Lexicon Financial Group Weekly Update — APRIL 17, 2024
“You don’t need to raise taxes on rich people, because they create capitalization and investment. But you need to tax speculation - meaning capital gains.”
From the desk of Craig Swistun, CIM, MFA-P, Portfolio Manager, Raymond James Investment Counsel, and Wayne Hendry, Client Relationship Manager, Raymond James Investment Counsel
Looking Around
Well, it’s been a week! With apologies to those living outside of Canada, our focus this week will be on digesting the proposed Canadian budget and changes to our tax system. If tax policy bores you, feel free to skip to the market overview below.
Normally budget announcements are met with a whole bunch of “meh”, but not this one. To put it bluntly, the business community does not like this budget. We’re not going to discuss politics or policy, but rather use this space to explain what is going on and explore how it might impact the public personally.
The biggest bone of contention in the proposed budget is the increase to the capital gains inclusion rate. Let’s dive in.
When you purchase an asset (a stock, bond, mutual fund, piece of land, vintage car, whatever), what you pay for it is called by accountants the “book value.” If in the future, you sell that asset, you will receive the “market value.” If you sold it for more than you paid, the difference is considered to be a “capital gain” – your capital (money) bought something that went up in value.
As we all know there is no guarantee that any investment will appreciate, tax policy has been there to encourage more risk-taking in investment to spur an innovative economy. Consequently, capital gains receive preferential tax treatment in Canada. For years only 50 per cent of any capital gain was considered “income” for the purpose of calculating income tax. In simple terms, if you bought a stock for $1000 and sold it for $2000, you would generate a $1000 capital gain. The inclusion rate of 50 per cent meant that only $1000 x 50 per cent or $500 would be considered taxable income.
Experienced investors may recall that things started to change in the late 1980s. The capital gains inclusion rate rose from 50 per cent to 66.67 per cent in 1988, and then again to 75 per cent in 1990. Essentially, instead of “including” $500 of income under a 50 per cent inclusion rate, Canadians had to include $1000 x 75 per cent = $750 as income. And that’s how things stood for almost a decade until 2000, when the inclusion rate was reduced (some would say “returned”) to 50 per cent.
For over 20 years now investors have become accustomed to a capital gains inclusion rate of 50 per cent, but history shows that this number is far from set in stone. The budget proposes a return to an inclusion rate of 66.67 per cent, but only on capital gains in excess of $250,000 in any given tax year.
Of course, tax policy can get confusing. The capital gains calculation doesn’t determine how much tax an investor owes, it determines how much income is used when making the tax calculations. We encourage you to speak to a tax professional for exact numbers, figures, and calculations. Here, for the sake of simplicity, we’ll keep the discussion generic.
Let’s show some math in two parts.
| Capital Gains | Inclusion Rate | Taxable Amount of Capital Gain | Blended Inclusion Rate |
| First $250,000 | 50 per cent | $125,000 | 50.00 per cent |
| $500,000 | 66.67 per cent | $291,675 | 58.34 per cent |
| $1,000,000 | 66.67 per cent | $625,025 | 62.50 per cent |
| $1,500,000 | 66.67 per cent | $958,375 | 63.89 per cent |
| $2,000,000 | 66.67 per cent | $1,291,725 | 64.59 per cent |
| $2,500,000 | 66.67 per cent | $1,625,075 | 65.00 per cent |
For investors generating less than $250,000 in capital gains in a given year, there is no change to their tax system. However, imagine an investor who generates $500,000 in capital gains. What does that look like? Well, the first $250,000 has an inclusion rate of 50 per cent. Then next $250,000 would have an inclusion rate of 66.7 per cent. Blended, a $500,000 capital gain would have an inclusion rate of 58.34 per cent. This investor pays more tax in the proposed budget than currently.
Most ordinary Canadians’ investment portfolios are unlikely to trigger this level of gains in a given year. Professional portfolio managers can ensure that gains can be spread across multiple years to reduce tax burden, for example. So why is this important to average Canadians? What situation could arise where they are generating large capital gains? Here are a few examples:
An investment portfolio purchased years ago may have a high level of “unrealized” capital gains – gains that would become due if all assets were sold. This may be a problem for individuals invested in mutual funds or proprietary investment products who are contemplating a change to their investment strategy or structure, because moving to a new provider may require them to sell the asset, triggering all unrealized gains.
