Canada's Choices

Chapter 7

Capital Gains Taxes

Again let's get smart and ahead of the rest of the world. What I am going to propose may seem at first blush a gift to the wealthy but upon thoughtful consideration, I think you may draw the right conclusions. Capital flows around the globe today in nanoseconds. It goes where it is wanted and receives a friendly welcome with little liklihood of seizure and complications.

I propose to eliminate capital gains taxes on gains made in Canada.

Canada needs a lot of new capital for all sorts of reasons. Most of all we need to de-leverage our economy. New infrastructure in the form of bridges, rail, ports, schools, hospitals and factories is needed. Canada has to compete with every other global marketplace for capital today. The pool is limited. Canada is an ideal place to put capital except for one reason. Our taxation of capital gains is high and unfriendly.

Why do I propose total elimination of taxation on capital gains? I do so because I believe capital is the lifeblood of an economy. The more capital you can attract to your economy, the better off you are going to be. Attracting debt is an entirely different matter. The debt load many of our companies, not to mention the government, carry is like a ball and chain. Cash flows have to be reserved to pay debt service and this limits the amounts left over for re- investment and just simple risk taking which often pays of at a much higher return.

Buying and selling assets free of capital gains allows for the rapid turnover of assets and realization of profits. There is many an old business that doesn't get sold and rejuvenated simply because a purchaser could never pay enough of a premium to take care of the capital gains taxes that would have to be paid by the vendor. The old story is that the prospective vendor keeps the business going with old machinery and eventually it succumbs to foreign competition. This story has been played over and over to our detriment yet we remain in a mind set where we are incapable of realizing that long term it is disastrous for our economy.

So what is the real effect of capital gains taxes? They are in essence a drag on capital turnover, and as I have pointed out before, capital needs to be invested and turned over and over and over. That is how prosperity comes about. Therefore I have come to the conclusion that any society that holds itself out as having a capitalistic free market system is not optimizing it's economy as long as it taxes capital gains.

Think about it. In the heyday of early capitalism in North America, people bought and sold assets, moved on to new opportunites, recycled factories and equipment without so much as a thought. Capital was deployed where it was needed most and where it would offer the best return and it was deployed without the constraint that plagues it today-how does this affect my overall taxes payable?

The simple lesson we must learn is that capital creates more capital and even more again. Employed capital creates income than can be taxed.

Now I would be the first to admit that this smacks of letting the rich off easy, but the fact of the matter is that today most capital today is pooled investment capital. Rarely is there one rich capitalist alone making the decision; it is more likely a mutual fund or insurance company or large widely held multinationals that are committing the capital. The point is that we want to differentiate between making capital welcome in Canada for fixed investment purposes and taxing income streams. We need unprecedented levels of capital investment here and we should attract it by offering the incentive to be free of tax. However, to protect ourselves, we could go a little further and stipulate that capital gains are free of tax as long as the gains are re- invested in Canada within let us say for argument's sake, a year. This means we keep the capital gain onside for the Canadian economy, turning over and growing.

If Canadians want to invest outside of Canada and make a gain in another jurisdiction, that is fine with me. I am not suggesting for one minute that we establish capital controls. Foreign capital gains should be taxed at normal income tax rates so the incentive is to invest in Canada but by no means is it obligatory. I have given a lot of thought about capital gains taxation and I have come to the conclusion that it is really a misguided understanding of the nature and roll of capital that has led to it's taxation. First and foremost capital formation is like building a foundation for your house. Everytime you add a new floor, you don't go to the basement and take a block out of the foundation. You add to the foundation and everyone becomes more wealthy or to use the house analogy, there are now more rooms on the new floor for more people. The care and nurturing of capital formation within the economy is perhaps the single most important thing our government can do to foster economic growth. To tax it away and weaken the economic foundation that it too must ultimately rest on is misguided. For the state to tax capital, it is the same as paying excess dividends out of a company. You eventually weaken the capital structure and cannot support the volume of business you are doing because you are over-leveraged and you have to re-trench until you build up your capital again. Canada as a nation is no different than a company in this respect.

