Proceedings of the Standing Senate Committee on
National Finance
Issue 18 - Evidence - Afternoon meeting of June 19, 2007
OTTAWA, Tuesday, June 19, 2007
The Standing Senate Committee on National Finance, met this day at 2 p.m. to examine Bill C-52, to implement certain provisions of the budget tabled in Parliament on March 19, 2007.
Senator Joseph A. Day (Chairman) in the chair.
[Translation]
The Chairman: I call this meeting to order. Welcome to the Standing Senate Committee on National Finance. My name is Joseph Day. I am the Chair of this committee and I represent the Province of New Brunswick.
[English]
This committee's field of interest is government spending, either directly through the estimates or indirectly through bills that provide borrowing authority or bear upon the spending proposals identified in the estimates. Today we are continuing our examination of Bill C-52, to implement certain provisions of the budget tabled in Parliament on March 19, 2007. This morning, the Honourable James M. Flaherty, along with his officials, appeared before our committee.
This afternoon, it is my pleasure to welcome the Honourable Rodney J. MacDonald, M.L.A. and Premier of the Province of Nova Scotia. Mr. MacDonald was sworn in on February 24, 2006. He became the twenty-sixth Premier of Nova Scotia since confederation. Premier MacDonald was elected leader of the Nova Scotia Progressive Conservative Party at its leadership convention on February 11, 2006. On June 13, 2006, he was elected premier by way of a general election, first elected to the legislative assembly in 1999 for the riding of Inverness in Cape Breton. He was re-elected in August 2003 and again in 2006.
Accompanying the premier today is the Minister of Finance, the Honourable Michael Baker. Minister Baker was first elected to the legislative assembly in 1998 and re-elected in 1999, 2003 and 2006, and he has served in a variety of cabinet portfolios. We also have with us Deputy Minister of Finance Vicki Harnish and Assist Deputy Minister Liz Cody.
I appreciate you all being here on short notice. We had this bill referred to us last evening about nine o'clock, and we are already into our second round of hearings on it in committee.
Hon. Rodney J. MacDonald, M.L.A., Premier of Nova Scotia: Thank you very much, Mr. Chairman, and good afternoon. It is an honour to be here.
While I am grateful to have the opportunity to appear before your committee, I deeply regret the need to do so. Having exhausted every diplomatic effort to have the Government of Canada right a wrong, I am here to appeal to the Senate to use all of its power and all of its authority to restore the honour of the Crown by requiring the Government of Canada to honour the terms and conditions set out in the 2005 Canada-Nova Scotia offshore accord.
I will be brief, and I will be blunt. The federal government's efforts to tear up the 2005 Canada-Nova Scotia accord are not only extremely harmful to Nova Scotia, but they do great damage to the reputation of the Parliament of Canada. They fuel public cynicism, create regional divides and cast a dark shadow over the future of our federation. How? By demonstrating to Canadians that the word of their government is to be questioned and the contracts it signs on their behalf are not worth the paper they are written on. These are strong words, I know, but they are words that cannot be challenged when you examine the evidence in black and white, taken against the standard of honour, integrity or legitimate concern for the national good.
Let there be absolutely no misunderstanding. The Canada-Nova Scotia offshore agreement is very clear. There is not a lick of ambiguity in the wording and not a speck of doubt about its intent. The accord was expressly written and specifically designed to support Nova Scotia's efforts to grow its economy and to become more self-reliant and, over time, more self-sufficient. Let there be absolutely no misunderstanding that the federal budget, Bill C-52, is also very clear. Again, there is no lick of ambiguity in the wording and no speck of doubt about its intent. It was intended to appeal to vote-rich areas of the country by rendering null and void signed agreements with Nova Scotia and Newfoundland and Labrador, agreements that are not widely popular either with the federal Department of Finance or with those who mistakenly believe that Atlantic Canada got something special.
Before I respond to that particular and misleading allegation, I want to address what can only be characterized as a deliberate attempt by the federal government to confuse and confound Canadians about the facts of the offshore accord and the effects of the 2007 Budget. Let me take a moment to set the record straight by putting the facts on the table.
Fact: The 2005 Canada-Nova Scotia offshore accord bears the signature of the Government of Canada and the Government of Nova Scotia, two legally constituted authorities under the Canadian constitution.
Fact: The accord is an economic development agreement between the federal and provincial governments and is rooted in the Government of Canada's constitutional obligation under section 36.1, which provides the federal government with the power to further economic development in all regions of our country.
Fact: Clause 4 of the accord guarantees that Nova Scotia will be the full beneficiary of its offshore resources with no clawback of equalization benefits at any time over the life of the agreement, no matter what equalization formula is in effect at any time over the life of the agreement.
Fact: Clause 81(a) of the federal budget strips clause 4 out of the accord by imposing a cap that claws back equalization payments to Nova Scotia without any corresponding compensation in offset payments, in direct violation of the accord.
Fact: The federal government's ultimatum to Nova Scotia to either stick with the accord and sacrifice equalization dollars to which it is constitutionally entitled or opt into the new equalization formula and surrender the full benefits of its offshore resources violates both the principle and the provisions of the accord.
Fact: The Prime Minister has repeatedly said that Nova Scotia and Newfoundland and Labrador are asking him to sign new side deals. Not true. We are asking the Prime Minister to honour an agreement that is already in place, an agreement he did not just tactfully support but actively campaigned on while in opposition, and we thank him for that.
Fact: When he led the opposition, Prime Minister Harper came to Nova Scotia just days before the accord was officially signed and said, "Do not trust the Liberals. They will find a way to claw it back.'' The Prime Minister clearly understood the dangers we were facing in placing our trust in the federal government.
Fact: The federal budget violates not just the spirit and the intent of the accord; it violates the letter of the accord in every way, shape and form.
Fact: If the federal government can tear up its agreement with Nova Scotia, if it can tear to shreds its agreement with Newfoundland and Labrador, it can and likely no doubt will tear up others.
Mr. Chairman, those are some of the indisputable facts and the reason I am here today. I would like now to address some of the urban myths spinning out of the offices of the Prime Minister's and the Minister of Finance.
Both Prime Minister Harper and Minister Flaherty have repeatedly stated that "not one comma of the accord has been changed and that it remains its original pristine form.'' Again, that is absolutely not true, and they know it. The federal government has unilaterally wiped out an entire clause of the agreement — in fact, the most important clause of the agreement, clause 4. The accord post-budget is nowhere close to being in its original form. In fact, for all intents and purposes, it does not exist anymore. If Bill C-52 passes through the Senate chamber without amendment, the final nail will be driven into the casket that holds the Atlantic accord.
The Prime Minister also said that the federal government is being more than generous to Nova Scotia by giving it a choice. We can keep the accord as it was, or we can forfeit the enriched equalization benefits flowing from the new equalization formula. Pick one or the other, he said, adding it was choice between a better deal and an even better deal. Actually, it is more like pick your poison.
Clause 4 of the accord guaranteed Nova Scotia that it would never have to make that choice. Let me repeat that. Clause number 4 of the accord guaranteed that Nova Scotia would never have to make that choice.
Clause 4 reads:
and I quote: Commencing in 2006-07, and continuing through 2011-12, the annual offset payments shall be equal to 100 per cent of any reductions in Equalization payments resulting from offshore resource revenues. The amount of additional offset payment for a year shall be calculated as the difference between the Equalization payment that would be received by the province under the Equalization formula as it exists at the time . . .
Mr. Chairman, neither of the two options the federal government has put on the table comes close to being acceptable, and here is why. Neither of them comes within a country mile of meeting the federal government's obligations as spelled out under the accord.
The difference between option one, the so-called O'Brien formula, and the accord would mean that Nova Scotia would lose an estimated $1.3 billion over the life of the agreement. The difference between option two, the so-called fixed framework, and the accord would mean Nova Scotia would lose an estimated $793 million.
In either case, Nova Scotia stands to lose hundreds of millions of dollars. These are dollars the federal government promised we would have to support our efforts, our determined efforts, to grow our economy, to become a have province and to begin levelling the playing field so that our citizens pay roughly the same taxes for roughly the same services as other Canadians.
Beyond the financial hit Nova Scotia will take as a result of the federal budget, there is something equally if not more troubling to me and to many Atlantic Canadians, and that is the underlying insinuation that we Maritimers want to have our cake and eat it too. Some are suggesting that the accord was some kind of special sweetheart deal others did not get and we do not deserve.
Well, did other provinces deserve their economic development agreements? Again, Mr. Chairman, the 2005 Canada- Nova Scotia accord is an economic development agreement, it is not double equalization.
The accord was meant to allow Nova Scotia to use the full benefits of its offshore resources, resources that have a limited shelf life, to gain some economic momentum and to put us on the road to greater self-sufficiency and to making an even greater contribution to Canada. So why is it that Nova Scotia's economic agreement is under such harsh attack when the financial benefits to our province pale in comparison to so many others across our country? They pale in comparison to the billions of dollars that have gone into supporting Quebec's aerospace industry, they pale in comparison to billions of federal dollars that support Ontario's automotive industry and they pale in comparison to the billions dollars that were poured in Western grain subsidies or the Alberta tar sands.
Just two years ago, when the federal government supported economic federal opportunities in the province of Ontario with a cheque for $5.75 billion, roughly seven times the value of Nova Scotia's accord, Nova Scotia did not object because economic development in one part of the country is good for all Canadians in all parts of the country.
Why is it that just days after the federal budget was introduced, a budget that gutted our accord, Nova Scotia's economic development agreement, the federal government pumped another $900 million into Quebec's aerospace industry and nobody batted an eye?
Mr. Chairman, let me be clear. I do not want anyone around this table, or anywhere else for that matter, to think I am against any of the examples I just cited. In fact, it is the exact opposite. I strongly believe that the federal government has an important role, indeed an obligation, to support economic opportunities in all regions, provinces and territories within our country. In fact, that is what section 36.1 of the Constitution is all about and what our accord is rooted in.
I strongly believe that a strong Ontario is good for Canada and good for Nova Scotia. I strongly believe that a strong Alberta is good for Canada and good for Nova Scotia. I strongly believe that a strong Quebec is good for Canada and good as well for Nova Scotia. I fully support the government's efforts to help Western grain farmers and, despite the fact that we do not have a formal commitment from the federal government to support our Atlantic gateway initiative, I fully support the federal government's investment in the Asia Pacific Gateway.
All of these economic development agreements are essentially federal transfers and for that reason they are not subject to clawback. However, the 2005 accord, also a transfer, is clawed back in the 2007 Budget. In fact, the 2005 accord is the only transfer in federal history that we are aware of that is clawed back.
Mr. Chairman, it comes down to an issue of fairness. It took more than 25 years, five Prime Ministers and a promise by Nova Scotia to put aside its jurisdictional claim over the offshore for us to get where we were on February 14, 2005, the day the offshore accord agreement was signed by the Government of Canada and the Government of Nova Scotia.
Only two years later, in an agreement that was supposed to last at least 15 years, we find ourselves back at square one. By tearing up the Nova Scotia and Newfoundland and Labrador accords, the federal government has sent the wrong message to Atlantic Canada. They have broken faith with the people of Atlantic Canada and have created divisions within our country that will not be settled until the problem is fixed.
Mr. Chairman, I hope you and all members of your committee fully appreciate how much is at stake here, not just for Nova Scotia, not just for Newfoundland and Labrador, but for the future of federal-provincial relations within our country.
For Atlantic Canadians this is about much more than dollars and cents. It is about equality of opportunity for all Canadians, about fairness and respect for all Canadians, about harmony within our federation, and it is about what value we can put on the Government of Canada's signature.
For Nova Scotians it is about a lot more than a political dust-up over a two-page, nine-paragraph agreement between two levels of government. Nova Scotians know that our accord presented a rare window of opportunity to achieve greater prosperity, to provide a better future for our children and to contribute to a stronger Canada. Today they feel betrayed — and so do I.
Mr. Chairman, shortly I will cede the floor to my colleague, Mr. Baker, who will put forward for the consideration of this committee and all members of the Senate amendments to Bill C-52. Before I do, I want to end with a few brief comments and a request.
All of you here today are proud Canadians representing different regions of our country all with the best interests of your fellow citizens top of mind and our nation's interest at heart. Like me, you know that nation building does not begin at the Pacific coast and stop at the boarder of Atlantic Canada. Nation building recognizes and supports the legitimate interests of every Canadian citizen and the economic potential of every province and every territory.
I know that you can make the case that no matter what the federal government does, there is always one province or one region crying foul. Fair enough. However, after hearing the full testimony of the Province of Nova Scotia and examining in full the evidence we put before you today, I ask you to ask yourselves this: Has Atlantic Canada been treated fairly?
I ask you to ask yourselves this also: How can the average Canadian, any other level of government or any other country, for that matter, trust the Government of Canada to keep its word when signed contracts can be so easily dismissed and disposed of?
I urge you to consider our amendments and take whatever steps are within your power to restore the 2005 Canada- Nova Scotia offshore accord and the honour of the Crown.
Mr. Chairman, the issue of fairness for a small region of Canada and Confederation partners means a great deal to who we are and what we think of ourselves. The value of our agreements must be more than here today and gone tomorrow.
The Atlantic accord was designed to last at least 15 years. It will survive about two years unless Bill C-52 is amended. I ask you to consider Minister Baker's amendments that will restore the benefits of the 2005 Atlantic accord, benefits that will put us further down the road to self-sufficiency.
The Chairman: Mr. Baker, do you intend to go over the list of the five proposed amendments or do you just want to make general comments on those?
Hon. Michael Baker, Q.C., M.L.A., Minister of Finance, Government of Nova Scotia: I would like to make some general comments on the nature of the amendments we are proposing, if that would be acceptable.
The Chairman: Yes, that would be acceptable. I would like to ensure that all honourable senators have received a copy of your proposed amendments.
Mr. Baker: We will circulate the amendments in just a moment.
The Chairman: We have the amendments here. We are making copies at this time. We will ensure that all senators have copies.
Mr. Baker: Briefly, we are proposing the deletion of clause 81 of the bill. Clause 81 is a provision that amends the Nova Scotia and Newfoundland and Labrador Additional Fiscal Equalization Offset Payments Act. Clearly, it is our contention that it is not possible to argue that the accord is not affected when you are actually making amendments to the act itself.
That act required that there be the mutual consent of both the Government of Canada and the Government of Nova Scotia. I want to state categorically that, as the premier indicated, the Government of Nova Scotia does not consent to the amendment of the act. Consequently, pursuant to the provisions of that act, no amendments should be introduced.
