With capital gains change, the Liberals grasp the tax reform nettle again

In the fall of 2021, the editors of the Canadian Tax Journal devoted several dozen pages to the "hotly debated" topic of capital gains.

On balance, the editors wrote, their selected contributors were in favour of raising the inclusion rate for capital gains — the share of an individual's capital gains that are subject to income tax rates. But they acknowledged that putting such a change into practice would not be easy.

"Opposition to capital gains tax increases among affected taxpayers is apt to be vociferous," Michael Smart and Sobia Hasan Jafry wrote in one of the featured papers, "precisely because such a reform would act like a lump ­sum tax that would be difficult or impossible for taxpayers to avoid in the long run by changing their behaviour."

Whatever its exact causes or motivations, "vociferous" opposition to tax hikes may be as old as taxation itself. But the Liberals already have firsthand experience of how loud that opposition can get, having watched one set of reforms struggle to survive an onslaught of confusion and controversy in the summer of 2017. 

Now they're taking another swing at it — and one big question is whether they're better prepared for the blowback this time.

If the Liberals are hoping to look reasonable and measured, they can at least point to the fact that they haven't gone nearly as far as some wanted them to go.

In their 2001 paper, Smart and Hasan Jafry proposed increasing the inclusion rate from 50 per cent to 80 per cent for all capital gains. In her third budget, tabled last week, Finance Minister Chrystia Freeland proposed an inclusion rate of 67 per cent for capital gains of $250,000 or more.

In their 2021 analysis, Smart and Hasan Jafry pointed out that the wealthiest families benefited disproportionately from the preferential tax treatment afforded to capital gains (though there is some debate over exactly how disproportionately the benefits are distributed). That's now a key aspect of the government's argument.

"The government is asking the wealthiest Canadians to pay their fair share," last week's budget document said, adding that only about 0.13 per cent of Canadians would be affected by the change.

As Freeland noted, her changes also aren't unprecedented. From 1990 to 2000, the inclusion rate was 75 per cent for all capital gains. Freeland is also promising a special carve-out aimed at entrepreneurs.

"There are a lot of reasons why the inclusion rate should go up for capital gains," Smart said in an interview this week.

For one thing, Smart argues, "it's fairer for all Canadians if taxpayers with capital gains pay the same rates of tax as the rest of us do right now." Also, he says, "it's better for the economy if every investor is paying the same tax rate on everything she or he invests in," pointing to differences in the way dividends and capital gains are taxed.

While condemning the budget, Pierre Poilievre's Conservatives have been noticeably quiet on the issue of capital gains. That might be because they sense — correctly — that the Liberals would be happy to accuse them of supporting tax breaks for the rich.

For the time being, other voices are filling the void — including doctors, who came forward with their own concerns this week. The technology sector has been the loudest in its objections. The Council of Canadian Investors has sponsored an open letter that has now been signed by hundreds of tech executives.