Flaherty Kills the Income Trust: Right Thing to Do, But No Good Deed Goes Unpunished

The big political/economic story in Canada, of course, is the Minister of Finance's announcement on Halloween that the Government is going to eliminate the favourable tax treatment of income trusts relative to corporations. The general corporate tax rate is to drop by half a percentage point to make the change (statically) revenue-neutral.

The predictable reaction of the markets was a $25 billion selloff. If your a Canadian and have any investments at all, you almost certainly lost money this week. To make matters worse for the Tories, they specifically promised not to do this in their election platform.

From a policy perspective, this was the right thing to do. Under existing law, the income trusts are tax-efficient, but they are inefficient corporate governance vehicles. The alternative to doing this would be to abandon corporate income tax altogether, and just tax income in the hands of individuals. That wouldn't be an entirely awful idea. There is much that is economically illiterate in the NDP call to faire payer les corporations -- since corporations are fundamentally legal fictions, they can't ultimately bear the tax burden. Only individuals can. But a corporate tax does effectively tax foreign investors in Canadian enterprises and prevents a simple form of tax deferment and tax splitting.

But if the Tories have done the right thing, they are going to pay a political price for it. John Ibbitson's claim to the contrary is not convincing.

First of all, it is hard to imagine a change in government policy with such a direct, immediate effect on the finances of millions of potentially Conservative voters. A good or bad economy may or may not be the work of the party in power. The loss of value in the markets on Tuesday clearly was.

Second, it is easy to point out that the Tories went back on a promise, just as Chrétien did with the GST. From a policy perspective, Chrétien was absolutely right not to eliminate the GST, but a promise is still a promise, and it did him some harm. This will probably be worse, since there is no deficit to point to in explanation, and since the effect is so immediate.

Ibbitson's response is that by getting this out of the way now, Harper can recover later. This analysis misses two points. First, a quick election, before the Grits have their act together, might have been a good deal for the Tories. They don't have that option now.

More subtly, this changes the whole dynamic of a minority Parliament. Harper could act as if he had a majority only because the opposition didn't really want to defeat him and go to the polls. We'll see what Angus Reid has to say, but if it's bad news for the government, then the opposition has the upper hand in the game of chicken that a minority Parliament inevitably is.

Politically, it surely would have been better to tie this announcement to much broader tax relief than Finance is proposing now. But the Government still doesn't know what kind of deal it might make on the diséquilibre fiscale. So it is stuck.

Update: The early empirical evidence isn't kind to my instant political analysis. It appears the Tories are up in the Ipsos Reid poll taken immediately after the Income Trusts decision.