We would also respectfully suggest that, in order to remove any confusion that may exist regarding the so-called cap on equalization, there be consequential amendments to the bill — and those are the ones that are circulated — that make it clear that the money flowing under the offset payment act is not to be included in calculation of the cap. In simple terms, that is what we are proposing.
We also believe, as the premier indicated, that the payments being made to us are economic development payments within the provisions of the Constitution. It seems the federal Department of Finance feels the same way. I am looking at a copy of today's website of the Department of Finance, and the third bullet down, under "background,'' says:
Offset payments under both the 1986 Accord and the 2005 Arrangement are separate from the Equalization program.
I do not think the federal Department of Finance can be any clearer on their position on the subject than that. In taking the position we are, we are simply confirming the position taken by the Government of Canada in writing on their department's own website.
We believe that there is constitutional protection for these payments as economic development payments. We want no changes to the 2005 act. Again, it required the consent of the Government of Nova Scotia, which they obviously do not have. We would propose the consequential amendment that would clarify the issue by making it clear that in calculating the cap on equalization, these economic development payments are not to be included. In simple terms, that is our legal position.
The Chairman: Thank you very much, Mr. Minister. For the record, and for all the senators here, the last document referred to has a heading "Federal Transfers to Provinces and Territories''; then below that, "Nova Scotia Offshore Arrangements.'' You say that is on the federal Department of Finance website.
Mr. Baker: It was on the federal Department of Finance website today, but it may not be there tomorrow, Mr. Chairman. I would like to thank the webcaster.
The Chairman: I will start with questions. A good number of senators here have a deep and abiding interest in this particular subject. You are available for questioning, so I would start with the critic for Bill C-52, who is Senator Rompkey, from Newfoundland and Labrador.
Senator Rompkey: I will be brief because I want to give as much time as I can to my Nova Scotia colleagues. However, I want you to know, Premier MacDonald, that you are speaking for at least two provinces today — and probably more — because we are with you on this. We suffer just as you do, and we have been wronged just as you have. We share the concerns that you have and we appreciate the fact that you voiced them.
I just want to make two points, and it is important to clarify this because I asked Minister Flaherty this morning if he believed that this was an economic development agreement under section 36.1 of the Constitution, as Senator Murray has pointed out to us time and time again. His answer was that no, he did not. I am very interested to see that it is on the website, because the transcript will show that the minister said clearly this morning that he did not believe this was an economic development agreement.
This has been characterized as an equalization issue. By the way, Prime Minister Harper, before he became the Prime Minister, said that the Ontario cap should never have been brought in. He said it was unacceptable that when we get to Ontario fiscal capacity, we suddenly stop benefiting from an economic development agreement. Others can benefit with other agreements, but we have to stop because we have somehow reached a threshold of the fiscal capacity of Ontario. That is being used as a cap, as a break for us for this economic development agreement. I wanted you to comment on that.
The second thing I wanted you to comment on, because this is important for people to understand too, is that for us — and I suspect for you too — this is perhaps the last window of opportunity. Oil is a finite resource. We will not have it forever; we are going to run out. We need to take advantage of that now to pay down our debt. The first cheque that went to Nova Scotia, as you know, went to pay down the debt. We have the highest per capita debt in Canada; and if we cannot pay down our mortgage, we can never readjust our finances to be the people we want to be and to be contributors to the Canadian economy.
I want you to comment on that, and particularly to make people understand that this is a window that we have to keep open until the oil is gone and we have taken full advantage of it. If we do not, we are going to be stuck as have-not provinces for the rest of our lives.
Mr. MacDonald: Perhaps I will comment on the first question and refer to my honourable colleague for the second part.
The roots of the arguments that have been made around this issue for well over 25 years now have been around that very issue — that this is an economic development arrangement. Clearly, that has been shown — both in some of the background information that we are providing you with today and in the 1985 agreement, the 1986 agreement and the 2005 arrangement.
Unfortunately, this issue has gotten mixed up with equalization. I say that is unfortunate because, as you have indicated, this is a resource that will not be around forever. It is an opportunity for our province to move forward and to be able to spend in areas of the economy and areas of provincial spending that can help our province grow and become a have province.
In addition to that, in the agreement there are also aspects in the framework that mean that if we do not become at some point a province that is receiving equalization — which I very much hope will be the case — we will not be receiving all of those associated benefits. That is clearly articulated in the agreement.
The Province of Nova Scotia, at the time of the 2005 agreement, put the full $830 million toward paying down our debt and legislated it as well. With what is happening today, we will see a clawback in future years of that $830 million that we have already received and put toward our debt, which I believe was a responsible thing to do at the time.
As you mentioned, Newfoundland and Labrador has the highest debt per capita in the country. We have an extremely high debt as well, very close in that regard. Therefore, this is a significant issue for us. Perhaps the Minister of Finance would like to make a further comment with respect to that.
Mr. Baker: Two sheets of paper should have been circulated to the committee — one called "Nova Scotia's interpretation of the Expert Panel Approach with Offshore Accord Protection'' and the other called "Nova Scotia's Position on Equalization and the 2005 Offshore Accord.''
I refer you to point 6 of the latter paper, which says that in 2005, the federal government made an upfront offshore offset payment of $830 million to the province. As Premier MacDonald said, that was applied directly to the debt. Up to the end of 2011-12, under the expert panel approach — the so-called richer of the two approaches — almost $700 million of that $830 million will be effectively clawed back by the federal government.
On the other page, the second set of columns from the end identifies offshore accord payments. You can see that effective 2008-09, with the exception of $54 million, we will be clawed back partially in that year. In the next three years, we will be clawed back $196.675 million, $224.7 million and $219.616 million respectively for a total of approximately $700 million. The assumptions used in calculating the loss to Nova Scotia, based on the value of the offshore accord protection, are based on the federal government's latest estimate of provincial fiscal capacity and disparity and population for 2008-09 remaining static into the future. The only thing that has been projected from our own data is based on the offshore natural resource revenues in the medium term — revenues that we can expect over the medium term. The numbers are based on the federal government's numbers. We did not try to create our own numbers because we thought it prudent to compare apples with apples in the discussions.
The Chairman: Thank you, Mr. Baker. We will hear from the sponsor of the bill in the Senate, Senator Angus, from Montreal.
Senator Angus: I welcome you and commend you for fighting so hard for the good citizens of Nova Scotia, for which I have a certain affinity. My parents felt it important that I live there for seven years to prepare me for living in Quebec. I was quite hardened to the exigencies of being a downtrodden citizen. It is tough.
I am trying to understand your real problem with the budget. First, may I ask you, Mr. Premier: In your view, is there anything, apart from the equalization or regional economic development issue, in the budget that you like?
Mr. MacDonald: I do not mind commenting on that at all. There are some good things in the budget for Nova Scotia, but that is not to say that there are not other issues that we have with the budget as well. One good thing is gateway, which will be a great opportunity for Nova Scotia. However, that cannot be overshadowed by the Atlantic accord issue, which is the only thing Nova Scotians are talking about. As long as our issue remains, unfortunately none of those good things will be talked about on the streets of Nova Scotia. Whether it is around the kitchen table or the board room tables, Nova Scotians are passionate about this. They see the accord as a real opportunity to move forward and they do not want to be an equalization-receiving province; rather, they want to be a have province.
I neglected to mention in my previous answer that this stems from a jurisdictional matter to resolve that issue. Fundamentally, looking at the arguments made, we have been successful, I believe, in large part because this is the right thing to do not only for Nova Scotia but also for the country.
Senator Angus: I hear you. I am glad that you found some good in the budget. As the minister said this morning, it is a balancing act, because he is the Minister of Finance for all Canadians. He pointed out to me, but I do not know whether you would agree, that the budget includes an option such that for 2007-08 Nova Scotia has indicated that it would prefer to have the new equalization formula in order to receive an additional $95 million. Is that a fact?
Mr. MacDonald: Yes, we have opted in for one year. Obviously, you recognize that when we are preparing a budget in a short time frame following a federal budget, we had to make some decisions. That in no way changes the fact that the proposal in Bill C-52 goes against the agreement that was signed, in good faith, in 2005.
The language is clear and it is not a long document. The issue before this committee and the Senate will be this: Do you believe that Nova Scotia and Newfoundland and Labrador have been wronged in this? I believe that we have been wronged.
Senator Angus: That is fair. We respect your opinion. I am right in saying that you have already opted for the new equalization formula for 2007 and 2008.
Mr. MacDonald: Yes.
Senator Angus: Do I understand your view to be that that rules out your participating under the status quo equalization formula? Obviously, that would make me angry, too, if I did one thing for a small piece of chocolate and then I found there was a much bigger piece chocolate in the other corner of the box.
Mr. Baker: We agree that there is a benefit to Nova Scotia in the first two years of the expert panel approach. We understand that the Government of Canada will allow us to elect the expert panel approach and make a choice in subsequent years, and I have two comments on that.
First, the original offshore accord agreement did not require us to make an election.
Senator Moore: Precisely.
Mr. Baker: That is the whole point: We were not required to make an election. Second, the way the proposed legislation is written, in subsequent years we would have to make an election, thereby putting us under the gun because we would be captured forever in the system that we pick. As you can appreciate, the expert panel's new equalization formula is much less satisfactory to us over the long term based upon the federal numbers.
I find it interesting as a finance minister to know that the Government of Canada has already booked the money that they paid us, $830 million in 2005, which we applied to our debt. As that money is recaptured over the years, revenue will come to them as a result of that because they will have prior years' adjustments. The books are closed so they will have an adjustment for those prior years when they recapture that money. In fact, it creates revenue to the Government of Canada by virtue of an accounting adjustment. The short answer is that we do not think we should have to make an election inside one year.
Senator Angus: I understand that.
Mr. Baker: For this year.
Senator Angus: The reality is that you have a choice and that you made the election that you made in the early days before you had a chance to see what Premier Williams was up to. The big talk around the kitchen tables in Atlantic Canada is this issue. It has become a huge national issue; there is no question about it. I find it interesting. Many of us in this place need to understand more about why we have equalization and how it works, because it is complex.
In the kitchen table discussions in Atlantic Canada, all the good things in the budget, for example for women and girls in Canada and for the environment and other issues, are not getting their fair air time. They are in the budget and many of them will be lost if we defeat the bill.
However, this is what I want to get clear from you, Mr. Premier. I was reading carefully in the Atlantic Canadian newspapers about how you were quite pleased with the budget. Indeed, Minister Flaherty confirmed before the committee this morning that in a phone call two nights ago, you told him you were onside and fine with this. Then, something happened to change your mind.
I know there is a big groundswell. My colleague Senator Rompkey puts it the way I would, too, if I were in his shoes. It is a window of opportunity. There is an emotional wave starting to roll in; we have our life preservers on; and let us go for it. I believe you did change your mind, although I am not suggesting bad faith, sir; on the contrary.
Saskatchewan said that they will sue the feds. I have not heard you say that you are suing the feds. I have not heard Mr. Baker say that he is suing the feds, nor have I heard Premier Williams say that. I am an attorney trying to get my head around this issue. I do not believe there is a strict legal case against the federal government for breach of contract. Would you agree?
Mr. MacDonald: I will comment on something you said earlier in your remarks that is categorically wrong. I have never indicated that we should receive less than the full benefit of the offshore — period, full stop. That should be very clear.
Have I indicated that there are some good things in the budget? Yes, without question. Again, however, I am here today to speak about Nova Scotians being wronged with respect to the offshore accord.
You mentioned that there are two choices. Yes, there are two choices. Neither of the choices we are presented with is the 2005 agreement that we signed. It is great to have choices, but that does not negate the fact that we had an agreement and that that agreement is being broken. We have never veered from that path nor will we veer from that path. We maintain today as we maintained on March 19 — and you can look back at my comments — that, as per our agreement, Nova Scotians should receive and deserve to receive the full benefit of the offshore in regard to that jurisdictional issue.
Senator Angus: I do not want to argue with you on this point because it is complicated, but I think you just said that one thing you were not offered a choice on is the 2005 accord.
Mr. MacDonald: Correct.
Senator Angus: Whereas I understand — perhaps incorrectly — that if you opt for the status quo equalization formula, you have the 2005 accord as drawn without any change. That is my understanding, sir. Am I out to lunch?
Mr. MacDonald: I would certainly disagree with what you are suggesting. I believe that in fact the choices made are not in keeping with the spirit or the intent of the 2005 accord in any way, shape or form. The budget outlines a number of areas and, in the words of my Minister of Finance, it directly impacts the spirit and intent of the Atlantic accord. What we signed in 2005 is not being honoured in this budget.
Senator Angus: In your view.
Mr. MacDonald: In my view.
Senator Angus: Premier, is it your intention to sue? Do you believe there has been a breach of contract? I understand things like spirit and intent because they are subjective. One has their own take on these matters. When you become federal finance minister, I am sure you will not want to be sued for having broken existing agreements. I know the Honourable Minister Flaherty does not want to be sued. I believe the federal government is comfortable with its legal position. Do you think the government is legally wrong in law, strictly jurisprudence?
Mr. MacDonald: It would be a terrible thing if every time a province and the federal government had a disagreement we had to go to court to settle it. I have always believed that the reason for coming before this committee is that the Senate is the chamber of sober second thought. I would hope that you will take a look at the background of this matter and take a look at the history of how these accords were signed. I believe that many people did not look at the history of why we have these accords. I think that history is being lost, unfortunately, in the debate. My hope is that the Senate will make the right decision, honour Nova Scotians and ensure that the Parliament of Canada honours the accords.
Senator Angus: That is great, but I am putting you down as a no for your answer.
The Chairman: Honourable senators, I have allowed a bit of leeway to the critic and the sponsor of the bill. I would now ask you to try to keep your questions short so that all senators, in particular senators from the same province as the premier, have an opportunity to ask questions.
Senator Cowan: Welcome, premier. There are two areas I want to cover. First, I do not know whether you had an opportunity to hear Minister Flaherty this morning.
Mr. MacDonald: Some, yes.
Senator Cowan: He talked about having had consultations prior to March 19, I think with Minister Baker but perhaps with the premier. I would like you to comment on whether or not there were such consultations with respect to the Atlantic accord prior to March 19.
Mr. MacDonald: I will leave that with the Minister of Finance. I did not have discussions with the Minister of Finance in that regard.
