Income trust uproar exposes a policy of taxpayer
abuse
The Vancouver Sun
Fri 23 Sep 2005

Page: A19
Section: Editorial
Byline: Terence Corcoran
Column:
Terence Corcoran
Source: National Post

TORONTO - That Canada's tax system is a shambles of
distortions, disincentives and neglect was amply demonstrated on the stock
market this week.

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 eight per cent or
more, help offset a tax system that otherwise expropriates most investment
income.

An investor who buys a bond that nominally yields six per cent faces a tax
rate of 40 per cent and an inflation loss of more than two per cent, effectively
lowering the real rate of return to 1.6 per cent. On a four-per-cent bond, which
is closer to current market values, the real return drops to 0.4 per cent.

Retire on the income, they say. What income?

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 per cent from its current level of about 46 per cent.
That would let Canadian investors hold on to 75 per cent of their dividend
income. At the same time, Ottawa should cut corporate income tax rates to 25 per
cent. 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, advisers -- are already scrambling to the defence
of trusts.

Resistance to change is even more deeply entrenched around other distortions
identified by the Howe report. We have 70-per-cent 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 per cent
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.

The biggest obstacles to change, however, are the politicians and their
addiction to using the system to buy votes.

Edition: Final
Story Type: Business; Opinion

Length: 727 words