Rumours abound that the Trudeau government may raise the capital gains tax in tomorrow’s federal budget so it’s critical for Canadians to understand that raising this tax will cause much economic pain for very little revenue gain.

Capital gains taxes are applied to the sale of assets (such as a business or stocks) when the selling price exceeds the original purchase price. Canada currently taxes capital gains income, with some exemptions, at half of one’s marginal income tax rate and there is speculation this will be increased to three-quarters of one’s marginal tax rate in the budget. For someone living in Ontario, that would increase the top combined federal and provincial tax rate on capital gains from 26.8 per cent to 41.1 per cent.

Since recent commentaries by our Fraser Institute colleagues and many others have explained why raising capital gains taxes will impose significant economic costs, we won’t go into that here. Instead, we will focus on the fact that this tax currently brings in little revenue to federal coffers and raising it will generate little if any new revenue.

The government does not publically release how much revenue it receives from taxing capital gains but we can estimate the revenue from this source using a model provided by Statistics Canada. According to this model, capital gains tax revenue from individual Canadians amounts to $4.3 billion each year. That’s just 1.5 per cent of the government’s total $291.1 billion revenue take.

While the amount of revenue that the federal government currently receives from individual capital gains taxes is relatively small, hiking the capital gains tax will likely do little to raise more revenue. Why?

Because Canadians will change their behaviour in response to the tax hike in ways that will reduce the amount of new revenue the government collects. The government’s own Department of Finance warns of this, stating that if capital gains taxes are increased, “taxpayers would react by postponing certain transactions on capital assets in order to reduce the burden of the resulting tax increase.” This means that if the government were to increase the inclusion rate by 50 per cent, it will not likely receive a corresponding increase in capital gains tax revenue due to behaviour responses.

Experience with capital gains taxes in other jurisdictions suggests that higher capital gains taxes are self-defeating as a means of raising more rev¬enue, and that lowering tax rates on capital gains can be positive for the tax base, particularly in the short-term. A review of the literature points to considerable evidence that reducing capital gains taxes increases government revenue for a year or two, as a tax reduction sparks a rush of investors buying and selling assets. The evidence is mixed for the longer-term as the initial impact wears off, but still there is evidence that a capital gains tax increase could fail to raise additional revenue, even in the long-term.

Bottom line: raising the capital gains tax would carry considerable economic costs and provide little in new revenue for the government.