Sunday, February 14, 2010

A message from Bill Vander Zalm, who is leading the fight in BC against the HST

Brent, I read your message "a tale of two tax policies" and I'm very impressed. Your article is very enlightening and sound , it could be an effective and extremely beneficial way of rebuilding our Province and Country. Thank you. Bill Vander Zalm

A tale of two tax policies


If the common goal that we all presumably share is to make Canada a more competitive and prosperous country with greater employment prospects, productivity and standard of living for all, rather than making some people rich at the expense of others, then the route charted by Canada’s corporations and their lobbyists on tax policy has taken two very significant wrong turns in the recent past, namely the income trust tax and its direct illegitimate descendant, the HST. Two tax policies that are clearly intended to make corporate CEOs rich and the rest of us poor.

Just like two wrongs don’t make a right, the same can be said about two bad tax policies, especially when one tax is borne from the other, and the second tax (HST) is only a remedial exercise in attempting to correct what was inherently wrong about the first tax (income trust tax) in the first place.

It is very clear that tax policy in this country is being dictated to federal and provincial politicians by the corporations and their lobbyists. Politicians from all parties (Conservatives. Liberals, NDP and Bloc) have allowed themselves to be completely bamboozled by this intense corporate lobbying on which these tax policies are being advanced, and wrapped up for ease of political and public consumption, by invoking their many lofty, albeit false, goals, promises and premises

Surely, Tom Flanagan must be giving spiritual guidance to these corporate lobbyists who have obviously taken to heart his mantra of “it doesn’t have to be true, it just has to sound plausible.” Knowing the difference between what is true and what is only plausible, when it comes to implementing sweeping tax policy, requires a degree of expertise and understanding that is sorely lacking in our elected politicians across this country, of all political parties.

Here is the real truth of what is really going on here with respect to this bamboozle known as increasing Canada’s competitiveness, starting with that huge problem child, known as HST.

The sole purpose of the HST tax is to shift the burden of taxation from corporations to consumers. Full stop. The supposed benefit of reducing corporate tax rates in this regressive manner is the Pollyanna belief that doing so will enhance economic growth and competitiveness, across the board, notwithstanding the indiscriminate manner in which these corporate tax cuts are taking place and which will even accrue fully to corporations who make no incremental investment in the economy, creating widespread windfall profits with no offsetting benefits. Like indiscriminately sowing seed on a parched fields, rather than selectively on rich soil.

Even assuming some benefits are realized from this indiscriminate corporate tax cut that is being fully underwritten by the HST, its net effect is likely to be negative, as the HST represents an enormous new burden imposed on an already highly overtaxed consumer (and at the absolute worst of possible times), and will materially lessen consumers’ purchasing power in two of Canada’s most populous provinces, their savings power, and will drive an even larger underground economy than exists today. Thanks to taxation, over 50% of cigarettes sold today in Ontario come from the underground economy. Post the implementation of HST, I suspect that well over 50% of home renovations and the associated labour in Ontario will have been driven into the underground economy as sole result of the HST.

Meanwhile there was a far better route to achieve the goal of less tax burden on corporations that would have precluded the need for this grossly absurd HST altogether. An alternative that had NO imbedded trade-offs associated with it whatsoever. And strangely it was the VERY alternative that these SAME corporations and their lobbyists fought to destroy, namely the income trust alternative form of business model.

The income trust model has nothing but benefits to bestow upon Canada, and yet it was intensely lobbied against by corporate CEOs and their lobbyists for reasons that were completely self serving, totally narrow minded and contrary to the interests of the other 32 million Canadians living today. Allow me to explain.

Despite all the seemingly “plausible” arguments advanced by corporations and CEOs for why income trusts had to be shut down (in their view), the singular reason that motivated them to lobby so intensely against income trusts was that the advent of income trusts threatened the manner and form by which these CEOs are paid under the corporate model, namely the use of stock options, a pox on the economy (see recent work by Roger Martin, Dean of the Rotman School of Business) that does not exist in the income trust world. A world in which management is compensated for real tangible economic gains as opposed to illusory ones and ones that are easily gamed and manufactured within the context of the corporate model, as manifested by the use of stock options as the predominate form of compensation, often leading to adverse consequences like the Global financial meltdown (the conclusion reached by Roger Martin).

