Episode 317 - An Economist's Perspective on Capital Gains Taxes with Kevin Milligan

23:45So those are the kind of the two polar cases where if dollars are coming from abroad, personal taxes don't matter for the investment side of the economy. Whereas if we're kind of in a trapped economy with all money coming from domestic sources, then you do care about that. Because if I'm an investor, I'm like, well, if you tax corporations more, that's less in my pocket when I pull that money out of the corporation and put it in my pocket. And so that's kind of the two polar cases. Which case we are in, different economists have different views of things. The way I tend to look at it is it really depends what sector you're in.

24:18If you're a big international company. My exemplary is too old. Last time I talked about this, when I talked in front of my classes about this, talked about Bell Canada Enterprises, which I think is still publicly traded. Went through a weird thing back 10 years ago. At that point, it was traded in the New York Stock Exchange. Or take any big Canadian company that might be traded in New York, traded in Toronto as well. They're cross-listed. This happens for the big companies. Similarly, they float their own corporate bonds. Just think of the capital they have access to. They can walk into an investment bank in New York.

24:50Like, yeah, we want to drop$100 million of bonds or a billion dollars of bonds or whatever the quantity might be. And they get an investment bank, gets placed with some German credit union. It gets placed with some Japanese pension fund, total international. In contrast, you got a small construction startup, guy wants to buy some equipment, buy a front-end loader, buy a new dump truck, doing great work for the Canadian economy, working hard, getting up in the morning. We love this guy. But the thing about him is he can't go to New York and flow bonds to fund his operation. What he's got to do is borrow from friends, borrow from the bank, that kind of thing.

25:27So he's going to be faced with domestic capital system. So he's going to care. It might be self-funding as well. So he's going to care a lot. The corporate tax rate goes up. He's going to care about that, how that passes through to his individual taxes. So the big picture here is there's these different models. I think they affect different kind of firms differently. And this all feeds into that question we were talking like, why is it that the very high earners are paying a bit less tax than other earners in Canada? It's because they get a lot of dividends and capital gains. But why is it that we treat dividends and capital gains differently than other forms of income?

26:03The answer comes to, well, these forms of income have already been taxed at the corporate level. And should we care about that or not, comes down to this question of this international economics and international capital flows. So it's a very deep dive there. But the reason why we have to do the deep dive is that is the reason why we think about the inclusion rate and the dividend tax credit as a special thing. And there's a lot of debate among economists about whether we should care about that and how much we care about that. How does the concept of tax integration, where personal income tax accounts for tax paid at the corporate level, How is that affected by capital mobility?

26:40This is kind of a part I skipped over a bit in talking about the international capital flows. But just think about what happens when a firm makes profit. A firm makes profit, it pays corporate taxes, then goes into retained earnings after tax profit account in the firm. What happens then? Well, two things can happen, or three things. One is the firm reinvests that into the firm. That's great. We like when that happens. The second thing can happen is that they pay a dividend. The dividend then goes into shareholders' pockets. The third thing that can happen is they retain the earnings inside the firm, maybe to pay future dividends, maybe to do something else, whatever it might be.

27:20But when they do that, the value of the firm is going to go up. And so if future dividends are higher, the stock price might go up if it's a publicly traded company. That's going to then kind of transmit that value to the shareholder through a capital gain. Another thing they can do is take that retained earnings and do a share buyback program. When I've mentioned this, I've had a lot of pushback from financial industry professionals saying, aha, if a firm does a share buyback program, that gets deemed as a dividend. And so what you're talking about, about how that gets transmitted to shareholders through a capital gain is not true.

27:55Well, the answer is it is true. It depends on how you structure it as a firm. If a firm says, okay, every 10 shares you have, I'm going to buy back one of them, then that's deemed as a dividend under a certain part of the Income Tax Act. In contrast, the firm just says, I got$100 million of retained earnings here. I'm going to go out to the market and put in orders and buy a bunch of shares on the open market. What happens then is that the price of the stock gets bid up, and then that benefits everyone who holds that stock through a capital gain. And that's a way to transmit that firm value to the shareholder through a capital gain.

28:30I was very confused when I got angry emails like, what are you talking about? How firms do share buybacks? That never happens. You just Google up share buyback Canada and you get dozens of firms saying the CFO makes an announcement in their quarterly earnings call. Okay, we did well this quarter. We're going to institute a share buyback plan instead of reinvesting the firm. We're just going to buy back a bunch of shares. Why are they doing that? They explicitly say we want to juice the stock price. That's fair. I mean, there's nothing wrong with that per se. It's a way to transmit firm value into shares.

29:00value. What could be wrong with it, though, is if the tax system is favoring that way over, say, dividends or over, say, reinvesting in the firm. That gets into why we made the change to capital gains taxation. But generally, that's the big thing here. When we talk about integration of the tax system, the personal and corporate tax system, it's about accounting for all the taxes that are paid in that journey from the corporate taxes through to the personal taxes. So, I always like to say from the profit of the firm to the pocket of the shareholder. Corporate tax, dividend, tax credit, dividend taxes, capital gains taxes, all of that stuff.

29:40We think about it as the integration of the personal and corporate tax systems. Wow. This is so interesting, Kevin. So how does the new capital gains inclusion rate affect integration for incorporated business owners? So what we've seen over the past, I'd say 20 years, is that there's been a change in how capital gains are taxed relative to dividends. So going back to that decision of profit to pocket, what I would like to see in the tax system is the tax system being neutral across those different things. If for a firm, for business reasons, it's the best thing to reinvest in the firm, that's what we want it to do.

30:15If it's the best thing to pay out dividends, the best thing to do a share buyback program, for internal company reasons, for good business reasons, that's what we want them to do. What we don't want is the tax system to push firms one way or the other. And we've seen that through time when one of these channels gets tax favored over another, you have a CFO saying, well, we could invest in refurbishing our fleet of trucks. That's going to cost us a bunch of money. And the other competitors aren't doing that because capital games are so cheap to transmit value to shareholders right now. We're just going to do a shared buyback plan and flush the money out of the firm rather than investing in the firm.

