Proceedings of the Standing Senate Committee on Banking, Trade and
Issue 1 - Evidence for November 24, 1999
OTTAWA, Wednesday, November 24, 1999
The Standing Senate Committee on Banking, Trade and Commerce met this day at
3:30 p.m. to examine the present state of the domestic and international
Senator E. Leo Kolber (Chairman) in the Chair.
The Chairman: Honourable senators, this is the first substantive meeting of our
committee since we decided what our plan of attack would be for the coming
session. Aside from whatever legislation will be referred to us, we have
decided to discuss the various effects of our present capital gains tax regime
in as broad a context as possible.
The Canadian economy is relatively small and open compared to the other major
industrial democracies. In recent years it has become more internationally
intertwined in the global economy. With the advent of the FTA and NAFTA, Canada
has become more vulnerable to the business and economic conditions in the
In practical terms, Canada is subject to the global competitive pressures in the
markets for goods and services. That mirrors our productivity performance in
the international market for capital and labour, particularly entrepreneurial
skills. This competitive pressure also extends to the stance of public policy
in many substantive areas, such as tax policy, trade policy, industrial policy,
health and education policy and the regulatory regimes.
Because of the international mobility of resources, the committee believes that
Canadian public policy makers must take careful account of substantive policy
developments among Canada's trading partners in areas such as tax policy, if
Canadian society is to flourish in economic terms. The ability of Canadians to
find "good jobs" is a prerequisite to meeting this objective. The key
policy instrument that structures the willingness of entrepreneurs to take
risk, which sets the stage for a prosperous society in the global context, is
As a first step, the committee will begin immediately its fact-finding study in
a domestic and comparative context. In other words, we will study Canada's
policy on capital gains taxation. The committee wants to determine the real
economic effects on such variables as savings, investment, cost and
availability of capital and ultimately on job creation. In undertaking this
study the committee has in view making recommendations to the Minister of
Finance on how this tax might be improved in order to best benefit tax payers
and provide better prosperity for all Canadians.
We are delighted to have with us this afternoon Mr. Reuven Brenner, who has
written a provocative and interesting piece on capital gains tax, which has
been circulated to you all. Mr. Brenner holds the Repap Chair at McGill's
School of Management. He is on the faculty of DUXX, Monterey, Mexico, and is a
partner at Secor, a well-known Montreal-based strategy-consulting firm. He also
works with Gilder, Gagnon and Howe, a New York-based money asset management
firm, and WEFA, a Philadelphia-based company. As well, he is a partner in the
Washington-based Alan Reynolds and Associates, as well as Lamerac, a
Montreal-based M&A boutique. He has done consulting work for corporations
in Canada, the United States and Mexico, and is often invited to give speeches
to both business and general audiences. He is on the board of two internet
companies -- Stria Communications, based in Montreal, and Assista, based in San
Mr. Brenner is the author of six books, is a regular contributor to Forbes,
Global, The Straits Times (Singapore) and is on the Board of Contributors of
the National Post.
In 1992 he had the honour of receiving the Killam Award, which is given every
year to 15 Canadians in the arts and sciences. In 1995 the Masters and
Mavericks of Modern Economics dedicated a chapter to his works, which range
from finance and currency matters to history. In 1999 the Cato Institute in
Washington appointed him as Adjunct and the Royal Society elected him a Fellow.
Welcome, Mr. Brenner. Please tell us what you think of capital gains and then we
will open the meeting to questions.
Mr. Reuven Brenner, Faculty of Management, McGill University: Capital gains
taxes are frequently singled out for specific treatment. I shall explain this
in a few basic steps. Prosperity is not based on the GDP numbers we see
published in newspapers. Those numbers are not relevant to prosperity, as you
will see in the simple example that I will give to you. You purchase a stock for
$100. The stock's value drops by 50 per cent and is now worth $50. Then the
stock increases by 50 per cent and now is valued at $75. Therefore, you have
lost 25 per cent of your initial value.
Now, when we publicly state that Canada is growing at a rate of 3 per cent or 4
per cent, I think people forget that in fact this is actually in devalued
Canadian dollars. So, first, we devalue ourselves by 30 per cent, and then, if
we grow by 3 per cent or 4 per cent, some people may try to make publicity out
of that, but in fact we have become much poorer. It is the growth rates that
you must be careful to measure, whether in a monetary standard or in a devalued
currency. Those are two completely different things.
Prosperity really means something else. It means moving capital away from the
old human and financial capital to do something new. In order to do something
new, we must experiment. No one knows what the future holds, so we are making a
lot of mistakes. Therefore, the issue is whether there are better people who
should be making the decisions about the future? More important, are there
institutional arrangements in place to quickly correct the mistakes as soon as
they are recognized? In this sense, when governments err in their
decision-making about the allocation of human and financial capital relative to
private markets, they tend to persist in their mistakes simply because they can
cover them in various ways. One way is by raising taxes; another is by
devaluating -- two options that, fortunately, are not open to most private
Once it is clear that prosperity means moving capital from the old to the new,
then capital gain tax has a very clear meaning: it is really a tax on this
switch and it has the effect of slowing down the process. I shall give you some
very clear examples of what that means and how to quantify it.
Let me say first, though, that in public discussions much is made of the fact
that the capital gains tax is a tax on the relatively rich and, therefore, on
the basis of fairness, that is what should be done. However, that is a
completely mistaken argument, because taxes are not always paid by the entity on
which the government imposes the tax. The tax is only paid by those who cannot
move either the capital or themselves.
I will give you an example. You may remember that a few years ago the government
of Quebec increased the tax on cigarettes. The next day, all cigarette stocks
went south of the border and were then quickly smuggled back into Quebec. In
vain did the government impose a tax on cigarettes because, in fact, the tax
was not paid. It was evaded and avoided. The same process takes place the
moment you impose a tax on capital. Capital will not move to Canada, if it is
taxed at a high rate, but will move to other countries, and capital that is
here will, the moment it is freed, move out of the country.
