This paper reviews recent empirical evidence on the economic effects of capital gains taxation. We focus on two issues. First, we examine the effects of changes in capital gains taxes on government tax revenues. The balance of the evidence suggests that while a decrease in the capital gains tax rate may lead investors to rebalance their portfolios more frequently, the increased volume of capital gains realizations will be insufficient to offset the revenue loss from the lower rate. This is especially true in Canada because of the deemed disposition of capital assets at death. For 1996, we calculate rough estimates for the federal government revenue loss in response to a reduction in the capital gains inclusion rate from 3/4 to 2/3. We find an upper bound of $400 million. If there is an increase in capital gains realizations in response to the reduction in the rate, the revenue cost would of course be lower.
Beyond the budgetary considerations, changes in capital gains taxes can have important effects on investment in the economy. We examine evidence relating to the effect of capital gains taxes on firms' cost of capital, which plays a critical role in firms' decisions about productive investment. Even in a world with large tax-exempt entities (such as pension funds) and some degree of international capital mobility, taxes do appear to have an impact on the cost of capital for firms. We use the results of recent research to calculate that a reduction in the inclusion rate from 3/4 to 2/3 could increase investment by as much as 2%.Draft, September 1999: PDF.