Monday, December 7, 2009

Today's Hill Times: Harper's income trust cover-up

Secrecy and cover-ups: the case of the income trust tax
Canada's 'new government' made a fetish of secrecy from the start.

December 7, 2009
The Hill Times

The attempted cover-up by the Harper government concerning what it knew and when it knew it about the possibility of torture of detainees turned over by Canadian Forces to local authorities in Afghanistan continues. Some new tactics have been added to the list published last week (see W.T. Stanbury, The Hill Times, Nov. 30, 2009).

In this piece, I examine an earlier cover-up by the Harper government to keep secret the analysis it employed to support its claims of "tax leakage"—the main stated rationale used to justify the punitive tax imposed on income trusts on Oct. 31, 2006.

Given this tax represented the reversal of an explicit promise by Harper in the 2006 election campaign that he would not tax income trusts (see Stanbury, The Hill Times, Jan. 26, 2009), the government would have been well served by releasing the proof of tax leakage.

Instead, no proof of tax leakage was ever presented by the Harper government. Without the NDP's support the tax would never have passed in the Commons. Yet it accepted the leakage argument without any proof whatsoever. The new tax, a major change in policy, was developed and legislated under a shroud of secrecy. It caused an estimated loss of $35-billion in Canadians' retirement savings. It also resulted in a large number of takeovers of trusts by entities which pay little or no tax, thereby causing real tax leakage.

This case study illustrates the culture of secrecy in Ottawa and explores some of the tactics of the "secrecy game,"(see Stanbury, The Hill Times, June 15, 2009.)

The secrecy game

The main tactics used by the federal government to maintain secrecy concerning the income trust tax issue were as follows:

(i) It did not hold any form of public consultation process in 2006, as the previous government did in 2005.

(ii) The Department of Finance put out less information on the estimate of federal revenue losses for 2006 (in the "backgrounder" of Oct. 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 partly remedied by the news release of Jan. 30, 2007, to accompany the testimony of the minister of finance before the Commons Finance Committee on that date. This was done, however, only after the Liberals and Bloc Québécois had been successful in forcing such hearings over the considerable resistance by the Conservatives, and the NDP.

(iii) The government response under the Access to Information (ATI) Act request was blacked-out. "National Security" was the stated rationale for withholding this information.

(iv) The government interpreted the ATI Act in the most restrictive fashion when dealing with requests regarding the income trust tax issue.

(v) In at least one instance, the government flooded the person requesting information with as much irrelevant material as possible. On Feb. 8, 2007: Liberal MP, and the party's finance critic, John McCallum, stated that despite the release of close to a thousand pages of documents pursuant to ATI Act requests, there was no evidence of the information and calculations on which the minister of finance relied in making his Oct. 31, 2006 announcement.

(vi) No spokesperson for the government ever described how the estimates of tax leakage were calculated. Further, the government did not respond frankly to questions about the analyses done by other credible groups who had concluded that no tax leakage existed when deferred taxes were included, foremost of which were HLB Decision Economics (Dennis Bruce), BMO Capital Markets, RBC Capital Markets and PricewaterhouseCoopers. See below.

The blacked-out documents

In November 2006, several individuals, including Gordon Tait of BMO Capital Markets, made Access to Information Act requests to obtain the information used by the Department of Finance officials to justify their "tax leakage" claims of $500-million per annum. On Dec. 12, 2006, the Department of Finance responded with some 25 pages of material to Tait and others.

Brent Fullard, founder and president of the Canadian Association of Income Trust Investors (CAITI), described the almost entirely blacked-out documents as follows:
"Pages 001-016: Tax leakage analyses under various scenarios, in which row and column headings are visible. However the body of the analysis (i.e. the actual numbers) and footnotes are 100 per cent blacked out.

"Pages 017-021" Input data used in preceding tax leakage analyses, consisting of what appears to be all the outstanding trusts, in which EBITDA/Interest/Distribution data is blacked out for about half the companies, i.e., pages 017 and 018, but not pages 019 – 021

"Pages 022-028: More input data, none of it blacked out. Source is a public research report by CIBC, also includes CIBC's forecasted trust distributions for 2006."

During his testimony before the Commons Finance Committee on Jan. 30, 2007, Fullard (of CAITI), said: "it's amazing how much the redacted documents ... provided under ... the [Access to ] Information Act actually do reveal as to the methodology." He also said these documents showed the government's methodology was grossly flawed, as the analysis failed to include any of the deferred taxes paid on the 38 per cent of income trusts held in RRSPs, the inclusion of which would result in tax neutrality rather than tax leakage. These insights were afforded by the row and column headings that were not blacked out in pages 1-6.

