Thank you very much, Mr. Chair.

It's a pleasure to be here in person. It's been a very long time since I've had that opportunity. Usually it's been by Zooming, but it's very nice to see everybody in person today. Thank you for the opportunity to address the finance committee on the April budget.

I've decided to focus my comments specifically on capital gains taxation, which is one of the most complex areas of tax policy. Starting on June 24, 2024, the government increased the tax rate on realized capital gains from the disposal of assets by including two-thirds instead of one-half of gains as part of taxable income. For individuals, this increase applies to realized capital gains net of losses in excess of $250,000. For corporations, the higher rate applies to all of their net capital gains.

The budget estimates that only 40,000 individual taxpayers—0.3% of all filers—and 307,000 corporations—12.7% of all corporate tax filers—will be impacted by the increased capital gains tax. The lower number of personal filers hinges on the design of the tax change, including a $250,000 capital gains threshold for individuals, which the budget claims limits its economic costs and its incidence on the wealthiest.

However, capital gains are often lumpy, because assets are sold regularly. Many taxpayers may realize more than $250,000 in capital gains in a single year, but not in others. Significant asset disposal, such as selling real estate, farmland, business assets, secondary homes, or during events like death or immigration, may occur only once or twice in a person's lifetime. Longitudinal data from 2011 to 2021 shows an average of 40,664 tax filers per year reporting capital gains exceeding $250,000, aligning with the budget's forecast. If these were the same individuals each year, the affected group would be small. However, further analysis reveals that nearly two-thirds of taxpayers who reported over $250,000 in capital gains in 2011 did so only once in the subsequent 11 years, and only about 3.5% reported such gains in seven years or more. Importantly, many of these taxpayers have middle-class or modest incomes aside from their capital gains. In 2018, 50% of those with $250,000 in capital gains had non-capital gain taxable income below $117,592, with 10% only having $18,131. This demonstrates that significant capital gains can occur for individuals who are not consistently high earners.

Far more Canadians will be affected by the tax change than the government seemed to anticipate. I estimated that 22,088 unique Canadian taxpayers per year, or 1.26 million Canadians on a lifetime basis—4.3% of taxpayers—will be affected by the increase in the capital gains tax on individuals, half of whom earn less than $117,000 per year.

The other claim in the budget was that the capital gains tax increase would have no impact on business investment. I will argue that this is incorrect, for two reasons.

First, as in many other countries, Canadians have a bias to invest at home. Smaller companies don't have easy access to international markets. Companies that are Canadian-controlled need a significant share of Canadian ownership beyond 2.5%. Canadians have more information about domestic opportunities and risks than they have with respect to international assets. While Canada doesn't have capital controls, except for Investment Canada Act limitations on foreign direct investment, the dividend tax credit and certain other tax preferences apply only to Canadian resident companies, not foreign ones. If there was no home bias, Canadian household ownership of Canadian companies would obviously be much smaller and have little impact on the cost of investment for large companies. However, based on Statistics Canada data, I estimate that Canadian households own 35.5% of listed company shares in Canada. Under home bias, capital gains taxes have been shown to suppress equity values and raise the cost of equity finance investment of Canadian companies, based on studies looking at the capital gains tax reductions in 2000—and I will admit, I was an author with Kevin Milligan and Tom Wilson at that time.

Second, tax increases on corporate capital gains increase the cost of investment, not only for small and medium enterprises, but also for large corporations. Since the corporate tax applies to nominal capital gains, that capital gains tax increases the cost of investment even if there are no real capital gains. From 2011 to 2021, taxable corporate capital gains were roughly 7% of corporate taxable income of non-financial corporations. By the way, one should not look at financial ones, because financial traders are taxed on all their capital gains, and that should be recalled. Based on merger and acquisition data, and the market value of the stock market, I estimate that the annualized non-financial capital gains tax rate, the so-called accrual equivalent capital gains tax rate, rose from 6.4% to 8.5% due to the budget's capital gains tax hike.

Overall, the capital gains tax hike had a significant impact on the incentive to hold capital in Canada and on employment. Two-thirds of the impact is due to an increase in the corporate capital gains tax rate, and one-third is due to the increase in the personal capital gains tax rate. We estimate that the tax-inclusive cost of capital of Canadian companies rose by 5%. Based on a conservative assumption that an increase in the tax-inclusive cost of capital by 10% causes the capital stock to fall by 7%, I estimate that Canada's capital stock would fall by $127 billion.