In this sense, "capital gains" is really a misnomer and that is why
the revenues from this tax are relatively minuscule.
How does it prevent switching to the experimentation? I will give a simple
example. Take the fibre optics industry, which is currently one of the fastest
growing industries. In fact, it was invented by David Huber an engineer working
for General Instruments. For years he tried to promote fibre optics within his
company but without success. In the end, an angel gave him a few hundred
thousand dollars and he left his job at General Instruments and later
established his own company. When that company had the IPO, the market value of
his shares was about $200 million. Now, if there were no angels, this man would
have continued as an engineer. That is what it means to finance the future, and
that financing depends on capital gains. The higher the capital gains tax, the
fewer angels we have.
In the United States, the capital gains tax is about 18 per cent, whereas in
Canada, the rate is about 40 per cent. If our tax rate were lowered from 40 per
cent to 30 per cent, that angel could finance many entrepreneurial ventures at
much lower costs because he would have less costly access to equity. The
reduction of tax on capital gains speeds up the flow of capital. It does not
keep it locked. Thus, an engineer turned into an entrepreneur and created a
multibillion dollar business. That is how Apple was created, and so forth.
This brings me immediately to the point now being discussed in Canada. Which tax
should be cut if we want the strongest effect? We can consider three
alternatives. One option is to cut personal income tax; another option is to
cut corporate tax; and the final option is to cut tax on capital gains.
Why should capital gains, in my view, take priority? It is exactly for the
reasons that I mentioned. Let us take the previous example with the engineer.
Even though General Instruments had to pay somewhat less corporate tax, that
did not necessarily mean that the management of the corporation would bet on
that engineer. The ones who are betting on the future, in general, are the
angels -- the angels who were entrepreneurs themselves and experienced success.
They took the entrepreneurial way, they have the network and they can do the
matching. Therefore, the biggest bang for the buck comes when you lower the
capital gains tax. If you lowered personal income tax, obviously people would
benefit, but that would not allow someone who is earning $50,000 or $100,000 to
become an entrepreneurial angel. If you compare the three options previously
mentioned, I would say the fastest way to encourage entrepreneurial ventures
would be to reduce the capital gains tax.
Today the federal and provincial governments realize that something is wrong.
They have tried to compensate for the very high capital gains tax by
subsidizing various ventures. For example, Montreal is the biotech capital of
Canada, or so it claims, because the companies pay only 40 per cent of that
cost and the government picks up the other 60 per cent of the tab.
How many of the biotech companies existing in Montreal will ever be commercial
successes? I do not know. Here we come back to the difference between
governments approving and continuing to finance ventures and private angels or
venture capitalists doing it. It is not the same process, nor the same people.
To give an extreme example, there are also a lot of media, movie and other
businesses in Montreal that are similarly heavily subsidized. If a company like
that had come out with a cartoon, with a mouse, would the government
bureaucracy have ever financed such a venture? Probably never, and you would
not have another Walt Disney.
So this is not the same process; it is not the same people. We have the biotech
and other industries in Montreal today, but very few of them are commercial
successes. We really do not know if it is just the pure transfer of wealth
without creating very much.
In a few words, that is the skeleton of the argument that capital gains should
be singled out and should get priority, and interestingly, as you may have
noticed, it was reported in today's Financial Times that Argentina is moving in
that direction; and the U.K. has just lowered its capital gains taxes. However,
in Canada we are only debating it in terms of fairness.
I want to add one more point. David Huber had a $200 million stake in the Sienna
IPO. That is not an unusual value for human capital. You can see that almost
daily when you look at trading in stock markets. There is a group of people
called the "vital few". When those people go from one company to
another, the market value of the respective companies can drop or rise by half a
Take as an example the CEO of Kodak, although he does not have as good a
reputation as he had when he was previously the CFO of Motorola: the moment it
was announced that he had quit his job, Motorola market value went down by $300
million; when it was announced that he had joined Kodak, their market value
went up by half a billion dollars.
Imagine what might happen if Bill Gates said that he did not want to put up with
the investigation, or torture or whatever you want to call it, and he moved out
of the United States and came to Canada. How much wealth would be transferred
from one place to the other? This tells us that some people, the vital few,
have very high value. In a society in which envy is rationalzied under the veil
of fairness, we may end up losing those vital few. In such an event all of this
wealth would not be created, because compensations of $200 million are
considered to be too high. However, if you look at it historically, many people
have been compensated at this amount.
Senator Tkachuk: With regard to the "vital few," in your paper you
mention that business is no different from the arts or athletics or any other
singular profession in which there are a vital few who move what happens in the
economy or in the arts. One could say, for instance, that that is why Wayne
Gretzky got paid so much money. It was because he filled the building. Frank
Mahovlich used to fill the building, too.
We have heard a great deal of debate about the brain drain -- people leaving our
country because of the lack of opportunity and because of high individual tax
rates. I agree with you that capital gains tax has a lot to do with the fact
that they are leaving the country, especially in the business world. Would you
comment on that? We have had people saying that there is really no brain drain,
that that is a myth.
Mr. Brenner: First, what you were saying, using Wayne Gretzky as an example, is
well documented. I do not have the numbers before me, but I gave statistics to
the National Post that show how one individual can make a huge difference.
Before Michael Jordan joined the Chicago Bulls, the company was bankrupt. There
was no attendance, nothing. The only thing different was that he joined and
pulled up that team. Yes, he was the same type as Wayne Gretzky. In that case
you could see how much value was created just by one individual. There is a big
difference between a good team and a good team under one inspiring leader. I am
sorry that I did not bring the numbers with me.
