Thursday, December 29, 2005

Leak or not, Liberals bungled corporate tax policy

VICTORIA - I don’t know if Ralph Goodale should resign now that the RCMP are investigating whether pre-election leaks from his ministry helped insiders get richer at the expense of the rest of us.
But I do know that the whole income trust saga is a case study of tax policy bungling, and the triumph of politics over sound planning.
Stripped down to its essence, this is pretty straightforward stuff.
Some smart tax lawyers and corporate types found a loophole in Canada’s income tax laws, and drove through it in ever increasing numbers.
The ploy was simple enough. A corporation is taxed on its profits, including the money sent out to shareholders as dividends. But companies found they could create income trusts and funnel their profits through the trusts to shareholders without paying taxes on the money.
They paid less tax, the payouts to investors were bigger and the value of the businesses increased. Happy days.
Except for people who pay income tax. The rush to take advantage of the trust loophole meant that the federal government was losing about $300 million a year in tax revenue. The money has to come from somewhere.
The federal finance ministry started to worry, belatedly, about the losses. Some economists also questioned whether the shift hurt corporations’ ability to innovate and invest to create growth, since the priority would be on keeping up payments to the trust.
None of this should have caught the government off guard. Australia and the U.S. went through similar experiences almost two decades ago, and decided to close the tax loopholes.
But Ottawa dithered. By the time the federal government started talking about changing the rules, Canadian income trusts were worth $120 billion. They had become popular investments, and a reduction in their tax benefits would cut their value. Canadians would see their RRSPs and mutual fund holdings lose ground.
Corporations, the investment community and seniors’ groups were all over the government. And with an election imminent, the Liberals backed down. On Nov. 23 Goodale announced that income trusts would keep their tax status, and that the tax on regular corporate dividends would be cut to try and reduce the rush to trusts.
The news was sure to have a big effect on investment markets. So the finance ministry made the announcement in the evening. That way everyone supposedly had the same chance to consider the implications before markets opened the next day.
Except that trading patterns that afternoon, hours before the information was public, strongly suggest some people knew what was coming. Trading volumes soared, and some buyers started snapping up shares in companies that would benefit from the announcement. BCE Inc., the communications conglomerate, was a big winner as a result of the dividend tax cut. Its shares jumped 3.3 per cent in the final two hours of trading before the announcement. The Yellow Pages Income Fund rose by 3.4 per cent. Other stocks showed similar extraordinary trading.
The people who bought made quick gains. After Goodale’s announcement that evening their holdings were worth even more.
But the people who sold to them lost out. If they had hung on to those shares for one more day, they would have got much more for them.
It could be that the buyers just made a good guess. Rumors of similar action were flying around in the pre-election frenzy.
But the analysts who have looked closely at the trading patterns say it’s much more likely that some investors had advance knowledge, which they used to their advantage - and to the detriment of those who weren’t in on the plan.
That’s what the RCMP is investigating. It’s a serious issue. If information leaked, then people were cheated and Canada’s reputation as a safe place to invest will have been harmed.
But just as serious is the government’s stumbling response to the whole issue of income trusts, ending with the last-minute pre-election corporate tax cut.
Canadians deserve a more considered, intelligent tax policy.
Footnote: Goodale says he asked his staff if there was a leak and they said no; Paul Martin is standing by his finance minister. But newspaper headlines on the RCMP investigation were not the kind of kick-off the Liberals wanted for the second half of this long campaign.

1 comment:

Anonymous said...

Good point, Paul. Not to underplay the seriousness of a potential leak, but focussing on this misses the real crime--i.e. a massive shift of the tax burden from wealthier Canadians onto those who can't afford to benefit from income trusts, dividends and investment portfolios.