Government Secrecy on the Income Trust Tax Issue

By W. T. Stanbury, Professor Emeritus, University of B.C. May 24, 2009


1. INTRODUCTION:

The Harper Government exacerbated the anger it created by the Halloween Surprise (October 31,2006) when it announced a 31.5% tax on certain types of income trusts by the secrecy it imposed on the methodology, data and assumptions used to calculate the purported “tax leakage” or revenue losses for the federal government. For 2006, these were said by the Department of Finance to be $500 million. Ironically, two things helped the critics to get around this secrecy.

First, as we explain below, the parts of the documents released pursuant to Access to Information Act requests in December revealed a crucial part of the methodology—namely that Finance had failed to include deferred taxes. That hugely inflated the so-called “tax leakage” Second, the Minister stated on January 30,2007 that the same methodology was used for the 2004 and 2006 estimates. The previous government had provided more information on Finance’s methodology in the “Consultation Paper” of September 8,2005. Still---the Government stonewalled and fueled the critics’ anger. See below.

Section 2 describes the blacked-out documents. Section 3 outlines the secrecy game as it was played by the Harper Government on the trust tax issue. It should be read in conjunction with Appendix A. Section 4 questions the need for secrecy about the methodology. My conclusions are in Section 5.


2. THE BLACKED-OUT DOCUMENTS

In November,2006, several individuals, including Gordon Tait of BMO Capital Markets, make an Access to Information Act request to obtain the information used by the Department of Finance Officials to calculate the “tax leakage” of $500 million in 2006. On December 12,2006, the Department of Finance provided some 25 pages of material to Gordon Tait and others in response to their ATI Act requests. See Appendix A.

Brent Fullard, the President of the Canadian Association of Income Trust Investors, describes the blacked- out documents he received from Gordon Tait as follows:

Page 000 Cover page

Pages 001-016 Various analyses in which row and column headings are visible,. and body of analysis is 100% blacked out

Pages 017-021 Input data concerning what appears to be all the outstanding
trusts in which EBITDA/Interest/Dist[ribution] data is blacked out for about
half the companies, ie, pages 017 and 018, but not the other half, ie, pages
019 - 021

Pages 022-027 More input data, none of it blacked out. Again, concerning
what appears to be all the outstanding trusts Title: Summary of 2005
Distributions Tax Treatment. This is derived from a non government source (
I believe CIBC) in a report called 2005 Tax Report - April 06, 2006

Page 028 More input data. Sheet has logo of CIBC. This is also not blacked
out. Has only selected trusts from the Power & Pipeline sector and the Oil
and Gas sector. Contains CIBC's 2006 estimated Distribution.

During his testimony before the House of Commons Finance Committee on January 30,2007, Fullard, said: “ it's amazing how much the redacted documents that we were provided under the spirit of the Freedom of Information Act [sic, Access to Information Act ] actually do reveal as to the methodology.”

The putative reasons for the secrecy was explained by a finance official (Mr. Lalonde ) before the Senate National Finance Committee on June 19,2007 as follows: “ As a department of the Crown, we are subject to the Access to Information Act. We spend an inordinate amount of time dealing with access to information requests. We also have to comply with the provisions of the Access to Information Act……

Senator Ringuette: We broadened the provisions so that Canadian citizens could have greater access.

Mr. Lalonde: As I was saying, one of provisions of that act is section 69, which is not a discretionary provision. It is a mandatory provision that talks about cabinet confidences. To the extent that there is information in documents that relates to legislation or pending legislation or advice to ministers for particular use by ministers, that cannot be released. The law says that it cannot be released. It is not a discretionary exclusion or severance; it is a mandatory exclusion. We have to comply with the law.

Senator Ringuette: I understand that you have to comply with the law. However, I do believe that if the minister refers to such a document publicly, then the document should become public. I understand that you are not political people, and I respect that, but there is a balance in the transparency and accountability process. Perhaps we will soon have another bill. I know that not all the provisions in Bill C-2 [ the budget implementation bill ] are in effect yet, even though it has been quite a few months since we passed that bill.