Mr. Baker: Obviously, leading into the budget, ministers of finance talk about all sorts of issues. I can indicate to the committee that the position and the message that I and our officials consistently sent to the federal Minister of Finance and his officials was that no modification to the offshore accord would be acceptable to Nova Scotia. At no time, in no meeting, was there ever any suggestion that we would consent in any way, shape or form to an amendment to that accord agreement. Certainly, Minister Flaherty never suggested to me that we would even be asked to do that.
Senator Cowan: Second, I would like to ask you about clause 4 of the Atlantic accord and section 8 of the Nova Scotia and Newfoundland and Labrador Additional Fiscal Equalization Offset Payments Act, which you understand was the act of Parliament that implemented the provisions of the Atlantic accord.
Clause 4 talks about the offset payment being calculated or taking into account the equalization payment that would be received by the province under the equalization formula as it exists at the time. It does not say as at February 14, 2005, or at December of 2004. In the implementation act, section 8 states that when doing this calculation, you must take into account the fiscal equalization payment for the fiscal year under the equalization formula in effect at that time.
We had the minister and his officials here this morning. I put that point to them and said that in my view it was clear. The minister had referred to the equalization program as an evolving program, which was not set in stone at any particular point in time. Obviously that recognized that there would be evolutions in the program.
I asked them to provide a legal opinion or a person who could provide a legal opinion interpreting those two provisions as the Minister of Finance and the Prime Minister apparently interpret them. My interpretation — and I think it is yours as well — is that Nova Scotia and Newfoundland and Labrador are entitled to the benefits of the equalization program as it exists in the year in which you are doing the calculation. It is not frozen at any particular point in time.
I also read to them a quotation, which I am sure you have seen, from an article that appeared in The Globe and Mail this morning by Mr. John Crosbie and Mr. Roland Martin, who will be appearing this evening. They no doubt will have an opportunity to elaborate on it. They wrote:
It would be hard to imagine that in the middle of these fundamental fiscal policy actions by the federal government, Nova Scotia Premier John Hamm and Newfoundland Premier Danny Williams and all of their ministers and advisers would agree to enter into the February, 2005, Offshore Agreement and not insist that any deal protect their provinces against future changes in the equalization program, changes that might cancel out the benefits of these bilateral economic agreements.
Both of you gentlemen were ministers in the John Hamm government. Without breaching cabinet confidentiality, can you tell us what discussions, if any, took place amongst you and your colleagues with respect to whether you were buying into a program as it existed at the time or you recognized that there would be future iterations of that program and that you would want entitlement to those benefits?
Mr. MacDonald: I will start off with a quick comment. At the time, it was very clear to our government and to my predecessor, the Honourable John Hamm, that we would not sign an agreement that included the cap. I read the letter to which you were referring this morning by Mr. Crosbie and Mr. Martin. It was around the time of the flag issue, as well as my predecessor's coming back to Nova Scotia. This was a major issue at that point in time.
As you have indicated, the accord and the implementation act clearly state that it is the equalization formula at the time. We knew that the equalization formula would change. We were aware that there would be a new equalization formula, so we were cognizant of the fact that we needed to ensure that our agreement was ironclad. We believed at the time we had done so. Unfortunately, today we find ourselves in a different position. Perhaps Mr. Baker will want to add to those comments.
Mr. Baker: I was Minister of Justice at the time and I remember reviewing the agreement when it was signed with the Government of Canada. It was clearly the understanding of myself and the Department of Justice that this was covering the equalization program that existed from time to time, that the existing equalization program was expiring and that there would invariably be a new program that would be developed by the Government of Canada, and that whatever program that was, we would have the benefit of the accord agreement to protect us from changes so that we would not be clawed back. In fact, my recollection is that the talks had even broken down at one point because there was a suggestion that there would be a cap, and Nova Scotia, represented by our premier of the day, and Newfoundland as well, were not prepared to sign any accord agreement that involved a cap.
It has been the consistent approach of both the Government of Nova Scotia and the Government of Newfoundland and Labrador that no cap was acceptable.
Senator Cowan: Has the Government of Canada ever provided you with a legal opinion supporting their interpretation of either the offshore accord or the section in the implementation act to which I referred?
Mr. MacDonald: No.
Mr. Baker: No.
Senator Ringuette: Thank you for being here. I have just a comment. This is a 16-month old government, and we have witnessed in these 16 months other accords that have been broken: the Kelowna Accord, child care, Kyoto, not to mention the list of broken promises. As an Atlantic Canadian, I do feel threatened, but in the spirit of collaboration, I will cede my questioning time to my colleague Senator Moore.
Senator Moore: Thank you, Senator Ringuette.
Senator Angus: There is a real equalization formula going on here.
Senator Moore: Thank you, premier, minister and your colleagues for being here. I want to follow up on what Senator Cowan was asking. Had the accord contained a clause dealing with choice, would you have signed it? John Hamm was premier at the time and you were in the cabinet. Would you have signed that document?
Mr. MacDonald: I certainly cannot speak for my predecessor, but there has never been any indication, other than the March 19 budget, that there would be any sort of choice. I would say no, that we would not have signed it. We believe, and it is recognized through the legislation, that we are to be the full beneficiary of the offshore revenues, and we believe that the agreement fulfils the spirit and intent of that.
Senator Moore: This morning, Minister Flaherty was here and he said that the accord was never written in stone. We have a legal agreement, a contract, which a minister of the federal Crown can unilaterally strike down. I find that to be astounding. Perhaps that is a manifestation of the attitude of this government.
I have before me a campaign brochure that was circulated during the January 2006 election campaign, under the name of Stephen Harper, then Leader of the Opposition. In the brochure, he says:
The Conservative Party of Canada believes that offshore oil and gas revenues are the key to real economic growth in Atlantic Canada. That's why we would leave you with 100 per cent of your oil and gas revenues. No small print. No excuses. No caps.
In view of that campaign promise and the situation we are facing today, has Stephen Harper broken his word?
Mr. MacDonald: I will refer that to my colleague, who will go into some of the aspects, but I will make a comment.
Without getting into the political aspects of an election, my being here today is not based on something that came up during the election. It is based on history, on jurisdiction and on a commitment by the Government of Canada, not simply a political party. It is based on the fact that we signed that agreement in good faith.
Senator Moore: I know that. Minister Baker?
Mr. Baker: Very simply, we believe that the Government of Canada had made both a political commitment to us — which, of course, was the signing of the agreement — and a legislative commitment to the people of Nova Scotia, which was the passage of the act. Putting aside the campaign rhetoric that may have been going on by one or more parties in that election, we believe that all parties — certainly major parties, the Liberal Party of Canada and the Conservative Party of Canada — unequivocally supported the accord.
Frankly, I was surprised on the federal budget day when I was briefed after the lock-up by our officials who were in the lock-up. They indicated that the budget had proposed legislation affecting the accord. I was astounded. I understand that our officials were also astounded, because there was no forewarning to Nova Scotia that there would be any suggestion of our losing any benefit that we had been given under the accord. There did not seem to be any reason in law or in politics, quite frankly, for that to happen, and we were astounded.
It is interesting to note that shortly after that budget, when we came up with our initial numbers on how much we might lose if the accord were amended by the budget, the numbers were lower than they are today, but the higher numbers are a result of federal data. I want to make that clear. We received new federal data and we adjusted our numbers as a result of federal data; it was not a situation where we changed our minds. We simply had been given older data at the time the federal budget came out and then subsequently got new data from the federal Department of Finance. The estimates that you see on the sheet that was circulated are based upon the new data that came from the Government of Canada.
Senator Ringuette: You are lucky you got data. We cannot have that.
Senator Moore: In spite of the fact that you did not get what you were promised and what you signed in writing, you are still not prepared to say that the word was broken? I do not understand.
Mr. MacDonald: We are saying that the commitment made to Nova Scotia in the 2005 accord and the commitment made by the government at the time have been broken, yes.
Senator Moore: Thank you.
The Atlantic Provinces Economic Council issued a report last week analyzing the new equalization plan and stating that Nova Scotia would receive $1.4 billion less. I think your figure, Mr. Baker, was $1.3 billion. They are close, I think. The report mentions the fact that Nova Scotia is getting $95 million this year and $64 million next year, for a total of $159 million, and after that it tails right off.
Mr. Baker: We are saying that based on the expert panel number, under the new equalization formula we would lose $1.3 billion. That is correct.
Senator Moore: I would like to touch on an area I did not see in your suggested amendments, the Canada Social Transfer. This budget provides for the distribution to be calculated on the basis of per capita as opposed to the former system, which was a combination of tax points, cash equalization and cash. Under that, this year, our province of Nova Scotia will get $6.5 million, based on the latest Statistics Canada population numbers. Alberta will get $344 million, and over ten years that will be $65 million versus $3.44 billion.
Have you, Minister Baker, or your officials looked at this gap and what it will do to our post-secondary education program in our province? We have been educating the young people of Canada for over 200 years. We are very good at it; this is a business for us. Looking at these numbers, I do not know how the gap can be closed. I do not know how we will not lose our best educators, professors, researchers and students to another province that simply does not need this type of a transfer. Have you looked at that?
Mr. Baker: This program has always been a per capita program. The calculation of how the program was paid out, as you indicated senator, was a combination of tax points and cash, and the new system is entirely cash. We believe the difference between the two formulas will make a difference in Nova Scotia of $28 million. We still will receive more money as a result of the change, but it is $28 million less as a result of the change in the payment formula, not the allocation formula.
The other thing that is a long-term grievance of Nova Scotia with respect to this program is the fact that students are counted based upon their province of origin, not where they in fact receive their education. For example, Nova Scotia for most students is their home. It is where they reside where they go to university for nine months of every year. On the other hand, the province that receives the payment under the Canada Social Transfer is their province of origin, while we have all of the expenses of running our 11 universities in Nova Scotia and all the expenses of providing programming for those students when they are in Nova Scotia. We believe that that is an error in the per capita formula. The per capita formula should be based on where the students actually are. We do not count other Canadians based on their place of origin; we count them where they live. We believe students should be counted the same way.
Senator Moore: That does not address the ever widening gap. Have your officials looked at that? It will happen with regard to the Canada Health Transfer, starting April 1, 2014, when that is switched over to this method. Have we looked at this? It can have a devastating impact on our people and our health care system. Are we all going to move out west to have health care and get educated?
Mr. Baker: Quite frankly, we hope not. We recognize and our officials have flagged for us the difference on the CST and on the CHT when that formula cuts in. We are deeply concerned about it, and that underlines for us the importance of the offshore accord and a fair equalization formula. Equalization is designed to partly make up for the gap created by per capita and based on your taxation ability. Equalization is fundamental, as are, obviously, the accords, and that is why our government is here today.
Senator Murray: The three main questions I wanted to ask have been answered in the presentations of the premier and his minister:
Does Bill C-52 amend the Atlantic accord? The answer is yes.
Did you consent to those amendments as required under the accord? The answer is no.
Is the Atlantic accord an economic development agreement or equalization? The answer is it is an economic development agreement.
I just want to say how much I admire what you have said and the way you have said it. All of your predecessors as Premier of Nova Scotia — and I am old enough to have known quite a few of them — would be proud of the way you have defended the interests of Nova Scotia but also defended a sharing concept of Canadian federalism that Nova Scotia has defended for 140 years, and I am happy about that.
I would now like to have a word from one or the other of you about this insurance policy that was briefly on the table this morning in an exchange we had with Mr. Flaherty. I am not sure whether it is a live issue or whether it is an offer, a decision or an add-on. We will find out from you.
Finally, on the question that Senator Moor was talking about, the Canada Social Transfer, we had an exchange with the officials from Finance Canada this morning, and they were clear in their view that whatever you might be losing going forward by the change to equal per capita funding is more than compensated for by the "enriched'' equalization formula.
I would like to hear from you on those matters, please.
Mr. Baker: I will deal with the latter part first. As everyone understands, post-secondary education programs are fast escalating programs. In answer to your question, the difficulty we have is that we may be getting another $6 million or $7 million as a result of the enhanced Canada Social Transfer, but that in no way is proportional to the rate of increase in the cost of providing those services to our citizens, which gets back to the principle of equalization I alluded to earlier, to provide relatively equal levels of service at relatively equal levels of taxation. We are finding it harder and harder in Nova Scotia not only to provide the services for our citizens that other Canadians expect but also to provide them at a level of taxation that does not further exacerbate national differences.
In short, that is a big problem and we believe that the federal solution, which clearly was to skew the allocation to richer provinces, is unfair to poor provinces.
Senator Murray: I wanted to know about the insurance policy and whether you have bought it or not.
Mr. MacDonald: Thank you for that question. We are not aware of what this so-called insurance policy would look like. It is difficult for us to comment on that. I did hear the Minister of Finance use those words on a few occasions. I believe that the best insurance policy is to ensure that the commitment made in 2005 is kept.
Senator Murray: In other words, to amend this bill.
Mr. MacDonald: To amend this bill. In that way we will all know for sure that the full beneficiaries will be Nova Scotians and Newfoundlanders.
Senator Eggleton: You make a very strong case that the accord has been violated by this budget and the decision of the federal government. I want to return to a couple of principles. One is in the Constitution, and that is that the equalization program is designed to ensure that all Canadians have access to reasonably comparable services at reasonably comparable levels of taxation. Another principle is how that is measured. The O'Brian report, among others, said that the fiscal capacity of a receiving province should not be higher than that of the lowest of the giving provinces.
I accept what you say about the accord being an economic development program, and I accept what is on the website of the Finance Department today about being separate from the equalization program, but how do you reconcile that with these two principles? At the end of the day, if you are measuring fiscal capacity and this economic development measure, the accord, is designed to increase your fiscal capacity, how can you avoid rubbing up against the very principle of not passing the lowest giving province, Ontario, which, also according to Finance Canada, is likely to happen in your case and maybe the case of one other province this year?
Mr. MacDonald: I certainly stand to be corrected, but I believe that our fiscal capacity is about 75 per cent and that Ontario's would be in the range of 105 per cent or 106 per cent.
Senator Eggleton: Currently.
Mr. MacDonald: We have a lot of room for growth in our province, which we want to continue, and we see the offshore accord as part of that growth. There are also provisions within the accord itself that, should we, as hopefully we will — and I believe we will — become a province that is no longer receiving equalization, we would no longer receive the full benefits of that.
Senator Eggleton: Therefore, in the long haul, and perhaps in the short haul, you have no adjustment time. However, you have no quarrel with the argument that once you pass a giving province in terms of your fiscal capacity, that should be the end of equalization?
Mr. Baker: Aside from the accord, which is an agreement we have with the Government of Canada that we believe is sacrosanct —
Senator Eggleton: And it should be honoured, yes.