If the corporations’ real goal, as they claim, is to lessen their tax burden, then the income trust model is the way to go, as it shifts all of the tax burden of business onto its owners. Just like Jim Flaherty’s law firm, in which the business pays NO TAX and the owners pay the tax, at rates equal to income from employment. Under this model, the government collects as much if not more from a business structured as a trust as opposed to a corporation.

Meanwhile, and of great public policy importance, is that Investors are willing to assign a higher value to a given business structured as a trust versus as a corporation. This higher value ascribed by investors to businesses formed as trusts, has nothing to do with any tax benefit associated with income trusts, but rather has everything to do with the higher value assigned by investors to the payout discipline associated with the adoption of the income trust model. Adoption of the income trust model requires by tax law, that 95% of a business’s discretionary earnings (i.e. after capital reinvestment) be distributed to its owners, to be taxed immediately in their hands. The income trusts model places control of a businesses’ discretionary earnings in the hands of its owners (investors) as opposed to its management (CEO and Board).

This "control over earnings" is the reason why investors place a higher valuation on businesses formed as income trusts and confers upon these businesses a lower cost of capital, since “cost of capital “is simply the inverse of “valuation”.

There is no other single more important determinant of a businesses’ ability to compete and be competitive, across all businesses, than its cost of capital. The beauty of the income trust model is that it achieves a significantly lower cost of capital without introducing any offsetting trade-off, whereas HST attempts to create a lower cost of capital by reducing corporate taxes, but it does so at a huge offsetting cost to the economy and consumers, as outlined above. Furthermore reducing taxes as a means to reduce a business’s cost of capital has only a tangential effect on reducing cost of capital, since taxes are only part of the mix in determining a business’s overall cost of capital, whereas income trusts reduce the cost of capital by actually reducing the cost of capital, DIRECTLY, in the marketplace for capital.

Therefore, the very corporations who today are behind this shrill and inherently self destructive exercise, about the imperative to reduce their corporate tax rates via HST, arguing about the importance of cost of capital and the need to increase competitiveness, etc, are the VERY PEOPLE who were behind killing the vastly better way to achieve those ends, but WITHOUT the trade-offs, namely the income trust model form of business arrangement.

The formulation of tax policy in Canada these days is almost like a remake of the failed sale of BCE, but on a much grander scale, in which the most self destructive course of action is sought out at every opportunity, while remaining brain dead about better ways to achieve the same ostensible goals. That striking but haunting similarity probably has to do with the fact that the same people are behind both of these still born exercises of self destruction.

Just as proved, would have been the case for BCE, the income trust model form of business arrangement was (and can remain) a huge advantage to Canadians and the Canadian economy, in that it:

(1) Maximized government’s tax collection on business earnings

(2) Provided businesses with access to a significantly lower cost of capital, without requiring new taxes like the HST or asking the government to forego tax revenue

(3) Provided Canadians with a means to generate essential retirement income and provide a means for a dignified retirement and lessening the overall burden on social programs, while making direct investments in the Canadian economy, rather than other synthetic, derivative "retirement products" that are flawed in their very nature (ie ABCP, and variable rate annuities like Manulife's Income Plus)

(4) The higher valuations accorded by investors to Canadian companies structured as trusts made these business less susceptible to foreign takeovers

(5) Provided a deep pool of capital from domestic as well as foreign sources, all of whom were subject to Canadian taxes.

(6) Structured the economy with business managers who were incentivized to create real economic gains, rather than illusory economic gains, employing the many gaming techniques common to the corporate model (eg stock buyback and leveraged buyouts).

(7) Structured the economy on a foundation of “equity” as opposed to over reliance on “debt”, thereby reducing the country’s overall risk posture and increasing the soundness and robustness of Canada’s economy.


When will facts and logic govern the policies of this country, rather than the incessant back room lobbying of corporations and outside interests? Where are our paid elected Members of Parliament? Who do they profess to represent when they support policies like the HST tax and the income trust tax? Policies that are enacted based on some person’s whim and designed to achieve narrow self interests, wrapped up in lofty (albeit false) promises. These MPs and MPP are delusional if they think they are representing the needs of those they profess to represent, as they are strong-armed into voting for these policies about which they know nothing, except that their constituents are up in arms against them.

Canada: The place where bad economics meets bad democracy, and the corporate CEO comes out on top......every time.

2 comments:

Dr Mike said...

It just goes to show you that all it takes is common sense to run a country.

The problem is that the present crop of politicians do not know the concept.

Well done Brent

Dr Mike Popovich

Anonymous said...

Are you listening Mr.Ignatieff?

Railhound