30:53That's the kind of thing that is good for existing shareholders perhaps right now, but isn't good in the long run for the economy. We don't want firms to have an incentive to flush the money out of the firm instead of investing in the firm. Similarly, with dividends versus capital gains, having a level playing field there is kind of the goal. So that's how I entered this discussion of the capital gains inclusion rate. Over the last 20 years, the total tax rate from profit to pocket of capital gains versus dividends as a channel to transmit those firm profits to shareholders got out of line. And so what that meant was if you graph over time, you saw a decline in dividends and a big increase in these share buyback programs.

31:39So to me, that was just an inefficiency that was going on. And we want to have those things made on business reasons, not to try to game the tax system. And so to put those things back online, an increase in the capital gains inclusion rate was one way to do it. Of course, you could also say the other way to do it is to lower the dividend tax rate, and that's a fair comment. This government was also interested as another thing that they viewed as a benefit of this was to try to shift that buffer curve up a bit and make high earners pay a bit more. So that's why they made that choice. That's the question of who pays what in the tax system.

32:10Any government gets a choice of doing that. And we all, as voters, get a choice of whether we like that or not. There's an efficiency argument for it, which is to say, we want the integration to be level across all these different forms. And then there's the fairness argument of who should pay more, should pay less. Those are two different arguments. In this case, they both aligned to say we ought to increase the capital gains inclusion rate. You talked about how the two different models of who bears the cost of corporate taxes, how does that modeling decision affect how progressive taxes are at the personal level?

32:43It actually makes a huge difference. And the reason is, if you assume that capital gains and dividends are fully taxed at the corporate level, and you account for those corporate taxes when you wash it through to the individual level. So I get some dividends. I get a dividend tax credit. So they're a bit more lightly taxed. But the firm already paid profits on those taxes. If I take those corporate taxes and add it to the personal tax bill, that actually makes a pretty big difference. It makes our tax system look fairly progressive in that the high earners are paying more because, again, those high earners are getting this capital income that was already taxed potentially at the corporate level.

33:25Now, in contrast, if what's happening is that those corporate taxes that are being paid at the corporate level, we don't want to account for those. If that's the other way you want to go, that you're not going to account for those, then all we see is what we've been talking about is that, geez, those high earners are getting capital income, which is lightly taxed. Therefore, they're not paying enough tax. They should pay more. Whether you think the system is progressive or not depends on whether you think that those corporate taxes that are being paid by companies in Canada are being passed through to the shareholders or not.

33:59And some people think they are, some people think they aren't. To me, it depends a bit what kind of firm we're talking about. So just to put that in a nutshell again, if you think that those corporate taxes are being passed through to shareholders, then the system is already pretty progressive because those dividend tax credits and the inclusion rate are fair game because you want to account for the fact that corporate tax has already been paid. One of the points of my work on this is if you're worried about the progressivity of the tax system, you kind of have to take a stance on how much of those corporate taxes are going through to shareholders.

34:33That part of your paper was mind-blowing for me. If they're not being borne by shareholders, I know you already talked about this. I just want to come back to it to make sure our listeners and myself understand. If it's not being borne by the Canadian taxpayer, it's because it's being borne by international investors effectively? Well, yeah, that's the thing. The international investors have other options. So if they're not going to invest in Canada, they can invest somewhere else. If corporate taxes go up, they're not going to pay any more for Canadian assets. What they're going to do though, is they're going to pay less for Canadian assets.

35:02So what happens under that model, where it's international investors we're worried about, when the Canadian corporate tax rate goes up, the stock market goes down. Oh, man. Wow. It's an equilibrium argument. Yeah. And so that's where the burden is actually shared by not capital. It's actually shared by labor, by workers, because in that model, whenever you put the corporate tax rate up, the value of the shares go down. The only way that the firm essentially can pay is about paying the workers less. So that's perhaps a weird argument. It's a bit counterintuitive to people that corporate taxes up hurts workers, but there's a serious argument for it.

35:37Whether it holds empirically or not, again, there are different views. But in theory, if who holds Canadian shares is mostly international investors, they don't care about Canadian taxes. They need to be compensated if Canadian taxes go up or else they're not going to hold the stuff. Wow. I actually made a similar argument on Twitter when this was first announced and I was lambasted by quite a number of people. So it's very validating to hear you elucidate that to our audience. It can often be the case that speaking a bit of truth on Twitter gets you lambasted. Tell me about it. So you have to, as I'm sure you have, learn to take that with a grain of salt.

36:11Oh, absolutely. You touched on this already. I think you mentioned there's kind of two schools of thoughts around who bears the cost of corporate taxation. So can you elaborate a little bit on that? Is there a right way of thinking about that? I don't think there is a right way, but it again comes down to who you think the marginal investor is. If the marginal investor is a domestic taxpaying entity, I'm going to take a diversion there. I said domestic taxpaying entity because you know who's the biggest shareholder in Canada. It's the Canada Pension Plan Investment Board. You want to talk about the middle class.

36:43The Canada Pension Plan is paid into by all Canadians and really middle class is a big beneficiary of it. So when you tax companies a lot more and that diminishes the return to the Canada Pension Plan, And that's the kind of channel you think about hurting the middle class right there. The biggest shareholder in the country is not some rich family. It's the Canada Pension Plan Investment Board. Just as a sidebar there, that's where I'm talking about taxable domestic entities. So if you're a taxable domestic entity, that model says that if you increase corporate taxes, then I'm going to have to bear the burden of that when I pull the money out of the firm.

37:18I will have effectively paid that corporate tax, then have to pay personal tax on top of that. if you don't allow some relief for the fact you already paid the corporate tax, that's going to lead to a very high tax burden. Your corporate tax rate is 30%. Your personal tax rate is 53.5%. That's an 83.5 % tax rate. And that's not fair. That's not efficient. That's not good in any way to have 83.5 % tax rate. So that's why you might give relief. What we're going to do is we're going to lower the personal tax burden to account for the fact you've already paid 25 % or 30 % at the corporate level. That's one model.

37:53That's why you want to give this relief. The other model is that the money is coming from abroad. They're going to be paying that Canadian corporate tax, but they're not paying the Canadian personal tax. Their decision of what to do in Canada doesn't depend on personal taxes at all. So if you give dividend tax relief, if you give capital gains tax relief, that does not change anything with respect to the firm's behavior. Because what the firm cares about is international investors. international investors aren't paying Canadian personal tax. So overall, how progressive is Canada's personal income tax system?

