Thursday, November 09, 2006

"Black Wednesday" for Canadian Trusts

If have any Canadian trusts and you're wondering what happened to them on Wednesday, November 1, just remember that the best oxymoron is "I'm from the government and I'm here to help you."

Canadian trusts have been a very popular high-income investment for the last few years. The government of Canada allowed companies under certain conditions to be exempt from separate taxation if they paid out most of their income to investors. So a wide variety of trusts have been created, notably in the oil and gas production sector.

Investing in these trusts has been a relatively safe, conservative way to earn 10%, 15%, and even higher rates of return. This kind of yield is unheard of almost anywhere else. And it gets better: there is still Canadian income tax owed by the investor, but U.S. investors get most or all of it back by simply claiming a credit on their tax return.

Well, it seems politicians can't leave well enough alone. They thought too many companies wanted to get in on the deal. Even though they had previously promised not to change things, the Canadian government torpedoed the market on November 1 by announcing a proposal to start taxing these trusts, starting in four years. This provoked the predictable "Sell first, ask questions later" response, and prices plunged.

The best commentary I've seen on this situation is from the always entertaining and never-at-a-loss-for-words Tobin Smith of ChangeWave. I highly recommend it -- it's entitled O Canada, Are You Out Of Your Mind? (Scroll down the page a little to find it.)

Today a Canadian was telling me about some of the fallout. For example, a guy was in the news who was just about to retire, had saved all his life, and had all his retirement funds invested in these trusts. He lost about $100,000 and his savings are devastated. Now he will have to work five more years before he can retire! Thanks a lot, Mr. Government Man.

(Yes, he should have been more diversified, but either way it still would have hurt him a lot. You generally can't go all to cash upon retirement, or else it won't last.)

Only time will tell how this ends up. I've sold part of my trusts when they dropped to predetermined levels, but have kept others -- so far.

Maybe these guys will eventually come to their senses. Maybe when a lot of jobs start getting lost -- jobs that were created because of the trusts? This is the kind of shenanigans you'd normally expect from liberals (generally speaking, the Democratic party in the U.S.), but from what I understand the proposal was made by a "so-called" conservative.

At least one lesson is clear: higher taxes do not lead to greater overall prosperity; rather, it has the opposite effect (this is merely a particularly dramatic example). For instance, in the U.S., the lower taxes of the last several years have not only helped the economy recover, but also (as was just announced the other day) increased government revenues even more than expected. The result has been a dramatic reduction in the federal deficit, helping every citizen and confounding the opponents of the tax cuts.


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