Will retirees have to eat cat food if the government messes with income trusts? The financial industry would have you think so. A well-choreographed barrage of protest is depicting income trusts as essential to the retirement security of Canadians. But will seniors really be hurt if Ottawa intrudes on the sanctity of income trusts?
Since they serve no real economic purpose, income trusts are a peculiar beast. They exist only because of a legal loophole that enables businesses to avoid paying corporate income tax. Here is how it works:
When a traditional corporation earns a profit, it is supposed to pay corporate income taxes. After paying corporate income taxes, the owners of the firm (the shareholders) can receive dividends. Shareholders in turn must pay income tax on their dividends.
Let’s say this business restructures itself as an income trust. Its assets are placed in a trust, and the firm’s owners (now called “unitholders”) are those who buy a slice of that trust. Now watch the magic: since the business is now classified as a trust, it doesn’t have to pay those pesky corporate income taxes. Profits are “flowed through” directly to the unitholders, who then pay income tax on them.
From a given amount of corporate profits, unitholders stand to receive more cash than they would if they were shareholders in a regular corporation. As you may have guessed already, those involved in income trusts are not needy seniors with modest retirement savings. They are sophisticated investors beefing up their ample investment portfolios thanks to the extra boost provided by this tax loophole. (Income trusts are also good for Bay Street advisors who can earn many times their regular commissions by peddling income trusts.)
So why should we care if income trusts are the darlings of the affluent? When businesses avoid paying their taxes, the government gets less tax revenue. How much revenue is being lost? The federal government thinks it was $300 million in 2004, although this is likely a low estimate. On top of this, the provinces lose tax revenue as well.
If this loophole remains open, income trusts will produce a serious hemorrhaging of public revenues. Governments have two choices to deal with this pressure on their revenues: raise taxes or cut spending.
Since raising taxes is taboo these days, the price we all pay for income trusts may well be a squeeze on government spending. Ironically, just when the federal government is sounding the alarm about the expenses of an aging population, it may have to prune the spending that retirees really need. It is truly loony that the government could be forced to cut back on, say, health care or other social programs that all seniors need, just to enable the wealthiest of retirees to engage in legalized tax evasion.
Until recently, federal Finance Minister, Ralph Goodale, was quite easy-going about this income trust tax loophole. (What is a few $100 million among friends?) But his laid-back attitude became increasingly strained as income trusts morphed into a giant cash-sucking vortex.
So the Finance Minister signalled that he might do something about this problem. The possibility that he would close this loophole shook up the market for income trusts, and unleashed howls of protest from those who were understandably dismayed that the government might stop requiring other taxpayers to subsidize their tax loophole.
The Bay Street crowd pressured the government to implement a cure for income trusts that is worse than the disease. Their argument is that income trusts are merely the symptom of the unbearable burden of taxation. They claim that shareholders of corporations suffer under double taxation since taxes are levied both on the corporation and on the dividends the shareholder receives from the corporation. Never mind that this so-called double taxation is something we all live with (all of us pay income tax and then pay sales tax, property tax, gasoline tax and so on).
The Bay Street solution? Solve one tax giveaway by creating more giveaways! Either by changing the tax treatment of corporations or by changing the taxation of dividends, these lobbyists want to use the situation created by income trusts to leverage more tax cuts. But the Bay Street solution would dramatically deplete government tax revenues, which would in turn force cuts on all kinds of government spending.
In the end, Goodale succumbed to pre-election pressure and announced that the income trust tax loophole would not be closed. Instead he enhanced the dividend tax credit to boost the after-tax income of investors in traditional corporations. So his solution to tax avoidance by some well-off investors is to help all of the affluent pay less taxes.
I can think of a lot more worthy uses for tax dollars than providing gratuitous hand-outs to well-to-do investors. Every dollar that we give away on tax breaks to the affluent is a dollar we don’t have to spend on the rest of us.
But the income trust saga may not be over yet.
Ellen Russell is a senior economist with the Canadian Centre for Policy Alternatives. This article appeared in the January/February issue of This Magazine.