Mr. Baker: We have never had a problem with that principle, and indeed we have supported it. In fact, one urban myth that has been bandied about is that payment to Nova Scotia or Newfoundland and Labrador under the accords in some way diminishes equalization going to another province. That is absolutely untrue. In fact, as our revenues go up, there is more money in the equalization pot to be distributed among other provinces.
So this is not a situation where the interests of Nova Scotia and Newfoundland and Labrador are in conflict with another receiving province such as Manitoba, for example. The truth is to the contrary. We have no quarrel with the principle, outside of the accord, that equalization needs to be tied to a principle, as you indicated, senator.
Senator Eggleton: I have a question about the CST transfers or the per capita formula. Much has been said about the amounts of additional money going, in particular, to Alberta and Ontario, which, as I understand it, is to try to bring about a balance again within that formula of per capita, which has been out of whack. Ontario, for example, gets $86 less per capita, when both social assistance and post-secondary education are counted, than do receiving provinces. The intent of the federal government is to balance that, and of course there is some adjustment in numbers, which is why the numbers are higher in the first instance.
You have indicated a couple of concerns about this. One has to do with the province in which the person is educated, which sounds like a valid concern. Do you charge additional fees to people from out of province?
Mr. Baker: No. Tuition for Nova Scotian students and students from Ontario, for example, would be the same.
Senator Eggleton: You have a point there.
The other point you made is that the costs might be higher. The Atlantic Institute for Market Studies thinks that the costs are higher in Ontario than in many of the receiving provinces. They say this is because wages are higher in Ontario and costs of real estate and rents, et cetera, are higher. I believe the institute is located in Halifax.
Mr. Baker: In short, one problem that our province has been trying to address, and one commitment of our premier, has been to bring our levels of tuition down to the national average. In fact, university tuitions in Nova Scotia are significantly higher than in other Canadian provinces. That, of course, is a function of our fiscal capacity to provide that. With great difficulty we are beginning to reduce our tuitions and have not increased them in the last year.
I fail the see how that analysis could work out, because our tuitions are higher as a result of the fact that we have many more students and many more institutions per capita than do most Canadian provinces.
Senator Eggleton: That figure was on public services in general, not just education.
Senator Di Nino: Welcome and thank you for being here. I, too, wish to congratulate you for your spirited defence of your position, even though some of us do not totally agree with it.
I come from Ontario, and I am going to make some comments and ask some questions related to my area. My first comments relate to Senator Eggleton's remarks. The principle of all transfers, whether equalization or accords, under whatever umbrella, is to respect the constitutional mandate of equalization. Some provinces, and Ontario is one of them, have expressed concern about the general fairness of this to the have provinces.
Some weeks ago at this committee, Minister Bountrogianni made a very strong statement. She said that every year Ontario sends billions of dollars to the federal government. The problem is we get back less than our fair share. In fact, we get back billions less, which means less money for health care and education, less for transit and highways, and less for job training and benefits, et cetera.
Recently the premier, in speaking about Budget 2007, commented that arrangements that could possibly see equalization-receiving provinces — not provinces that only receive equalization, but equalization-receiving provinces — with a higher fiscal capacity than Ontario's — in other words, they could essentially be wealthier than Ontario — at the same time that we would continue to send payments to these provinces would be unfair. On behalf of Ontarians, of course, we would not support that.
In another statement in a CP release he specifically said, "I hope the people in the Senate are going to pass this budget because Ontarians are counting on that.''
Can you make some comments on Ms. Bountrogianni's statement and the comments made by the premier?
Mr. MacDonald: First, I would go back to our earlier remarks about fiscal capacity and reiterate that we have no issue with ensuring that there are the appropriate guidelines and framework around the equalization formula. The 2005 accord clearly goes to that direct issue if we were, in effect, a non-equalization receiving province. The issue raised by Premier McGuinty as well would be satisfied if the 2005 accord were kept.
Senator Di Nino: Are you suggesting though that you want both the 2005 accord and the new equalization as presented by this budget?
Mr. MacDonald: The 2005 accord clearly refers to the equalization formula of the day, and today that would be the O'Brien formula. In addition to that, we would receive the offset payments as per the agreement.
Senator Di Nino: That would be as well as the arrangements under the accord then.
The Toronto Star — not a particularly strong supporter of our party — made a very strong comment. It said, "Williams and Nova Scotia Premier Rodney MacDonald are upset because Harper's choices deny them the chance to have their cake and eat it too . . .''
I am sorry to be so aggressive on this, but that feeling is prevalent in Ontario and people are talking about it. Are we wrong then? Are you telling us that those who have this opinion are wrong in assuming that you will actually end up with a fiscal capacity greater than Ontario's?
Mr. MacDonald: No, we are not suggesting that at all. We are suggesting that we had an agreement in 2005, an agreement we signed in good faith with the Government of Canada over a jurisdictional issue; it is an economic development agreement, and if Ontario or any other province has an economic development agreement, those dollars would not be included with respect to the calculation, nor should ours be with respect to fiscal capacity.
Senator Di Nino: Premier, are you saying then that the accord should be treated totally separately from the equalization? We do not necessarily agree.
Mr. MacDonald: Exactly, and the agreement also states that, yes.
Senator Di Nino: I have one final comment. Premier McGuinty said that the Prime Minister's job is trying to reconcile those competing interests and do it in a Canadian way, and he was praising the Prime Minister when he said that. Do you disagree with Premier McGuinty?
Mr. MacDonald: I believe it is in everyone's interest that we do things in a Canadian way. I believe that regardless of party affiliation we are all interested in seeing Canada become a stronger country and our provinces be stronger and, as I indicated during my remarks, I think a stronger Ontario, a stronger Alberta, a stronger Quebec or a stronger Saskatchewan, whatever it may be, is good for Canada and is good for Nova Scotia. Obviously you have to have principles around your equalization formula. We have never indicated that we were against any such thing. However, we do believe in the principle of honouring agreements. It makes it extremely difficult, in working from one government to another, to know that you have just signed an agreement that is now being broken and then perhaps be asked to sign another agreement in the future. This is the question on the minds of Nova Scotians; it is certainly the question on my government's mind, and I believe that in order to get past this, the issue needs to be resolved, which can be done through the amendments proposed by our Minister of Finance.
Senator Di Nino: Thank you for that. Obviously governance requires tough balancing acts and decision-making processes. We disagree on this issue, but respectfully, sir.
Senator Cordy: In my questioning last week and the week before to the Leader of the Government in the Senate on the Atlantic accord she said that the accord that was in place the day before the budget is the accord that was in place the day after the budget. Those of us who have read both the accord and the budget know that that is not true. In fact, I agree with Senator Murray that you have certainly clarified that Bill C-52 has indeed broken the deal that Nova Scotia signed in good faith with the federal government.
Mr. Premier, you said that this matter is being discussed at kitchen tables around the province of Nova Scotia. I spent the weekend in Nova Scotia and the discussion is happening in more places than kitchens. I was at one of the universities and people were talking about it there. Wherever I went — to church, shopping, at an official dinner at Province House, at political events on Saturday evening and Sunday afternoon — people were talking about it; and it did not matter which political party people belonged to or whether they were even partisan, they are very concerned and they feel betrayed by what has happened here.
I have two questions. The first has to do with the Prime Minister's attitude that if you do not like what has happened, sue. Should Nova Scotians have to spend our tax dollars suing the federal government because the Prime Minister has broken a promise?
Second, I am not an accountant, not an economist, and not a lawyer. I was a teacher before I came to the Senate. However, I grew up in Nova Scotia. Nova Scotia is a small province, but people in Nova Scotia believe that a deal is a deal is a deal. Why should Nova Scotians have to make a choice between two options, neither of which is the Atlantic accord, which was signed by the Government of Nova Scotia and the Government of Canada? Why should we not believe that a promise made, an agreement signed, should be honoured?
Mr. MacDonald: I will refer that to my Minister of Finance.
Mr. Baker: In short, we believe that they should not have to make a choice. In fact, that was the fundamental deal that was made between the people of Nova Scotia as represented by the Government of Nova Scotia and the Government of Canada on behalf of Canadians. The deal was that they would never have to make that choice during the length of that agreement. It is not an agreement that is perpetual and goes on forever. It is an agreement with a fixed term and a renewal provision based on a determined formula.
While I was not at the same events the senator attended, I was at a fair number of events over the weekend as well, including events for Father's Day, and this was the topic of conversation at both the supper table and elsewhere amongst Nova Scotians, who just do not understand how it is that they are being placed in a position to make a choice. It is fair to say that they are surprised that their government must engage in this debate because they believed when the accord was signed that 100 per cent of the benefit of Nova Scotia's offshore resources would flow to the benefit of Nova Scotians during the term of that accord. People are now suddenly talking and they are very frustrated.
We are determined to set out the facts so that people in other places of this country, not only from Nova Scotia and Newfoundland and Labrador, will understand that there are principles at work that affect them and their lives. The issue is not only about the principles that affect Nova Scotians, Newfoundlanders and Labradoreans. It is also about the people in Ontario, British Columbia or Quebec, where, I might add, they take their commitments by the Government of Canada very seriously as well. They should. That is why we are here today.
Senator Baker: Senator Phalen and I were discussing this matter prior to coming to this meeting. Senator Phalen is, of course, from Glace Bay, Cape Breton, and he is a famous Nova Scotian. He described himself as the godfather of this bill in the Senate.
Senator Angus asked you whether there is a specific legal position that you are in whereby you could sue the federal government. I thought, Mr. Chairman, that we should ask that question with some specificity to someone who was a great trial lawyer in a previous life. Senator Angus used the words "are you estopped from doing something.'' This lawyer won the last case he tried on estoppel. The lawyer I am talking about is the minister we have with us today, Michael Baker from Nova Scotia.
I would like to ask you, Minister Baker, to give your opinion specifically on the following words I will read from the accord. Give your opinion without deciding whether these words prevent the federal government from operating unilaterally, in your personal opinion.
First, we have the memorandum of agreement on the Atlantic accord from 1985. The words in clause 60 are as follows:
Except by mutual consent, neither government will introduce amendments to the legislation . . .
In your opinion, Minister Baker, does this appear to bar unilateral action by the federal government?
Mr. Baker: Yes.
Senator Baker: Second, the Accord Implementation Act of 1987, the words are as follows:
. . . neither Government will introduce amendments to this Act or any regulation made thereunder without the consent of both Governments.
In your opinion, without deciding, does this prevent the federal government from unilateral action?
Mr. Baker: Yes.
Senator Baker: The third quote is from the Canada-Nova Scotia Offshore Petroleum Resources Accord Implementation Act. That act, under the heading of Amendment of Accord, section 7, says the following:
The Government of Canada . . . may, jointly with the Government of Nova Scotia, amend the Accord . . .
In your opinion, does this bar unilateral action on the part of the federal government?
Mr. Baker: Yes.
Senator Baker: Finally, we come to the 2005 Nova Scotia and Newfoundland and Labrador Additional Fiscal Equalization Offset Payments Act, which incorporated those accords into an act. It changed the definitions accordingly so that the same definitions are used in the Canada-Nova Scotia Offshore Petroleum Resources Accord Implementation Act. The Nova Scotia and Newfoundland and Labrador Additional Fiscal Equalization Offset Payments Act states:
The Minister may recommend the making of a regulation . . . only after receipt by the Minister of the approval . . . from the minister designated by the Province for that purpose.
Do these words, in your opinion, bar the federal government from unilaterally doing what that section wants to do?
Mr. Baker: Yes. This is why the honourable senator is the more eloquent of the Baker clan, since I provide such short answers.
Senator Baker: I wonder if Justice Angus could make the final determination. Do they, Justice Angus, have a real case to bring to the courts against the federal government?
[Translation]
Senator Angus: I do not understand the question, but I will take it under advisement.
[English]
Senator Baker: Those are all my questions.
The Chairman: I am glad you were able to discuss those with Senator Phalen beforehand. That has moved things along nicely.
Senator Mercer: Premier MacDonald and Minister Baker, it is good to see the both of you.
Along with hundreds of other people, I was in the room on February 14, 2005, when the deal was signed at the World Trade Centre in Halifax. I never thought I would see the day we would be sitting here having this discussion. I thought when the deal was signed by a Liberal Prime Minister and a Conservative premier that this was written in stone. I am amazed that we are here.
Premier MacDonald, the media has reported over the last little while that you have had ongoing discussions with Minister MacKay, Minister Flaherty and perhaps even the Prime Minister. I am curious. At the same time they were saying that there were no side deals to be had, you were having what the media described as negotiations.
Please clarify for us: Were there negotiations? Are there negotiations? Are they on or off? I interpreted what you said earlier to mean that there was no room for negotiations.
Mr. MacDonald: Following the March 19 budget, because of the impact it had on the accord, I felt it prudent, as my predecessor did in signing the 2005 accord, to have discussions with the federal government to see if this issue could be settled. We were having discussions, but to date I have not seen anything that will ensure that we remain the full beneficiary of the offshore accord.
The simplest way to make sure that the commitment made in that agreement is kept is to honour the agreement itself.
Senator Mercer: I was interested in your comments during your presentation this afternoon. I am a member of the Standing Senate Committee on Transport and Communications, and we are doing a study on containerization. I have a particular interest in the Port of Halifax. You said that you still do not have a formal commitment from the federal government to support your Atlantic gateway initiative. I would have interpreted the testimony given this morning by Minister Flaherty and by his officials to mean just the opposite. I understand there is a pot of money in the budget that Nova Scotia must apply for, whereas there is a separate pot of money for the Pacific Gateway.
I urge you, first, to review the testimony from this morning. Is that still your understanding, namely that we have to apply for this money as opposed to the Pacific Gateway where there is a separate pot of money?
Mr. MacDonald: Certainly we must apply for that money. Much work has been completed in that regard, and it is a great opportunity for our province to move forward with respect to the amount of traffic coming through the Suez Canal from Asia. We have not yet signed any formal agreement, but it certainly would present a great opportunity for our province.
Senator Mercer: We have heard estimates of $1.3 billion or $1.4 billion that would be lost if Bill C-52 were to pass. Minister Baker, have you done any analysis of the positive and the negative side? We will use your number and not the one from the Atlantic Provinces Economic Council. What kind of services would this $1.3 billion provide to Nova Scotians over the length of the accord? That is the positive side. On the negative side, what would we as Nova Scotians be losing? What services would I stop receiving as a resident of Nova Scotia if this bill passed and we lost that $1.3 billion?
