The news from ottawa early this spring was that new Finance Minister Jim Flaherty might leave the Conservatives’ proposed capital gains tax deferral out of his first budget. That would be too bad because the logic behind the idea is compelling. The compounding effect of having extra cash to reinvest is remarkable: an almost 25% increase in overall wealth — and far greater government tax revenue, to boot.

Let’s take a simple example: start with $100 after taxes and invest it in the stock market. Assume your $100 investment doubles over 10 years. At that point, you liquidate your investment for $200 (assuming no trading commission, for simplicity). That would bring us to the first fork in the taxation road. Under the proposed reforms, you’d avoid paying taxes on the capital gains if you reinvested them within six months, meaning you’d have the full $200 to reinvest.

Say you do that, and it doubles again over the next 10 years to $400. Repeat this twice more and after a total investment period of 40 years, you’d have $1,600. Assuming today’s proposal remained as the law throughout this period, your overall capital appreciation of $1,500 would then be subjected to capital gains taxes of approximately 20%, depending on your home province. The $300 in taxes would let you walk away with $1,300.

Compare that with the current system. The $100 gain on your first divestment of $200 would be taxed at 20%, or $20, leaving you with $180 to reinvest. If that doubled, you’d have $360 vs $400 under the proposed system (notice the gap already?). Take off another 20% in taxes for the $180 in capital gains, which equals $36, and you’re down to $324. Double that to $648, subtract $64.80 in capital gains taxes and there’s $583.20 left over. Double that again to $1,166.40, and lop off $116.64 in capital gains taxes. At the end of 40 years, you’re left with $1,049.76.

The difference to you is around $250, or 23%. If the Conservative government follows through on its election promise, deferring capital gains taxes would enable investors to increase their personal wealth substantially. The wealth gains would be even larger for those who hit a “home run” by investing in, say, a resources stock that tripled in three years.

Equally remarkable is that Ottawa’s total take in taxing every single transaction is actually lower, $237.44 in total, than the $300 on the single instance of taxation upon final disposition. Further, let’s assume the investor’s money is ultimately spent. The $1,300 would incur $91 in GST (at the current 7% rate), generating more GST than on the comparable $1,049.76, which would equal $73.48. Under a regime of “tax cuts,” Ottawa’s ultimate tax take would increase by more than 25%.

An actuary would caution that the $300 in capital gains taxes combined with the GST in 40 years is almost worthless in net present value terms. On the other hand, the first and second rounds of taxes under the current system are a pittance, while the bigger hits would also be decades away, and similarly discounted.

The current capital gains tax regime is estimated to take in only about $2 billion per year. The Conservative tax reforms would increase the liquidity of capital markets, probably improve the transparency of stock valuations and enrich the federal treasury, to boot. This is a proverbial case of win/win, and another demonstration that wealth begets wealth. This also shows that the much-derided Laffer Curve — which holds, very roughly, that reductions to tax rates generate increases in tax revenue — is valid. IE