Does Stéphane Dion’s promise to cancel the tax on income trusts make sense?

As politicians’ broken promises go, the Conservative government’s decision in October 2006 to reverse course and put a new tax on income trusts was a doozy. The move was so surprising and so punishing for hundreds of thousands of Canadian investors, that it became known simply as the Halloween Massacre. Today, Liberal leader Stéphane Dion announced that, if elected, he would scrap the tax—replacing it with a lesser, 10 per cent levy, which would be refundable for Canadian residents, but not foreign investors. The government would still generate some revenue ($1 billion over four years) while also helping to restore some of the billions of dollars in value the trusts lost when the Conservatives announced the tax, the party says. But while it’s sure to appeal to those still invested in income trusts (particularly retirees who rely on them as a source of monthly income), most observers say the Liberal plan is more political pandering than sound economic policy.

When the Conservatives created the 31.5 per cent tax, which is slated to come into effect in 2011, a number of large corporations, including Telus and BCE, had indicated they would convert to the income trust structure, threatening to take away a massive chunk of government tax revenue. (Income trusts don’t pay corporate taxes, but distribute all their taxable income to unit holders.) It was an unpopular move, but also an entirely necessary one, according to most observers. “There was a significant risk of revenue loss to the Canadian government,” says Lisa Philipps, a professor at York’s Osgoode Hall Law School. “It was a difficult promise for the Conservatives to break but they did the right thing.”

Michael Sprung, president of Sprung & Co. Investment Counsel, didn’t agree with the Conservative decision in 2006, but says reversing course now wouldn’t accomplish much. “For investors who have lost their money, I’d doubt many of the original investors still own these,” he says. More likely, the people who would benefit would be those who bought into the trusts after the implosion, he adds.

What’s more, little has changed since 2006 and the reasons the Conservatives had for introducing the new tax are just as valid today. Not surprisingly, Stephen Harper was quick to announce his government is sticking with its decision. “Any party that is suggesting it will reverse that is not telling the truth. They will find, and they know just as we knew, that they will have to reverse course,” he said.

Dion’s income trust policy was packaged with a host of other proposed tax cuts, $16 billion in new spending, and a vow to keep federal budgets in surplus. “Fiscal discipline is now part of the Liberal DNA,” Dion said. “We were the party that turned a huge deficit into eight years of surpluses and we will continue to put fiscal responsibility first. A Liberal government will never put Canada into deficit. Period.” The announcement may succeed in shifting focus onto the economy (and away from the Liberal’s troubled carbon tax). But the income trust part of the equation has failed to resonate so far, says Lawrence Booth, a finance professor at the University of Toronto’s Rotman School of Management. By midday of the Liberal announcement, the markets had reacted with a big Dion-like shrug. Income trusts were up only about one per cent, notes Booth, compared to the roughly 16 per cent drop they saw two years ago—perhaps a sign that the market doesn’t see a Dion victory in the future, but more importantly that this policy likely will never fly.