It is good that you mentioned sports, because we say all the time that people
are our assets and yet the only business in which the people are actually on
the books is professional sports in the United States. In no other business do
the people appear on the books. That is why it is so misleading. You really
cannot learn the value of a company by just looking at book values. When you
look at the professional sports in the U.S., then Michael Jordan appears on the
balance sheet at the value of his contract.
On your question about the brain drain, we only have approximate numbers. For a
couple of reasons we do not know the exact number of young people or
entrepreneurs who are leaving Canada for the United States or other places. One
of the reasons is free trade. Since the Free Trade Agreement, Canadians who
have post-secondary education, for example, a master's degree, can get a kind of
temporary visa for the United States; they do not appear under immigration but
under something else. It has become much easier just to move. Students who
finish at, say, McGill with a master's degree in engineering or computer
science often move to the United States, and they do not appear in the
statistics at all as if leaving for the United States. Therefore, whatever
numbers exist underestimate the movement by far.
There is also a big difference in quality. Someone with a degree in engineering
from some other country may enter Canada. There may also be an engineer who
finishes his degree at Waterloo and moves to the United States. That does not
mean that the two are the same type of engineer. There is something called
Let us look at Waterloo again. I would not say that this is scientific; it is
more anecdotal. However, if you were to ask the people at Waterloo, they would
tell you that the top of the class will all end up in the United States. Those
who are not at the top of the class will stay in Canada. That is a big
difference. There is a big difference in quality and quantity.
Statistics Canada measures the quantity but not the quality. Thus, I do not buy
all their numbers. If we look at the composition of the mix of people leaving
Canada, they are computer engineers, scientists and physicians, and Statistics
Canada does have the composition and the ages. Obviously they do not know their
potential in the U.S. nor how much they will earn there.
Senator Tkachuk: I have a question on the capital gains tax itself. The
government publishes a book that I find rather fascinating and humorous. The
book is based on the assumption that the government holds all the wealth and
every tax break granted is a cost or an "expense" that the government
In my view we should eliminate the capital gains tax all together. What would be
the cost, if any? I do not believe there would be any cost, but I would be
interested in hearing your opinion.
Mr. Brenner: No. In fact, in all the countries where capital gains taxes were
significantly diminished, there was such an effect on the income-generating
side that other indirect taxes more than compensated. There is plenty of
evidence on that. In every country where capital gains taxes were significantly
lowered, incomes increased for the very simple reason, as I said earlier, that
this is a tax that can be easily avoided by simply not selling one's asset. How
much income does holding assets generate for the government? None. The
principle is very simple: When such a tax is lowered, the capital starts
flowing faster and revenue is produced.
We touched on a more important point and one in which the Senate can play a
role. It is not possible to make a significant change in tax policy unless the
language of public discourse is changed. That is not something that happens
easily from one day to another. Senator Tkachuk's example that a lowering of
taxes is somehow termed a cost for the government shows the absurd language that
is in use. That absurdity must be explained. There are many other absurd terms
used in political discourse today, but it is not a short-term process to effect
As an example, people talk all the time about job creation. In my view, that is
also very false language. The wealth of the country depends on the types of
jobs you are creating. The government can always create jobs. I grew up in a
communist country for the first 14 years of my life. The statistics said that
99 per cent of the people were employed there. So what? If the country has
devaluation and taxes and closed capital markets, the country will be made so
poor that it cannot import any capital. Then people will shovel snow with a
spoon. Sure, plenty of employment is created; everyone will work like crazy.
Everyone also will be very poor. It is as simple as that.
False language in public discourse is so ingrained that it will take some time
to educate people that not every created job is worthwhile. It matters a great
deal what types of jobs are being created.
Senator Kroft: I do not know quite where to begin. You set up so many
enticements for me. The question of outflow of people or brain drain is a
subject of great debate; there are many views and many analyses. I do not want
to press you for your sources now, but have you very specific numbers and very
real evaluations of that situation? It would be helpful to the committee's work
if, at your leisure later, you could provide to us the support that you have
for these numbers.
Mr. Brenner: On that, there are two things. Are you asking how I go, in the text
illustrations, from the 100,000 to the 200 billion?
Senator Kroft: No; how do you get the 100,000? What are the nets? A lot of data
is being tossed around. I read different numbers all the time. We will hear
much about that question, so I would be interested in knowing just how you
arrive at those numbers in net terms. That would be very helpful.
Mr. Brenner: Yes, okay.
Senator Kroft: I will move through the various aspects. I would also like to
pursue something on which I take quite strong issue with you. Before I get too
involved in differing with you, I want to be sure I have understood you
correctly. You are talking about the reasons people move. You make the
statement that those who move in order to search out greater opportunities,
rather than differential taxes, are on the wrong track.
I believe that people move for opportunity and that, if there is a tax benefit,
that is not part of the mix but is lower down the line. You are really taking a
very strong slam, if I can use the vernacular, at the suggestion that people
move primarily for opportunity. I would like to have you expand on that a bit
if you would.
Mr. Brenner: Regarding opportunity, take the example of the engineer who was
working for General Instruments. A person like that, an innovator, works on a
project and he wants to see it brought to life. He did not know when he moved
that he would have an IPO that would bring him a $200-million value. That is
not what I am saying. The point is that that engineer would not have been
financed by the angel under another tax system.
For example, there may be many good engineers in Canada today who simply need
the backing of a financial angel to bring their dream to life, but if the angel
is facing a 40 per cent tax here while just 20 minutes south of the border he
is facing only an 18 per cent tax, where will the financing likely be raised?
It will be raised there and not here.
I am linking the two things, the pursuing of opportunities and the financing of
dreams. I am not saying that that engineer ever thought he would have $200
million, but he did want to see that fibre optics project brought to life. That
As an extreme example, Israel today saw one of its biggest booms when, suddenly,
800,000 immigrants came from Russia, many of them engineers and scientists with
good ideas. Those ideas obviously were not realized in Russia. Why they were
not realized? The people were the same. The issue is not the ideas. The issue
is whether, in one environment relative to another, the ideas can be
I do not say that this is a tax issue only. We would be on the wrong track to
think that. People want to experiment. They have dreams. Some cities in Canada
are only 20 minutes north of the U.S. border, so the residents there have only
a 20-minute difference between paying a 40 per cent tax or an 18 per cent tax.
