How eliminating the capital gains tax can restore the Alberta Advantage
The Alberta Advantage isn’t just a political slogan, and it’s much more than the occasional oil boom or tax cuts. It is the operationalization of the idea that private enterprise, resource development, and self-reliance are key factors in fostering prosperity.
A regulatory environment that does not undermine development, but rather encourages it as long as it follows certain reasonable standards, has also helped enable some of that “can-do attitude. Coupled with a tax environment that is more favourable to investment, it has yielded some of the highest-paid jobs in the country, along with large resource royalty revenue.
Unfortunately, this advantage Alberta built in relation to other jurisdictions has eroded over the years. While some of it can be attributed to economic uncertainty and other external factors, part of it can also be attributed to the provincial government’s policy decisions. The end of our flat tax, for instance, contributed to the erosion of this competitive advantage.
To reassert the Alberta Advantage won’t be an easy process, but one of the first steps should be to reevaluate how we treat investment in our province. Most importantly, we need to stop taxing it.
Capital gains are taxed on proceeds from the sale of an asset, from a second home to a small business. Currently, the government uses a 50 percent inclusion rate, which means subjecting half of realized capital gains to the income tax.
The problem with taxing capital gains is that it amounts to taxing savings and investment, which are the very building blocks we need to create new enterprises and, in turn, generate new and better-paid jobs.
To boost employment, improve our standard of living, and reclaim the Alberta Advantage, the Alberta government should abolish its capital gains tax, letting investment flow into our province.
By levying taxes, the government distorts the incentives that drive investment decisions. This makes investment less attractive by reducing the expected return while leaving the risk unchanged. That was one of the key arguments against the Trudeau government’s recent attempt to increase the capital gains inclusion rate.
Another less widely discussed but nevertheless damaging effect is how such taxes change the behaviour of existing investors. When considering the sale of an asset, investors take into account how it will affect their tax bills. Sell too many assets with a great return in one year, and you might be forced into a higher tax bracket, for instance.
As such, some investors choose to keep certain investments on their books for longer than they otherwise would, as a way to minimize their tax bill in a given year, or rather, smooth out their income over time, in order for their taxes to better reflect their income. This is what economists refer to as the “lock-in effect.”
Making investors hold on to an investment longer than necessary leads to a situation where there is less capital available to fund newer, more productive projects. What this means in essence is that there are fewer funds available to invest in other opportunities, such as new businesses started by Albertan entrepreneurs.
For the rest of us in Alberta, this means fewer new jobs and paycheques that grow more slowly as firms have a harder time starting up and scaling up.
This lock-in effect was acknowledged in 1969, when the federal government wrote the white paper that led to the implementation of the current capital gains tax system, which the provincial government now also applies to Albertans’ capital gains. Unfortunately, acknowledging the issue is not the same as resolving it, as the lock-in effect and its cascade through the rest of our economy is still undermining our prosperity.
Around the world, other governments have understood this negative effect and elected not to tax capital gains at all, or very little. This includes large international financial centres such as Hong Kong, Singapore, and the United Arab Emirates. Other countries tax it only under very specific circumstances, such as Switzerland, the Netherlands, and New Zealand.
Closer to home, nine U.S. states have elected not to levy a provincial capital gains tax. And the list is growing, with Missouri joining that group no later than last year.
For the government of Alberta, getting rid of capital gains taxation would put a good chunk of money back into Albertans’ pockets. Using Statistics Canada’s SPSD/M model, we found that the removal of this tax could boost Albertans’ disposable income by as much as $1.1 billion per year.
Meanwhile, the loss of provincial tax revenue would be limited to approximately $431 million. In essence, every capital gains tax dollar given up increases how much Albertans can spend, invest, or save by a bit over $2.50.
It’s also something that’s entirely within its power to achieve. Over the years, a number of respected academics have pointed to different ways that Alberta could stop taxing capital gains at the provincial level. One way, as pointed out by Ben Eisen and Jason Clemens from the Fraser Institute, would be for the province to exclude capital gains from total provincial taxable income.
To boost employment, improve our standard of living, and reclaim the Alberta Advantage, the Alberta government should abolish its capital gains tax, letting investment flow into our province.
Gerard Lucyshyn is Vice President of Research and Senior Economist at the MEI. He is the author of “Reasserting the Alberta Advantage: The Case for Capital Freedom and Abolishing Capital Gains Taxation” and the views reflected in this opinion piece are his own.