The elimination of capital gains taxes would encourage entrepreneurship and increase investment in innovative new ventures, according to a new study from the Fraser Institute.

The report says that entrepreneurs typically accept low pay so earnings can be reinvested to meet the needs of their growing companies. In return, entrepreneurs expect to be compensated when their business matures and is taken public or bought by another company. Capital gains taxes reduce the return that entrepreneurs receive from the sale of their businesses and therefore discourage them from starting and investing in new ventures, the study explains.

“Capital gains taxes have a negative impact on the number of entrepreneurs and risk-takers,” said the report’s co-author Niels Veldhuis, who is also director of the Centre for Tax Studies at the Fraser Institute. “Eliminating capital gains taxes will increase entrepreneurship and result in a more dynamic Canadian economy.”

The study also found that capital gains taxes cause investors to hold on to their current investments, even if more profitable opportunities are available — a result known as the ‘lock-in’ effect. So, new investment projects that are unable to compensate for capital gains taxes and provide a reasonable rate of return will go unfunded even though they may be more profitable than current investments.

“Capital gains taxes impede the movement of capital from older, less profitable investments to those with higher rates of return. Given that these new ventures are the engines of productivity and employment growth, capital gains taxes reduce the well-being of Canadians,” Veldhuis said.

In addition to hindering the reallocation of capital, capital gains taxes also have a significant impact on the amount of capital in Canada, it added – because capital gains taxes make capital investments more expensive, less investment takes place.

Veldhuis also said governments in Canada raise very little revenue from the tax, pointing out that in 2005/06, the federal and provincial governments raised approximately $3.5 billion in total from capital gains taxes — less than 1% of total federal and provincial government revenues. “Given the damaging economic costs of capital gains taxes and the fact they raise less than 1% of overall government revenues, federal and provincial governments should eliminate their use of capital gains taxes,” he added.