Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

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 financial system.

Senator E. Leo Kolber (Chairman) in the Chair.

[English]

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 United States.

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 taxation.

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 Francisco.

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 companies.

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 billion dollars.

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 self- selection.

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 incurs.

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 language changes.

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 is it.

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 commercialized.

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 whatever.

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 fell behind.

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 today.

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 spend it?

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 Canada.

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 an issue.

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 about floating.

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 tax?

Senator Mahovlich: No. Do you think he should have been given special incentives?

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 points, senator.

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 global idea.

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 language.

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 to eat.

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 people.

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 all.

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 business.

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 taxes.

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.

Senator Tkachuk: Thank you.

The committee continued in camera.