Asleep at the switch

If nothing else, Jim Flaherty is a study in complete hypocrisy and profound fiscal mismanagement. His inability to discern good from bad, right from wrong is proving detrimental to all Canadians.

In the accompanying photo we see a beaming Jim Flaherty about to report on his school project entitled “How I taxed income trusts, after promising I never would”.

Jim Flaherty seems to think the loss of $35 billion in Canadians hard earned life savings is deserving of a grin from ear to ear. The main theme of Jim Flaherty’s school project was based on the false premise that income trusts cause tax leakage. Had Jim Flaherty been so confident in this central premise, he probably wouldn’t have issued 18 pages of blacked out documents as his sole source of proof. Eighteen pages that he subsequently demanded be returned, even though they had been issued under the Access to Information Act.

As with all snake oil salesman of his ilk, Jim Flaherty makes good use of the tactic known as fear mongering. What other possible purpose would the coloured slide haved serve, apart from invoking the fear that the announce conversions of BCE and Telus, meant the beginning of the end? This is where being able to discern good from bad is a very useful trait in a Finance Minister. The conversions of BCE and Telus to income trusts were actually the best possible outcomes for Canada, as the conversions of these two companies, which at the time were paying no corporate taxes whatsoever and who were forecasting that they would not be paying any corporate taxes for many years to come, would have meant that these two companies would have paid over $1 billion a year more in taxes as income trusts, beginning immediately.

Jim Flaherty is the first Canadian Finance Minister to bring into legislation a set of provisions that acting alone and acting together serve to promote the foreign takeover of Canadian businesses, and in so doing results in a loss of taxes to Ottawa. As such Jim Flaherty’s policies represent Government tax subsidies that encourage foreign takeovers. These policies are:


- The imposition of a 31.5% income trust tax that is paid by average Canadians, but not by foreigners who acquire these income trusts, that have been devalued by the trust tax. This creates what is called an arbitrage, with the economic advantage going to foreign owners is to the detriment of average Canadians, thereby creating an unlevel playing field. Foreigners acquire these trusts using debt in sufficient amounts to avoid paying any Canadian taxes on the earnings which previously were fully taxable in the hands of average Canadian investors resulting in a net loss of taxes to Ottawa. This was widely predicted to occur. When it did occur, Flaherty defended his actions by saying: “It’s not my fault”.

- The imposition of growth restrictions on these companies while in the hands of average Canadians, which are not imposed while in the hands of foreign owners. Again this creates and arbitrage that favours foreigners to the detriment of average Canadians

- The elimination of the 15% withholding tax on foreign investors of leveraged buyout loans used to acquire Canadian companies at reduced cost and at grander scale, such as was the case with BCE whose foreign funded buyout vastly benefited from this measure


So rather than bemoaning the growth of income trusts, on the basis that they were a bad thing, when in fact they were a good thing, and rather than have been fear mongering about BCE’s announced conversion to an income trust, when in fact all the policy served to do was to bring about the worst possible outcome, namely a highly debt levered private equity takeout that will cost Ottawa a mere $793 million a year in lost taxes, Flaherty should have been alert to the real crisis that was unfolding before his very eyes, namely the ABCP meltdown.

But then Jim Flaherty was asleep at the switch wasn’t he?

Jim Flaherty and the Department of Finance who are responsible for the regulation of the “exempt” market were completely oblivious to the crisis about to unfold in the Asset Backed Commercial Paper (ABCP) market. A house of cards if there ever were one, as it involved the purchase of a portfolio of long term fixed rate financial assets with short term floating rate paper. This market was growing at a pace that should have made the fear mongering Jim Flaherty blush, assuming he was even aware of its existence.

During the past three years the ABCP market has nearly doubled to its present level of more than $115 billion which mirrors the pace of growth in the US ABCP market. Of this amount, $35 billion forms the non bank ABCP market which is the segment that is in peril. How much of that $35 billion in ABCP market investment will be lost and how much will be recovered is anyone’s guess, as the whole value equation turns on the perception of risk.

So rather than attending to the crisis that was unfolding before his very eyes, Jim Flaherty manufactured one of his own, by taxing income trusts, which has resulted in the loss of $35 billion in the life savings of average Canadians, induced over $65 billion in trust tax related takeovers, which to date has caused the loss of $1.4 billion in annual taxes. This takeover activity will continue unabated and ultimately will see the loss of $7.5 billion in annual taxes to Ottawa. All to fix an alleged loss of $500 million in taxes that was was never proven to have even existed. Investors who were making long term investments in income generating instruments are now finding their investments turned into short term investments and are sustaining the $35 billion loss in the process.

Meanwhile the ABCP fiasco that was left unadressed has resulted in a group of short term investors finding themselves with a failed market instrument that will be replaced by long term paper. Unlike income trust investors, these ABCP investors were sophisticated institutional investors who should have known better. Furthermore their loss was the result of a systemic problem and not one brought about by the direct act of government, but rather from benign neglect. The good news is that they will have to recover zero cents on the dollar, before they sustain the $35 billion loss experienced by income trust investors, and nor will they be burdened with the fear of how they are going to make up the funding shortfall for their retirement brought upon them solely by the governments ill conceived actions.