For Finance Minister Flaherty – and for Bay Street – tomorrow is another day

November 8, 2006

For a politician, the only thing worse than having to use up political points cleaning up someone else’s mess, is cleaning up when the mess was created by tax cuts -- that you originally supported in opposition -- turned out to be a bad idea.

That’s the unenviable prospect faced by Conservative Finance Minister Jim Flaherty when BCE and Telus finally forced the government’s hand on the income trust file.

Surprised by the trust turn-about? You shouldn’t be. The surprise isn’t that the Conservatives finally acted to close a tax loophole that you could drive the entire corporate income tax system through. The surprise is that it took them so long to do it. The surprise is that the Liberals’ Rip van Winkle imitation allowed the income trust phenomenon to get out of control in the first place. The surprise is that the Liberals, having royally messed up the income trust file in the first place, now don’t seem to be able to muster up the good grace to keep quiet about it.

None of it made any sense. Not the very public decision to “study” the issue. Not the decision to give trust conversion the full-speed-ahead notice. Not even Goodale’s attempt to level the playing field by increasing the dividend tax credit. Did it not occur to the Liberals that the dividend tax credit is irrelevant to the very investors -- foreign investors, pension plans and tax sheltered mutual funds – for whom the income trust tax dodge was most lucrative? The increase in the dividend tax credit was an expensive and unsolicited give-away that accomplished nothing.

What happened in the trust sector after the Liberals opened the door was perfectly predictable. So was the eventual decision to slam the door shut. And so was the near-hysteria of the response -- from one end of Bay Street to the other.

No government could sit by and do nothing as the corporate income tax system disappeared. No government could sit by and do nothing as conversions that only made sense as tax avoidance vehicles threatened the investment and risk-taking that are fundamental to economic growth. No government was going to keep in place a tax avoidance vehicle that had been outlawed everywhere else in the world it had been tried.

The well-paid financial geniuses on Bay Street who are now howling like stuck pigs should have known. But they didn’t want to know. What they wanted was the ‘deal flow’ – along with the enormous fees – from income trust conversion. The income trust phenomenon was selling Porsches and Ferraris and houses in Rosedale and Forest Hill by the dozens as the Bay Street dealmakers literally cashed in.

Now the party’s over. The outrage was predictable. And so was the scramble to find hard-done-by senior citizens behind whom to hide Bay Street’s naked self-interest. With more than a little assistance from the smart people on Bay Streeet, the media were able to find “typical” seniors whose 10% loss in their income trust investments cost them $50,000 or $90,000.

Unfortunately for those who have lost money, it’s not going to work. The vast majority of seniors – indeed, the vast majority of Canadians – would be happy to have income trust investments of $500,000 or more on which they could have lost $50,000. Most Canadians see the income trust fiasco for what it is – a tax loophole, allowed to balloon in size thanks to governments that were asleep at the switch, finally and none-too-soon, closed.

The outrage of those who lost tens of thousands of dollars overnight, from an investment that was legitimized by the Liberals and endorsed by both the Prime Minister and the Minister of Finance, is understandable. If I had lost that much money and had voted Conservative, I wouldn’t vote Conservative ever again either.

While they’re at it, they should save some of that outrage for the investment professionals whose advice led them to believe that the trust loophole was secure and whose advice – or lack thereof – led their clients to ignore that basic rule of investment risk management, diversification.

So spare some sympathy for those investors who couldn’t see, didn’t see, or didn’t want to see the warning signs and put too many of their retirement eggs in the income trust basket.

Don’t worry about the crying and gnashing of teeth from the Bay Street guys. There’ll be a temporary slump in sales of Porsches and Ferraris. Some of Toronto’s tonier restaurants will feel the pinch. But in the immortal words from Gone with the Wind, tomorrow is another day. And tomorrow, the fees and commissions will come rolling in again as the companies that converted to income trusts accept these same professionals’ advice and convert back to conventional corporate organization.

Hugh Mackenzie is a CCPA Research Associate.