Does Canada really need an inheritance tax?
Should Canada have an inheritance tax?
That’s the question sparked by a recent report by the Canadian Centre for Policy Alternatives (CCPA), which found that Canada’s 87 richest families collectively own more wealth than everyone living in Newfoundland and Labrador, New Brunswick and Prince Edward Island combined.
And wealth is increasingly concentrated at the top and passed on from generation to generation, found the author, economist David Macdonald.
It’s a negative feedback loop, he wrote: “A family’s stock of wealth can accumulate not just over a single lifetime but over generations, through inheritance, which further widens whatever income gaps may have existed on an annual basis.”
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But Canada could reduce the distance between the super-rich and everyone else with an inheritance tax, Macdonald argued. His proposal is a 45 per cent tax on estates over $5 million, which he estimated would add $2 billion a year to federal coffers.
The idea has generated much debate, but does Canada really need an inheritance tax?
The taxes Canadians pay when they die
Canada is the only country in the Group of 7 advanced economies (G7) without an inheritance, gift or estate tax, Macdonald noted in his report.
But that doesn’t mean Canadians can pass on their wealth tax-free. When you die, your legal representative has to file your final tax return to the Canada Revenue Agency (CRA) and pay any tax owed up until the point of death. This includes taxes on some of the assets you owe, such as your car, your cottage and certain types of investments. (You principal residence is a notable exception to this tax.)
The government will tax you as if you’d sold all those assets at market value just before dying. If those assets have increased in market value since you bought them, you’ll be taxed on 50 per cent of that value increase, called capital gain.
For example, if you bought a cottage in 1980 for $100,000, and that property’s value is now $300,000, you’ll have to pay tax on half of $200,000. That $100,000 will be added to your other income for the year and tax applied at your personal income tax rate.
Canada opted to ditch its federal estate tax in 1971 in favour of making half of most capital gains taxable.
In addition to income tax, provinces also have so-called probate taxes or fees, which also apply to your assets, with a few exceptions.
To re-introduce an inheritance tax on top of the current system would be taxing certain assets two if not three times, according to Lindsay Tedds, an economist and tax expert at the University of Calgary.
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How inheritance and estate taxes have fared in other countries
Canada may be the only member of the G7 without an inheritance or estate tax, but a number of countries have been ditching these taxes over the past decade, including Sweden and Norway.
Death taxes in countries that have them account for only a tiny proportion of total government revenues, according to data from the Organisation for Economic Co-Operation and Development (OECD).
In Sweden, inheritance tax rates peaked at 65 per cent of the value of a deceased’s assets but never raised more than 2 per cent of total tax revenue. By the 1990s that proportion had dropped to 0.2 per cent, as Swedes found creative ways to avoid the unpopular duty.
Similarly, the U.S. has a 40 per cent estate tax that accounts for less than 1 per cent of total federal revenue, according to the Tax Foundation. The tax doesn’t seem to have done much to tame wealth inequality in America, where the richest 1 per cent now owns 40 per cent of the country’s wealth.
Americans have become adept at skirting the estate tax even though the U.S. is one of only two countries in the world (along with Eritrea) to levy taxes based on citizenship, regardless of where the assets are located.
Asked about the case of the U.S., Macdonald told Global News via email that “an estate tax is one piece of the puzzle.”
“The U.S. has the largest stock exchange in the world, providing opportunities for much greater gains in wealth than would be possible in Canada,” he noted. “Despite the U.S. corporate tax rate being now similar to Canada’s, their corporate tax system is far more riddled with loopholes than Canada’s is, potentially providing more opportunities for low taxation if you know the right people.”
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So what can Canada do about wealth inequality?
Not everyone agrees that wealth inequality is a problem. But even among those who do, there’s ample disagreement about how to tackle the issue.
Some economists think Canada can learn from other countries’ mistakes to draw up a better inheritance or estate tax.
Macdonald, for one, isn’t persuaded by arguments that people would easily find ways to circumvent a new estate tax.
“You’d want to design it so obvious ways [to avoid it] couldn’t be exploited, like gifting the same amount just prior to death which is the way most fortunes get around the much smaller probate taxes in Canada,” he said. “Given we’d be the last in the G7 to have such a tax, it should be possible to design it quite well learning from errors other jurisdictions have made or examining the common tax avoidance strategies used elsewhere.”
But the wealthy are particularly resourceful when it comes to protecting their riches from the taxman, Tedds noted.
“You’d have to look at trusts, foundations, offshore accounts,” she said. Designing an estate tax that works would get “incredibly complicated.”
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And even if the Canadian government was able to successfully complete the task, would it be worth it?
Kin Lo, of the University of British Columbia Sauder School of Business, reckons the estate tax proposed by Macdonald would probably raise between $400 million and $1.8 billion a year or even less, based on revenues gathered by the U.S. estate taxes between 2011 and 2016.
But for those small revenue gains, an estate tax would provide “a greater disincentive to be successful and accumulate wealth,” among other drawbacks.
“On the whole, my opinion is that the small amount of potential tax revenue does not justify creating this entirely new tax on Canadians,” he told Global News via email.
Still, an inheritance or estate tax isn’t the only way to use taxes to tame wealth inequality.
One idea is to tax capital gains at progressively higher rather than flat rates. Another one, recently examined by the OECD, is to levy recurrent taxes on the assets, much like property taxes already do.
Another option would be to eliminate the capital gains exemption for people’s primary residence for homes above a certain value, Tedds said.
This wouldn’t matter too much for the super-rich, who have less than 20 per cent of their wealth tied up in real estate on average, according to Macdonald.
But wealth inequality is growing even among the middle and upper middle class, where the divide is widening between baby boomers who enjoyed enormous house-price gains and younger generations who experience those gains as unaffordable housing prices. And as baby boomers subsidize their grown children, that wealth, too, is becoming increasingly hereditary, Tedds noted.
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