3. THE SECRECY GAME RE THE INCOME TRUST TAX ISSUE IN 2006

Here are the main tactics used by the federal government to maintain secrecy over the largest possible domain with respect to the income trust tax issue.

•Did not hold any form of public consultation process in 2006 as the previous government did in 2005).

•Put less information on the estimate of federal revenue losses for 2006 (in the “Backgrounder” of October 31,2006 ) than was put out for 2004 in the “Consultation Paper” of September 8,2005 when the Liberal Government was in office. But this was largely remedied by the News Release of January 30,2007 to accompany the testimony of the Minister before the Commons Finance Committee on that date.

•Respond slowly as possible under the Access to Information Act rules and reply beyond the statutory deadline if the issue needs more time to cool down politically.

•Interpret the ATI Act in the most restrictive fashion when dealing with requests regarding the income trust tax issue. Or, flood the person requesting information with as much irrelevant material as possible. See Appendix A for November 29,2007 and February 2008.

•When replying to ATI Act requests, black-out all the key data and calculations. Do not provide details of the model or assumptions.

•Make sure no spokesperson ever describes how the estimates of tax leakage were calculated, and make sure they do not respond frankly to questions about the analyses done by others. [Note, however, that the Minister said in his testimony before the Commons Finance Committee on January 30,2007 that the methodology used to calculate the “tax leakage” for 2006 was the same as that used to prepare the estimate for 2004.]

•Let the critics reason, or rant, but never give up any information that might validate their criticisms. Stonewall, stonewall, stonewall. Richard Nixon would be proud.

•Have the “feisty” Minister of Finance attack the critics, or more frequently ignore them.

•Promote the key senior Finance official to a better, higher-paying job ( Governor of the Bank of Canada ) where he can’t be questioned or if someone rudely does so, he can shrug, smile and say, “No comment.”


4. SECRECY RE METHODOLOGY, DATA, ASSUMPTIONS RE “TAX LEAKAGE” IN 2006?

In March 2004, Dennis Bruce’s (HRD/HLB Decision Economics) study for the Canadian Association of Income Funds: showed that Finance’s standard operating procedures did not include present value of taxes on income trust units in tax deferral accounts like RRSPs; showed that what Finance’s method showed was a revenue loss due to income trusts instead of business corporations was a net gain; and included a sophisticated sensitivity analysis using Monte Carlo simulation to calculate the probability of the net effect on tax revenues being negative (or positive).

During the summer of 2005, Bruce worked with Finance officials on the methodology, data and assumptions to estimate the tax consequences of income trust versus regular business corporations. a)They agreed on almost everything; b) They disagreed about whether the present value of the personal income tax on income trust units inside RRSPs should be included. Finance said no. Bruce said yes. c) This difference in methodology produces highly significant differences in the estimates of the effects on federal revenues. Indeed, it can turn a large negative effect into either a “wash” or even slight positive effect on revenues.[cite data from Bruce 2004 study ] d) The interaction with Finance showed Bruce the big difference in Finance’s “annual budget” approach versus his broader “policy analysis” approach. e) Both Finance and Bruce failed to look at effects on provincial tax revenues and – as importantly – at the re-distributional effects across provinces.

In the Goodale Round, the Finance “Backgrounder” of September 8, 2005 gave considerable details regarding the calculation of claimed federal revenue loss for 2004. [Note: at that time the phrase :tax leakage” was not used by Finance.]

In the key table, Finance provides the assumptions about the key data used in calculation. Finance shows the tax effects for each of four types of flow through entities. Finance does a sensitivity analysis of revenue loss based on different assumptions. Finance does not include the p[resent] value of deferred taxes.

In January 2007, in response to criticisms about failing to release the details re methodology, data and assumptions, Finance officials (and the Minister) emphasized that the estimate of “tax leakage” (a new emotive term introduced in the October 31, 2006 announcement) for 2006 was done using the same approach as was used in September 8, 2005 Consultation Paper (and Backgrounder).The implication was that the Liberals had used that methodology to make plans to tax income trusts in 2005.

It seems reasonable to believe that Finance officials knew that even with the heave redacting (blacking-out) on the 25 pages of documents released in December 2006 (in response to several ATI Act requests), that at least some analyst’s – and certainly Dennis Bruce – would be able to tell that Finance had continued to exclude the present value of personal income tax revenues from income trust units in tax deferral accounts such as RRSPs.

