Fraser Institute says Canadians Would Benefit from Scrapping of Capital Gains Tax

Contact:

Herbert Grubel, Senior Fellow
The Fraser Institute, (604) 688-0221 Ext. 543 Email: herbg@fraserinstitute.ca

Release Date: 18 May 2000

VANCOUVER,BC>>>Canada should eliminate its capital gains tax to spur economic growth, says a new book, Unlocking Canadian Capital: The Case for Capital Gains Tax Reform, written by economist Herbert Grubel and released today by The Fraser Institute.

"To stimulate economic growth, I recommend that Canada eliminate its capital gains taxes. As a second-best policy, I suggest the rate be lowered to, and kept at, that of the United States. The third-best policy is to return the inclusion rate (currently 2/3) to 50 percent, the level at which it was introduced in 1972," says Grubel.

The defenders of capital gains taxation in Canada claim that capital gains taxes are required to raise revenue, make income distribution fairer, and improve economic efficiency. According to Grubel, all three arguments are flawed.

The author points out that the capital gains tax raises little revenue. In fact, lower rates are likely to increase revenue in the short run because lower tax rates induce the sale of appreciated assets and bring in more tax payments. There is also strong evidence that lower capital gains tax rates induce higher revenues in the longer run, largely as a result of increased economic growth and the subsequent payment of more personal and corporate income taxes.

In 1992, the tax brought in about $700 million (equal to .3 percent of total taxes collected). However, the net revenue generated is considerably less because of the high costs associated with collecting the tax.

In a startling finding that challenges conventional wisdom, the author concludes that a majority of capital gains are paid by middle-income earners with less than $50,000 a year in income. This is contrary to the widely-held perception that mainly the rich pay capital gains. Grubel explains that incurring capital gains is often a one-time circumstance, such as the sale of a small business.

"Over half of all capital gains taxes are paid by Canadians earning less than $50,000. In other words, the bulk of the taxes are paid by middle-income earners," says Grubel.

In fact, the capital gains tax introduces an important element of unfairness because it taxes phantom gains that are the result of inflation. During the last 30 years, inflation has been greater than the growth in Canadian equity values and Canadians lost about one third of the real value of their holdings. The capital gains tax brought this loss to near 45 percent.

The author notes that the capital gains tax creates economic inefficiencies because it encourages the owners of capital to hold on to their investments, and prevents them from taking advantage of more profitable investment opportunities - a practice known as the "lock-in effect."

"While there are no estimates of the size of the efficiency loss due to the lock-in effect, there is no doubt that it is substantial, and is responsible to a significant degree for the revenue increases observed in the United States in the wake of lower rates of taxation," concludes Grubel.

Established in 1974, The Fraser Institute is an independent public policy organization based in Vancouver.

For further information contact:

Suzanne Walters, Director of Communications,
The Fraser Institute, (604) 714-4582,
Email suzannew@fraserinstitute.ca

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