38:30My answer to that is actually, it's not bad. Even at these two polar extremes of how we think about capital income taxes is whether we ought to add in the corporate tax or whether we shouldn't. The curve still goes kind of up so that the Buffett rule is pretty much satisfied. There is a bit of a dip down for the top half of the top 1 % of the top 1%, the top 1 in 20 ,000 taxpayers, there's definitely some progressivity there. What's interesting to me is a lot of the debate of what goes on in the middle versus the bottom. There, as I mentioned up front, depends a lot on how you think about those refundable tax credits, like the Canada Child Benefit, the GST tax credit, whether those are income, negative taxes, or whatever.

39:11But in general, there is a good degree of progressivity there. It's true for almost all Canadians that if you earn more, you're going to pay more. And that satisfies the rule of having a progressive tax system. Whether it ought to be more progressive or not, especially at the top, to me, depends a lot on how you want to think about that capital income taxation. That's really a core thing, which to me, it's a difficult question because it depends a bit on your view of how international capital flows around. The way I think about these questions is, is something progressive enough? The questions of like, what will be the impact on the economy?

39:45What would be the impact on efficiency and investment and growth? These are all good questions for an economist, and we have models and we have data on that. When it comes down to how much different people ought to pay, I get one vote out of 40 million Canadians. And so I have my own views on that, and I just don't think I have anything special to say on that. We all have a view on how much more someone who's making a bit more ought to pay, whether we kind of hit the sweet spot on that. What I note is that there's been a lot of political mud-throwing about what's going on over the past seven or eight years in terms of higher taxes at the top.

40:19When you look at the last 30 years of progression on this, it's pushed it back a bit up, nowhere near what it was in the 90s. So you could argue we shouldn't have gone up, tried to reverse that at all. That's fine. You can argue that. Like I said, you have one vote, I have one vote. We all get to make our choices on election day. But what's empirically true is it was much worse for higher earners in the 90s than it is now. Going back to the capital gains taxes and specifically the increase in the inclusion rate around the capital gains taxes, what effect do you expect that to have on how progressive Canada's tax system is now?

40:54I think it will have some effect, especially at the top, as I mentioned, the people in the top 1%, specifically at the top half of the top 1 % is where they start getting a lot more capital income in your income mix. It's going to have an increase in their taxes, that will increase the average tax rate for those folks. And that's going to increase the progressivity of the tax system a bit. A couple of notes on that that have come up in thinking about this. One thing people have argued is that a lot of the realization of capital gains is very lumpy. You do it once in a lifetime. You work, you save through a firm, and then you sell off the firm.

41:30And there's like a one-time hit on capital gains. And that can be true. The way that this capital gains increase was structured was it's only the first 250 ,000 in any year is exempt from the increase. The new capital gains tax rate only applies after you've already received 250 ,000 in one year. What I would say to a small business who might have a million or 2 million saved up through their firm, through all their hard work, through the life, first I'd say, thank you for working hard and doing well. That's great. We'd like people to do well. But then I'd say, if you were to realize all of that in one year, you should get a new accountant because there are ways that you can spread this out that would avoid it a bit for those people who are doing very well or did okay over their lifetime.

42:11If there's a target for this, it's the people who are in that one in 20 ,000 taxpayers who receive four or$5 million of income every year. Those are the folks who are going to be hit by it. And those are the folks who, if you want to increase the progressivity of the tax system, you're going to want to hit. That's one argument about who's going to be hit, how this will impact progressivity is, it's going to have an impact for people at the top who essentially can't avoid it very easily. There's going to be some people at the margin who have these once in a while transactions selling off a firm or something where they can potentially avoid it.

42:44And that's okay, because I'm not sure that someone who's making $70 ,000 or$80 ,000 a year is a small business person and then has a big payday at the end of their career is to sell off their firm. If they don't get hit by this, I don't think that's the worst thing in the world. That's fair. And you mentioned the$250 ,000 threshold where the new inclusion rate applies, and that's for personal taxes. $250 ,000, that's right. So at the corporate level, within corporate transactions, there's no threshold there. So companies will be paying capital gains immediately on their first dollar of capital gains at the higher inclusion rate.

43:17I don't know how far you want to go into this, but to the degree that some small businesses do have retained capital and are potentially not the target of this new inclusion rate increase, the$250 ,000 threshold that applies to individuals seems to be reasonable. What are your thoughts on having or not having a similar threshold within a business? Generally, for businesses, this is a first principles tax policy thing. Having thresholds and brackets is more difficult because businesses, unlike people, can be cut into pieces. So if you tend to have a threshold,$250 ,000 in this case, or whatever kind of tax you're talking about, there'd be an incentive to keep firms smaller, break them into little pieces so that each of those little pieces gets under the threshold and you stay in the bottom bracket.

44:03So that's just a general principle. My suspicion is this is where the government was on this. We don't want to have an incentive of firms to stay small, want firms to stay big. But you have identified something here, which is a downside of this tax policy change. Where I have some concerns is exactly that small and medium, the smaller wants to become a medium-sized business. You have a firm who's doing well, generating some cash flow, has some retained earnings. They might want to start investing in other firms, expand a bit, whether it's taking over someone in a neighboring city, whether it's expanding their operation, going to a different industry a bit, a neighboring industry, maybe vertically integrating in some way, whatever it might be.

44:43You can have these cross-firm transactions that can get messed up because of this capital gains tax rate, messed up in the sense that it would be subject to higher taxes. As a basic principle, we want business decisions to the extent possible made on business principles. Is this a good cash flow? Are revenues bigger than costs? These are things we want to matter. We don't want people to say, well, that would be a good investment, but the taxes are better if I make the investment over here. That's not what we want. And the concern is these across business transactions might be affected by the fact that the capital gains inclusion rate is a bit higher.

45:22Now, it's a bit higher. at 16 points higher from 50 to 57. It's not going to be the end of the world here. These are more rare transactions. I think there is some legitimate concern there. Similarly, an entrepreneur who does well in one firm wants to roll that money into a new firm. They have a lifetime capital gains exemption. Once they exhaust that, they're going to be hit by the new one. And again, rolling over into a new operation, that's the kind of thing we want to have. Entrepreneurs successful, we want those people to do it again. Here is where there's been some pushback. You could see in the budget announcement that the finance minister was concerned about this as well.

