Pity the Poor Capital Gains-Makers

I am glad that Jim Flaherty’s budget did not actually come through with a rumoured exemption for capital gains income.  Recall that the Conservatives’ 2006 platform had promised a ridiculous and unworkable exemption from income taxes on capital gains so long as the winnings were “re-invested.”  This high-profile broken promise still clearly niggled the Harper government, and expectations were high that the budget would contain some other form of loophole for the coupon-clippers of the land.

Instead, we got something almost as bad: personal tax-free savings accounts, in which ALL forms of investment income (not just capital gains) will be tax sheletered, on up to $5000 of capital per year for every adult Canadian.  Someone in their late 50s, therefore, will be allowed to avoid tax on all investment income on $200,000 of capital.  This measure, applauded on Bay Street (more subsidies for brokers, even as Mr. Flaherty claims to be not “picking winners”), is insidious and dangerous.  Investment income in general is very unequally distributed (very few Canadians have any significant financial wealth outside of registered pension plans and RRSPs), so this goodie is aimed clearly at the top.

My only regret is this: based on the rumours, I had prepared a zinger of a Globe and Mail column berating the idea of a capital gains exemption — that I had to pull at 4 pm, when we realized there was no such exemption!

Nevertheless, the facts and figures about the incredible concentration of capital gains income at the very top of the income ladder are worth repeating — column or no column! 

44 percent of capital gains savings are claimed by the richest 0.5% of taxpayers — those with incomes over $250,000.  Two-thirds are claimed by those making over $100,000.   In its pre-budget submission, the Investment Funds Institute of Canada claimed speciously that “55 percent of those reporting capital gains income have incomes under $50,000 per year” (quoted in the Globe and Mail, sometime in February!)  Yes, but how MUCH did those salt-of-the-earth coupon-clippers claim?  Not much (see stats below).  IFIC’s claim is reminiscent of the other old Bay Street red herring: the one about how 50% of Canadians own (directly or indirectly) at least one share in a major bank, so why on earth would anyone ever complain about sky-high bank profits?

Here are excerpts from the column on capital gains that (happily) did not see the light of day.  Thanks to Toby Sanger for highlighting the escalating tax expenditure cost of the existing 50% loophole for capital gains.

A capital gain is the income you get by successfully following the old investor’s adage, “buy low, sell high.”  You don’t actually have to do anything useful or productive.  You just have to resell an asset (stock, bond, rental property, collectible hockey card, whatever) for more than you bought it.  In other words, you speculate.

Speculators already enjoy incredible favouritism from the taxman.  Capital gains are only taxed when they are realized (that is, when the asset is sold).  And even then, investors only declare half of their winnings.  The other half is tax-free.  A grease-covered cook flipping burgers at McDonald’s must report every penny of hard-earned cash on their tax return.  But the coupon-clippers of the land only declare half.  Go figger.

In 2005 Finance Canada pegged the cost of the current 50 percent loophole for individuals at $2.3 billion per year.  But due to clever tax avoidance (and the booming stock market), that has suddenly doubled, to over $5 billion per year.  If a government social program did that, critics would claim Ottawa’s spending is out of control.  But when the cost of a rich government loophole for investors balloons, nary an eyebrow is raised.
And the efforts of financiers to custom-design increasingly complex vehicles to take advantage of this tax favouritism lead to all sorts of economic mayhem.  Securitized mortgages, asset-backed commercial paper, and other now-discredited derivatives were all spurred, in part, by this lucrative government subsidy to speculators.

It costs Ottawa another $5 billion per year to give corporate tax-filers the same loophole.  So in total, Ottawa now spends $10 billion per year subsidizing financiers (both individuals and corporations) to play any market that moves.
What’s more, the benefits of this loophole are amazingly concentrated at the top of the income ladder.  In fact, there is no other single measure which more effectively delivers value to the super-rich of the land, than the favourable treatment of capital gains.

According to 2005 tax returns (most recent data available), there were 134,000 Canadians whose total income exceeded $250,000 that year – one half of one percent of all tax-filers.  Yet that tiny, privileged slice of society claimed 44 percent of all capital gains.  Those rich Canadians were allowed, legally, to hide $7.3 billion in capital gains (or about $55,000 each).  Over two-thirds of capital gains were declared by those with total income over $100,000.

In contrast, the 22 million Canadians with total income below $100,000 were allowed to hide capital gains averaging $24.79 per person.

Of course, financiers justify this imbalance with pious claims about the productivity of their investments, the need to foster frugality, and all sorts of other mumbo jumbo.  If you believe that, I have some sub-prime mortgage bonds I’d love to sell you. 

2 comments

  • Clearly Jim Stanford doesn’t know much about the whole subject of Capital Gains – there is also Capital Loss when the investment doesn’t work out profitably . That is the risk factor . What percent does one attach to that risk ?
    Not all , in fact less than one half , of Capital investments don’t pay dividends ( coupons he calls them ) , and those that do receive dividend income are taxed almost as highly as interest income .
    And getting back to a Capital investment such as publically traded shares – without sufficient chance of a gain of some sort , the investment money would go somewhere else – that would be very very bad for business expansion in Canada . I thought everyone understood that , but I was wrong . Money can go into Gold bullion as it does in some third world countries , and it can go to other countries that understand that a profit has to be made equal to the risk involved .
    And there is the matter of the Capital Gain ( so called ) on the sale of one’s personal residence . Taxing that after having taken property taxes from the owners over the years ,is double taxation . Over the years there is often repairs and expansions and improvements made to the home and sales taxes have been paid on the materials and labor to do that .
    I can go on and on but Stanford should get an economics course first before he reveals how little he understands about risk and reward in money investments .

  • “Someone in their late 50s, therefore, will be allowed to avoid tax on all investment income on $200,000 of capital”

    Where does this $200K number come from??

    “(very few Canadians have any significant financial wealth outside of registered pension plans and RRSPs), so this goodie is aimed clearly at the top.”

    You undermine your own argument here by admitting that more than just a “very few” have RRSPs. These instruments are entirely analgous to RRSPs, except you pay your tax at the beginning instead of at the end. Whether they are better than a RRSP depends on the expected income profile of the investor, and that’s largely demographic.

    “In other words, you speculate”

    This is simply false. CANADIAN TAX LAW CONSIDERS PROFITS WHICH CAN ONLY BE REALIZED BY A CHANGE IN THE PRICE OF THE ASSET AS ORDINARY INCOME. If you are a day trader your profits are taxed like employment income. A capital gain is realized by someone who, in contrast to a speculator, invests for income. When I buy and hold something like a company’s stock and the company retains its income instead of dividending it out, I get a capital gain. But I’m still passively investing for the income that company makes and that is not “speculation”.

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