Finance Committee on Feb. 1st, 2007

[Kevin Hibbert]

Okay, I'll give you the Reader's Digest version, then.

First off, I've never really spoken about valuations. That's certainly outside of my scope at Standard & Poor's, and outside of the scope of our ratings agency. Really what we were talking about was the fact that there are financial reporting risks that are evident within trusts that investors somehow didn't really think too much about. Our thinking around that was because there was a significant focus on cashflow, and many people consider cash to be this absolute figure that is somehow immune to reporting distortions. So when we highlighted that issue, we didn't really do it to isolate or single out the trusts, but rather to underscore the fact that the reporting distortions are there, they exist, they're very real among cashflow numbers of trusts, and as a result, the same vigilance they have in looking at earnings figures for corporates has to be extended to the trust environment.

The last part of your question, around government action—

[The Chair, Conservative, Brian Pallister]

I'm afraid I must cut you off there. We've extended the time.

We move to Madam Ablonczy now for five minutes.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

Thank you, Mr. Chairman.

Thanks to all of you for being here. This is an important issue, and we appreciate the contribution you've made.

Mr. Dodge, there was no shortage, of course, of opinions expressed here on this issue today. But I'd like to start with you. When you've appeared before the committee previously, you've made it clear that you take very seriously your commitment to Canada's standard of living, our quality of life. As an important steward of Canada's economy, why do you believe that the move on October 31 was good for Canada's economy, that it levelled the playing field? Why was it good for the economy?

[David Dodge]

As I said in my opening remarks, we've done no highly specific work on this, and work on what affects productivity down the line is very difficult. So I must say that I'm speaking here on the basis of general principles and on our general knowledge of what affects productivity going forward.

Obviously, there are only two real sources. One is innovation—finding new technology and new ways of organizing to do business. Second is the investment in both physical and human capital, which augments the amount of capital that people have to work with. Those are the only two sources. The question is what impact the income trust form of organization, as opposed to the corporate form of organization, has on this?

In the case of a business that is essentially using an existing piece of physical capital and running it down or out—there are businesses like that, as Mr. Paquette said, but they're not all in any one sector—the trust form of organization may well be an appropriate form of organization for running that business so as to get maximum efficiency out of it.

In any other businesses, which will be the majority of Canadian businesses, where innovation in new investment is critical, the income trust form of organization is not an appropriate form of organization to maximize the contribution of that business. And over time, because of that, one would argue and it follows that if those businesses organize in that form, it has some long-term negative impact on output and performance.

So I think we're saying things in different words—the way Mr. Dancey put it, or the way Mr. D'Alessandro put it—but I think those are the general points we ought to be very clear on. Hence the conclusion: that there ought to be no bias in the tax system to incent a business to operate one form of corporate organization or another.

While not perfect, as Mr. Dancey pointed out, the changes proposed on October 31, which you will have to deal with as parliamentarians, at least make the system more neutral and more conducive to higher output and better performance in the future.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

So you're telling the committee that you believe what Mr. Flaherty, the finance minister, did with this announcement was the right thing to do.

[David Dodge]

I think so. I guess from a strict point of view, as Mr. Dancey said, the right thing is to have a tax system with low rates and a broad base and that is as neutral as possible, and probably years ago we should have recognized that we had a bias here that could lead to problems. But better late than never.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

Mr. Dodge, what do you think might be the risks of extending the transition period by another six years?

[David Dodge]

That I really can't answer. You'll have to ask somebody with more tax expertise than I have.

[The Chair, Conservative, Brian Pallister]

Thank you, Madam Ablonczy.

We'll continue now with four-minute rounds.

Mr. McKay.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Thank you, Mr. Chair.

Thank you, witnesses.

Really the only issue here is tax leakage.

Professor Fortin, you've taken a rather hard look at whether in fact there is a tax leakage.

The allegation by the minister on Tuesday was that there was going to be a $500-million leakage, which is a curious juxtaposition to something in the order of about a $25-billion to $30-billion meltdown. This is an even a more curious juxtaposition to a $5-billion revenue reduction by GST. So you have a half billion versus five billion dollars, in terms of policy choices. One might say that's a curious set of policy choices.

The presumption is that trusts distort the market, that people make choices based upon the tax treatment.

The question I put it to you is that the trust entity is simply a download of tax liability from the corporation to the individual. If in fact we could eliminate the flow-through entities from the calculation, would the government generate more or less revenue from trusts, by virtue of downloading onto the person, as opposed to the taxation liability on the corporation, where a person generally pays a greater effective rate than does a corporation?