45:58There was an increase in lifetime capital gains exemption. There was some discussion of special rules for the tech sector on how they might be able to roll over this kind of money. The government's aware of these concerns. I think they're right to be aware of these concerns. But that comes down to these within corporate sector transactions could be hit by the higher inclusion rate. And there is some concern there that that might be at the margin diminishing a bit, the ability of firms to make good investment decisions. I want to keep going on that. What does the evidence say about the relationship between productivity and capital taxation?

46:31When you look at the big picture of productivity, like how much output we're getting per worker, the way the theory would go is that you change personal tax rates, which gives firms an incentive to invest more, which then allows them to invest more and they buy more equipment, they expand, they invest in their workers, and the workers are more productive in the workplace. So that's all potentially true. Each line in that logic has some sense to it, but it's kind of a real bank shot to get there. And what I mean by that is, think of the first step of that is that an increase in the capital gains inclusion rate affects whether the firm wants to invest more or not.

47:09Well, that depends on whether the firm cares about personal taxes. Again, if the marginal investor is from New York or Switzerland or Bahamas, they don't care about the inclusion rate. The firm is not going to invest anymore. So if you're in this world where you think that the marginal investor in the Canadian economy is international, this has zero impact in investment in Canada. When you look across time, like if you look over the past 30 years, we clearly have a productivity problem. I don't think that's up for debate. If you think that the best way to address that is by like cutting the capital gains inclusion rate.

47:43I'd say that you're crazy. I don't see over the last 30 years, we've had inclusion rates of 50, two thirds, 75%. Through this whole time period, productivity has been getting worse. I just don't see that there's any coherence in the time series for that. Internationally, there is some evidence that there may be some relationship between corporate investment and capital gains rates. It's going to depend on whether it's a firm or a sector that has access to international capital or not, as we talked about before. For me, though, if your goal for increasing productivity was to try to increase corporate investment, which is one way you can get there, not the only way, but one way, I'd rather do it more directly, which is provide an incentive for investment.

48:27And that's what we've done through the accelerated depreciation that we've had in place the past few years, so that when you invest, you get to write off those investments more quickly. that provides a firm big incentive to invest more quickly. It's kind of boring stuff. Imagine you're Rogers and you have a big fleet of vans that go out and fix people's internet when they're down. How often do you update those vans? Do you do it every five years or every six years? Well, I can tell you the CFO at Rogers has like a spreadsheet that has a model of that. If the investment of that gets them a big accelerated depreciation credit, they might change that decision and say, you know what, we're going to do more vans every year.

49:04It's kind of very boring and methodical like that, but it actually, that's really how this works. We're going to invest in upgrading our band fleet more often. We're going to invest in expanding our 5G network more quickly than otherwise would. That's the kind of thing that can happen with accelerated depreciation. It's very tightly in coherence with investment. You invest more, you get a tax cut versus this bank shot. It's like, well, we'll give some rich guy a capital gains tax credit, and then maybe the The firm will account for that when they do stuff. It seems like it's so far away that I don't prefer that.

49:37If I wanted to increase corporate investment, it's the seller depreciation where I go. The seller depreciation has expired. I really think that we ought to bring that back if that's the channel that we want to do to increase corporate investment. A last point on this is increasing corporate investment is one part of that, giving workers a better environment to work, better equipment, better tools to work with. That's one way. The other way to increase productivity is to make sure the workers are skilled up and tooled up and ready to go. One part of that is making sure our education system is doing well.

50:08But there's other more fundamental part, which is making sure that people have a good core education when they're going through school. When you think about the good functioning of the Canadian economy and where we want it to go, a large part of that you might think is elite higher education, that people go on and be lawyers or MBAs or whatever. And that's fine. We can do better or worse at that. Maybe that's good for the Canadian economy. But all of that investment, the corporate investment in those better vans for Rogers or better computer equipment for whoever, there's a user sitting there and they're not in the top 1 % of the IQ distribution.

50:42There's lots of middle-class regular workers there. We want those guys to be tooled up so they can make best use of the equipment and tools and stuff they have. How do we do that? That's the education system. It's making sure they feel secure, that they feel happy and able to work. It sounds far afield, but it's actually not. things like parental leave and sick leave and this kind of stuff can make workers more productive and able to invest in their own careers. Childcare can make women more able to invest in their own careers because they know they're going to be there in the workplace over the long run.

51:11And when I think about productivity, I do think about the corporate investment side. That's important. Also got to think about the workers and making sure they're doing a good job and that we have a good education system and good social support so they can be on the job, invest in their own career. I just want to mention, you touched on earlier in our conversation about how tax rates have generally gone down over time, but productivity has also gone down. So to think that lowering taxes is going to fix productivity seems, at least in Canada, empirically false. That's kind of it. The idea that our productivity problem will be solved by cutting corporate or personal tax rates, we've kind of done that over the past 20 years.

51:51Maybe it's pushed us a bit more and a bit more corporate investment, and that's a good thing. But it's not been enough to reverse this productivity slide. It just occurs to me, a last point on this, think about AI stuff. We know that it involves big corporate investment and big server farms and fancy fast computer chips, huge investment there. And so on the corporate side, imagine you wanted to have for a productive economy, do stuff through a lot more AI rather than people slaving over spreadsheets or whatever, having some AI doing that all for us. But what we also need is, so that's one side, that's the corporate investment part.

52:26The other part is, and this is a lot of discussion of AI, is who's typing the instructions into the AI? We need workers who are able to exploit that. And that kind of really brings us into focus. If we're going to make best use of this new technology, the countries are going to win or the ones perhaps who have access to the technology, but I think we're all going to have access to it. Countries are going to win economically out of this. So the ones that have the workers who are able to exploit this and make best use of that. Again, I think this is so important. Think of plumbers as an example.

52:54So plumbing is a very hands-on profession. It's a great profession. My kids end up being a plumber. I'm going to tell them, you're going to do well in life right now because maybe 30 years from now, there will be a robot that can dig down deep into stuff. I'm not sure. There's a lot of human judgment there. There's a lot of hands-on work that's needed and a lot of skill. I want my plumber doing this, not me. But think about that, of where that can go with technology. You can imagine a plumber typing in like, okay, here's what I see. Okay, Chad, GBT, what do you think the problem is? Oh, looks like there might be a blockage in the toilet pipe.

