Raising Taxes on the Rich Results in Adverse Effects and Doesn’t Pay in the Long Run, Study Shows

A person looks at a Canada Revenue Agency homepage, in Montreal on Aug. 16, 2020. The Canadian Press/Graham Hughes

Policies to increase taxes on the rich are often proposed, but penalizing those who create wealth doesn’t pay in the long term and could threaten Canadian prosperity, according to a recent study by an independent public policy think tank.

“Choking Hazard: The Adverse Effects of ‘Eat the Rich’ Policies,” the study conducted by the Montreal Economic Institute (MEI), looks at four fiscal measures that are regularly recommended for raising taxes on the rich and how they can result in the opposite of their intended effect.

“The point here is not to defend the rich, but it must be understood that by increasing the tax burden, the government would push economic actors to invest less, to work less, to move, and to export their capital and wealth,” Valentin Petkantchin, economist and VP of research at MEI, said in a press release.

Whatever the definition of the term “rich,” the study said, such selective taxation targets the “best-performing economic actors on the market, and therefore those who create wealth.”

“Instead of seeking to increase the tax burden on the rich just because they are rich, the government of Canada should favour initiatives that will improve Canada’s international competitive positioning, notably with regard to the United States, and make it more attractive for foreign investment and wealth creation,” it said.

The four popular fiscal measures examined in the study are a 1 percent wealth tax levied on fortunes over $10 million, an increase in the capital gains inclusion rate (from 50 percent to 75 percent), an increase in the federal income tax rate (from 33 percent to 35 percent) for incomes over $216,000, and an increase in the federal corporate income tax rate (from 15 percent to 18 percent).

Wealth Tax

In its 2021 federal election platform, the NDP proposed an annual 1 percent tax on those with a net worth of over $10 million—part of the party’s pledge to tax the wealthy to pay for welfare programs like a national pharmacare.

The MEI, however, said such fiscal policies, albeit alluring, are difficult to implement.

“Defining what constitutes taxable wealth, calculating the value of the assets of which it is composed at the precise moment when the tax is calculated, and curbing the problems of tax avoidance and capital migration are all obstacles to its implementation and administration,” according to the press release, adding that “this measure also discourages saving and investment, as it reduces returns.”

Nathalie Elgrably-Lévy, senior economist at the MEI and co-author of the study, pointed to the European countries that “eliminated their wealth taxes because of the economic harm they caused,” including Austria, Germany, Sweden, and France.”

“These negative effects are often missing from the public debate, yet they deserve to make up an integral part of it,” she said in the release.

Capital Gains Inclusion Rate

In its 2021 platform, the NDP also pledged to increase the capital gains inclusion rate from 50 percent to 75 percent, which is used to determine an individual’s taxable capital gains and allowable capital losses.

According to MEI’s study, this measure has several unwanted and harmful repercussions for the economy as a whole, affecting taxpayers of modest means as well as those with the highest incomes.

“It would also increase the cost of venture capital, reduce the capacity of SMEs [small and medium-sized enterprises] to attract qualified labour, slow the fluidity of capital in the economy, and ultimately compromise productivity growth,” the study said.

“In contrast, eliminating this kind of tax is beneficial,” it added, pointing to the example of Switzerland, where the non-taxability of capital gains allowed for increased real incomes, all while maintaining the overall level of tax revenues.

“Indeed, asked to decide in a referendum in 2021, the Swiss rejected—by a large majority of 65%—an initiative aiming to raise the inclusion rate up to 150%, much like what is proposed these days in Canada,” the study said.

Taxing Large Corporations

As for increasing the federal corporate income tax rate from 15 percent to 18 percent, while in theory it aims to bump up the taxes of company owners, the study found that “this measure proves to be disappointing, as it would undermine the international competitiveness and attractiveness of Canada,” the press release said.

The authors cited a 2010 study that looked at corporate income taxes in 85 countries, and showed that “[higher] corporate income taxes have substantial unintended consequences on investment and entrepreneurship, and thus on economic growth.”

Federal Income Tax Rate

MEI noted that a policy to increase the federal income tax rate from 33 percent to 35 percent for incomes over $216,000 would be “particularly harmful in the Canadian context, for several reasons.”

“As income from labour represents 3/4 of the total taxable income of high earners, increasing the income tax rate directly targets those taxpayers who create wealth as employees,” the study said.

“It risks having a negligible, or even a negative, effect on total tax revenues in Canada, since it would incentivize individuals to modify their behaviour in the labour market. Certain taxpayers could even be tempted to emigrate to a country with a more attractive tax regime, which would affect the future performance of Canadian companies, and thus economic growth and the standard of living of the population.”

Pointing to an income tax increase that took effect in 2016, the authors said hiking the federal income tax rate from 33 percent to 35 percent “would have a negative impact on total tax revenues when considering combined federal and provincial revenues.”

In 2015, the newly elected Liberal government introduced changes to Canada’s personal income tax system for the 2016 tax year, adding a new income tax bracket that raised the top tax rate from 29 percent to 33 percent on incomes over $200,000.

That policy had significant consequences for the Canadian economy, according to a 2020 study by the Fraser Institute.

“The federal change to the top rate in 2016 has markedly worsened Canada’s competitive position,” said the think tank.

“In particular, high and increasing marginal tax rates—that is, the tax rate on the next dollar earned—discourage people from engaging in productive economic activity, ultimately hindering economic growth and prosperity. This occurs because marginal tax rates reduce the reward of earning more income and, in the case of personal income taxes, more labour income.”