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Finance Minister Bill Morneau responds to a question during question period in the House of Commons, Dec. 6, 2016. Liberal promises to tackle inequality and boost innovation are on a collision course in the run-up to the 2017 budget.

Sean Kilpatrick/THE CANADIAN PRESS

Liberal promises to tackle inequality and boost innovation are on a collision course in the run-up to the 2017 budget.

For months now, officials at Finance Canada have been working with a panel of outside experts on a review of federal tax credits, with the stated goal of raising at least $3-billion a year in new revenue.

The Liberals have said the review will focus on tax credits that primarily benefit Canada's highest income-earners. That has triggered widespread speculation among tax practitioners that the government may increase taxes on capital gains, which are the profits made when selling stocks, bonds or investment properties.

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The challenge for Finance Minister Bill Morneau is that the government has also promised to make Canada more innovative and attractive to investors. Critics of capital gains taxes argue they hurt innovation by limiting the amount of money in the economy that is free to be re-invested in new projects. There are also numerous voices – including former Bank of Canada governor David Dodge's – warning federal Liberals to rein in the tax-the-rich agenda in light of plans in Republican-controlled Washington to dramatically reduce personal and business taxes.

Larry Chapman, executive director and chief executive officer of the Canadian Tax Foundation, said higher capital gains taxes would run counter to an innovation agenda.

"They're trying to walk both sides of the street on this one and I think they've found that some of their election promises conflict which each other," he said in an interview.

At the foundation's late-November annual conference in Calgary, accountants, public servants and academics from across the country gathered to talk about trends and rumours in the tax world.

Mr. Chapman said there was talk among accountants that clients were already taking measures to realize capital gains out of concern that Ottawa will raise the rate. Currently, tax is applied only on 50 per cent of income from capital gains. The rate of tax depends on an individual's total income.

The inclusion rate has previously been as low as zero prior to 1972 and as high as 75 per cent in the 1990s. It declined to 50 per cent in 2000.

Policy experts who are concerned with income inequality see capital gains as a key target given that it is primarily higher-income Canadians who have the means to generate significant additional revenue from investments.

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Finance Canada keeps a tight lid on its future tax plans and final decisions won't be revealed until the budget, which is commonly released in March, though no firm date has been announced. But Mr. Chapman said the signals suggest a capital gains change is on the government's radar.

"I'd say it's 50-50," he said of the chances that Ottawa will raise taxes on capital gains. Similar rumours circulated ahead of Mr. Morneau's 2016 budget, but the capital gains inclusion rate was left untouched.

A wide range of federal tax credits – officially called tax expenditures – are in place now with a combined value of more than $100-billion annually in forgone government revenue. The Liberals have explicitly ruled out a change to some of the credits, including one related to stock options and another that allows senior couples to split their income to reduce their overall tax.

However, the Liberals have consistently refused to shut down speculation about other tax credit changes, such as whether the government would treat workplace health and dental plans as a taxable benefit.

"As part of our plan to grow the economy by strengthening the middle class, we're reviewing the tax system as a whole, and specifically tax expenditures, to ensure fairness, simplicity and effectiveness," said Mr. Morneau's spokesperson Daniel Lauzon in a statement.

There is significant money at stake when it comes to the capital gains rules.

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Finance Canada reports that the policy of including only half, rather than all, of a capital gain means the federal government lost out on $6.3-billion in personal tax revenue and $6.7-billion in corporate tax revenue in 2015.

There is significant debate, however, as to the behavioural effects that would be created by a change in the inclusion rate and how that might affect federal revenues. Finance Canada has said that raising the inclusion rate likely would not produce the amounts listed because individuals may delay certain transactions due to the higher tax.

The topic has also come up as part of the Conservative Party's leadership race. Conservative MP and candidate Maxime Bernier has called for the tax on capital gains to be eliminated entirely.

"The capital gains tax is a tax on investment," Mr. Bernier said in September when he announced the policy stand. "Everybody understands the logic: The more you tax something, the less of it you will get."

A recent report by the left-leaning Canadian Centre for Policy Alternatives analyzed federal tax expenditures to determine which ones are the least progressive, meaning they provide the most benefit to high-income Canadians.

The report identified the partial inclusion of capital gains as among the top five most regressive tax credits, along with pension income-splitting for seniors, a stock option deduction, the foreign tax credit and a dividend gross-up, which is a credit for shareholders of dividend-paying firms. Those five credits provide 99 per cent or more of their benefit to the upper half of income earners, according to the CCPA analysis.

Economist David Macdonald, who authored the report, said capital income should not be taxed at significantly lower rates than regular income.

"It's not fair that the janitor sweeping the floors at the Toronto Stock Exchange, all of their income counts towards income tax, whereas the people trading the stocks on the stock exchange, half of their [investment] income counts towards income tax," he said.

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