Unlocking Canadian Capital - Exhibits to John Dobson and Ian Soutar Presentation

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Exhibit 1: The Power of Compound Interest
Effect of Negative Canadian Policies

$1,000 compounded annually at the following rates over a 40-year time period produces the following returns: (40 years is taken to illustrate a young person of 25 saving until retirement at 65).

20% $1,500,000

15% 268,000

12% 93,000

10% 45,000

9% 31,000

8% 22,000

6% 10,000

$1 doubling annually for 20 years produces $1 million.

Three government actions cause the investor to receive significantly less.

1. Capital Gains Tax: A rate of 40% applies to taxable income above $60,000.

2. Inflation: Since the arrival of the Capital Gains Tax in 1972, the purchasing power of the Canadian dollar has declined to 25%. The Capital Gains Tax rate is much greater than 40% when applied to the real purchasing power of the original investment dollar.

3. Currency devaluation: Since 1976 the purchasing power of the Canadian currency has dropped from $1.00 to $0.72 in terms of the US dollar. Investors preserving their purchasing power by owning foreign assets must also pay a capital gains tax on this loss.

Let's look at some scenarios:

• $1,000 compounding 20% for 40 years = $1,500,000
• $1,000 if you pay 40% on capital gains as tax annually = $93,000
• $1,000 held for 40 years and pay 40% capital gains tax at termination = $900,000
• $1,500,000 would be worth in 1972 dollars = $375,000
• $1,500,000 would be worth in US purchasing power versus 1976 = $1,081,5000

Conclusion

Excluding the big inflation and devaluation losses - the 40% Capital Gains Tax results in the following:

• $1,000 compounding at 20% for 40 years untaxed = $1,500,000
• $1,000 compounding at 20% for 40 years with annual capital gains tax = $93,000
• Government receives over 40 years if taxed annually = $22,000
• Government receives if taxed only at end of 40 years = $600,000

The individual loses $1,407,000 of wealth creation so that government gains $22,000!! Not a great trade-off for Canada!

Clearly, to create wealth and take advantage of savings, the investor should aim for long-term holdings and high rates of return. It is difficult to build a competitive country with this attack on wealth.

Canada's great growth years of the 1950s and 1960s took place before 1972 when Canadians enjoyed NO capital gains tax.

Exhibit 2: Wealth Creation Means Job Creation
The Effect of Capital Gains on Real Returns
Submitted to the Vancouver Symposium on Capital Gains Taxation - The Fraser Institute, June 1999

Case A: Capital Gains Tax Effect on Real Return

Assumptions: 25 year holding period.
5% inflation rate.**
40% capital gains tax.
Portfolio turns over every three years.***

If the inflation assumption is changed to 3.5% the respective true capital gains rate would be 107%, 81%, 71%, and 59%.

The return required to break even as a real basis would be 5.6%.

Case B: Actual Experience of Formula Growth Fund Investors

Conditions: 25 year holding period.
21.1% compound annual rate of return.
Portfolio turns over every three years.

Conclusions

A. Capital creation is much more rapid in lower tax regimes: Hong Kong and the US create wealth at 4.7 and 2.2 times the rate of Canada, respectively. This means that assets will increasingly be owned by investors from lower tax regimes.

B. Investors must invest aggressively to overcome the effects of inflation and capital gains tax (not a traditional Canadian approach to investing).

C. The government must set up the RRSP vehicle as a measure for helping Canadians to look after themselves, not as a wealth creation vehicle.

Notes

*Proportion of real return paid to government.
**Canadian actual rate has been 5.3% over the past 25 years.
***Actual turnover of Peter Lynch, John Templeton, and Formula Growth.

Exhibit 3

Investor 1

Child gets $1,000 per year for 21 years
Reinvested at 20% annual return
Turns over portfolio every third year

With taxes Income below $8,000: 0%
Income between $8,000 and $25,000: .75 x 35%
Income between $25,000 and $60,000: .75 x .45%
Income above $60,000: .75 x 52%

Investor 2

McGill Commerce Graduate Saves $5,000 per year
Reinvests at 20% annual Return
Capital Gains Tax Paid of 30% on Returns

Investor 3

Secretary Saves $5,000 per year
Reinvests at 20% annual return
Capital Gains Tax paid of 30% on returns

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