May 1, 2024

Bolder moves needed for taxing the rich

By and fair taxation

The big surprise in the 2024 federal budget was a very small, but very important, tax increase on the richest Canadians. Although modest, the increase has some on Bay Street fuming. But the reality is we need to do much more to improve tax fairness and reduce the growing gap between the rich and the rest of us.

The 2024 tax changes affect capital gains, or the income received when selling an asset above its purchase price. Currently, only half of capital gains are taxable, with exemptions for primary residences and up to $1 million in other qualifying assets, such as farming and fishing property.

Under the new rules, 66% of the gains above $250,000 will be taxable. The primary residence exemption remains, with the lifetime exemption increased to $1.25 million.

The government is also reducing the inclusion rate to 33% on up to $2 million in capital gains for business founders. Under the new rules, those selling a business for under $6.24 million will actually pay less tax.

While modest, this change is expected to raise $18 billion over the next five years and be paid by only the 40,000 or so richest individuals.

Even with the 2024 change, the income from buying and selling assets will be taxed less than from working.

These discrepancies lie at the heart of inequities in the Canadian tax system. The highest-income households benefit from several sources of untaxed or lightly taxed income, such as inheritances and bequests, and employer-provided benefits, in addition to capital gains.

A fair tax system should be based on “horizontal equity”, the principle that two people with the same amount of income in a given year pay the same rate of tax regardless of the source of that income. Bay Street accountant Kenneth Carter, who headed a royal commission on taxation in the mid-1960s, captured this notion with his comment that “a buck is a buck.”

Even with the 2024 change, the income from buying and selling assets will be taxed less than from working.  

Carter and the other commissioners also advocated an overall progressive tax system. Have we achieved that?

Our new study of Canada’s tax system, which examined all sources of income and all taxes across the income distribution, finds that we have not.

Taxes at the bottom of the income distribution are modestly progressive. Then, there is a flat tax structure through the middle. Finally, it gets regressive at the top with the top 5% paying a lower rate than the bottom 95%, and the top 1% paying an even lower rate.

Part of the problem is the partial exclusion of capital gains because as you approach the top, ever more income is from owning rather than working. Further, many taxes, such as property taxes and payroll taxes, are not progressive.

Since 2004, Canada’s tax system has become less progressive, with rates in 2022 as much as 4.7 percentage points higher for the bottom two deciles.

One positive development is that rates for the top 5% of households are somewhat higher in 2022 than 2004, largely due to the addition of a new top income tax bracket in 2016. The new capital gains inclusion rate will help nudge up rates at the very top.

Outside of the top 5%, federal taxes were generally lower in 2022 than 2004. However, this reduction was more-than-offset by higher provincial taxes. Provincial tax distribution is more regressive across the whole distribution and has become more so.

What should be done? First, we need higher top rates and elimination of various tax preferences, like capital gains exclusion, that primarily benefit top earners. In addition, we need to tax inheritances and wealth to level the generational playing field. Finally, we need to increase corporate taxes with a focus on windfall taxes in sectors like groceries and oil and gas.

A fair and decent society should have neither extreme of obscenely rich nor desperately poor. Taxation of the wealthiest is a central means to reduce inequality, provide robust public infrastructure and services that benefit all, and create opportunities for all to live a decent life.