53:25You know where to go. It saves a bunch of time of trying the kitchen pipe and everything else. So that can really make that plumber more productive. But that plumber has to be comfortable with technology to access that, has to be literate, has to be numerate. These are things we think about elite education. When I think about education, it's like taking those people who are maybe not going to be an MBA or a lawyer, but going to be a plumber, making sure that they can read the instruction manual and they can be comfortable with technology so that they can make most use of these new tools that are available.

53:55Those are the countries that are going to do well as the ones that have the workers that can complement the investments in IT and other kinds of investments. Kevin, how much of an effect have taxes had on the long run trend of income concentration in Canada? Over the long run, I don't think the biggest impact on this has been taxes. What we see is bigger trends going on. The bigger trends being more of a winner-takes-all economy for people at the very top. People get paid best. If you're the top stockbroker, the top software engineer, there's a global market for your talents and you get paid an awful lot by the highest and best use of your talents around the world.

54:3830 or 40 years ago, that might not have been the case so much, that kind of winner-takes-all labor market leads to a concentration of labor market earnings. The concentration of labor market earnings perhaps happens in the US more than anywhere, but that has feedback effects, especially on Canada with NAFTA and KUSMA now, where we have a lot of labor mobility for professionals. If you're in Toronto, you know very well that people who work, say, in the financial district in Toronto, the good ones are getting offers from New York. and the Canadian banks have to stay competitive with that, keep mark-to-market a bit their salaries.

55:15That's true in the tech sector in Waterloo. That's going to be true in the tech sector in Vancouver. That's true, you know, the software that's all produced here in Vancouver as well. They kind of have to mark-to-market what's going on in the U.S. and more broadly in the world, but mostly the U.S. People here in Vancouver are getting offers from Silicon Valley. We can't be out of line with that. Those kind of labor market things are, to my mind, which has driven inequality more than anything over the past 30 years. What the tax system can do is push back against that a bit. How can it do that?

55:46It can increase those transfers to people in the bottom. That's the increase in things like the Canada Child Benefit that we've seen, cut their income taxes a bit here and there, but also perhaps push back against that a bit at the top, which means that you're going to increase the taxes on higher earners a bit. So that's kind of where the tax system comes in. It's really, really hard to use the tax system alone to try to reverse these big global trends. You can push back at it a bit here and there, and we can debate how much you want to push back and how much is too much, how much is too little.

56:15To try to push back against those global trends would be very hard. Just think what would happen if we were to impose a 65 % tax bracket on high earners in Canada. Think about the financial district in Toronto, the tech sector in KW or Ottawa or Vancouver. The firms would have to, again, mark to market, against Silicon Valley, against other places, and pay really high pre-tax salaries to account for those higher taxes, which means they just wouldn't be here. Those firms would not locate their labor here. They would put it back in Silicon Valley to start with and not have their Vancouver operation going.

56:48I just don't see those really, really big tax rates at the top to be feasible because of that kind of mechanism. For that reason, I think it's more fair to argue when I push back against it a bit, but those big global trends in labor markets are something that's harder for the tax system to completely undo. So before we jump to the next topic, I have to ask you about capital gains. In your view, is the increase in the capital gains inclusion rate a good thing for Canada? Overall, where I come down is I think it is good for two reasons. The one is that it better aligns the taxation of capital gains with dividends so that the tax system is neutral across ways of getting firm profit to shareholder pocket.

57:28That's kind of efficiency argument. On the fairness side, I get one vote out of 40 million on this. I kind of think that people who are doing well ought to contribute more to the pot. And this is one way to get them there. Other people have different views on that. And that's fine. Sometimes people, when people talk about having the rich pay a bit more, it's like, why do you hate the rich? I don't. We have more people working hard and making a lot of money. That's great for Canada. I like that. That's good. But when you've been successful, I just think you have an obligation to pay back a bit to the rest of society who's helped you in some ways get there, whether it's the education system for you, your family, the society around you.

58:05I just think you ought to throw some more back in the pot. That's kind of where I am on that. I'm not someone who rages against rich people. I get paid a good salary here. I don't hate myself. I do think when I make more, I have an obligation to put a bit more back in the pot. Now, how much more you put back in the pot, people have different views. Some people think they put enough and that's fine. We all get a vote on election day. We have a few more questions on some of your other research, which was just too interesting not to ask you about. Can you talk about how longevity in Canada has evolved over the last 50 or so years?

58:34So what we've seen across Western countries anyway, is over the last century is that lifespans have been getting longer. People have been living longer, both men and women. Over the last half century, what's unique about that is that most of this has been in the last half of your life. In the 50s, 60s, 70s, and 80s, you have more and more people surviving. Part of that is the first half of the 20th century, we kind of almost exhausted the gains. It's really good that child mortality is down by a huge factor. People dying in their 10s, their teens, 20s, 30s, 40s is way down. Where we were making the gains recently is in the older end.

59:10Thinking about longevity is an important part of thinking about overall mortality trends. What we've seen is people are living longer, and it's quite a bit. Even over the past 50 years, we've gained like five years of life expectancy. That's really huge when you start thinking about it. Start thinking about your balance of how long you want to work, how much you have to save. If you have an extra five years or not, that can matter a lot. What my research has done is look beyond. So that's the kind of number, the fact that life expectancy has been getting longer. You can get that stats scan produces every year, a life expectancy estimate, and that's good, but that's for the average Canadian.

59:46What I did in some work with Tammy Sherrill from Wilfrid Laurier is to look at the distribution of that and see how does that vary across different kinds of Canadians. And we look specifically at high earners and low earners. What we found is there's quite a bit of difference in how long people live. And in fact, if you look at the top 5 % of earners versus the bottom 5%, it's about eight years of life expectancy difference, which is almost like 10 % of a lifetime. And when you start thinking about that, We've all had loved ones during the last year of their life and you want to spend more time with them.

1:00:20Every day seems precious when you're in that position. Imagine what you can do with an extra eight years, how many more birthdays you can attend. It gets you teary-eyed. You start thinking about grandma or grandpa, what you could do with an extra eight years. High earners have eight more years on average of life expectancy than low earners. And that's just, I think, a tremendous element to think about Canadian society and how our economy works, just in terms of what we're doing here in life in the 21st century. I want to importantly say that's not a question necessarily of income. It's not like, oh, we tax the high guys more and give it to low guys, that's going to reverse it.

