Good morning, Mr. Chairman, and members of the committee.
I should start by making clear where the Bank of Canada's main interest in the income trust sector lies. Our interest in income trust relates to the efficient functioning and health of Canada's financial system. A safe and efficient financial system is essential to Canada's economic well-being. The Bank of Canada works with other government agencies, as well as market participants, to promote the safe and efficient functioning of the financial system. Capital markets are a key component of that system. And so we are naturally interested in developments in financial markets—such as the evolution of the income trust market—that has the potential to affect financial system efficiency.
With that introduction, Mr. Chairman, let me quickly summarize the highlights of the bank's work on the topic.
l refer committee members to our June 2006 Financial System Review. In that publication, we noted that limited evidence suggests that income trusts can enhance market completeness in a number of ways. Income trusts can provide diversification benefits to investors, because trusts can have different risk-return characteristics from those of either equities or bonds. Second, the income trust structure appears to allow some firms improved access to market financing.
Insofar as income trusts allow investors to achieve risk-return benefits they couldn't otherwise achieve and serve as a source of financing to firms that might not otherwise have access to markets, it can be said that income trusts enhance market completeness and therefore support efficiency.
But we note in the same article two areas where the standards for trusts really don't come up to those for corporations, and where improvement is clearly needed: in standards related to accounting and distribution of revenue and those related to governance.
These are the aspects, committee members, that we at the bank have specifically looked at. Of course, there are very important public policy questions related to income trusts that fall well outside the bank's mandate. The bank has done no specific research on how the income trust structure affects economic performance or would affect future productivity in Canada.
Based on general economic principles and our understanding of the structure of the Canadian economy, I can say that while the income trust structure may be very appropriate where firms need only to manage existing assets efficiently, it is definitely not appropriate in cases where innovation and new investment are key. To the extent that the system was favouring the use of the income trust structure, in these cases the incentives for innovation and investment were reduced and potential future productivity growth was reduced.
Finally, members of the committee should realize that different risk-return characteristics of trusts may not enhance market completeness, if they arise from differences in tax treatment. Clearly, there has been a very significant tax incentive to use the income trust form of organization in cases where this would not have been an appropriate form of organization from a business efficiency point of view.
By giving incentives that led to inappropriate use of the income trust form of organization, the tax system was actually creating inefficiencies in capital markets—inefficiencies that, over time, would lead to lower levels of investment, output, and productivity.
We at the bank have not done any research on how the rules of the tax system could or should be designed so that they do not give inappropriate incentives. The changes proposed by the government last October would appear to at least substantially level the playing field. For the income trust sector to deliver the efficiency benefits through its enhancement of market completeness, it is absolutely critical that the tax system provide a level playing field.
Thank you, Mr. Chairman.