So why the secrecy in 2006? Here are some possible explanations:

a)Arrogance – both by Finance, but more likely by the Minister and the Prime Minister.

b)Providing the details would shine a light on the lack of public consultation process in 2006 versus 2005 when the Liberals were in power.

c)Providing the details would confirm with certainty that the methodology was seriously flawed. If it was proven flawed as Bruce has indicated, then the “huge tax leakage” argument falls. But it was the core stated rationale for the huge tax on income trusts!

d)“Fuzzification” and uncertainty is a powerful tool for a Government hell bent on a policy for reasons it does not want to disclose.

e)The Minister of Finance did not want to provide any support for his main argument against the income trusts, namely that they had a lower re-investment rate and so reduced productivity growth.


5. COSTS OF UNNECESSARY SECRECY

The biggest costs of unnecessary government secrecy are the following: It facilitates poor analyses of proposed government actions. It covers-up ex post analysis of government programs that reveal waste, corruption inefficiency and lack of efficacy. Such secrecy facilitates the cover-up of shoddy analyses which led to poor (even spectacularly bad) decisions by ministers, cabinet, PM. It helps to foster a “culture of mediocrity” in the policy analyses done by government officials. There is no peer review by independent outside experts. And the policy analyses tend to incorporate political factors and to muddy the important distinction between efficiency (or efficacy) and distributional effects.

Appendix A

Chronology re Secrecy Issue, 2006-2008

November,2006: Several individuals, including Gordon Tait of BMO Capital Markets, make an Access to Information Act request to obtain the information used by the Department of Finance Officials to calculate the “tax leakage” of $500 million in 2006.

December 12,2006: The Department of Finance provided some 25 pages of material to Gordon Tait and others in response to their ATI Act requests.

December 12,2006:The ATI Act was amended in an effort to reduce the scope of the greater secrecy authorized ironically by the Federal Accountability Act.

January 23, 2007:The headline of Steven Chase’s article in the Globe and Mail is “Finance refuses to divulge trust data.” In response to Gordon Tait’s (BMO Nesbitt Burns) ATI Act request, Finance released 13 pages that appear to detail the calculations, but these were heavily blacked-out so only the columns and row headings were revealed. Another 12 pages were less heavily censored – details of distributions by income trusts – information already in the public domain. The justification given for the censorship was the provision in the ATI Act which allows withholding data “which could reasonably be expected to be materially injurious to the financial interests” of the federal government. The law makes it clear, however, that this is a discretionary provision, not a mandatory one. Finance’s second reason: it is allowed to keep secret advice provided to ministers.

Mr. Tait was quoted as saying, “Do they feel they can’t substantiate the tax loss claims that they have made? I can’t find another reason why you wouldn’t make it available.” The “tax leakage” argument was central in the Finance Minister’s explanation for the new tax. Tait said “What we want to know is how they took information and processed it to come up with these losses so we know if its valid or not.” Brent Fullard of CAITI called the failure to disclose “a joke.” They’re treating it like somebody’s private health records or bank account details.”

January 24, 2007: CTV.ca News Staff: “Ottawa won’t show details of income trust figures” (posted on Brent Fullard’s blog, February 20, 2008).

February 8, 2007: Liberal MP, and the party’s finance critic, John McCallum, states that despite the release of close to a thousand pages of documents pursuant to ATI Act requests, there is no evidence of the information and calculations on which the Minister of Finance relied in making his October 31, 2006 announcement.

April 16, 2007: A Finance Department official (Kathy Wesley) sent a letter to a CAITI member,to Gordon Tait and others requesting that some of the information released by Finance to him (on December 12, 2006) be returned and not disseminate it further. She said PCO had determined that “portions of the released information, namely pages 1-5 and 9-21, are confidences of the Queen’s Privy Council of Canada.” Tait complied even though all of the documents had been posted on the Internet in December 2006.

May 14, 2007: CAITI has a double-page ad in The Hill Times: “If Finance was Wrong” then how can Flaherty be Right?”