Mr. Baker: That $1.3 billion figure is based upon the expert panel approach. If we were to elect into the old calculation method, our calculation is that that amount is lower than the figure. That is for the sake of using the expert panel approach.
In simple terms, it would mean a diminution in the kinds of programs that cost many dollars for taxpayers, and those programs in Nova Scotia include health, education, community service and transportation. The vast majority of our budget is spent on those programs. Those are the kind of programs that would be affected by a loss in revenue to the Government of Nova Scotia.
The government has only two choices, because we are committed in Nova Scotia to a balanced budget. We have seen what happens when you do not live within your means, and we are committed to living within our means. The only choices I would have to recommend to my cabinet colleagues as Minister of Finance would be to raise taxes or reduce programs. Those are the only two choices I have. Quite frankly, neither of those choices is appealing because either I will reduce the kinds of programs that Nova Scotians depend on — health, education, community services and transportation — or I will further exacerbate the taxation gap that exists between Nova Scotia and other Canadian provinces, which affects not only our individuals but also our business climate and our competitiveness with other parts of the country. As Canadians, we all want to see parts and regions of this country flourish. It is impossible to do that with a taxation system that draws disproportionately in particular on business taxation and makes it difficult to attract and keep people. If I am a young person graduating from one of Nova Scotia's universities and I am looking for my future, I have to look at the taxation environment in which I will be living as well as the overall economic environment.
Senator Mercer: That leads nicely to my final question and to follow-up comments that the premier made in his presentation about a healthy Ontario and a healthy Quebec. Premier, would you agree that the honouring of the accord is a solid investment for the contributing provinces of Ontario and Alberta? Is it not a solid investment for them that allows Nova Scotia and Newfoundland and Labrador to come closer to becoming a have province where we will maybe not receive equalization payments in the future? Would it not be wonderful if all of us would live long enough to see us all contributing to the pool? Is this not a solid investment for the contributing provinces?
Mr. MacDonald: I certainly hope that we see that day. Our belief is that this is our window of opportunity to get to a point where we are no longer receiving equalization and become a so-called have province. As I indicated, this represents more than dollars and cents to Nova Scotians. By my estimation, it is a matter of what people would signify as hope to be in that situation where we are contributing to the country rather than receiving in the area of equalization.
Senator Stratton: Coming from the have-not province of Manitoba, I know how it feels, although our premier is quite happy with the new agreement. I want to go back to basics here.
The Council of the Federation, of which your province and all provinces are members, could not strike an agreement or consensus on how to approach this whole issue of equalization. It became an issue that had to be dealt with particularly by the federal government. If the provinces could not make a decision or have an agreement, then the federal government had to do something.
Page 16 of the Council of the Federation's document Reconciling the Irreconcilable: Addressing Canada's Fiscal Imbalance states:
The federal government's 2004 New Framework for Equalization, with its fixed pool of money and fixed escalator, has broken the link between the redistribution of equalization funds and the relative fiscal capacities of provincial governments. The dramatic run-up in the price of oil and natural gas has had a major impact on how we think about Canada's system of regional redistribution, not least the equalization formula. The bilateral arrangements with Nova Scotia and with Newfoundland and Labrador have drawn criticism because they seem to guarantee transfers regardless of enhanced fiscal capacity. All in all, it is fair to conclude that the Equalization program has drifted from its principles and must be tied back to the basic purposes for which it was developed.
That is in your statement to the Canadian public from the Council of Federations.
Having looked at this, I would think that the Prime Minister and the Minister of Finance said, "Okay, we have to return to basic principles.'' Mr. MacDonald, I think you agreed and made that statement clearly. There are hard choices to be made. The difference we are having here is that the equalization is being viewed by the federal government to include the accord, fundamentally. Your view is that no, that is not true, and it is an enhancement that we need to have apart from it.
If you come from a have-not province like Manitoba that does not have oil, you look at this and say, "I think, in a lot of cases, this is not based on principle; it is based on a principle of `we need more in Atlantic Canada.''' I am not disagreeing that you should have the opportunity over time to become a have province, but we see it as skewed when compared to the statement from the Council of the Federation that it needs to go back to a set of principles. Equalization needs to go back to that. The government did that, based on the O'Brien report. How do you reconcile the differences between what you said and what your government agreed to in this statement by the Council of the Federation and what you are saying now?
Mr. MacDonald: To be clear, the report to which you are referring is not Nova Scotia's report but the Council of the Federation's report.
Senator Stratton: Yes.
Mr. MacDonald: We were more than happy to take part in the review of equalization because we, too, believed — as many provinces believed — that changes needed to be made. We certainly put our views forward in that respect. I believe Minister Baker presented some of those views here on a previous occasion.
Again, we cannot lose sight of the fact that, yes, we need a principled approached to equalization, but, outside of that, we need assurance that we maintain the agreement over a jurisdictional issue, which is an economic redevelopment agreement. Unfortunately, the confusion for many people is thinking that the accord and equalization are one and the same when, in fact, the accord should be honoured as it is, as an economic development agreement. The spirit and the intent of that were not only outlined in 2005; they were clearly outlined for many years in previous agreements.
If another province has an economic development agreement with the federal government, then that should be honoured as well. I would hope that your province, if it has an agreement, would find that agreement honoured as well. I am sure you would hope for the same.
Senator Stratton: I am not disagreeing with that. Unfortunately, our province does not have oil. It does not have the ability to strike an accord with the federal government to develop and use that resource. I think the argument on Manitoba's part would be this: Why should you be given special circumstance as a have-not province when we, as a have-not province, do not have that same opportunity? When you go back to basic principles, you have to measure things against a fundamental principle of fairness across the board, that is, across the entire country and not for a region or for a province. Would you not agree with that?
Mr. MacDonald: I would certainly agree with respect to ensuring that all provinces should be given the opportunity, and I think it is our constitutional right to know that the equalization formula that we have to adhere to is the same one that any other province would have to adhere to. Having said that, I do believe that the federal government needed to do a review of the formula. They have put principles in that formula. Again, that issue is separate of the economic development agreement that we signed in 2005 and the history of it. Unfortunately, many people have not looked at the history of how this jurisdictional issue was settled and agreed upon, which resulted in the accords in the 1980s and in the 2005 agreement. It is unfortunate that this is the case.
Senator Murray: Excuse me for interrupting, premier and senator, but my name is signed to that report of the Council of the Federation. I can tell you that nowhere is there any suggestion, any thought or any hint that those Atlantic accords should be overturned by some new equalization formula.
Second, the expert panel report that the federal government commissioned explicitly avoids giving that advice to the federal government. They say, "We will not advise the federal government to upset those accords.'' That is up to the federal government and the signatory provinces.
The Chairman: I assume, Mr. MacDonald, that you accept that position?
Senator Angus: On the advice of counsel.
Mr. MacDonald: Considering that the gentleman who helped write the report is here, I think it is very important that we get clarity on that point.
Senator Stratton: I refer you to page 16 of the Council of the Federation's report, which states:
The bilateral agreements with Nova Scotia and with Newfoundland and Labrador have drawn criticism because they seem to guarantee transfers regardless of enhanced fiscal capacity.
That is where the problem lies with my province and with other provinces, namely, that it gives you a leg up, where Manitoba is out in the cold.
The Chairman: Honourable senators, I have five names on my list of questioners, but we have run out of time. Those five names will be put on the list for this evening when our guest will be Mr. John Crosbie. We will pick up where we left off.
On your behalf, honourable senators, I would like to thank Premier MacDonald, Mr. Baker, Ms. Cody and Ms. Harnish for being here today. We very much appreciate your testimony.
Mr. MacDonald: We thank you for the opportunity, and we hope that you will give some consideration to what we have put forward.
The Chairman: We will get under way with the next phase of the meeting. It is my pleasure to welcome to the proceedings by way of video conference from New York City, Mr. Jack M. Mintz, Professor of Business Economics, Rotman School of Management, at the University of Toronto. He is a visiting Professor at New York University Law School. Dr. Mintz was the former President and Chief Executive Officer of the C.D. Howe Institute until July 2006. In 2002, Mr. Mintz's book, Most Favoured Nation: A Framework for Smart Economic Policy, was a winner of the Purvis Prize for best book in economic policy and runner up for the Donner Prize for best book in public policy.
Dr. Mintz, it is a pleasure to have you with us today.
Jack M. Mintz, Professor of Business Economics, Rotman School of Management, University of Toronto; Visiting Professor, New York University Law School as an individual: Thank you for the introduction. It is much appreciated. I thought it would be best to take a different stance than I have in the past when we have met. Instead of having a set of remarks on the budget per se, I will make myself available for as many questions as possible during the time that we have. I am sure many of you have known my views on a number of issues related to this budget, whether on the taxation of income from capital, issues related to equalization or some of the more hot topics, such as income trusts and interest deductibility on foreign investment. I have commented on all of these issues in the past and have written articles about them for the Canadian public. Certainly, it would be more productive if we had an opportunity to discuss these issues through questions and answers rather than through a presentation on my part about various aspects of the budget.
The Chairman: That will prompt honourable senators to ask questions and we will begin with Senator Mitchell, from Alberta.
Senator Mitchell: I should mention to the chairman and to the committee that Dr. Mintz and I were fellow students at the University of Alberta about 38 years ago in 1969.
Mr. Mintz: We took English together.
Senator Mitchell: I have a number of questions and will begin with productivity. For the better part of the 1990s, Canada faired well, in particular with respect to the United States. Correct me if I am wrong, but of late our productivity has dropped off. Could you indicate your general impressions of how this budget addresses the issue of productivity and perhaps elaborate beyond that with recommendations that you might present that could enhance Canada's economic productivity?
Mr. Mintz: I will begin with a small correction on productivity. Canada has had a challenge vis-à-vis productivity for some time now. Our performance in the 1990s was not particularly good. We have done a little better since 1997 after we balanced our budget and were able to cut interest rates. We were also able to grow the economy better than we had done before, in part because the federal and provincial governments got their fiscal acts together. Despite that, from 2001 to 2005, U.S. productivity was still much better than Canada's, even though we did improve during that period. We still have a challenge ahead, of course, and those are some of the things that I have been particularly concerned about.
In my view, there are two significant challenges. The first is to ensure that governments spend money well, because when governments are inefficient, we create problems for the Canadian economy because tax dollars cost a great deal of money to the Canadian economy. If governments do not spend money well, then we will not have the kind of bang for the buck that we hope to get out of the money that we take out of the economy in order to spend on government public services.
The second challenge is to ensure that we have a good tax structure. I have been concerned about our high taxes on capital. Canada still has a relatively high corporate income tax rate, by international standards. Today, the average corporate income tax rate amongst all countries in the Organisation for Economic Co-operation and Development, OECD, is about 28 per cent. Even by 2011, we will have brought our corporate income tax rate down to 30.5 per cent, which is still high relative to the average today, never mind the average three or four years down the road when countries are still continuing to announce cuts to their corporate income tax rates. Not only that, but Canada also has a high effective tax rate on capital, which reduces investment. That has a negative impact on productivity, because one of the best ways to enable workers to grow incomes is to cut taxes on capital. Businesses are able to acquire technologies and are able to invest in the machines and structures required to grow their businesses and to meet international competition head on. To the extent that we have high taxes on capital, that reduces the demand for technology. We have poor innovation in Canada not because we do not have large tax incentives for research and development, because we do have. Rather, it is because we have very high taxes on businesses that use research and development in their normal production processes. That is a highly significant problem that still needs to be addressed in this country.
Senator Mitchell: If you had a choice between reducing the GST and reducing taxes on capital, obviously your priority would be to cut taxes on capital.
Mr. Mintz: Absolutely. Few countries today are looking at reducing consumption taxes because consumption taxes, even though there are some negative aspects to them and one cannot say they are perfect, are really the tax of the future. What we need to do first is enable all individuals to accumulate wealth for their retirement, and having high taxes on savings is not a good idea for them to achieve that.
Similarly, if you want to have more capital investment we need to cut business taxes on capital. We might be able to tax businesses in other ways through user fees or other types of taxes that could be applied to businesses. Taxation on capital is not really the way to proceed in today's world in terms of tax policy and that is where governments are going today throughout the world.
Senator Mitchell: Would you subscribe to doing away with capital gains tax entirely? Is that too dramatic or is that exactly the right solution?
Mr. Mintz: No, I do not believe that you can just eliminate the capital gains tax without changing the overall personal income tax system. In fact, one way you could move towards a consumption tax is by broadening the types of tax preferences we have in the system that relieve savings from taxation. For example, increasing registered retirement savings and pension limits would relieve savings from taxes altogether and whether people get it in the form of dividends, capital gains or interest, it does not matter. It would reduce taxes and move us towards what is called an expenditure base under the personal income tax where expenditure is the difference between income and savings. If you deduct savings from your income then effectively you are paying tax on your consumption, because that is what is left over. When you did save and then you take money out of the accounts you pay taxes on that as well. That is the way we should be moving.
Just eliminating capital gains taxes can create a significant problem in the tax system because people will then try to pay out income in the form of capital gains rather than dividends and that, of course, is a problem we had before 1972 when we moved to a system of capital gains taxation in this country.
Senator Mitchell: How do you integrate all of this with environmental policy? Would you say that tax incentives or disincentives would be the way to go?
Mr. Mintz: I look at environmental taxation as trying to put a price on the environment. In some ways it is like a user fee for the use of clean air and water and other good aspects of our environment. I think one can think of environmental taxation in that framework, just like we think of various user fees or benefit taxes for the use of that environment.
Of course, you have to be very careful about the way that you levy these taxes, because you have to worry about international competitiveness, you have to worry about how effective taxes or tax incentives can be and I think you have to be cognisant about the appropriate way to approach environmental taxation.
I do not think environmental taxation is necessarily the most effective way of dealing with environmental issues. There are other ways of government policies, such as regulations, that might be more effective on the environmental side, but I do not think that it would be incorrect to think of environmental taxation as part of an overall tax system, and certainly the idea of moving away from taxing goods to taxing bads is not a bad idea.
Senator Eggleton: I want to ask you about income trusts. There are two issues on income trusts. One is the issue of promise and betrayal, but I will not ask you about that one; that is certainly the heavy political one.
