Canada's Capital Gains Tax Hike Closes a Loophole Being Used to Fleece Canadians on Debt, Housing and Rent

There is no question: lots of people who don't want to pay taxes on capital gains are folks who have been profiting from driving up the price of real estate and rent.

Above: the debate on the new capital gains tax. Actually, it’s a French Farmer performing a manure protest.

The blowback on proposed change to Canada’s capital gains tax in the Federal Budget has been greeted with the usual shower of bovine scatology.

As I wrote earlier, the quality of Canada’s policy debates on economics is absolute dreck, and this is true from the left, the right, gaslighting thinktanks and grossly inaccurate financial journalism.

It’s being claimed that this change will discourage innovators and investors, when it is absolutely clear from the reaction to this change is that will not only increase government revenue, but it throws a monkey wrench in the business models of investors who are fleecing Canadians who have enriching themselves by fleecing the middle and working classes with massive increases in real estate, rent, and debt.

First: the policy.

The federal government is increasing taxes on a certain level of capital gains. Let’s say you buy an asset (a house, or an investment) for $200,000, and you sell it for $400,000, your capital gain is $200,000.

It’s been explained here fairly well. The federal government points out that this is from large profits from selling assets, and there are still all kinds of exemptions. It’s doesn’t apply to the house you own - there is still an:

“existing exemption for capital gains from selling a principal residence…

It also retains an existing lifetime capital gains tax exemption on the sale of small business shares, and farming and fishing property.

The new budget proposes to increase that exemption to $1.25 million, and to index that figure to inflation thereafter.”

As I’ve written before, at length - you need to understand how concentrated asset ownership in Canada is.

We still measure income and wealth in “quintiles” - we split the population into five equal groups of 20%, which colossally distorts who owns what and who earns what. Sometimes it is broken down into “deciles” which still doesn’t improve it, because income and assets tend to be concentrated according to a “power law”. It’s not a steadily rising slope, it’s not a bell curve.

For the vast majority of the population, it’s a slowly increasing slope, then at the very top, the amount of income and property that a very small group of people owns increases exponentially.

In the individual incomes graph, the actual highest income was many times higher than will fit in this graph for income (below left).

The reaction from Conservative organizer Stephen Taylor was probably the single most important tweet about the budget. Because it tells you what is really going on, and why people will push against it.

They’ve been buying apartment buildings, and raising your rent.

https://x.com/stephen_taylor/status/1780378111281897839

There is an important point here, which is related to debt, ownership and rent - and Canada’s massive housing bubble, which one strategist has described as “the biggest housing bubble of all time.”

“As recently as ten years ago property speculators were a minority amongst Ontario’s home buyers. Investors now surpass first-time buyers as well as the total number of people moving between homes. According to a recent report, between January and August of last year investors were responsible for a quarter of house purchases in the province.”

Property speculators are not building new buildings or housing. That is why we have a housing and rental shortage. Instead, these speculators use low-interest debt to finance large loans to drive up the price of existing buildings. They may make minor improvement and evict current tenants (through renovictions) and raise the rent, in order to make it more attractive for resale, to the next investor who has an even larger loan.

This has created Canada’s housing and affordability and debt crisis - and it is happening in other countries like the UK, US and elsewhere, for exactly the same reason.

It’s not based on the creation of new value or innovation - it is all financial engineering. Real estate and debt are not new businesses. This is not good business: it’s absolutely terrible for everyone, and one of the reasons it has been possible is that our capital gains tax system allows for it.

If Taylor is correct, the capital gains tax will result in people selling their overpriced commercial real estate, because the value of a rental property has just been “crushed” when they have been massively artificially inflated by speculators.

Former NDP Leader Thomas Mulcair, the Globe and Mail, and various other pundits have all been screaming that a tax on capital gains will hurt the “middle class”. This is not surprising from Mulcair, who as a Quebec MNA sang the praises of Margaret Thatcher and ran a right-wing pro-austerity campaign in 2015.

What is actually happening is that the Federal Government is taxing the people whose capital gains have been made at the expense of owners, renters, borrowers, younger generations, and the economy as a whole.

The “Council of Canadian Innovators (CCI)”

As reported here, the “Canadian Council of Innovators” has compiled a list of signatories who don’t want the federal government to proceed with the capital gains changes.

I’ll start with what is a reasonable comment from that article.

“Ali Asaria, founder and chair of Tulip, said those arguing against the changes are “a tiny minority” of who will be impacted and that the criticism creates distraction and polarizes the conversation.

“I’m a bit afraid of speaking out on this issue just because I know that there are investors who are very mad that I said anything [on Twitter],” Asaria said in an interview. “I wouldn’t recommend an entrepreneur try to optimize for capital gains exemption when they’re starting a company—there’s so many more things to worry about.”

The signatories are on this website, where it is argued the capital tax changes should be pulled from the budget because “among innovative high-growth companies, stock options — subject to capital gains tax — are a key form of compensation.”

Frankly - that is the problem right there: the capital gains tax deduction being used for compensation, even if people haven’t invested any capital up to that point.

