If you’ve purchased stocks or own some real estate then you’ve likely heard about what changes the federal government has proposed to the capital gains tax. I thought I would go through and talk about this and in a future post I may go over some of the other changes proposed. There was talk of millions of homes getting built which might be what we need to work through our housing problem. But will we have to manpower to accomplish these lofty targets? I’m not so certain.
Let’s begin with the big headline. The changes to capital gains tax. Under the proposed 2024 budget the capital gains inclusion rate, which is the percentage of the gain that is taxed, will stay at 50% for gains under $250,000. However, beyond $250,000, 2/3rds of the gain will be taxable at your marginal tax rate. This would most likely be taxed at the highest tax rate since the gain itself will almost produces enough income to put you in the highest tax bracket.
So lets take an example. You sell a real estate asset and it produces a gain of $500,000 under the current system where 50% of the gains are taxable, you would owe tax on $250,000. If you’re in Ontario the combined federal and provincial tax rate is 33+13.16 = 46.16%. So you would owe approximately 250,000*.4616 = $115,400 total on the gain.
Under the proposed change, your first $250,000 would produce $125,000 of taxable income. I’m going to assume this is still taxed at the highest tax bracket. This means you would owe $57,700. Then on the next $250,000 gain, you would have an inclusion rate of 2/3rds which is $166,666.67 of taxable income. This means you would owe $76,933.33 in taxes. The total tax amount is $76,933.33+$57,700 = $134,633.33.
So the change in taxes owed is approximately 134,633-115,400 = $19,233 increase. As you get into higher gains this number does increase quite a bit. Another way to look at this is as an “effective” tax rate. If you get taxed on 50% of the income at a 46.16% tax rate your effective rate on all this income is .5*.4616 = 23.08%. The effective rate of 2/3rd’s is 0.6667*0.4616 = 30.77%. So this is an increase of around 7.69% in taxes on any capital gains beyond $250,000.
If you are an investor, and you are buying and selling many stocks, real estate, or businesses and making millions of dollars a year doing so, you’re going to owe approximately an additional $76,900 in taxes per $1,000,000 in capital gains. That would be a total of around $307,700 per $1,000,000. Where under the current system it’s closer to $230,800 per $1,000,000 gain. The increase is the equivalent of a pretty decent salary for the average Canadian. Crucially, primary residences remain tax free, which is the majority of Canadian’s largest asset and many Canadians retirement plans.
Many people in the business community are arguing that this change could do a few things. It could disincentivize venture capital from investing in Canada, disincentivize general investment in new businesses, and cause investment money to leave Canada altogether and put us into a further state of stagnation. Our per capita economic output has actually declined over the past year due to our recent population influx combined with higher interest rates. Interest rates impact borrowing costs which is how a lot of business invest, less investment equals less economic growth; generally speaking. Additionally, if companies who are mobile choose to leave the country altogether, depending on the nature of their work, they may or may not be able to keep a Canadian workforce. Which could also negatively impact the Canadian jobs market.
Regardless of your stance on this I do believe that a change of this nature (some type of tax increase) was likely to be proposed at some point as more and more people feel they cannot get ahead for one reason or another and politicians hear about peoples problems and look for someone to come after. With the higher interest rates impacting food, gas, and other essentials. The cost of purchasing a home having outpaced wage growth by almost 4x. It is likely to put a target on the backs of people who have already found their success as governments search for a solution to these issues and try to find people to help pay for their programs and chosen investments.
So if this change does pass what will happen? I think this change most likely won’t cause any major exoduses out of capital markets. It’s unlikely that people with strong ties to their families and communities will end up jumping ship. After this change, capital gains are still going to be taxed at a lower rate than equivalent earned income theoretically still making it a good idea to invest. I also doubt that it will cause any investors to change their long-term plans and sell all their investments this year. Investment is a long-term game and takes detailed planning. So even with this change I don’t see it having an outsized impact on the markets.
I’m not a politician, not an economist either, so I can’t say whether or not this new tax will actually provide a meaningful contribution to the deficit or if maybe the better approach is to simply spend less. There could also be a variety of other solutions out there that don’t require a tax like this. No one enjoys paying higher taxes. Another point I think is worth mentioning is that the current government has lost some popularity among constituents. Therefore, if I was a prudent politician looking at my odds to win the next election, I would likely try to be a bit more aggressive on what could be one of the last budgets I get to table to see if I can push through some final big changes before I get the boot. We’ll see how this pans out, and I will be following the news on this change closely. While I do have further thoughts on this topic it is a bit of a challenging one to discuss so I’ll leave it there for now. Feel free to let me know your thoughts via email or leaving a comment below.
All the best,
Oliver