At the same time as capital gains taxes would be eliminated, I would implement an estate tax program as further outlined in Chapter 10. Capital gains are untaxed in a few areas such as homeownership and some small businesses and farms but one area that it is untaxed and has proved very successful in building up a pool of investment capital, will be the subject of my next chapter-RRSP's.

Chapter 8


The concept of RRSP's is a good one. It is an attempt by government to make the individual responsible for his own welfare in his retirement years. Every Canadian should have one and use it to provide for his own retirement.

RRSP's have become a big business for big business and a closer examination of the way RRSP funds are invested will show that we are not maximizing the potenntial of RRSP funds within Canada's overall economy. What is good for large financial instutions-banks, brokerages and insurance companies may not be best for Canadians and particularly their communities We can do better.

The range of investment possibilities for RRSP's is at the core of the problem. A good many Canadians put their money into guaranteed income certificates issued by banks and trust companies or into straight deposit accounts. These fixed income certificates benefit the issuers tremendously. They have fixed terms that are usually long. This provides a good stable deposit base for these institutions. By and large if you leave your money in these types of deposits you might do a little better than inflation as your money is compounding tax free. But what really happens? Tax rates are escalating faster than your money is capable of compounding. By the time you come to take the money out either in the form of an annuity or lump sum, you may very well be paying an average tax rate of 50% or even higher on this income plus indirect sales taxes and other assorted hidden taxes that will have compounded in the economy's price structure in the meantime.

Other Canadians have taken a step further with Self Directed Plans. Everyone who has a RRSP should make the plan self- directed. In this way you can choose much better investments than you would otherwise get in a deposit account RRSP. Certainly, your portfolio should be diversified into stocks and bonds both domestic and foreign to the extent allowed. If you are a talented market player, you can build a substantial portfolio rather quickly free of tax.

This pool of substantial investment capital in individual self directed RRSP's is by and large not benefitting the economy to the extent it could. Let's be a little more imaginative. This past year we saw the first glimpse of sense in an alternative use of this huge pool of capital built up by thrifty Canadians. This was the new home ownership program allowing people to withdraw up to $20,000 for down payments on new homes.

I recommend we go further. Let individuals use the funds in their RRSP's for leveraged equity investments in new homes, apartments or industrial buildings in Canada. Why? These are long term fixed asset investments that will benefit the economy for years to come. Moreover, these investments are usually levered investments so $100,000 of equity from an RRSP might support $900,000 of debt in the construction of an apartment building. This means substantial economic activity can be created right away.

If you are like me, I've got the maximum foreign content as I am concerned about the financial situation in Canada. This is the only way I can protect myself in a self-directed plan from a Canadian financial calamity. This is a stupid policy as it effectively means close to 20% of savings in these plans is shifted out of the Canadian context. Talk about misguided policy! If I could use funds to make a long term leveraged fixed asset investment in Canada, then I would do so because I would know that whatever happens I am protected against inflation. This is what saving is all about. Saving is pointless if inflation and taxes eat up your paper gains.

Furthermore the present structure of investments in self- directed plans is heavily oriented towards the benefit of the major financial centres and leaves most of the rest of the country out in the cold. I am surprised no one has really ever examined the impact of this but I am sure if a study were made most of the RRSP money ends up in Toronto or Montreal for administration and investment.

To illustrate the injustice of the control exercised over these savings let me describe a hypothetical example. I may have $100,000 of equity saved up and I would like to build a new medical service building in Kenora. I have the doctors and dentists lined up to rent the space and the bank will give me a mortgage of $650,000. I am about to create 20 construction jobs for four months, the new building will create ancillary employment in the community for ongoing maintenance, the municipality will start collecting new real estate taxes and the extra school taxes may mean another teacher can be hired in the community. Do you get the picture? The only problem is that my $100,000 of equity is in an RRSP and I cannot invest it this way. Instead I am forced to put it in a mutual fund or stock or bond benefitting not my local community, but somewhere else. The absolute worst case for the economy is if the bank or trust company whose GIC I might have invested in turns around and lends this money not in Canada but overseas.

