Raising the capital gains inclusion rate will deter venture capital investment and entrepreneurship in Canada, asserts the Montreal Economic Institute in a study released this week.

“If the Trudeau and Legault governments are looking to chase away investment, then they’re on the right track,” says Emmanuelle B. Faubert, economist at the MEI and author of the study.

“We already have enough trouble attracting investment as it is, and a tax hike will certainly not reverse this trend.”

In its latest budget, the federal government announced its intention to increase the capital gains inclusion rate from 50.0% to 66.7%. For individuals, this applies past a $250,000 threshold, whereas corporations and trusts are subject to the new inclusion rate for all capital gains.

Following this announcement, the Quebec government under Premier François Legault said it would do the same. These changes are set to apply to capital gains realized after June 25^th.

For a Quebec investor, this would amount to an increase of 8.9 percentage points, or 33.3%, to the applicable tax rate for capital gains above $250,000.

The author explains that such a tax increase reduces the availability of venture capital by lowering projected returns, while keeping risks just as high — an estimated 90% of start-ups fail.

A secondary effect of this form of tax increase is the delaying of potential sales by venture capitalists, which reduces the stock of capital available to finance new projects.

The MEI study identifies these two effects as responsible for the fall in investment and entrepreneurship that is associated with increases in capital gains taxes.

This connection is confirmed by a 2022 study, which found that increased capital gains taxation led to decreased investment and innovation in US-based venture-capital-backed start-ups, resulting in a smaller number and lower quality of patents.

“People make their investment decisions by weighing risks against the potential rewards,” explains Faubert. “If you reduce the reward, but keep the level of risk the same, investors will be much less likely to invest, as studies have clearly shown.”

The MEI is an independent public policy think tank with offices in Montreal and Calgary. Through its publications, media appearances, and advisory services to policy-makers, the MEI stimulates public policy debate and reforms based on sound economics and entrepreneurship.

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