1:00:54It could be other things going on. It could be the healthcare you've received over your life. It could be where you live. It could be choices that you make about lifestyle. It could be lots of things that income might not change. So I'm not saying that income is the driving path. I'm whatever reason, tend to live a lot shorter than the people who are in the top 10%. The other interesting fact on this is a strong contrast to the US. In the US over the past 30 years, the way this has evolved, the top half of the income distribution has seen all the gains in longevity. The bottom half has stayed the same.

1:01:30They have not seen any gains at all. In contrast, in Canada, it's almost uniform, a uniform shift up for low earners and high earners. When I presented this research in the U.S., people immediately jumped to health insurance as a big thing that matters for this. And that's possible. But what's interesting is our public health insurance system didn't actually start until the 1960s. And so a lot of this people who were looking at, a lot of this happened while they all had public health insurance. So these gains have happened. This uniform shift has been happening in the context of everyone having public health insurance.

1:02:06Also, in the U.S., they have Medicare, they have Medicaid for lower earners, do have public health insurance in the U.S. People who are hurting more are the people in the working poor who don't qualify for their public health insurance but don't get health insurance through the workplace. That's where the gap is in the U.S. I'm less convinced there's health insurance. I don't know what it is. There's lots of theories bouncing around. It might be different health behaviors. It might be different things going on. It might be crime and exposure to violent crime. I don't know what's going on, but it's really different in the United States and Canada in that the shift has been more uniform.

1:02:41We're really happy to see that in our results. It gives me a sense that even though there is this difference in life expectancy, at least it's not getting worse over time, that everyone's benefiting from the gains in society, that people are living a bit longer at the bottom. So that's, I think, a good thing. But why this was a new and interesting finding is that, again, we kind of knew the life expectancy overall was getting better. What we didn't know was how that varied across different kinds of Canadians. And what we learned is there's a fairly big gradient. That eight-year difference between the top and bottom 5 % I mentioned in the U.S., that's 12 years.

1:03:13It's even bigger in the U.S. 12 years and getting bigger every year. Crazy. You mentioned there's other things that impact longevity. It's not just income. And you've done some research into the relationship between geographic location in Canada and longevity. So can you talk a little bit about the relationship there? What we see is that the biggest difference when you look at a map, so I've mapped this out by the first three digits of your postal code. I'm sitting here in B6T in Vancouver, which actually is one of the highest longevity postal codes in Canada. Lots of rich people live outside UBC in the neighborhood there.

1:03:47So income is one part of it. I said rich people. Income is certainly one part of it. You see that correlated within Vancouver. The poor neighborhoods tend to have lower life expectancy. The rich neighborhoods tend to have more. So that's one factor you see. you look at the city level, same in Toronto, same in Montreal, we look at a bigger map of the whole country. What really jumps out is rural areas have lower longevity. The urban areas have higher. So there's a couple of things going on. One is the income. Maybe you can afford a nicer house, better access to, for purchase, parts of healthcare and a more stable life if you have more income.

1:04:20But my research shows that's not all that's going on. Because even if you take someone with the same income living in a poor neighborhood in Vancouver. So imagine you're making$200 ,000, but you happen to live in a poor neighborhood versus living in a rich neighborhood. It cuts like five years off your life expectancy to live in the poor neighborhood. So it's not just income that's driving this. This is kind of an emerging area. We're learning more about it. I was at a conference in Paris in June talking about this. Research from Sweden suggests that across different areas, tends to be correlated with income, you have access to different quality of healthcare.

1:04:55So doctors in Canada, it's all part of a public system, but you get to choose where to locate. And you might have a different client base if you're located in a rich area versus a low area. Maybe you're someone who really has a passion for dealing with people with a whole host of social problems when they walk into your door. Maybe you don't want that. And maybe there's a difference in the kind of doctor who goes here and there. You know, the availability, that's the quality of health care. It can also matter for the access to health care. When I look at the rural-urban differences, that's the first thing that comes to mind there.

1:05:26If I'm living in a more rural area, I might have to drive three or four hours to go see a doctor, let alone a specialist. British Columbia has a really big geography. A lot of specialists live here in Vancouver. And so we have a lot of people who would come from Prince George or Fort St. John to come to Vancouver for cancer treatment or something like that. That's 1 ,000 kilometers, man. And that's only Prince George. Fort St. John is even farther. That's a real big burden on that. So that's another piece of evidence. There's evidence from the Netherlands that what really drives these differences is healthcare access, specifically for chronic illnesses, things like cancer.

1:06:04So it might be detected earlier. It might be this easier for you to get treatment if you live in an area that has better access to care. So I think that's most likely one of the big things that's going on. We look at these longevity differences is access to quality health care is going to be a thing. Even within a public system, you're going to have these differences. The other thing I'll mention that people think about a lot is the quality of the neighborhood. People pay more to live in a nicer neighborhood where nice might be defined as nice leafy trees, good parks, good schools, nice amenities around the neighborhood.

1:06:37Some argue that those are things that can have a causal impact on your health and your longevity. Taking the same person and being around other neighbors can improve their longevity. People differ on how much they believe that. There are some mechanisms you can imagine. If you see everyone else jogging, then maybe you take up jogging. If you have bike paths and nice parks around you, you might go exercise more. Those are arguments that are possible. Those are plausible. I'm a bit more skeptical than others that this stuff kind of through osmosis affects me. Some people argue that it's about the stress in your life, that if you are at less stress of being subject to violent crime, that can just improve the pleasantness of your life.

1:07:17and the stress chemicals, cortisol is something. If you get shocks of cortisol every day, you're not gonna live as long. These are things that really matter for your long run longevity. Just live in a less stressful environment. Maybe that's something that helps you. A lot of stuff in the mix there. Income is certainly gonna play a role. My guess based on evidence from the Netherlands, from Sweden is that access to quality healthcare plays a role. And then there's these kind of neighborhood effects of being around other people who are doing good pro-health kind of things. It might matter for you.

1:07:47Super interesting. What do you think the implications of those findings are for personal financial planning decisions? I think they're really big. The thing of the financial planning stuff for pensions, it makes a huge difference. If you look at your life expectancy and people kind of know, oh, it's around like 80 years or something. So I'm going to plan for 80. If you're someone who's in the top 10 % of earners, your life expectancy isn't 80 on average. It's going to be closer to 90 than 80. And so it really does make a difference. I'm sure good financial planners have known this for a while.

