Freeland defends budget’s capital gains hike despite widespread criticism from tech leaders

Finance Minister Chrystia Freeland defended the government’s proposed capital-gains tax hike that has drawn widespread criticism from economists and innovators alike, characterizing the measure in this week’s budget as a call to prosperous Canadians to contribute more to fund her government’s spending promises.

The budget, released Tuesday, included measures to increase the taxable portion of capital gains to two-thirds from one-half for corporations and trusts. The change also affects individuals, but only on capital-gains earnings more than $250,000. The new rules are set to come into effect June 25.

“People who are enriching our country with their work, and are doing really well, we’re asking those people to contribute a little bit more so that we can make the investments that Canadians need,” Ms. Freeland told reporters Friday after a lab tour at University of Toronto, part of the government’s roadshow to showcase its budget.

The minority Liberal government said these added taxes will raise $19.4-billion in revenue over five years needed to fund spending commitments in housing, health care, defence and scientific research. The Liberals are hoping to build back support and court young voters in the face of polls that have put them well behind the Conservatives for months.

But the measure has enraged many technology entrepreneurs and their investors, overshadowing a raft of other innovation-friendly measures in the budget including $2.4-billion in funding for artificial intelligence. The capital-gains tax hike will dampen profits for those selling businesses or converting stock options, disincentivizing startups in Canada at a time when productivity is dropping, critics say.

The changes to the capital-gains tax rates have become the most contested element of the budget, with many in the innovation sector saying the move will chill venture capital investment and discourage entrepreneurs from starting and scaling technology companies here.

“There has been uniform frustration,” said Daniel Eberhard, chief executive officer of Vancouver-based consumer financial technology company KOHO Financial Inc.

“It’s symbolic of the drift in how the business community feels about how we get out,” of Canada’s productivity challenges “compared with how the government thinks we do,” Mr. Eberhard said.

As of Friday afternoon, 1,400 Canadian tech CEOs, financiers and other leaders had signed an open letter published by the Council of Canadian Innovators (CCI), an industry group representing domestic companies, expressing opposition to the capital-gains hike.

Several economists, industry groups and even former Liberal finance minister Bill Morneau have criticized the move as well, saying it will not help a country that has been dogged by weak productivity and per-capita economic stagnation.

“It’s not positive for investments in Canada,” National Bank of Canada chief executive officer Laurent Ferreira told shareholders at the bank’s annual meeting, saying it could further drag on investment, innovation and wealth creation.

The budget did include several measures that will benefit small business owners and entrepreneurs. It increased the lifetime capital-gains exemption for qualified small businesses to $1.25-million from $1-million. That means a small-business owner can sell his or her business and not pay taxes on the first $1.25-million in capital gains.

The budget also brought in a new “entrepreneurs’ incentive,” which will allow company founders to pay less tax on up to $2-million in capital gains over their lifetime, when they sell their businesses. However, a number of industries are excluded from this measure, and critics argue that many startup investors won’t meet the qualifications needed to receive the preferable tax rate.

Middle-class Canadians could be hit by increases to capital gains tax. Here’s how to prepare

Ms. Freeland also met with a small group of innovators and investors Friday to discuss the budget. Among them was CCI president Ben Bergen, Alison Nankivell, chief executive officer of MaRS Discovery District, startup CEOs Raquel Urtasun and Martin Basiri, venture capitalist Jordan Jacobs and John Ruffolo, managing partner of Maverix Private Equity.

Ms. Freeland responded to the criticism by saying that academic evidence suggests raising capital-gains taxes will not threaten entrepreneurship or economic growth. But some say the evidence is much less clear-cut than she suggests.

When asked by The Globe which research her department had relied upon, Ms. Freeland referred to work by the University of Calgary’s Trevor Tombe, University of British Columbia economics professor Kevin Milligan and the late Simon Fraser University economics professor Jonathan Kesselman.

Indeed, Prof. Kesselman conducted a comprehensive review of the academic literature on capital gains in 2023. While he concluded evidence about the long-run economic impact of higher capital-gains taxes are “mixed and not easily quantified,” he said the research is more definitive about the impact on startups. He said that “economic analysis confirms the adverse effects of higher capital gains taxes” on the creation and success of young enterprises.

Among other papers, he pointed to a 2005 European Central Bank analysis of 14 countries that found a lower corporate capital-gains tax rate increased the share of venture capital investment in early-stage high-tech enterprises. He also highlighted a 2019 study of 32 countries which found that higher capital-gains taxes “leads to a reduction of startups receiving venture capital in a statistically and economically significant way.”

Katherine Cuplinskas, a spokeswoman for Ms. Freeland, provided The Globe a list of other researchers studied by the department, including former United States secretary of the treasury Larry Summers, but was unable to provide references to their specific publications used to craft its tax hike.

Ms. Freeland said the changes keep Canadian capital-gains taxes in line with jurisdictions such as New York and California. The top effective tax rate on capital gains in Canada will be around 36 per cent when the changes come into effect, compared with 37 per cent in California and 38 per cent in New York.

But Laurent Carbonneau, the CCI’s director of policy and research, said the comparison with New York and California “is missing the point to a comical degree.”

“California and New York are charging you a premium because they can afford to” as global innovation and financial centres, he said. “I do not think we have that same luxury.”

Editor’s note: An earlier version of this story incorrectly referenced PwC Canada employee Trevor Toombs as the author of a report. The story has been changed to correctly attribute the report to author Trevor Tombe.