Which place will attract that critical mass of people who can put their own
plans into place? The critical mass is crucial and it is linked to opportunity.
People do not bring their dreams to life alone. Other people are needed.
I used to work with some American companies. Many times they put in a condition.
For example, despite the Internet and so forth, they are not ready to finance
them even in Boston or New York. They are ready to give the money, but only if
they move to Silicon Valley. It is that strict. Even under the same tax system,
they want them to be closer to that critical mass of talent so that the
information and knowledge can flow quickly and the matching of people can
happen and people can reconfigure quickly.
Now, here we are, just 20 minutes north of that place, and we want to tax these
types of experiments at more than double what they do there. That is what I
meant by opportunity.
This links back to your first question about how I arrived at the numbers.
First, on the 100,000 people who left Canada, that number was estimated by
Statistics Canada and is their number. How did I calculate the wealth? In my
example, I considered someone who made $100,000 a year. With that $100,000, at
a 5 per cent discount, the wealth is about $2 million. You multiply and arrive
at those numbers. That is what I did, and that is all.
The historical context is very clear. Consider a place like Hong Kong. Hong Kong
was a port of fishermen. Hong Kong did not become what it is today because
suddenly the fishermen became entrepreneurs. Hong Kong was made when the
communists threw everyone out of Shanghai without a penny. All those people
arrived in Hong Kong with a tremendous amount of knowledge and
entrepreneurship, and they rebuilt everything from shipping to textiles or
You can go back further in history, and it is the same story. Amsterdam was the
miracle of the 17th century. That was where you had the first stock market in
the world, and very sophisticated derivatives were traded there. It is not the
fishermen who did that. It was the first federal type of republic that was
tolerant toward all religions. The Jews of Spain and the Huguenots from France
and Protestants from all around arrived there, as well as the bankers from
Italy. They made Amsterdam what it was. Most of the capital in Amsterdam
belonged to foreigners. That is how that city came to such a scope.
I can go on with as many examples as you want. Historically, the movement of
people who followed where they could be financed brought a place either to very
quick ascendance or into quick oblivion. I will tell you how Amsterdam
declined. When England wanted to catch up with Amsterdam, they told the
entrepreneurs that, if they came to England, they would get a monopoly on their
trade. In fact, we live even today with the inheritance of these power
politics. That is where the 17-year patent protection comes from. England
promised that any foreign artisan or craftsman who came to England would get a
monopoly until he trained two to three generations of apprentices. Since
apprenticeship was seven years, that is 14 plus 21 divided by two, and rounded
it is 17 years. That is the origin of the patent law that exists still day.
That is how they got the entrepreneurs out of Amsterdam and the financial
market moved to London.
If you want, I can go on with endless examples about how places prospered and
Senator Kroft: That is a fascinating piece of economic history, but I hope we
can continue as a committee to keep our focus on capital gains tax. It is still
not clear to me that these connections are necessarily so. I would like to
conclude with your general perspective. I found that an astonishing paragraph,
but perhaps in some way you can link it to your thesis. You indicate that
politicians have an interest in preventing a country from being prosperous. My
concern is that, if you start with a premise like that, it is difficult to know
where you will end. It does not incline me well toward what follows in your
other views, unless I perhaps can understand that more clearly.
Mr. Brenner: I will give you just one example, that of Mexico, but I can go to
almost every country around the world. Ask yourself this question: Why have
Latin America and the Asian countries, which are democracies with elections and
so forth, remained poor? I will give you the statistics on Mexico. Only 1 per
cent of the population, after 70 years of democracy, has an annual income above
$10,000, officially. Let us say that the numbers are wrong and three times as
many have it. I think you must also ask yourself this question: How did a
country like Argentina, which was one of the richest countries between the two
world wars, become one of the poorest countries?
If you go to these countries and see what is happening there behind the facade
of words, you can see that this is exactly the game that was being played. Once
again, there is nothing new about it. Catherine the Great always said that she
would invest as much in education as was necessary to win the next war but not
as much as to bring about an internal revolution. More or less, that is the
policy that shaped many Latin American and Asian countries.
The Chairman: We will have trouble getting that one across. This is fascinating,
but we must try to stick to the issue. I appreciate what you are saying.
Senator Tkachuk: Senator Kroft opened this up. He asked a question.
Senator Kroft: I referred to the report. I am trying to understand. I have a
concern that we be effective and focused. Therefore, I am trying to bring major
statements -- iconoclastic statements, in some cases -- into focus to ensure
that they do indeed relate to the subject at hand.
Senator Tkachuk: Then let him answer the question.
Senator Kroft: I did not say a word.
Senator Oliver: Thank you for your presentation. We are lucky to have you here
As you know, this is the beginning of our study on capital gains. We know what
the Canadian capital gains situation is. Based on your research and your
experience, it would be very helpful to me if you could tell us briefly what
some of the other major countries in the world have done vis-à-vis
capital gains tax. In your paper, you mention Taiwan, Australia and the U.K. I
would be interested to hear about countries such as Holland and Sweden. What
has happened there in relation to their capital gains tax?
Some people have said that Canada should completely eliminate the tax, and that
that would solve our problem. A number of other jurisdictions have said that
they should keep the tax but develop a new public policy. For example, if you
have a capital gain on a real estate deal and you dispose of the income on that
gain within three, four or five years, there would be no tax. That is one public
policy possibility. What do you think of some of those possibilities vis-à-vis
what has happened in some of the states in Europe such as Holland?
The Chairman: When you say "dispose", do you mean reinvest or just
Senator Oliver: Reinvest. In Holland, for instance, they say "reinvest in
some other like business".