The second issue is whether this is good fiscal policy. A number of people are saying that the consequences of all of this have been pretty bad. They talk about things like the takeovers and say that this has made a number of Canadian entities easy buyout targets. In fact, Canaccord Adams recently estimated that recent takeovers will mean that $130 million less tax revenue will be collected by the Government of Canada each year. Then, subsequent to the budget or the decision last Halloween, we have had comments such as the one from the Gartner Letter in the U.K., which ranks the income trust taxation decision as "one of the worst decisions ever rendered by a person in a position of monetary authority.'' A comment by Amtelecom Income Fund sums up many of the complaints:
It is interesting that a program which was originally designed to enhance `tax fairness' may end up not only costing the government revenue but ownership is passing from Canadians to foreign entities. I doubt this was the plan. The question now is, how much of this can the government take? Will they admit this was an ill-conceived idea, revise it, drop it or dig in their heels and in the face of the evidence which is starting to build, stay the course and let the foreigners buy up Canadian assets on the cheap?
In addition, we have a number of letters from the energy sector who claim that they should be exempted from those provisions. They cite the master limited partnership plan in the United States as working quite well and they want to do the equivalent here.
What are your comments? Is it a good policy or not?
Mr. Mintz: First of all, let me say that the income trust issue has been around for a long time. When I did the business tax report for then Minister of Finance Paul Martin, our committee actually commented on income trusts as an issue the government would need to deal with. We pointed out two issues that we were particularly concerned about. One was tax leakage that could be faced by the government. This was back in 1997 when we wrote the report. Also, we were very concerned about neutrality in the tax system, the concern being that you could end up getting a large number of companies converting into trusts, and it would be only those that found it particularly advantageous to do so that could give them a competitive advantage over other companies.
I was always very concerned about the neutrality issue and for that reason in 2003 I wrote my first paper suggesting that there was about a $500 million loss in revenue, both in federal and provincial taxes, associated with income trust developments by that point when they had grown quite a bit since 1997.
I was more concerned about the neutrality issue, about the incentive for companies to convert into income trusts. I then updated that analysis last year when I talked about the $1.1 billion revenue loss, and that was taking into account real estate, investment trusts, business trusts as well as the royalty trusts. Again, however, my big concern really was not the revenue issue, because I feel governments have a lot of revenue right now and in fact have been spending a lot of it. The federal government particularly has been running significant surpluses. My real concern is over the neutrality issue.
When TELUS and Bell announced that they would become income trusts, I guess that was really the point when all the sheep were falling over the cliff. I knew that there were going to be a number of other conversions coming along the way and so therefore the pressure was on to do something that would level the playing field.
My view is that I always would have liked to level down business taxes from the corporate world to the trust level, rather than level up taxes from the trust world to the business world. That is why I always recommended having a refundable dividend tax credit, which could equally apply to taxable trusts as well, as a way of trying to give pension owners and RRSP owners the corporate tax that has been deducted from the distributions that they receive, either on corporate securities or on income trust securities.
My preference would have been that we went one further step than what we did last October, where we levelled the playing field between trusts and corporations. We just simply made the trusts taxable, as opposed to contemplating a much more significant change in the tax system that I think would have been very beneficial to people trying to retire, as well as making it even better for businesses to raise capital in the market and to therefore get relief for what I thought are relatively high business taxes. That still is my preferred solution.
I have to admit, senator, that I have not liked the Liberal solution that has suggested putting a 10 per cent refundable tax on trusts. It still maintains a significant advantage for trust conversions in the long run for pension plans and RRSPs and foreign owners, and it is not a very good way of trying to approach the issue. I think we need to look at a wholesale change in the tax system that will not only drive the economy in terms of more capital investment, but also allow savers to get higher returns.
The demographic changes coming in the future will make it imperative that Canadians can accumulate capital for their retirement years. Otherwise, governments will be facing huge pressures to fund people in their retirement for health care, pensions and other things, which will be on the backs of those working at that time. Twenty years down the road, there will be a smaller group of people working relative to those who are retiring.
Senator Eggleton: What approach would you take now in the short run to correct the more severe aspects of this budget provision? Also, could you comment on the energy trusts and the similarity to the United States' master limited partnerships? Do they have a case?
Mr. Mintz: First of all, I would not have had a problem if there were a 10-year transition, as the United States did with the master limited partnerships in 1987. However, you have to remember that the difference between the United States and Canada is that the U.S. moved very quickly on conversions in stopping the erosion of their tax base. It all developed in 1986 with tax reform; and in one year, the government had put an end to it in the United States. We took many years to deal with the issue and I think that as a result it was much more difficult.
When I tell people here in New York that almost 20 per cent of the Toronto Stock Exchange was converted into trusts, they find it unbelievable that we have allowed that to go on for so long — particularly potentially having telecommunications companies becoming trusts. They would have never tolerated that here in the United States.
In fact, even today, with the debate over private equity in the United States, we are just now talking about one fund that has become public, which is Fortress, and another one, Blackstone, that is proposing to become public. Already Congress is looking at a way of dealing with it, which is to make these limited partnerships taxable, just like what we did in Canada with a transition period up to 2012. The problem in Canada is that we let it go so long that it made things much more difficult. That is why I think maybe a 10-year transition would have been at least somewhat helpful in relaxing some of the impact.
As for the exemption for energy, I do not like even the exemption for real estate trusts, never mind energy. I would have made it completely neutral and put an end to it all. As soon as you allow one sector to have trusts, what is the argument for not giving it to another sector, like the film industry or whoever? My preference would have been to simply put an end to the whole trust situation entirely and go to the kind of system that I have been advocating as a much more preferential way of dealing with the issue.
In the case of energy trusts, in the United States there is an exemption for oil and gas and a couple of other industries that get included under their exemption. However, we have to remember that if you take away the real estate side in the United States, I forget the exact number but it is around $60 billion to $70 billion in master limited partnerships in the oil and gas industry, which is pretty small relative to the U.S. economy. In Canada, the difficulty is that if you had an exemption for royalty trusts, it would be pretty large relative to the Canadian economy, which makes it much more difficult to provide an exemption in that case.
Senator Stratton: I want to go back to the question of the new equalization that has been proposed by the federal government. As we all know, equalization had really gotten into trouble. Even the Council of the Federation, which is made up of all 10 provinces, could not arrive at an agreement or a consensus at all.
The council did state that equalization had to return to principles, that it had to be based on principles. In the government's view, that is exactly what we did. Of course, we met with Premier MacDonald of Nova Scotia, who is saying no, you did not. We are in a conundrum with respect to two Atlantic provinces versus what the federal government is proposing.
Could we have your comments on that?
Mr. Mintz: Yes, it is my pleasure. First, I thought the O'Brien report was very good because it would move us back to a principle-based approach to equalization. It did make some political tradeoffs to try to satisfy at least some of the conditions that people were looking for. I will talk about the issue of resources in a moment, because I think that that was really the most difficult issue that had to be dealt with.
With respect to what the government actually did in the budget, I think they went beyond the O'Brien report to help Nova Scotia and Newfoundland by satisfying the conditions of the Atlantic accord. Frankly, if I were the Prime Minister, I would never have negotiated that Atlantic accord in the first place. I think a lot of mistakes were made in developing that accord. However, I think it was quite appropriate for the government at that point to agree to give what was promised to Nova Scotia and Newfoundland and Labrador regarding the Atlantic accord.
It is very clear, in my view, that it was wrong in principle to ever think that resources should be taken out of the equalization formula. We got off on the wrong track. Some people concluded that somehow it was wrong to include resources because every time a province tried to develop its resources, it would end up getting clawed back through lower equalization payments and the province would get very little money out of the royalties that they were able to collect.
That is a problem, but it is a problem with respect to all the taxes that are under the equalization formula. In fact, when I spoke to the provinces 10 years ago, I found that many of them did not want to cut corporate rates when they received equalization payments. They would end up not only losing corporate tax revenues, they would also lose equalization payments under the way the formula operated. Therefore, that was a real tax on growth and an issue that I think we still have to deal with under the system.
With respect to resources, I do think there is one very important argument for why equalization should not apply to resources, which is that it is an asset in the ground and if the government sells that asset in the ground and puts it into a bank account to earn interest, it is not changing anything. It is getting the same financial income in principle as it would holding the asset in the ground. One can argue that if a government uses resources either to pay down its debt or to invest in a financial asset, that money should not be equalized.
Again, you have to ask: Why apply that principle only to resource revenues? Why not apply it to other revenues that governments raise? For example, one province, New Brunswick, has gone out of its way over the past several years to reduce it debt using its revenues in a very hard way to lower its debt ratio so that it can reduce the size of burden it will impose on its future population down the road. They get no acknowledgement for that under the equalization formula. They do not get a reward at all for that kind of smart decision making because those revenues still end up getting equalized.
With Finn Poschmann, a colleague at the C.D. Howe Institute, I have proposed a new way of measuring fiscal capacity, which we call cash flow. In effect, if you take revenues and use them to buy assets, those revenues would not get equalized. If you use the revenues to pay down debt, those revenues would not be equalized. On the other hand, if the province borrows money, that is a flow coming into the province just like raising revenue, and that should get equalized. In other words, you start penalizing debt financing. Similarly, if money is taken out of an asset fund to be spent on goods and services, it would get equalized at that point.
We analyzed the impact of that on the provinces. Over time it does not have a huge impact, but I think the incentive impacts that it would have had would have been a far better way of thinking about the problem than what we developed.
Again, I think the O'Brien report was a good compromise for a very difficult situation. What the government did in the budget was very fair to Nova Scotia and Newfoundland and Labrador. Over time, we need to address some of the issues that are still facing us with respect to the equalization program, but I am afraid that will be put off for many years now.
Senator Nancy Ruth: I want to continue with the income trusts. You spoke about the corporate side and the need to stop tax leakages and make neutrality between competing corporations.
I want to ask about the unit holders of these income trusts, though, and how you understand who they are, how they break down by workforce attachment, income level, age and gender. On the flip side of that, who typically are not unit holders of income trusts?
Mr. Mintz: First, I do not have figures on age and attributes of income trust holders. Some people have done analysis that I have seen but I do not have that at my fingertips. I do know that some people hold income trusts as units as part of their pension and RRSP savings, which is, if I recall, roughly 40 per cent of overall units. Non-residents, particularly from the United States, also hold income trust units. That was somewhere around, if I recall, 40 per cent as well. The rest would be taxable investors, people who actually pay tax on income outside of their registered retirement savings plan and pensions and who hold units on that basis.
First, with respect to the latter, at least in the long run, the new dividend tax credit regime in Canada, where a much higher dividend tax credit is given for ownership of corporations that are subject to the high corporate income tax rate, is a tremendous benefit to taxable investors. For example, if you take a dividend yield — I am trying to remember the calculations now — of 8 per cent, the taxable investor would get approximately 5.7 per cent after-tax return on those dividends. If you take an income trust unit, which provides a 10 per cent yield, the investor would be getting an after- tax yield about the same as a person getting a dividend.
This suggests that for taxable investors in the future, dividend-paying stocks will be very good investments from a tax perspective. Certainly they will have a good replacement income with respect to that. That will not be true for pension plans and RRSP holders because they pay no tax on the income they receive and so they will end up paying corporate tax that will be deducted from their units, which will be subject to corporate taxation just like corporate securities.
That is why I argued for a refundable dividend tax credit, because if we did that we would actually pay money to RRSP accounts and to pension accounts equal to the corporate tax that would be levied on the dividend. This is not a crazy idea. The Europeans used to do this, particularly in the United Kingdom, where they used to pay refunds to pension plans. It was a tremendous benefit to owners of pension plans where they got back the corporate tax that was deducted from their income.
With respect to non-residents, I am afraid that is a whole set of issues where Canada is trying to protect its corporate tax base to some extent. That is one way foreign investors can contribute to the public services that are provided. Whether roads, education systems or what have you, that is beneficial to businesses when they operate in this country; it helps their profitability.
The October 31 changes addressed the kind of changes needed for non-residents.
Senator Nancy Ruth: Can you tell me a bit more about foreign investors in terms of tax treaties and things like that? If my investments abroad receive a tax treaty basis, my income tax is paid, I think, at the corporate rate. How does it work for foreign investors investing in Canada if their country has a tax treaty with Canada?
Mr. Mintz: Tax treaties get fairly complicated. It depends on the country you are talking about.
Senator Nancy Ruth: Let us say the United States.
Mr. Mintz: We will take the United States as our example. If an American owns a Canadian security, like a corporate security, the corporation will pay corporate income tax, currently at the rate of 34 per cent. If it pays out a dividend, there will be a dividend tax assessed of 15 per cent on that dividend. For the overall tax, one is talking about 46 per cent on the dividend, including both corporate and the withholding tax.
In the case of income trust distributions, when the United States went to its 15 per cent dividend tax rate, the U.S. Congress, for some reason, did not define that tax rate to be applied only to dividends in the United States but also dividends coming from other countries of eligible stock exchanges. Interestingly enough, it was taken so broadly that it included other types of distributions, including income trust distributions from Canada. Therefore, if a company converted to a trust and eliminated the corporate income tax altogether in Canada, the only tax applied to the income trust distribution coming out of Canada would be 15 per cent. That tax would be credited against the U.S. dividend tax rate of 15 per cent, so effectively no U.S. tax would be paid. However, the only tax that would be paid would be 15 per cent on that income, which is much less than the combined corporate and dividend tax rate that would apply to corporate security. That is why, for U.S. investors, it was a tremendous advantage for any company to convert into a trust because you could bypass entirely the Canadian corporate income tax.
Senator Nancy Ruth: Thank you.
Senator Di Nino: Mr. Mintz, welcome. It is nice to see you again. I want first to clarify a point you made when you were talking to Senator Mitchell. You talked about taxes on capital, and then we got into capital gains taxes. Not being an expert, I see that as two different things. Am I correct?
Mr. Mintz: That is correct.
Senator Di Nino: I thought so. Give me one good reason why capital should be taxed at all.
Mr. Mintz: There are several reasons for putting a tax on capital. It depends really what you are doing with the overall tax system.
First, one will choose to tax capital perhaps because one believes that people who have capital maybe have more power and, therefore, should be subjected to some level of taxation. By the way, I do not believe in that argument. However, there are people who do argue that point of view.
I actually believe that taxation of capital is really double taxation of earnings. If you go out and earn income, you pay tax on it under the Income Tax Act. If you consume it right away, that is the only time you pay on it. Because you have consumed it, you do not pay any more income tax. However, if I put that money into a bank account and get some interest income or dividends or capital gains or whatever income on that investment, I will pay tax on that. Savers end up paying more tax on their earnings compared to consumers under an annual income tax. That is why I am a great believer in moving towards expenditure taxation, because I think it is fairer between savers and consumers. For that reason, I do believe that one should move away from capital taxation altogether, but I will say that there are people who take an alternative point of view.