September 9, 2007: On his blog, Fullard said NDP MPs sent letters to constituents saying the party’s Finance critic “is confident that the government’s estimates of future tax leakage are accurate.” He asked how NDP finance critic Judy Wasylycia-Leis could be confident in light of the refusal of the government to disclose its methodology, and the inferences many analysts drew from the parts of the 18 blacked-out pages that were not covered up.

November 29,2007: Liberal MP and finance critic John McCallum filed an ATI Act request for the estimated tax leakage if the corporate income tax rate is 15%,not the 21% rate used in the Finance estimate released on October 31,2006. See response in February 2008 below

December 7, 2007: The Green Party called for a public inquiry into the Finance Minister’s unproven allegation that income trusts result in a loss of tax revenues to Ottawa. Finance has provided no evidence to date. After supplying heavily blacked-out documents in response to an ATI Act request, the government has asked for them to be returned. The press release also referred to the study of takeovers of trusts by Deloitte, released the same day.

December11, 2007: The Liberal Party calls for a public inquiry regarding the Harper government’s tax on investment trust distributions.

December 24, 2007: Brent Fullard received 340 pages of documents (at a cost of $193) under Ontario’s access to information law. The documents dealt with allegations made in a letter from Ontario’s Minister of Finance Greg Sobara (in January 2007) that Ontario was losing tax revenue as the result of income trusts (the conversion of corporations into income trusts). Many of the documents were copies of studies already in the public domain. But then there was the memo by Brian Lewis (in Finance Ontario) called “Net Revenue Impact of Income Trusts.” He concludes Ontario was losing $38 million p.a. in tax revenues. Yet Ontario supported the 31.5% IT tax. [Owen stated that 37.7% of trust investors reside in Ontario.] Note that when compared to Ontario’s total tax revenues - $38 million p.a. is a rounding error.
February ?, 2008:The Department of Finance replies to Liberal finance critic John McCallum’s question of November 29, 2007. Here is a summary of the response.

The Tax Fairness Plan was necessary due to “troubling trend of acceleration of companies to income trusts” – more than $70 billion in conversions taking place or announced in the first 10 months of 2006. Some were purely to avoid paying corporate income tax. Federal and provincial governments feared hundreds of millions in revenue losses. Answer also said that John Manley and Sheila Copps (prominent Liberals and both former Deputy PMs) favored the action taken by the government. The response noted that the new tax will not hit until 2011 tax year.

The response concludes with a “gotcha” by quoting Mc Callum’s remarks on CTV on November 5,2006. Then McCallum had said that the tax decision removing the distortion was “absolutely the right thing and [former Liberal government] had started on this tract to protect the tax base, to ensure tax fairness and to work for the productivity of the nation.”

Note that the response never actually answered Mc Callum’s question—because it involved a hypothetical calculation. [Note that Dennis Bruce did this and found that by failing to take into account the already announced cuts in the federal corporation income tax, Finance had substantially overstated the so-called tax leakage. And every one of Finance’s five omissions had the same effect!!! See his testimony of February. 1,2007 before the Finance Committee.]

February 29, 2008: The four Liberal members of the Commons Finance Committee called on the Auditor General to investigate the government’s claims of tax leakage caused by income trusts. John McCallum said the “stonewalling has gone on long enough…” A direct request by the Committee to Finance to see the data resulted in “two thick binders of superfluous information that did not contain the data or methodology originally requested.” (See Fullard blog of same date.) The Liberal members’ press release review other efforts to get this or similar information.

March 19, 2008: Financial Post columnist Diane Francis’ blog entry is “Energy trust tax: “dumb and dumber.” She argued that the 31.5% tax on income trusts “is the single biggest reason the Tories have not, and cannot get a majority at the polls…it devastated and alienated their base.” Energy trusts have joined the Liberals in asking the Auditor General to investigate the Minister of Finance claims about tax leakage. About 20% of the 33 energy trusts have been acquired by foreigners. Flaherty’s point about tax leakage, she said, was debunked by a report by Deloitte Canada a few weeks ago.[ that study was released on December 7,2007. ]

May 2, 2008:A news story headline: “Tories kill access to information data base.”