May 24, 2024

Reasons for the Capital Gains Rate Increase: 1987 vs. 2024

The pushback from the business community against the proposed increase in the capital gains inclusion rate from 50% to 66⅔% has been ferocious and, for reasons I'll explain below, justified. However, we have seen a greater increase without the current level of opposition. As part of its White Paper on Tax Reform released on June 18, 1987, the Conservative government of Brian Mulroney increased the inclusion rate from 50%, where it had been since 1972, to 66⅔% for 1988 and 1989, and to 75% for 1990 and subsequent years. The rate stayed at 75% until 2000, when it was returned by the Liberal government of Jean Chretien to 50%, where it remained until this year.

In June 1987, I was a manager in the small business group of a large accounting firm, a place I was discovering God did not design me to be. I dealt with income tax issues every day. With two young daughters, I didn't have as much time to read the financial press as I do now. However, I don't recall anything like the current furor over what was a more significant increase in the capital gains rate. 

Curious why that might be, I recently re-read the White Paper and the 1987 and 1988 Budget speeches delivered by then Finance Minister Michael Wilson. The increase in the capital gains rate was a small part of a broad program of income and sales tax reform, international trade initiatives (mainly the Canada-United States Free Trade Agreement) and deficit reduction. 

Personal tax reform measures included a reduction in the number of tax brackets from ten to three, a reduction in the top marginal rate from 34% to 29%, a broadening of the base by eliminating many special preferences, and a conversion of most deductions and exemptions, which had applied at the taxpayer’s marginal rate, to credits which mostly applied at the lowest marginal rate.  Corporate tax reform included a reduction in the basic federal tax rate from 36% to 28%, a significant broadening of the base for financial service and real estate businesses and elimination of many high rate capital cost allowance categories.  The effect of the increase in the capital gains inclusion rate was modified somewhat by the reductions in the corporate and top marginal personal tax rates.

The White Paper also contained the basic outline to replace the manufacturers sales tax with a value added tax that was to be implemented three and a half years later as the GST. The GST was unpopular with consumers because it was visible, while the tax it replaced was not. However, the GST reduced costs significantly for many businesses.

No specific reason is given in the White Paper for the increase in the capital gains rate, other than to balance personal and corporate tax reductions in other areas.  The key word is “balance”.  I assume that the business community did not get so upset in 1987 and 1988 because the Tax Reform included features, particularly the general rate reductions, that were supportive of business. The implementation of the Canada-United States Free Trade Agreement in 1989 had an enormous influence on the success of many Canadian businesses.

It is balance that is sorely lacking in the current proposal for increasing the rate. We have a tax on investment being imposed to finance overspending on current government programs.  That sends a terrible message to entrepreneurs and investors.  As my friend Kim Moody never tires of pointing out, the Canadian income tax system is beginning to crack. It is in sore need of fundamental reform, almost certainly greater than the last one in 1987.  The GST system also needs some fundamental attention.  The rules for financial services and non-residents have become too complicated. The rules surrounding residential and personal use real property have always been too complicated.

The current government is too old and tired to look seriously at tax reform. However, the topic should be addressed following the next election. Any change in the capital gains rate should be deferred until then when, as was the case in 1987, it may possibly make sense when balanced against other changes in the system.

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