So all it takes is a little imagination. If the RRSP funds opened up to leveraged fixed asset investment, it would immediately benefit the economy. Fixed assets do not get up and walk away, and these investments, by and large, create a lot more spin-offs in local communities than financial market paper investments in far off places.

If you are not feeling more optimistic by now by some of these suggestions, you have a serious problem. But wait, there is more. Canada Works!

Chapter 9.

Canada Works Program

Our rate of unemployment is a national tragedy. It is imperative that we put these people to work and reduce the drain on social services and welfare as quickly as we can. This is a huge country with a large need for renewed infrastructure. Infrastructure is the public side of the investment input equation.

We certainly do not need any new fancy office buildings; we have had our Olympic Stadium disaster and we have had lots of museums built, many of which few Canadians actually get the opportunity to see or use. We need infracture renewal in those areas that are going to have a future pay-off for us in making us more competitive: roads, ports, bridges, railroads and airports.

Governments do not need to hire high priced consultants to tell us how to become more productive. It is right before our noses in many cases. Every morning and night in Montreal, there is an outstanding example. I cannot get over the fact that no new bridge has been built to the south shore for over 25 years now. When the government talks about productivity, do they ever really consider the millions of hours lost in the traffic on the bridges of Montreal?

The debate over the Quebec-Windsor rail corridor has been going on for years. A completely new, straightened, high speed rail bed should be built. Here we are subsidizing Bombardier to the hilt to try and sell this technology around the world and yet we haven't even got a system up and running here in Canada. It is truly senseless. All we do is talk, talk, talk. In fact if there was a productivity award for talking about things, we would be the world's champion!

We persist in operating Mirabel Airport in Montreal at a horrendous operating loss, when a proper upgrade of Dorval would meet our needs for years to come. Do you think we will ever reach the level of operations of LaGuardia or Chicago if both airport facilities are consolidated at Dorval? Dorval is adequate period.

Roads and bridges all across Canada need work. In some places, we risk structural failure of overhead highways rotted through by winter salt applications.

So the conclusion is clear that we need infrastructure. What we are sorely lacking in is the leadership to make the decision to get on with it. You may be asking yourself right now the question, how can we afford it? How will we finance it?

First of all, investing in the future always makes sense if the investment is one that has the potential to deliver and facilitate expanded economic activity. This is not immediate consumption. Unemployment insurance and welfare payouts represent immediate consumption with no return. An unemployed person is not productive and if you are paying him to not produce, it is egghead economics! Far better to get the unemployed working on public projects for infrastructure than to let thousands of Canadians stay idle, lose their work ethic, and impose a cost on the rest of the working population that makes the rest of Canadians uncompetitive. As I have stated above, increasing UIC levies on healthy businesses to finance UIC payouts to a permanently unemployed workforce is plain stupid.

At the annual meeting of the Bank of Montreal in January 1992, Matthew Barrett, the Chairman of the bank, had it right when he proposed we undertake a massive public works program. The finance Minister immediately threw cold water on it saying it would increase the deficit. Both were right!

So how do we do it without creating a larger deficit?

I propose that we fund the most massive infrastructure program yet undertaken in Canada through an international issue of Canada Reconstruction Zero Coupon Bonds. I first proposed these as a method of financing over a year ago and I have made further refinements to my idea since then.

Canada needs capital rather than debt to finance these projects. Bonds represent debt. Zero Coupon Bonds represent debt but with a little bit of difference. They are issued for a price today with no interest payable until they mature at a future date. This means the liability can be pushed well into the future. It is still a liability but it is an ideal way to finance assets that have a long term life. This is known as matching maturities of assets and liabilities. It is important that an issue of these bonds not go into general revenues but be specifically set aside for investment into clearly identified public infrastructure. We must insure that these funds be matched to each project and not just disappear or more likely frittered away. A bridge is identifiable. A kilometer of highway is identifiable. You should have come to the conclusion by now that we can only do this by setting up anew, very lean (management wise) administrative body to manage these public works projects apart from the day to day adminstration of public works.

