Further Thoughts on the Capital Gains Tax

The paper illustrates why Canada’s Budget 2024 tax rules do not treat the earners of capital gains uniformly or fairly, because of inflation. The effective tax rates on real capital gains vary substantially among taxpayers depending upon the holding period and the rate of return. Furthermore, capital gain taxes may even create real losses. Uniform inclusion rates applied to nominal capital gains poorly measure real capital gains and typically result in considerable underassessment or overassessment of actual capital gains income (i.e., improvement in purchasing power). An appropriate measure of capital gains should use a cost base adjusted for inflation.

Under the current system, capital gains are taxed differently across comparable taxpayers so taxpayers are treated unevenly and unfairly. If real capital gains were the tax base, capital gains would be taxed at a uniform rate across like taxpayers. Taxpayers without real gains, even if experiencing nominal gains, would (unlike now) pay no capital gain taxes. Assuming that a 53 per cent income tax rate applied to the full amount of real gains, those facing an effective tax rate on capital gains that exceeded 53 per cent of real gains under present methods (e.g., Case B) would benefit from lower taxes on their real capital gains. In situations where a larger real appreciation rate would result in an effective tax rate on real capital gains that was less than 53 per cent (e.g., Case C where effective rates are less than 53 per cent in most instances), those taxpayers would pay greater capital gains taxes than now. Furthermore, these benefiting from a higher rate of return would experience a larger increase in their tax rate. Thus, some earners of capital gains would benefit from a conversion to capital gain taxes assessed on real gains versus the existing system based on portions of nominal gains, while others would lose, but the tax treatment would be equitable and less distorting.