(Bloomberg) -- Canada’s decision to increase the capital gains inclusion rate is unlikely to generate as much cash as Justin Trudeau’s government expects, a research group says.
The changes will add a net C$3.3 billion ($2.4 billion) to federal government revenues from individuals over five years, according to a paper being released Thursday by the C.D. Howe Institute.
That’s less than 40% of the C$8.8 billion forecast by the government when Finance Minister Chrystia Freeland proposed the tax changes in April.
The paper’s authors say the discrepancy in estimates is due to different assumptions about personal income tax revenues and the “cyclical nature of capital gains realizations and the adjustments firms and individuals may make in response to the tax change.”
The parliamentary budget officer, the country’s fiscal watchdog, has also projected revenue gains will end up lower, saying the increased tax will add just C$5.8 billion to personal income tax revenues.
In June, the federal government increased the inclusion rate to two-thirds from one-half for gains over C$250,000 earned by individuals. The broader increase, which also impacts corporations and has some exceptions, has drawn the ire of business groups and some economists.
Weaker-than-expected revenue gains would raise questions about the benefits of the tax changes, which have faced widespread criticism during a period when sluggish business investment and lagging productivity are already weighing on the economy’s long-term growth prospects.
The Liberal government says it’s asking wealthier Canadians to help foot the bill for new expenditures meant to make housing more affordable and improve the lives of young people. Freeland has promised to cap the country’s deficit at about C$40 billion, and higher debt payments have eroded capacity to roll out new social programs, a cornerstone of Trudeau’s fiscal governance.
Capital gains ‘cyclical’
In the paper, the authors note the government’s estimates of the corporate income tax proceeds from the tax changes appear “plausible,” though they don’t model them. The Finance Department pegs that amount at C$10.6 billion.
As for personal income tax revenue, the authors point out the budget lacks detail on the assumptions underlying the government’s estimates, so they can’t fully explain the difference. However, several factors may account for the discrepancy.
First, the authors say the most recent data are from the 2021 tax year, when near-zero interest rates, fiscal stimulus and quantitative easing pushed up demand for assets. They accounted for the cyclical nature of capital gains realizations in their projections, but don’t know the extent to which the government did the same.
They also note the newly reformed alternative minimum tax — which imposes a basic tax level on those who claim certain deductions, exemptions or credits — will interact with the higher capital gains inclusion rate, limiting extra revenue from the latter.
Further, their projections account for taxpayers responding to changes in capital gains taxes by adjusting the timing and amount of their realizations. And finally, the higher inclusion rate at the corporate level will reduce non-taxable capital gains that can be distributed to owners as tax-free dividends, thereby increasing personal income tax revenues.
Personal income taxes totaled C$208 billion in the 2022-23 fiscal year, while corporate income taxes totaled C$94 billion.
Polling suggests a slightly higher proportion of Canadians have a negative view of the capital gains tax hike than positive. Some 45% said the change will decrease investments and weaken the economy, while 38% thought it was fair and would help close the gap between the rich and poor, according to an April poll by Nanos Research for Bloomberg News.
--With assistance from Jay Zhao-Murray.
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