Selling any property that is not a primary residence – including a vacation property – is considered a capital gain. Given the rise in real estate prices in the past decade, many property owners have significant “unrealized” gains that could exceed the $250,00. From a pure tax optimization perspective, they should want to pay an inclusion rate of 50 per cent instead of 66.67 per cent.
Lastly and unfortunately, death. When someone dies (or in the case of spouses, the last to die), all of their property is deemed to be sold on the date of their death. Vacation properties, non-registered investment assets, everything. If the estate has more than $250,000 in capital gains, they will be caught under the new rules and subject to higher taxation.
Even though we’ve lived through higher inclusion rates in the past, nobody likes paying more in taxes. This is where some prudent tax and investment planning can help. We’re certainly not advocating that people rush out and sell their family cottage because the capital gain rate is increasing. We are advocating a need for more detailed planning, and closer integration of portfolio management within the context of a broader tax and estate plan.
Fortunately, this is what we do anyway. It’s not to say that we love tax increases, but we’ll help clients navigate their way through them the most effective way we can. Alternatively, we can cross our fingers and hope that this or a future government reverses the decision and leaves the inclusion rate at 50 per cent, where it has been for a generation of investors. You know which option we will choose.
Looking Back
Major North American equity markets sold off on Friday last week after major U.S. banks’ (including the biggest U.S. bank by assets, JPMorgan Chase & Co., Wells Fargo & Co., and Citigroup) earnings failed to impress in a week marked by market-moving inflation data, evolving expectations for U.S. Federal Reserve policy, and looming geopolitical tensions between Israel and Iran.
In fact, all three major U.S. stock markets fell by more than one per cent, and registered losses on the week. The Toronto Stock Exchange’s S&P/TSX composite index (TSX) ended down 0.95 per cent on Friday, which is its biggest decline since February this year. For the week, it lost 1.6 per cent, after eight straight weeks of gains. All 10 major TSX sectors lost ground on Friday, including a decline of 0.91 per cent for heavily weighted financials. The S&P 500 index experienced its biggest weekly percentage loss since January, while the Dow Jones Industrial Average’s weekly loss was its steepest since March 2023. All 11 major sectors in the S&P 500 closed in the red, with materials suffering the steepest percentage loss. On top of all this, last Wednesday’s hotter-than-expected Consumer Price Index (CPI) report, which suggested that inflation could be stickier than previously thought, has further raised doubts about the timing and extent of the U.S. Federal Reserve’s (Fed) rate cuts this year. (1)
Weekly North American Market Statistics
| Index | Week's Change | Year to Date |
| S&P 500 | -1.6% | 7.4% |
| Nasdaq Composite | -0.5% | 0.8% |
| Dow Jones Industrial Average | -2.4% | 7.8% |
| S&P/TSX Composite Index | -1.6% | 4.5% |
Overall inflation rose 3.5 per cent over the preceding 12 months, its biggest gain since September. As a result, futures markets began pricing in roughly a 20 per cent chance of a rate cut at the Federal Reserve’s June policy meeting versus roughly 50 per cent before. Richmond Fed chief Thomas Barkin said that the latest data did not increase his confidence in disinflation, and Boston Fed President Susan Collins said that the recent data argue against an imminent need to cut rates.
Read and Watch
Want deeper insight into topics in your Weekly Update? Then, read and/or right click:
Wall Street pushes out rate-cut expectations, sees risk they don’t start until March 2025 - CNBC
Why China’s economic woes should raise concern for the West – The Hill
These comments, to say the least, did not help assure investors. Oil prices also rose, along with the U.S. dollar (which is typically viewed as a “safe haven” in times of international turmoil), as tensions between Israel and Iran grew. Meanwhile, the CBOE Volatility Index (VIX), Wall Street’s so-called fear gauge, spiked to its highest level since November. The higher CPI helped drive the yield on the benchmark 10-year U.S. Treasury note to its highest intraday level since November before Treasuries rallied on Friday as investors sought out U.S. dollar-based assets. Remember that bond prices and yields move in opposite directions.
However, Thursday’s release of producer price inflation (PPI) data helped calm inflation fears and assisted equity markets recoup a portion of their losses. Producer prices rose 0.2 per cent in March, slightly below expectations and well under February’s 0.6 per cent increase.