Senator Di Nino: I happen to share your opinion. Thank you for that.
Mr. Mintz, I want to go back to this equalization issue that we are dealing with. There are some differences of opinion, but I contend that all transfers, any payment made by the federal government from the general revenue fund to provinces, should be considered when calculating the fiscal capacity of that province. We have had this discussion about the Atlantic accord not being part of the calculation of the fiscal capacity. Would you give an opinion as to whether you believe that whatever you call a transfer payment, it adds to the economic well-being of that province and should be considered in calculating the fiscal capacity of that province.
Mr. Mintz: In principle, I think you are right, senator. When you look at conditional grants, whether they are going for infrastructure or health care or education, they are a payment that helps cover the costs of providing health care and education and other expenditures by the province. You could argue that it adds to fiscal capacity and, therefore, should be subject to equalization.
Of course, that means that every dollar given in conditional grants will result in a dollar less in equalization payments, so the province will be no better off. That is the problem of trying to include conditional grants in the formula. This actually goes back to the whole principle of what we are trying to achieve with respect to equalization.
I must tell a quick story on a seminar held at New York University on the Canadian equalization system. Of course, I was the only Canadian in the crowd. It was an amazing discussion by Americans on the Canadian system. The big criticism was that the equalization system, which is based on trying to measure and equalize fiscal capacity, has no relationship to actual effort — "effort'' being what governments actually spend money on. For many of the Americans, their view was that if you have equalization, you should tie it to the expenditure side of government and not to the fiscal capacity side of it.
Senator Di Nino: That is an interesting comment.
Senator McCoy: To go back to income trusts for a moment, I understand that you agree with changing the tax status of income trusts. However, you have indicated that you would recommend a 10-year transition period to somewhat ease the negative impact that it has had on various unit holders and trusts themselves. What would your opinion be regarding grandfathering existing trusts as of October 15, 2006 or some such date?
Mr. Mintz: I think it is impossible to do that, unless you put a handcuff on those trusts so that they can never grow or change, because life changes. Some of them will want to be acquired by others, and some will want to grow and acquire others. That would be a very significant problem. In fact, I think it would undermine our productivity and the efficiency of the corporate sector if you had an such an exemption operating. In my view, it is impossible to do.
I think you have to have some moratorium on the length of the period, as we have often done with transitional changes under major tax policy reforms. For example, when we brought in capital gains taxation in 1972, a 21-year transition was involved. When we eliminated deferral for small businesses that were not incorporated, there was a 15- year transition, or 12 years; I cannot remember the exact length. It is not unusual to have some sort of transition period, but you cannot make it permanent. Otherwise, you have to put limits on what people are doing, and I do not see that being very good for the Canadian economy.
What should be the optimal transition period for the case of what we did under the trust task? You can get into a debate about that. On the one side, there is the whole issue of how long you allow this moratorium to go along that could interfere with the efficiency of the economy, never mind having some revenue impacts for the government. On the other side, you want to bring in some transition that relieves some of the impact on people who were hurt by the proposal.
Senator McCoy: You seem to me to have advocated a general movement towards decreasing general corporate taxation rates. I take it this would be part of a larger framework of income tax reform that you are advocating that is not in this budget.
Mr. Mintz: Yes, that is correct. I think that as a country we have been moving in the right direction, lowering rates. In my view, we should try to keep the bases broad. I do not like governments picking winning and losing industries. I am a bit concerned, especially coming out of this budget, that, while a number of good measures have been brought in with this budget that I would say move to a more neutral tax base, such as enhancing some of the capital cost allowances for structures that were inadequate relative to the true cost of depreciation, in other respects there were some special changes brought in that I would call "targeted preferences'' to help certain losing industries, manufacturing and forestry, which are facing a challenge. I think those temporary changes are not particularly valuable. In fact, some of the work I have done, which will be coming out in a few weeks time, suggests that the government would have been far better off accelerating the corporate income tax reductions it had planned for 2011, or by 2011, than providing special tax credits for investments by manufacturing and forest sectors in machinery. In this way, we would not have had this special preference introduced in the system that makes Swiss cheese out of our tax system and instead would have had generally lower rates that would have benefited many parts of the economy, especially those industries in the service sectors that still remain relatively highly taxed.
The Chairman: Dr. Mintz, we are over the time we had arranged with you. On behalf of the Senate, I would like to thank you very much for your comments.
Mr. Mintz: Thank you.
The Chairman: Honourable senators, I have arranged for a bus to be outside at 5:15 to proceed to the vote in the chamber that is scheduled for 5:30, which means we will have to cut down on the time available for our next witness, Mr. Kestevan.
Mr. Kestevan is President of the Canadian Association of Income Funds. He appeared before the House of Commons Finance Committee when they examined Bill C-52, and we are pleased that he is able to be here with us today.
George Kestevan, President, Canadian Association of Income Funds: Mr. Chairman and committee members, thank you for this opportunity to appear on behalf of the Canadian Association of Income Funds. I also have in attendance with me in the gallery Margaret Lefebvre, the executive director of the association.
In the interests of time, I will summarize my remarks furnished to the committee earlier and then take your questions.
The Minister of Finance's stated intention with his so-called tax fairness plan of October 31 was to level the playing field, stop future conversions and halt tax leakage. In fact, it has harmed investors, undermined a valuable structure in the Canadian economy and, with the damage caused by the policy, very likely will reduce future government revenues, not increase them.
Some of the unintended negative consequences to date have been to destroy billions of dollars of investor value; make it difficult for Canadian trusts, especially resource trusts, to access capital, making them prime targets for takeovers; tilt the playing field in favour of private equity, foreign equity and pension funds — none of which, I might add, pay taxes to governments at any level once they acquire trust assets; facilitate, to date, the takeover of close to 15 trusts in the last six months, with more than 20 announcing publicly that they are on the block at fire sale prices; cause an immediate 25 per cent plummet in market valuations, with the trust sector lagging the broader market since October 31 by roughly 20 per cent; and give a boost to the U.S. growth in master limited partnerships, or MLPs, the U.S. equivalent of Canadian energy and infrastructure trusts, by eliminating any Canadian competition.
In light of the comments made by Dr. Mintz, I should add that the total U.S. MLP market is U.S. $480 billion, with infrastructure trusts accounting for $90 billion and oil and gas royalty trusts and limited liability partnerships, LLPs, accounting for $50 billion. There have been six IPOs — initial public offerings — of U.S. oil and gas royalty trusts in the last six months. One might want to speculate why they are going to market looking for capital at this time. We in the industry in Calgary strongly suspect that they have us in their gun sights.
Mr. Chairman, it is not tax fairness when a government makes a promise not to tax income trusts — which investors and the sector took on good faith — and then breaks that promise in a punitive way without any consultation whatsoever. It is not tax fairness to impose a 31.5 per tax on income trusts when corporations, on an effective or cash tax basis, pay only 5 per cent to 10 per cent using standard corporate tax deductions with which many on this committee are familiar. It is also not tax fairness when Canadian investors are cut off from an investment vehicle that provides them with cash flow needed for retirement.
What makes this situation incomprehensible is that the government has acted in the name of solving so-called tax leakage, yet the damage in this bill will reduce federal and provincial tax revenues, not increase them. The facts are quite clear in this regard.
First, I urge you to look at the federal government's own documents of October 31, 2006 — and I believe copies have been circulated to the committee — which forecast zero tax revenue to Ottawa and, by extension, the provinces through 2010 from the trust tax.
Second, the damage that this tax causes the sector puts in grave doubt additional revenue after 2010 as trust assets end up in the hands of entities paying little or no tax or trusts convert to corporations that minimize cash taxes paid through generally accepted rules under the current Income Tax Act.
Third, for trusts that disappear, all of their unitholders stop paying personal income taxes to Ottawa and the provinces, and this totals many billions of dollars per year. For a province like Ontario, where roughly half of the sector's 2 million investors live, the net drain on the treasury will be real.
Let me further add to the comments of Dr. Mintz that our industry information is that 61 per cent of our unitholders hold trust in taxable accounts; 39 per cent hold them in tax deferred accounts, RRSPs and pension plans, which means roughly 60 per cent of the taxes paid on those distributions are paid in the current year as they are received. All of this makes curious the Department of Finance's promise to join with the provinces to negotiate revenue sharing when no revenue is reasonably expected.
Mr. Chairman, there are serious gaps in the bill itself which, aside from our general policy concerns, will make compliance and administration very difficult — I would actually say impossible. For example, rules on how income trusts will be treated during the transition period are not in the legislation. The bill only references guidelines from a news release issued on December 15, 2006. The relevant language can be found on page 20 of the bill, at lines 20 to 24, and again on page 33, lines 13 to 16, which state:
. . . as determined by reference to the normal growth guidelines issued by the Department of Finance on December 15, 2006, as amended from time to time. . .
What kind of legislation enables bureaucrats to make changes as to how a citizen is taxed without parliamentary scrutineer approval?
There is no legislative framework in Bill C-52 to facilitate conversion back to corporate status on a tax deferred basis, similar to other tax deferred rollover rules already in the Income Tax Act. It is section 85(1) of the Income Tax Act. There is also no legislated mechanism to eliminate the remaining trust vehicle after conversion to a corporation in a tax efficient manner.
The Joint Committee on Taxation of the Canadian Bar Association and the Canadian Institute of Chartered Accountants also submitted a brief to the Department of Finance with dozens of technical deficiencies and flaws that were identified to the government, yet no changes were made as the government sped this legislation through Parliament. I understand you will hear from CICA on Wednesday.
Mr. Chairman, we urge the government to follow the recommendations of the Standing Committee on Finance that are in place. Take the trust legislation out of Bill C-52 for stand-alone consideration, further consultation and improvements where they are clearly needed.
We are in agreement with Minister Flaherty's contention this morning that prudence is important'' and that if we act too suddenly, it creates risk. We think these words of sage advice apply to the income trust file just as they do to the environment file.
The Canadian Association of Income Funds remains committed to working collaboratively with all levels of government. We wish to achieve a tax system that is fair for all. I welcome your questions and thank you for your attention.
The Chairman: Thank you for that succinct overview of your points.
Senator Angus: As you know, I am the sponsor of this bill and am anxious that the budget bill pass.
I was trying to figure out what exactly you were looking for. At the end of your evidence, you made it clear. If you had your druthers, would you rather have the income trust provisions removed from the bill?
Mr. Kestevan: Yes, carved out. I think they are too important to be buried within enabling legislation for a broader budget.
Senator Angus: You have heard Minister Flaherty's views on income trusts and have heard him say that he has tried to listen to all opinions. Before the committee this morning, he indicated that there are two sides to the gloom-and- doom scenario, that many such trusts have increased in value and that 40 per cent of these funds in your association were owned by offshore people, either Americans or others, who were effectively getting away with withholding tax. When the announcement came, the biggest outcry was heard from our foreign investors who said it was the best deal they had ever had.
Mr. Kestevan: I will make a couple of points. The market cap in the income trust sector has gone from $259 billion at October 31, 2006, to, as of March 31, 2007, $197 billion. I am not suggesting that the entire $63 billion difference is attributable to this change, because there have been sales of assets, structural changes in the economy and so on. However, a substantial part of the $63 billion is an overhang that can still be attributed to this legislation. It is key that senators understand there has been a loss in the marketplace.
Your comments are quite correct on the foreign investment side, in a sense. I work for a trust with a substantial non- resident ownership base, and Mr. Flaherty has done no favours for Canada's capital markets with foreign investors. I can assure you of that.
Senator Angus: All my friends in the U.S. who own such investments were sorry to see such a golden goose disappear. However, we are not in the business of making life good for those folks. As you and the Governor of the Bank of Canada, David Dodge, tell us, currently there is all kinds of money in the system, more than we have ever seen in ages. It is having other deleterious effects, such as a lending mania whereby there is risk of adverse situations developing, and hedge funds are becoming a systemic threat. The minister had to address, rightly or wrongly, the income trust funds, whom you represent. Is that right?
Mr. Kestevan: Yes, I am here to talk about the income trusts.
Senator Angus: May I ask who are the members in your association?
Mr. Kestevan: We had 104 members but I suspect that we are down to about 90 members. We would have a broad spectrum of income trusts as members.
Senator Angus: I understand Ms. Margaret Lefebvre is here with you today.
Mr. Kestevan: Yes.
Senator Angus: I understand also that Mr. Boudria is here with you as a lobbyist for your firm.
Mr. Kestevan: He is an advisor more on parliamentary protocol than on anything else.
Senator Angus: He is a very effective government affairs consultant in Ottawa and he has registered as a lobbyist for your group. We have a copy of the registration certificate. I understand he would have made on your behalf the appropriate representations to the Department of Finance Canada on the issues you are talking about today. Am I right?
Mr. Kestevan: Not really. The amazing thing is that we have not had consultations with the Department of Finance because Mr. Flaherty moved unilaterally on this on October 31, 2006.
The Chairman: We are almost out of time.
Senator Angus: I find that hard to believe.
Mr. Kestevan: There was virtually no consultation. One of the other things I want to address is that you presented half the equation in the capital markets — the liquidity equation. Yes, there is a great deal of private equity, but if the assets go on sale at 20 per cent to 25 per cent off, what are the chances of that liquidity stepping up and buying it out? That has happened. We are for sale. I am on sale today at 20 per cent to 25 per cent off where I probably would have been in a normally valued market. The capital markets are saying, "Your economics as an entity are truncated in four years so we will be able to pick up your assets cheap,'' and that is what they are doing.
Senator Angus: That is one of the consequences, but it is not a reason to attack this budget.
Mr. Kestevan: It is very much a reason to attack this budget. We want transparency in capital markets and we would like to have had some consultation. As Dr. Mintz pointed out, there are precedents for changes in the Income Tax Act where consultation takes place and there is a phase-in period. Four years is not a phase-in period but will be the destruction of the sector.
Senator Angus: Well, that is your view and I respect your view. With all due respect, though, I suggest there is another side to that argument.
Senator Ringuette: As a senator from New Brunswick, I am sure that the majority of investors in income trusts do not come from New Brunswick. I was amazed by the quantity of email I have received on this issue — over 400. That is far beyond the quantity of email I received on the issue of same sex marriage. Believe it or not, the major difference in the emails is that people on the income trust issue took the time to include their name, address, postal code and telephone number. I do not know if it was an organized campaign or if it came from concerned citizens.