The way a stock option works is that a company gives you the option to buy some of its shares in the future at a certain price. The company gives you options to buy 1,000 shared at $20 a piece, for a potential total of $20,000. The stock goes to $30. You exercise your option and sell the shares for $30,000, which means you have a capital gain of $10,000. The thing is, you did not have to put any of your own money in to exercise your option. The money to pay for the shares can be from debt. The company is selling the shares at a discount, so it gets less investment from stock options.

The investment is all after the fact. For the share option to be worth exercising, the stock price has to already be higher than the option - the original investments are already paying off.

How can this discourage investment, when it is not investment? It can’t. It’s about avoiding having to pay taxes at the same rate that everyone else who makes money from their work does.

Many of the Innovators to the Innovator List are not Innovators

Real estate, banks, and predatory lending are not innovative or new businesses.

At a time of record inflation, record inequality, record debt, rising interest rates, and sky-high rents and housing - these are the sectors of the economy that are taking all the money that everyone else is running out of.

Many, many of the signatories to the list are in the finance business, including for Canada’s big banks - Toronto Dominion.

• Tom Lowden, Director, TD Bank, Toronto

• Shez Samji, Vice President, TD Bank, Toronto

The fact that they work of one of Canada’s big banks is less interesting than who they worked for before: Silicon Valley Bank, which collapsed in March of 2023. It was the largest bank collapse in years. So, their perspective on the changes may be worthwhile, which is to say, whether they see the same risks facing Canada’s banks.

There are a variety of apps and bespoke software solutions, but one stood out: “goPeer” which is a Toronto-based company where you “invest” by lending your money at interest rates up to 34.99% to other Canadians who can’t get money anywhere else.

From their Disclaimer, at https://gopeer.ca/borrow/#how_it_works

GoPeer presents itself as “shifting the balance of power from the large financial institutions to individual, everyday Canadians,” when it offers individuals with large amounts of money to turn themselves into predatory lenders who, if they make the “investment” can write it off as a loss, and if it pays off, they can claim it as a capital gain.

The basic social and mathematical reality of interest, is that it is a price on risk, based on whether you’re uncertain about someone paying you back. And the poorer you are, the higher risk you are, and the richer you are the lower.

If someone is borrowing $5,000 and paying 34.99%, they’ll be paying back double in just five years. Think of it this way, from the borrower’s point of view. They’ve paid back the principal in just two and a half years, and for the remaining two and a half, it’s just interest.

And they have arranged for millions of dollars of loans already. They have “reviewed” over half a billion dollars worth of loans.

Selling Real Estate and high-interest lending are not modern innovations - and a large number of the other tech companies are in the business of coming up with systems to put people out of work - various kinds of software that means that instead of hiring employees, businesses can just get an app or software.

What Innovation and Investment Requires

Marianna Mazzucatto has written an incredible book called the entrepreneurial state. Mazzucatto is an economist who has researched innovation.

On innovation, she makes the point that real innovation takes long-term commitment of up to twenty years, and that only occurs in research done by the private sector. For many companies and investors, the “long term” is three years.

Mazzucatto said one of the questions for Europe was why the U.S. has such a powerhouse of global tech firms. One answer is that the U.S. government, military, and department of energy pays for and develops incredible amounts of technology - hardware, software, medical, IT, engineering, materials - which is then commercialized by U.S. companies. The U.S. also guards and enforces its copyright.

Mazzucatto has chart showing how every single key piece of technology in the iPhone was developed at public expense.

That is the product that truly turned Apple back into a global tech powerhouse and the first trillion-dollar company. The private R & D at companies like Xerox and Intel, and Bell Labs was paid for with public funding.

Notably, it is not because government was the first choice. When it came to building the Internet, both IBM and AT&T were approached by the Defense Advanced Research Projects Agency (DARPA) in the 1970s, but they did not want to invest in it, because they saw it as competition. The British Post Office was an investor in U.S. Internet.

The other is a technology called “thin film transistors” which enable flatscreen and touchscreen technology. The original research funding at Westinghouse came almost entirely from the U.S. Army. When the research was shut down and its investor, Peter Brody, sought to commercialize it, he contacted a number of top computer and electronic companies including Apple and others, including Xerox, 3M, IBM, and Compaq. None were interested. It was only when he got a $7.8-million contract from DARPA in 1988 that he could move forward.

I make this point, because this is the kind of innovation that helps reshape markets for the better, with new technology and new tools.

That is the kind of innovation we need - innovation that helps people be healthier, that is more environmentally efficient, that helps let us all get things done with less effort, energy, money and waste.

It can be the private sector working with the public sector. But true breakthroughs and innovation tend to take 20 years still require stable long term funding.

The Challenge: Making the Switch

The reality is that the Federal Government has done the right thing: they’ve pulled the emergency brake, and closed a tax loophole that, combined with ultra-low interest rates has been fuelling our affordability crisis.

But this explains the precise problem - with what we are being asked to do.

Everyone acknowledges we have a rental, housing and affordability crisis. Everyone says the government needs to do more to make housing more affordable.