In local currency terms, the pan-European STOXX Europe 600 Index ended 0.26 per cent lower. Germany’s DAX lost 1.35 per cent, France’s CAC 40 Index declined 0.63 per cent, and Italy’s FTSE MIB slid 0.73 per cent. However, the UK’s FTSE 100 Index gained 1.07 per cent. The British pound’s weakness relative to the U.S. dollar helped support the index, which includes many multinationals that generate significant overseas revenue. Headline annual inflation in the eurozone decelerated more than forecast to 2.4 per cent in March from 2.6 per cent in February. Core inflation, which excludes volatile food and energy prices, also slowed to 2.9 per cent from 3.1 per cent. The European Central Bank (ECB) left its key deposit rate at a record high of 4.0 per cent, which was expected. It said that if an updated inflation assessment, which is due in June, “were to increase its confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction.” So Europe could be headed for a June interest rate cut.
Japan’s stock markets rose last week, with the Nikkei 225 Index up 1.4 per cent and the broader TOPIX rising 2.1 per cent. As the Japanese yen hovered close to a 34-year low, the focus of investors was on whether the country’s authorities would step in to support the currency.
Following a hot U.S. inflation report and the subsequent rise in U.S. Treasury yields, the 10-year Japanese government bond yield rose to 0.84 per cent, from 0.77 per cent at the end of the previous week. It briefly touched its highest level since November 2023 last week.
Chinese stocks retreated as weak inflation data highlighted the weak demand hanging over China’s economy like fog in London. The Shanghai Composite Index declined 1.62 per cent, while the blue chip CSI 300 gave up 2.58 per cent. In Hong Kong, the benchmark Hang Seng Index ended nearly flat after anxiety about the flagging recovery pared earlier gains.
China’s consumer price index rose a below-consensus 0.1 per cent in March from a year earlier, down from February’s 0.7 per cent rise, as food costs retreated following a brief increase during the Lunar New Year holiday in February. Core inflation rose by 0.6 per cent, which was weaker than February’s 1.2 per cent increase. The producer price index fell 2.8 per cent from a year ago, marking its eighteenth month of declines and accelerating from February’s 2.7 per cent drop.
Adding fuel to the fire, China’s exports and imports fell in March and reversed gains from the first two months of the year. Exports shrank a worse-than-expected 7.5 per cent in March from a year ago compared with a 7.1 per cent rise in the January to February period. Meanwhile, imports fell 1.9 per cent, down from 3.5 per cent growth in the first two months of the year. The latest results dealt a setback to China’s reliance on external demand to bolster its economy and added pressure on Beijing to ramp up stimulus measures if it wants to achieve its five per cent annual growth target set at the National People’s Congress in March this year. (2)
Inflation, like the dragon in the Game of Thrones drama series, seems to be hard to bring down. The Fed chair, Jerome Powell, cautioned on Tuesday this week that persistently elevated inflation will probably delay any Fed interest rate cuts until later this year, which opens the door to a period of higher-for-longer interest rates in U.S. and globally. In the past several weeks, government data has shown that inflation remains stubbornly above the Fed’s two per cent target and that the economy is still growing robustly. The closely watched gauge of “core” prices, which exclude volatile food and energy, rose sharply for a third straight month. It is ironic that as recently as December last year, Wall Street traders had called for as many as six quarter-point rate cuts this year. Now they are down to only two rate cuts, with the first coming in September. (3)
The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable, but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors, and we recommend that clients seek independent advice from a professional advisor on tax-related matters.
The close: Stocks sharply lower amid mixed U.S. earnings, sticky inflation and geopolitical fears, The Globe and Mail, April 12, 2024
Global Markets Weekly Update, T. Rowe Price, April 12, 2024
Fed chair Jerome Powell: high inflation likely to delay rate cuts this year, Associated Press, Tuesday, April 16, 2024.
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Looking to Learn?
If you want to know more about some of the topics we wrote about this week, just click on the links below:
Budget 2024 makes changes to capital gains tax. Who will it affect?
Federal budget 2024: Key measures that may have a direct impact on you
2024 federal budget's key takeaways: Housing and carbon rebates, students and sin taxes