1 Should Canada ' S Rate of Capital Gains Taxation Be Reduced ?

The paper lays out a simple model of business income taxation that includes the taxation of asset capital gains. The concepts of tax distorted and undistorted user costs of capital are also defined. The tax distorted user cost differs from its undistorted counterpart by two distortion terms. The first distortion term is associated with the fact that the imputed interest cost of equity capital cannot be deducted from taxable income and the second distortion term is associated with the present 75% inclusion rate for capital gains. Rather than further reducing the inclusion rate, the paper argues for a more fundamental tax reform that would reduce both distortion terms to zero. A technical appendix relates the size of the distortion terms and the efficiency costs to the economy of the tax distortions.