Because we have a housing bubble. And a housing bubble means that people are paying too much for housing. And the reason for that is that even though those houses are way overpriced, and commercial real estate is driving up rent, banks keep lending. Because it’s not about living, it’s about investment.

And that has speculative development has become such a big part of the economy, that people are too dependent on a bubble that, the longer we wait to deal with it, the worse it is going to get. People cannot afford their mortgages that banks told them they could afford.

We’ve been kicking this can down the road since the great financial crisis of 2008-2009, because the Bank of Canada and banks kept trying to fill in gaps and cracks in the economy with cheap mortgages that drove up real estate - everything from homes to farms.

So we need to recognize that the economy needs what is usually called “a correction”.

The issue is that so many of these investments are not based in profit from a business at all, but at their origin are just personal payments someone is trying to make every month. It’s not like a manufacturing company where you’re selling something for more than it cost to make.

It’s money and money, and that is part of what makes the purely financial economy so volatile. It is a zero-sum game where there is no win-win. For every dollar one person wins, another person has to pay out. When a series of contracts with commitments and triggers of payment are strung together like firecrackers, they can start to go off.

So when that sector of the economy - which is purely financial - collapses, it implodes. That is different than the “real market,” though it has huge impacts on it.

Roger Martin writes:

“Because the real market is grounded in real people, real companies, real employees, real factories, and so on, it shifts slowly without huge volatile swings. A great year in the real market is 4 percent economic growth and a bad year — like 2008 — is 3 percent shrinkage. But because expectations have no bounds, the expectations market swings wildly with huge volatility. While the economy shrank modestly in 2008, stock prices dropped 50 percent.”

The problem is that Canada’s real estate market has been inflated for so long, and people are so heavily invested in it, there is active economic and political resistance to actually lowering prices, even though it is acknowledged they are unreasonably high.

It has inarguably distorted Canada’s economy, because if it had not, we would not be having a national rebate about it.

We need to bring Canada’s real estate market back down to earth, while recognizing and dealing with the consequences of the price drop. One of those realities is that investors kept making investments while ignoring warnings that this could not possibly continue, as the entire country was debating the housing crisis and people warned we were in a bubble.

This needs careful shepherding, and one of the things that must change is we cannot reinflate the housing bubble.

We also have to recognize that we have to work to fill the economic space that’s been lost, in part because many people have made money in real estate and will be losing their jobs, facing reduced income, or debt challenges.

One of the consequences of the economy being dominated by real estate is that lots of people have invested in it because nothing else was safe. We have to be conscious of those individuals, to ensure that they have better options for pensions.

All of this is why developing structured ways to assist with immediate debt relief are essential. We do not have to be forced into austerity, when the problem we have is a financial system with faulty policies. People have no choice but to continue to demand higher and higher prices, because they can’t afford to take less.

Our affordability crisis in house prices is a financial problem. It is fundamentally about money - a financial problem that can be solved financially.

It is not just about supply and demand: it’s fundamentally about debt - about finance, which we are treating as a series of unbreakable, iron rules that must be followed.

As a consequence, we are continually trying to solve fundamentally economic and financial problems with non-financial solutions. We are focused on people and items when we need to be focused on the finance.

It’s not the number of people, houses and apartments that are the problem. It’s the number of jobs and the amount of good money people can earn to pay their bills, and the excess debt that’s been used to drive up the price of housing.

Blaming immigrants and liberals has happened for a long time, in countries around the world. The reason we know it’s not just Canada’s immigration or housing policies, is that this is happening at the same time all over the world, in countries that don’t have Canada’s immigration or housing policies. What they have in common

It’s not immigration, that has caused Canada’s housing and affordability crisis, it’s debt.

The reason we know this is that exactly the same thing is happening in other countries at the same time. The UK and Canada - which, while they have different policies in many other ways, have central banks that share the same policies and formulas.

The UK has an affordable housing crisis. The US has an affordable housing crisis.

As researchers at Positivemoney UK point out:

This is not, in most places, due to a sudden physical shortage of overall building space – today there are 0.44 homes per person in England, compared to 0.41 homes in 1991, and homes have become slightly less crowded in the last decades – but a lack of genuinely affordable homes trapping too many people

The reason is that

our homes have been transformed into financial assets that are bought and sold to store and generate wealth, they have become particularly sensitive to changes in interest rates. When interest rates are low, mortgages are cheap, so house prices soar.

That is what has distorted the market - the financial market in mortgages. That is the market that is broken and needs fixing - not the number of buyers and supply, or “retraining”

I will reiterate - the problem is that the housing market and debt-driven speculation pulls in other investors because the “real economy” cannot achieve the kind of inflated short-term returns that occur in a debt-driven bubble based on speculation.

We need a parallel, multi-year investment in actual innovation, real economy investments that can do the things we always say we want government and business to do.

So yes, tax the capital gains and close the loophole. Compensation is not investment, and neither is speculation on flipping real estate. From a public policy view, these are not what the government should be incentivizing with tax breaks.

For more solutions - check out my last post :

It's the private economy that's broken, not the federal government

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•DFL