The Chairman: That is clearer.
Mr. Brenner: First, "The longer you keep the capital, the lower the tax"
is one idea that has been proposed in a couple of countries. I think it is
wrong, because you get into all types of fiscal manipulations. It makes the
system very complicated and you give a lot of jobs to lawyers and accountants.
You want to speed up the transfer of capital, not lock it in. However, you tend
to give the wrong incentives. By holding the capital longer, you are locking it
in. If you had withdrawn it more quickly, you could have invested it in
something new. In that sense, those are mistakes. That is why many people have
said, with regard to this particular tax, that the optimal rate is zero. You
want to speed it up.
Senator Oliver: Is that your view?
Mr. Brenner: Whenever Mr. Greenspan gives testimony, he always says that it
should be zero. I would not say that that is my only view, no. Absolutely not.
I tried to explain why, in this particular case, the number zero arises. It
would speed up the process where I begin to move away from the locked capital
and move quickly into new experiments.
You must put this in the broader context, because the capital gains taxes are
zero in both poor countries and rich countries. That is to say, you can have a
zero capital gains tax, but the country will not be successful if you close the
financial markets there. I am not saying that a zero capital gains tax is the
remedy for everything. There are plenty of poor countries in which the capital
gains tax is zero.
Concerning what happened in Sweden and Ireland, and so on, the general evidence
is that wherever the capital gains was significantly lowered you then
experienced booming new experiments and new enterprise. I am not saying that
that is the only factor, but if we want to choose between three factors, it is
the entrepreneurs and the angels who finance new companies.
Let me give you another example. The Scandinavian countries are often portrayed
as welfare states, and yet they succeed. For example, today many people use
Nokia and Erickson products, which are the two best wireless companies. Why do
those companies come from Finland, then, and not from the United States? Again,
this relates to a superficial debate. Finland has been doing well because it
was among the few countries in the world where telephone companies were never
regulated. In the 1930s, Finland had 850 telephone companies; over the years
those were reduced to about 45. They had a very competitive environment and
their employees were prepared. The moment telecommunications became deregulated
around the world, they were ready to take advantage of the situation because of
their background -- that is to say, because that happened to be their
competitive advantage because that sector had never been regulated in Finland.
The Chairman: What do you think would happen if we brought our capital gains tax
back to zero?
Mr. Brenner: You would immediately see a lot of movement toward experimentation
in different areas, especially wherever there was a critical mass of talent.
Also, it would attract a lot of the talent that left this country to return to
Senator Oliver: In the terms of reference that our chairman gave outlining what
this committee is beginning to study, he stated that "the committee wants
to determine the real economic effects on such variables as savings,
investment, cost and availability of capital, and ultimately on job creation."
Assuming that the capital gains tax in Canada becomes zero, would you mind
commenting on that?
Mr. Brenner: Let me go backward, because this is important. Capital would be
instantly available; a lot of capital would flow here. There would be a lot of
job creation. They would be good jobs, not the types of jobs that we
artificially create or sustain through taxes. That would be the first effect.
What would be the effect on savings? That is not important. Savings can be
negative. The moment Canada establishes itself as a credible booming country
after so many years of decline -- and, if the rest of the world is ready to put
their savings in Canada -- why shouldn't Canadians benefit? I can save much
less if the rest of the world savings can flow into Canada. I do not think
savings is an issue at all.
Let us take, for example, the parallel with the successful company. If people
give credibility to management and I have access to the capital markets but no
retained earnings or profits, my stock and market valuation will continue to
rise in spite of the fact that I have "negative savings". That is not
Senator Oliver: Savings is one thing, but there are also investment,
availability of capital and job creation.
Mr. Brenner: All those things are increasing. Savings will probably decrease,
but that is not important.
Senator Mahovlich: Mr. Brenner, what effect would it have on our dollar if we
were to go to zero?
Mr. Brenner: It would go way up.
Senator Mahovlich: I am all for that, but what happens to our exports? We have
people who rely on a low dollar. The country would be in turmoil.
Mr. Brenner: Considering the previous comments, I do not know how I can answer
that question because it goes in a different direction.
Senator Oliver: It concerns productivity.
Mr. Brenner: No, not so much productivity; rather the issue of currency,
monetary standards and exports.
Today we are living in a world of floating currencies, which happened when the
Bretton Woods Agreement for a fixed exchange rate disappeared. Why did that
disappear? It disappeared because, at that time, the popular fad was that
central banks could print money and, somehow, that would bring about prosperity
rather than inflation. With all the different regimes -- that is, in France, in
England, in the U.S., and so on -- all the central bankers were printing money
at different rates. Yet they wanted to maintain a fixed exchange rate.
Obviously, you cannot do that, because the one who is more disciplined is
selling exports, which hardly produces goods for a worthless piece of paper.
Senator Mahovlich: What year was that?
Mr. Brenner: That occurred in the seventies. That is why the argument in favour
of floating rates came in. Floating, however, was not the remedy. If you are in
any business, you want to sign a contract. You want to stay in that business
and you do not want to go into the exchange rate business. For example, you are
in the machinery business or the mine business, or whatever, and that is what
you want to do; so you try to sign a contract so that you know what you are
getting into. The floating exchange rate did not allow that. That is why you
had, simultaneously, the development of this huge derivative market in which
you try to ensure that you will continue to stay in your line of business and
not inadvertently depend on how the central bankers pursue their various ideas
Senator Mahovlich: I do not know if the Prime Minister enjoys my saying this.
Mr. Brenner: He should not, but it was one mistake after the other. After you
make a lot of mistakes, it is not easy to correct them.
Senator Mahovlich: That is just like a hockey game.
Mr. Brenner: Absolutely. It is similar. If I make a lot of mistakes, it takes
time to rectify them. I absolutely agree that you cannot do these things
abruptly from one day to another. That is not the purpose of this presentation.