Mr. Kestevan: I should clarify that there is a huge demand for this vehicle because of our aging population who are looking for an income stream, not capital appreciation. Between 2 million and 2.5 million Canadians hold trust units. Our read of the demographics based on our industry survey is that about half of those people live in Ontario, with the bulk of the remainder living in the provinces of Alberta, Quebec and British Columbia. There is a substantial base of holders, and the majority of them are retirees looking for something that will generate a regular periodic payment of cash.
Senator Ringuette: The emails I received with addresses are about representative of the numbers you just mentioned.
I would like to read to you a statement from the Conservative Party of Canada Federal Election Platform 2006, at page 32, under the item "Security for seniors.'' The preamble states:
The Liberal track record for Canadian seniors is a sad story of unfair taxation, poor government services, and now an inexcusable policy blunder that has destroyed the retirement savings of Canadians invested in income trusts.
It is time for a government that respects those who have spent their lives raising families, saving for their retirement, and building this country.
Under "The plan'' it says that a Conservative government will "Stop the Liberal attack on retirement savings and preserve income trusts by not imposing any new taxes on them.''
Mr. Kestevan: That is probably the most damaging aspect of all of this. In my day job with PrimeWest Energy Trust, I had had a number of people in the fall of 2006 who went out and bought additional units of my company as well as other units in the income trust industry based on the promise, and I quote: "We won't play with the income trust file.''
That is exactly what you have just read. Probably the most damaging aspect of all of this is that there were people who actually invested based on that promise.
Senator Ringuette: Absolutely. What a deception to all those investors, most of whom are seniors looking for a secure pension plan.
I have another issue for you. After the Halloween massacre, the minister promised to put together a joint committee with the provinces. To your knowledge, has that been done or is that another broken promise?
Mr. Kestevan: There has not been a joint committee put together but it is ironic. Why would you have a joint committee when there is no incremental revenue to jointly split up? Clearly, even in the government's own documents, there will not be any incremental tax revenue coming out of this until 2011. With a punitive tax rate of 31.5 per cent, either there will not be any income trusts left standing or they will convert to some corporate mode.
The problem is that the way the legislation is written, there is no road map to do that. Even if today I said, okay, the government wants me to become a corporate structure, how do I do it? There is no legislative framework there. There is nothing that tells me what the mechanics are to do it.
What will be interesting to me as a practitioner in the industry is, quite frankly, whether the Canada Revenue Agency will be able actually to implement this legislation. Because it is so ambiguous, how can they give me a ruling? How can they even tell me what I should do when I ask?
Senator Ringuette: Have they consulted with you on what kind of legislation to put forward for a framework to transition to corporate?
Mr. Kestevan: We are hopeful that at some point we will get that degree of clarity. In our view, this is very bad public policy but the implementation is even more atrocious. The reason I say that is, of course, capital markets, and there are people here who know more about capital markets than I do. Capital markets do not like uncertainty. When you bring in punitive legislation and then you layer on poor implementation, you create even more uncertainty and you do more damage and that is what we are seeing today. The attitude seems to be let us do it in the clumsiest way we can so as to cause as much damage as we can to the investor.
Senator Ringuette: Thank you very much.
The Chairman: There are three names remaining on my list; obviously in the two minutes we have left before we have to go for this vote we will not be able to get through each of these questioners. We did not know about this vote, which is one of the hazards. Mr. Kestevan has come a long way to be here, we started late with him and now we have a 15-minute shortening of his presentation. We are planning to be back here at 6:00 o'clock for our next witness. I propose that we put off our next witness for 15 or 20 minutes and finish up with Mr. Kestevan from 6:00 until 6:20.
Mr. Kestevan: Thank you very much, Mr. Chairman.
The committee suspended.
The committee resumed.
The Chairman: Honourable senators, with your permission, having two independents, two Progressive Conservatives and one Conservative here, perhaps we could proceed. I think we have three opposition senators.
Mr. Kestevan, we will carry on from where we left off.
Senator Eggleton: I thought the sponsor of the bill, Senator Angus, had the best description of this particular measure. He called this the "Halloween massacre.''
I would like to ask about the comments that came from Dr. Mintz. I believe you heard them, Mr. Kestevan. As I understand them, he did not seem to be too concerned about tax leakage. He put more emphasis on neutrality. I guess that is vis-à-vis unitholders versus shareholders and the normal dividend-paying situation.
Finally, he said that if there was any change in this, he would have thought a 10-year transition would be better than the Liberal proposal. Could you comment on his submission, as well as indicate what step could be taken to pull this back from where it is now?
Mr. Kestevan: The 10-year transition would allow some adaptation as opposed to the four-year plan we now have, which will be destructive. We would have a problem with the four years because, as we have already seen, it is destructive to the sector. Several analysts did some work on this back in the fall. They surmised, based on their own back-of-the-envelope calculations at that time, that the market might come back as much as two thirds if there were a 10-year runway instead of the four years. Definitely, it is preferable.
As Dr. Mintz alluded to, normal protocol in this country when we have a major tax policy change is to have a consultation process and a transition period. It is not normally a Halloween massacre, as you described, where there is a sudden massive sea change in policy with no consultation and it is virtually immediate. That is somewhat unprecedented.
Senator Di Nino: As a question of principle, I have always had concern about investments that are driven by tax avoidance schemes. Those of us who have been around for a while have seen many of these things come and go. I put my comments right at the beginning so that you know where I coming from. I do not like schemes that are based on tax avoidance.
On this one, some of the criticism one can understand. I am not sure I would agree with it, but there has been some strong support for what the government has done, particularly from people like the Governor of the Bank of Canada, David Dodge. He said: "By giving incentives that led to inappropriate use of the income trust form of organization, the tax system was actually creating inefficiencies in capital markets — inefficiencies that, over time, would lead to lower levels of investment, output, and productivity.'' Would you like to comment on that?
Mr. Kestevan: Another point I would make around what David Dodge said last October is that the income trust model was in fact appropriate to certain sectors. I do not think his broad-brush criticism of the income trust is complete. There is some ambiguity there.
Further to your comment about tax avoidance, the income trust vehicle is a flow-through vehicle. It is not avoiding tax. It is putting taxation in the hands of the unitholder, so this is where governments may see tax revenues go down because effective cash tax rates are lower than personal tax rates in this country. Unitholders pay a marginal tax rate of 46 per cent or 47 per cent, depending on the province they live in. That is where the tax is paid. It is not paid at the corporate level. It flows through to the unitholder. Taxation is still paid, but just once and by the unitholder. That is a critical point to be made. It is not as if these entities exist and pay no tax whatsoever.
Senator Di Nino: No entities ever exist that do not pay tax. It is a form of deferral, if you wish, using a vehicle such as RRSPs and pension plans and, of course, a foreign component of it that would potentially reduce the tax payable.
The single biggest concern that people have expressed throughout the system is the neutrality factor. Kevin Dancey, the president and CEO of the Canadian Institute of Chartered Accountants, dealt with that when he appeared before the House of Commons Finance Committee. Again, let me quote him. Speaking of fairness and neutrality, he said:
The tax system, as it related to income trusts before October 31, did not meet these criteria. Why? There are two reasons. First, the tax system was not neutral, as there was a significant incentive to use a trust, rather than a corporation, for tax purposes, and business structure should be created and selected for good business reasons, not for tax reasons. Second, there was tax leakage with respect to both the units held by tax-exempts and non- residents, and this leakage was growing.
That is his opinion and maybe you can comment.
Mr. Kestevan: First, the tax leakage issue has largely been discounted in terms of the numbers that originally came out. The government said there was a tax leakage of $500 million a year. There were two major material errors in their analysis that were identified and were part of the testimony to the House of Commons Standing Committee on Finance. One was that the Department of Finance ignored their legislated reductions going forward on corporate tax rates. In other words, the benchmark they used was up here when it should have been coming down like this. If you take it down like that and you gap it to the income trust, that $500 million goes to $32 million a year. There is a huge gap there. That is one of the major problems with the analysis that has been done so far.
The concept of tax neutrality is a great model. I am not suggesting otherwise. However, as Dr. Mintz alluded to in his comments, there are two ways to do it. You can take the income trust and punitively take their tax rates to where he is planning to go with it and actually eliminate the structure, or you can also amend the way dividend taxation is applied at the corporate level. If those were done in sync and properly, we would not have this problem. We might not be here today. However, what has been done is to say we will punish the income trust side and eliminate it. You are not creating tax neutrality; you are just destroying the vehicle.
Senator Di Nino: The other concern that has been expressed is the fine balance that finance ministers and governments generally try to achieve between corporate taxes, personal taxes and other forms of taxes. There is no question that the way this vehicle was growing in Canada, it was becoming a factor that would greatly unbalance that fine balance that was being established by creating a bigger tax burden on the individual as opposed to the corporate component of our society.
Mr. Kestevan: I would argue that as an investor in trusts, you knew up front that you were paying those taxes on those distributions — for sure, if you are holding them in a taxable account. If they are being held in a tax deferred — and I should emphasize that, as well: let us not get tax deferred confused with tax exempt. RSP-held units and the turnover in RSPs create a lot of tax revenue in and of themselves, so to suggest that they are tax exempt is really a temporary measure; tax deferred is more correct.
Essentially, that investor's expectation is built on a post-tax or after-tax basis, so he knows he will be paying that as part of his income stream. I have not had any unitholders tell me in the last six months that they would prefer it if corporations paid this instead of them. They I know they have to pay it. As an investor, I go in with my eyes open and I know I have to pay the tax on those distributions as they were received. I would argue the investor knew that. That was not part of the problem.
Senator Di Nino: On the deferral schemes — RSPs, pension plans and things of that nature — we do that for the purposes of creating an opportunity for us to pay less tax. In many cases, the vast majority of people would pay considerably less tax on an RSP than they would have had they paid the tax at the time they contributed to an RSP. I think that has to be a serious consideration, as well as the fact that if the corporation is distributing these earning through an income trust, many — I do not have the statistics, but many — would not have the funds to reinvest to grow the company. That is another criticism that is being directed there.
Mr. Kestevan: That shows, if I might be so bold, a lack of knowledge around the structure and governance of the income trust model. Let me give you an example; I will use the company I work for. We pay about 70 per cent of our cash flow out to our unitholders. People might say that means we are not retaining enough to develop our assets. Well, we are; we are balancing it off so that the other 30 cents on the dollar has to be deployed well to develop the existing assets.
If we want to make a major acquisition or launch a major development activity, we have to go back to the capital markets directly to raise that money. We have direct accountability to the capital markets — as opposed to the corporate structure, I might add, which uses retained earnings. Historically, in this country, the governance on retained earnings has not been particularly good. It has been the personal savings fund, if you will, of the incumbent management and board. Deployment and returns on reinvested funds have not been that good, which is one of the reasons unitholders of trusts love the model so much — direct accountability to the capital market. We are not precluded from growing. We simply have to go back and fund ourselves from the capital markets directly.
Senator Biron: The Coalition of Canadian Energy Trusts said in a letter that since October 31, there has been a decline in activity in the conventional oil and gas base, which I believe has been exacerbated by the impact of the tax proposal. They say that their sector also witnessed increased merger and acquisition activities; as well, it has become a target for takeover by foreign exempt entities and private equity funds.
The Canadian energy and trust interests in their group say that the government decision to tax energy trusts has already and will continue to significantly and negatively impact the competitiveness of their company.
The oil and gas sector company that will not have been bought in 2011 will transfer their company to the United States. Consequently, they will not pay any more taxes in Canada and they will reduce the number of their employees. Would you comment on that scenario that will eventually arise since these companies will expand in the United States?
Mr. Kestevan: The two organizations being referred to are organizations that we work closely with and for the most part have commonality of membership with. We are very much in agreement with what they have to say.
You have addressed many issues so I will delve into each of them quickly. Drilling activity in Western Canada will be down roughly 20 per cent to 25 per cent this year. That is largely due to the income trusts that have reduced their capital spending. Most of the income trusts have taken a cautionary approach, saying they do not know what the rules are; they have such uncertainty at this point. Also, as they evaluate drilling opportunities, they have to consider that the economics are truncated in four years. Therefore, many of the projects they were looking at putting money into pre-October 31, they will no longer pursue.
I referred earlier to the MLP threat out of the United States. Contrary to what came out on October 31 from Minister Flaherty, there is a comparable vehicle in the United States called a master limited partnership. It is very similar; it is a flow-through entity. I alluded to its size earlier. The MLP structure is available on a number of fronts to the oil and gas trusts in Western Canada. They could, in fact, come in and start to buy us out, using a number of vehicles, many of which would minimize their Canadian tax. The other option available to Canadian energy trusts is they could convert to an MLP and relocate themselves to the United States. I make that sound overly simplistic. It is not just a matter of sending out change-of-address cards. It would require some structural changes but it can be done; and it is something that the trusts are looking at, as you note in the letter. It is certainly being evaluated as a possibility for people to look at.
The other organization — the Canadian Energy Infrastructure Group, CEIG — is composed strictly of trusts in the power and pipeline industry. They are probably the most vulnerable trusts in the entire sector. The MLPs in the United States are made up mainly of pipeline-related structures. Those people are obviously very interested in those assets, based on where they are priced today. The CEIG people are concerned that they either will be taken out by private equity or by U.S. master limited partnerships.
Senator McCoy: Perhaps I can summarize what I have heard as I have listened to you and invite you to expand upon it, if you wish.
I have heard the thrust of your comments being this: If that larger policy issue is to be dealt with — that is to say, if tax neutrality between unitholders and corporate shareholders is to be done — so be it; but at least let us do it in a way that takes into account the needs of both investors and companies. The manner in which the implementation is being put forward is devastating and unnecessary.
Would you endorse that summary or would you prefer to correct it?
Mr. Kestevan: That is an excellent summary. Perhaps I can end my comments by saying that what we are asking for is that the legislation in Bill C-52 that deals with the income trusts be carved out of the bill. It should never have been included in a budget bill because it is too detailed and critical. It should be refined; I guess that is a better term.
There needs to be some consultation because the way the rules are written in the draft legislation, I have a strange suspicion it is unenforceable. It is so ambiguous people will not be able to figure out what to do with it or how to interpret it. We then need the clarity. We need it redrafted so that we know what the rules are over the next three and a half years. We need to know what we are allowed to do and have a road map to get there.
The Chairman: This is the end of this particular session. Senators, on your behalf, I would like to thank Mr. George Kestevan, President of Canadian Association of Income Funds.
Mr. Kestevan: I appreciate the opportunity.
The committee adjourned.