IMAGES

Peter Redman, National
Post

"We can't say we are
competitive. We have some serious issues we need to deal with," says Jack
Mintz, president of C.D. Howe Institute. The think-tank calls for a
dramatic overhaul of the tax system.

A roadmap for ending the abuse
National Post
Wed 21 Sep 2005
Page: A8
Section:
Canada
Byline: Terence Corcoran
Column: Terence Corcoran
Source:
National Post

That Canada's tax system is a shambles of distortions,
disincentives and neglect was amply demonstrated on the stock market yesterday.
Shares of a dozen Canadian companies -- TSX Group, CI Fund and BCE among others
-- dropped dramatically, wiping billions of dollars off total market
capitalization. The only reason for the fall in values -- nothing had happened
to change the business outlooks of these companies -- is a federal tax move that
some see as Ottawa's attempt to pull the plug on the creation of tax-driven
income trusts.

The turmoil in income trusts, the product of a kind of tax loophole, is a
perfect backdrop for the latest tax policy report from Jack Mintz and his
colleagues at the C.D. Howe Institute. The report, optimistically subtitled
Unleashing the Canadian Tiger, is a catalogue of federal and provincial abuse of
taxpayers. It's also a detailed roadmap on how to fix the warped network of tax
measures that punish work, strip investors of their income, and distort business
and economic behaviour.

Income trusts, in fact, are described as ''the most important example of
financial distortions'' caused by the tax system. The system discriminates
against dividends and promotes the creation of trusts to dodge high dividend
taxation. The Howe report offers a clean fix: Reform the tax system to stop the
double-taxation of dividends and create a level playing field.

Above all, the report inadvertently helps answer another big question: Why
have Canadian investors bought more than $100-billion in trust units in recent
years? Because they are being screwed by the tax system, and income trusts offer
a small way out, a chance to get some kind of real, after-tax cash back on their
invested dollars. Income trusts, with their nominal returns of 8% or more, help
offset a tax system that otherwise expropriates most investment income.

An investor who buys a bond that nominally yields 6% faces a tax rate of 40%
and an inflation loss of more than 2%, effectively lowering the real rate of
return down to 1.6%. On a 4% bond, which is closer to current market values, the
real return drops to 0.4%. Retire on the income, they say. What income? With an
8% yield, the post-tax and post-inflation return on trusts would be 2.8%. Not
great, but it's more than Ottawa now leaves on the table on the average bond.

To fix the distortion and remove the artificial incentive to create income
trusts, the Howe paper proposes a new tax regime that would lower the effective
tax on dividends to 25% from its current level of about 46%. That would let
Canadian investors hold on to 75% of their dividend income. At the same time,
Ottawa should cut corporate income tax rates to 25%. That would end the tax game
over income trusts.

The trouble with those proposals, as with most recommendations to fix the tax
system, is that they must overcome an army of vested interests opposed to
change. The C.D.
Howe paper calls for a new tax system based on
low rates, a broad base and a shift to a system that removes weird incentives
and eliminates barriers to economic growth. Stop taxing savings and investment,
and move toward greater reliance on consumption taxes.

Sensible enough. But each existing tax measure, no matter how bad or
distortive, inevitably benefits someone who wants to maintain the status quo.
The massed forces of Bay Street -- lawyers, accountants, investment dealers,
hedge funds, pension managers, advisors -- are already scrambling to the defence
of trusts.

Toronto lawyer Alfred Apps, of Fasken Martineau, told Dow Jones yesterday
that income trusts are now a vital part of Canada's financial system. They
provide investors with yield-generating securities at a time with other sources
are drying up. That yield opportunity, however, exists only because of the mess
in the tax system that currently buries investors. The income trust boom is a
rush for liberation by investors escaping an abusive system. The solution is to
fix the system.

Resistance to change is even more deeply entrenched around other distortions
identified by the Howe report. We have 70% effective marginal tax rates that
make it uneconomic for people to work more, or increase their income; marginal
corporate tax rates that effectively confiscate an average 39% of the return on
capital invested; taxes that give preferences to some at the expense of others.

One set of industries -- construction, communications, wholesale -- pays more
taxes while forest industries and manufacturers pay less. Small businesses pay
even less, due to special preferences. Such uneven tax burdens on different
business activities lowers productivity because they ''distort the allocation of
investment,'' as the report puts it. When taxes determine investment decisions,
the best investment decisions don't get made. This would mean cleaning out the
special deductions and tax credits for films, small business, labour-sponsored
venture funds. You can hear the howls of protest.

The biggest obstacles to change, however, are the politicians and their
addiction to using the system to buy votes. But surely Canadians are not
immovably chained to the rotting hull of a regime of taxes that is manifestly
unfair, a system that prompts people to make decisions about employment,
retirement, savings and investment that are not good for them or the economy.

Illustration:
• Black & White Photo: Peter
Redman, National Post / "We can't say we are competitive. We have some serious
issues we need to deal with," says Jack Mintz, president of C.D. Howe Institute. The
think-tank calls for a dramatic overhaul of the tax system.

Edition: All but Toronto
Story Type: Business;
Column; Statistics
Length: 878 words