It is to see it as a kind of anchor and to see where we are heading.
You have touched on another issue. The senator did not like my comments about
politicians. Nevertheless, it goes back to that. One of the reasons that the
export business, not only in Canada but around the world, has been "subsidized"
by devaluations is that politicians depend on immobile people much more than
they do on those who are mobile. They can count on their votes. Mines and
forests are not so mobile. Therefore, you help them out because you gain their
votes. It is almost impossible to separate these two things.
In response to what you are saying, yes, it will not be easy. It will take time
to adjust these businesses to a monetary standard. That is why these things
cannot be done from one day to another. They must be done gradually.
Senator Mahovlich: We have had some very wealthy people in the past, many of
whom you have probably studied, such as E.P. Taylor. He moved a lot of money
out of this country and down to the islands. What are your comments on that? Do
you think that the government should have allowed him tax relief to put money
into Newfoundland, for instance, to create jobs?
Mr. Brenner: Do you mean that he should have been forced to pay a kind of exit
Senator Mahovlich: No. Do you think he should have been given special
Mr. Brenner: That is not the solution for this country. You can give incentives
to one very rich guy to keep his money here. However, even if he keeps his
money here, that will not bring so much. You want creation of wealth and the
free movement of capital.
One of the other mistakes frequently made in these discussions about
redistribution, job creation and fairness is that somehow, if you take away the
money from the rich, then the poor people will become rich. That does not work.
It does not work because, even if you take from the richest and give to
everyone who is poor, the poor will each receive only $100. Then you are
finished and the rest of the capital from the rest of the world will not come
here. Your brains will be leaving to another country that will not deal with
these kinds of games. The fact that somehow you entice a very rich guy to hold
his $5 billion, for example, in this country, is neither here nor there. Those
are very small sums you are talking about.
I was reading in today's The Ottawa Citizen an article about Canada becoming the
fifty-first state of the United States. I think that argument is completely
wrong. Perhaps there is a way to look at Canada with 30 million people as a
kind of fifty-first state of the United States, but the conclusion does not
follow. California is also just one of the states. That does not mean that
California will adjust itself to the rest of the United States. Each state has
its critical mass of people and its advantages, which can be developed under
the proper tax system that retains and attracts better people.
Senator Angus: Professor, I apologize for not being here for your opening
remarks. I was in my office reading the Carter report on tax reform, as well as
your very fine article that appeared in today's Financial Post. It occurred to
me that, perhaps, people like yourself who are advocating an abolition of the
capital gains tax are not approaching the matter correctly. Let me explain why I
am saying that.
Back in the 1950s and 1960s, when I was in university, as well as subsequently,
there was no capital gains tax in Canada. I studied in the United States in the
early 1950s. They had a capital gains tax while we did not. There was
tremendous prosperity in Canada and a great flow of capital into our country.
There was industrial development going on. It was a great time to be a Canadian.
In 1971, as far as I can determine, we brought in the capital gains tax. What
were the reasons used to justify the bringing in of the capital gains tax at
that time? We all know the history. Since then, it has gone up gradually. I
think you will find most people agree with the situation in which we find
ourselves, as explained by you. That is to say that the problem is that it gets
put into the perspective that only the rich people are interested in removing
it, that this is just a rich man's game with no political sex appeal and it is
a terrible thing even to address it. Yet, reading and rereading your papers, as
I have done since they were circulated to us by the Dobson Foundation some
months ago, it is such an obviously good case why can we not make it better?
Do you agree that, perhaps, you have gone about it from the wrong side? Could we
not go back to the way it was in the 1950s and 1960s, which is, perhaps, the
kind of situation to which you would like to see us return, from a fiscal point
of view? The effects of not having a capital gains tax were there in living
colour. It is not a case of your being wrong; they really were happening.
That is a long-winded way to ask my question.
Mr. Brenner: Some people here want historical perspective, while others do not.
It is hard to satisfy everyone.
Senator Angus: The name of the game is to get somewhere with your arguments.
Mr. Brenner: I shall try to use my arts of persuasion in responding to your
First, why were capital gains introduced and why was inflation pursued in the
1970s? The truth is, as I mentioned indirectly before, this did not take place
only in Canada. The late 1960s and the 1970s were the heyday of what I would
call the Keynesian fad. The idea was that, somehow, the government can be the
solution for everything. Thus, it was linked with something broader. As to why
I think that became popular at the time, it was the result of a wrong inference
from a particular situation.
When the U.S. succeeded very quickly in catching up with the Sputnik and sending
their man to the moon, people thought that, if that could be sold so well by
the government, then how come we cannot declare war on poverty and solve all
the problems of the world? The big difference between sending people to the
moon and solving problems on this earth is that the moon does not change its
orbit in response to what we are doing. However, people do change their
behaviour in response to what we are doing. That is a big difference. Somehow,
that difference was, I would say, out of sight and mind.
I shall go back to politics once again. The Keynesian view had great appeal. It
is still used in public discourse today. You have asked why we cannot go back
to correct the situation. We cannot, because we are using the wrong language in
public discourse. The fundamental reason behind the Keynesian model and why the
government has to interfere and spend is that investors are irrational and
government bureaucrats are making much more rational decisions.
Obviously, such a model translated to mathematics would have great appeal. Once
it is adopted that government spending is good and government bureaucrats know
better how to spend and when, you go slowly to increased spending, in many
ways. Members of the government bureaucracy, and not only in Canada but in
western Europe and the U.S., were almost compensated for coming up with new
ideas and new programs. That is how the system was changed in response to this
It was combined with the idea that the central bank can print money and, as long
as there is unemployment in the range of 7 per cent to 8 per cent, there would
be no problem. Twenty years later, when they noticed problems with that idea,
they changed the vocabulary to the "Phillip's curve", saying that
somehow there is a trade-off between inflation and unemployment and all types of
macro-economic fads. We are now slowly getting out of it, but it will take
time, because the public must be re-educated. This must be debated with other
We always hear the term "job creation". That is the wrong language,
because it matters what type of jobs you are creating. Also, when the
government says it "invests", that is an inaccurate word. The
government spends. Is that investment? If I spend on a highway that goes to the
village of my constituents, a road which no one uses, that is not investment
but spending. If I build a golf course, is that investment or spending? This is
a play on words. To become investment, there must be some very good mechanism
in place to correct mistaken decisions from persisting too long. This is what
we do not have within government today.
