Scotiabank Economics is recommending against instituting a capital gains tax on principal residences as Canadian home prices continue to surge.

In a research note published Sunday, Scotiabank Chief Economist Jean-François Perrault said such a tax would only serve as a blunt instrument to take some of the heat out of the red-hot residential real estate sector and would not address deeper structural issues.

"A more significant revision to capital gains on principal residences should not be considered. The tax-sheltered gains from owning a home confer a significant advantage to homeowners versus renters," he said.

"As tempting as it might be to reduce this advantage by taxing a portion of the capital gains on a principal residence, such a change in taxation would represent a significant financial blow to Canadians."

The call comes in the wake of RBC Senior Economist Robert Hogue’s recent argument that policymakers should put everything on the table to tame runaway housing markets in Canada, including "sacred cows" like a capital gains tax on primary residences. Currently, gains on the price appreciation of a principal residence are not taxed in Canada, though any appreciation on secondary residences like a cottage are subject to a tax. A capital gains tax on principal residences could theoretically slow down home sale activity, and it would present a sea-change in Canadian housing policy that would catch many current homeowners flat-footed.

Perrault said such an abrupt change in the taxation regime and any further tweaks to protect current homeowners from its ill-effects could ultimately create an unfair, two-tiered taxation framework.

“Policymakers could get around [changing taxation for current homeowners] by limiting the tax to those that purchase homes in the future, or by imposing a cap on these tax-sheltered gains but that would raise inter-generational equity issues: why would there be a differential tax treatment for new homeowners relative to existing ones? To reduce the incentive to own over renting, a better approach would be to allow a certain portion of rents to be deducted from income," he said.

Chief among the concerns being raised in the current home price cycle is the acceleration in prices outside of Canada's largest cities.

Though average home prices in Toronto and Vancouver have eclipsed $1 million through the pandemic, the heat has bled into bedroom communities, pushing prices in some outlying areas up more than 30 per cent over the past year.

The combination of rock-bottom interest rates and increased flexibility in work-from-home arrangements has helped fuel that fire in domestic markets, and there are few signs monetary policy action will take any heat out of the trend, with the Bank of Canada signalling it plans to keep its policy rate at the effective lower bound until at least 2023 to help support the economic recovery.

While Perrault thinks a major move like the capital gains tax should be off the table, he did say that ultimately Canada needs to address the supply side of the housing equation in order to deal with the problem of rapidly accelerating prices and overall housing precarity, but warned such measures would take time.

"The overwhelming challenge facing the Canadian housing market remains the chronic insufficiency of supply relative to demand owing to the high rates of population growth registered in recent years," he said.

"While not a near-term solution, policymakers should respond by easing obstacles to new construction for all forms of housing—affordable housing, rentals and owned accommodations."