kennedy, many American liberals championed radical cuts in income tax rates – and repeal of capital gains taxes.

In doing so, they launched supply-side economics, the theory that low tax rates can yield the same revenue as high rates – a theory now indelibly associated with Republican President Ronald Reagan. Boston Globe writer Jeff Jacoby revisited the 1960s era in a column published this month. “His name was Kennedy,” he wrote. “He was the pre-eminent figure in the Democratic Party. And he was a resolute supply-side tax cutter.” The policy contrast between President Kennedy and Senator Edward Kennedy could not have been more explicitly made.

“It is a paradoxical truth,” President Kennedy told the Economic Club of New York. “Tax rates are too high today and tax revenues are too low. The soundest way to raise revenues in the long run is to cut the rates now.” In 1961, he described high tax rates as a danger “to the very essence of the progress of a free society.” In 1962, he proposed across-the-board, top-to-bottom cuts in personal and corporate tax rates. In 1963, in a speech prepared for delivery in Dallas, he planned to proclaim “a massive tax reduction, with particular benefits for small business.” And: “The tax on capital gains directly affects … the strength and potential growth of the economy.”

Mr. Kennedy’s tax cuts mostly went into effect in 1964, after his death. The U.S. economy emerged quickly from a period of slow growth. GDP expanded at rates in excess of 5 per cent a year – until the 1970s, when Democratic and Republican presidents Lyndon Johnson and Richard Nixon restored higher tax rates.

Economists who object to capital gains taxes generally do so because these taxes do not produce new revenue – and instead merely re-allocate old income tax revenue inefficiently.

Who would benefit from the elimination of capital gains taxes? Only the rich? In an assessment of Canada’s capital gains taxes in 2000, Simon Fraser University economist (emeritus) Herbert Grubel concluded that the bulk of capital gains taxes is paid by lower- and middle-income wage earners ($50,000 a year or less) who appear “rich” only in the single, exceptional year in which they realize a capital gain.

It’s time to encourage entrepreneurial activity. It’s time to release – for productive employment elsewhere – much of the brain power held needlessly captive by Canada Revenue.