Senator Oliver: Unless it generates a nice rate of return.
Mr. Brenner: Political return.
Senator Angus: Professor, it comes through clearly in your paper and in what you
have said today that, if we reduced or even abolished the capital gains tax, we
would have a stronger currency, more capital investment, more employment
generally, a stronger economy, and greater prosperity for all Canadians. What
could be a better election platform?
However, people do not believe you when you say that. I believe you, but people
think that is because I have a lot of unrealized capital gains and therefore a
personal interest. It is a compelling story. All of those things are "motherhood"
things. Any politician would love to say that the government is doing this
because it will create greater prosperity, a stronger dollar, and a better
country to live in in every respect.
Perhaps one way is to say that we made a mistake, that Keynesian economics were
badly conceived and wrongly applied in this country, and that when we did not
have capital gains tax things were a lot better.
I urge you to come up with credible ways to make the politicians believe you,
especially the ones who wear red hats, because they are the ones who have the
power to do it with one stroke of the pen. In the last three months, I have
probably spent 200 hours alone with the Minister of Finance, and he does not
want to know. He does not want to hear about it. It is absolutely politically
incorrect for him to contemplate it. He is smart, he is a patrician, he has
capital gains of his own in his blind trust. Politicians just do not believe
that they can get the message across to the people.
This is a golden opportunity. The chairman of this committee has decided, at his
own risk and peril, to institute this study, and we are all his willing horses.
Mr. Brenner: I will give you a pessimistic answer, but this is how I read
political and business history. People do not make major changes unless forced
to so. Companies make major decisions when they fear competition or are close
to bankruptcy. Historically, governments have not made major changes unless
their credit rating was cut and they could not bribe -- although that is a
strong word -- their constituents into obedience. It has been 10 years since
the fall of communism. I know that has been attributed to many things, but I
believe it happened simply because the country was bankrupt. If the Russian
government had had more money to pay for the military and for the bureaucrats,
it would not have fallen. The major revolution in Japan and the French
revolution happened when those governments did not have access to credit, to
money. That is one element.
Senator Angus: It is a negative one, with all due respect. You are saying the
reason I cannot give positive answers is that the government will resist major
change. We know that, but we have to give it a carrot that is delicate and nice
Mr. Brenner: I will proceed to the next one, and this is where the government
can be pushed into action. This is the debate that is going on today in Canada.
The opposition try to say that Canadians are falling way behind, to which Mr.
Chrétien answers that Canada is the best country in the world, that by
all the OECD and United Nations bureaucratic studies we are number one. The
debate is on whether we are really falling behind the United States or are
still up with them.
Although over the last year the National Post has succeeded in putting this
debate in the public sphere, it is not enough. Newspapers are one thing. On the
federal level, there is not an effective political opposition, and these types
of debates only happen when there is an effective political opposition. That is
why this debate is not taking place.
Senator Angus: But it is a no-brainer, professor. You have said yourself, on all
the five key points, that it is a no-brainer, that it is good for everyone. It
is not a sop to the rich. This would be the greatest thing for Canadians.
Somehow we have to make the people believe it.
Mr. Brenner: Senator Kroft did not like my starting point that this debate is
not taking place, because the politicians want to stay in power, but I shall go
back to that point. Unfortunately, I must disagree with your statement that
this would be good for all Canadians. That is not true, because the more that
financing goes through government, the more power the government has, including
the power to appoint friends or people who are not fully qualified, people who
may not be the head of a state-owned enterprise if they did not belong to the
Liberal Party. Those Canadians would not have a chance of heading those
operations if we moved toward the system we are talking about.
Senator Angus: That is a cynical approach, I must say. You may be right, but, in
my view, we must impute some good faith to the elected representatives of the
Senator Kroft: I would like to return to several very specific points. Your
point about looking at what one might call the velocity of capital, or doing
everything possible to avoid capital becoming stale and embedded is an
important point and very relevant to the question of capital gains tax.
I would like to look to the U.S. on two things, and also in the context of this
massive intergenerational transfer of wealth that is occurring. A very
important aspect, as I am sure you would agree, of public policy now is how
that gets tapped into; and does it get tapped into in a way that is productive?
The tax world is a world of tradeoffs. First, has the U.S. found much that is
positive in the capital gains rate? It is intriguing to me, and always has
been, as to why they have their capital gains tax rate where it is. Perhaps it
is for the same reason as here. Although it is at 20 per cent or whatever it is,
it is not zero. There is a powerful constituency even in the enlightened U.S.
to keep it where it is or higher.
Senator Oliver: There is a move afoot to reduce it now.
Senator Kroft: There is movement constantly both ways and the 20 per cent has
been a saw-off in those two moves. The other thing that we must never lose site
of, and it concerns both the intergenerational aspect and the inclination of
capital to move, is that, while we have our estate and capital planning
industry, they also have theirs. We have no gift tax. They have a gift tax.
They have found another way of intruding on the public purse in the way of the
capital transfer value. Perhaps they have made a judgment that it is bad to
transfer capital value from one generation to another, and they have a severe
regime of estate taxation. On the supposition that the government needs
revenues to work on and there are tradeoffs, what would your comments be if we
were to step into the American position? Take it the other way around, so that
the transfer of capital from one generation to another was heavily taxed but
the realization of current capital gains was less heavily taxed or not taxed at
Mr. Brenner: Taxes are always a matter of compromise. Nothing is perfect.