The ability of skilled observers to infer key aspects of the government's faulty methodology may well explain why the government subsequently demanded that these highly redacted documents be returned in a letter sent to all individuals who had received them. Apparently, this is the first occasion where this was done. By this point the cat was long out of the bag, as CAITI had featured these blacked out documents in billboard and bus shelters ads across the country (see Stanbury, The Hill Times, Feb. 23, 2009).

The putative reasons for the secrecy was explained by a Finance official (Mr. Lalonde) before the Senate National Finance Committee on June 19, 2007:

Sen. Pierrette Ringuette: "We broadened the provisions so that Canadian citizens could have greater access."

Mr. Lalonde: "As I was saying, one of the provisions of that act is Sec. 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."

Sen. 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...."
Why the secrecy on the "tax leakage" issue?

In March 2004, Dennis Bruce's (HRD/HLB Decision Economics) study for Canadian Association of Income Funds, showed that Finance's methodology did not include present value of taxes on income trust units in tax deferral accounts like RRSPs. Bruce's analysis, which incorporated the present value of deferred taxes, resulted in a slight net gain in tax revenue as opposed to tax leakage. Bruce's analysis also included a far more sophisticated sensitivity analysis than was done by Finance in 2005.

Prior to the consultative process in the fall of 2005 established by Liberal finance minister Ralph Goodale, Bruce worked collaboratively with Finance officials on the methodology, data and assumptions to estimate the tax consequences of income trust versus regular business corporations. They agreed on everything—except about whether the present value of personal income tax on trust units inside RRSPs should be included. Finance said no. Bruce said yes. 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.

Under Goodale, the Finance "backgrounder" of Sept. 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.) Finance provided the assumptions about the key data used in calculation; it showed the tax effects for each of four types of flow through entities. Finance did a sensitivity analysis of revenue loss based on different assumptions. However—and most importantly—Finance did not include the present value of deferred taxes. This is contrary to sound economic principles as well as being totally inconsistent with the federal government's policy that its accounting be on an "accrual" basis, which would include these deferred taxes, rather than ignore them completely. (In its February 1995 budget, the federal government announced that it would adopt full accrual accounting. The 2002/03 fiscal year was the first time that the federal government's financial statements were prepared on a full accrual basis.). Therefore, the Harper government's tax leakage claims were premised on a methodology contrary to how the government had pledged to keeps its books.

In January 2007, in response to criticisms about failing to release the details regarding methodology, data and assumptions, Finance Department officials (and the minister) emphasized that the estimate of "tax leakage" (a new emotive term introduced in the Oct. 31, 2006 announcement) for 2006 was done using the same approach as was used in Sept. 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, however the Liberals concluded—in the face of an imminent election—in the end that no taxation of income trusts was warranted.

It seems reasonable to believe that Finance Department officials knew that even with the great deal of blacking-out on the 25 pages of documents released in December 2006 that at least some analyst's—and certainly Dennis Bruce—would be able to tell that Finance had continued to erroneously exclude the present value of personal income tax revenues from income trust units in tax deferral accounts such as RRSPs.

The critics of the punitive tax on income trusts foretold with great accuracy the wave of foreign takeovers of trusts that ensued and the associated loss of billions in tax revenue. These included the acquisition of Harvest Energy Trust by state-owned Korean National Energy, and the takeover of Prime West Energy Trust by Abu Dhabi Energy. Such takeovers are completely contrary to the professed purpose of the new tax policy announced on Oct. 31, 2006. They create real tax leakage where none existed previously.


The income trust tax (announced on Oct. 31, 2006) illustrates the high price associated with the culture of secrecy that has been expanded by the Harper government since it came to office in early 2006. Very simply, those in power have far too much opportunity to implement policies with perverse outcomes, or that achieve highly questionable objectives.

Secrecy as practised in all its forms is the antithesis of transparency. It is a means to evade accountability to the citizens. It is highly corrosive to the implicit trust that citizens should be able to have in their government. Is there any doubt that the kind of excessive secrecy practiced in Ottawa degrades democracy?

W.T. Stanbury is professor emeritus, University of B.C.


Dr Mike said...

On one hand we have Dr Stanbury , professor Emeritus at UBC & then we have Jim Flaherty , Lawyer.

Who would you believe??

Dr Mike

Emily Dee said...

And let's not forget that Flaherty was a personal injuries lawyer. What did he know of finance?