Monday, March 22, 2010

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.


Dr Mike said...

I just hate it that the government was never held to account for this so-called tax--they were allowed to black-out the proof , call it "fairness" , "leveling the playing field" & get away with it.

Never once has the little investor been taken into account here--we were left twisting in the wind with no-one to look-out for our backs.

Where were our local MPs??

They were voting party line with no understanding of the facts--they didn`t care anymore than the Harper`s & Flaherty`s of the world.

A pox on them all & I hope some day they will come to fully understand what they have actually done.

Dr Mike Popovich

Anonymous said...

Brent, I am quite familiar with options, but do not understand the difference between these two.............marketplace settled??? Cash settled??

Thks Colin

CAITI said...


Turns out these corporations were double dipping where the options were cash settled with the employer, in which the employer paid in cash to the employee the gain that had been realized on the stock, and the employer got the expense deduction on the gain and the employee received capital gains treatment on the cash settled gain. The employer deduction has been eliminated, but not the capital gains treatment for the employee. Marketplace settles is the term I used to describe the alternative means of settling the option, i.e. By selling the stock in the marketplace to realize the gain. Under both situations, the capital gains treatment had been preserved...which is grossly unfair to all taxpayers who pay full taxation on their employment income and only get the capital gains benefit when they actually have capital at risk, which is not the case with employee stock options.


Stan said...

Hi All,

I suggest we start planning our "strategy" for the coming election. We should canvass our membership and solicit their financial support for a Media blitz on informing the Canadian Public on this Gov't record and action on a number of issues affecting Canadians. I could easily make a list of 15 items which were a complete reversal in "stated Gov't policy" i.e.Senate appointments,Income Trusts,Fixed election dates, etc. Our focus should be on democratic core values that are being threatened.
* Honesty
* Integrity
* Transparency
* Accountability
If each of the 2.5 million investers that were affected by the Income Trust decision contributed $100.00 dollars to a fund to inform Canadians we could raise $250,000,000.00. WOW
It is obvious that the media are not prepared to tackle this issue, and it is my opinion that they have been threatened and their employment status is at risk.
If we paid for our message and it was very professionally crafted and of empecable moral and ethical standards with no attacks on individuals the media would have no choice but to air it.If they still refused we could use the courts to resolve this issue. It is important that Canadians be informed, because we are all affected by undemocratic practices.Certainly none of the Political parties are prepared to hold the Gov't to account and the press are obviously shackled.
What do you say? Lets use our collective energy and brain power and just do it, and prove that the power is still in the hands of the people.Our approach should be viewed as concerned Canadians and not have any attachment to any political parties. Perhaps we could solicit the support of concerned and informed citizens like Paul Szabo, Diane Francis and all the professional accounting and Investment firms and business's which support our position on the Income Trust. I believe we could assemble a formidable team to give the message. I am willing to contribute both the money and time to make this happen.
What do you think?