Since their earliest days a rogue asset class — a breakaway tax haven from the archaic world of REITs — income trusts have drawn the ire of free-market economists and the capital of free-wheeling investors alike. The former see the structure as an anti-competitive perversion of natural capital flows, while the latter flock to invest in a sea of premium yields. Traditionally, policy makers have been hamstrung by this natural dichotomy, but with their latest Halloween trick, Flaherty and the Tories have taken a bold step toward a fair and open capital market. Baby boomers may cry foul over their lost pot of gold, and socialists may applaud their conservatives counterparts for a rare shot across the bow of a red hot economy, but unwinding this loopiest of loopholes is one experiment in fiscal policy-making whose success or failure still won’t be clear for many years to come.
From pipelines to pizza franchises to airlines to coin-operated laundry machines, income trusts now represent nearly $150 billion of Canadian capital, locked up in a world free of taxation and strategic reinvestment. Critics argue that the structure distorts the distribution of income in the economy, drawing valuable tax revenues away from social services and public research and development. Others complain that an asset class unique to any given market is a competitive burden, in an age of harmonization and commodification across the major bourses of the globe. Still others see trusts as a form of protectionist foreign policy, stymieing competition from foreign companies looking to invest capital in the booming Canadian economy. Whatever the slant, two certainties emerge: 1) myth-busting lobbyists are fanning an already dangerous fire; and 2) flip-flopping politicians have confounded an otherwise straight-forward economic decision.
Theoretically speaking, open, homogeneous and competitive financial markets provide the most capital, liquidity, efficiency, innovation and growth of any existing economic model. Where command or protected economies insulate their domestic stock from foreign competition and investment, open economies tend to flourish with competitive spirit. Where closed markets are stifled by disinterest and debt, open markets have produced 19 of the top 20 economies in the world (both in GDP per capita and across most human development indices).
Given their unique structure and nationality, income trusts are actually a form of protectionism, allowing Canadian companies to remain artificially competitive with their larger, taxable peers. Take the recently proposed conversion of a major phone carrier into an income trust: in paying out substantially all of its cash flow to unitholders, Telus would be less able to reinvest in innovation, and because of its higher distributions, the securities themselves would inevitably trade at a premium to regular, taxable entities. Both consequences are damaging to domestic interests, the former because it draws down taxable revenues at the expense of qualified, specialized technological innovation, and the latter because it encourages any competitors to follow suit.
Responses to the trust debate have focused on many of these considerations, but all seem to hinge on the short-term impact to investors rather than the long-term impact on Canadian competitiveness. Contrary to the belief of many investors on both sides of the border, the news isn’t all bad. For those invested in Canadian markets over the last three years with reasonably diversified portfolios, October 31st was a brief intermission on the road to record highs. The TSX Composite has climbed nearly 72% over the last five years to the heels of a robust market for commodities and a tidy fiscal house. Grumblings about retirement savings from disgruntled investors are only to be expected, but politicians would be wise not to bend to the pressure of myopic policymaking.
As boomers become an increasingly powerful demographic, corporations become increasingly effective lobbyists, and minority governments become an increasingly popular form of political partisanship, there’s a real risk to Canada that band-aid concessions like income trusts will spring up to ease the competitive burdens of a globalized world, stiffling our ability to innovate and lead. Where these groups ultimately fail is not in their instinct for financial self-preservation, but much like the drug addict, in the sub-conscious pursuit of self-destruction.
Ceteris paribus, the loophole needed to be fixed. World markets digested the news, gathered their winnings, and moved on to the next table. If all goes well, future Canadian innovators will follow their lead — or risk leaving the table empty-handed.