I'm asking you, is that a warranted presumption? If so, then the problem is with flow-through entities, rather than with the trusts themselves. Is that a reasonable question?

[Yves Fortin]

The point I have tried to make is that presently for the so-called fully taxable accounts, these people are paying more taxes than if they invested in corporations. That also includes the taxes paid by the corporations.

[John McKay, Liberal, Scarborough—Guildwood, ON]

So then it's fair to say that if you could eliminate flow-through entities from the equation, you would actually generate more revenue out of persons? Is that correct?

[Yves Fortin]

What I'm saying is that if all the trusts were to reconvert to corporations, the government would end up with much less revenue. That's what I am saying.

This is the point I make in tables 1A, 1B, and 1C of my document entitled “A Recipe for Tax Revenue Loss”. It is documented there with the tax rights.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Your second point is that treating tax-deferred vehicles as tax-exempt is the serious flaw in the department's methodology.

[Yves Fortin]

It is, Mr. Chairman, in terms of both the medium and longer term, but also in terms of the present situation, the annual budget. I think I have emphasized that point.

In the longer term, the government will lose, only if the present value of the future taxes collected is less than the taxes forgone at the moment. With trust distributions at 8% and 10%, and the inflation rate at 2%, I wonder how the government can lose in the short run—as I mentioned, in 2004, because those are the only statistics we have to date.

What happened there is that—

[The Chair, Conservative, Brian Pallister]

Sorry to interrupt you, Mr. Fortin.

We will continue with Mr. St-Cyr.

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

Thank you very much, Mr. Chair.

I am going to continue the dialogue with Mr. Fortin because I would like a clarification concerning a study he tabled. Page 5, Table 2A, tax on investments in income trusts and the impact on income trusts if they are placed in a RRSP and where taxes carried forward eight years.

A footnote under the table states: “Based on an average federal/provincial personal income tax rate of 38%”. The thing that bothers me is that every year when I meet with my financial planner and he gives me a basic RRSP refresher course, he tells me that one of the advantages of contributing to an RRSP is that your tax rate when you contribute is generally higher than it is once you retired, when your income is usually lower.

Have you taken this in consideration into your calculations and determine what the government would loose if an entire segment of the tax field was subject to a lower taxation rate?

[Yves Fortin]

I think that the 38% rate is the average rate the Department of Finance uses as a general rule. It is highly likely that retirees would be subject to a lower tax rate, but it is also highly likely—and I know a lot of retirees for whom this is the case—who would be taxed at 38% or higher.

The public paid $38 billion into RRSPs in 2004 in the form of deferred taxes and withdrew $52.5 billion. Even if the taxation rate was lower, I can guarantee you that the government would not lose out. This is not the future, as Mr. Flaherty pointed out. You have to look at the current obligations. Today, this week, $ 1 billion will be taken out from RRSPs and RRIFs.

Even if the tax rate was lower—

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

—it will still be a higher amount.

[Yves Fortin]

—it would still be a higher amount. Since RRSPs were created, people have piled away hundreds of billions of dollars. As the population gets older, this money is starting to be taken out. The aging population means that the pace at which people will withdraw their RRSP and RRIF money will speed up. And with an aging population, contributions will remain stagnant or drop.

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

Thank you very much.

My question is directed to Mr. Tait. You said that some investments may be recovered if the transition period were extended. Have you put a dollar amount to the money investors would recover if the transition period were, for example, increase from 4 to 10 years?

[Gordon Tait]

Yes, we did put a number on that. It's just a fairly simple present value calculation.

We estimated that if you extended the time period when you would implement this proposed tax, it would probably bring back about $9 billion or $10 billion worth of value to the trust sector. That's because the impact of it doesn't happen as quickly; it happens further out in the future, so it doesn't have as big an impact on today's investor.

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

Is that study available?

[The Chair, Conservative, Brian Pallister]

Merci beaucoup.

We continue now with Mr. Wallace.

[Mike Wallace, Conservative, Burlington, ON]

Thank you, Mr. Chairman.

I thank the panel for coming this morning.

I think it's interesting: we didn't call these meetings before the legislation got back to us as a committee, but the opposition parties did, and we've heard from Mr. Dodge, Mr. Dancey, Mr. Olin, Mr. Hibbert, and Mr. D'Alessandro—all with what I would consider to be independent opinions on these things—and all are supportive in general of what the finance minister has proposed and what we have in our ways and means motion.

My question is for Mr. D'Alessandro. There is some short-term pain, of course, but what, as a leading business person in this country, do you think is the long-term risk for our economy? And what do you think the issue is in terms of productivity for corporations in general?