However, there are two issues here. First, if you try to impose too high a tax
on something, then people will avoid it or evade it. We have seen that in
Canada with the black market and so forth. Second, economists work out
theoretical models about this tax or that tax, but they never take into account
what happens if capital moves south and people go into black markets. Also,
people tend to find wonderful loopholes. Whatever tax the U.S. has, there are
plenty of ways to avoid it. You must remember that, when you write a tax code,
that language is never so precise that a good lawyer and some good accountants
cannot violate it.
You went in another important direction, regarding the question of fairness and
mobility and about how the rich may or may not stay rich. Just looking at the
United States, Forbes Magazine publishes annually the list of the 400 richest
people in the U.S and in the world. You will notice that in the United States,
in contrast to any other country, there is a huge turnover in that list. The
people who were at the top 10 years ago in the United States are almost out of
the list or are very close to the bottom, while those who are at the very top
now, who are the called the 'Silicon Valley aristocracy', were nobodies 10
years ago. They did not have a penny.
When people mention inequality, it is big mistake to link the capital gains tax
with that debate, because inequality has two meanings. You can have the same
statistical measure for inequality in two countries. However, that does not
matter, because the interpretations would be very different, if in one country
it is all the time the same people who are at the top, in the middle, and at the
bottom, while in the other country the people move up and down. If you compare
that measure across countries, you will see that one of the biggest movements
is in the United States, and there is even greater movement in places like Hong
Kong -- the kind of esoteric, accidental places, I would call them.
Why do they have that greater movement? I would say once again that it is
because of two things. One is their tax regime and the other is the extent that
their capital markets are democratized. The two are linked in my view because
the angels will give seed money to the newcomers, and they have a chance to go
up. If you do not have that market, whether because of bad taxes or because you
regulate your financial markets, the poor are prevented from succeeding. They
stay at the bottom.
Perhaps I did not understand your question correctly, but I thought that that
was the direction you were going in. I am glad you raised that question.
I will return to what was said about the gift tax versus the estate tax in the
United States. Most of the fortunes go from one generation to another because
there are trusts and a lot of ways to avoid paying inheritance tax.
Senator Angus: There are no deemed dispositions.
The Chairman: They have estate tax, but we have deemed realization on death,
which means that 40 per cent of what we accumulate during our lifetime is paid
out upon death. That makes a huge difference, believe me.
Senator Tkachuk: I was particularly interested in the exchange between Senator
Angus and you about how cynically you view politicians. I have a lot of empathy
for that as a Western Canadian. I am in favour of lowering the capital gains
tax or eliminating it, because in the East you have a huge manufacturing base
here and the falling dollar continues to subsidize it further and further. The
weaker the dollar becomes, the harder it is to have the political incentive for
changing the capital gains tax.
We import in the West. We think that the reason we have this situation is that
we are all risk takers out there looking for oil and gas and everything else,
which is all capital gains. In the East you have a lower manufacturing tax on
companies as well. Therefore, politicians have been acting cynically with the
country. Are there any credible economists left in Canada who think that capital
gains tax should be raised?
Mr. Brenner: You are asking the wrong person.
Senator Tkachuk: You must travel and go to forums. Have you ever heard an
economist say we should raise the capital gains tax because it would be good
for the country?
Mr. Brenner: It would not be said too loudly. Actually, I do not think I have
ever heard of increasing it. However, let me say something about manufacturing.
Someone asked how you would pursue it with the public. I will give you an
example about what that means in a place where there is no capital gains. How
quickly could the manufacturing base adjust?
You asked me a question about the early seventies. You may remember that at that
time one of the most popular fashion items were wigs for women. They were
changing them three times a day. Most of those wigs were produced in Hong Kong.
That fashion disappeared after two years. There were 22,000 people at the time
employed in that industry in Hong Kong. All of the factories closed except for
two. Within less than two years, those same people worked in the electronics
We here live with the idea that somehow people cannot adjust. The attitude is
that if a fisherman never fishes for another fish in his life, he still has the
right to be called a fisherman. If you had a lower tax that would finance
experiments, including training, you would then see from other countries'
experiences just how quickly people would adjust.
Certainly, if you give them the ability to stay fishermen forever and fish in
the ocean called Ottawa rather than in a real ocean, then why not?
Senator Tkachuk: Are the only people left the ones who say we have it just right
or the ones who say we should lower or eliminate capital gains tax? Is that
what the only credible economists we have left are saying? I tried to find
books in the library by people who would actually have an argument for it.
There are not any moderates left who are in favour of increasing capitol gains
Mr. Brenner: I doubt that you would find anyone in favour of increasing it to 40
per cent when the U.S. is at 18 per cent, at this stage.
Senator Tkachuk: I do not think so. I will make a big leap here, because I do
want to get back to Senator Kroft's point of narrowing down the focus, but
everything is politics.
On the question of capital gains, we actually tax options. Once an option is
granted to a member of the board of a company, an executive of a company or an
employee of a company -- a lot of McDonald's employees and managers have
options -- and once they exercise those options, we charge tax in Canada. It
seems a strange thing to me. Nonetheless, I want to get your views on that.
Should we tax them when they are exercised or when they are sold?
The Chairman: You are saying taxed at a regular rate, not even capital gains.
Senator Tkachuk: At a regular rate, like earned income.
Mr. Brenner: Stock options are mainly thought to be effective to attract the top
management. Once again, I do not think you can tax in that way, because the
whole world is open to compete for top management. Therefore, you cannot
discuss this in isolation as if we could set our rate for Canada independently.
We must do it relative to Detroit, or wherever this top management could move.
These are the most mobile people. Since they are the most mobile, you cannot
determine your tax in isolation.
If in the United States they are taxed like that, then that is more or less the
range in which you can tax them here too. That is it.