Bonds payable a long time in the future represent a lot of risk in terms of potential inflation and many investors want to be assured that inflation will not eat up their return. I propose that we attach a rider to these bonds to index them to the CPI in Canada. With 30 year rates approaching 6% in the United States at the time of writing, I think it would be easy for Canada to market an issue of $25 Billion priced to yield 3% plus an indexation clause to match changes in the CPI. This guarantees the lender the historical long term rate of return of bonds above inflation.

I also would propose that we attach a very special tax credit to these bonds. This will encourage that the bonds for the most part are put away until maturity. This tax credit will be the "sweetener" to market the bonds. I propose a 10% tax credit of the face value be attached to each bond that will only vest and become tradeable at maturity. I think a lot of Canadians would like to invest in these bonds for their RRSP's as when they mature this tax credit will be detachable and saleable as a separate instrument. I think a lot of international investors will recognize that these bonds are a good buy because of the CPI indexing and the added sweetener of the marketable tax credit.

If an issue of $25 billion face value is made then discounted at 3% this will result in a pool of about $10 billion available for immediate spending on a Canada Works Program. We create a liability in the future for the tax credit of $2.5 billion which has negligible present value depending on the inflation rate. The liability for the bonds is $25 billion plus whatever the CPI inflation is over 3%. This serves as a restraint on our politicians to keep inflation in check. This liability should have a sinking fund established as soon as the economy begins to generate higher revenues but in no case later than ten years. Remember these liabilities are matched to assets and this type of matched financing of capital assets and liabilities should become the norm in all financing of government capital expenditures. Presently all capital spending is financed out of general revenues. This is part of the problem in Ottawa. As long as general revenues are available through higher and higher tax rates, they have spent the money. No one ever really contemplated that revenues might fall. Moreover, I think all bonds of the government should be issued with a 3% coupon plus a CPI rider. If we cannot establish a balanced budget amendment to our constitution, which I have some reservations about, this will keep our government from future spending sprees touching off inflation.

Clearly projects like new bridges in Montreal and the high speed train corridor should be built. It takes enormous confidence to undertake these kinds of mega-projects but they have a far higher societal return in the long run than the capital cost. This brings me to the question of choices in capital expenditures. The purchase of military helicopters of the calibre we are contemplating is just plain wasteful when compared to building the Quebec-Windsor rail corridor. The societal payoff is really questionable. The military say they need the sophistication of all the nav aids, infrared detection, instrument flying capability, icing capability etc.,etc. It is high time someone questioned the pay-off of the cost of high technology. The costs of searching and rescuing do have a limit from the point of view of what society can afford and what human life is worth. As for protecting Canada it is hogwash. We cannot defend ourselves and have never been able to. Who are we fooling? The military could do with 200 off-the-shelf new Bell 226's at a cost of one Billion not six. To boot we would have a lot more 'copters to spread around the country. If response time to emergencies is important then a greater dispersal will equate to a faster response. All weather capability is important but frankly as someone who speaks with some experience and knowledge of weather flying, I do not want helicopters operating in icing conditions or very heavy weather under any circumstances. The risk to the crew is too high.

The federal government is about to embark on a fixed link bridge project between PEI and the mainland. This is a multi- billion dollar project. More people cross the St. Lawrence every day in Montreal than live in Prince Edward Island! Montreal needs bridges. The societal benefits are just not on the same scale of magnitude at all. We could probably build three bridges in Montreal for what the PEI link will end up costing. We must make hard choices of what is really important. The PEI link is a political event. We simply have to have the courage to draw the line and say no to many things.

All the above programs can be implemented through a DNEE and can be set in place very quickly. Modifications to tax statutes to deal with tax credits, RRSP's and capital gains could be announced in a new budget and put into effect immediately.

Chapter 10