Ottawa’s hike to the capital gains tax has been slammed as a blow to Canada’s productivity, but closer to home, it will also hit your stock portfolio, say analysts.

The corporate tax increase “is the latest in a long line of decisions that for various, arguably legitimate reasons has reduced the returns investors can expect from Canadian public equities,” said analysts at CIBC Capital Markets.

Their report identifies three sectors that have been “consistently at the sharp end of the political stick” — banking, energy and communications.

It’s significant that these three sectors have generated half of S&P/TSX earnings over the past 10 years and also play heavily in retirees’ investment holdings because of their higher dividend yields.

The change proposed in this year’s federal budget will increase the capital gains inclusion rate from 50 per cent to two-thirds for corporations and individuals with gains over $250,000. The higher taxes will reduce corporations’ profitability and return on equity and follow other government initiatives that have weighed on business, said the analysts.

In the 2022 budget, Ottawa imposed a 1.5 per cent income surtax on banks and insurers. Higher capital requirements, tax changes for dividends, initiatives in the Canadian Mortgage Charter, not yet law, and the intent to cap NSF fees, all threaten to reduce banks’ profits, they said.

Communications also face regulations aimed at encouraging competition in the sector, and in energy, to limit carbon emissions. “The high-yielding stocks in the banking, communications and energy sectors typically underpin Canadian retirement investment portfolios,” said the analysts.

“Policies that pressure ROE in these sectors can directly reduce the ability of these companies to grow dividends, and retiree income, over time.”

The upshot is that Canadian equities have become less appealing. In recent years Canadian investors have been shifting away from domestic stocks to greener pastures, especially the United States, says CIBC.

U.S. world-beating performance can be explained by its global leaders, such as the tech companies in the Magnificent Seven, but another factor in the difference in gains has been the accumulation of taxes and regulations in Canada, said the analysts.

“These have penalized various sectors of the S&P/TSX that produce a disproportionate share of public company earnings. Over the past 20 years, U.S. companies have been 40 per cent more profitable than Canadian companies, the analysts said, allowing them to either return more money to shareholders or reinvest in their businesses.

“It should come as little surprise that both individual and institutional investors are increasingly eschewing Canadian equities in favour of foreign assets,” they said.

Source: The Financial Post