1:08:20I remember talking to chief actuary of the Ontario Teachers Pension Plan at one point. He was like, here's the thing about teachers, they live forever. And so he knew this because he could see in the Ontario Teachers Pension Plan how long people were getting their benefits. So he couldn't use the stats can life tables to calculate how much the contributions are, how much the benefits are, whether the pension plan is in balance. He had to think about his clientele there at the Ontario Teachers Pension Plan. And the same thing for each of us here. We kind of have to think about our own lives. We kind of know there's a sex difference.

1:08:52Women live longer than men. We know that there's difference in ethnic background, that Asians tend to live a bit longer than others. Again, whether that's lifestyle things, some cultural thing, I don't want to get into that. I don't know. And that gets into some more dangerous territory. But we know on average, that's the case for whatever reason that might be. So you kind of have to think about yourself. One trick I've learned is the best way to figure out your own longevity is to look at your same-sex parents. So for me, I'm male. I look at my dad. For my wife, she looks at her mother, her mother's mother.

1:09:22That's the best guess. The best indicator of how long you're going to live is look at your same-sex parent and grandparent as an indicator of just of your genetic heritage of where things are going. Again, whether it's genetics, lifestyle, mental attitude, I don't want to get into. I'm not a genetics-only kind of guy. I think a lot of things matter. But anyway, that's kind of where that goes. It matters for financial planning because if you're retiring at, say, 65, if you are planning for a 10-year horizon versus a 30-year horizon, that makes a huge difference on your spend rate and also whether you want to retire at age 65 because whether you can afford it.

1:09:58The other thing that matters for us, So that's kind of for your own personal financial planning. From a policy point of view, this actually makes a really big difference to thinking about things like the Canada Pension Plan. It's actually kind of moved my thinking about this a bit. When you think about lower earners paying in with the same contribution rate as everyone else, but the payback period is much less for them than a higher earner, it makes me think about the Canada Pension Plan in a bit of a different way. I'm worried that rather than being neutral about what kind of earner you are, that it It might actually pay off more to high earners than low earners.

1:10:30That's something that I don't think we ought to be doing with our public pension plans. Now, it's not to say the CPP is a bad thing. There's disability insurance in there. It provides a pension for people who don't have one in the workplace. I'm a believer in the Canada pension plan as social policy. But I think we do have to be attentive when we're thinking about the Canada pension plan to when we make a change to it to think about, well, what's the payoff period going to be for someone who's going to live to 90 versus someone who might only live to 65 or 70. I've thought about that. It feels kind of gross that it's kind of redistributive from lower income people to higher income people because of the distribution of life expectancies.

1:11:08And that goes back to the more fundamental thing that those people are getting 10 more years of life or whatever it might be. Again, you think about the joy you get out of one year of life, and you do that times eight or times 10. And the amount of joy you get out of that is just amazing to contemplate. And the fact that there's that much difference, and frankly, in Canada, it is what it is at about eight years of bottom versus top, and the US is 12. Man, that's just a huge difference in the quality of life taken over your whole lifespan. That's really fascinating. I wonder, and you probably don't have an answer to this, but do people shift through that distribution over their lifetime?

1:11:42And specifically with respect to CPP, you might be sort of lower income or living in a rural area for part of your life, but then maybe through promotions or you start a business, you become a high-income earner and move to, say, Vancouver downtown or what have you. And I'm just curious about if you've thought about regarding CPP specifically, how you might even manage something like that. For a lot of thinking about CPP, it's going to be the average over your lifetime is going to matter for your benefit. An interesting question there is the payoff period for CPP of your longevity. If I move to, here I am in V6T, one of the longest longevity periods, I was joking, my daughter's actually a student here at UBC and she's living just off campus, but in the neighborhood in an apartment here.

1:12:20I was joking like, you're going to live to 90 now because you're spending a couple of years in V6T. It's kind of a joke, but also thinking about the example you just gave, what if there's someone who's done well and retires to V6T? Are they going to benefit from the magic of V6T only living here for four or five years? What years of your life, how many years of your life do you have to live somewhere before you kind of get that benefit of living in a nicer place? I don't know the answer to that, but it's really a kind of a deeper question that gets at a bit of this. Like, is it the income that allows you to buy stuff?

1:12:49Is it the neighborhood that you're living in and you learn from your neighbors and you benefit from your neighbors? I don't know. But one way to get at that is to see where you get this longevity boost of where you live when would help us to address that a bit. That is wild. Interesting. Thanks. Super interesting. All right, Kevin, that's the end of our questions. We really appreciate you coming on. We started off talking about capital gains, which was awesome. And your longevity stuff was just too good to pass up. So we appreciate you sticking around to discuss that as well. I really enjoy the conversation.

1:13:17So thanks to you. It's amazing. Thanks, Kevin. Thanks.

1:13:23All right, guys, after show, us and three others here. It's still funny to me every time. It is always funny. It's fun. Before we get to, I know you got some community comments, Ben, but you doing okay out there, Mark, on your own? Yeah, so my family's away. My wife took the kids to Mexico to see my in-laws, my wife's parents, and my son and daughter, all their cousins and uncles and aunts and everything. And they decided to make it a pretty long trip. So they're gone for still another three weeks from the date that we're recording. So it's been really good. I'm getting incredible amounts of sleep.

1:13:57I'm sleeping well. I'm waking up early. I'm eating healthy. I'm exercising every day. I'm very productive at work and it's been good. But at the same time, the novelty sort of wears off after the first couple of weeks. We've done this before where they've taken a long trip. And so the novelty kind of wears off and you're like, okay, I miss you guys. Just come home now, right? So looking forward to them coming back for sure. And you got the manuscript off to Dan Solon, right? For Wealthier? I did. I got that off. He reviewed it. He sent some edits. I took his comments and applied them. And we are now sending it off to some line editors and indexers.

1:14:29And he's got a whole army of people lined up to go through the professional publication process. And I know nothing about that, but it's in his hands and it's moving forward. And target releases sometime this fall, hopefully. Yeah, I chatted with him the other day and he's thinking probably October. We were originally targeting September and then I did a couple of rewrites, but still on track for this whole, as far as I can tell. Awesome. So what's up in the community here, Ben? We had last week's episode with Andrew Chen, which was awesome. And roughly a week before his episode came out, I posted about it in the RationalMinder community.

