Hill Times: Flaherty’s two biggest budget blunders

Flaherty’s two biggest budget blunders: half measures on stock options, no measures on income trusts
Failure on the part of Finance Minister Jim Flaherty to correct his income trust fiasco is the economic equivalent of losing 2.5 million full and part-time jobs.

By Brent Fullard
The Hill Times
March 22, 2010

OTTAWA—Since 2007, I have argued that taxing employee stock options gains at half the rate of income is unfair to taxpayers, and counter to the interests of society, since stock options skew corporate decision-making. Others like Roger
Martin, dean of the Rotman School, have drawn similar conclusions as outlined in The Globe and Mail article of May 22, 2009, entitled “Distorted incentives behind the financial crisis.”

Budget 2010 contains measures to eliminate what Finance Minister Jim Flaherty calls this stock option “loophole.” However, Flaherty’s measures contain loopholes of their own, and only apply to options that are “cash settled” with their employer versus the marketplace.

The effects will be clear: all employee stock options will now become marketplace settled as opposed to cash settled.

This will do nothing to address the question of tax fairness, as no logic holds that taxing stock options at half the rate of employment income is any more fair, simply because these options are now being cashed in with the marketplace and not the employer.

This is a distinction without a difference, leaving a huge tax loophole in place and the issue of distorted incentives completely ignored.

If Flaherty possessed vision and leadership he would have made the taxation of employee stock options his number one agenda item at the Iqaluit G7 Finance Ministers meeting, as the means to prevent another global financial meltdown by eliminating
the distorted incentives, principally employee stock options, that caused it.

The adverse consequences inherent in stock options will not be addressed by merely changing the manner in which they are taxed, but rather through their
elimination entirely.

Stock options are a creature of publicly-listed corporations. One form of business model not reliant on stock options is the income trust model that compensates managers for making real economic gains in the business, rather than merely artificial
and transient ones.

Income trusts are a profit-sharing investment vehicle that pays out profits to its owners in the form of monthly distributions that are fully taxed in the hands of investors. To the extent that management increases these distributions to their owners, they participate in those gains, which are real economic gains by their very nature. Contrast this with the corporate manager whose compensation is tied to gains like boosting earnings per share, which can be easily manipulated and share price gains, which often occur for reasons outside the managers’ control. This, coupled with the “no downside, all upside” nature of stock options themselves, and the corporate world of compensation, starts resembling a lottery ticket more than it does a prudent form of compensation.

The faux crisis that arose from the announced conversions of BCE and Telus into income trusts, which led to Jim Flaherty’s irrational knee jerk move to kill the income trust model, along with $35-billion in the value of Canadian’s retirement savings, had nothing to do with the professed loss of tax revenue to Ottawa (since there was no such loss), but everything to do with a group of highly-influential corporate business people who were hell bent on keeping the system of personal compensation that they were so adept at gaming, namely stock options.. So they decided to game the government.

Therefore the “distorted incentives” that were behind the global financial meltdown were also behind one of the worst policy blunders this country has witnessed as described in the article by W.T. Stanbury, entitled: “Leadership? 10 reasons why tax on income trusts a public policy ‘train wreck,’ ”(The Hill Times, Sept. 22, 2008).

Failure on the part of Flaherty to correct his income trust fiasco, whose looming double taxation of retirement income is the economic equivalent of losing 2.5 million full and part-time jobs for the 2.5 million Canadians who are reliant on this essential
source of income, demonstrates that Jim Flaherty possesses neither the compassion nor the competence to be the Finance Minister of Canada and when faced with making easy economic decisions is only capable of taking half measures and no measures at all.

Brent Fullard is the volunteer President of CAITI and one of the 75 per cent of Canadians without a pension for whom he seeks to preserve income trusts as an essential investment choice.

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