“It’s a perfectly gloomy day,” said John Ruffolo, founder and CEO of Maverix Private Equity, on the rainy Toronto morning after Finance Minister Chrystia Freeland announced a tax increase on capital gains in the federal budget. The prominent investor wasn’t just speaking about the weather.

The hike on the taxable amount of capital gains—the earnings from selling assets like shares, bonds, real estate and companies—has set off a firestorm among investors and founders who say it outweighs any attempt in Tuesday’s fiscal blueprint to support the innovation economy. “Everything that was in the budget got overshadowed by this decision,” said Kim Furlong, CEO of the Canadian Venture Capital & Private Equity Association. “The decision to move on capital gains is a signal that entrepreneurship and risk-taking is not valued.” 

What’s the fuss about?: Under the current system, when someone sells an asset, 50 per cent of profits are taxed as income. The federal government wants to increase that shared to 67 per cent for capital gains above $250,000—with some exceptions. 

The budget touted the change as a means to establish fairness between wealthy and middle-class Canadians by better aligning the capital-gains tax scheme—which disproportionately benefits the wealthy—with taxes on income and dividends. Currently, the capital-gains rate is lower for many transactions than the rate an average worker pays on income. 

The government expects the change will add $6.9 billion to its revenue this year and more than $19.3 billion over five years.

Some exemptions: The budget does acknowledge the challenge of capital availability, establishing a carve-out for entrepreneurs, applying the tax to only a third of their first $2 million in lifetime capital gains from selling businesses they found.

Ruffolo said it isn’t enough and could even discourage companies from scaling. It tells firms “we thought about you, but only as long as you don’t make more than two million bucks,” he said. 

Founder flight risk: Investors and entrepreneurs say the change could deter founders from starting and scaling companies in Canada and even trigger an exodus to the U.S. 

“We’re living in an incredibly competitive and global marketplace,” said Boris Wertz, the founding partner at Vancouver-based Version One Ventures. “Obviously, taxes matter.” 

Furlong said Canadian founders already have an eye on the U.S. while building their firms because that’s where many of their customers and investors are. The new tax measure could tip their decision. “We’re so close and so connected with Boston, New York and the Valley. Of course people are going to think about where they build.” 

Wertz said there’s growing dissatisfaction in the tech sector with the Liberals that goes beyond the capital gains changes. “This is just the final straw in a series of decisions of the government to not prioritize entrepreneurship [and] over-prioritize regulation, over-prioritize picking winners,” he said. Wertz pointed to what he said were Ottawa’s rigid proposed AI rules, unsuccessful supercluster initiative and delayed rollout of open banking.

A possible chill on funding: Ruffolo said the increase undermines the government’s calls for more private capital to support innovation. “You’re now dissuading the very capital that you’ve been demanding to come into the asset class,” he said. 

Konata Lake, head of the emerging companies and venture capital group at Toronto-based law firm Torys, said investors may try recouping their lost gains by imposing tougher terms on companies they invest in, by demanding more equity in the company or more generous payouts when a portfolio company sells or goes public. 

Allen Lau, who started and sold Wattpad, suggested the increase will make it harder to solve Canada’s long-standing productivity problem. “We actually need more incentives to drive investment [and] growth, not less,” he said, comparing Canada’s income and capital-gains tax rates unfavourably against peer countries. The budget says Canada has the lowest marginal effective tax rate—an aggregate figure—in the G7. But Lau notes that other advanced economies like Singapore, which are increasingly attracting tech firms and talent, have no capital-gains levy. “I’m not saying we should go to zero, but we are competing with nations like that,” said Lau, now co-founder of Two Small Fish Ventures.

Others expressing concern about the Liberals’ capital gains move in social posts included Shopify CEO Tobi Lütke and president Harley Finkelstein; Cohere CEO Aidan Gomez; and Portage CEO Adam Felesky.

Fewer options for talent: Andrew Graham, co-founder and CEO of Toronto-based fintech Borrowell, said the capital gains change could make it harder for startups and scaleups to attract top talent. Many offer generous stock-option packages to make up for low salaries in the early days, said Graham. “For later-stage companies, stock options get everyone aligned to build the largest, most successful company possible.” If employees have to pay more capital-gains tax on their option sales, he said by email, the incentive disappears. 

Take a deep breath: Trevor Tombe, an economics professor at the University of Calgary, said the backlash was predictable—tax increases are rarely popular among those they’re imposed on. But Tombe said the change does its intended job of bringing capital gains in line with wage and dividend taxes. “Before, there was a strong bias to distribute corporate earnings through capital gains, not dividends,” he said. “That detracts from the efficiency of the tax system, and encourages a lot of aggressive tax planning, which is also problematic.” 

Tombe said raising the tax rate has a different effect than increasing the inclusion rate. “The inclusion rate is all about just aligning how we treat capital gains versus dividends,” he said. “Whereas the tax rate affects both.”

Often the government tinkers with both levers for a broader tax reform, said Tombe. “We definitely shouldn’t exaggerate the implications of this change,” said Tombe, “but it’s entirely fair for some to oppose higher taxes.”

Harmonizing capital gains with dividends taxes doesn’t much help entrepreneurs, said Lake. “People don’t build [startups] thinking, ‘I’m gonna get a dividend and a revenue stream over time,’” he said, “People build them thinking, we’re going to grow it, sell it, do really well and then redeploy [the gains].” 

Still, Lake said he thinks most people will live with the tax increase rather than uproot their lives to pay less on capital gains in the U.S. Entrepreneurs just starting their careers and already considering Silicon Valley may be the exception. “They’re much more mobile,” said Lake. “This is just one more thing for them to say, ‘I’m just going to make the move down south.”