1:15:04I posted his papers that we talked about, and I just briefly explained what the discussion was about and just said, I think you guys are going to find this super interesting. Turned into this massive thread in the community about his research and whether factor investing makes sense anymore based on his stuff. It was a really good discussion. Really, really good. If anyone is nerdy enough, I highly recommend reading that thread. Been further great discussion, including some contributions from Andrew himself in the episode thread for his episode, since people have actually listened to it now. Really great discussion.

1:15:36His research suggests in very simple terms, and I mean, you can listen to the episode for the less simple version if you haven't already. In very simple terms, it says that factor investing is probably not a great idea, empirically and especially after costs. His research is great. It's really high quality. He's presented at conferences with John Campbell, another past RationalMinder guest, as one of the discussants. So it's no joke. Most of the stuff, we talked about one unpublished paper, but most of it's been published in the top journals as we talked about in the episode. So it's great research.

1:16:05I think it's important. I don't think it's a death blow to factor investing though. People in our podcast community tend to like get really excited about new research and want to change everything that they're doing immediately. I made the comment in one of those discussion threads that in the, whatever it is, how many years, seven years we've been in the podcast? Just over six. It's just over six years. PwL's investment philosophy hasn't changed. Our portfolios have not changed in any material way. My personal portfolio has not changed any material way. So anyone that wants to change their portfolio after an episode should probably take a deep breath.

1:16:40To come back for a second, Andrew's research suggests that factor premiums are roughly zero after costs. I do want to mention on that, that that research is assuming the effective bid-ask spread, which Andrew explained to us in the episode, you can think of as assuming aggressive market orders for a small trader who does not have price impact. Now, if we think about what do firms like Dimensional say that they do really well, one of those things is they're really good at managing transaction costs, which is what Andrew is talking about. Dimensional has research on their own trading costs showing that they're considerably lower than something called the SBBO benchmark.

1:17:18That is the immediately executable price, which is the prevailing bid price for a sell and offer price for a buy or sell at the bid and buy at the offer, SBBO. Dimensional trade price advantage over the SBBO is pretty significant in smaller stocks. It's also pretty big in international stocks. It's really big in emerging market stocks, and those things can be combined. Small cap emerging market stocks, their trade price advantage is substantial. But even in US large caps, there is an advantage that they have over that SBBO benchmark. Andrew said this during the episode, if you want to pursue these premiums, because they still exist a little bit before cost, just after cost are gone.

1:17:59If you want to pursue them, cost management is really, really important. I think that's something that Dimensional has always recognized. I don't know the details of a firm like Avantis. I don't know if they do have the same type of research that I was talking about for dimensional, but presumably they're doing similar cost management stuff. The other point that I think is really important is that if Andrew were to reconduct it, and I talked to him about this, if he were to reconduct his research using international data over the same period that he looked at, which is post 2005, it's likely that the expected premiums would be all by positive after costs.

1:18:35My chat about this with Andrew over email. There's a paper he referred to in the Journal of Financial Economics showing that premiums internationally have been substantial over the same period where premiums in the US have been small. But Andrew did explain that could be caused by market frictions like investors having home country bias. And if that is the case, you would not expect those non-US anomalies to persist. So Andrew is still skeptical. But between real transaction costs from a firm like Dimensional that's focused on cost management and the fact that these premiums have still been pretty strong internationally.

1:19:10The other interesting thing is that out of Andrew's sample, premiums have been like in the US. All of a sudden, they've actually been kind of positive again in recent history. There's a lot of interesting questions like that. But I thought it was important to mention this because a lot of people heard the episode or saw my post about it and we're like, oh no, factor investing, including you and I, Mark, after we talked to Andrew when we first finished the conversation. First thing I said, I was like, okay, well, we're just going back to XEQT or VEQT or whatever. Like I guess that just torpedoed at the end of all the years.

1:19:43Ben's entire reason for existing was just blown up live, so. Mike Green posted on Twitter, what did he say? Mike is pretty happy that we were willing to hear his perspective on something that we had disagreed with in the past. he posted that interview with Andrew Chen and said, it's been a rough year for the Rational Reminder podcast crew's mental models. He blocked me. I can't see his posts, but you'll have to send me a screenshot. Oh, Mike, you got to unblock Mark. Yeah. Ask him to unblock him. I don't think I ever interacted with him. I think I just probably like harped up index funds enough times that he was just like, okay, this guy is deserving of a block.

1:20:20So Mike, if you're listening, I apologize. I don't think I ever talked to you, but please unblock me. speaking of twitter on twitter we all have our calendar links and i don't know about you guys but i'm talking to probably three to four people a month just reaching out for a bunch of different reasons and i got a nice email last week from someone that i spoke to in march so check out this email dear cameron i hope this message finds you well i'm ready to express my sincere gratitude for the time you spent with me in march your career insights were incredibly valuable and I'm thrilled to share some exciting news with you.

1:20:54I've been offered a graduate position with Dimensional, which I start in February after finishing university at the end of this year. The program is a remarkable opportunity involving a year in portfolio management and a year in trading. I'm honored to have been chosen, especially considering DFA only selects one investment graduate each year. This is in Australia, by the way. Your advice and the Rational Wider podcast played a pivotal role in helping me decide that this was the area I wanted to pursue. The podcast episodes featuring Brad Steinman, David Booth, Gerard O 'Reilly, and David Butler were particularly influential.

1:21:28I listened to them multiple times, taking detailed notes, and their insights significantly assisted me throughout the interview process. Once again, thanks for your invaluable advice and the contributions from the podcast. They have made a profound impact on my career path, and I'm deeply grateful. Best regards, a fellow Cameron. awesome yeah that's super cool that is a pretty smart way to prepare for an interview with dimensional true true i mean those episodes were all fantastic so thought that was really nice no reviews this week no reviews no the global treasure in the mids had no reviews this week global treasure in the mids if anyone's listening that has not left a review yet we always appreciate them they're fun to read especially when you're called a global treasure Yes.

1:22:15In my limited understanding of how the algorithms work for the podcast platforms, the reviews do help people find the show. We always appreciate people leaving reviews. Any parting thoughts for the three people? I gave all my thoughts that I have, I think, for the day. I'm good. All right. You want to sign off, Mark? Yeah, that's it. Thanks, everyone. See you next time. Talk to you next week. See ya.

1:22:43Thank you.