Slash capital gains tax, IIAC urges

The introduction of the tax-free savings account is all well and good, but if the president and CEO of the Investment Industry Association of Canada had his way, you wouldn’t need it for small cap stock investments.

Speaking to a lunchtime audience, hosted by the Canadian Club of Toronto, Ian Russell called on the federal government to reduce or even eliminate capital gains taxes realized on smaller companies, say, those with a market cap under $100 million.

“The Canadian economy will only become more productive if Canadian investors get back into the game,” he said. “They play a vital role — providing liquidity and promoting the price discovery process.”

While capital gains already enjoy tax-advantaged status due to their 50% inclusion rate, that still leaves top-margin taxpayers with a rate of 24%, compared to just 15% in the U.S.

“High effective capital gains tax rates discourage economic activity. That just holds down tax revenues,” he said. “If we are to tax wealth, then first we have to create it.”

An influx of fresh capital into smaller companies would spur the creation of far more jobs than any government stimulus program, he argued, making such a program a net-gain for government coffers.

This recommendation was one of many that Russell made in a speech entitled Smart Reforms Ensure Competitive and Sound Markets. He also called on governments to make it easier for boomers to rebuild their retirement savings, as they now face very limited time horizons.

A key component of such a plan would be to allow older Canadians to make retroactive contributions to a TFSA. Because these contributions would still be made with after-tax dollars, the immediate impact on government funds would be limited, he suggested.

But Canada should look beyond its tax system and aggressively pursue an array of regulatory reforms as well. Russell renewed his call for a single national securities regulator, comparing it to the great historical infrastructure projects that bound Canada together in the past: the construction of the Canadian Pacific Railway and the building of the nationwide telecommunications system.

“Canada stands alone in the world with a balkanized regulatory system focused on local markets, local financings and transactions between local market participants,” he pointed out. “To protect investors, regulation must look both inward and outward. It must be sufficiently localized to ensure the integrity of the investment process, and sufficiently centralized to focus on broad market developments.”

On transnational issue that global regulators are focusing on is the failure of the world’s ratings agencies to accurately define the risks associated with the derivative products that were at the centre of 2008’s financial seizure.

“There is clearly a need for more robust analysis and better disclosure,” Russell said. “But we must not try to solve the problem in different ways in different countries. Given the international nature of today’s financial markets, we need a level global playing field for credit ratings.”

In the U.S., the Securities and Exchange Commission is already looking into reforms, as is the Committee of European Securities Regulators. If Canada wants to ensure that its voice is heard in any new regulations, it must speak up immediately.

Reforms initially targeting credit default swaps did not pose much of a threat to the way business is conducted in Canada, he said, because the country does not really have a market in these instruments. But talks rapidly expanded at the G20 to include interest rate swaps, a market which is “very active” in Canada, according to Russell.

“We have to keep informed in terms of the discussion and where it is going, but we also have to be prepared to implement some of the reforms,” he said.

Making up only a tiny portion of the global economy, Canada does a disproportionate degree of authority on regulation, despite its fractured securities regime. Strict oversight in the banking sector allowed the country to sail through the financial crisis with barely a scratch.

“There’s no question; the fact Canada came through the crisis far better than most other countries in the developed world, I think makes us far more credible in the global reform process,” he said. “Canada got a lot of things right, so [the world] is going to listen to us as the reform process unfolds.”

(11/09/09)